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The lies of (some) economists
Let's start with five:
1. Believe in comparative statics, the income effects will wash out in the aggregate. (Larry Summers once taught me: "Economics is a theory of substitution effects but we live in a world of income effects.")
2. The model predicts well, don't worry about the assumptions. (As Paul Samuelson pointed out, don't false assumptions, by their nature, involve a very large number of (sometimes implicit) false predictions?)
3. People may make mistakes when the stakes are small, but as they become more decisive over larger prizes, the irrationality goes away. (Name any major politician or how about Tom Cruise on Oprah?)
5. There are many firms in the sector, they must be price-takers. (Does demand go to zero when your local Chinese restaurant raises prices by a penny? Or for that matter by a dollar?)
Do you wish to suggest other lies in the comments?
Here is Guy Kawasaki with The Top Ten Lies of Engineers. The Top Ten Lies of Entrepreneurs. The Top Ten Lies of Venture Capitalists. Thanks to Chris F. Masse for the idea and the pointer to Kawasaki.
Posted by Tyler Cowen on May 10, 2006 at 06:27 AM in Economics | Permalink
Comments
Yes, there may be many chinese firms in aggregate, but they serve highly localized markets -- I live on the east cost, and can't realistically buy chinese food from a supplier in California, even if their price is 0. Therefore, my local supplier has pricing power...
Posted by: Quanty at May 10, 2006 8:29:31 AM
Great post, thanks.
Posted by: Chris Meisenzahl at May 10, 2006 8:31:12 AM
A few from econometrics:
Instrumental variables really correct for endogeneity.
A significant coefficient is an important (or even an actual) effect.
Five percent significance levels mean something.
Posted by: Jonathan at May 10, 2006 8:48:48 AM
6. Money matters.
7. Money doesn't matter.
Posted by: Jason Briggeman at May 10, 2006 8:57:11 AM
Coase's Theorem means that initial distribution of costs is irrelevant.
(Only true when transaction costs are zero.)
Posted by: SamChevre at May 10, 2006 8:59:07 AM
(1) "Demand is inelastic" for some products
As Paul Heyne said, there are substitutes for everything.
(2) Inequality is an unfortunate outcome from enjoying the benefits of capitalism - even Mises himself said so much
(3)Market power, externalities and information asymmetries should all be corrected via government intervention and not by some alternative mechanism.
Posted by: Mike at May 10, 2006 9:22:41 AM
6. Scarce resources matter most.
Posted by: Dan K at May 10, 2006 9:23:11 AM
1) Real Analysis reveals truths better than simple algebra.
2) Empirically, all demand curves are inelastic.
Posted by: eric at May 10, 2006 9:39:56 AM
When the model is wrong, blame the data.
Posted by: Timothy at May 10, 2006 9:49:57 AM
Philosophising about assumptions is fine and dandy but until you can systematically show me better predictions via alternative assumptions/models, then I'm not impressed.
Yes, assumptions imply accepted errors, but error control it's what it's all about.
Of course, people should be encouraged to explore alternative paradigms and consider instrumentalism critically, but most results are disappointing... they either can't provide better predictions or they don't provide predictions at all (are they still "science"?).
Posted by: Gabriel Mihalache at May 10, 2006 10:37:40 AM
Lie: The set of all choices is well-ordered, and money values can approximate that order.
Posted by: eye56 at May 10, 2006 11:04:01 AM
I disagree with Tyler's characterization of the last error. Economics may make its share of errors, but that's not one of them.
Economics does not assume that many firms must generate price-taking behavior. In almost any Economics 101 text, the sufficient conditions for price-taking also include homogeneous products. You can have a lot of firms, but if those firms have some difference in their product (which would include location in many cases), then you no longer obtain price-taking behavior. Most Econ 101 texts include chapters on "monopolistic competition," which is competition with many firms that don't engage in price-taking behavior.
On a somewhat more advanced plane of microeconomics, in the sub-field of Industrial Organization, there's a mind-numbingly huge literature on product differentiation. It's all about the joint strategy of how different or similar to make your product and how to price, and the equilibrium we should expect under different assumptions about consumer preferences and optimal firm strategies.
I will say, however, that I have seen many layman with some (but not enough) familiarity with economics make that mistaken assumption that many firms must generate price-taking behavior. Many people probably don't know how that the model of perfect competition relies on such extreme and stringent assumptions. Many economists may not be eager to let them know, because supply and demand models (or at least their welfare properties) rest on perfect competition...
Posted by: Keith at May 10, 2006 11:29:57 AM
1. Microeconomics is a positive science (falsifible assumptions driving influential normative recomendations)
2. Entrepreneurship is about supernormal profits (what about independence and irrational will)
3. Markets are everywhere :) (and organizations too)
Posted by: PlanMaestro at May 10, 2006 11:32:26 AM
Market actors know how to maximize their expected utility. Or profits. It isn't just trial and error.
Companies can set their production such that marginal revenue and marginal cost match, rather than just setting a price and producing what is needed to fill orders at that price, and then adjusting the price if they 'missed' the target. Producers know what the marginal cost of the last unit produced is and what the elasticity of demand of their product is.
Posted by: rvman at May 10, 2006 3:39:32 PM
If my local Chinese restaurant suddenly raised the price of every dish by a dollar, and the other restaurants kept their prices the same, the local place would lose a lot of customers, and likely go bankrupt. Consistent with (the right application of) economic theory.Economics works pretty well as long as we are not trying to do the equivalent of hammering a nail with a wrench instead of a hammer!
Posted by: Paul Johnson at May 10, 2006 4:48:30 PM
So, Paul, if you are craving for duck, and you discover that your local Chinese restaurant charge a dollar more than the local pasta joint charges for their Spaghetti Bolognese, I gather that clinches the deal?
Posted by: Dan K at May 10, 2006 5:02:23 PM
Theres no such thing as a free lunch.
(think: free trade)
Supply side economics is for political hacks
(get real: demand side economics is bunk)
Geography is destiny
(think: Hong Kong)
Irrationality abounds
(get real: theres no $50 bills lying on the sidewalk)
Education has big externalities that merits state finance
(they're reading Karl Marx in the sociology dept of my uni)
Fiscal policy is an effective stabilization tool
(yeah right)
Capital accumulation is the key to growth
(um, its A stupid)
The kinked demand curve in oligopoly
(george stigler was vehement that this is bunk)
Budget deficits lead to higher interest rates
(think: Japan + US)
The existence of a stable NAIRU
(doesnt even dignify refutation)
The permanent income hypothesis
(all right, its a very, very rough rule of thumb, but thats it)
The coefficient of relative risk aversion is one.
(almost all RBC models are contingent on this)
..........................................
Okay, Ill stop there, but I could go on.
Posted by: mvpy at May 10, 2006 6:37:20 PM
I agree with rvman.
Also, a biggie, "equities markets are efficient"
Posted by: michael vassar at May 10, 2006 6:51:58 PM
Pareto efficiency is a good criterion for normative policy analysis.
Posted by: Mark at May 10, 2006 7:39:57 PM
Believe in comparative statics, the income effects will wash out in the aggregate. (Larry Summers once taught me: "Economics is a theory of substitution effects but we live in a world of income effects.")
The Summers quote isn't clear to me, can someone help? "Substitution effects" are when you use less of something or something else when the price goes up, and "income effects" are when you use less of something because your income went down. Right? Where's the overlap?
Posted by: Noumenon at May 10, 2006 8:41:48 PM
Samuelson wrote a paper showing that perfectly anticipated stock prices fluctuate randomly.
But in the real world, something that Samuelson should have bothered himself to learn about,
stock prices aren't perfectly anticpated, and therefore don't fluctuate randomly.
(Just look at the last five days' prices for practically any stock, and notice the interday--and sometimes even intraday--jumps.)
Speaking of the real world, Coase taught us that lighthouses worked by charging shippers for their use of ports' services. Samuelson protested that this still didn't solve the free rider problem. He has since done a zillion google searches, but hey the free rider is still dat big bad bogeyman.
Samuelson had some chutzpah in taking the Austrians to task for "shadow boxing with reality."
I submit he should be stripped of his Nobel posthaste. He sure gets my vote as the most overrated economist ever.
Posted by: Bill Stepp at May 10, 2006 10:53:59 PM
The biggest lie by far in recent years was during the great Nafta debate when Paul Samuelson got up before an audience in the East Room of the White House and said that "protectionism had never caused wages to go up." Since the issue was whether protectionism could keep wages from going down, he was being disengenuous to the point of lying, as he (co-author of the famous Samuelson Stolper paper on protectionism and real wages) knew full-well.
In general it is a lie to say that free trade makes everybody better off without regard to the principle of compensation; when the comparative advantage concerns relative factor endowments (ie, high-wage vs. low-wage countries) the principle of compensation becomes critical; otherwise, the vast majority of workers in the high-wage country will most assuredly be made worse off than they would have been under the old regime.
Basically it comes down to the laws of supply and demand; whenever economists claim that these laws don't apply in some particular situation, they are lying. Immigration is the currently most topical example: to say that increasing the supply of low-wage labor does not depress the wages of low-wage labor is a bald-faced lie, and everybody in America (except for a few brain-washed editorial writers) knows it.
Posted by: Luke Lea at May 10, 2006 11:08:59 PM
The biggest lie by far in recent years was during the great Nafta debate when Paul Samuelson got up before an audience in the East Room of the White House and said that "protectionism had never caused wages to go up." Since the issue was whether protectionism could keep wages from going down, he was being disengenuous to the point of lying, as he (co-author of the famous Samuelson Stolper paper on protectionism and real wages) knew full-well.
In general it is a lie to say that free trade makes everybody better off without regard to the principle of compensation; when the comparative advantage concerns relative factor endowments (ie, high-wage vs. low-wage countries) the principle of compensation becomes critical; otherwise, the vast majority of workers in the high-wage country will most assuredly be made worse off than they would have been under the old regime.
Basically it comes down to the laws of supply and demand; whenever economists claim that these laws don't apply in some particular situation, they are lying. Immigration is the currently most topical example: to say that increasing the supply of low-wage labor does not depress the wages of low-wage labor is a bald-faced lie, and everybody in America (except for a few brain-washed editorial writers) knows it.
Posted by: Luke Lea at May 10, 2006 11:10:21 PM
Free markets only produce good results when everyone has perfect information
Laissez-faire capitalism inevitably allows one firm in each sector to become a monopoly.
Inflation is defined as a widespread rise in prices.
Inflation is caused by wage and price increases.
(You may argue that no economist ever said these things, however people must be learning them from SOME economist.)
Posted by: Russell Nelson at May 11, 2006 1:19:16 AM
I remember many lies, myths, misunderstandings or half-truths that people say about economy. For example:
"What is good for economists is not always good for poor people."
"Economics is only about money, but not about people."
"The Laffer curve is a joke."
"Reagan tax cuts caused budget deficits."
"Speculative markets are merely good for speculators; they have no significance for the real economy."
"Economics is no science, because you cannot do controlled experiments."
"Economics is, in fact, accounting."
"Free market means extreme wealth for some, but extreme poverty for many."
"Poverty in Latin America is caused by the lack of social protection legislation in these countries."
And so on, and so on.
Generally, economists are perceived as greedy people, which I think is nonsense.
Posted by: PK at May 11, 2006 7:13:41 AM
