The Three Axioms at the Heart of Neoclassical Economics

As identified by Paul Davidson, they are as follows:

(1) the neutral money axiom;

(2) the ergodic axiom, and

(3) the gross substitution axiom (Davidson 2002: 40–45; Davidson 2009: 26–31).

While Fazzari (2009) argues that the neutral money axiom is more a consequence of unrealistic models rather than a real axiom (Fazzari 2009: 6), the concept of neutral money holds that changes in the money supply will only affect nominal values (e.g., prices, money wages, etc.), not real variables (such as production, employment, and investment).

While most neoclassical economists are of course willing to concede that money is non-neutral in the short run, nevertheless most do think money is neutral in the long run (Davidson 2002: 41).

Keynes and Post Keynesians, by contrast, reject the view that money can ever be neutral even in the long run (Davidson 2002: 41).

The ergodic axiom holds that the probability of future events can be predicted objectively by means of statistical analysis from past data (Davidson 2002: 43). But the world contains many non-ergodic processes and phenomena where statistical data simply does not yield probabilities of this sort: that is, fundamental uncertainty is a real, frequent and ineradicable aspect of economic life.

The gross substitution axiom is the idea that every good can in theory be a substitute for any other good (Davidson 2002: 43). In essence, this means that the law of demand can be applied to all goods, assets (even financial assets on secondary financial markets) and money.

This is unrealistic. As the blogger “Unlearning Economics” puts it rather pithily,

“economic theory assumes there is a price at which all commodities will be preferred to one another, which implies that at some price you’d substitute beer for your dying sister’s healthcare.”
“The Illusion of Mathematical Certainty,” Unlearning Economics, July 10, 2014.
http://unlearningeconomics.wordpress.com/2014/07/10/the-illusion-of-mathematical-certainty/

But the problems with the law of demand actually run far deeper than this, as pointed out by Steve Keen.

The gross substitution axiom is also not realistic for a much more profound reason as pointed out by Keynes: when applied to both financial assets and newly produced goods, it does not necessarily work (Davidson 2002: 44).

Fundamentally, money and financial assets have zero or near zero elasticity of substitution with producible commodities:

“The elasticity of substitution between all (nonproducible) liquid assets and the producible goods and services of industry is zero. Any increase in demand for liquidity (that is, a demand for nonproducible liquid financial assets to be held as a store of value), and the resulting changes in relative prices between nonproducible liquid assets and the products of industry will not divert this increase in demand for nonproducible liquid assets into a demand for producible goods and/or services” (Davidson 2002: 44).

And once we see that money and secondary financial assets (as demanded as a store of value) have a zero or very small elasticity of production, it follows that a rise in demand for money or such financial assets (and a rising “price” for such assets) will not lead to businesses “producing” money or financial assets by hiring unemployed workers (Davidson 2002: 44).

All this is sufficient to damn the gross substitution axiom.

All in all, the three axioms that form the basis of neoclassical economics cannot be taken seriously.

Further Reading
“The Law of Demand in Neoclassical Economics,” June 1, 2013.

“What is the Epistemological Status of the Law of Demand?,” September 19, 2013.

“Steve Keen on the Law of Demand,” September 20, 2013.

“Keynes on the Special Properties of Money,” May 8, 2011.

“F. H. Hahn in a Candid Moment on Neo-Walrasian Equilibrium,” January 29, 2011.

“More on the Gross Substitution Axiom,” July 28, 2011.

“Gold as Commodity Money and its Elasticity of Production,” November 18, 2011.

BIBLIOGRAPHY
Davidson, P. 2002. Financial Markets, Money, and the Real World. Edward Elgar, Cheltenham.

Davidson, Paul. 2009. John Maynard Keynes (rev. edn.). Palgrave Macmillan, Basingstoke.

Fazzari, Steven M. 2009. “Keynesian Macroeconomics as the Rejection of Classical Axioms,” Journal of Post Keynesian Economics 32.1: 3–18.

“The Illusion of Mathematical Certainty,” Unlearning Economics, July 10, 2014.
http://unlearningeconomics.wordpress.com/2014/07/10/the-illusion-of-mathematical-certainty/