August 8, 2015

How markets work

Comment on ‘Macroeconomic Theory and Operational Reality’


“I often wonder whether other subjects suffer as much from textbook writers.” (Hahn, 1980, p. 127)

Economists think they can explain economic phenomena by painting a supply-demand-equilibrium cross or what Leijonhufvud has ironically called the totem of the micro. However, already Schumpeter found it necessary to diffuse doubts about the scientific content of the whole exercise.

“The primitive apparatus of the theory of supply and demand is scientific. But the scientific achievement is so modest, and common sense and scientific knowledge are logically such close neighbors in this case, that any assertion about the precise point at which the one turned into the other must of necessity remain arbitrary.” (Schumpeter, 1994, p. 9)

As a matter of fact, the ‘primitive apparatus of the theory of supply and demand’ is a thoroughly faulty construct.

“There is little or nothing in existing micro- or macroeconomics texts that is of value for understanding real markets. Economists have not understood how to model markets mathematically in an empirically correct way.” (McCauley, 2006, p. 16)

The familiar microeconomic ss-dd cross is built on nonentities like utility, equilibrium, well-behaved production functions, decreasing returns, rational expectations, simultaneous adaptation, etcetera and consequently has to go out of the window. The same holds for macroeconomic versions like IS-LM. For the refutation of Krugman’s silly model see (2014).

“What is now taught as standard economic theory will eventually disappear, no trace of it will remain in the universities or boardrooms because it simply doesn’t work: were it engineering, the bridge would collapse.” (McCauley, 2006, p. 17)

Because the textbooks are wrong, it is one of the first tasks of Constructive Heterodoxy to deliver the correct formal depiction of a market (2015). It is high time that economists learn how the market system works.

Egmont Kakarot-Handtke

Hahn, F. H. (1980). General Equilibrium Theory. Public Interest. Special Issue: The Crisis in Economic Theory, pages 123–138.
Kakarot-Handtke, E. (2014). Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It. SSRN Working Paper Series, 2392856: 1–19. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: The Market. SSRN Working Paper Series, 2547098: 1–10. URL
McCauley, J. L. (2006). Response to "Worrying Trends in EconoPhysics". EconoPhysics Forum, 0601001: 1–26. URL
Schumpeter, J. A. (1994). History of Economic Analysis. New York, NY: Oxford University Press.