ABSTRACT
In my 1981 AER article (Chapter 6 above) I examined various critiques of the realism of the neoclassical maximization assumption. I explained why all critiques of the realism of this assumption miss the point-among neoclassical economists, any failure of a neoclassical model will never be blamed on that assumption. But maximization by itself is not a sufficient foundation for neoclassical explanations of the economy we see outside our windows. So now the question is, what other assumptions are required in neoclassical models? There would appear to be one other fundamental assumption: specifically, the assumption of a market equilibrium. In this chapter I will critically examine two problems with this secondary assumption. First, under circumstances which depend on what we mean by the term maximization, the assumptions of an equilibrium and of universal maximization are equivalent. Second, and related, the extent to which the assumption of an equilibrium adds to the analysis
depends on whether the model offers an explanation as to why the state of equilibrium exists. As I explained in Chapter 13 (as well as my 1982 book), neoclassical economics is committed to methodological individualism. Methodological individualism at minimum says that only individuals make decisions. Neoclassical economists go beyond the minimum and further require that the only exogenous variables beyond acts of nature are psychologically given tastes as represented by utility functions. This narrow version of methodological individualism is called psychologistic individualism. The motivation for every decision is to maximize one’s utility or profit. All prices are endogenous, unintended consequences of everyone’s attempts to maximize. Specifically, a demand curve as defined is the implied relationship between price and the quantity demanded when all demanders are truly maximizing their individual utility and we define a supply curve as the similar implication of all suppliers truly maximizing their individual profits.
