Home > Uncategorized > Supply and Demand: fundamentally flawed model of labor market

Supply and Demand: fundamentally flawed model of labor market

from Asad Zaman

I am currently engaged in teaching the final semester of Advanced Micro in our Ph.D. program. I have freedom to do here at PIDE, Pakistan, what may be extremely difficult in US/Europe — My course is built around demonstrating how conventional micro theory is strongly contradicted by empirical evidence. I also go on to build a convincing alternative. The first lecture on micro topics, starts by dismantling the fundamental Supply and Demand model in the context of the Labor Market. This is exactly where Keynes starts his book the General Theory. What amazes me is that conventional Labor Econ texts use exactly the same theory that Keynes demolished, and never mention Keynes — his objections are swept under the carpet, instead of being adressed or answered. I have posted an outline of the first lecture on WEA Pedagogy Blog:

This is an outline of the lecture 3 in Advanced Microeconomics — expands somewhat on the slides available from the link. This should be useful to heterodox economists looking for ways to teach an alternative course, radically different from conventional approaches. First two lectures consisted of some preliminary math, and can be skipped without lack of continuity.  Video of the lecture (90m) is available at the bottom of the post.

Supply & Demand is Central to Economics: This is the modern Theory of Value. The market price determines the value – this is in conflict with classical conceptions of value.

BUT, this theory is WRONG!  The central question in theory of Value is: HOW are prices determined? Why are water and tomatoes cheap, and why are diamonds expensive?   read more

 

  1. April 8, 2017 at 12:03 am

    What Keynes focused on was the importance of *demand* and, specifically, propensity to spend on the part of consumers, in determining employment. In a pure Keynesian world, employment is determined by the demand for goods and services, not by the cost of employees. In a pure Keynesian world, the number of employees hired are the minimum needed to fulfil the demand for goods and services, and not one more — even if the additional worker would be paid 1 cent an hour, he’s not going to be hired, because then the competitor that *didn’t* hire that extra worker will be able to undercut you on price and put you out of business. The employees are paid as little as the employer can get away with (see previous), but the number of employees hired is not related to the price of the employees — they’re the minimum needed to meet demand, and if their price in the economy is too high, the prices of goods and services sold rise in order to a) reduce demand, and b) thus increase unemployment enough that the price of labor can be driven back down again.

    In short, in a Keynesian world, employment converges upon the minimum needed to fulfil the demand for goods and services in the economy, regardless of the price of labor or the supply of labor. If labor becomes expensive, in a Keynesian world employers raise their prices, which in turn reduces consumer demand, which in turn reduces need for employees and thus the price of employees. In a Keynesian world unemployment is the gap between the available supply of labor, and the amount of labor needed to fulfill consumer demand for goods and services.

    Of course, we no longer live in a Keynesian world, thanks to internationalism. In Keynes’ time, international trade was fairly insignificant as far as the US economy is concerned, less than 5% of the US economy prior to the Great Depression. In today’s world, the labor to fulfil consumer demand for goods may be in China, meaning that even if you increase demand here in the United States, it will not affect unemployment here in the United States as much as Keynes would have predicted if he’d had the statistical tools we have now.

  2. May 9, 2017 at 1:04 pm

    This is a good lecture recommended for all students who have only received mainstream economics teaching. However, as this lecture should be accepted by wider audience, I think that several points should be improved.

    As this is a lecture for 90 minutes, you talk about many things and I cannot comment on all of them. These are only four most important points.

    (1) The names of economic theories or schools of economic thought
    The primary contrast should be classical economics and neoclassical economics. At the first part of your lecture, you use two terms in a standard and meaningful way: Classical economists vs. Modern answers. After you start to talk about Keynes and his theory of employment (or involuntary unemployment), you start to use the confused terminology introduced by J. M. Keynes. He called all economists “classical economics” including classical and neoclassical economists before him. This denomination is a bad one and the origin of many of confusions. Please tell students on this and use your terminology in a more standard way. If not, students will be bewildered by confusions.

    (2) Law of supply and supply
    The law of supply and demand is flawed not only for labor market but for almost all industrial products (including services). If you only emphasize that the law of supply and demand is wrong for labor market, you may mislead your students that in the product market the law holds. As David Ricardo explicitly claimed in Chapter 30 of his Principles of Political Economy and Taxation just 200 years ago, this is one of the most important oppositions between classical and neoclassical theories of value.

    (3) Complexity theory
    You mentioned here only briefly. I believe you are just preparing for a later lecture that introduces complexity science more fully and complete. You refer to P8 Keynesian Complexity. It is full of arguments that people should know. They are almost all correct but it does not seem to me sufficient.

    Complexity theory is composed of two parts. One is systemic theory and the other is behavioral theory. You talk only about systemic side. When we argue economics, it is necessary to criticize its main systemic idea: equilibrium. You are of course opposed to general equilibrium framework. In order to go beyond it, you must present an alternative framework on which to construct more realistic economics. A key concept will be in my opinion dissipative structure. See
    https://www.researchgate.net/publication/236149834_Economy_as_a_Dissipative_Structure

    You are also opposed to optimization. Here you are concerned with behavioral side of the complexity theory. We need a true theory of economic behaviors and human knowledge. I believe it is a C-D transformation. See
    https://www.researchgate.net/publication/301766363_Microfoundations_of_Evolutionary_Economics

    (4) Classical theory of value
    Labor theory of value is not a unique classical theory among various theories of value. It is usually interpreted that David Ricardo preached labor theory of value, but this is not correct. It is true that he started to explain his theory by the simplest case where labor is the unique input for a production. Later he introduces materials and machines. His theory is some thing what we have to call cost-of-production theory of value (in this cost of profit, he includes “normal” profit). See the footnote at the end of Section 6, Chapter 1 of the Principles.

    P.S. By the way, we are both members of the ResearchGate. We may know more closely through RG. Your papers The Death of a Metaphor: The “Invisible Hand” and The Conflict between General Equilibrium and the Marshallian Cross seem very interesting (I have not yet read them through. I have only read abstracts).

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