Academic journal article World Review of Political Economy

What Is the Problem with Neoclassical Price Theory?

Academic journal article World Review of Political Economy

What Is the Problem with Neoclassical Price Theory?

Article excerpt

Abstract: The article seeks to focus attention on Neoclassical price theory, as one of the two problematic foundations of modern mainstream economics-the other being the theory of distribution. After outlining what is understood to be Neoclassical price theory and noting the various criticisms which it has been subject to from both within and without the school, the article proceeds to argue that its major flaws need to be understood as stemming from how it conceives of the formation of prices in the first instance. Specifically, the article argues that the basic problem with the Neoclassical theory of price is that it abstracts from both production and money in the first instance, such that when these are eventually brought back into the explanation of price it is done so in an inessential manner; one where production and money have no bearing on the findings of the analysis of price which excluded them.

Key words: price; relative price; production; money; equilibrium; inflation; perfect competition

Introduction

The simple answer to the question posed by the title of this article is its starting point; how Neoclassicals conceive of the formation of prices. At first glance the theory of price may appear as an odd, even esoteric, choice of topic given the overwhelming attention being paid by all-and-sundry to various aspects of the on-going global economic and financial turmoil. Yet, when the much needed soul-searching by the economics profession begins, as it already shows signs of beginning, many economists may be forced to take a fresh look at the economic foundations that they have hitherto held to be immutable.

Why begin the soul-searching with price theory? Well, quite simply because there is nothing more foundational than the theory of price (and implied theory of money). Indeed, the theory of price, together with the theory of distribution, provides the foundations for most attempts to understand any market-based economy.

Why Neoclassical price theory? Because the Neoclassical approach can be argued to represent the dominant view of how market economies work, and therefore any consideration of the foundations of current economic thinking needs to begin with those underpinning this approach. As the dominant view, the Neoclassical approach is seen as having failed decision-makers with respect to the current economic turmoil. It is seen as having failed to flag the potential for this turmoil and, for some, may have even contributed to it.1

What is Neoclassical Theory?2

The origins of what has come to be referred to as the Neoclassical school of thought can be traced to the writings of Stanley Jevons, Karl Menger and Leon Walras in the latter part of the 19th century.3 These writings represented a fundamental break with the then dominant Classical school whose representatives included Adam Smith, David Ricardo and Karl Marx. Whereas the Classical economists focused on classes and production when explaining economic phenomena, the Neoclassicals came to focus on the behavior of individuals and the process of exchange between them. Given the nature of the break between the Neoclassical and Classical approaches, it can justifiably be argued, as quite a few economists have done, that the Neoclassical label is a misnomer.4 However, while agreeing with this criticism of the use of the Neoclassical label to describe the general subjectivist, individualist approach to economics, I will nevertheless retain its use in the present article because of its widespread adoption in the literature. Moreover, while it is readily apparent that there are differences among adherents of this school when it comes to the explanation of economic phenomena in general and prices in particular, I argue that they share certain basic principles which are manifest to one degree or another in these explanations. It is these shared principles and common elements in the explanation of prices that I will focus on in the present article, noting in passing divergent explanations of various sub-groupings where I consider these material. …

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