Teaching of economics — captured by a small and dangerous sect

28 Feb, 2014 at 10:56 | Posted in Economics | 4 Comments

The fallacy of composition basically consists of the false belief that the whole is nothing but the sum of its parts.  In the society and in the economy this is arguably not the case. An adequate analysis of society and economy a fortiori can’t proceed by just adding up the acts and decisions of individuals. The whole is more than a sum of parts.

This fact shows up when orthodox/mainstream/neoclassical economics tries to argue for the existence of The Law of Demand – when the price of a commodity falls, the demand for it will increase – on the aggregate. Although it may be said that one succeeds in establishing The Law for single individuals it soon turned out – in the Sonnenschein-Mantel-Debreu theorem firmly established already in 1976 – that it wasn’t possible to extend The Law of Demand to apply on the market level, unless one made ridiculously unrealistic assumptions such as individuals all having homothetic preferences – which actually implies that all individuals have identical preferences.

This could only be conceivable if all agents are identical (i. e. there is in essence only one actor) — the (in)famous representative actor. So, yes, it was possible to generalize The Law of Demand – as long as we assumed that on the aggregate level there was only one commodity and one actor. What generalization! Does this sound reasonable? Of course not. This is pure nonsense!

How has neoclassical economics reacted to this devastating findig? Basically by looking the other way, ignoring it and hoping that no one sees that the emperor is naked.

Having gone through a handful of the most frequently used textbooks of economics at the undergraduate level today, I can only conclude that the models that are presented in these modern neoclassical textbooks try to describe and analyze complex and heterogeneous real economies with a single rational-expectations-robot-imitation-representative-agent.

That is, with something that has absolutely nothing to do with reality. And — worse still — something that is not even amenable to the kind of general equilibrium analysis that they are thought to give a foundation for, since Hugo Sonnenschein (1972) , Rolf Mantel (1976) and Gerard Debreu (1974) unequivocally showed that there did not exist any condition by which assumptions on individuals would guarantee neither stability nor uniqueness of the equlibrium solution.

So what modern economics textbooks present to students are really models built on the assumption that an entire economy can be modeled as a representative actor and that this is a valid procedure. But it isn’t — as the Sonnenschein-Mantel-Debreu theorem irrevocably has shown.

Of course one could say that it is too difficult on undergraduate levels to show why the procedure is right and to defer it to masters and doctoral courses. It could justifiably be reasoned that way – if what you teach your students is true, if The Law of Demand is generalizable to the market level and the representative actor is a valid modeling abstraction! But in this case it’s demonstrably known to be false, and therefore this is nothing but a case of scandalous intellectual dishonesty. It’s like telling your students that 2 + 2 = 5 and hope that they will never run into Peano’s axioms of arithmetics.

Once the dust has settled, there is a strong case for an inquiry into whether the teaching of economics has been captured by a small but dangerous sect.

Larry Elliott/The Guardian


  1. What most economists don’t seem to suspect but all marketers know is that many demand curves, especially new products, are wavy (non-monotonic) rather than downward sloping. A least I have never heard an economist mention it.

    This phenomenon occurs because a price set to low undermines perceived value and a price set too high is of course exclusionary, both of which reduce sales relative to both perceived value and affordability. Only testing reveals the sweet spot. A lot of money is invested in this kind of testing and the methods are fairly sophisticated, since there are regional considerations.

    Since new products are alway being brought to market, this is a significant factor in considering demand and pricing.

  2. And what about a wide distance between suppply and demand, when as Fernand Braudel said, producer and consumer link is break. Price and demand are object of handling and experimentation to maximize profit.

  3. Lars, this is just an incorrect description of what the SMD theorem says. It proves that normal/reasonable assumptions of individual behaviour guaranteeing well behaved individual demand and supply curves (i.e. convexity) do not guarantee a well behaved AED function. It absolutely categorically does not prove the following:

    ‘there [does] not exist any condition by which assumptions on individuals would guarantee neither stability nor uniqueness of the equilibrium solution’

    For example, if you assume all goods are gross substitutes for all agents, then we have a downwards sloping AED function in any (relative) price and a unique aggregate equilibrium. You place a far stronger rhetorical weight on the SMD than is justified by what it actually proves.

  4. Textbooks have multiple weaknesses and there isn’t too much to say that is good about them. Textbooks which include cases and biographies are more useful. In the example above, the axiom is given that if prices decrease, then demand increases which is absolutely false. Consider the case of the car salesman who can’t sell his cars fast enough, does he need to decrease the price? In this case, demand preceded price fluctuations so the salesman increases the price! OTOH, if it is getting near to when the new models are arriving, the old but brand new cars must be sold, so the price is reduced to move the product. Or is it? Perhaps but the credit rate is not!!

    Textbooks are on safer ground when they compare the equilibrium point of products which have oppositional properties, like guns and butter. Guns are needed by certain people but everyone needs food, so the equilibrium point considers the particular necessity and the general necessities, like food. But, this kind of reasoning does not appreciate production costs related to butter or margarine, just as the production costs for different cars are often not calculated in a car price which price is determined more by brand ranking. If you ask the economics student whether s/he can apply what s/he is learning from the class to their everyday life, they probably say they cannot. If you ask the student of Marxism, whether the concept of surplus labor or the rate of exploitation makes sense, what do you think they’ll say. So, economics needs to address the problems of capitalism and the problems of equilibrium and stop denying that they are both equally relevant.

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