Economists Do It With Models

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Don’t Blame Me, I’m Just A Microeconomist…

July 27th, 2009 · 16 Comments
Econ 101 · Policy

So Friday was my first day of class, which meant that in addition to introducing myself to my students (at which point I realized that I am not as interesting as they are) I also gave an overview of my philosophy on the course that I teach. For this audience (midcareer students coming back to the Kennedy School to get a Masters in Public Administration), I basically promise them that I will try to correct the wrongs committed by their Econ 101 professors in college. The typical objections that I hear from these students fall into the following categories:

  • There is too much focus on math and not enough on intuition
  • The models taught are not representative of the real world (or, new this year, the models are wrong, or, worse yet, economists are all wrong)
  • Economics 101 doesn’t take politics or other practical considerations into account

You can imagine that, given the current state of the economy, these objections were louder than usual. (Though, in fairness, my students are very considerate and respectful of what economists have to offer. Perhaps they are still on their best behavior around me.) I did my best to (briefly) address each of these concerns, and I think it’s something that the general population could stand to hear as well.

Objection 1: too much math- I think I agree with my students on this point. Much of what is valuable in an introductory economics course is not dependent on the specific math of the models as much as on the intuition and the conclusions. In fact, the math often times just serves as a distraction to what is actually helpful to learn. If a student is going to move on to more advanced economics courses, it makes sense for her to go through the math, but for the casual economics student, not so much. In general, I think that students would be well-served if Economics 101 were to be split into different tracks for different students. (For example, I think that there is a good case to be made for a specific version of Econ 101 for music industry majors.)

Objection 2a: unrepresentative models- In other fields, it is well-understood that scientists make simplifying assumptions that may or may not be representative of the real world. For example, a physicist might simplify a model by assuming a lack of friction in order to draw conclusions about force and acceleration. (I know, I am totally butchering this, but bear with me.) If I then try to use that model to estimate how hard it is going to be to push the table at the front of the classroom from one side to the other, I am going to be in for a big surprise. (insert visual gag here) In physics, people seem to generally know better than to do this. In economics, they seem to try to shoehorn models in where they don’t necessarily belong. What’s the difference? My suspicion is that the underlying assumptions are not as clear in economics as they are in physics, so one of my priorities is making these assumptions explicit. Also, students need to learn not only the basic models but also how to extend the models to apply to specific scenarios.

Objection 2b: incorrect models- Again, there is a fine line of distinction between “wrong” and “applied where it shouldn’t be.” There is also a line between “wrong” and “economists don’t have crystal balls.” (Though maybe they do with with crystal balls. Hm…) To address this particular issue, I direct you to two sources. The first is an article written a few months ago by Greg Mankiw explaining what was going to change in Econ 101 as a result of the financial crisis. The short answer? Not much.

“Despite the enormity of recent events, the principles of economics are largely unchanged. Students still need to learn about the gains from trade, supply and demand, the efficiency properties of market outcomes, and so on. These topics will remain the bread-and-butter of introductory courses.”

He goes on to explain in what subtle ways the course should and will change, and most of these ways are focused on the teaching of macroeconomics rather than microeconomics. In addition, my RA (who I am beginning to think is just a tad psychic) pointed me toward a story in The Economist entitled “What Went Wrong With Economics” that partially defends economists against the backlash of public perception:

“In its crudest form—the idea that economics as a whole is discredited—the current backlash has gone far too far. If ignorance allowed investors and politicians to exaggerate the virtues of economics, it now blinds them to its benefits. Economics is less a slavish creed than a prism through which to understand the world. It is a broad canon, stretching from theories to explain how prices are determined to how economies grow. Much of that body of knowledge has no link to the financial crisis and remains as useful as ever.

And if economics as a broad discipline deserves a robust defence, so does the free-market paradigm. Too many people, especially in Europe, equate mistakes made by economists with a failure of economic liberalism. Their logic seems to be that if economists got things wrong, then politicians will do better. That is a false—and dangerous—conclusion.”

I think that is very well put. Furthermore, the article goes on to clarify that most of the “wrongness” of economists was to be found among macroeconomists and financial economists. (hence the title of this post) Therefore, it is not justified to blithely purge everything you learned in your introductory micro courses, ok?

Objection 3: No practical considerations- Again, I think I side with my students here. Economists generally focus on a particular measure of efficiency that looks at the total dollar value created by a market (or destroyed by distortions to that market). The fundamental assumption underlying this measure is the idea that a dollar to one person is the same as a dollar to another person. This conveniently abstracts away the concept of who wins and who loses and labels as efficient any policy where the winners win more than the losers lose. (The justification is that the winners could transfer some value to the losers such that everyone would be made better off. Economists conveniently forget that it was usually attempted transfers that caused the inefficiency in the first place.) In addition, economists tend to shy away from equity (as in fairness, not necessarily equality) considerations in their analyses since discussions about equity tend to veer into non-objective value judgment territory. From a policy perspective, however, these equity considerations are very important, and there is usually a tradeoff to be had on the efficiency versus equity scale. (Sidenote: A student asked if efficiency and equity could ever move together. I gave a tentative yes, citing Corporate Social Responsibility initiatives that claimed to “do well by doing good.”)

Consider a quick example of the efficiency/equity tradeoff: Suppose the U.S. implemented a lump-sum tax whereby each household would pay a fixed amount regardless of how much income it had. This is the most efficient type of tax since it doesn’t give a disincentive to work. (The idea is that, because the tax is the same no matter what the household does, it doesn’t factor into decision-making processes.) That said, it doesn’t exactly pass the equity sniff test- does anyone out there really think that he should be paying the same amount in taxes as Bill Gates? How about Tom Cruise? Katie Couric? I think you get my point.

From a political perspective, it probably doesn’t matter that a lump-sum tax is efficient because it will likely never happen. That is not to say, however, that economic models have nothing to say in the discussion. It’s still important to understand how much efficiency is sacrificed for an increase in equity since this is how intelligent decisions are made. It’s admittedly a little frustrating, but sometimes economics doesn’t give you the answers, just the tools to analyze tradeoffs. But hey, it’s still better than nothing.

In short, students and readers of eocnomics need to be clear on what economics can and cannot offer. I will leave you with a typical response from me that I give in response to the question “When is the economy going to turn around?”

“Hm. I can tell you how markets function, and even how they fail to function, but unfortunately I cannot answer your specific question since I left my crystal ball at home. And no, despite the fact that I studied computer science, I cannot fix your hard drive.”

Tags: Econ 101 · Policy

16 responses so far ↓

  • 1 Justin Ross // Jul 27, 2009 at 8:43 am

    I teach the same class at Indiana University, the micro for the MPA classes and I encounter the same objections. Everything you said was great, I have some additions that I employ as well:

    Objection 1 (too much math): The math in micro is really a part of a sending a strong signal. It is nice to be able to write on a letter of recommendation stating that the student is able to do calculus based optimization problems. The people who can solve these problems signal to others their ability to do other types of analytical problems.

    Objection 2: Blaming economists for the financial panic is akin to blaming medical doctors for swine flu. Ok, neither really foresaw it, but come on.

    Objection 3: Unfortunately, most policy/politics does not take economics into account. Oftentimes these policies kill people. Our objective is to focus on the economics because there are few other places to learn those aspects of the problems, and you will face these other concerns everywhere else.

  • 2 Tony // Jul 27, 2009 at 10:26 am

    Nice defense of (micro)economics.

    I do, however, have a comment on your statement:

    “From a political perspective, it probably doesn’t matter that a lump-sum tax is efficient because it will likely never happen. That is not to say, however, that economic models have nothing to say in the discussion.”

    I agree that a lump-sum tax fails on equity, but my view of the lump sum tax is that the exercise teaches us a lesson about what to tax if we care at all about efficiency.

    Taking your lump sum example, the efficiency lump sum tax is an extreme case of “it’s best on efficiency grounds to tax inelastically supplied or inelastically demanded goods.”

    The lesson in the exercise is that to promote efficiency, tax activities that don’t go away when you tax them (as long as you’re not trying to make them go away).

    That knowledge can be quite useful politically. Hence, the lump sum example matters a lot because it’s a useful input in understanding a more complicated reality.

    My takehome point is: Even if the economic model does not apply, it’s a very useful input (even if we use it by careful analogy). For appropriate policy, we just have to understand how it applies and how it doesn’t.

    I think that’s one of your points already, but I felt compelled to clarify.

  • 3 Mike Visser // Jul 27, 2009 at 12:09 pm

    I agree with basically all you say. My undergrads raise basically the same objections. The text book is really good about showing what economics can offer, but not very good about demonstrating the limitations of economics, so I go out of my way to do that. I think that is the great failure of economics education in the last 20-30 years, actually. We’ve gotten pretty arrogant as a discipline.

    When people ask me when the economy will turn around, I say “if I knew, I wouldn’t tell you; I’d go make myself rich.”

  • 4 The Weakonomist // Jul 27, 2009 at 12:23 pm

    @justinross, it is not akin to medical doctors predicting swine flu. MDs treat problems not predict them. The analogy you’re looking for is the CDC predicting Swine Flu. And the simple fact is that they did.

    Some economists and finance types saw the implosion coming, but unlike Swine Flu, the general consesus was the credit bubble was a non-issue and the media laughed at those pessimists that predicted it.

  • 5 LL Cool A // Jul 27, 2009 at 2:36 pm

    As for Objection #2b (henceforth referred to as “#2” or “Deuce Bigalow”), those economists that DID predict a housing market collapse years ago, and many other economists (OK, maybe just me) who complained of the lack of transparency and regulation of investment companies and banks. Furthermore, that lack of transparency basically meant there was an asymmetry of information in the market for investments. You tie these mortgage-backed securities to a sinking housing market, and of course the fit will hit the shan!

    Also, under Objection #3, are you referring to Potential Pareto Efficiency? Because I always liked that argument…

  • 6 Chase // Jul 27, 2009 at 2:52 pm

    Being a student myself I can understand all of the objections and agree with most of them but I’ve figured out my own ways of getting through the classes. Jodi, you are perfect in your statement about intuition is usually better than the math because they lead you to the same place (or at least that’s how I read it). For my own experience I usually know the answer but not the equation and have to make something up on the spot. If the test is multiple-choice I get it right, if not the professor is just shaking their head wondering. Also, objections 1 and 2 are very similar in nature. The math is way too precise in predicting something that is for the most part unpredictable to a degree and many of the models presented become way too precise. Most teachers show the model and say this is the way things are and teach using the models as a base. When I tutor I usually teach why the model is the way it is and the driving force behind it. If students know why the model works the way it does they then can have a more intuitive idea of what should happen and in the end a better understanding.

  • 7 Justin Ross // Jul 27, 2009 at 4:25 pm

    @ The Weakonomist, respectfully.

    The CDC is not akin to individual economists.

    I am sure you can find some medical doctors who specifically foresaw swine flu, but most were busy doing other things.

    The CDC expresses concerns at all times about all things. It is a pretty wide web, so they catch things here and there. Could they have told us when and where and the specific variation of flu that would have emerged? Probably not. In which case, finance and economics did a little better than the medical community for our respective pandemics.

  • 8 Mikul Bhatia (MPA, Mason) // Jul 27, 2009 at 6:04 pm

    Thank you for a wonderful lecture.

    Although there may be enough empirical evidence to suggest that growth and equity tend to have a negative correlation, I think that this is at least in part a result of absence of perfect market conditions. For example, entry and exit barriers to industries do indeed exist (especially in developing countries), and businessmen capture scarce resources to earn super-normal profits. Knowledge of manufacturing technology may not be easily accesible to all. Similarly, entrepreneurship requires special skills, and certain skills are also required for consumers to gather market information and take intelligent purchase decisions. Obviously, such skills come from education, which itself is to an extent a function of wealth and income. Thus the poor usually do not face a perfect market, where imperfections allow the rich to corner a larger share of the benefits of growth than the poor. I would argue that if markets were perfect, growth and equity could go hand in hand.

  • 9 SteveO // Jul 27, 2009 at 9:09 pm

    I appreciate your argument, and most of what is mentioned in the comments above. My additions would be these, mostly as a defense of a defense, in the “hey, why don’t you cut us economists some slack” mode:

    1. Much of what people expect to learn in econ has been surrendered by academics who became to cowardly to hold up the philosophical end of economics and therefore retreated into their calculators. Boo, cowards. Let’s reclaim some moral ground.

    2. There is no such thing as externalities. Everything designated as an “externality” is merely the evidence of an implicit assumption already made on the scope and scale in question.

    3. I’d like to write this on a baseball bat and whack Paul Krugman over the head repeatedly, “the moral question in economics is one of DOMAIN. Who has the right to make moral hazard and agency decisions about the well-being of others?”.

    The chief difference in economists from GMU for instance and Krugman is the arrogant belief that it is ever your domain to control others resources. Economics in the classroom should, above all other lessons, teach the folly of going beyond ones own moral domain.

  • 10 fenzel // Jul 29, 2009 at 9:02 pm

    Honestly, you’re being too easy on the profession. There were definitely lots of economists who made a lot of money contributing actively to the recent financial crisis. It had little to do with academic economics, but a lot to do with how the mantle of the profession was used in the private sector.

    They may not have been practicing rigorous economics while they were doing it, and they may have been too-quietly insisting on the limitations of their predictions, but they were paid to get people to believe things that they knew were at least unreliable and at most false, so the profession of the reputation deserves to be damaged.

    Thinking economists were not complicit in the last financial crisis suffers from a bit of willful ignorance. Understandable willful ignorance, but willful ignorance nonetheless.

    It’s just the true Scotsman fallacy, really.

    “No economist made predictions of the future that convinced people to do things that caused the financial crisis.”

    “Well, this one did. And this one did. And so did this other hundred. And these thousand people who have masters degrees in econ also helped.”

    “Well, none of them are TRUE economists!”

    Right.

    😉

  • 11 holmegm // Aug 3, 2009 at 1:39 pm

    >That said, it doesn’t exactly pass the equity
    >sniff test- does anyone out there really think
    >that he should be paying the same amount in
    >taxes as Bill Gates? How about Tom Cruise?
    >Katie Couric? I think you get my point.

    Sure … I should pay *more*, since I will likely consume more government provided services.

  • 12 Julien Couvreur // Sep 5, 2009 at 3:31 pm

    I took microenomics back in college and had much of the same feedback. In the last few years, I re-gained interest and a particular school of economics caught my attention, the Austrian economists.

    Focus on maths: Austrians don’t think that maths are part of economics, which is more like logic in their sense. Maths can be used in modeling, heuristics and forecasting, but that is outside of the realm of economics.

    Realism: Austrians make very few assumptions. In fact the only assumption is that humans act, which entails preferences, scarcity, etc. From that assumption, they derive the theory of price, interest, money, etc.

    If you’re interested in learning more, check out: http://mises.org/
    Since I just attended Mises University 2009, I also compiled list of the recorded lectures:
    http://spreadsheets.google.com/pub?key=tMSZPATFHsEUehWnBYG2H1g&output=html

  • 13 Julien Couvreur // Sep 5, 2009 at 4:09 pm

    “The fundamental assumption underlying this measure is the idea that a dollar to one person is the same as a dollar to another person.”
    Yes! So far what I read in mainstream economics textbooks veers into interpersonal utility comparisons very quickly. That is very insidious.

    If you avoid the pitfall of interpersonal comparison, the only provably efficient market is the free market, as it involves only voluntary win-win exchanges. That makes it hard to discuss any kind of “beneficial” policy 😉

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