Amongst the glossary items published this morning is this quite important one on the utterly absurd concept of economic equilibrium. Comments are welcome:
Equilibrium is the state to which classical, neoclassical and neoliberal economists all think that an economy should aspire.
Equilibrium exists at the point where supply and demand within an economy are matched and no participant in that economy has an incentive to change their position because to do so would leave them worse off, meaning that the optimal situation that equilibrium suggests exists will have been foregone.
Theories of equilibrium assume that all participants in an economy are:
- Rational, meaning that they behave consistently.
- Are in possession of perfect knowledge i.e. they not only know what they want to achieve at a point in time and how they might achieve it because they are aware of all the options available to them but are also aware of this information for all time to come.
- Aware that equilibrium is the outcome of a dynamic process that they now wish to halt because an optimal outcome has been reached not only for themselves but all other market participants.
The idea of equilibrium, with the stable state that it implies, is borrowed from physics, where it can be observed. In contrast, economic equilibrium has never been achieved because the conditions for it to do so are quite obviously absurd and contradict all known and observable human behaviour.
Because it is claimed that supply and demand are stable and have delivered both optimal prices and optimal levels of supply at the point at which economic equilibrium happens the theory of equilibrium is necessarily dependent upon and embraces theories of market supply and demand and of the profit maximising firm upon which the foundations of neoclassical economics (are built, as are those of neoliberal economics. These theories are built upon the idea that a firm can accurately predict the demand for its product at each price at which it might offer it for sale and also its own marginal (or total additional) cost of producing each item that it supplies at every possible level of production so that it can equate its supposed marginal cost for an item it makes available for sale with the additional or marginal extra revenue that it will generate from doing so. It is then argued that the firm in question will continue to supply that product until such time as the two are equal.
It is important to note that no firm in history has ever been in possession of this information.
It is also important to note that the only conditions in which they might have this information are those where:
- The products of one firm are incapable of being differentiated from those of another firm so that the consumer is indifferent as to which firm supplies them, which is almost certainly a condition that has never existed.
- There are many firms in a market and each is so small that they cannot influence the price of the product that they make in that market, which is an assumption that contradicts what is now known about the behaviour of even very small numbers in mathematics.
- There are no barriers to entry to firms that wish to make supplies in a market meaning that it is assumed that all firms can have access to the technology, labour and capital that they need to have possession of to make a product. It is also assumed that each firm who wants it can also have such possession instantaneously if a change in demand for the product requires that additional supply be created it can be delivered instantaneously. These conditions have never existed anywhere, at any time.
The implication of these conditions is that only markets can deliver equilibrium outcomes within economies and what is assumed to be the distortionary activity of government is not required because the optimal position created by a market meeting these conditions cannot be bettered.
Although, as noted, it is impossible that the conditions that might deliver economic equilibrium might ever exist the achievement of this state remains the goal for almost all neoclassical economics and neoliberal economics. The argument that each presents that government interference prevents equilibrium is not based on an analysis of any achieved state of equilibrium but solely upon the assumption that government action will prevent this state being achieved when that is already inevitable because equilibrium will always, as a matter of fact, be impossible to deliver.
It is accepted that neoclassical and neoliberal economists can and do relax the assumptions pertaining to the achievement of equilibrium when undertaking their work, and this cannot be disputed. However, this relaxation is usually undertaken to determine the supposed cost of the sub-optimal outcome that they suggest arises within the economy as a consequence of that sub-optimal behaviour so that they might suggest the gain that might arise if only the perfect market to which they (alone) aspire was in operation. As such these relaxations are largely meaningless.
The concept of equilibrium lies at the very heart of neoclassical, neoliberal and positive economics and so at the very heart of much of the work of the economics profession whilst simultaneously explaining why most of the work of that discipline is as inevitably flawed and destined to fail as that of the alchemists always was. If you work on the basis of flawed assumptions you can never achieve a useful result.
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I think you have covered the ground. The item is already long, so the only observation I would offer is to cross reference it to Hyman Minsky’s Financial Instability Hypothesis, since the FIH cuts the feet from under the whole neoclassical-neoliberal superstructure.
The short form version is simply to say the theory of equilibrium is fundamental to the discipline of economics for neoclassical and neoliberal economists; however, there is no enduring state of equilibrium; it is not an observable economic phenonmenon. It is purely an abstract idea, like ‘perfect competition’. It does not exist in the real world, therefore equilibrium in economics is a redundant idea.
Noted
Might the emphasis on “Equilibrium” be a submerged message that orthodox economics does not/ should not need any regulation and that it is “pure” and is/ should be considered to be detached from human beings and their foibles?
If it is it remains about absurdity
Very interesting.
My introduction to the concept of equilibrium was through cybernetics and organisational theory – the use of ‘feedback loops’ to guide organisational behaviours, responses and policies (Stafford Beer etc.,)..
The key thing I learnt from this was that if the objective was to align an organisation with the real world, that any equilibrium achieved was fleeting and temporary to varying degrees depending on what you were looking at. A well managed organisation would regularly consult its feedback loops and change so that it was in tune with the outside world – that was what cybernetic equilibrium meant to me (Beer went on to work with President Allende in Chile to work on industrial and economic policy – worker participation, decentralisation and regulation etc. , before he was kicked out when Allende was deposed by one of Thatcher’s best friends).
Then I read Steve Keen in ‘Debunking Economics’, and his take was that economic equilibrium as defined by Neo-liberalism was a gross over-simplification and an imagined point of time that instead of moving and changing was simply static – some sort of perfect state.
Keen contended that no such equilibristic state existed because – as noted in cybernetics – there is constant churn in any environment anyway and that what was often put forward as equilibrium was merely a clumsy summary of extremely complex data at one point in time – a multitude of equilibria for each sector of say an economy that had its own logic and key points in time. The data was simply too complex to reduce down into something useable. There is not one truth in the function of an economy. There are many and they can change. Economics is not physics.
But that never prevented the Neo-liberals from creating their own reality and claiming that one perfect form of equilibrium existed in order to add power to their lies about the world. It’s a reductionist view as Keen points out.
I follow Steve on this
‘Churn’ is a concept I as a lay person struggle with. I always assumed it meant turnover but now it appears to have a different explanation when used in politics
If you google the word you are faced with so many different examples.
Maybe a useful addition to your glossary?
I have noted it
‘”The argument that each presents that government interference prevents equilibrium …'”
I seem to remember that some versions of traditional micro economics do say that govt intervention is called for when the conditions of perfect equilibrium are not fulfilled – ie they do not always suggest that equlibrium would be achieved provided govt doesnt interfere,
I suppose they would argue that the perfect equilibrium state is a useful if theorietical benchmark against which to measure the actual state of an economy – eg degree of monopoly etc etc.
But they stick to the idea
And demand it be delivered
Which is what I think you heard
I got the same impression as Pilgrim from reading Steve Keen.
Yet the term is still deployed.
Another term I find dubious is ‘structural deficit.’ Might just be me.
Added to the list – one I had missed
It may not be a very supportive entry….
Another term I struggle with is Whole of Government Accounts, or is it already covered elsewhere?
Not yet due, but on my list
Not sure what happened to my question Richard, but I was asking if Whole of Government Accounts will be included?
I thought I answered it
Apologies if I made a mistake
That entry is coming – explaining what it is and why it is problematic
Enjoying the glossary, will you be publishing it in book form? Sorry if I’ve missed it, but will you be tackling Public Goods and Natural Monopolies? I’ve seen these misunderstood by some who claim to be knowledgeable and it would be great to have something definitive to refer to.
Both are ion my list
Neither has been written as yet – although I have written on public goods before
The aim of equilibrium in neocon theory is to achieve a “steady state” economy akin to physical theory. Just looking at supply and demand and deliberately stating that “externalities” are not to be introduced thus ignoring major economic factors that now affect production and consumption such as war, climate change, ecological degradation, the exhaustion of critical minerals that will occur with ever-increasing economic growth that is advocated by the neocons means they are living in a complete fantasy world cut off from the changes in real life on earth.
Hopefully “externality” will be in the glossary.
And “market failure”.
I have just pout externality live, at your request
Market failure needs more work as yet
Is that externality entry too brief?
If equilibrium is nonsense then DSGE beloved of the so called New Keynesians is nonsense on stilts
I totally agree
I will get to it
Oh DSGE was a great advance for academic economists. The number of papers that can be published in that branch of applied mathematics is phenomenal – and think of the grants! Quite a shock to the general equilibrium.
Wasn’t it the Central Banker Raimondas Kuodis who said (more or less) that DSGE was brilliant, but the only problem with DSGE models is that; they aren’t Dynamic, they aren’t Stochastic, they aren’t General, and there isn’t Equilibrium. Roughly.
I think Kuodis is from Lithuania, so perhaps he is helped by not being the meek economic gopher for some Anglo-Saxon Financial Pirate.
Some readers may think I have confused the Gopher (a small North American rodent), with a gofer (someone who runs errands) in my comment on DSGE.
I haven’t, I am talking about a special category of economic gopher, gofer.
There’s a related term used all the time in economic commentary – “shock”. Any unexpected influence on economic activity is a “shock” – a pandemic or a war, or even some new regulation. It’s as if the economy is a finely balanced gyroscope, in a stable equilibrium, which gets thrown into a new position by a “shock”. Maybe a glossary entry – shock: equilibrium theorists term for an unexpected influence.
On the list
How do you differentiate from black swan? Just musing….
We’ll I think of black swan as something happening that is so unlikely only a few consider it. Think of the tails in a probability distribution. Whereas “shock” is used to describe any upset to the current economic status quo, even if it’s widely predicted and not that major. Eg, broadband / mobile operators price gouging consumers with 15% price rises would be considered a “shock” to the equilibrium, leading to a new equilibrium, but I think no one would call that a black swan event.
OK, fair comment
I was curious and you have provided an indicator of scale
I have both to do now
The thing is is that economics is about embracing complexity – the inter-relationships between sectors of the economy, the money supply, trade, supply chains, human reactions to these and trying to make sense of it.
Neo-liberalism decided to ignore that and set out on a a route of self justification using reductionism – reductionism should in my view included in your glossary perhaps. But reductionism is a complex topic in itself.
So I thought about this you might be better to include a section on ‘lying’ instead as a sub-section of ‘Neo-liberalism’.
Send me an entry….
At the risk of being too frivilous, can you have two seperate entries.
One for ‘ Capitalism’ and one for ‘Capitaism’
I will think about it
But not for long..
I was trying to be funny or even sarcastic that is all.
But if you are serious………………………?! I won’t use wears words either.
You can…
“assume that all participants in an economy are:” “Rational, meaning that they behave consistently.”
“Are in possession of perfect knowledge i.e. they not only know what they want to achieve at a point in time and how they might achieve it because they are aware of all the options available to them but are also aware of this information for all time to come.”
It is always nice to match theory (or in this case fantasy) to the real world – empirically how does the above “theory” look?
I follow stock markets, a filthy habit but remunerative. Rockwool – earlier this month @ circa 290DK (pre yearly results announcement), the results pretty much matched expectations, shares tanked to below 210Dk. Vestas, 2012 trading at 23Dk – (breakup was 47Dk by the way. “Rational, meaning that they behave consistently.” – stock markets behave consistently – consistent in that there are a large number of imbeciles taking part.
Electricity markets? Now we are on much firmer ground since, to a high degree of accuracy, elec demand can be predicted 24hrs ahead, indeed days ahead. The stochastic element in generation (renewables) can be predicted to a high degree of accuracy, 24hrs ahead. This starts to meet the considition: “all participants in an economy (markets) are in possession of perfect knowledge”. I can think of at least 20 to 30 times in 2022 when elec wholesale prices changed by 2 orders of magnitude within 4 hours. Two cases where two markets react hysterically. Doubltess there are more.
Whoever cooked up the economic equilibrium theory needs to get out more – reality shows that it is garbage and those that support it imbeciles.
Sometimes I wish you would get off the fence Mike 🙂
Surely the problem is that most economists seem to think their subject is a science. It isn’t. It isn’t even a social science. It is one of the arts. And, as practiced by many, one of the dark arts.
Mike,
Isn’t the wide fluctuations in the electricity market due to marginal costing of the final MWh needed to meet demand. As I understand it, every half hour, bids are made for the electricity demand. However, since we want a stable supply, whatever the cost of the final MWh needed has to be paid. The issue is that under the current system, that is the price then paid for all the MWh. So, if there is enough wind/solar to meet demand, then expensive gas generation is not needed, and the price is reasonable, but if any gas generation is needed, the price shoots up.