February 3, 2017

Paul the Menace

Comment on Paul Krugman on ‘Donald the Menace’

Blog-Reference

Paul Krugman presents himself as economist, however, his main occupation is not economics but politics. In his capacity as political commentator he points out that the institution of presidency has been hijacked by an incompetent and dangerous person.

This comment is the unintended proof that the institution of academic economics has been hijacked by agenda pushers and incompetent scientists.

Krugman defines himself as follows: “most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point.” What he completely overlooks is that maximization-and-equilibrium is not a scientifically acceptable starting point, that is, the acceptance of maximization-and-equilibrium is disqualifying for an economist.

Economists are not very smart. History shows that they swallow every logical blunder hook, line and sinker provided it is presented in the form of an easy to grasp narrative. The most prominent example in the history of economic thought is the diamond-water paradox. It goes as follows: “The paradox of value (also known as the diamond–water paradox) is the apparent contradiction that, although water is on the whole more useful, in terms of survival, than diamonds, diamonds command a higher price in the market.”#1

The paradox is solved by ‘thinking at the margin’ which is advertised as the outstanding characteristic of an economist. Accordingly, the price of diamonds is high relative to water because the marginal utility of diamonds is high relative to the marginal utility of water which in turn is normally more abundant than diamonds.

The idiotism of the answer is obvious, except to an economist. Water and diamonds cannot be compared in this way because water is consumed, i.e. it vanishes, and the very characteristic of diamonds is that they are NOT consumed but, just the opposite, they are the proverbial eternal store of value. Because of this, the determination of the prices of perishable and durable goods follows entirely DIFFERENT principles. The first thing to notice is that there is NO such thing as “the” market but that there are at least TWO entirely different types of markets.#2 This alone makes it clear, that the economist’s one-size-fits-all supply-demand-equilibrium explanation must be false.

By consequence, what in the first analytical step has to be done is to determine the relative prices of two perishable goods within the framework of what Keynes called the ‘monetary theory of production’. Barter models are out from the outset. The correct starting point is a pure hand-to-mouth economy where, for example, bread and wine is produced in two firms and fully consumed by the households in one and the same period. The stock of goods is zero at the beginning and at the end of the period. The total number of working hours is given and the wage rate is, for a start, equal in the bread and wine production. The wage income is fully spent. Because total consumption expenditures are equal to total wage income total profit of the business sector is zero.#3

For this elementary two-goods hand-to-mouth economy we get with a little algebra for the relative price of bread and wine Pb/Pw=Rw/Rb, that is, the relative price is inverse to the productivities, that is, the relative price or the exchange ratio is OBJECTIVELY given and INDEPENDENT of marginal utility. In other words, the production conditions determine relative prices. This amounts to a refutation of marginalism which is a subjective concept.

To see this more clearly, let us assume that the preferences of the households change from one period to the next. In order to cut out the details of the adaptation process it is assumed that the household sector tells the business sector that it wants more wine and less bread. Accordingly, the business sector shifts labor from bread production to wine production. Because the wage rate is equal total wage income and total consumption expenditures do not change. Only the partitioning of total expenditures changes according to the new preferences, that is, expenditures for wine go up and expenditures for bread go down. With a little algebra we arrive under the condition of market clearing and zero profit in both firms again at Pb/Pw=Rw/Rb, that is, a change of preferences or marginal utilities has NO effect on relative prices. In other words, demand is NOT a determinant of price. Changes in the partitioning of demand lead to a change of quantities and NOT to price changes.

This result plainly refutes marginalism. This gives a pause to recall where marginalism came from. Ultimately, marginalism can be traced back to the importation of calculus into economics and the translation of the formalism into the BEHAVIORAL assumption of utility maximization under constraints. This assumption is part of the Walrasian axiom set which is given by: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub)

The upshot is that not only constrained optimization (HC2) is forever unacceptable as an axiom but rational expectations (HC4) and equilibrium (HC5), too. Therefore, marginalism or, more precisely, the microfoundations approach has already been dead in the cradle 140+ years ago. The representative economist and Paul Krugman have not realized this until this very day. The water-diamond story is still told as exemplary for how economists think ‘at the margin’ and every student generation since Walras/Jevons/Menger swallows this methodological crap without turning an eyelid.

Maximization-and-equilibrium economists like Krugman are groping in the dark with regard to the two most important features of the market economy: the profit mechanism and the price mechanism. And this means that their economic policy advice lacks a sound scientific foundation. And this in turn means that they are a hazard to their fellow citizens roughly on a par with ‘Donald the Menace’.#4

Egmont Kakarot-Handtke

#1 Wikipedia
#2 See ‘Primary and Secondary Markets
#3 For details see ‘The Logic of Value and the Value of Logic
and ‘The Value of Water and Diamonds: Back to Square One’ and ‘The Pure Logic of Value, Profit, Interest
#4 See ‘Economists and the destructive power of stupidity

Related 'Scientific suicide in the revolving door' and 'Krugman is not an economist'