The Flawed Foundations of General Equilibrium Theory: Critical Essays on Economic Theory

The Flawed Foundations of General Equilibrium Theory: Critical Essays on Economic Theory

The Flawed Foundations of General Equilibrium Theory: Critical Essays on Economic Theory

The Flawed Foundations of General Equilibrium Theory: Critical Essays on Economic Theory

Synopsis

This title explains how general equilibrium, the dominant conceptual framework in mainstream economics, describes an impossible world. The book will appeal to students and researchers in economics and related social science disciplines.

Excerpt

Underneath the flawed foundations

Frank Ackerman and Alejandro Nadal

Few academic theories have achieved as much influence as the economics of competitive markets. Few eighteenth-century metaphors are as well remembered and widely quoted as Adam Smith's invisible hand. Mathematical restatements of that metaphor are endorsed by the great majority of economists, and provide the framework for a large and growing number of decisions about public policy. Prominent economists have described the invisible hand as the most important contribution of economics to social theory (Arrow and Hahn 1971:4). In the case of economics, the ivory tower casts a long shadow over social and political life.

The image of the invisible hand arises in a parable about the socially desirable outcomes of private competition. The magic of the marketplace coordinates isolated individual decisions, "as if by an invisible hand," to achieve the best possible outcome for society. The individuals are assumed to be selfish (if they were selfless altruists, there would be nothing to prove); and the optimal outcome is not foreseen or planned by anyone. In the opening chapters of his Wealth of Nations, Smith made an early, but incomplete, attempt to explain how competitive markets achieved this happy result through the price mechanism. Smith's image of invisible coordination was supported by verbal argument, with stories about bakers and butchers learning by trial and error that they will profit by selling the goods that consumers want to buy. These stories are suggestive, but do not strictly prove that the invisible hand is always in touch with our collective best interests.

Recognizing the incompleteness of the theory, economists continued to struggle with the question of the optimality of market outcomes. Almost two hundred years after Smith, his point about the invisible hand and its desirable results was apparently proved by Kenneth Arrow and Gerard Debreu, in the imposingly abstract mathematics of general equilibrium theory. Imagine an economy of many consumers and producers, selfishly engaged in optimizing satisfaction and profits and satisfying a long list of assumptions (many of which are discussed in this book). Under those assumptions, the model built by Arrow and Debreu shows that there is always a market equilibrium at which supply equals demand for every

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