Blog-Reference and Blog-Reference and Blog-Reference and Blog-Reference on Jan 17 adapted to context
“Since every act of spending results in income for somebody else, total spending for the economy as a whole equals total income. This is true by definition and is a basic building block in macroeconomics.” (Cooper)
Both, orthodox and heterodox economists subscribe to this statement as the self-evident rock-bottom truth of all of economics. Too bad that this statement is materially/logically false.
The foundational error/mistake/blunder consists in the methodological fact that the two most important magnitudes of economics — profit and income — are ill-defined.#1 In order to see this one has to go back to the most elementary configuration, that is, the pure production-consumption economy which consists of the household and the business sector.#2
In this elementary economy, three configurations are logically possible: (i) consumption expenditures are equal to wage income C=Yw, (ii) C is less than Yw, (iii) C is greater than Yw.
- In case (i) the monetary saving of the household sector Sm≡Yw−C is zero and the monetary profit of the business sector Qm≡C−Yw, too, is zero. The product market is cleared, i.e. X=O in all three cases.
- In case (ii) monetary saving Sm is positive and the business sector makes a loss, i.e. Qm is negative.
- In case (iii) monetary saving Sm is negative, i.e. the household sector dissaves, and the business sector makes a profit, i.e. Qm is positive.
Loss or profit are NOT income. Only distributed profit is income. The profit theory is false since Adam Smith.#3 As a collateral damage, all I=S or IS-LM models are false.
Economists are too stupid for the elementary mathematics of accounting.#4 The statement total income equals total spending is simply false because of the all-important phenomenon of credit. Equipped with credit the household sector can spend MORE than its period income (= dissaving) or in the opposite case LESS (= saving). Total spending and total income are NEVER equal, the foundational intuition of macroeconomics is false ― and so is all the rest. Macroeconomics is dead since Keynes.#5
#1 For details see ‘How the Intelligent Non-Economist Can Refute Every Economist Hands Down’ and ‘Keynes’ Missing Axioms’ Sec. 14-18
#2 The elementary production-consumption economy is given by three macro axioms: (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.
#3 See ‘Essentials of Constructive Heterodoxy: Profit’ and cross-references Profit
#4 See ‘The Common Error of Common Sense: An Essential Rectification of the Accounting Approach’
#5 How Keynes got macro wrong and Allais got it right
Related 'Economists never understood how the price mechanism works' and 'Profit: after 200+ years, economists are still in the woods' and 'How economists missed out on the essential relationship of economics'. For details of the big picture see cross-references Keynesianism and cross-references Scientific Incompetence and cross-references Paradigm Shift.
REPLY to Brian Romanchuk on Jan 14
You say “So you have proven that cash expenditures on investment by the business sector are truly an expense!”
I have proven nothing of the sort but I have indeed proven that macro is dead since Keynes and that you have not realized it until this very day.#1
#1 Note that nominal magnitudes Yw, C, Qm, Sm are normally NOT identical with cash payments. For the relationship between the nominal flow magnitudes and the stock of cash see The creation and value of money and near-monies.
COMMENT on Brian Romanchuk on Jan 15
Your discussion of macro is the usual echo chamber economics. You do not ask what the correct approach is but are content with stating that current macro is crap and watching what your clueless peers are doing and opportunistically waiting who fetches the most likes on Twitter or Facebook. You argue:
• “I had contact with hundreds of economists over the course of my career.” There is no use of talking with people who have not even realized that supply-demand-equilibrium is proto-scientific rubbish.
• “One of the requirements of being minimally competent was being able to read another researcher’s paper, and compare what they demonstrated within the body of the paper versus what the abstract says the paper accomplished.” This does not even prove minimal competency but only how low the scientific standards in economics are.
• “In summary, he [Krugman] argues that we could just use IS/LM … to analyse the policy response to the Financial Crisis.” If you have not realized until now that Krugman is not a scientist but a soapbox economist nothing can help you.#1, #2
• “The other line of defense of mainstream macro is that young researchers are doing all this amazing new work.” Macro is axiomatically false and the new generation is busily but senselessly digging at the same wrong place as the old generation.
• “One argument is that mainstream macro is more empirical.” Yes, but this does not help if the theory is axiomatically false, to begin with.
• “As should be clear, I pay almost no attention to the latest developments in mainstream macro. … Unless you are being paid to keep up with the latest research fads, it is probably safe to wait until some form of new consensus appears among researchers before actually reading the papers.” Very smart, indeed. What about getting off your ass and figuring things out for yourself?
“The highest ambition an economist can entertain who believes in the scientific character of economics would be fulfilled as soon as he succeeded in constructing a simple model displaying all the essential features of the economic process by means of a reasonably small number of equations connecting a reasonably small number of variables. (Schumpeter)
What is your simple macro model? If you cannot answer this question you are out of economics and out of the discussion.
#1 Krugman is not an economist
#2 Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It
REPLY to Brian Romanchuk on Jan 15
Thank you for the reference to your Bitcoin articles.
I have only one thing to criticize: the issue is macro and with Bitcoin, you switch to partial analysis in good old Marshallian tradition. What your analysis, first of all, shows is that microeconomic price theory does not work and, worse, that the one-size-fits-all explanation with supply-demand-equilibrium explains, in fact, nothing and never has.#1 Neither has general equilibrium theory, the very core of economics. In other words, 200+ years after Adam Smith, economists still do NOT know how the price mechanism works.
You say “Note how I explain how ‘simple’ models fail when applied to the straightforward question of valuing Bitcoin. How well is a simple model going to do when applied to all prices?”
Indeed, the explanation of the price mechanism has to start from macrofoundations and NOT from microfoundations or partial analysis. So we are back at macro.#2
The elementary macroeconomic Law of Supply and Demand is shown on Wikimedia.#3
This price formula gets, of course, longer with the increasing complexity of the economy. All these details are not needed at the moment.
The elementary macroeconomic Law of Supply and Demand says:#1
(i) An increase of the expenditure ratio ρE=C/Y leads to a higher market clearing price (the Greek letter ρ stands for ratio). An expenditure ratio ρE greater than 1 indicates credit expansion, a ratio ρE less than 1 indicates credit contraction. Credit expansion/ contraction, in turn, affects the quantity of money.
(ii) An increase in the ratio of wage rate to productivity W/R leads to a higher market clearing price.
Roughly speaking, the macroeconomic Law of Supply and Demand explains the price level and its development over time. The equation contains only measurable variables and is therefore testable in principle. Starting with one product market, the way forward is differentiation.
The crucial differentiation is between primary markets (= perishable consumption goods from current production) and secondary markets (= durable goods). Both markets run on entirely different principles.#4 The formula above holds for the primary market.
In brief, the nominal anchor of the whole price system is unequivocally given with the macroeconomic Law of Supply and Demand. But from primary markets to secondary markets and then to Bitcoin is a longer analytical way.#5 In any case holds, if it isn’t macro-axiomatized it isn’t economics, and ― definitely ― microfounded price theory is dead.
#1 The monstrous utility-supply-demand-equilibrium failure
#2 This is the correct core of macroeconomic premises: (A0) 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. (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.
#3 Wikimedia, Law of Supply and Demand, pure production-consumption economy
#4 Primary and Secondary Markets
#5 The creation and value of money and near-monies