Neoclassical economists don’t understand neoclassical economics

This post was originally published on Steve Keen’s Debtwatch.

That transcendental truth occurred to me while writing the second edition of Debunking Economics–which will be published in September. In this video, I point out the most egregious instance of this, the “Sonnenschein-Mantel-Debreu” (SMD) conditions. This refers to research by leading neoclassical economists on whether the so-called “Law of Demand” that can be proven for an individual’s demand curve applies to a market demand curve.

The “Law of Demand” is the proposition that, if a commodity’s price falls, the demand for it will rise. That sounds like a reasonable statement at first glance–and it will often be true in the real world. But it is an article of faith for economists that this is always true.

Ironically, neoclassical economists proved that this is in general not true. Even when you are working with individuals who all individually have what economists call “well behaved” preferences, and for whom individual demand curves can be derived that obey the “Law of Demand”, the market demand derived by summing these individual demands can have any shape at all.

If neoclassical economists took this neoclassical result seriously, then they would not draw “downward sloping market demand curves” in microeconomics–they would instead draw squiggly lines–and they wouldn’t use equilibrium “supply and demand” analysis. But not only do they do that, they also model the entire economy as a single individual in what they call “Dynamic Stochastic General Equilibrium” models.

These absurd models were what led to them believing that the economy was in great shape, just before it collapsed into the Great Recession.

I cover this issue at great length in Debunking Economics II. In this video presentation, I give an overview of the SMD conditions. At one point, you’ll hear me take a straw poll of how many people in the room knew of these conditions: only two did out of about 60. This was a brilliant illustration of my basic point, that neoclassical economists don’t understand their own theory.

Click here for the Powerpoint slides.

Steve Keen is Associate Professor of Economics at the University of Western Sydney, and author of ‘Debunking economics’.