The biggest fallacy of Economics is Market Equilibrium which is taught in basic economics or ‘Econ101’ everywhere as the supply and demand curve forming an ‘X’ and meeting in a state called exact equilibrium. Smith exposed this as mercantile sophistry in the 18th century, then called the ‘balance of trade’. To prove that this idea of ‘balance’ is the same in essence with the ‘equilibrium’ of economics, we shall compare the philosophy behind both ideas.
The Law of Demand
We will use Samuelson’s version as it is more popular. He begins in Chapter 4: Supply and Demand: The Bare Elements, by describing a downward sloping ‘Demand Schedule’ which means that the price of a thing goes down the more abundant it is:
When the price of a good is raised (at the same time that all other things are held constant), less of it is demanded. (Economics, p. 61)
This is obvious. He then goes through a few more paragraphs to prove this. Smith uses only 4 sentences to explain this from the viewpoint of an impartial spectator (not as a buyer nor seller):
The things which have the greatest value in use have frequently little or no value in exchange. On the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce any thing; scarce any thing can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it. (Smith, WN I. 4. 13)
Like Smith, Samuelson also gives the example of water. However, Samuelson’s version observes this phenomenon from the viewpoint of businesses or the supplier first instead of the buyer or demander. This is important because in reality, the buyers are made up of people in society.
Thus a first reason for the validity of the law of downward-sloping demand comes from the fact that lowering prices brings in new buyers. (Samuelson, Economics, p. 61)
The Mercantile Version
Smith points to Mun’s England’s Treasure on Foreign Trade as the origin of equilibrium, so we look for Mun’s version of the demand curve:
By lowering the price of our cloth in Turkey, we have sold more. The Venetians have lost because theirs is dearer. When our cloth was expensive, we lost at the least half our clothing to foreigners. 25% lower prices raises sales by over 50%, to the public benefit. When our cloth is expensive, other nations sell more cloths. When our cloth is cheap, they lose business. We therefore should increase the sale of our cloth. (Simple England’s Treasure, Chap. 3)
Plotting this we get the same downward sloping demand curve. We thus prove that Samuelson, Smith, and Mun agree on a downward sloping demand curve:
In the part 2, we shall discuss the supply curve of Samuelson, Smith, and Mun to see the difference.
Edit Feb 2017:
Digression on the ‘Law’ of Demand: Creating the non-problem ‘paradox of value’ to justify the fallacy called Profit Maximization
Many economists, including Samuelson, cite Smith’s example as a ‘paradox of value’, where in fact, there was never a paradox to Smith. Anything that is difficult to obtain yet desired by the mind, such as diamonds, simply will naturally have a higher price than that which is easy to obtain, like water.
Economists create a paradox in order to justify the creation of the concept of marginal utility to ‘solve’ the paradox. This marginal utility requires the quantification of pleasure or utility, which is then ‘maximized’ as ‘profit maximization’ — the second key fallacy being perpetrated by Economics.
By destroying the paradox of value, by keeping value properly subjective instead of being objectified into numerical increments, then profit maximization (which are merely numbers-based, carrying no moral quality) loses its top importance in the minds of businessmen and people in general. This then makes businessmen shift their focus on the actual non-numerical, non-quantifiable benefits that their businesses create.