Neoclassical economists don’t understand neoclassical economics

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That transcendental truth occurred to me while writing the second edition of Debunking Economics–which will be published in September. In this video, I point out the most egregious instance of this, the “Sonnenschein-Mantel-Debreu” (SMD) conditions. This refers to research by leading neoclassical economists on whether the so-called “Law of Demand” that can be proven for an individual’s demand curve applies to a market demand curve.

The “Law of Demand” is the proposition that, if a commodity’s price falls, the demand for it will rise. That sounds like a reasonable statement at first glance–and it will often be true in the real world. But it is an article of faith for economists that this is always true.

Ironically, neoclassical economists proved that this is in general not true. Even when you are working with individuals who all individually have what economists call “well behaved” preferences, and for whom individual demand curves can be derived that obey the “Law of Demand”, the market demand derived by summing these individual demands can have any shape at all.

If neoclassical economists took this neoclassical result seriously, then they would not draw “downward sloping market demand curves” in microeconomics–they would instead draw squiggly lines–and they wouldn’t use equilibrium “supply and demand” analysis. But not only do they do that, they also model the entire economy as a single individual in what they call “Dynamic Stochastic General Equilibrium” models.

These absurd models were what led to them believing that the economy was in great shape, just before it collapsed into the Great Recession.

I cover this issue at great length in Debunking Economics II. In this video presentation, I give an overview of the SMD conditions. At one point, you’ll hear me take a straw poll of how many people in the room knew of these conditions: only two did out of about 60. This was a brilliant illustration of my basic point, that neoclassical economists don’t understand their own theory.

Click here for the Powerpoint slides.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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87 Responses to Neoclassical economists don’t understand neoclassical economics

  1. kys says:

    Tom Shaw

    I would say that Steve has given enough counterexamples to disprove the “Law of Demand”, without handwaving and shoehorning. I hope you agree.

  2. Tom Shaw says:

    Hi Kys, exactly! The counterexample is enough by itself without Steve trying to turn it into a proof by contradiction.

  3. alainton says:

    @steve

    Steve sorry but path dependence and temporary equilibrium doesn’t mean lack of equilibriation, im thinking of dynamic equilibrium here more in the classical economics sense of an attractor that might never actually be reached, as it shifts before reaching universal prices.

    Im not trying to defend neo-classicism, but I think there will be a group who will say of your book – hey that doesn’t apply to be because I don’t use DGSE – and dismiss the argument. The Austrians will say they never did. Having said that getting neo-classicists off DGSE is surely the first step towards salvation.

  4. Steve Keen says:

    Andrew, I expect every manner of “that doesn’t apply to me/us because” reply to DE II. Ultimately I take the Max Planck attitude here: let them keep saying that to their graves, and let the young take over.

  5. Anarkist says:

    Actually according to these articles Eastern Australia at least is in a deep recession whilst the economy of Western Australia remains bouyant due to the resource boom. But its apparent the two economies have significant structural differences and needs.

    http://www.theage.com.au/victoria/the-pain-of-the-hidden-recession-20110708-1h6st.html

    http://finance.ninemsn.com.au/newsbusiness/aap/8257209/east-coast-in-deep-recession-linfox

  6. ferb says:

    Interesting to see what people think of this…http://www.theage.com.au/business/property/schwartz-weathers-markets-big-chill-20110717-1hk4q.html

    Is he selling to truely fund further ventures or does he see the writting on the wall and is cashing out..?

  7. Nicolas Leveroni says:

    Professor,

    What can you tell us about the “healthy balance sheets” in the US economy (http://seekingalpha.com/article/282608-healthy-u-s-corporate-balance-sheets-within-an-unhealthy-u-s-economy)? Isn’t this very different from the situation that Japan went through during the lost decade?

    Thanks, and I hope you enjoyed the rest of your stay in Argentina.

    Regards,
    NL

  8. Steve Keen says:

    Hi Nicolas,

    That’s one of the features of this crisis that distinguishes it from the Great Depression. I haven’t got the exact figures to hand, but from memory at the end of 1929, the non-financial business sector in the USA had a debt to GDP ratio of over 120%. When the debt bubble burst, they were in serious straits and the slip into deflation was immediate and severe.

    This time round, non-financial business debt peaked at less than 80% of GDP–from memory again, about a 70-75% peak–and is now being rapidly unwound. It’s the household sector (and the financial business sector!) that is mired in debt this time–debt to GDP peaking at near 100% versus under 40% back in the GD (and financial sector debt hit 120% of GDP this time, versus in the tens last time).

    So it’s quite possible for the business sector to reduce its debt levels and accumulate serious cash reserves during this crisis, where the household sector is largely unable to reduce its debt levels because households are much more constrained in their financial decisions than are firms.

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  11. Kozak says:

    My name is Buddy Rojek. I am a CPA and live in Melbourne.

    I am developing a new Political Party. The Australian Nationalist Party.

    I need 500 plus members to be available when the AEC roll calls to prove membership.

    My economic philosophy agrees with Steve Keen. I am pro Austrian school.

    please email me at birojek@hotmail.com. I am developing a mailing list and eventually we will from a formal party.

    I have a penchant to reducing Government, as most Government departments are toothless tigers and inefficient. I propose Debit Card based systems were fiscal targeting is directed at the individual micro level and not the macro level (Projects) The money is harvested via taxes during economic booms to temper inflation and prevent deflation. i.e not debt based.

    I welcome your feedback, or interest in joining.

    Buddy Rojek, CPA

    Convenor of

    The Australian Nationalist Party.

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