The first thing everyone learns about economics is about supply and demand specifically that the demand curve slopes downwards. This is presented as an obvious fact not needing any proof or discussion. Surely it is obvious that when prices rise, people buy less of a good? What if I told you this wasn’t the case? What if I told you economists have never been able to prove this actually happened in the real world? What if I told you that attempts to prove this actually did the opposite? What if I told you this had been discovered not by cranks or outsiders but rather by some of the main neo-classical theorist? What if I told you that the very foundations of economics weren’t true?
This is known as the Sonnenschein-Mantel-Debreu theorem. It is named after three neo-classical economists who were independently trying to prove that the foundations of neo-classical economics were true. Instead they each disproved it.
The law of demand applies on an individual level. It is when it is tried to apply this to the whole economy that it runs into trouble. It is straight forward to compare consumer’s preferences for two separate goods (this is commonly done in economics lectures using indifference curves). It is always assumed that if the price of one good goes down then the consumer will buy more of it. However this isn’t necessarily the case as a consumer can get the same quantity by spending less. A decrease in the price of a good makes you richer. It is perfectly possible for you to spend this extra money in a way different to how you spent your previous money. Many goods carry a stigma of being cheap and it is assumed that they must be of poor quality. Likewise consumers buy some goods because they are expensive (these are known as luxury goods). There is also the wealth effect. If the demand for a good changes that will boost the income of whoever is selling it changing their demand curve.
But more than anything, the purchases of an individual will depend on their personal taste. This by definition is different to everyone else’s and rules out applying it to the macro scale. If you were to examine a shopping cart in a supermarket you would see that no two carts are the same. Even on a simple level, if you were to give people a choice between 5 chocolate bars and 5 packets of chewing gum, or any proportion in between, the nature of human taste means everyone will pick different proportions. This means the only way you can draw a national indifference curve is if everyone in the economy has the exact same tastes. Essentially this means that there is only one individual in the economy as that is the only way everyone could have the same taste.
Indifference curves fail to take account of changes in income. They assume that the proportion of goods stay the same regardless of income, only absolute amounts change. Basically they assume that an individual spends the same proportion of their income on pizza when they are poor as when they are a millionaire. It should be obvious that this is not the case. Purchases change radically as our income changes. There is also the question of the distribution of income as the rich have different preferences to the poor. Therefore the only way it can be assumed that the economy’s demand curve is the same as an individual’s is if there is only one good in the economy.
These assumptions don’t hold true in the real world. This means rather than the typical downward sloping demand curve, it can have any shape. In a world of many different consumers with changing incomes, different tastes and with many goods to choose form, demand may rise, fall or stay the same in response to a price change. This is why the theorem is also known as the “Anything Goes” theorem.
Neo-classical economists respond in two ways to the above problems. Either they assume them away (essentially pretend they don’t exist) or come up with the most bizarre and ridiculous scenarios. Either they assume that there is in fact one consumer who represents everyone (an idea too daft to mention any further) or they get really daft. The main textbook for masters in economics is written by Mas-Colell who on page 117 says “Let us now hypothesize that there is a process, a benevolent central authority perhaps, that, for any given prices p and aggregate wealth function w, redistributes wealth in order to maximise social welfare.” Yes that’s right, in order for the law of demand to be applied to the market there must be God-like dictator that gives everyone in the country the same amount of money! You cannot be serious! This is the most absurd argument I have ever heard and basically says that in order for the free market to work efficiently, we must have something like Communism. Few realise how weak the foundations of economics are.
The law of demand is considered a basic accepted fact. However in order for it to be applicable to the whole economy, you must assume that the economy is composed or only one consumer and only one good or that income is perfectly redistributed by a benevolent dictator. This is too absurd to be credible and therefore must be abandoned. With it goes the basic foundation of economics. Question everything you thought you knew because it just might not be true.