Behavioral Finance Lecture 02: Debunking Demand and Supply Analysis

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In the first half of this lec­ture, I show that even if all con­sumers were util­i­ty max­i­miz­ers whose indi­vid­ual demand curves obeyed the “Law of Demand”, the mar­ket demand curve derived from aggre­gat­ing these con­sumers could have any shape at all. This result, known as the “Son­nen­schein-Man­tel-Debreu Con­di­tions”, is actu­al­ly a Proof by Con­tra­dic­tion that mar­ket demand curves do not obey the “Law” of Demand, and there­fore that Mar­shal­lian par­tial equi­lib­ri­um mod­el­ing of indi­vid­ual mar­kets is invalid–let alone the Neo­clas­si­cal prac­tice of mod­el­ing the entire macro­econ­o­my as a sin­gle agent in “Dynam­ic Sto­chas­tic Gen­er­al Equi­lib­ri­um” mod­els.

In the sec­ond half, I show that even if the mar­ket demand curve were valid, sup­ply and demand analy­sis is still impos­si­ble. A sup­ply curve that is inde­pen­dent of the demand curve can only be derived if firms set price equal to mar­gin­al cost, which neo­clas­si­cal econ­o­mists claim is the con­se­quence of prof­it-max­i­miz­ing behav­ior by com­pet­i­tive firms. I show: that equat­ing mar­gin­al cost and mar­gin­al rev­enue does not max­i­mize prof­its; that there­fore if firms from dif­fer­ent indus­try struc­tures faced the same costs, the amount pro­duced is inde­pen­dent of the num­ber of firms in the indus­try and cor­re­sponds to the so-called “monop­oly” lev­el of out­put. In this case, a sup­ply curve can­not be derived.

Here are the Pow­er­point files for this lec­ture:  Part 1Part 2.

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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.