April 21, 2016

The solemn burial of Marginalism

Comment on Chris Dillow on ‘Limits of marginal productivity theory’


In order to tackle the problem of wages, profits, and employment economics has to switch from microfoundations to macrofoundations. The Paradigm Shift is achieved as follows.

(A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
(A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L,
(A2) O=RL output O is equal to productivity R times working hours L,
(A3) 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 macro axiom set contains NO NONENTITIES like utility, maximization, equilibrium, or a well-behaved production function. For the graphical representation of the absolute formal minimum set, see Wikimedia#1.

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 (i) budget balancing, i.e. C=Yw, and (ii) 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. These details are not needed at the beginning but come later with DIFFERENTIATION.

Under the conditions of (i) market-clearing and (ii) budget-balancing in each period the price is derived as P=W/R (1), i.e. the market-clearing price is in the most elementary case equal to unit wage costs. This is the elementary form of the macroeconomic Law of Supply and Demand which, in a later step, has to be generalized for an arbitrary number of markets.

The first thing to notice is that the real wage W/P is invariably equal to the productivity R according to (1). So, for the economy as a WHOLE, the marginal principle does NOT hold. The real wage is NOT equal to marginal productivity — because there is NO marginal productivity — because there is NO such thing as a well-behaved production function. The real wage is equal to productivity in the most elementary case (see Wikimedia#2).

Marginalism MUST ASSUME a well-behaved production function in order to make the green cheese assumption of constrained optimization work. This is methodologically ILLEGITIMATE and known since antiquity as petitio principii. To fool around with assumed NONENTITIES is like kindergarten kids playing with Spiderman, Tooth Fairy, and Easter Bunny.

For the economy as a WHOLE holds: 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, and profit for the business sector as a whole is invariably zero. So, the next question is where does profit come from? This question has NEVER been answered by standard economics. So economists have NO idea of the most important phenomenon of their subject matter.

All changes in the system are reflected by the market-clearing price. The most elementary economy is REPRODUCIBLE for an indefinite number of periods under the interim condition of no external limitations. With further DIFFERENTIATION one eventually arrives at the axiomatically correct Employment Law #3 and eventually at a single firm, that is, at micro.

What is standard economics? Krugman put it thus: “most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point”.

And this is why Krugman and the rest of standard economics are a failure. If the premises are false the whole theoretical superstructure implodes with karmic necessity. It is as simple as that: garbage in, garbage out. This methodological truism, though, is forever beyond the ant horizon of marginalist losers.

Egmont Kakarot-Handtke

#1 Wikimedia AXEC31 Elementary production-consumption economy with market-clearing and budget-balancing
#2 The formula for the general case is given on Wikimedia AXEC28.
#3 Wikimedia AXEC62 The structural-systemic Employment Law

Related 'Putting the production function back on its feet' and 'Mathiness and the Ur-Blunder' and 'Infantile model bricolage, or, How many economists can dance on a non-existing pinpoint?' and 'Sending Solow’s growth model to the dump of proto-scientific history'.

Immediately preceding Marginalism is the landmark of scientific incompetence.