If you had an economics course at school or college, classical theory is unlikely to be the theory you were taught. Instead you would have been taught the neoclassical theory that was developed in the late nineteenth century by writers like Jevons or Marshall. It is arguable that neoclassical theory gained its popularity because the classical theory, having by then been adopted by socialist writers, had a rather disreputable image in polite society. The neoclassical theory appeared considerably more sophisticated. It was more mathematical and had a scientific feel.34 Its plausibility for young students is enhanced by a beguiling use of diagrams. For those of you who did not take an economics course, figure 3.8 is what millions of students have been given as the theory of price.

There are two lines, sometimes drawn slightly curved: one is called the supply function, the other the demand function. The demand function rests on the commonsense notion that if something is cheap, people will buy more of it, so it slopes down. Teachers have little difficulty getting this idea accross to their class.

The other line, the supply function, is shown sloping the other way. What it purports to show is that as more is supplied, the cost of each item goes up. Teachers have more difficulty with this, as common knowledge and experience will have taught students that the reverse is the case: as industries ramp up production they find they can produce more efficiently and supply the output at a lower cost. Such objections provoke some hand waving at the blackboard as well as excuses.35

The great thing about a classic diagram is that it is both memorable and intuitively understandable. If you can present math this way you leverage the processing ability of our visual cortex to understand it. That is why Venn diagrams are so much easier for students to grasp than axiomatic set theory [Lakoff and Nunez, 2001]. Our brains tell us that if it looks right, it not only is right, but it is real. So having seen the diagrams, students come out thinking that supply and demand functions are real things—after all, they have seen them. Not only that, one can see that the intersection of these functions exactly predicts both the quantity of the commodity sold q, and its price p.

Had the theory been presented entirely in algebraic form it would be more confusing, less appealing, and more subject to critical analysis. I will demonstrate that once you convert it to algebraic notation it is evident that the theory violates two cardinal principles of the scientific method. Its science feel is faked.

“Occam’s razor” is the principle widely credited to the monk William of Ockham in the Middle Ages. He is supposed to have said that in an explanation “frustra fit per plura quod potest fieri per pauciora” [Adams, 1987], “it is futile to explain with many things what can be done with fewer.” His dictum has been widely adopted by scientists who interpret it to mean that when constructing a hypothesis you should keep it simple.36

Why is this a good principle for science?

Beyond philosophical beliefs that the laws of nature are simple and elegant, there are pragmatic reasons why sticking to Occam’s razor is good scientific practice. The main one is that if you make your theory complicated enough you can make it fit any particular set of observations, but this is at a cost of loss of generality of predictive ability. A famous example is the way that the Greek geocentric theory of astronomy was extended by adding epicycles to account for the retrograde apparent movement of Mars.37 Ptolemy was able to get good predictions, something that classical economists signally fail to do, but he got them at the cost of a theory with little inner logic, and one that we now know was totally inside out.

The neoclassical supply and demand theory does multiply entities without cause. Each of the functions has at least two parameters specifying its slope and position.38 But the real observed data only has two parameters: a price and quantity on a particular day. So the theory attempts to explain two numbers and in the process introduces four new numbers—entities lacking necessity.

For Ptolemy the epicyclic complexity brought precision in predicting planetary motion, and in the sense that there were no more epicycles than was necessary to achieve that precision, Ptolemy’s theory obeyed Occam’s razor. But the profligacy with which the economists strew free variables around, brings the opposite effect. Their price theory is underdetermined and makes no testable predictions at all.

Testability is another cornerstone of the scientific method. A causal theory should be testable to see if it is true. For that to work, the entities you use have to be measurable. But what testable predictions does the neoclassical theory make about the structure of industrial prices in, for example, the U.S. economy?

It can make none, since the supply and demand functions for the various commodities are not only contingently unknown, but are in principle unknowable. The theory says that the two functions uniquely define the price and quantity that will be sold on a particular day, but there are infinitely many pairs of lines that could be drawn so as to intersect at the point (q, p) in figure 3.8. It is no good trying to look at how the prices and quantities sold vary from day to day, since the theory itself holds than any changes in price or quantity must be brought about by “shifts” in the functions. What this means is that the economics teacher goes to the board with a ruler and draws two more lines intersecting at the new price and quantity. This, the teacher tells the class, is what happens in a real market: prices change because the supply and demand functions move about.

But splatter any arbitrary set of points on the price-quantity graph, and you can draw intersecting lines through each and every one of them. Let these points be prices on successive days, there could never be a sequence of these price value measurements that could not be explained by suitably shifting a ruler about and drawing pairs of intersecting lines. So the theory is unfalsifiable. It makes no specific operational predictions about prices and quantities. It is true by definition and vacuous by definition. It is not even wrong [Woit, 2002].