Re: gross substitution

[Paul Davidson <pdavidson@xxxxxxx>]

At 07:46 PM 4/15/99 PDT, you wrote:
>Professor Davidson:
>
>It seems to me that rejecting the gross substitution axiom is by
>itself sufficient to invalidate Say's Law.
>
>Then why is it also necessary to reject the ergodic axiom, which many
>philosophers say is the very basis of the scientific method?
>
>This aspect of your theory is what many of us find so difficult to
>accept.

Why do we need to reject other axioms as well? Mainly because we want a
logically consistent system including an EXPLANATION of why the gross
substitution axiom is inapplicable.  Otherwise the argument is subject to
the "as if" methodological argument of Milton Friedman and the response
that in the long run everything is always a substitute for everything else
-- and people who are introducing nonconvexities. etc are merely
introducing short-run frictions-- similar to air pressure in the universal
law of gravity  where a feather and a stone falls at the same rates. Keynes
wanted to show that it was not merely some friction that caused
unemployment -- rather it was something inherent in the use of money in an
entrepreneurial system. that is why his title is THE GENERAL THEORY OF
EMPLOYMENT INTEREST AND MONEY.  It was money and (nominal) interest rates
that affected employment -- not nonconvexities in production or less than
pure competition and labor unions, etc.

Keynes argued that it was the use of money in an entrepreneurial economy
that liquidity was the fundamental  problem--
Keynes wanted to demonstrate that money (or any other liquid asset -- even
in the absence of money) was not merely a (producible good) numeraire and
therefore the existence of liquid assets was a necessary and sufficient
condition to demonstrate the possibility of involuntary unemployment --
even in a world of perfect wage and price flexibility and complete
substitutability among factors of production and producible goods!!

.. Keynes had to invoke the  rejection of the ergodic axiom, i.e., that
agents could predict the future with acturial certainty.  If the future was
not statistically reliably predictable then people could not, and would not
plan all their coordinated income and spending plans throught the future
(as, for example assumed in the life-cycle hypothesis, the overlapping
generations models, the permenant income hypothesis, etc.) and is necessary
for an intertemporal Say's Law to hold.

Only if the future is uncertain  (rejecting the ergodic axiom) and  there
exists certain liquid assets that have chaper 17s "essential propertiers",
then even if  all isoquants and indifference curves among producible goods
and services are convex, Money is non-neutral  and Say's law is inapplicable.

Your willingness to escape Say's Law merely becasuse you reject the gross
substitution axiom  is not a general theory -- you are advocating  a
"special case" of the classical theory (which itself is a special case of
Keynes's general theory).  In other words you want to invoke a special case
of a special case to disprove Says Law.  It has long been known that if
isoquants are not continuously convex, and/or there is not complete
flexible prices, then Say's Law would be not applicable

Now this special case of a special case is exactly the strategy of  NEW
Keynesians have taken to provide short-run "Keynesian-like" unemployment
equilibrium -- and why the term NEW Keynesian (invented by Parkin in 1984)
was defined so that New Keynesianism is a theory of aggregate SUPPLY --
also see Robert Gordon's article on "What is A New Keynesian?" in the Jour.
of Econ. Literature 1990 or David Colander's 1992 EEJ article, etc.

In other words, for Ryan and for New Keynesians it was a market
imperfection of the supply side that causes the gross substitution axiom to
fail either because (1) nonconvexities in the production function, or (2)
non-flexibilities in prices.  Now, long berfore Keynes wrote, all
economists KNEW that nonflexible wages or prices and/or fixed production
coefficients could cause unemployment in the short-run!!

 Therefore if that is all that Keynes was invoking , he was not providing a
revolution in economic theory(as he claimed in a latter dated Jan 1, 1935
to George Bernard Shaw); instead he was an economic charlatan claiming to
having rediscovered the wheel.

But Keynes's claim that it was not an imperfection on the supply side that
was the ultimate and fundamental cause of underemployment equilibrium in
both the short run and the long run.  It was, as Keynes specifically states
on p. 26 of the GT,  the misspecification of the aggregatee demand function
that was the fault.

To get the more general theory's  aggregate demand function whose
parameters are independent of anything happening on the supply side (i.e.,
independent of flexible or non flexible prices, nonconvexities or complete
convexity, etc.) Keynes had to reject three classical restrictive axioms--
gross substitution in terms of liquiddity (not in terms of producibles),
ergodicity (because only in a nonergodic world would utility maximizers
seek liquidity) and neutral money (because only in a world where liquidity
was important is money non-neutral in both the short-run and the long-run.
{Please not Keynes called his equilibrium the long-period employment (GT,
p. 48)

Now all of this is in my POST KEYNESIAN MACROECONOMIC THEORY  book -- and I
would hope that before people raise these same issues over and over on the
pktnet-- they would read somthing of the POST KEYNESIAN literature-- after
all this is the Post Keynesian net and one would hope that participants
were at least somewhat familiar with the PK literature.

Many seem well versed in orthodox classical and new keynesianism -- but
refuse to spend the necessary energy to read any Post Keynesian literature
(heaven forbid reading Keynes) before criticsizing Keynes and Post
Keynesianism

Paul

Paul
Paul Davidson
Holly Chair of Excellence in Political Economy
Editor, JOURNAL OF POST KEYNESIAN ECONOMICS [JPKE]
Economics Department -- 523 SMC
University of Tennessee
Knoxville, Tennessee 37996-0550
email: Pdavidson@xxxxxxx;   phone: (423)974-4221;    fax: (423) 974-1686
http://econ.bus.utk.edu/Davidson.html