Lecture Eleven
Critiques of Economics
Dogma versus Debate
• Economics differs from “hard sciences”
– Normally at least two rival schools
• In classical period
– Smith, Ricardo, Malthus: objective theory of value
– Say (and others): subjective theory
• In neoclassical period
– Neoclassical
• Austrian (anti-equilibrium analysis)
– Post Keynesian, Evolutionary, Institutionalist,
Marxian, Econophysics…
– One dominant, others marginalised but still
“professional”
• i.e., represented by academic economists rather than
“cranks”
Dogma versus Debate
• Physical sciences normally have just one school of thought
– Fundamental concepts agreed upon
– Physicists differ by their specialisations only
– Except during periods of “paradigm change”
– E.g., today, all physicists accept Quantum mechanics, Relativity, &
Thermodynamics as fundamental
• Then specialise in different aspects
• But Quantum mechanics & Relativity are in conflict…
– Different schools compete here to try to resolve conflict
– String theory was dominant
– Failure to produce refutable experiment causing other
approaches to arise
– Competing “Scientific Research Programs” arising, as
Lakatos argued
• But agreement on fundamental concepts, and different schools read
each others papers…
Dogma versus Debate
• Different schools of thought in economics
– Don’t agree of fundamentals
– Generally don’t read each others papers
• But asymmetric:
– members of some non-mainstream schools do read
mainstream papers to critique them;
– most mainstream economists don’t read (or even
know about) non-mainstream theories
• So there is critique, but rarely debate
– Many disputes really contests over “theory of value”
• One school disputes “hard core” of the other
– Critique really is re-phrasing of one school’s core
beliefs in terms of the others
– Necessarily incompatible
Dogma versus Debate
• E.g., “Diamond-Water paradox”
– Diamonds comparatively useless, but high price
– Water very useful, but low price:
• “The things which have the greatest value in use have
frequently little or no value in exchange;
• and, on the contrary, those which have the greatest value
in exchange have frequently little or no value in use.
• Nothing is more useful than water: but it will purchase
scarce anything;
– scarce anything can be had in exchange for it.
• A diamond, on the contrary, has scarce any value in use;
– but a very great quantity of other goods may
frequently be had in exchange for it.” (Smith, Wealth
of Nations, Book I)
Dogma versus Debate
– Neoclassical/subjective theory of value explanation
• Marginal utility of diamonds much higher than water
• Alleged classical/objective theory had no explanation
– But classical school did have a “labour-value” solution:
• Diamonds much scarcer than water
– More effort needed to produce them
• Effort to mine diamonds vs effort to draw water
explains relative prices
• Both sides rejected each other’s explanation
– At issue is incompatibility of “hard core” beliefs
• Significant disputes are about internal consistency
• Most prominent early critique: Neoclassical/Austrian
critiques of labour theory of value
Bohm-Bawerk & the transformation problem
• Labour theory of value asserts
– Surplus Value comes from labour only
– Surplus Value is the only source of profit
– Assumes rate of surplus value constant across
industries
• No real explanation as to why…
– Assumes tendency for rates of profit to equalise
across industries
• Desire for maximum return will cause capitalists to move
capital from low to high return industries
– But ratio of “constant capital” (commodity input) to
“variable capital” (labour) differs between industries
• So rates of profit should differ…
Bohm-Bawerk & the transformation problem
• How to make values consistent with equalised rates of
profit?
– Engels promised Marx would provide solution in Volume
III of Capital (edited by Engels & published after his
death)
– Marx’s “solution” was a pair of tables
• One with values, different amounts of surplus and
differing rates of profit
• Other with values, same amounts of surplus and same
rate of profit
• Sum of rows and columns the same.
– Just arithmetic, not analysis
• First major evaluation made by Austrian economist
Eugene von Böhm-Bawerk:
Bohm-Bawerk & the transformation problem
• “I cannot help myself: I see here no explanation and the
reconciliation of a contradiction, but the bare
contradiction itself.
– Marx's third Volume contradicts the first.”
• (Karl Marx and the Close of His System, p. 30.)
• Transformation problem still debated today
– By remaining groups trying to preserve labour theory
of value (mainly TSS School: “Temporal Single
System”)
• Failure of Marx & successors to solve problem assisted
decline of Classical School, rise of Neoclassical in late
19th century
– And it had its critics…
Veblen & “evolutionary science”
• Neoclassical theorists had ambitions to be dynamic &
evolutionary:
– “The main concern of economics is thus with human
beings who are impelled, for good and evil, to change
and progress.
– Fragmentary statical hypotheses are used as
temporary auxiliaries to dynamical—or rather
biological—conceptions: but
– the central idea of economics, even when its
Foundations alone are under discussion,
– must be that of living force and movement.” (Marshall,
Principles, p. 22)
• But in practice, never moved beyond static analysis
– Thorstein Veblen posed question “Why not?”:
Why is economics not an evolutionary science?
• Veblen
– “father” of institutional economic thought
– Co-developer of evolutionary economics (Schumpeter)
– In 1898, scathing critique of neoclassical economics:
• “Why is economics not an evolutionary science?”
• Argued that
– True sciences seek explanation of actual phenomena in
terms of cause and effect
– Neoclassical theory instead based on ideal ideas of
what behaviour should be
• Therefore unable to explain what is observed except as
exceptions to what should be observed
• Rather than explaining what is observed
– proposes idealised interpretations of what should be
observed…
Why is economics not an evolutionary science?
• E.g., Money: “should be” only a medium of exchange
• Actual role of money in society not really analysed; just figure of
speech “medium of exchange” asserted:
– “it is this facile recourse to inscrutable figures of speech as the
ultimate terms of theory that has saved the economists from
being dragooned into the ranks of modern science…
– By their use the theorist is enabled serenely to enjoin himself
from following out an elusive train of causal sequence.
– He is also enabled, without misgivings, to construct a theory of
such an institution as money … without descending to a
consideration of the living items concerned,
– except for convenient corroboration of his normalised scheme of
symptoms.” (p. 383)
• Veblen’s opinion of theory of individual as a utility-maximiser:
Why is economics not an evolutionary science?
• “The hedonistic conception of man is that of a lightning
calculator of pleasures and pains
• who oscillates like a homogeneous globule of desire of
happiness under the impulse of stimuli that shift him
about the area, but leave him intact.
• He has neither antecedent nor consequent.
• He is an isolated definitive human datum, in stable
equilibrium except for the buffets of the impinging
forces that displace him in one direction or another.
• Self-imposed in elemental space, he spins symmetrically
about his own spiritual axis until the parallelogram of
forces bears down upon him, whereupon he follows the
line of the resultant.
• When the force of the impact is spent, he comes to rest,
a self-contained globule of desire as before…” (p. 389)
Why is economics not an evolutionary science?
• Veblen on equilibrium reasoning:
– ‘Professor Marshall’s work… remains an inquiry directed to
the determination of the conditions of an equilibrium…
– It is not … an inquiry into … institutional development …
– it is the movement of a consummately conceived and selfbalanced mechanism,
– not that of a cumulatively unfolding process or an
institutional adaptation to cumulatively unfolding
exigencies.’ (1919: 173)
• The neoclassical view of dynamics is that
– “The more ‘dynamic’ the society,
– the nearer it is to the static model;
– until in an ideally dynamic society, with a frictionless
competitive system …
– the static state would be attained…” (1919: 190)
Why is economics not an evolutionary science?
• What should economics really be?
– “the theory of a process of cultural growth as
determined by the economic interest,
– a theory of a cumulative sequence of economic
institutions stated in terms of the process itself.’
• It would attempt “to trace the cumulative working out of
the economic interest in the cultural sequence.
• It must be a theory of the economic life process …”
• Neoclassical economics can’t do this because:
– “a hedonistic psychology … does not afford material
for a theory of the development of human nature…
– It is therefore not readily apprehended or
appreciated in terms of a cumulative growth of habits
of thought…” (p. 163-64)
Why is economics not an evolutionary science?
• Reception of Veblen by neoclassical economists set
standard for later debate between opposing schools:
– deny that opponents are economists…
– “As to the merits of his work, opinions differ more
widely and more fervently than on any other writer of
equal prominence.
– He is rated among the great economists of history, or
as no economist at all;
• as a great original pioneer or as a critic and satirist
without constructive talent or achievement.
• And he was, one might almost say, all of these
things; from different standpoints and by different
criteria, each of which it is possible to understand
and even to appreciate.” (John Maurice Clark, AER
obituary for Veblen, 1929, p. 747)
Sraffa and “discarding Marshall’s theory”
• Veblen dismissive of entire neoclassical vision
• Next major critic back on logical soundness of one
neoclassical argument: the upward-sloping supply curve:
– “I am trying to find what are the assumptions implicit
in Marshall’s theory; if Mr. Robertson regards them as
extremely unreal, I sympathise with him.
– We seem to be agreed that the theory cannot be
interpreted in a way which makes it logically selfconsistent and, at the same time, reconciles it with the
facts it sets out to explain.
– Mr. Robertson’s remedy is to discard mathematics…
– in the circumstances, I think it is Marshall’s theory
that should be discarded.” (Sraffa 1930, p. 93)
Sraffa and “discarding Marshall’s theory”
• Sraffa’s argument
– Basis for rising supply curve is rising marginal cost of
production
– Rising marginal cost occurs because of diminishing
marginal productivity
– Marginal productivity falls because
• One input to production fixed in short run
• One input variable in short run
• Adding more of variable input causes less output per
additional unit of input
• Sraffa disputed assumption of “fixed input” in short run…
Sraffa and “discarding Marshall’s theory”
• 2 cases
– broadly defined industry
• e.g., “Manufacturing”
• Similarly broad definition for “fixed input” needed
– E.g., “Land” or “Capital”
– Narrowly defined industry
• e.g., “Cardboard boxes”
• Similarly narrow definition for “fixed input” needed
– E.g., “glue guns”
– Sraffa asserted that in either case, assumption
undermined concepts of supply & demand analysis
• Recap of basic neoclassical idea:
Sraffa and “discarding Marshall’s theory”
• Supply curve derived from production function combining
– (at least) one fixed input with variable inputs
– result: diminishing marginal productivity
• productivity may rise as initial variable inputs added
• but eventually diminishing productivity sets in
A
C B
Labor
Input
Diminishing
marginal
productivity sole
basis for rising
marginal cost
(variable input
cost assumed
constant)
B
C
A
Flip axes & multiply by wage rate:
Wheat
Output
Sraffa’s Broad critique
Diminishing marginal productivity means rising marginal
cost, & hence upward-sloping demand curve
(c)
Wheat
(a)
PF
MPF
Fertiliser
Fixed Land
(b)
Fertiliser
PW
(d)
SW
P2
D2
P1
Fertiliser
D1
Wheat
Sraffa’s Broad critique
• If broadly define factor/industry, then can regard
factor as fixed since attracting additional units difficult
– But increasing output of industry will affect incomes
of all other industries/factors:
• “If in the production of a particular commodity a
considerable part of a factor is employed,
– the total amount of which is fixed
– or can be increased only at a more than proportional
cost,
• a small increase in the production of the commodity will
necessitate a more intense utilisation of that factor,
– and this will affect in the same manner the cost of the
commodity in question…
Sraffa’s Broad critique
• and the cost of the other commodities into the
production of which that factor enters;
• and since commodities into the production of which a
common special factor enters are frequently, to a certain
extent, substitutes for one another ...
• the modification in their price will not be without
appreciable effects upon demand in the industry
concerned.” (Sraffa 1926)
• So demand shifts for each movement along supply curve
– Can’t have independent supply and demand curves
Sraffa’s Broad critique
• Increased usage of fixed resource increases price and
changes income distribution
– not all land used by agriculture (e.g., fallow, housing)
– increased demand for agriculture partly met by
switching resources from fallow/housing
– prices of land, fertiliser will rise
– Supply and demand curves therefore not independent
– If not independent, can have indeterminate outcome
• No unique “equilibrium” price because demand and supply
interdependent
Sraffa’s Broad critique
Fertiliser
Fixed Land
(b)
PF, PL
(a)
Different
“demand
curve” for
every point on
supply curve
since change
in supply
changes
incomes
Price/bushel
MPF
Agriculture
Income effects with Broad Definition of Industry
Price?
F
PL
(c)
Dq3
PF
Dq2
Supply
?
Dq1
?
q1
?
Demand
q2
Quantity?
q3
Wheat
Sraffa’s Narrow critique
• If use narrow definition of industry
– (e.g., wheat industry rather than “agriculture”)
• Sraffa argued assumption of fixed input much less
justifiable
• Instead, extra “fixed” input can normally be found if
increase supply needed
– Increased demand for wheat will mean conversion of
land from (e.g.) barley to wheat
– Negligible change in cost of land
– Fertiliser to land ratio remains constant
• Marginal product & thus marginal cost remains constant
• Constant cost with narrow definition
Sraffa’s Narrow critique
• “If we next take an industry which employs only a small
part of the ‘constant factor’
– (which appears more appropriate for the study of the
particular equilibrium of a single industry),
• we find that a (small) increase in its production is
generally met much more by drawing ‘marginal doses’ of
the constant factor from other industries
• than by intensifying its own utilisation of it;
• thus the increase in cost will be practically negligible…”
(Sraffa 1926)
Sraffa’s Narrow critique
Wheat
Constant cost with narrow definition
PF
(a)
Fertiliser/land ratio
held constant at ideal
ratio
F
Fertiliser
Land
MPF
Price of fertiliser
unaffected by
(c)
increased use in wheat
production
Horizontal wheat
supply curve with
constant MPF
PW (d)
(b)
Marginal productivity
of fertiliser therefore
constant
F
P
D1
D2
SW
Wheat
Supply sets
price, demand
sets quantity:
position of
classical
school
Sraffa and “discarding Marshall’s theory”
• Sraffa’s views debated by profession, but then ignored
– From Lakatos perspective “Diminishing marginal
productivity” too much a “hard core” belief to allow
challenge
• Next major critique empirical
– Interviews with businessmen found marginal costs
constant or falling for most firms
• Accidental critique
– Originated in “Oxford Study Group” in UK
• Intended to help economists & businessmen communicate
• Businessmen couldn’t accept economists’ concept of
“diminishing marginal productivity”
• Economists surveyed business to find out why…
The empirical critique
• In USA, similar critique arose from WWII rationing
• Economists put in charge of price-setting
– Key people Gardiner-Means, J.K. Galbraith
• Found two different price regimes
– Agriculture, raw materials had volatile prices
– Manufacturing, services had stable prices
• Developed concepts of
– “administered prices”
• Prices not set by “supply & demand” but by markup on
relatively constant average costs of production
– “Engineering” explanation for costs
• Manufacturing cost structure reflects design of
factories to achieve maximum efficiency at maximum
output:
The empirical critique
• E.g., Eiteman &
Guthrie 1952
showed
managers 8
hypothetical
average cost
curves:
• 3-5 “neoclassical”:
– 3 most like
textbook
drawing
• 6-8 had constant or
falling MC:
• Text description
given to managers
as well:
• “6… high at
minimum output, …
decline gradually
to a least-cost
point near
capacity, after
which they rise
slightly;
• 7… high at
minimum output, …
decline gradually
to capacity at
which point they
are lowest…”
(Eiteman & Guthrie
1952: 835)
The empirical critique
Curve Indicated
Number of companies
1
0
2
0
3
1
4
3
5
14
6
113
7
203
8
0
Total
334
Only 18 out of 336 fit neoclassical vision of
diminishing marginal productivity, rising marginal cost
Almost 2/3rds have lowest unit costs at maximum output
The empirical critique
• Eiteman’s explanation for these & similar results:
• Factories are designed by engineers “so as to cause the
variable factor to be used most efficiently when the
plant is operated close to capacity.
• Under such conditions an average variable cost curve
declines steadily until the point of capacity output is
reached.
• A marginal cost curve derived from such an average cost
curve lies below the average cost curve at all scales of
operation short of capacity,
• a fact that makes it physically impossible for an
enterprise to determine a scale of operations by
equating marginal cost and marginal revenues.” (Eiteman
1947)
The empirical critique
• Neoclassical response to this critique:
– Friedman’s “Methodology” paper:
• “The lengthy discussion on marginal analysis in the
American Economic Review some years ago is an even
clearer, though much less important, example.
• The articles on both sides of the controversy …
concentrate on the largely irrelevant question whether
businessmen do or do not in fact reach their decisions
by consulting schedules, … showing marginal cost and
marginal revenue.”
– Friedman advised economists to ignore this literature
• After making the analogy that billiard players don’t
actually use Newton’s mathematics to sink balls…
The empirical critique
• “ Excellent predictions would be yielded by the hypothesis
that the billiard player made his shots as if he knew the
complicated mathematical formulas … , could make lightning
calculations from the formulas, and could then make the balls
travel in the direction indicated by the formulas.
• Our confidence in this hypothesis is not based on the belief
that billiard players, even expert ones, can or do go through
the process described; it derives rather from the belief that,
unless in some way or other they were capable of reaching
essentially the same result, they would not in fact be expert
billiard players.” (Friedman 1953: 21)
• This evidence is in part similar to that adduced on behalf of
the billiard-player hypothesis--unless the behavior of
businessmen in some way or other approximated behavior
consistent with the maximization of returns, it seems unlikely
that they would remain in business for long.
The empirical critique
• Let the apparent immediate determinant of business
behavior be anything at all--habitual reaction, random
chance, or whatnot. Whenever this determinant happens
to lead to behavior consistent with rational and informed
maximization of returns, the business will prosper and
acquire resources with which to expand; whenever it does
not, the business will tend to lose resources and can be
kept in existence only by the addition of resources from
outside.
• The process of "natural selection" thus helps to validate
the hypothesis--or, rather, given natural selection,
acceptance of the hypothesis can be based largely on the
judgment that it summarizes appropriately the conditions
for survival…
The empirical critique
• “It is only a short step … to the economic hypothesis that
… individual firms behave as if … they … calculated
marginal cost and marginal revenue … and pushed … to the
point at which … marginal cost and marginal revenue were
equal.
• Now, of course, businessmen do not actually and literally
solve the system of simultaneous equations in terms of
which the mathematical economist finds it convenient to
express this hypothesis…
• the businessman may well say that he prices at average
cost, with of course some minor deviations when the
market makes it necessary.
• The one statement is about as helpful as the other, and
neither is a relevant test of the associated hypothesis.”
The empirical critique
• Neoclassical economists behaved “as if” they took
Friedman’s advice and ignored this empirical research
– Other schools took it seriously—e.g., Post Keynesians
• Kalecki, Eichner, Lee-Downward
– Developed “cost plus” pricing models
• Kornai
– Developed “demand-constrained” models to explain
why diminishing marginal productivity does not apply
– Another sub-school has developed
• Experimental Economics
– Neoclassical economists continue to be surprised when
this empirical information is re-discovered
• Blinder 1998
• Next critique after this: Sraffa round two…
Sraffa and input-output
• In debate over Marshall, Sraffa’s noted interdependence of markets:
– “and this will affect in the same manner the cost of
the commodity in question and the cost of the other
commodities into the production of which that factor
enters…”
• After 1930, Sraffa (based in Cambridge University UK)
attempted to state this problem rigorously
– Published “Production of Commodities by Means of
Commodities: Prelude to a Critique of Political
Economy” in 1960
• Argued marginal productivity theory of income
distribution invalid
• Position disputed by neoclassical economists in Cambridge
University, USA: the “Cambridge Controversies”…
The “Cambridge Controversies”
• Neoclassical theory argues that
– increasing supply of factor of production will
reduce its price
– reducing its price will increase its use in production
– Factor’s price equals its marginal product
– Direct relationship between supply of factor and
its price
– Models production as
• involving “factors of production” (Land, Labour,
Capital) as inputs and goods as outputs
– versus classical position: goods produced using
goods and labour as inputs
• The neoclassical position of profit and capital is…
The “Cambridge Controversies”
Labour
Output
Increasing
supply…
Decreasing price...
Marginal Product
Capital
Diminishing
marginal
product
Capital
Capital
Increasing use of factor
relative to others...
Rate of profit is the
marginal product of
capital…
The “Cambridge Controversies”
• Sraffa, 1960
– Take economy in full general equilibrium
• All “marginal” changes complete
– What determines prices in full equilibrium if all
marginal changes are over?
– Self-reproducing system of commodity production
• inputs commodities & labour
• output commodities
• equilibrium prices of outputs must enable their purchase
as inputs in next period
– System (1): Simple reproduction, commodity inputs
only:
The “Cambridge Controversies”
• 240 qr wheat + 12 t iron + 18 pigs --> 450 qr wheat
• 90 qr wheat + 6 t iron + 12 pigs --> 21 t iron
• 120 qr wheat + 3 t iron + 30 pigs --> 60 pigs
• 450 qr wheat | 21 t iron | 60 pigs (sum of inputs=sum of
outputs)
• Regardless of demand, prices must allow system to
reproduce itself:
– 450 qr wheat must buy 240 qr wheat, 12 t iron, 18 pigs
– 21 t iron must buy 90 qr wheat, 6 t iron, 12 pigs
– 60 pigs must buy 120 qr wheat, 3 t iron, 30 pigs
The “Cambridge Controversies”
240  pw  12  pi  18  p p  450  pw
System of production:
90  pw  6  pi  12  p p  21  pi
120  pw  3  pi  30  p p  60  p p
As a matrix
 240

 450
equation:  90
 21
 120

 60
Has the solution:
12
450
6
21
3
60
18 

450   pw   pw 
12     
 p    p 
21   i   i 
30   p p   p p 

60 
 1
 pw   
   10 
 pi    1   $
   1
 pp 
 2
i.e., price system for simple reproduction independent of
demand, marginal utility, etc.; depends instead on system of
production
The “Cambridge Controversies”
• System (2): Expanded reproduction
• surplus produced, split between capitalists and workers
– in equilibrium, uniform rate of profit r, wages w
A
A
a
b
 pa  Ba  pb ... Ka  pk   1  r   La  w  A  pa
 pa  Bb  pb ... Kb  pk   1  r   Lb  w  B  pb
Amount of ...
Amount of B produced
A used to
Ak  pa  Bk  pb ... Kk  pk   1  r   Lk  w  K  pk

produce B
Labor fully employed
La  Lb ... Lk  1
Aa  Ab ... Ak  A, Ba  Bb ... Bk  B...
+ive net output
The “Cambridge Controversies”
• r & w values determine split of surplus between
capitalists, workers. To determine prices, must therefore
know either r or w beforehand
– Distribution therefore not determined by “market”
– Instead, different pattern of prices for every pattern
of distribution: marginal productivity theory of income
distribution incorrect in general equilibrium
• But what about validity of production function, isoquants,
when marginal changes still relevant?
The “Cambridge Controversies”
• Neoclassical position (by Samuelson):
– Concedes Classical position more factual
• output produced by heterogeneous commodities and
labour, aggregate capital an abstraction
– But neoclassical position still defensible as an
abstraction
• Samuelson (for neoclassicals) argues
– isoquants just a parable we use to teach students
– reality is different technologies, each with fixed ratio
of capital to labour
– increase in price of capital will lead to less capital
intensive technology being chosen:
Labour
The “Cambridge Controversies”
Technology 1: low K/L
ratio, used when K
expensive
“Envelope” is isoquant
Technology 5: high K/L
ratio, used when K cheap
Capital
Decreasing price of capital means more
capital intensive methods used, akin to
simple parable that decreased price means
more capital used
The “Cambridge Controversies”
• As an aside, Samuelson ridicules classical theory’s
problems with labour theory of value, that capital-labour
ratios must be the same in all industries.
• Problem: Samuelson assumes each technology can be
represented by a straight line relationship between
capital and labour
• Garegnani shows that straight line relationship only
applies if capital to labour ratio is the same in all
industries
• If K/L ratios differ, each technology will be represented
by a curve, not a straight line
• Curves can cut each other in more than one place:
Labour
The “Cambridge Controversies”
Technology 1: low K/L
ratio, used when K
expensive
“Envelope” is isoquant
Technology 2: only used in
intermediate K/L price
range
Technology 1: could also be
used when K cheap
Capital
Problem known as “reswitching”: simple neoclassical parable
does not work when multiple industries considered.
The “Cambridge Controversies”
• Why a curved relationship?
– The definition of capital
• What is “capital”?
– Money?
– Machine?
• Both, obviously; but how to “add” machines together?
• Money value only common feature
– but money value reflects expected profit
– “rate of return” and “value of capital” thus linked
• Sraffa’s solution: reduce all machines to “dated labour”
– Machine today produced with
• labour last year, plus
• machinery inputs last year
The “Cambridge Controversies”
• If economy in long run equilibrium for indefinite past
– then all goods produced earned normal rate of profit r
– therefore value of machine now equals
• value of previous year’s inputs (labour and capital)
• multiplied by 1+r
– Do it again: replace last year’s machine inputs with
• labour and capital used to produce those machines
• multiplied by 1+r
– Get a whole series of terms for the labor input each
year multiplied by 1+r, (1+r)2, (1+r)3
– Machine/commodity component reducible to almost
(but not quite) zero.
The “Cambridge Controversies”
• Next: the “standard commodity”
– Earlier, Sraffa shows how to devise a “measure of
value” unaffected by the distribution of income: the
“standard commodity”
– When measured using this, there is a simple linear
relationship between the real wage w, the rate of
profit r, and the maximum possible rate of profit R:
r  R  1  w
This can be reworked to give an expression for the wage
in terms of the rate of profit:
r

w  1  
R

The “Cambridge Controversies”
• Each year’s labor input to producing a machine today is
thus broken down into
– the number of units of labor performed (say 1 unit)
– times the wage rate w (now expressed in terms of r &
R)
– times 1+r raised to the power of n, for how many years
ago the labor was applied:
Number of years
Wage in
r
ago that machine
n

terms of rate
1    1  r
was made
R


of profit
Rate of profit
Expression gives an unambiguous value for today’s capital
input in terms of dated labor, but…
the measured value of capital depends on the rate
of profit:


The “Cambridge Controversies”
• So rather than the rate of profit depending on the amount
of capital (marginal product theory of income distribution),
the amount of capital depends on the rate of profit
• Second problem: this relationship is very nonlinear
– First part falls uniformly as rate of profit rises
– Second part
• rises slowly as r rises
• rises rapidly as n (number of years ago rises)
– Two parts interact very unevenly
• For small change in r, second effect outweighs first as n
rises
• For large change in r, first effect outweighs second for
small n
• In between, can’t pick whether increasing r will increase
or decrease measured amount of capital:
The “Cambridge Controversies”
Value of machine produced with one unit of labor applied n
years ago at a rate of profit r between zero and 25% when
R=25%:
Made this
year (n=0)
1
w( r , 0) 0.5
1
Made 5
years ago
(n=5)
w( r , 1) 0.5
r=0
r=25%
0
0
0.05
0.1
0.15
0.2
0
0.25
0
0.05
0.1
r
w( r , 10)
20
1.5
15
Made 10
years ago
(n=10)
0.5
0
0
0.05
0.1
0.15
r
0.2
r
2
1
0.15
0.2
w( r , 25)
Made 25
years ago
(n=25)
10
5
0.25
0
0
0.05
0.1
0.15
r
0.2
0.25
Measured
value rises
& then
falls as
rate of
profit
rises
0.25
The “Cambridge Controversies”
• Can’t apply marginal productivity theory to capital:
– return to capital can’t reflect marginal product of
capital
• measured amount of capital depends on rate of profit
– numerator/y-axis (r) and denominator/x-axis
(“amount of capital”) are interdependent
– relationship is “messy”
• rises as r rises for a while
• then falls as r rises
Output
– Rate of profit therefore can’t be “marginal
productivity of capital”
Diminishing
marginal
product
Capital
The “Cambridge Controversies”
• Numerous other facets to Cambridge Controversies
• Minority of neoclassicals who got involved in debate
(Samuelson, Solow, Hahn, etc.) had 2 eventual responses
– Grudgingly conceded critique had validity and started
to develop alternative approaches to neoclassicism
themselves (Samuelson, Solow)
– Abandoned attempt to make neoclassical economics
relevant to real world and developed general
equilibrium models as abstract thought experiments
only (Hahn, etc.)
• Majority of neoclassicals assumed (wrongly) that debate
won by neoclassicals and continued on as always.
• Next major “critique” an “own goal”
“Sonnenschein-Mantel-Debreu conditions”
• Individual demand curve derived by
– Holding consumer’s income constant
– Varying relative prices
– Working out points of tangency between budget line
and indifference curves
– Normally results in downward sloping demand curve
• Except for “Giffen goods”
– Always does for “compensated demand curves”
• Market demand curves derived by…?
– Neoclassical economists posed question: does market
demand curve necessarily have same properties as
individual demand curve?
• Answer? No!
“Sonnenschein-Mantel-Debreu conditions”
• Problem
– Valid to hold income constant when considering one
isolated consumer
– But when considering a market, changing relative
prices changes distribution of income
• Under what conditions will this not affect the shape of
market demand curve?
– i.e., under what conditions can market demand curve
be guaranteed to
• Be downward sloping
• Obey axioms of rational choice (“Axioms of
revealed preference” WARP, SARP & GARP)
• When conditions don’t apply, what shape will market
demand curve have?
“Sonnenschein-Mantel-Debreu conditions”
• “First, when preferences are homothetic and the distribution of
income (value of wealth) is independent of prices,
– then the market demand function (market excess demand
function) has all the properties of a consumer demand function...
• Second, with general (in particular non-homothetic) preferences,
– even if the distribution of income is fixed,
– market demand functions need not satisfy in any way the
classical restrictions which characterize consumer demand
functions...
– The importance of the above results is clear: strong restrictions
are needed in order to justify the hypothesis that a market
demand function has the characteristics of a consumer demand
function.
– Only in special cases can an economy be expected to act as an
‘idealized consumer’.
– The utility hypothesis tells us nothing about market demand
unless it is augmented by additional requirements.’” (Shafer &
Sonnenschein, Handbook of Mathematical Economics, 1982)
“Sonnenschein-Mantel-Debreu conditions”
• Neoclassical economics response has been to invent “the
representative consumer”
• Sounds like “representative firm”, but much more
restrictive
– “Suppose that all individual consumers’ indirect utility
functions take the Gorman form... [where] ... the
marginal propensity to consume good j is independent
of the level of income of any consumer and also
constant across consumers...
– This demand function can in fact be rationalized by a
representative consumer…” (Varian 1984)
• What does this mean in terms of consumer theory?
– All Engel curves are straight lines
– Engels curves of different consumers are parallel
“Sonnenschein-Mantel-Debreu conditions”
• Remember “Engels curves”?
– Show how consumption on different commodities
change as income rises
– Four possibilities
• Luxury: consumption rises proportionately as income
rises
• Necessities: consumption falls proportionately as income
rises
• “Giffen”: consumption falls absolutely as income rises
• Neutral: consumption proportion remains constant
“Sonnenschein-Mantel-Debreu conditions”
a. Necessity
All other goods
Bananas
c. Luxury
Bananas
b. Inferior
Bananas
d. Neutral
Bananas
• All goods likely to fit 1st 3
cases: few if any likely to fit 4th
“Sonnenschein-Mantel-Debreu conditions”
• Most neoclassical economists
– Either accept conditions
– Or don’t know they exist
• Some neoclassical economists
– Take conditions seriously
– Realise theory must change
a. Banana hater
All other goods
• Engels curves will differ between
individuals because indifference
curves differ between individuals
• Engels curves could only be
identical if people were all clones
of each other
Bananas
b. Banana lover
Bananas
“Sonnenschein-Mantel-Debreu conditions”
• E.g. of first camp: the original discoverer of problem
– “The necessary and sufficient condition quoted above
is intuitively reasonable.
– It says, in effect, that an extra unit of purchasing
power should be spent in the same way no matter to
whom it is given.” (Gorman 1953)
• E.g. of second: developer of heterogenous agent models
– “If we are to progress further we may well be forced
to theorise in terms of groups who have collectively
coherent behaviour.
– Thus demand and expenditure functions if they are to
be set against reality must be defined at some
reasonably high level of aggregation.
– The idea that we should start at the level of the
isolated individual is one which we may well have to
abandon.” (Kirman 1989)
Dispute and Debate today
• Past history of debates makes critics wary about worth
of criticism
– If critique will be ignored, why bother critiquing?
• Less communication now between schools of economic
thought than ever
– Some debate within schools
• E.g., some neoclassicals involved in debate over
“representative agent macroeconomics”
• Post Keynesians debate theory of endogenous money
– Some cross-school critiques
• E.g., my critique of profit-maximisation mathematics
– See Debunking Economics website for papers
• Econophysicist McCauley’s critique of Efficient Markets
Hypothesis
• But largely, schools of thought don’t communicate with
each other…
Back to Billiards…
• My critique of the theory of the firm
– Rejected by neoclassical journals (AER, EJ)
– Published in non-neoclassical ones…
• One element
addresses
Friedman’s “billiard
players” analogy
• Set up artificial
market
• Have “trial and
error” profit
maximising firms
• Does what they do
conform to MR=MC?