What is economics? In his Principles
of Economics, Carl Menger tells us that his goal is to “reduce the
complex phenomena of human economic activity to the simplest elements that can
still be subjected to accurate observation, to apply to these elements the
measure corresponding to their nature, and constantly adhering to this measure,
to investigate the manner in which the more complex economic phenomena evolve
from their elements according to definite principles (46-7).” Economics is
about the relationships that arise between elements, and those new elements
that come into existence within the market order. These cannot be studied with
Cartesian causation, with what Menger referred to as “a natural-scientific
orientation,” if the goal of the study is to understand the economic processes
and complex relationships of diverse economic elements. Emphasis must be on
structure and process as opposed to simple input-outputs processes defined by
parameters. This requires greater emphasis on the elements of economic analysis
than is embodied by the modern paradigm.
What are the objects of study in economics?
Before, we considered the example of a husband pleasing his wife within a
general economic framework, but we did not identify systematically the objects of
interest to the study of economics. These include:
- Agents
- Preferences
- Goods
- Capital Structure
- Money
- Property Rights
- Prices
- Expectations
- Entrepreneurship
I will review these one at a time.
1. Agents
The economy is comprised of real life human
beings. These agents are ecologically rational, meaning they do not reason only
by means of internal objects. They relate their thought processes to the webs
of objects that comprise their reality (Gigerenzer 2008). While agents can adopt
technically advanced methods of decision making, most decisions are made using
heuristics – rules of thumb. Those that reduce decision making down to the
attributes of one or a few elements in their environment have been shown to be efficient
(Gigerenzer and Goldstein 1996). The common practice in economics has been to
assume that agents have perfect information. This assumes away the process that
economics, at its core, seeks to analyze.
Marshall referred to supply
and demand as a pair of scissors. One blade requires the other for successful
analysis. Herbert Simon and Gerd Gigerenzer suggest that a new pair of scissors
to motivate analysis:
The structure of natural
environments, however, is ecological rather than logical. In Simon’s words:
“Human rational behavior is shaped by a scissors whose two blades are the structure of task environments and the computational capabilities of the actor
[emphasis mine]” (Simon, 1990: 7). Just as one cannot understand how scissors
cut by looking only at one blade, one will not understand human behavior by
studying either cognition or the environment alone. (Gigerenzer 2008, 7)
Agents offload computational work by using objects that they have
identified from the environment. This is why doctors don’t understand how to
apply Bayesian statistics when information is couched in statistical jargon and
formalization, but can apply simple math to the structures they already use to
interpret reality, and thereby arrive at a more accurate survey of the data.
The information that agents access is typically not purely abstract. The habit
of academia is to assume that all reasoning must take place in formless models.
This has been true in economics as a consequence of the growth of rational
expectations as the dominant mode of analysis.
The problem here discussed is well represented by analysis of the real
world. Gerd Gigerenzer notes:
When physicians try to draw a
conclusion from conditional probabilities, their minds tend to cloud over
(chap. 9). What can be done to correct this? From an internalist perspective,
one might recommend training physicians how to insert the probabilities into
Bayes’s rule. Yet this proposal is doomed to failure. When we taught students
statistics in this way, their performance dropped by 50 percent just one week
after they successfully passed the exam and continued to fade away week by week
(Sedlmeier & Gigerenzer, 2001). Moreover, the chance of convincing
physicians to take a statistics course in the first place is almost nil; most
have no time, little motivation, or believe they are incurably innumerate. Are innumerate
physicians inevitable? No. In the ecological view, thinking does not happen
simply in the mind, but in interaction between the mind and its environment.
This opens up a second more efficient way to solve the problem: to change the
environment. The relevant part of the environment is the representation of the
information, because the representation
does part of the Bayesian computation [emphasis mine].”(17)
This efficient form of computation – let’s call it
ecological Bayesian computation – has no analog in typical models. Luckily, an
agent-based computational framework allows for this sort of representation and
decision making. This paradigm of analysis has an obvious medium for modeling!
In our model of the economy, preferences are the
ultimate given. I (implicitly) spent enough time last
post describing preferences. Preferences are observed directly from the
actions of agents. If an agent chooses to take a particular action, it is
because she believes the results of the action, given its expected cost, to be
better than the other options she can imagine. Traditional models abstract away
from decision-making processes and make decisions dependent upon expected utility.
This measure is typically treated like a cardinal value, which might be useful
for conveying the nature of economic action. From the perspective of “pure”
theory, preferences are ranked ordinally, not cardinally. We can only observe
what an agent does. If in a model, an agent’s preferences are assigned utility
values, the states that arise from the interaction of the agent with her environment
are the objects of interest to the study of preferences. Any sort of
optimization of utility derived from calculus is a convenient tool for arriving
at ordered preferences. Cardinal utility has no bearing on these real life
processes.
Carl Menger clearly defines a good in his Principles. He writes:
Things that can be placed in a causal connection with the
satisfaction of human needs we term useful things. If, however, we
both recognize this causal connection, and have the power actually to direct
the useful things to the satisfaction of our needs we call them goods (52).
A thing is a good if the following prerequisites
are met:
1. A human need
2. Such properties as render the
thing capable of being brought into a causal connection with the satisfaction
of this need.
3. Human knowledge of this causal
connection.
4. Command of the thing sufficient to
direct it to the satisfaction of the need. (52)
Not only must these prerequisite be met, but
they must also appear to be achievable by the agent in question (Note criteria from #2).
A thing loses its good character if:
1. Owing to a change in human needs,
the particular needs disappear that the thing is capable of satisfying
2. Whenever the capacity of the thing
to be placed in a causal connection with the satisfaction of human needs is
lost as the result of a change in its own properties
3. If knowledge of the causal
connection between the thing and the satisfaction of human needs disappears
4. If men lose command of it so
completely that they can no longer apply it directly to the satisfaction of
their needs and have no means of reestablishing their power to do so. (52-53)
But a good that loses its goods character may
still be treated like a good:
1. When attributes, and therefore
capacities, are erroneously ascribed to things that do not really possess them
2. When non-existent human needs are
mistakenly assumed existent. (53)
Last time, I described a good with a simple
story about a husband seeking to please his wife. While a story is a nice way
to remember a concept, it is important for the sake of study this more general
definition. Remember that a good can only exist if some agent expects that attainment
of the good will improve his position. Thus, the definition and type of good
requires context.
4. Capital Structure
a.
Orders
Capital structure is a formal description of the
arrangement of economic goods. A good can be described by its order: its
position in the process of production. If a good is employed to produce a
higher order good (say machinery), the good is itself a higher order good. But
if that same good is consumed with expectation that consumption will improve the
welfare of the agent consuming it, then the good is a first order good. Thus,
there is nothing intrinsic about the order of a good. It is a description
relative position in the structure of production.
5. Money
Money serves several roles. It is:
1. A medium of exchange.
2. A store of value.
3. A common unit of account.
a.
A standard of deferred payment.
Historically, money has arisen when agents in a
community begin to accept one a small number of commodities as a medium of
exchange. Consider the first oat farmer who realized that he was not only
growing food, but money! Under such a standard, exchanges are measured in terms
of volume of wheat. Oats have a finite lifespan, which does not serve well for functioning
as a store of value. Eventually, a money that is durable and easily divisible
will be commonly accepted.
6. Property Rights
Assumed in our analysis is an organization of
ownership described as private property. Menger describes property rights as:
The entire sum of goods at an economizing individual’s command for
the satisfaction of his needs, we call his property. His property
is not, however, an arbitrarily combined quantity of goods, but a direct
reflection of his needs, an integrated whole, no essential part of which can be
diminished or increased without affecting realization of the end it serves.”
(76)
In our model of the economy, as well as in real
life, agents are empowered by their ownership of goods. When an agent owns a
good, that good is under his control. Thus, property ownership provides a
social space for a property owner to experiment with the allocation of goods at
his disposal. When property rights are considered alongside the existence of
money and money prices, the scheme serves to account for all of society’s available
resources, assuming that property rights are secure.
Property rights, however, are not perennial. While
ownership may be a natural habit of humankind, formal property rights, guarded
by the legitimated use of violence – historically from the state – must be
developed. Security of property rights has fluctuated overtime, and has seen
its greatest development since the Glorious Revolution with the ascension of a
government that served a broader array of interests than those of the
aristocracy (North, Wallace, and Weingast 2012). This is not to suggest that
property rights did not exist elsewhere, or that they were perfected at that
time. Rather, this era marks a turning point in the representation of group
interests in the edifice of government. It is no coincidence that since that
time, society has flourished in a manner never before observed in history. It
is also no coincidence that this move toward well-defined property rights has tended,
even if imperfectly, to shift responsibility of ownership to those who are best
able to maintain valued resources.
Thus, we have explored a large part of the
general economic framework. In future posts, I will spend more time investigating
prices, expectations, and entrepreneurship as each of these elements merit thorough description.
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