May 16, 2016

The real trouble with Econ 101

Comment on Peter Dorman on ‘Issues with Econ 101 at Three Levels’

Blog-Reference and Blog-Reference on 24 Jan 2017 adapted to context

Econ 101 performs a vital function within the framework of current economic methodology: “It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals. Our behavior in judging economic research, in peer review of papers and research, and in promotions, includes the criterion that in principle the behavior we explain and the policies we propose are explicable in terms of individuals, not of other social categories.” (Arrow, 1994, p. 1)

This commitment to methodological individualism is — in the case of neo-Walrasianism — specified as follows: “the program is organized around the following propositions: 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, 1985, p. 147)

Ultimately, the content of Econ 101 is derived from this axiom set. The theoretical superstructure embraces the various phenomena of the market economy from supply-demand-equilibrium to unemployment and distribution, enriched with practical, institutional, organizational, technical, historical details and examples. These informative details, however, are merely the loosely associated illustration/decoration of the theoretical hardcore.

Everyone with a modicum of scientific instinct who takes a relaxed view on the axioms HC1|HC5 comes eventually to the conclusion that they are forever unacceptable. NOT ONE axiom holds water. Econ 101 students, though, accept them generation after generation with minor reservations and occasional superficial variations.

More than two centuries after Adam Smith it is obvious that economics is a failed science. As part of the whole, Econ 101 and the textbooks are false. Condensed to one word, the fatal methodological error/mistake lies in microfoundations.

Keynes identified the weak spot intuitively and switched to macrofoundations. He formulated the formal core of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (1973, p. 63)

This elementary syllogism is conceptually and logically defective because Keynes did not come to grips with profit (Tómasson et al., 2010, p. 12). This means that the whole Post Keynesian theoretical superstructure has also been built upon false premises. Let this sink in: Keynes had no idea of the fundamental concepts of economics, viz. profit and income, and neither pro- nor anti-Keynesians realized it.

With Samuelson’s textbook, the conceptual blunder became a canonical part of Econ 101: “GDP, or gross domestic product, can be measured in two different ways: (1) as the flow of final products, or (2) as the total costs or earnings of inputs producing output. Because profit is a residual, both approaches will yield exactly the same total GDP.” (1998, p. 392). The fatal error/mistake resides in the premise income = value of output which holds only in a zero profit economy.

Standard economics is PROVABLY false with regard to the two most important features of the market economy: the profit mechanism and the price mechanism (2015). Both, the Walrasian and Keynesian strand of standard economics lack sound axiomatic foundations. Thus, Econ 101 does not transmit valid knowledge about how the economy works but is essentially an incubator for the reproduction of scientific losers.

Egmont Kakarot-Handtke

Arrow, K. J. (1994). Methodological Individualism and Social Knowledge. American Economic Review, Papers and Proceedings, 84(2): 1–9. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. London, Basingstoke: Macmillan.
Samuelson, P. A., and Nordhaus, W. D. (1998). Economics. Boston, MA, Burr Ridge, IL, etc.: Irwin, McGraw-Hill, 16th edition.
Tómasson, G., and Bezemer, D. J. (2010). What is the Source of Profit and Interest? A Classical Conundrum Reconsidered. MPRA Paper, 20557: 1–34. URL
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): pp. 146–149. URL

Related 'Econ 101 — worse than useless' and 'Econ 101 or How to train morons' and 'How to get out of the Econ 101 PsySoc woods' and 'Coming soon: the canonical economics textbook'.

Immediately following 'Econ 101: Dull teachers and dull students in the endless loop'.