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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  • kys

    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.

  • Tom Shaw

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

  • alain­ton

    @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.

  • 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.

  • Anark­ist

    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

  • ferb

    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..?

  • Nico­las Leveroni

    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

  • 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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  • Kozak

    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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