What happens when a small and dangerous sect captures the teaching of economics

5 May, 2017 at 17:57 | Posted in Economics | 2 Comments

Dept_of_Econ_Fac_Pic

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

2 Comments

  1. It already happened about the year 1900 when John Bates Clark and his friends claimed that the activities of landlords should be included with those of the capitalists, thereby destroying the earlier work and partial models of Adam Smith, Karl Marx, Henry George, and others. This claim fell on the fertile ground provided by the influence of big monopolistic corporations on the way that macroeconomics was and still is being taught. We should get out of this by re-introducing the previous views or we will be fooling ourselves and damaging future claims for a better world..

    Comment by David Chester— 6 May, 2017 #

  2. On my limited understanding of the SMD theorem, it merely states or implies that identical homothetic preferences are sufficient conditions for negatively sloped market demand curves and a unique general equilibrium. But this does not imply that identical homothetic preferences necessary conditions.
    If so:
    .
    (a) Conventional economic theory, Marshall etc:
    When the price of a commodity falls, the market demand for it will USUALLY increase.
    Most goods have negatively sloped demand curves, but there are exceptions to the general “rule” in the case of very inferior “Giffen” goods where there is an exceptionally strong income effect.
    – TRUE
    (b) SMD theorem:
    When the price of a commodity falls, the market demand will increase if all individuals all have identical homothetic preferences.
    – Logically TRUE, but of zero relevance in the real world.
    .
    (c) Prof. Syll’s extension of the SMD theorem:
    When the price of a commodity falls, the market demand will increase ONLY if all individuals all have identical homothetic preferences.
    – FALSE both in logic and in the real world.

    Comment by Kingsley Lewis— 6 May, 2017 #


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