May 5, 2017

True macrofoundations: the reset of economics

Comment on Jason Smith on ‘The reason for the proliferation of macro models?’

Blog-Reference and Blog-Reference adapted to context and Blog-Reference

The ultimate reason for the senseless proliferation of micro/macro models is that they are methodologically false, more precisely: axiomatically false, and therefore fail sooner or later. After the definitive refutation of false Walrasian microfoundations and false Keynesian macrofoundations it is time for the true macrofoundations of economics. The methodological rule to follow is known since 2000+ years: “When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.” (Aristotle)

This is the correct core of premises:
(0) The objectively given and most elementary systemic configuration of the (world-) economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
(i) Yw=WL wage income Yw is equal to wage rate W times working hours. L,
(ii) O=RL output O is equal to productivity R times working hours L,
(iii) 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 set of premises is minimalistic, that is, Occam’s Razor has been applied and the set cannot be reduced further, only expanded. The set contains no nonentities like maximization or equilibrium and no normative assertions. The graphical representation is given on Wikimedia.

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 market clearing and budget balancing in each period the price is given by P=W/R (1), i.e. the market clearing price is always equal to unit wage costs. This is the MOST ELEMENTARY form of the price theorem, also called LAW OF SUPPLY AND DEMAND. Note in passing that there is NO such thing as supply function, demand function, production function with decreasing returns, or other figments of the imagination.

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 elementary market economy is indefinitely reproducible under the condition of no external/physical limitations like space, raw materials etcetera, which ALL have to be introduced later in the course of an ever more detailed analysis.

This has been the first step. With the second step the conditions of market clearing and budget balancing have to be lifted. This GENERALIZATION produces the phenomena of inventory changes (O-X greater than 0 or less than 0) and of saving/dissaving (Sm≡Yw-C greater than 0 or less than 0) and of monetary profit/loss (Qm≡C-Yw greater than 0 or less than 0).

It always holds Qm+Sm=0 or Qm=-Sm, in other words, the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). Loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the PROFIT LAW. Profit for the economy as a WHOLE has NOTHING to do with productivity, the wage rate, the working hours, exploitation, competition, or the smartness of business people. Overall profit/loss is determined by the change of the household sector's debt.

Given the minimalist core propositions (0) to (iii) one has to proceed top-down by successive DIFFERENTIATION until one arrives at the INDIVIDUAL agent. Differentiation is the opposite of bottom-up or aggregation. The bottom-up approach, also called methodological individualism, is false because it runs with necessity into the Fallacy of Composition.

How to reset economics: (a) THROW OUT the neoclassical and Keynesian set of premises. (b) Take the premises (0) to (iii) as common core of ALL economic analysis. (c) Differentiate the common core, that is, INCREASE COMPLEXITY successively, and derive ALL observable economic phenomena and relationships CONSISTENTLY from the common core. (d) Take the first opportunity to TEST one of the derived complex relationships. (e) If the relationship is corroborated continue with differentiation and solve concrete economic problems, otherwise look for a new set of foundational premises. This is how a paradigm shift works. There can be NO pluralism of false theories.

The acceptance of the premises (0) to (iii) depends ALONE on the outcome of empirical tests of more elaborate theorems, which have to be carried out independently by econometric experts, and NOT AT ALL on whether one likes the macro axioms or not, and certainly not on any political preconceptions: “Research is in fact a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant) Economics has to be strictly SEPARATED from politics. Political economics has produced NOTHING of scientific value in the last 200+ years.

For ALL economic research, the premises (0) to (iii) are the macrofoundations that are ABSOLUTELY necessary ― as Aristotle put it ― “to produce scientific knowledge of a thing.” It holds: If it isn’t macro-axiomatized, it isn’t economics.*

Egmont Kakarot-Handtke


* Macrofoundations can be condensed to ONE equation called The First Economic Law:



Immediately preceding 'Economics ― a doctor worse than the disease'

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REPLY to Barkley Rosser on May 6

I wonder whether you got your degrees from Trump University

Market clearing is defined as X=O, i.e. quantity sold per period X = quantity produced per period O. You write X=O=C. According to axiom (iii) C is a NOMINAL variable, i.e. dollar per period. A REAL flow can NEVER be equal to a NOMINAL flow because of the different DIMENSIONS.

So with X=O=C you have yourself knocked out already in the 2nd line of your comment. Let us go into details nonetheless.

You write C+PX-wL > 0. Because of (iii), i.e. C=PX, this is equal to 2C-wL>0, which is devoid of any sense. It is NOT profit because monetary profit Qm is defined as Qm≡C-Yw (see above) and measurable with the accuracy of two decimal places.

In the initial case, the price has been defined as DEPENDENT variable. According to the price theorem P=W/R the price falls under the condition of market clearing X=O and budget balancing C=Yw if the wage rate W is reduced. Market clearing and budget balancing are two concepts that are familiar to every dull Econ 101 student.

If the price is not the dependent variable, i.e. if it does NOT perform its market clearing function, then the quantity sold X becomes the dependent variable and the condition of market clearing, i.e. X=O, NO longer holds. In other words, X is in this case less than O and the business sector’s INVENTORY GOES UP under the condition of budget balancing C=Yw. This case has been treated at length elsewhere.#1

If you were not so abysmally incompetent you could have figured this out for yourself. C=Yw translates into PX=WL. If you reduce W on the right hand side then ― logically ― either P or X or both have to be reduced on the left hand side (ask in the kindergarten for a math introduction if you do not understand what the = sign means). Under the additional condition of market clearing X=O the price must ― logically ― fall.

Whether the market is cleared or not, though, is IRRELEVANT for monetary profit. Monetary profit for the economy as a whole is defined as Qm≡C-Yw and as long as the budget is balanced, i.e. C=Yw, overall profit is ZERO, NO MATTER what productivity, employment, wage rate or price are.

Your error/mistake/blunder is that you are accustomed to argue from the perspective of a single firm (= micro). Yet, what holds for micro does NOT hold for macro. Obviously, nobody has ever heard of the Fallacy of Composition at Trump University.

The elementary Profit Law, i.e. Qm=-Sm, is UNIVERSAL, that is, it does NOT AT ALL depend on any specific assumption about market clearing or budget balancing.#2 You will never get this nor anything else.

#1 See working papers on SSRN
#2 Elementary means pure consumption economy. With government, foreign trade and all the rest added the Profit Law reads Qm≡Yd+(I-Sm)+(G-T)+(X-M). Neither Walrasianism, nor Keynesianism, nor Marxianism, nor Austrianism got the Profit Law right in 200+ years. This is why economics is a failed science.

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COMMENT on Blissex, Sandwichman on May 10

Profit for the economy as a WHOLE is in the elementary case given by Qm=-Sm, in other words, the business sector’s surplus (deficit) equals the household sector’s deficit (surplus).#1 Loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the PROFIT LAW. Profit for the economy as a WHOLE has NOTHING to do with productivity, the wage rate, the working hours, exploitation, competition, or the smartness of business people. Overall monetary profit/loss is determined by the change of the household sector’s debt.

Your error/mistake/blunder is that you are accustomed to argue from the perspective of a single firm (= micro). Yet, what holds for micro does NOT hold for macro. Economists have not grasped it until this day, neither the pro- nor the anti-capitalists.#2

It holds: If it isn’t macro-axiomatized, it isn’t economics. The representative economist is micro-axiomatized and because of this he is forever lost in the deep wood.

#1 See ‘True macrofoundations: the reset of economics
#2 See ‘Profit for Marxists