I’m reading through Steve Keen’s Opus: “Debunking Economics,” a book that aims to obliterate the orthodoxy of “neoclassical economics” (not sure where this definition comes from, probably should include Keynes) and fully revolutionize the school.
Getting straight to the point I wanted to make without fully picking apart this book, Keen’s assumptions are easily debunked by examining a history of prices and inflation in the United States. The U.S. was more or less an economy consistent with Austrian-defined natural deflation from 1776 to 1913. It was not fully perfect; however, with sharp but rapid and localized recessions (see the numerous literary references to “bank runs”) scattered along the way, but these were followed by periods of deflation that made purchasing power in the U.S. decrease, on average, over time, until the Federal Reserve was instituted and began a consistent record of inflation for the next 106 years. Only 2% of bank deposits, on average, were actually lost during this period prior to the Federal Reserve. Furthermore, we know that prosperity in America increased rapidly and income inequality was far lower during this period.
However, one of Keen’s central theses is that capitalism is unstable by nature by rightly attacking the dogma of the “law of supply and demand.” Keen argues that supply and demand are fundamentally untraceable and unpredictable, which is not a new or revolutionary idea in many schools of economic theory. Aggregate demand, he says, moves in a fundamentally unpredictable manner as price decreases, due to the fact that consumer preferences are, by nature, different from one another (not a revolutionary concept) and the interaction of producers/consumers with differing preferences leads to an “unstable” demand curve. But really this is a reliance on a small but minor fallacy of the theory of supply and demand: the idea that the aggregate (sum of) consumer demand curves can’t be derived from individual demand curves due to differing consumer preferences for each product. Yes, different people will clearly derive differing utility from different products, and yet, this doesn’t really matter. The aggregation of individual demand curves is accurate enough. The individual demand curves still determine the market price quite well. We can see this pretty easily whenever a new product is introduced into the market.
Let’s say it’s year 2000 and the iPod first comes out. Whatever price Apple decides to set for the value of an iPod is determined by some combination of cost of production + perceived value of the innovation. Most people usually only purchase one iPod, not fifty, which, according to Keen is some sort of “crap-shoot” due to the idea that consumer demand preferences are unpredictable as prices decrease. As the original people who demanded the iPods become more acquainted with the features and what they’re capable of, they have begun the process of “discovering” the true price of an iPhone. As the years go by, the price of an iPhone goes down due to greater efficiency in the cost of production as well as, in part, due to new entrants into the market for portable MP3 players with similar features. The price can also remain the same or go up slightly, but this only occurs when new features are added, as output will increase if the firms in the market are capable of doing so as a profitable business. When a new product emerges on the market, the iPod disappears fully only to be replaced by a new product entirely.
Jumping over to the supply side real quickly, Keen lobs a total airball by claiming supply is fundamentally “nonexistent”, but marginal cost of production is still constrained by “finance and marketing costs” which, he claims, are “costs of distribution!” The impact of this supposed zinger should be met with laughs. Keen debunks an unimportant technicality of the fine print once again, akin to hitting a bulls eye in the wrong target. The intellectual property of a highly innovative product is, indeed, a “cost of production.” The actual components of the iPod are available for FREE assuming you can access them with your hands just beneath the Earth! Yet, Keen examines cost of production in his own, and ironically orthodox, vacuum of academic technicality. He treats the components added to the cost to add one unit of output without ever considering the inextricable link between risk and increased output. Risk necessitates the existence of finance and marketing costs for every product and service, and is therefore inextricably and always tied to the cost of production, making Keen’s entire argument invalid. We will have to look at “cost of goods sold” when we consider the marginal cost of production, not simply operating expenses, but also capital expenses.
Keen’s economic theory of supply and demand can be extrapolated to show that housing prices in the U.S., for example, could have risen due to the fundamental “unpredictability” in the interaction between the two curves, so that as housing prices rise, we may actually see an INCREASE in the demand for housing. Yet at the same time his separately-designed computer models of bank loan creation are completely reliant upon an assumption that we are working within the parameters of an unconstrained money supply. Demand for home prices can only increase as prices increase in this very unconstrained and unstable model. Is it true that gold itself is a market commodity with a fundamentally and technically unstable price? Yes, but once again it doesn’t really matter. Under a gold standard the price was very efficient and output heavily constrained by the cost of production. Other forms of commodity currencies were quickly left in the dust in favor of gold.