Demand, supply, and their interaction on markets, as seen from the perspective of evolutionary economic theory

Since the time of Marshall economists have used the constructs of demand and supply curves in their explanation and analyses of how markets determine prevailing prices and the allocation of resources among different lines of economic activity. Today almost all expositions and interpretations of price theory take a neoclassical perspective. This paper develops an interpretation of demand and supply curves and their interaction on markets that is more compatible with the general viewpoint of evolutionary economic theory.     

Austrian economics at the cutting edge

Austrian economists today have a valuable opportunity to rejoin the mainstream of the economics profession. As Colander, Holt, and Rosser have argued, neoclassical orthodoxy is no long mainstream. What I call the “heterodox mainstream” is an emerging new orthodoxy. The five leading characteristics of the emerging new orthodoxy are bounded rationality, rule following, institutions, cognition, and evolution. When listed in this order, they suggest the acronym BRICE. The Austrian school is also an example of BRICE economics. The shared themes of BRICE economics create an opportunity for intellectual exchange between Austrians and other elements of the heterodox mainstream. Although Austrians should engage the heterodox mainstream energetically, they should also defend the essential elements of an early version of neoclassical economics, elements at risk of becoming half-forgotten themes of an earlier era. These elements are supply and demand, marginalist logic, opportunity-cost reasoning, and the elementary theory of markets. JEL Codes A14, B50, B53 This text is an edited version of a talk given in Washington, D.C. on 19 November 2005 at the SDAE annual dinner. I thank persons present at that time for a helpful discussion. I also thank William Butos, Roger Garrison, Steven Horwitz, and Peter Lewin for useful comments on an earlier draft.     

Sraffa: the theoretical world of the ‘old classical economists’ *

Sraffa's mature work is seen here as a re-discovery and resumption of the ‘submerged and forgotten’ approach of the ‘old classical economists from Adam Smith to Ricardo’. Wages determined by broad economic and social forces entail there product prices determined independently of demand and supply functions. Some main questions raised for the modern economists by this radical reorientation of economic theory are then considered in order to conclude that it is aginst that background that Sraffa's mature work should be set with its three main contributions, of a rediscovery of the approach, of a complete and transparent solution of the problems of price determination it raises, and of its application to the critique of neoclassical theory. Among several developments originating from Sraffa's seminal work, two are singled out for mention: (i) the possibility of deficiencies of aggregate demand in the long period no less than in the short one; this follows naturally from the abandonment of the neoclassical theory of distribution, of which the role of the interset rate in equilibrating savings and investment is a corollary; (ii) the question of the distribution of the surplus between wages and profits in a modern economy where wages are no longer confined to subsistence.     

Perspectives for Post-Keynesian Economics

The paper reviews and assesses the negative and positive advice which has been offered by various fellow economists to heterodox economists in general, and Post-Keynesian economists in particular, in light of changes that have occurred within neoclassical economics and in light of the rising hegemony of mainstream economics in economics departments. Various strategies are considered, among which is more engagement with orthodox dissenters, but it is concluded that the majority of heterodox economists ought instead to engage more with other heterodox economists and possibly other social sciences, developing and expanding their own agenda around real-world problems.     

The aggregate neoclassical theory of distribution and the concept of a given value of capital: towards a more general critique

The aim of this article is to show the weakness of the neo-Ricardian critique of the aggregate neoclassical theory of distribution which affirms the intrinsic inability of this theory to describe a stable equilibrium. The article shows that within the aggregate neoclassical framework both the supply curve for capital, founded on the concept of a given value of capital, and the demand curve for capital are each, and for different reasons, without any appreciable economic meaning. The kind of equilibrium determined by these curves is economically irrelevant. The article stresses the consequence that capital reversal and reswitching are unimportant for the critique of the aggregate neoclassical theory of distribution.     

Aggregation and the analysis of markets

The case for aggregating relations in Economics is often tenuous. This paper shows that under conditions of genuine ignorance and real historical time, it is not possible to aggregate from individual demand and supply functions to market-level demand and supply functions. Hence the traditional analysis of markets based on market demand and market supply is called into question. Two proposals for replacing the traditional market analysis are suggested that do not rely on aggregation within markets.     

Covered interest parity: The untestable hypothesis

Although post Keynesian economists advocate the realistic bankers’ view of the forward exchange rate, neoclassical economists formulate (CIP) as a testable hypothesis. In reality, CIP represents a formula used by bankers to calculate the forward rates they quote to their customers. This article provides arguments for the post Keynesian view of the forward exchange rate and suggests that CIP is not a theory, that it is a microeconomic relation, and that it is a hedging rather than an arbitrage condition. An empirical illustration shows that deviations from CIP are observed whenever published data are used, but these deviations disappear when transaction data are used instead. It is concluded that CIP is an untestable hypothesis.     

The transmission mechanism of monetary policy: Microeconomic aspects of macroeconomic issues

The article analyzes the transmission mechanism of monetary policy in light of microeconomic theory. We address the influence of microeconomic factors on the transmission of monetary policy while taking into account the contributions of conventional price formation and competition theory and heterodox microeconomic theories, including work inspired by the post Keynesians. We found a multiplicity of results regarding changes in price levels and inflation derived from shifts in demand and costs. These results challenge the conventional view, which postulates a single behavior in the circuit from changes in interest rates to demand, prices, and inflation. We conclude that microeconomic and macroeconomic aspects should be integrated to properly explain monetary policy and analyze its effects and transmission mechanism.     

Pluralism,the Lucas Critique,and the Integration of Macroeconomics and Microeconomics

Mainstream macroeconomics has pursued ‘micro founded’ models based on the explicit optimization by representative agents. The result has been a long and wasteful detour. But elements of the Lucas critique are relevant, also for heterodox economists. Challenging common heterodox views on microeconomics and formalization, this paper argues that (i) economic models should not be based purely on empirically observed regularities, (ii) heterodox economists must be able to tell an integrated story about goal-oriented micro behavior in a specific macro environment, and (iii) relatively simple analytical models have an essential role to play.     

An unpleasant dilemma for contemporary general equilibrium theory

By examining the contributions of two prominent contemporary neoclassical economists, i.e. Lucas and Hahn, the article attempts to shed light on the problematic relationship between neoclassical theory and observation. It is argued that this approach must face the unpleasant dilemma of having to choose between endowing general equilibrium theory with an explanatory role that is marred by its illegitimate notion of capital as a single factor of variable form (Lucas); or alternatively, to consistently treat each capital good as a distinct factor of production, with the bitter implication that the theory must simply renounce to have a correspondence with observation (Hahn).     

Heterodox Economics and its Critics

Heterodox economics has its critics. Most of the criticisms are friendly comments and analysis directed towards improving heterodox economic theory. However, the critics and their criticisms that are the concern of this article are the ones that challenge the existence of heterodox economic theory and the community of heterodox economists as manifested through their graduate programs, conferences, journals and identity. These critics observe that the academic status quo in economics, as manifested in its department and journal rankings, rules of academic engagement, and its institutions and organizations, favor mainstream economics and that it is unlikely to change in the future. Consequently, they argue that heterodox economists can survive only if they become more like mainstream economists. With focus on assimilation, the critics direct their criticisms towards the social characteristics of the heterodox community and to the personal characteristics of heterodox economists. This article is a response to the critics.     

Frederic Lee and Post-Keynesian Pricing Theory

Frederic Lee has been a major contributor to post-Keynesian economics, mainly to its theory of pricing. This article summarizes his objections to the neoclassical view of the firm and pricing, as well as his view that changes in quantities, rather than in prices, provide the important information to firms. It also outlines Lee's views on competition, and examines the three pricing doctrines Lee carefully analyzed—markup pricing (associated with Kalecki), normal-cost pricing or full-cost pricing (associated with Andrews), and target-return or administered pricing (associated with Means). The article then discusses the relationship between Lee and three strands of post-Keynesianism: Kaleckian, Sraffian and Eichnerian pricing theories. It explains why Lee objected to some features of each of these. The article concludes by discussing why, towards the end of his life, Lee felt (mistakenly) that his ideas had been dismissed by heterodox economists.     

What If There Are No Conventional Price Mechanisms?

Inspired by Frederic (“Fred”) S. Lee’s theoretical contribution to institutional-heterodox economics, I make the case that the neoclassical price mechanism is not only flawed, but also irrelevant for the study of actual coordination mechanisms, hence the price mechanism — as a theory as well as a way of thinking — should be discarded. While this position was addressed by early institutionalists, starting with Thorstein Veblen, later institutionalists have not completely rejected the price mechanism. The sympathy for the price mechanism has prevented institutionalists (and other heterodox economists) from fully developing an alternative theoretical framework concerning how actual economic activities are organized. I, therefore, provide an institutionalist-heterodox framework of the provisioning process focusing on business enterprise activities. This framework shows how institutional economics becomes more refined and useful when it is married to other traditions in heterodox economics, in particular, Marxian, social, and post-Keynesian economics. Such an integrative approach is what Fred Lee showed through his work toward producing a better theory and policy for the underlying population.     

The aggregate neoclassical theory of distribution and the concept of a given value of capital: a reply

In this reply to Paola Potestio, it is argued that there are cases in which both the “supply” of and the “demand” for “capital” can be conceptualised in an economically meaningful way and used in the conventional long-period neoclassical manner to determine an equilibrium or to investigate the adjustment process towards it. This conceptualisation is based on strict assumptions. If, for the sake of the argument, we concede these assumptions, the critique of the theory that tries to generalise the determination of distribution in a simple one-good model, or “corn-economy”, to multi-good models can be safely founded on the possibility of reswitching and capital reversing, contrary to Potestio's critique.     

Political and Social Economics: Beyond Orthodoxy and Heterodoxy

Economists face at least two problems when they try to go interdisciplinary. One is how to adapt their theory where the original set of assumptions may fail to apply. This is a particular problem for economists who carry the “default” neoclassical model around in their heads. This paper outlines a map for keeping track of assumptions when doing interdisciplinary work. A second problem is how to take a theory designed for one discipline and turn it into something intelligible to practitioners of another. One needs a common language, and it is argued that general systems theory might help, even though it is not a complete language. The map proposed here provides a unified way to compare and contrast the approaches of different orthodox and heterodox traditions and better see what problems they are most suited to addressing.     

A Guide to Paradigmatic Self-Marginalization: Lessons for Post-Keynesian Economists

While many heterodox economists hope that the recent financial crisis will lead to paradigmatic change in economics, we argue that path-dependent processes and institutional factors within the economic community hinder such a change. Focusing on the citation behavior of economists in heterodox journals in general and in Post-Keynesian journals in particular, we discuss structural reasons—connected to positive feedback mechanisms within the institutional framework of the economics discipline—for the marginalization of heterodox economic thought.     

Exploring the Economic Choice to Participate in Sport: Results from the 2002 General Household Survey

This article explores the decision to participate in sports activities in the United Kingdom using a qualitative choice framework. The consistency of the results with neoclassical theories of leisure, and heterodox economic theory, which embraces a psychological view of decision making and structure of demand, is assessed. Finding more support for the latter perspective, the implications of this for sports policy are discussed.     

The Exchange Rate and Inflation in Argentina: A Classical Critique of Orthodox and Heterodox Policy Prescriptions

In this paper we present an alternative framework to neoclassical theory of international trade and exchange rate determination. Our model, inspired in the classical tradition, provides support for the assertion that an exchange rate policy aiming to improve national competitiveness and to bring about a sustained trade surplus is a viable option. In fact, the success of this strategy does not depend on the effectiveness of monetary sterilization —as many argentinean heterodox authors claim— but on the ability to overcome the boundaries imposed by the evolution of the domestic wage rate and the potential emergence of competitive devaluations. In the particular case of Argentina, the introduction of export taxes on land-intensive commodities, in which the economy has absolute advantages, brings an additional policy tool that can make both the exchange rate target and the workers claims consistent.     

Unhealthy Accumulation: The Globalization of Health Care Privatization

The scepticism of economists—mainstream and heterodox—towards "new economy" ideas goes beyond the indignation of long-established traditions being told to rewrite their basic rules. With its emphasis on trade through interand intra-corporate networks, the "new economy" presents a model of exchange very different from that used by mainstream (neoclassical) economics. Its assurance of equality within the network, like neoclassical economists' equality before the market, is attained only by ignoring the power imbalances built into the new network forms. The enhanced "consumer sovereignty" associated with recent technological change, deregulation and trade integration is shown to be just as open to market power abuses as were consumers in the traditional economy. Rather than representing a break with the past, recent structural changes in highincome economies are argued to continue a long-running trend for consumption and production to be spatially and temporally separated, so that the individual pleasures of the first can counterbalance the collective pressures of the second. Producers remain in control of most supply chains, and the intensification and deskilling of consumption reinforces rather than reverses these same processes in production, by promoting longer work hours and closer pay-performance links.