What is neoclassical economics?
(This post draws on something I wrote on Usenet more than a decade ago.)
I believe I might have introduced this list of three
key assumptions, as noted by Roy Weintraub, into the wikipedia article on
the topic:
- People have rational preferences between outcomes that can be identified and associated with values.
- Individuals maximize utility and firms maximize profits.
- People act independently on the basis of full and relevant information.
One should recognize that neoclassical economics is associated
with mathematical formalism. So neoclassical economists speaking
among the clergy would prefer the language of topology and the
algebra of relations for stating their assumptions.
The point of neoclassical economics is to build a theory on
those assumptions which emphasizes equilibrium, characterizes
economics as the allocation of scarce resources, and justifies
supply and demand reasoning. Neoclassical economists wanted to
argue:
- Equilibrium prices are scarcity indices
- Marshall's principle of substitution is generally applicable
Neoclassical economists are unable to state assumptions that
justify such reasoning. Weintraub's assumptions, suitably
formalized, don't succeed. They do not succeed
because one can construct examples with these assumptions in
which the negation of neoclassical claims hold. I and others
have done this. This is a matter of logic.
Just to show you that others characterize neoclassical economics
in the same way as I do:
"The [Demand-and-Supply-based Equilibrium] theory visualizes
the economy as an aggregate of atomistic individuals (producers
and consumers) making their decisions autonomously, with no
interference from the influence of 'externalities'. Relative
prices and quantities are determined simultaneously in equilibrium
as an outcome of the interplay of 'forces of demand and supply',
generated by the optimizing behavior of individuals subject to
their resource constraints. A certain symmetry characterizes the
behaviour of producers and consumers. Each producer, given the
technological possibilities, chooses the profit-maximizing
activities and outputs, at the going prices; each consumer, given
his budget constraints and scales of preferences, maximizes
satisfaction at the going prices. It is through the operation of
the 'fundamental' and 'universal' principle of substitution that
individuals adjust their chosen quantities in response to the
parametrically given prices...
Further, the notion of 'change' in the DSE theory gets restrictively
predetermined by the theory in the following ways. First, all changes
in quantities within the system are seen as the outcome of the
ever-active principle of substitution. Thus the changes are primarily
in relative quantities involving allocational variations. The role of
prices as a scarce-resource allocator, given the resources, dominates
the theory as contrasted with the resource-creational role of
prices in classical theory... Secondly, all changes are explained as
induced by changes in relative prices and operate through the
decisions of individuals who are only 'quantity adjusters'; that is,
all influences affecting quantities have to be necessarily mediated
through relative prices or changes on the market and are outcomes of
the atomistic responses of individuals. The relative prices acquire
the all-powerful role of resource-allocation and the 'market' becomes
the 'arena' of action."
-- Krishna Bharadwaj (1989).
Here are a couple of examples of the incorrect reasoning to which I
object:
"It is indeed the great contribution of the Pure Logic of Choice
that it has demonstrated conclusively that even such a single mind
could solve this kind of problem only by constructing and constantly
using rates of equivalence (or 'values' or 'marginal rates of
substitution'), that is, by attaching to each kind of scarce resource
a numerical index which cannot be derived from any property possessed
by that particular thing, but which reflects, or in which is
condensed, its significance in view of the whole means-end
structure...
Fundamentally, in a system in which the knowledge of the relevant
facts is dispersed among many people, prices can act to co-ordinate
the separate actions of different people in the same way as
subjective values help the individual to co-ordinate the parts of a
plan. It is worth contemplating for a moment a very simple and
commonplace instance of the action of the price system to see what
precisely it accomplishes. Assume that somewhere in the world a new
opportunity for the use of some raw material, say, tin has arisen,
or that one of the sources of tin has been eliminated. It does not
matter for our purpose and it is significant that it does not
matter which of these two causes has made tin more scarce. All that
the users of tin now need to know is that some of the tin they used
to consume is now more profitably employed elsewhere and that, in
consequence, they must economize tin. There is no need for the great
majority of them even to know where the more urgent need has arisen,
or in favor of what other needs they ought to husband the supply...
The whole acts as one market, not because any of its members survey
the whole field, but because their limited individual fields of
vision sufficiently overlap so that through many intermediaries the
relevant information is communicated to all. The mere fact that there
is one price for any commodity or rather the local prices are
connected in a manner determined by the cost of transport, etc. -
brings about the solution which (it is just conceptually possible)
might have been arrived at by one single mind possessing all the
information which is in fact dispersed among all the people involved
in the process."
-- F. A. Hayek (1945).
"Let us then suppose that... there is a strike on the part of one
group of workers, say the plasterers, or that there is some other
disturbance to the supply of plasterers' labour... The rise in
plasterers' wages would be checked if it were possible either to
avoid the use of plaster, or to get the work done tolerably well
and at a moderate price by people outside the plasterers' trade: the
tyranny, which one factor of production of a commodity might in some
cases exercise over the other factors through the action of derived
demand, is tempered by the principle of substitution."
-- Alfred Marshall (1920).
Hayek and Marshall were writing before it was known that the
assumptions of neoclassical economics could not justify their
reasoning.
Here is an ignorant or dishonest neoclassical economist perpetuating ignorance
to another generation:
"Suppose the number of carpenters suddenly increases, due to the
immigration of thousands of new carpenters from Mexico. Both before
and after the change, carpenters receive their marginal revenue
product... But the wage after the migration is lower than the wage
before. Since the supply of carpenters is higher than before, the
equilibrium wage is lower.
...an increase in the supply of an input I own drives down its price
(and marginal revenue product) and so decreases my income. The same
is true for an increase in the supply of an input that is a close
substitute for an input I own. If I happen to own an oil well, I will
regard someone else's discovery of a new field of natural gas--or a
process for producing power by thermonuclear fusion--as bad news."
-- David D. Friedman (1990).
David cannot state his assumptions. Here is a quote from a refereed
paper:
"This note considers a linear programming (LP) formulation of the
theory of the firm. A neoclassical non-increasing labour demand
function is derived from the solution of the LP. It is argued that
only a small number of points on this curve, one or two in the
examples provided, are equilibria of the firm. Equilibria are
characterized by decisions of the managers of the firms that
allow the same decisions to be made in successive periods. Hence,
one can explain the quantity of labour that firms desire to hire
either by a traditional neoclassical labour demand function or by
an analysis of equilibria of the firm, but generally not both.
Explaining wages and employment by well-behaved supply and demand
functions for labour is of doubtful logic."
-- R. L. Vienneau (2005).
References
- Krishna Bharadwaj. 1989. Themes in Value and Distribution: Classical Theory Reappraised London: Unwin-Hyman.
- David D. Friedman. 1990. Price Theory: An Intermediate Text 2nd Edition.
- F. A. Hayek. 1945. "The use of knowledge in society. American Economic Review 35 (5): 519-530.
- Alfred Marshall. 1920. Principles of Economics: An Introductory Volume 8th edition.
- E. Roy Weintraub. 2007. Neoclassical economics. The Concise Encyclopedia of Economics.
- Robert L. Vienneau. 2005. On labour demand and equilibria of the Firm. Manchester School 73 (5): 612-619.
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