## Archive for **August 2009**

## The G8 protests and the logically inconsistent foundations of neoclassical economics

Neoclassical economics is deductive, using a mathematical axiom-proof-theory format. Arnsperger and Varoufakis (2006) list the three basic axioms of neoclassical as methodological instrumentalism, methodological individualism and methodological equilibration. In such an approach the basic axioms have to be correct otherwise the whole framework becomes unsound. In contrast to the deductive approach, the scientific approach is inductive, forming theories from observation and using prediction to falsify the theories (Neuman 2003, p. 51). Neoclassical economists have become adept at avoiding empirical falsification by creating ad-hoc explanations as to why their theories fail to work when confronted with empirical evidence, for example the Efficient Market Hypothesis predicting dividend volatility in excess of price volatility but the converse is observed (Shiller 1981). Falsification avoidance is the sign of a degenerative research program (Lakatos 1976). So, rather than use empirical falsification, a more suitable approach to disprove deductive frameworks is to use a logical proof showing their axioms lead to an absurdity. The Sonnenschein–Mantel–Debreu Theorem (Debreu 1959) proves the basic axioms of neoclassical economics are logical inconsistent. The Sonnenschein–Mantel–Debreu Theorem (Debreu 1959) shows that starting with the first two axioms leads to a shapeless excess demand curve. The shapeless excess demand curve means that there are multiple equilibria and equilibrium are unstable making the third axiom untenable. To fix this problem, it is assumed that all goods have constant Engel curves. A good would have a constant Engel curve if somebody spends the same proportion of their income on the good as their income grew (Keen 2001). This is an unlikely scenario as when income grows then people consume more luxury goods and basic goods become a smaller fraction of their income. Can you think of a good with a constant Engel curve? Colander (2000, p. 3) equates neoclassical economics *“to the celestial mechanics of a nonexistent universe”* for using theory outside its domain assumption (Musgrave 1981). That is neoclassical economics as a pursuit in pure mathematics for intellectual exercise is fine but claiming applicability to the real world is misleading. Read the rest of this entry »