05 October 2016
Attacks on New Classical Economics, Dynamic Stochastic General Equilibrium (DSGE) or Real Business Cycle theory usually focus on their poor record in forecasting or on issues like identification and parameterization. Here, we take a different tack, choosing instead to study the root of New Classical Economics which is General Equilibrium (GE) theory.
We show that (a) Marshallian demand analysis is not any less general than GE theory, and (b) that the unstated assumption of GE theory is that aggregate demand is constant. Together, these two results amount to saying that, shorn of the complicated math, GE theory is equivalent to Marshallian demand analysis. It also explains why the two arrive at identical results on subjects like involuntary unemployment.