Short interlude for some sports today, spurred only by the fact that this article by Gene Wojciechowski at ESPN was rather delightfully titled "The economics of insanity" by my iGoogle newsbar; sadly it didn't carry over into the article, but still some food for thought. The issue at hand is rookie contracts in the NFL:
"NFL commissioner Roger Goodell said it's "ridiculous" to reward untested rookies with lucrative contracts, and wants the issue addressed in contract talks."
I'm tempted to point out that no-one's forcing teams to enter into these contracts, but then I'm not completely sure what the rules are about draft picks going unsigned. In any case, the negotiated salary cap rules determine the total pot available to pay rookies, right? Either way, it's just more evidence in favor of the old truism that American sports are more socialist than their capitalist European counterparts: try this or this for some of the arguments.
It's staggering how exactly the analogy holds, precisely opposite to the stereotypes of American and European rules for resource allocation. American sports are organized to give every team a fighting chance of winning within a few years, with the help of active intervention in the form the draft and salary caps and the guarantee that a terrible season is not punished the following year, while European sports are dog-eat-dog, pure capitalism. Maybe it's because of cross-country competition in Europe: it would be hard for Spain, say, to use American-sport policies to level the playing field without players jumping ship to Italy or England and without Spanish teams being destroyed on the field by the elite of other countries.
Monday, June 30, 2008
Saturday, June 28, 2008
Happiness and behavioral stuff again
Via Arts & Letters Daily (again) comes a wonderful (and long) article by Alan Wolfe for the New Republic: "Hedonic Man, The new economics and the pursuit of happiness." There's far, far too much for me to discuss in suitable depth here, but, beyond recommending the article, let me pick out a couple of choice bits.
I wholeheartedly agree with Wolfe when he says:
"The social sciences are not just empirical; they are normative, too. It was precisely the insistent normative preference for market-based social arrangements that turned me against Chicago School economics. Governmental regulation is always sub-optimal, they inevitably maintained. Individual freedom is worth more than social equality. If market logic works for firms, surely it can work for recruiting an army, fighting poverty, or providing kidneys. Non-Chicago economists were subtler about these matters, and at times questioned the reliance on markets; but for the many sons and daughters of Milton Friedman, we are hard-wired to be rational choosers, and any efforts we make to direct the course of our actions collectively are bound to fail. Myself, I do not believe that any of these propositions bring us closer to a good society. Other people feel differently. Democracy requires that we argue out our differences. But democratic debate is not well served by pretending that the empirical findings of a single controversial approach in a single academic discipline contain definitive answers to these questions."
The presentation of economics as a discipline of study certainly does make it seem like we've magically cracked the nut of what is the 'best' way to organize a society, and, as I've argued before, that's not just dangerous, it's a misrepresentation of what good economic science is capable of. One reason why it's a misrepresentation is the measurement issue at work again: to say 'best', we need a metric, and to do that we need to ask what people want, to speculate on their motivations and desires. Of course, as misrepresentations go, it's a tempting one, because from day one of a Principles of Economics course it's made again and again and again.
Wolfe's article is built around the review of two books: Predictably Irrational by Dan Ariely (which I've talked about before, much to the author's chagrin, so I won't return to it now) and Happiness: A Revolution in Economics by Bruno Frey. 'Happiness', as discussed by Wolfe, is concerned with exactly that big question in normative social science, which is: what exactly constitutes a 'good' outcome? It's exactly that question that's the dangerous misunderstanding within economics, the dangerous belief that we know what's 'good'.
Wolfe talks at length about Daniel Kahneman and Amos Tversky, the pioneers of what has become 'behavioral economics', and I admit that I share Richard Thaler's reaction, as reported by Wolfe:
"When I read this paper," [Thaler] wrote of Kahneman and Tversky's classic article "Judgment Under Uncertainty," which appeared in 1974, "I could hardly contain myself."
He talks further about the supposed 'revolution' in economics to account for the kind of behavior documented by Kahneman and Tversky and the whole slew of experiments run by economists since:
"One has to wonder why the revolution in economics failed so badly even before it really got off the ground. Neoclassical economics may in some ways be preferable to what the revolutionaries offer, but it remains a vulnerable approach, stuck in unrealistic assumptions about human behavior and all too complacent about the beneficial equilibria established by markets. Nor can one deny the ingeniousness of the early days of economic psychology, especially the inventive puzzles that Kahneman and Tversky devised. If ever a field were ripe for revolution, it is economics. Yet if these two books are any indication, supply and demand, marginal utility, rational choice, and cost-benefit analysis are not going away. At best, economists will tweak their models a bit to account for some of our odder calculations. More likely, they will simply reiterate their belief that we need not examine the internal mechanisms of utility satisfaction because the price someone is willing to pay for something is really all we need to know."
Again, though, I offer this as the reason why the 'revolution' has 'failed': we simply can never say what motivates people, whether a person is "rational" or not. 'Neoclassical economics' does not restrict the range of assumptions one can make about human behavior. It is therefore completely resilient to any evidence on how people act in a given situation. That's not a defense of the approach, it's a fact. It's distressing, because my prejudice is definitely to agree that economics is 'complacent' about the superiority of markets (again, because we ignore the variety of normative metrics of comparison), and that there's too much arcana.
We need true normative debate. Look again at what Wolfe says about economics: "it remains a vulnerable approach, stuck in unrealistic assumptions about human behavior and all too complacent about the beneficial equilibria established by markets". It's a mistake to conflate this problem - the arrogant assumption that we know what's 'best' - with the neoclassical assumptions on human behavior, because, as I've argued repeatedly, the method of scientific economics doesn't actually assume anything about human behavior, as evidenced by the fact that the 'behavioral revolution' is comfortably within the confines of 'neoclassical economics'.
The real revolution would be quieter, and would say something much more familiar: keep your science separate from your opinion.
I wholeheartedly agree with Wolfe when he says:
"The social sciences are not just empirical; they are normative, too. It was precisely the insistent normative preference for market-based social arrangements that turned me against Chicago School economics. Governmental regulation is always sub-optimal, they inevitably maintained. Individual freedom is worth more than social equality. If market logic works for firms, surely it can work for recruiting an army, fighting poverty, or providing kidneys. Non-Chicago economists were subtler about these matters, and at times questioned the reliance on markets; but for the many sons and daughters of Milton Friedman, we are hard-wired to be rational choosers, and any efforts we make to direct the course of our actions collectively are bound to fail. Myself, I do not believe that any of these propositions bring us closer to a good society. Other people feel differently. Democracy requires that we argue out our differences. But democratic debate is not well served by pretending that the empirical findings of a single controversial approach in a single academic discipline contain definitive answers to these questions."
The presentation of economics as a discipline of study certainly does make it seem like we've magically cracked the nut of what is the 'best' way to organize a society, and, as I've argued before, that's not just dangerous, it's a misrepresentation of what good economic science is capable of. One reason why it's a misrepresentation is the measurement issue at work again: to say 'best', we need a metric, and to do that we need to ask what people want, to speculate on their motivations and desires. Of course, as misrepresentations go, it's a tempting one, because from day one of a Principles of Economics course it's made again and again and again.
Wolfe's article is built around the review of two books: Predictably Irrational by Dan Ariely (which I've talked about before, much to the author's chagrin, so I won't return to it now) and Happiness: A Revolution in Economics by Bruno Frey. 'Happiness', as discussed by Wolfe, is concerned with exactly that big question in normative social science, which is: what exactly constitutes a 'good' outcome? It's exactly that question that's the dangerous misunderstanding within economics, the dangerous belief that we know what's 'good'.
Wolfe talks at length about Daniel Kahneman and Amos Tversky, the pioneers of what has become 'behavioral economics', and I admit that I share Richard Thaler's reaction, as reported by Wolfe:
"When I read this paper," [Thaler] wrote of Kahneman and Tversky's classic article "Judgment Under Uncertainty," which appeared in 1974, "I could hardly contain myself."
He talks further about the supposed 'revolution' in economics to account for the kind of behavior documented by Kahneman and Tversky and the whole slew of experiments run by economists since:
"One has to wonder why the revolution in economics failed so badly even before it really got off the ground. Neoclassical economics may in some ways be preferable to what the revolutionaries offer, but it remains a vulnerable approach, stuck in unrealistic assumptions about human behavior and all too complacent about the beneficial equilibria established by markets. Nor can one deny the ingeniousness of the early days of economic psychology, especially the inventive puzzles that Kahneman and Tversky devised. If ever a field were ripe for revolution, it is economics. Yet if these two books are any indication, supply and demand, marginal utility, rational choice, and cost-benefit analysis are not going away. At best, economists will tweak their models a bit to account for some of our odder calculations. More likely, they will simply reiterate their belief that we need not examine the internal mechanisms of utility satisfaction because the price someone is willing to pay for something is really all we need to know."
Again, though, I offer this as the reason why the 'revolution' has 'failed': we simply can never say what motivates people, whether a person is "rational" or not. 'Neoclassical economics' does not restrict the range of assumptions one can make about human behavior. It is therefore completely resilient to any evidence on how people act in a given situation. That's not a defense of the approach, it's a fact. It's distressing, because my prejudice is definitely to agree that economics is 'complacent' about the superiority of markets (again, because we ignore the variety of normative metrics of comparison), and that there's too much arcana.
We need true normative debate. Look again at what Wolfe says about economics: "it remains a vulnerable approach, stuck in unrealistic assumptions about human behavior and all too complacent about the beneficial equilibria established by markets". It's a mistake to conflate this problem - the arrogant assumption that we know what's 'best' - with the neoclassical assumptions on human behavior, because, as I've argued repeatedly, the method of scientific economics doesn't actually assume anything about human behavior, as evidenced by the fact that the 'behavioral revolution' is comfortably within the confines of 'neoclassical economics'.
The real revolution would be quieter, and would say something much more familiar: keep your science separate from your opinion.
Monday, June 23, 2008
Happy happy joy joy
Via the wondrous fark.com comes 'How Rich People Spend Their Time' from the Washington Post - it's about an article in Science written by a battery of psychologist/economist types, including Daniel Kahneman. Very relevant to the question of what motivates people; my first instinct was to assume that it might reveal what people with the time to do what they want do with their time, if you see what I mean, and while the actual intention of the article is somewhat different it's still full of fun.
The original article is behind the Science subscriber wall, but via the wonders of institutional access, I can get access to metaphysical nuggets like this:
Schkade and Kahneman noted that, "Nothing in life is quite as important as you think it is while you are thinking about it."
Perhaps some intriguing fact about human nature; perhaps not. The article goes on to talk about some well-known results in the burgeoning 'happiness' literature, like the importance of relative rather than absolute income, and adaption to circumstances. I think a great article about this stuff, for the terminally interested, is Richard Layard's 'Happiness and Public Policy'.
But the thing that hooked me on this particular Science article is the following piece of weird:
"In a representative, nationwide sample, people with greater income tend to devote relatively more of their time to work, compulsory nonwork activities (such as shopping and childcare), and active leisure (such as exercise) and less of their time to passive leisure activities (such as watching TV)."
Let me get this straight: richer people work more and buy more stuff, and poor schmucks watch a lot of TV? Stop those presses. The point of the article is well-made (from the the title, 'would you be happier if you were richer', right on down), and that is to say that people with higher incomes aren't necessarily engaging in relatively more 'fun'; however, there are a bunch of unasked questions. Does 'TV'='fun'? Is this really evidence that the rich are wasting their time, or are there other reasons why they endure work to get money?
The happiness literature is desperate to find an answer to the question of whether money buys happiness; an eerie similarity to the oft-(mis?)perceived economists' equation of money with happiness when modeling people, and surely as deserving of the same retort: we know people care about more than money. The obvious question is, well, obvious. What does motivate people?
The original article is behind the Science subscriber wall, but via the wonders of institutional access, I can get access to metaphysical nuggets like this:
Schkade and Kahneman noted that, "Nothing in life is quite as important as you think it is while you are thinking about it."
Perhaps some intriguing fact about human nature; perhaps not. The article goes on to talk about some well-known results in the burgeoning 'happiness' literature, like the importance of relative rather than absolute income, and adaption to circumstances. I think a great article about this stuff, for the terminally interested, is Richard Layard's 'Happiness and Public Policy'.
But the thing that hooked me on this particular Science article is the following piece of weird:
"In a representative, nationwide sample, people with greater income tend to devote relatively more of their time to work, compulsory nonwork activities (such as shopping and childcare), and active leisure (such as exercise) and less of their time to passive leisure activities (such as watching TV)."
Let me get this straight: richer people work more and buy more stuff, and poor schmucks watch a lot of TV? Stop those presses. The point of the article is well-made (from the the title, 'would you be happier if you were richer', right on down), and that is to say that people with higher incomes aren't necessarily engaging in relatively more 'fun'; however, there are a bunch of unasked questions. Does 'TV'='fun'? Is this really evidence that the rich are wasting their time, or are there other reasons why they endure work to get money?
The happiness literature is desperate to find an answer to the question of whether money buys happiness; an eerie similarity to the oft-(mis?)perceived economists' equation of money with happiness when modeling people, and surely as deserving of the same retort: we know people care about more than money. The obvious question is, well, obvious. What does motivate people?
Monday, June 16, 2008
The arrogance of economics?
A while ago I mentioned the mysterious science of "welfare analysis". It tries to evaluate outcomes or predictions of economic analysis or modeling; the idea is to figure out whether x is "better" than y.
That's not an easy task; we have to figure out how we're going to measure things if we're going to compare them. Unfortunately, the only way to answer the question is to take a position on the motivations of the people who'd be affected by your policy. It's sometimes said that the noxious euphemism "thinking like an economist" means "taking all consequences into account"; leave aside for a moment the obvious point that that's not "thinking like an economist", it's "thinking properly", but rather let's figure out what "thinking like an economist" actually requires.
It often seems to require answering that question of "better", to require taking a position on how you're going to evaluate policies. It's more fundamental than assuming something about a utility function, or whatever it takes to perform welfare analysis, but rather seems to require an acceptance of those nefarious so-called "principles" of economics, an agreement with what constitutes a "better" outcome for society.
Then we're led into a world in which very few people who self-identify as "economists" profess support for any policy or means or resource allocation that lies outside the capitalism-with-some-government model that is the status quo. Is that because once a person has studied economics, it's obvious to them that this is "best"? Is it because it's impossible to succeed in the study of economics if you don't agree that it's "best", because you're turned off or ridiculed?
Economists run the risk of being seen as arrogant if we pretend to understand what a "better" outcome is. In the small this manifests as our faith in the cipher of "welfare analysis"; in the large it manifests as the homogeneity of belief and thought among economists.
That's not an easy task; we have to figure out how we're going to measure things if we're going to compare them. Unfortunately, the only way to answer the question is to take a position on the motivations of the people who'd be affected by your policy. It's sometimes said that the noxious euphemism "thinking like an economist" means "taking all consequences into account"; leave aside for a moment the obvious point that that's not "thinking like an economist", it's "thinking properly", but rather let's figure out what "thinking like an economist" actually requires.
It often seems to require answering that question of "better", to require taking a position on how you're going to evaluate policies. It's more fundamental than assuming something about a utility function, or whatever it takes to perform welfare analysis, but rather seems to require an acceptance of those nefarious so-called "principles" of economics, an agreement with what constitutes a "better" outcome for society.
Then we're led into a world in which very few people who self-identify as "economists" profess support for any policy or means or resource allocation that lies outside the capitalism-with-some-government model that is the status quo. Is that because once a person has studied economics, it's obvious to them that this is "best"? Is it because it's impossible to succeed in the study of economics if you don't agree that it's "best", because you're turned off or ridiculed?
Economists run the risk of being seen as arrogant if we pretend to understand what a "better" outcome is. In the small this manifests as our faith in the cipher of "welfare analysis"; in the large it manifests as the homogeneity of belief and thought among economists.
Friday, May 9, 2008
'Good' versus 'bad' economics
A peculiar distinction is often made between 'good' and 'bad' economics when analyzing economic policy. The current hot potato of a gas tax holiday in the US is a case in point - though it might be a trivial issue in the scheme of things, it did provide this absolutely outstanding moment from Hillary Clinton:
“Well I’ll tell you what, I’m not going to put my lot in with economists,” Clinton said, a response in line with some of the populist notes she’s been hitting in recent stump speeches on the gas tax.
There are a couple of things going on here. First, it just shows that declaring opposition to economists is just as popular a political strategy as declaring opposition to 'business' or 'the elite' or 'greedy oil companies'. This is almost certainly because 'economics' is perceived as being one and the same with these things, an ax wielded by the establishment to crush little people under the wheels of capitalism. Again, true economic analysis is valueless, and is subjective only once we evaluate the outcomes or the processes that would lead to or from one thing or another.
The other point, related, is the implicit invocation of a consensus among 'economists'. It's related because it is unambiguously true that the majority of economists evaluate things in a particular way - the subjective part is a collective subjectivity rather than a diversity of opinion. Why is that? Are economists molded into a particular normative stance that evaluates policies or outcomes in a particular way? A significant amount of work has been done on the question of which way the causality runs between studying economics and policy opinions: do economists dislike the gas tax holiday because they've studied economics or because people who dislike these kind of policies study economics?
The truth is that it's very easy to identify what 'good' and 'bad' economics are, because that label can be attached only to the logical, scientific chain of argument - the positive side - that draws the map from cause to effect. Of course we can argue about the validity of the links in the chain, test our assumptions, look to evidence, but the fact remains that 'bad' economics is that which fails to acknowledge the true effects of an action.
By contrast, the normative side cannot be labeled 'good' or 'bad', because it is only opinion. To argue against a normative stance is to argue against an opinion. This is why it is so dangerous for the 'Principles of Economics' to include value-loaded statements; this is why it is so dangerous to have a normative consensus among people who call themselves 'economists'. When that happens, we risk confusing the normative opinions of these people with a scientific conclusion; it is not.
If a politician was to ignore or lie about the tangible consequences of a policy, that is bad, in the sense of being misleading or untrue. However, if a politician acknowledges the best guess of the consequences, whether they argue for or against the policy is neither bad nor good. Economists would do well to remember that they are part of the second group, not the first. It is fine to point out misinformation, but to argue that 'economics tells us what to do here' is to assume that their opinion is good, which is a great sin of arrogance.
When one responds to the gas tax stuff with a line like (from Paul Krugman)
Why doesn’t cutting the gas tax this summer make sense? It’s Econ 101 tax incidence theory...
I'm sure they are really pointing out the tangible consequences of the policy, but the line between the positive and the normative is fuzzed, the value-free analysis becomes loaded with subjectivity. The two must be separated.
“Well I’ll tell you what, I’m not going to put my lot in with economists,” Clinton said, a response in line with some of the populist notes she’s been hitting in recent stump speeches on the gas tax.
There are a couple of things going on here. First, it just shows that declaring opposition to economists is just as popular a political strategy as declaring opposition to 'business' or 'the elite' or 'greedy oil companies'. This is almost certainly because 'economics' is perceived as being one and the same with these things, an ax wielded by the establishment to crush little people under the wheels of capitalism. Again, true economic analysis is valueless, and is subjective only once we evaluate the outcomes or the processes that would lead to or from one thing or another.
The other point, related, is the implicit invocation of a consensus among 'economists'. It's related because it is unambiguously true that the majority of economists evaluate things in a particular way - the subjective part is a collective subjectivity rather than a diversity of opinion. Why is that? Are economists molded into a particular normative stance that evaluates policies or outcomes in a particular way? A significant amount of work has been done on the question of which way the causality runs between studying economics and policy opinions: do economists dislike the gas tax holiday because they've studied economics or because people who dislike these kind of policies study economics?
The truth is that it's very easy to identify what 'good' and 'bad' economics are, because that label can be attached only to the logical, scientific chain of argument - the positive side - that draws the map from cause to effect. Of course we can argue about the validity of the links in the chain, test our assumptions, look to evidence, but the fact remains that 'bad' economics is that which fails to acknowledge the true effects of an action.
By contrast, the normative side cannot be labeled 'good' or 'bad', because it is only opinion. To argue against a normative stance is to argue against an opinion. This is why it is so dangerous for the 'Principles of Economics' to include value-loaded statements; this is why it is so dangerous to have a normative consensus among people who call themselves 'economists'. When that happens, we risk confusing the normative opinions of these people with a scientific conclusion; it is not.
If a politician was to ignore or lie about the tangible consequences of a policy, that is bad, in the sense of being misleading or untrue. However, if a politician acknowledges the best guess of the consequences, whether they argue for or against the policy is neither bad nor good. Economists would do well to remember that they are part of the second group, not the first. It is fine to point out misinformation, but to argue that 'economics tells us what to do here' is to assume that their opinion is good, which is a great sin of arrogance.
When one responds to the gas tax stuff with a line like (from Paul Krugman)
Why doesn’t cutting the gas tax this summer make sense? It’s Econ 101 tax incidence theory...
I'm sure they are really pointing out the tangible consequences of the policy, but the line between the positive and the normative is fuzzed, the value-free analysis becomes loaded with subjectivity. The two must be separated.
Tuesday, April 22, 2008
"Economics Basics"
Looking for something quite different (as usual), and found this page, from something called Investopedia, which is entitled "Economics Basics". It makes me think, more than anything else, of the Telephone game (or Chinese Whispers if you're British), because it's one degree removed from everything - one degree removed from correct, one degree removed from stereotypically bad, one degree removed from sensible.
Economics may appear to be the study of complicated tables and charts, statistics and numbers, but, more specifically, it is the study of what constitutes rational human behavior in the endeavor to fulfill needs and wants.
Immediately the lean towards 'professional' or investment-bank type economists is obvious: academic economics is emphatically not the study of complicated tables or charts or numbers. Statistics, maybe. But that's fine, a good way to start, to address the misconception about economics and math-y stuff.
Wait, though: the "study of what constitutes rational human behavior"? That makes zero sense. I don't really understand what that would mean, let alone how it relates to economics. I don't know what 'rational human behavior' is; no-one does. No economist should say to a person 'here's what you should be doing' (with the exception of policy advising normative economists, for obvious reasons), and indeed they don't.
As an individual, for example, you face the problem of having only limited resources with which to fulfill your wants and needs, as a result, you must make certain choices with your money. You'll probably spend part of your money on rent, electricity and food. Then you might use the rest to go to the movies and/or buy a new pair of jeans. Economists are interested in the choices you make, and inquire into why, for instance, you might choose to spend your money on a new DVD player instead of replacing your old TV. They would want to know whether you would still buy a carton of cigarettes if prices increased by $2 per pack.
Snooze. And then we default right back to the 'economics is money' thing. Goodness me, but the problem of scarcity informs questions so much more vital than 'how does this guy spend his money on electronics'. Sure, we're interested in consumer behavior, but come on, this is Economics Basics! Give me some life. The fruit of the earth, the budget of a government, the precious time of a modern human being, all of these are scarce resources. All of these are used to fulfill wants and needs, and are subject to choices.
To study these things, economics makes the assumption that human beings will aim to fulfill their self-interests. It also assumes that individuals are rational in their efforts to fulfill their unlimited wants and needs. Economics, therefore, is a social science, which examines people behaving according to their self-interests. The definition set out at the turn of the twentieth century by Alfred Marshall, author of "The Principles Of Economics" (1890), reflects the complexity underlying economics: "Thus it is on one side the study of wealth; and on the other, and more important side, a part of the study of man."
I love that Marshall quotation. It sums up very well the state of the economics art at the time, the discipline spawned by interest in wealth and how it accumulates, perpetuates, moves around. I hate the repeated 'self-interests'. Delete 'self-' and you'd have a (semantically identical) but more neutral, and more accurate, statement. And again - broken record time - this is misleading on the rationality assumption. We don't make it because we know what rationality is, because we don't, or because we believe people are rational, because that's unknowable, or because we're grumpy bastards who shout 'humbug' at the rich tapestry of life. We make it because we want to try to answer questions that involve the actions of people and groups of people, and we can't start that unless we breathe life into those actors.
If I ask you how the process of exchange of stuff between people works, do you a) dismiss the question, because people are weird and unpredictable, b) tell a parable about a guy who makes wine and a guy who makes cheese who get together and have wine and cheese, or c) model some people who like some goods and show that they might prefer to trade some of their goods with each other?
Well, b) and c) are the same. They are only the difference between an idea and its mathematical expression. If you say a), you can't be an inquisitive human being, let alone an economist. Fine, I don't care about a lot of stuff, especially in economics, but these are questions we can try to answer, and the denunciation of any model of human behavior, implicit in criticisms of this straw-man 'rationality assumption' is philistinism and willful ignorance.
I don't suggest that Investopedia is willfully subverting the course of human intellectual endeavor, though. I just accuse them of being a bit narrow-minded in their Introduction to Economics Basics. I know that "Economics Basics" can't be complicated or anything, but is this what a whirlwind tour of economics has to look like? But wait: our Introductory Economics courses are exactly the same. Pot, kettle.
Economics may appear to be the study of complicated tables and charts, statistics and numbers, but, more specifically, it is the study of what constitutes rational human behavior in the endeavor to fulfill needs and wants.
Immediately the lean towards 'professional' or investment-bank type economists is obvious: academic economics is emphatically not the study of complicated tables or charts or numbers. Statistics, maybe. But that's fine, a good way to start, to address the misconception about economics and math-y stuff.
Wait, though: the "study of what constitutes rational human behavior"? That makes zero sense. I don't really understand what that would mean, let alone how it relates to economics. I don't know what 'rational human behavior' is; no-one does. No economist should say to a person 'here's what you should be doing' (with the exception of policy advising normative economists, for obvious reasons), and indeed they don't.
As an individual, for example, you face the problem of having only limited resources with which to fulfill your wants and needs, as a result, you must make certain choices with your money. You'll probably spend part of your money on rent, electricity and food. Then you might use the rest to go to the movies and/or buy a new pair of jeans. Economists are interested in the choices you make, and inquire into why, for instance, you might choose to spend your money on a new DVD player instead of replacing your old TV. They would want to know whether you would still buy a carton of cigarettes if prices increased by $2 per pack.
Snooze. And then we default right back to the 'economics is money' thing. Goodness me, but the problem of scarcity informs questions so much more vital than 'how does this guy spend his money on electronics'. Sure, we're interested in consumer behavior, but come on, this is Economics Basics! Give me some life. The fruit of the earth, the budget of a government, the precious time of a modern human being, all of these are scarce resources. All of these are used to fulfill wants and needs, and are subject to choices.
To study these things, economics makes the assumption that human beings will aim to fulfill their self-interests. It also assumes that individuals are rational in their efforts to fulfill their unlimited wants and needs. Economics, therefore, is a social science, which examines people behaving according to their self-interests. The definition set out at the turn of the twentieth century by Alfred Marshall, author of "The Principles Of Economics" (1890), reflects the complexity underlying economics: "Thus it is on one side the study of wealth; and on the other, and more important side, a part of the study of man."
I love that Marshall quotation. It sums up very well the state of the economics art at the time, the discipline spawned by interest in wealth and how it accumulates, perpetuates, moves around. I hate the repeated 'self-interests'. Delete 'self-' and you'd have a (semantically identical) but more neutral, and more accurate, statement. And again - broken record time - this is misleading on the rationality assumption. We don't make it because we know what rationality is, because we don't, or because we believe people are rational, because that's unknowable, or because we're grumpy bastards who shout 'humbug' at the rich tapestry of life. We make it because we want to try to answer questions that involve the actions of people and groups of people, and we can't start that unless we breathe life into those actors.
If I ask you how the process of exchange of stuff between people works, do you a) dismiss the question, because people are weird and unpredictable, b) tell a parable about a guy who makes wine and a guy who makes cheese who get together and have wine and cheese, or c) model some people who like some goods and show that they might prefer to trade some of their goods with each other?
Well, b) and c) are the same. They are only the difference between an idea and its mathematical expression. If you say a), you can't be an inquisitive human being, let alone an economist. Fine, I don't care about a lot of stuff, especially in economics, but these are questions we can try to answer, and the denunciation of any model of human behavior, implicit in criticisms of this straw-man 'rationality assumption' is philistinism and willful ignorance.
I don't suggest that Investopedia is willfully subverting the course of human intellectual endeavor, though. I just accuse them of being a bit narrow-minded in their Introduction to Economics Basics. I know that "Economics Basics" can't be complicated or anything, but is this what a whirlwind tour of economics has to look like? But wait: our Introductory Economics courses are exactly the same. Pot, kettle.
Thursday, April 17, 2008
What economists do: the one model we use
Economics is jargon-heavy, like, well, everything. Economists, I can attest, are especially fond of that academic disease of using their jargon in everyday conversation, a kind of subconscious economic imperialism. Nevertheless, there's a difference between specialist knowledge (with its public face, jargon) and the concepts on which a body of knowledge is built.
How could we distill economics to its base? This is a slightly different goal than defining the principles of economics; here we want to identify the actual applicable results that derive from the principles and recur again and again in the whole discipline. As a first pass at this problem, let's look at the model we use in economics. That's model, singular.
Modern economics is built on the formalized statement of the definition of the subject: some entity has objectives, and limited resources with which to achieve them. These become the objective function and the constraints. Now the entity could be anything: a firm, a person, a government, a group of people.
The objective function might be expressed in math, but it doesn't have to be. It reflects, obviously, the objectives of the entity, and these could be anything, but will typically have to be a simplified version of what an entity really wants or needs. This is one place where the abstraction from reality might have to be made, although we can imagine, as a thought experiment, the omniscient modeler who is not subject to this particular problem.
The constraints can, again, be put into math but doesn't have to be. It is the expression of scarcity; constraints can reflect anything that poses a challenge to our entity's achieving its goal. The abstraction is often necessary here, too: time, money, social convention, technology are just some of the possible constraints.
Now this is really a very simple idea, but all economics uses this as its base. We are concerned with the allocation of scarce resources in the quest to satisfy objectives, and this is the model of that. The math angle comes in to make this model give tangible and quantifiable results; we could make arguments without the math, but using it often helps to make things clear. The challenge for the modeler is to write the model cleverly, making simplifications enough to make the problem understandable, but not too many to make it irrelevant.
Theoretical economists are explicitly writing this model, over and over, and the illustrative economic models we present in teaching students use this model exclusively. Empirical economists use it too, not just writing it down, but in subtle ways: perhaps the empiricist can identify a precise moment or situation in which the constraints on a particular entity's problem changed, offering them a useful opportunity to see how choices change in the face of the discrete change in conditions.
This model gives rise to the marginalist result. It says that our entity will allocate resources to a particular use while the benefit of doing so exceeds the cost of doing so, and that the point at which the entity stops will be characterized by the balance of cost and benefit at that particular point. If the decision was changed slightly in either direction, the results would be less satisfying, either because the cost would exceed the benefit, or because the benefit would exceed the cost. That might sound complicated, but it is a familiar idea from everyday life.
In the jargon, the result is that marginal benefit equals marginal cost in the solution to this model of an entity facing a resource allocation model. That simply means that from the "solution", there is no change that would be a better result for the objective function. Not to say that the solution is a perfect prediction or description; the solution is to the model, not the actual problem faced by the entity. Perhaps the loaded meaning of the word solution is a hindrance here. Much debate has been staged over the extent of predictive or descriptive accuracy of this economic model.
Where it gets a bit complicated is at the point where we're unsatisfied with the objectives or constraints we are using in our models. Benefit and cost are pretty easy to think about when our abstraction acknowledges only money, for example, but what if my entity's objective function included the wellbeing of others, the environment, the amount of time spent in the sun, the quality of life? These assumptions are not just more difficult to incorporate, they are more difficult to interpret.
Where does all this fit in with the themes I've touched on before? The debate about rationality, economic man and realism informs directly the objective function. For example, the behavioral school could be characterized as seeking to come up with a more realistic, tractable objective function. The economics-as-money fallacy crops up in both the objective and constraints, yet how we denominate these things doesn't change the model one bit. The debate about math in economics informs the language in which the model is presented; non-mathematical economists still use the model, even if they don't write all these components down as mathematical relationships.
This is the model of economics. Two examples to show what's going on.
First: how would a subsidy on the wage of low-income workers, such as the Earned Income Tax Credit, affect the number of people who work and how much they work? The common treatment of this problem in basic economics is to imagine a person who has a desire for money and for time, and to illustrate the wage subsidy as affecting the constraint, in this case the rate at which our person can earn money by giving up their time to work. We can then ask how this change in the constraint affects the hypothetical best choice of our simple person, and even ask how the person's relative desire for time and money affect this answer.
Theorists can try to answer this question by investigating the model itself; empiricists might look to the data to try to identify the change in actual choices observed when the subsidy is introduced. [Aside: as it turns out, weird things happen with the EITC during the income range when it's gradually phased out.]
Second: how would a person choose to react to another person they perceive to be unfair? Our person might have an objective function that includes preference for money and fairness, and their constraint could include the social norms for fairness as well as their money budget. This example is well-studied in experimental economics, where our person can decide to sacrifice some common good in order to punish a person who was greedy.
No matter what field of economics one works in, this is the one model most dominant in all of the work. It is, of course, very flexible (in fact, infinitely flexible, as I argued before), and I have stated it in the most general terms. Nevertheless, when economists argue, it is worth remembering that we all play the same game. It might just be the language, but it is a language that can seem daunting and restrictive to outsiders or students. I don't believe that is the case: the beauty of this most fundamental model is its simplicity and its malleability. To distill economics into its essence, this is the place to start.
How could we distill economics to its base? This is a slightly different goal than defining the principles of economics; here we want to identify the actual applicable results that derive from the principles and recur again and again in the whole discipline. As a first pass at this problem, let's look at the model we use in economics. That's model, singular.
Modern economics is built on the formalized statement of the definition of the subject: some entity has objectives, and limited resources with which to achieve them. These become the objective function and the constraints. Now the entity could be anything: a firm, a person, a government, a group of people.
The objective function might be expressed in math, but it doesn't have to be. It reflects, obviously, the objectives of the entity, and these could be anything, but will typically have to be a simplified version of what an entity really wants or needs. This is one place where the abstraction from reality might have to be made, although we can imagine, as a thought experiment, the omniscient modeler who is not subject to this particular problem.
The constraints can, again, be put into math but doesn't have to be. It is the expression of scarcity; constraints can reflect anything that poses a challenge to our entity's achieving its goal. The abstraction is often necessary here, too: time, money, social convention, technology are just some of the possible constraints.
Now this is really a very simple idea, but all economics uses this as its base. We are concerned with the allocation of scarce resources in the quest to satisfy objectives, and this is the model of that. The math angle comes in to make this model give tangible and quantifiable results; we could make arguments without the math, but using it often helps to make things clear. The challenge for the modeler is to write the model cleverly, making simplifications enough to make the problem understandable, but not too many to make it irrelevant.
Theoretical economists are explicitly writing this model, over and over, and the illustrative economic models we present in teaching students use this model exclusively. Empirical economists use it too, not just writing it down, but in subtle ways: perhaps the empiricist can identify a precise moment or situation in which the constraints on a particular entity's problem changed, offering them a useful opportunity to see how choices change in the face of the discrete change in conditions.
This model gives rise to the marginalist result. It says that our entity will allocate resources to a particular use while the benefit of doing so exceeds the cost of doing so, and that the point at which the entity stops will be characterized by the balance of cost and benefit at that particular point. If the decision was changed slightly in either direction, the results would be less satisfying, either because the cost would exceed the benefit, or because the benefit would exceed the cost. That might sound complicated, but it is a familiar idea from everyday life.
In the jargon, the result is that marginal benefit equals marginal cost in the solution to this model of an entity facing a resource allocation model. That simply means that from the "solution", there is no change that would be a better result for the objective function. Not to say that the solution is a perfect prediction or description; the solution is to the model, not the actual problem faced by the entity. Perhaps the loaded meaning of the word solution is a hindrance here. Much debate has been staged over the extent of predictive or descriptive accuracy of this economic model.
Where it gets a bit complicated is at the point where we're unsatisfied with the objectives or constraints we are using in our models. Benefit and cost are pretty easy to think about when our abstraction acknowledges only money, for example, but what if my entity's objective function included the wellbeing of others, the environment, the amount of time spent in the sun, the quality of life? These assumptions are not just more difficult to incorporate, they are more difficult to interpret.
Where does all this fit in with the themes I've touched on before? The debate about rationality, economic man and realism informs directly the objective function. For example, the behavioral school could be characterized as seeking to come up with a more realistic, tractable objective function. The economics-as-money fallacy crops up in both the objective and constraints, yet how we denominate these things doesn't change the model one bit. The debate about math in economics informs the language in which the model is presented; non-mathematical economists still use the model, even if they don't write all these components down as mathematical relationships.
This is the model of economics. Two examples to show what's going on.
First: how would a subsidy on the wage of low-income workers, such as the Earned Income Tax Credit, affect the number of people who work and how much they work? The common treatment of this problem in basic economics is to imagine a person who has a desire for money and for time, and to illustrate the wage subsidy as affecting the constraint, in this case the rate at which our person can earn money by giving up their time to work. We can then ask how this change in the constraint affects the hypothetical best choice of our simple person, and even ask how the person's relative desire for time and money affect this answer.
Theorists can try to answer this question by investigating the model itself; empiricists might look to the data to try to identify the change in actual choices observed when the subsidy is introduced. [Aside: as it turns out, weird things happen with the EITC during the income range when it's gradually phased out.]
Second: how would a person choose to react to another person they perceive to be unfair? Our person might have an objective function that includes preference for money and fairness, and their constraint could include the social norms for fairness as well as their money budget. This example is well-studied in experimental economics, where our person can decide to sacrifice some common good in order to punish a person who was greedy.
No matter what field of economics one works in, this is the one model most dominant in all of the work. It is, of course, very flexible (in fact, infinitely flexible, as I argued before), and I have stated it in the most general terms. Nevertheless, when economists argue, it is worth remembering that we all play the same game. It might just be the language, but it is a language that can seem daunting and restrictive to outsiders or students. I don't believe that is the case: the beauty of this most fundamental model is its simplicity and its malleability. To distill economics into its essence, this is the place to start.
Subscribe to:
Posts (Atom)