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The messy methods of macroeconomics
December 2017 / January 2018


The underlying insight was that, at the equilibrium point, a marginal change in any direction would make someone worse off, so that market forces would come into play to restore the prices and quantities found at the equilibrium. The resulting “marginal revolution” in economic ideas swept away a clutter of nonsense, from medieval notions of “the just price” to specious distinctions between “exchange value” and “use value”. If someone claims to be an economist and cannot explain why price and quantity are determined when supply equals demand, he or she is an impostor. Of course, a range of market contexts need to be analysed, and a competitive market (with many suppliers, none of which can control the price) has different outcomes from one that is oligopolistic (with a few suppliers) or monopolistic (with only one). But the same analytical tools, of supply and demand functions represented by curves in diagrams, can be harnessed in a multiplicity of situations. The versatility of the tools reflects the power and robustness of the intellectual framework.

It gets better. Microeconomics generates not just descriptions of the world as it is, but public policy prescriptions that are grounded in logic and fact. Again, the core principle is simple and appeals to calculation at the margin: society is worse off if the additional costs (or “marginal costs”) of a particular course of action exceed the extra benefits (or “marginal benefits”) that can be shown to accrue to citizens at large. This may seem so obvious as hardly to need statement. Unfortunately, much of public policy is driven by rhetoric, ideology, custom, habit and so on, and is even further mangled in practice by the political process. The key principles of welfare economics derive from microeconomics and price theory, while welfare economics lies behind “social cost-benefit analysis”.

Non-economists — even non-economists in occupations that are undoubtedly professions, like accountants, engineers or actuaries — do not have the skill set that allows them to conduct cost-benefit analysis in the same way as economists; they are sometimes surprised by the rigour, consistency and distinctiveness of the work that economists do.

I said that microeconomics with price theory, and welfare economics, plus its associate social cost-benefit analysis, are fairly uncontroversial. I have no objection to the suggestion that economists involved in these branches of the subject should be able to claim a status comparable with that of more established professions. But I have inserted the adverb “fairly” to weaken the adjective “uncontroversial”. While it is my view that an economist who cannot manipulate supply and demand curves is an impostor, a minority of economists (or perhaps of so-called “economists”) protest that price theory suffers from false assumptions and latent prejudice.

This minority alleges that the validity of microeconomics depends on a tacit premise, that the only economy of analytical interest includes the categories (firms, consumers, and — crucially — property rights) found in modern capitalism. In their judgment, wages and profits are determined not by equilibration at a margin, but by bargaining and power. As they see the matter, property rights are political in origin and enforced by the threat of state violence. In the extreme they want to junk marginalism, and instead to uphold Marx’s labour theory of value and sometimes a great deal more of the Marxist box of tricks.
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