Monday, 7 November 2011

Critiques of economics

In the comments section of a recent post at TVHE blog the question of Keen's critique of economics given in "Debunking Economics" is raised. Responses to Keen's argument have been made in a number of different places. As to local blogs, in the past, Matt Nolan has commended here and here and I have posted here, here and here. Canadian economist Chris Auld has a more detailed discussion in Auld, M.C., 2002. Debunking Debunking Economics. Working Paper, University of Calgary. Available at

An executive summary of a standard reply to Keen's arguments about models of firm behaviour would be that given by Schiffman (2004: 1909-1)
According to Auld, Keen is mistaken concerning the distinction between perfect competition and monopoly (or lack thereof—topic 3), and his perception that mainstream modeling ignores dynamics (topic 6). These errors, in Auld’s estimation, are caused by "either a lack of familiarity with the literature, conceptual errors, or both". As Auld shows, perfect competition can be rigorously derived as the limit of a model of imperfect competition (as the number of firms becomes large). Assume that each firm takes competitors’ outputs as given, but recognizes that it has some degree of market power (its own output influences the market price). The ratio of output under this form of imperfect competition to output under perfect competition is n/(n+1) (where n is the number of firms). When standard theory assumes that firms take prices as given, it is making an innocuous assumption; for example, an imperfectly competitive industry with 100 firms will produce slightly over 99% of the perfectly competitive output.
Another possible approach to rigorously deriving perfect competition is to assume there exists a continuum of firms. In such a situation , it is literally true that any firm can change its output without changing price, even when the market demand is smooth and downward-sloping. Aumann, R. (1964) ("Markets with a continuum of traders," Econornetrica 32:39-50) is a standard reference.

Overall Schiffman notes,
To summarize, Keen is correct that many issues that should be taught to students are not being taught. There is need for a book that introduces students to controversies in theory and methodology, on a level that is accessible to advanced undergraduates. Debunking Economics is, however, too biased to fulfill this need. If one wishes to advocate a reform of economics (and Keen may very well be correct that it is a necessity), one must provide a more nuanced, more accurate, and more up to date picture of its current state.

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