February 17, 2017

Why you should NEVER use supply-demand-equilibrium

Comment on Peter Dorman on ‘Why You Should Never Use a Supply and Demand Diagram for Labor Markets’

Blog-Reference and Blog-Reference

As can be seen in every textbook, economists answer any question by painting the triad SS-function―DD-function―equilibrium. Leijonhufvud called this analytical tool totem of the micro/totem of the macro. What economists do not understand until this day is that there is NO such thing as an economic equilibrium and NO such thing as SS and DD functions. The totem of micro/macro is a NONENTITY like the Tooth Fairy or the Easter Bunny.

After economists have applied their standard analytical workhorse supply-demand-equilibrium for more than a century self-doubts arise, at least with regard to the labor-market: “S&D is simply the wrong model, based on a failure to distinguish between offers and transactions.” (see intro)

But economists never bury one self-delusion without advertising the next: “Fortunately, there’s a better model out there, search theory, with fairly straightforward intuitions and tons of available data.”

What the representative economist fails to realize is that the foundational error/mistake/ blunder of the supply-demand-equilibrium approach lies in the microfoundations.#1 The lethal methodological blunder can be stated as an impossibility theorem: NO way leads from the explanation of individual behavior to the explanation of how the economic system works. Because of this, the microfoundations approach has already been dead in the cradle 140 years ago.

What the representative economist fails to realize is that the economy as a system is defined by the interrelationship of a number of elementary variables. Every model, no matter how differentiated, must contain these OBJECTIVE SYSTEMIC interrelationships as its formal hard core. In other words, the false microfoundations have to be replaced by the true macrofoundations. This in turn leads to an objective systemic theory of the labor market.#2

All this is forever beyond the horizon of the representative economist who can easily drop what he sold as the true model yesterday but not methodological individualism because: “It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals.” (Arrow)

The commitment to microfoundations is the ultimate reason why economics in general and labor market theory in particular is false. The search theory of the labor market is no exception.

Egmont Kakarot-Handtke

#1 The microfoundations approach is defined with these hard core propositions, a.k.a. axioms: “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)
#2 See ‘The one stone that kills orthodox and heterodox employment theory

Related 'Essentials of Constructive Heterodoxy: The Market' and 'The Law of Supply and Demand: Here It Is Finally' and 'How to Get Rid of Supply-Demand-Equilibrium'


REPLY to Stephen Williamson on Feb 17

Already Schumpeter found it necessary to diffuse doubts about the scientific content of the supply-demand-equilibrium approach: “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.”

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)

For the methodologically correct approach see: ‘Essentials of Constructive Heterodoxy: The Market


REPLY to ProGrowthLiberal on Feb 19

You say: “In my Brooklyn neighborhood, there are competing stores a few blocks apart. So if I cannot buy milk in one I go to the other.”

That is rather smart, but it escaped your attention that this thread is about the LABOR market and neither about the goods market in general nor the Brooklyn milk market in particular.

The SS-function―DD-function―equilibrium approach is false for BOTH the goods and the labor market because ALL microfounded approaches are methodologically false. The macrofounded approach delivers the following testable macro employment equation = true Phillips curve.

Explanations haven been given elsewhere.

Related 'NAIRU does not exist because equilibrium does not exist' and 'NAIRU: an exhaustive dancing-angels-on-a-pinpoint blather'