Munich Personal RePEc Archive Foundations of Economic Science Gani, Mohammad Osman Independent University, Bangladesh 18 August 2003 Online at https://mpra.ub.uni-muenchen.de/67567/ MPRA Paper No. 67567, posted 01 Nov 2015 20:35 UTC FOUNDATIONS OF SCHOLARS House 24, Road 7, Sector 9, Uttara, Dhaka-1230, Bangladesh ECONOMIC SCIENCE Phone (880-2) 895-1499 Fax: (880-2)-911-6692 First published 2003 Copyright © Mohammad Osman Gani 2003 All rights reserved. No part of this publication may be reproduced in any form or by any means without prior written permission of the publisher. MOHAMMAD OSMAN GANI General Editor: Abdur Rob Khan, Ph.D. Style Editor: Abdar Rahman Graphics: Md. Abdul Khaleque Text: Oli Ahmed Pallab Cover: Ashraful Hassan Arif ISBN 984-32-0655-X Published by M A Nasir, Scholars, House 24, Road 7, Sector 9, Uttara, Dhaka-1230, Bangladesh Typeset in Times New Roman SCHOLARS Typeset byPassword Communications, 262 Fakirapool, Dhaka-1000, Bangladesh Printer Shahban Printing Press 145/B, Fakirapool, Dhaka-1000, Bangladesh ACKNOWLEDGMENT Moni gave me 22 years of vacation to do economics. Without her, I would be nowhere. I was extremely lucky to be at New York University. Bernard Wasow took me there and literally sheltered my family and me in all possible ways. He also supervised my doctoral dissertation. Without him, I might have spared economics. Readers will notice the influence of my teachers Wassily Leontief, and Israel Kirzner on the form and substance of my work. However, I do not hold them responsible for my turns, twists, and stretches. My teachers (in alphabetic order) William Baumol, Peter Boettke, Boyan Jovanovic, Mario Rizzo, Andrew Schotter, Michael Todaro, Bernard Wasow and Charles Wilson helped me think about economic issues. New York University and Massachusetts Institute of Technology gave me decades of free access to two of the most resourceful libraries for economists (Bobst and Dewey). My debt to Vikas Vij is incalculable. He read every word of the manuscript through many revisions and made numerous suggestions. Without his passionate urge, this book would probably wait many more years before publication. Its first complete draft was ready in March 1991. Dr. Abdur Rob Khan persuaded Mr. Nasir to publish this. He worked tirelessly to get it out once he was convinced it is worth reading. Few publishers have the courage to publish such things. Md. Abdul Khaleque and Oli Ahmed Pallab of Pasword Communications, Abdar Rahman of University Press Limited and Ashraful Hassan Arif worked hard to design the book. Through stimulating discussions, my friends Michael Goldberg, Syed A Hasnath, Azizul Haque Mollah, and Mohammad Zahangir kept encouraging me through two decades of beginning at the beginning. Delwar H Malder of Young Economists Society and Mosharraf Mohsin of Group 75 gave much encouragement. I hope my children see why their father was unavailable. I wish my parents were here to see whether their sacrifices for their son were fruitful. Mohammad Osman Gani Dhaka August 2003 viii Foundations of Economic Science 2.6 Theory: How to Explain? 33 2.6.1 Pure Theory 33 2.6.2 Essentialism 33 2.6.3 Abstraction 35 2.7 Rhetoric 37 TABLE OF CONTENTS 3 A FIRST LOOK 47-79 3.1 Looking at the Economy 47 List of Figures 3.1.1 The Economy 47 Preface 3.1.2 Detectives and Fugitives48 3.1.3 Economics in One Page 51 1 AN INVITATION 1-15 3.2 Anatomy of an Economy 52 1.1 An Invitation 1 3.2.1 Economic Anatomy 52 1.1.1 A salutation 1 3.2.2 Anchored in Observations 53 1.1.2 Welcome to New Readers 2 3.2.3 Unified by Exchange 54 1.2 A Celebration 3 3.2.4 Animated by Gain 54 1.2.1 Disagreements Left Behind 6 3.2.5 Instituted by Agreements 55 3.3 Trade is Gainful 57 1.2.2 Towards Clearer Views 7 3.3.1 Gains from Trade 57 1.2.3 More Effective Policies 13 3.3.2 Measurement of Gains 58 1.2.4 The Intellectual Heritage 14 3.3.3 Formal Statement of Gains 58 1.3 A Dedication 15 3.3.4 The Allocation Model Denies Gains! 59 3.3.5 Divergence Between Value & Utility 61 3.3.6 The Challenge of Pareto Optimality 62 2 A ROADMAP 17-46 3.3.7 Can All Parties Gain? 63 2.1 As We Failed 17 3.4 Consistency of Choice 64 2.2 The Economy As It Is 18 3.4.1 Consistent Choice 64 2.2.1 Worldview:What to Study? 19 3.4.2 Social Choice 67 2.2.2 Epistemology: Why Study? 21 3..4.3 Arrow's Impossibility Theorem 71 2.3 What is Economics? 22 3.4.4 Double Coincidence is Necessary 73 3.5 Two Axioms of Economic Science 73 2.3.1 A New Definition 24 3.5.1 First Axiom: Menger Dictum 73 2.3.2 Economics & Social Science 25 3.6 Allocation versus Exchange 74 2.4 Worldview: What to Know? 28 3.6.1 Character of Consistency of Choice 74 2.4.1 Empiricism 28 3.6.2 Entrepreneurial Gains and Losses 76 2.4.2 Causality and Power 30 3.6.3 Artificial Pensations 78 2.5 Methodology: How to Know? 31 3.6.4 Intermediation 78 2.5.1 Analytical Tools 31 3.7 Integration 79 2.5.2 Analytical Concepts 32 Table of Contents ix x Foundations of Economic Science 4 ALLOCATION 81-96 5.5 An Analytical Tool 124 4.1 Allocation under Subsistence 81 5.5.1 From Vector to Matrix of Exchange 124 4.1.1 Meaning of Subsistence 8 5.5.2 Imposing Equilibrium Conditions:125 4.1.2 Preferences 82 5.5.3 Deriving Equations of Exchange 129 4.1.3 Technologies 83 5.5.4 Intermediation Issues 130 4.1.4 Production Possibility Frontier 84 5.5.5. Entrepreneurship 131 4.2 Subsistence Equilibrium 85 5.5.6 Transaction Costs 132 4.2.1 Equilibrium 85 5.5.7 Institutions 133 4.2.2 Shadow Prices under Subsistence 87 4.2.3 General and Partial Equilibrium 87 6 VALUE 135-158 4.2.4 Consumer Behavior and Demand 87 6.1 The Law of Value 135 4.2.5 Firm Behavior and Supply 89 6.1.1 Theory of Price 135 4.3 Significance of Equilibrium 89 6.1.2 Decomposition of Aggregate Output 136 4.3.1 Walras Law and Say's Law 89 6.1.3 Measuring Profit and Loss 136 4.3.2 Pareto and Arrow 89 6.2 Theory of Output (or Income) 136 4.3.3 Quantity Theory 90 6.2.1 Output under Subsistence 137 4.4 Beyond Subsistence 90 6.2.2 Output under Trade 137 4.5 Allocation under Trade 91 6.3 Theory of Price 139 4.5.1 Pure Profit Opportunities 91 6.3.1 Price under Subsistence 140 4.5.2 Expanded Production Opportunities 93 6.3.2 Price under Barter140 4.5.3 Competitive Market Constraints 94 6.4Value over Time 143 4.5.4 Price Constraints 95 6.4.1 Savings and Instability of Output 143 4.5.5 Payment Constraints 96 6.4.2 Economic Development 145 5. EXCHANGE 97-133 7 PENSATION 159-219 5.1 Substance of Exchange 97 7.1 Means of Payment 159 5.1.1 Estrangement 97 7.2 Analysis of Pensation 159 5.1.2 Compensation 102 7.2.1 The Analytical Tools 160 5.1.3 Reciprocity 103 7.3 Payment Circuit 160 5.1.4 Voluntariness 103 7.3.1 Breaking the Payment Circuit 161 5.2 Three Laws of the Market 106 7.3.2 Building a Payment Circuit 162 5.2.1 The Law of Value: 106 7.3.3 The Length of the Payment Circuit 154 5.2.2 The Law of Payment: 106 7.4 Decomposition of Output 157 5.2.3 The Law of Intermediation 106 7.4.1 Subsistence Matrix S: 168 5.3 Formal Model 107 7.4.2 Barter Matrix B:169 5.3.1 Steps in Developing a Formal Model 108 7.4.3 Wicksell Matrix W: 169 5.3.2 Raising the Questions:111 7.4.4 Fund Matrix F: 171 5.3.3 The Equilibrium Concepts 112 7.4.5 Decomposed into 4 Matrices 171 5.3.4 Pareto Optimality Again 118 7.4.6 Symmetry in Payment Matrices: 171 5.4 Towards Indirect Exchange 120 7.4.7 Loan Matrix of Bonds 173 5.4.1 Multiple Coincidence 120 7.4.8 Significance of the Decomposition 174 5.4.2 Payment Circuit 121 7.4.9 A Keynesian Multiplier 175 Table of Contents xi xii Foundations of Economic Science 7.5 Equations of Exchange 176 8.4 Entrepreneurship 230 7.5.1 Equation of Subsistence 176 8.4.1 Entrepreneurs as Producers 231 7.5.2 Equation of Barter 177 8.4.2 Entrepreneurs as Arbitrageurs 232 7.5.3 Equation of Money 177 8.4.3 Entrepreneurs as Seigneurs 232 7.5.4 Equation of Bond 182 8.5 Institutions 233 7.5.5 Equation of Liquidity 183 8.5.1 What is an Institution? 233 7.5.6 Consistency Analysis Again 186 8.5.2 The Enforcement Issue 233 7.6 Outline of a Theory of Money 186 8.5.3 The Spontaneity Issue 234 7.6.1 Definition of Money 186 8.6 Doctrine of Social Institutions 235 7.6.2 The Creation of Money 187 8.6.1 Three Institutions of Society 235 7.6.3 Need versus Demand for Money 192 8.6.2 Institutions and Organizations 235 7.6.4 Value of Money:192 8.6.3 Institutional Equilibrium 240 7.6.5 Issue, Availability, and Supply of Money 193 8.6.4 The Market and Other Institutions 243 7.7 Outline of a Theory of Bonds 194 8.7 The Challenge Ahead 244 7.7.1 Demand for Bonds:195 7.7.2 Supply of Bonds:195 7.7.3 Circulation of Bonds195 9.