April 6, 2016

The monstrous utility-supply-demand-equilibrium failure

Comment on Edward Fullbrook on ‘The Fisher—Becker Curio’


Economics is committed to methodological individualism. This is the foundational error/ mistake. After more than 140 years since Jevons/Walras/Menger the representative economist still has not got the point.

The methodological individualism of Orthodoxy, a.k.a. microfoundations, is formally encapsulated in this axiom set: HC1 There exist economic agents. HC2 Agents have preferences over outcomes. HC3 Agents independently optimize subject to constraints. HC4 Choices are made in interrelated markets. HC5 Agents have full relevant knowledge. HC6 Observable economic outcomes are coordinated, so they must be discussed with reference to equilibrium states.” (Weintraub, 1985, p. 109)

From this axiom set, the whole of marginalism, utility-supply-demand-equilibrium, and the narrative of optimal market coordination is derived. Needless to emphasize that this whole theoretical superstructure is scientifically worthless because the foundational propositions HC1 to HC6 are false. The story of the welfare producing performance of the market system is — just a story.

The microfoundations have to be discarded and fully replaced by these macrofoundations:
(A0) The objectively given and most elementary configuration of the (world-) economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
(A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L,
(A2) O=RL output O is equal to productivity R times working hours L,
(A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

These premises are certain, true, and primary, and therefore satisfy all methodological requirements. The new axiom set contains NO NONENTITIES like utility, maximization, or equilibrium. For the graphical representation see here.

At any given level of employment L, the wage income Yw that is generated in the consolidated business sector follows by multiplication with the wage rate W. On the real side, output O follows by multiplication with the productivity R. Finally, the price P follows as the dependent variable under the conditions of budget balancing, i.e. C=Yw and market clearing, i.e. X=O. Note that the ray in the southeastern quadrant is NOT a linear production function; the ray tracks ANY underlying production function. Note also that the wage rate W is an AVERAGE if the individual wage rates are different among the employees, which is normally the case.

Under the conditions of (i) market clearing and (ii) budget balancing in each period the price is derived as P=W/R (1), i.e. the market clearing price is in the most elementary case equal to unit wage costs. This is the elementary form of the Law of Supply and Demand which, in a second step, has to be generalized for an arbitrary number of markets.

If the wage rate W is lowered, the market clearing price P falls. If the number of working hours L is increased the price remains constant, provided productivity R does not change. If productivity decreases the price P rises. If productivity increases the price falls. In any case, labor gets the whole product, the real wage W/P is invariably equal to the productivity R according to (1), and profit for the business sector as a whole is zero. All changes in the system are reflected by the market clearing price. The most elementary economy is reproducible for an indefinite number of periods.

To define a reproducible minimal economy and to make its properties absolutely transparent is the FIRST step. From this step follows that the market price is determined by the three OBJECTIVE axioms A1 to A3 and by the two OBJECTIVE conditions of market clearing and budget balancing. That is, NO behavioral assumptions of any kind (utility, maximization, bounded rationality, rational expectation, etc.) are needed. Just the contrary, they are INADMISSIBLE because they would OVER-DETERMINE the formalism which is given with A1/A3 and (i)/(ii).

The two conditions (i)/(ii) are part of every orthodox model. Since the three axioms must hold for ALL economic models without exception, that is, also for orthodox models, one arrives at the conclusion of Becker and Fisher that orthodox models are behaviorally OVER-DETERMINED.

For more details about the axiomatically correct price and market theory see (2015; 2014; 2013)

Note for Econ 101 students: Supply-demand-equilibrium is an intelligence test; whoever accepts this construct as an explanation of how markets work has flunked the test and is irrevocably out of science. This applies first and foremost to your teacher.

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2013). How to Get Rid of Supply-Demand-Equilibrium. SSRN Working Paper Series, 2263172: 1–24. URL
Kakarot-Handtke, E. (2014). The Law of Supply and Demand: Here it is Finally. SSRN Working Paper Series, 2481840: 1–17. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: The Market. SSRN Working Paper Series, 2547098: 1–10. URL
Weintraub, E. R. (1985). General Equilibrium Analysis. Cambridge, London, New York, NY, etc.: Cambridge University Press.