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Methodology for a NewMicroeconomicsThe Critical Foundations
LAWRENCE A. BOLAND
Simon Fraser University, Burnaby, British Columbia, Canada
Lawrence A. Boland, 1986, 1987, 1993, 1998
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To my students from Milwaukee to Lawrence A. Boland, 1986, 1987,
1993, 1998Vancouver who question and criticize when
First published by Allen and Unwin, Inc. 1986.
they cannot understand.The 1993 version was reset and reprinted
at Simon Fraser University. Thiselectronics version was published
1998.All rights reserved. No part of this book may be reprinted
orreproduced or utilized in any form or by any
electronic,mechanical, or other means, now known or
hereafterinvented, including photcopying and recording, or in
anyinformation storage or retrieval system, without permission
inwriting from the author.
Publication data for 1986 and 1987 editions:
British Library Cataloguing in Publication DataBoland, Lawrence
A.
Methodology for a new microeconomics: the critical
foundations.1. Microeconomics
I. Title338.5 HB 172
ISBN 0-04-330407-9 (paperback)ISBN 0-04-330351-X (hardcover)
Library of Congress Cataloguing in Publication DataBoland,
Lawrence A.
Methodology for a new microeconomics. Bibliography: p.Includes
index.1. Microeconomics. I. Title1985 HB172.B545 338.5 85-6085
ISBN 0-04-330351-X (hardcover)
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Lawrence A. Boland
Acknowledgements
I wish to thank Tereasa Chudy, Shyam Kamath, Donna Wilson,
IreneGordon, David Hammes, Chris Jensen, Judy Alexander,
GeoffreyNewman and Zane Spindler for the many criticisms and
suggestionsoffered after reading the first draft. I also appreciate
the learnedassistance provided by John Heaney, Ken Collins and
Terry Heaps withregard to chapters 5 and 6. Students in my
undergraduate
microeconomic theory seminar deserve special praise for their
criticismsof my presentations of the ideas in this book.
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Preface
Secondary roads are preferred.... It was some years agothat [we]
first began to catch on these roads.... [T]heseroads are truly
different from the main ones. The wholepace of life and personality
of the people who live alongthem are different. Theyre not going
anywhere. Theyrenot too busy to be courteous. The hereness and
nowness of things is something they know all about. Its the
others,the ones who moved to the cities years ago and their
lostoffspring, who have all but forgotten it. The discovery wasa
real find.
Ive wondered why it took us so long to catch on. Wesaw it and
yet we didnt see it. Or rather we were trainednot to see it.
Conned, perhaps, into thinking that the realaction was metropolitan
and all this was just boringhinterland. It was a puzzling thing.
The truth knocks onthe door and you say, Go away, Im looking for
the truth,and so it goes away. Puzzling.
Robert Pirsig [1974, pp. 45]
Over the last twenty-five years an ever widening gap has
appearedbetween what we teach economics undergraduates and what we
expectgraduate students to understand. The gap is due entirely to
our graduatetheory classes since the microeconomics we teach our
undergraduateshas not changed significantly from what we taught in
the late 1940s.Today the gap between what we teach at these two
levels is such that itamounts to a contradiction.
Graduate microeconomic theory is considered a new
microeco-nomics. Graduate students are supposed to be concerned
with thedisequilibrium foundations of equilibrium economics rather
than withthe static descriptions of a market where demand equals
supply. The oldmicroeconomics that we teach undergraduates is
concerned with only asimple appreciation of the virtues of a world
governed by a marketsystem that is, an appreciation that if
everyone were guided by marketdetermined prices and were satisfied
by making their decisionsindependently, we would have an
equilibrium which is the best of all
possible worlds. While graduate students are supposed to
understanddisequilibrium economics, undergraduate students are
supposed to be
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Introduction
ON THE FOUNDATIONS OF COMPARATIVE STATICS
We have now to examine the general relations of demandand
supply; especially those which are connected with thatadjustment of
price, by which they are maintained inequilibrium. This term is in
common use and may beused for the present without special
explanation. But thereare many difficulties connected with it,
which can only behandled gradually.
Alfred Marshall [1920/64, p. 269]
It may seem discouraging that brilliant mathematicaleconomists
are able to prove little more than they assumein this area, but
there may be a methodological problemthat inhibits progress. No
sooner is a mathematician letloose on non-market-clearing problems
than he attemptsto prove the existence of a static equilibrium in
which
there is no incentive for an agent to change prices.Perhaps the
fixation on equilibrium is a crucial handicap.Robert J. Gordon
[1981, p. 514]
One sometimes has the impression that there are only twogroups
of economists: those who do not understand adifference equation;
and those who understand nothingelse.
Joseph Schumpeter [1954, p. 1168]
This book is a methodological examination of neoclassical
economictheory. It is primarily concerned with one fundamental
analytical tool of neoclassical economics namely, the idea of an
economy being in acomplete state of equilibrium. There seems to be
widespread agreementthat what is taught in traditional textbooks
about equilibrium falls farshort of providing an adequate
methodological foundation for itsunquestioned use as a basis for
explaining the behavior of individualconsumers and producers.
Recent efforts to repair neoclassicalequilibrium models have
unfortunately been directed at identifying ad
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Lawrence A. Boland
1The State of Equilibrium as anOptimum
It has long been held on philosophical grounds that productmust
be a homogeneous function of the first order of allthe variables,
and that if this is not so, it must be eitherbecause of
indivisibility or because not all [inputs] havebeen taken into
account. With regard to the first point, it isclear that labeling
the absence of homogeneity as due toindivisibility changes nothing
and merely affirms by theimplication that indivisibility does
exist, the absence of homogeneity.
With respect to the second point, ... [it] is a scientifi-
cally meaningless assertion that doubling all [inputs]
mustdouble product. ... [T]he statement is meaningless becauseit
could never be refuted, in the sense that nohypothetically
conceivable experiment could ever con-trovert the principle
enunciated. This is so because if product did not double, one could
always conclude thatsome factor was scarce.
I suggest that ... inputs ... be confined to denote mea-surable
quantitative economic goods or services. Theproduction function
must be associated with a particularinstitution (accounting,
decision-making, etc.), and must be
drawn up as of any unique circumstances pertaining to
thisunit....
So defined, the production function need not be homo-geneous of
the first order. If really homogeneous,marginal costs would always
be constant. It is indicativeof the lack of integration ... that
many writers assume U-shaped [average] cost curves in the same
breath withhomogeneity of the production function.
Paul Samuelson [1947/65, pp. 845]
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Lawrence A. Boland
errors that could endanger later efforts to put men on the Moon.
In otherwords, the first attempt was a mechanical success but a
scientific failure.
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wo ds, t e st atte pt was a ec a ca success but a sc e t c a u
e.Since disequilibrium is a state where at least one decision-maker
is
making errors, and since some of those errors may be part of a
process of learning, it would be grossly misleading to base our
understanding of
7disequilibrium economics on dynamic tools such as optimal
controltheory and dynamic programming. While they may be
appropriatetechniques for well defined mechanical engineering
problems, they arenot obviously relevant for the questions of
equilibrium processes where,as Hayek argues, learning from ones
errors plays a central role. Equilibrium vs Equilibrium
Processes
In modern Austrian economics ... we find the problem of
knowledge to be a matter of fundamental concern. In 1937Professor
Hayek divided the subject matter of economicsinto the pure logic of
choice and the enquiry into thedissemination of knowledge. In 1946,
in criticizing mostmodern theories of market forms, he pointed out
thatcompetition is a process, not a state of affairs, and that
itreflects continuous changes in the pattern of knowledge.
Ludwig M. Lachmann [1976, p. 55]
When Professor Hayek, ... in presenting Economics andKnowledge,
suggested that the most important task of economics as an empirical
science consists in explaininghow men come to acquire knowledge of
the datagoverning the markets in which they operate, ... the
wholeproblem was stated in equilibrium terms. ... After what
hashappened in economics in the last 30 years we are todayinclined
to look askance at the whole notion of equilibrium, and even more
so at the Hayekian version of 1936 in which we were told It can
hardly mean anythingbut that, under certain conditions, the
knowledge andintentions of the different members of society are
supposedto come more and more into agreement.... But even if
wediscard the equilibrium terms in which the problem wasfirst
stated, it nevertheless remains. In a stationary world... time will
in the long run, hammer logic into brains andteach its human pupils
what they must do to achievesuccess and stave off failure. Why this
should be so in achanging world is by no means clear.
Ludwig M. Lachmann [1982, pp. 6356]
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Part IV
Avenues for a New Microeconomics of Non-equilibria
Lawrence A. Boland
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9 Ad Hoc Theorizing about PriceDynamics: A Slippery Slope
[I]t cannot be denied that there is something
scandalous in the spectacle of so many peoplerefining the
analyses of economic states which theygive no reason to suppose
will ever, or have ever,come about. It probably is also
dangerous.
Frank H. Hahn [1970, pp. 12]
Let us now return to where we began, the theoretical problem
presentedby Arrow [1959]. In this chapter we wish to apply what we
have learnedso far to a critical evaluation of research programs
based on Arrows
theoretical challenge. Recall that he said that our
microeconomic theoryexplains an individuals behavior by presuming
the individual is a pricetaker while at the same time presuming
that the individual facesequilibrium prices. At best, our
microeconomic theory is incomplete; atworst, it is a contradiction.
If we wish to complete the theory of thebehavior of all individuals
who are presumed to be equilibrium-pricetakers, we need to explain
the process by which prices are adjusted totheir equilibrium
values.
The most common explanation of price adjustment is based on
thetheory of an imperfectly competitive firm. An imperfectly
competitive
firm is thought to be facing a downward sloping demand curve
whichrefers to the demand at many prices rather than just one
price.Explaining prices using such a firm begs the question of how
a firmknows the entire demand curve it faces [see also Clower,
1959]. A feweconomic theorists have interpreted this correctly to
be a matter of learning methodology [e.g. Gordon and Hynes, 1970]
along the linessuggested by Hayek [1937/48]. Unfortunately, most
economic theoristshave viewed Arrows problem as one of deciding
what to assume whenbuilding a mathematical model of the market
equilibrium [e.g. Hey,1981; Fisher, 1981].
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Lawrence A. BolandNames index
Alchian, A. 1401, 172 Grandmont, J. 63, 174
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, , , ,Alexander, J. 176 Grossman, H. 6, 174Allen, R. 48, 73,
178 Grossman, S. 174Aristotle 69Arrow, K. 67, 10, 20, 25, 34, 36,
59, 61, Hahn, F. 29, 34, 64, 104, 111, 133, 1367,
64, 104, 110, 117, 129, 133, 138, 146, 142, 174172 Hanson, N.
123, 174
Barro, R. 6, 172 Hayek, F. 34, 59, 93, 97107, 11011,Batra, R.
83, 172 11617, 120, 129, 133, 140, 150, 164,Baumol, W. 36, 172 166,
172, 1745Becker, G. 17, 172 Hey, J. 118, 1234, 133, 156, 175
Bell, D. 172, 174 Hicks, J. 25, 47, 55, 73, 75, 107,
147,Bennassy, J. 63, 172 1501, 155, 175Bhm-Bawerk, E. 32 Hirsch, A.
128, 175Boland, L. xv, xvi, 9, 1617, 19, 223, 59, Hitchcock, A.
118, 175
745, 119, 123, 1278, 138, 154, 1634, Hollis, M. 38, 175166, 168,
1726, Hoover, K. 128, 175
Boyer, C. 69, 87, 173 Houthakker, H. 47, 175 Hurwitz, L.
175Caldwell, B. 128, 173 Hynes, A. 7, 110, 117, 120, 133, 139,
174Chetty, V. 125, 173Chipman, J. 76, 78, 83, 1735 Infeld, L. 17,
174Clower, R. 5, 30, 345, 64, 108, 133, 138, Intriligator, M.
99101, 175
173Coase, R. 32, 34, 146, 173 Kaldor, N. 144, 175 Keynes, J.M.
5, 30, 345, 59, 129, 1445,Devany, A. 40, 173 14752, 1545, 15960,
1667, 1725,Dorfman, R. 99100, 173 177Drazen, A. 63, 145, 173 Kline,
M. 69, 87, 175Drze, J. 63, 173 Koopmans, T. 24, 61, 1046, 117, 175
Kristol, I. 172, 174Einstein, A. 17, 174
Lachmann, L. 1034, 175Fels, R. 128, 1734 Lancaster, K. 33, 143,
175Fisher, F. 39, 57, 64, 93, 956, 104, 107, Latsis, S. 16, 155,
175
110, 117, 133, 1357, 142, 147, 156, Leamer, E. 125, 175174
Leibniz, G. 6970, 73Frazer, W. 175 Leijonhufvud, A. 144,
175Friedman, B. 122, 174 Lester, R. 59, 1756Friedman, M. 111, 127,
1724, 1767 Lloyd, C. 76, 173, 176Frisch, R. 80, 174 Loasby, B. 146,
176Frydman, R. 123, 174
Machlup, F. 59, 176Gordon, D. 7, 235, 110, 117, 120, 133, 139,
de Marchi, N. 128, 175
174 Marshall, A. 1, 35, 31, 43, 57, 96, 146, 176Gordon, R. 1,
142, 174 Modigliani, F. 176
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