[Paper Review] Classical Economics: Lost and Found

Sabiou M. Inoua, Vernon L. Smith|arXiv (Cornell University)|Aug 21, 2023

Economic Theory and Institutions30 references4 citations

TL;DR

This paper argues that mainstream general equilibrium models, particularly the Arrow-Debreu framework, fail to capture the dynamic, real-world nature of markets. By reviving classical economics—emphasizing price discovery, entrepreneurship, and decentralized coordination—it proposes a foundation for integrating modern insights on market information creation and coordination.

ABSTRACT

"Economists miss the boat when they act as if Arrow and Debreu's general equilibrium model accurately describes markets in the real world of constant change. In contrast, the classical view on the market mechanism offers a helpful foundation on which to add modern insights about how markets create and coordinate information."

Motivation & Objective

• To critique the applicability of Arrow-Debreu general equilibrium models to real-world markets characterized by constant change.
• To reassert the relevance of classical economics in understanding market processes, particularly price formation and information coordination.
• To provide a theoretical foundation that integrates modern insights—such as entrepreneurial discovery and dispersed knowledge—within a classical framework.
• To challenge the dominance of Walrasian tâtonnement and general equilibrium models in economic theory and policy.
• To advocate for a market process approach that emphasizes dynamic, evolving exchange rather than static equilibrium outcomes.

Proposed method

• Analyzes the limitations of the Arrow-Debreu general equilibrium model in representing real-world market dynamics.
• Draws on classical economic thought—especially the work of Smith, Say, and Cantillon—to emphasize market processes over equilibrium states.
• Highlights the role of entrepreneurs and dispersed knowledge in price discovery and market coordination.
• Contrasts the static, equilibrium-based approach of general equilibrium theory with the dynamic, process-oriented view of classical economics.
• Uses institutional and historical analysis to demonstrate the enduring relevance of classical insights in modern market institutions.
• Proposes a framework where markets are seen as information-processing mechanisms that continuously discover and coordinate knowledge through exchange.

Experimental results

Research questions

• RQ1 Why do Arrow-Debreu general equilibrium models fail to accurately represent real-world markets characterized by constant change?
• RQ2 How can classical economics provide a more robust foundation for understanding market processes and information coordination?
• RQ3 What role do entrepreneurs and decentralized knowledge play in market price formation and coordination?
• RQ4 In what ways does the classical view of markets as dynamic processes improve upon static equilibrium models?
• RQ5 How can modern insights on information and coordination be integrated within a classical economic framework?

Key findings

• The Arrow-Debreu general equilibrium model is fundamentally ill-suited for describing real-world markets due to its static, tâtonnement-based assumptions.
• Classical economics offers a more accurate and dynamic understanding of markets as processes of discovery, entrepreneurship, and coordination.
• Price formation in real markets is not a result of simultaneous clearing but an ongoing, evolutionary process driven by individual action and dispersed knowledge.
• Markets function as mechanisms that create and coordinate information through exchange, a process better captured by classical than general equilibrium theory.
• The classical framework allows for the integration of modern insights on entrepreneurship, innovation, and information discovery.
• Reviving classical economics provides a more realistic and policy-relevant foundation for understanding market institutions and outcomes.