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Background Information

In his article on Neoclassical economics in The Library of Economics and Liberty, E.Weintraub articulates the following:

Neoclassical economics rests on three assumptions, although certain branches of neoclassical theory may have different approaches:

  • People have rational preferences between outcomes that can be identified and associated with values.
  • Individuals maximize utility and firms maximize profits.
  • People act independently on the basis of full and relevant information.

Whilst there is a fair amount of criticism of neoclassical economics coming from less dominant schools of thought within economics (behavioural economics is an example), It seems that there is a lack of philosophical criticism when there is some to be had.

An example

Given the previous assumptions, a model can start by holding them to be true (in addition to whatever assumptions the specific model makes) for any member of society. The whole of society is then the aggregation of every individual member and their homogeneous behaviour.

One could then raise an objection based on a saying by Kurt Koffka:

The whole is other than the sum of the parts.

Question

What philosophical issues arise from the fact that the assumptions which underlie the neoclassical paradigm, are wrong?

Models which rest on these assumptions are then used in attempts to inform economic inquiry. It's basically a case of internally consistent models being divorced from another important measure- external consistency.

I'm afraid of this question being subject to the subjectivity reason for closure, I will therefore try a more objective approach:

Let's say that within a field of study F, we have that:

  • There exists a paradigm P.

  • P rests on assumptions A.

  • A are wrong.
  • Models M, based on P , are then constructed.

What philosophical issues (related to epistemology etc..) arise from the fact that M ultimately endorse A insofar that P entails A and M entail P. The problem is that A are not in accordance with reality as we know it. But, M are ultimately used in an attempt to help inform F?

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The reason there isn't a huge amount of philosophical criticism is that the answer is simple and well-understood: if your premises are false, your conclusions may be also even if your reasoning is valid.

But there is a rather famous exposition by John Stuart Mill (summarized here) about the epistemological validity of economics in the face of not quite getting your assumptions right. The basic argument as I understand it is that if you get your premises essentially right, your conclusions will be approximately right, and that's good enough to tell whether you're on the right track.

This sounds lovely, and was very popular for a while, but as it came under criticism, a new idea from Milton Friedman (yes, the famous economist) gained hold, which is that you should see how accurate specific predictions are not worry too much about false assumptions. Also sounds lovely, but it's basically a dodge (we're wrong; who cares?) and inadequate because you want not just to get little easy-to-measure predictions right, but also make sure your whole economy doesn't tank (i.e. you want some assurance of whether big rare events are being made more or less likely).

The SEP article covers various modern responses. In particular, approaches inspired by Popper's approach to the scientific method (including the slightly more forgiving formulation by Lakatos) seem to indicate that economics is no science and should be treated with skepticism. It's not at all clear to me that this is wrong even if it is not acceptable to economists.

Because, as I began, the fundamental problem is pretty simple: the premises are false, and sometimes badly so, and it's just not that tricky of a philosophical issue when you're in that situation.

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First of all, whether it is neoclassical, classical or marginalist, what is the target subject of economics as a discipline?

I mean, today's economics is to some extent, a branch of the old Austrian-school. Is the goal to set the price of things on the market?

From a materialist’s point of view, this is one of the first questions to ask.

As far as modern economics is based on the assumptions in questions, paradoxes such as the following will never occur and will never be solved.

http://www.intellectualtakeout.org/library/chart-graph/water-diamond-paradox

But suppose you were offered an all-or-nothing choice: 100 gallons of water for $500 monthly or no water at all. (Many American families use 100,000 gallons or more a month.) If you could afford it, you would willingly pay at least $500 per month for water, limiting its use to drinking, preparing food, and sponge baths. Your lawn and plants would die, your car would go dirty, and washing machines and flush toilets would be forgotten luxuries. (Do you think this might explain why prospectors smell ripe after a few days of roaming the desert?) If you had to, you would pay considerably more for the 10,000 gallons of water you use each month than the $20 or so you do pay, so water yields an enormous consumer surplus.

Here, you are put in the middle of the desert and you have nothing with you. Neoclassical or not, as far as modern economics sticks to its own assumptions, the diamond has more value than the water even if water is the only thing that can save your life in the above situation.

Then, let's say, someone in the middle of a desert changes his preferences, he now values water way more than diamonds. Then the whole model should be completely abandoned. And then where is the first premise gone? It explains nothing if the assumption itself is only valid within a specific paradigm.

In this middle of the desert-case, since modern economics is completely ignoring the workforce (= the amount of labor) put into the the item in the process of the production, such a paradox can occur. In this middle of the desert-case, you have no tools such as shovels or drill to dig the hole, and you don’t even know where to find the water which could save your life.

So, it could take an enormous amount of labour effort to find the water. So the price is likely to skyrocket very high, maybe in extreme cases such as this, there would be no limit on the price, as far as the consumer A or B do not want to die.

However, on the premise of the preference assumption, there might exist a diamond worshipping consumer C who prefers diamond in all situations, irrespective of context. As far as consumer C exists, preference assumption-based modern economics will not have such a paradox, which to me, is quite nonsensical.

As far as modern economics is completely forgetting the amount of labour input required in the process of production, economics of this sort will remain in the metaphysical realm.

And here we might see the Marxian common (mis)understanding of the price analysis written by Engels in Capital Vol.2, which is the price will be set based on the amount of the labour put into the target item. (Actually, he failed. We might think of Okishio's theorem. People tend to misunderstand Marx’s work Contribution to the Critique of Political Economy, 1859, and Vol1 of Capital.

Marx never said that the price will be set based on only the amount of labour input , but he said something along the lines of "the commodity can be a commodity as far as the commodity is accepted by the other people". This view is not dismissive of the necessity of preference (Preference in a way, is exchangeable with necessity, or am I wrong here?)

In the view of the consumer, producing socially unaccepted items is not social-production (irrespective of the social condition)

Therefore, in the desert case, the diamond is not a socially accepted good. Under such circumstances, you may suspect that nobody would want to produce a diamond; they would all want to produce water.

Here is a clarification:

The total utility of water is substantially higher than its marginal utility and price, while the total utility of diamonds is close to their marginal utility and price. The areas representing consumer surpluses in Figure 4 are shaded. This analysis should help you understand why diamonds, which are not nearly as necessary to life as water is, are valued and priced much higher than water. The total utility, marginal utility, and price of diamonds are nearly identical for those of us who own, at most, a few of the baubles. The lesson to be learned from the paradox of value is that marginal utility, not total utility, determines the value and market price of individual products."

In my opinion, we can easily solve this. Diamond is metastable allotrope of carbon which means it is not as easily breakable as gold is. In ordinary life, it is simply treated in the same way that gold, silver accessories are treated. We can ultimately convert all three into money. Under the normal circumstances, marginalists would say that Diamonds have more utility than water. Unlike the extreme case above, let me use a more relevant, 20th century example. When Nazi Germany established concentration camps throughout the Lebenstaum, for those in the concentration camps, would they have preferred diamond or food? They would have sacrificed diamonds just for a loaf of bread in order to survive.

At that moment, the Reichsmark meant very little. In concentration camps, you are not even allowed to work, to produce crops and vegetables, in order to survive. A minimal ration of food was given until the prisoners died. Marginalist principles fail here. There was no choice. If prisoners had been allowed to work, they would have definitely put their "power" into labour such that they could have produced the goods necessary for their survival. Here we begin to understand the value of labour.

In short, economics, to me, cannot dismiss both of these premises:

A: Preference-necessity

B: The amount of labour required.

Since modern economics relies only on premise A, a paradox such as the one mentioned above, could occur.

We should also abandon the following premise:

People act independently on the basis of full and relevant information.

Nobody has full and relevant information all of the time, unless they are omniscient.

Footnote : Okishio's theorum --> regarding the Marx's proposition that all the value existing in the world equals with the total amount of the price.

--> To me, this is nonsensical. When we consider about the reification, the price is also the thingnification of the human activity, thus when we take the above mentioned premise A, Peference-neccesity, if an item was produced under the circumstance in which the item is not socially accepted, then the price will go down below the amount of the investment ( = materials plus added amount of the labor ( Although Marx admitted from the first there is a "facial" difference between the price and the amount of the value the target items holds )). In short, personally unless we conquer the above reification-thingnification, the difference between price and the total volume of the value the target item holds will be never solved. Therefore, I said Economics need the premise A ( since premise A is in a way only the reification-thingnification of human beings's inner desire ). But we can not abandon the premise B, since there is no item to which price is added in this world which has no amount of the labor ( even if it is an art ( = the thingnification of the artist's brain-image ( artists need to move their fingers so carefully in order to make their product to be sold )) Ordinary air which we inhale and exhale every second has no price since there is no amount of the labor added. But the special air such as the air for the relaxation purpose or scuba diving has the price since these have both the premise A and B.

  • I'm sorry for my poor English. – Kentaro Tomono Apr 10 '15 at 4:03
  • ahhmmm....thank you for editors for further clarification. It is O.K for you to edit per your own standard, though I am glad if you do not mislead the hyperlink which Five α edited kindly, ( correcting the linking the marginalism with the Okishio-theorum ) due to the sense of its technical meaning. Well thanks anyway. – Kentaro Tomono Apr 10 '15 at 13:59
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Empirical issues

It is well understood that in Economics, empirical research is constrained by the fact that you cannot perform experiments in controlled conditions, where variables can be isolated.

This sort of tension led some economists in the Austrian tradition to reject the idea that economics can be built up on empirical grounds. Hayek was of the belief that we just don't know enough about the economy to make policy decisions based on economic theory. His thesis is that those who think they understand anything close to the full workings of the economy, are wrong.

Economists face the problem that they can offer explanations, but predictions are harder to come by. The fact is that an economic system is a complex system, where every individual is alive and is making decisions.

What we should take from Hayek (and the Austrian tradition in general) is that even though areas of economic theory can be wrapped up in fancy mathematics and statistical models, they are still speculative. A poor theory written in elegant language is still a poor theory.

A Popperian approach?

The following is taken from SEP

Popper argued that scientists should formulate theories that are inconsistent with some possible observation reports. For example "all crows are black" is falsifiable in the sense that it is inconsistent with the observation of a white crow.

Popper insisted that unfalsifiable claims that rule out no observations are uninformative. Scientists should subject theories to harsh test and should be willing to reject them when they fail the tests.

Passing a test does not confirm a theory or provide scientists with reason to believe it. It only justifies continuing to employ it.

Duhem–Quine thesis

There is a concept in economics known as partial equilibrium analysis, which takes into consideration only part of the market. You consider this market in isolation which follows from ceteris paribus clauses. Historically, economists within schools of thought such as the classical one rejected the notion of "ceteris paribus". They regarded it as nothing but an analytic trick.

A supposed example of Popperian methodology with reference to economics is from Blaug and Hutchinson. Though it seems they have underestimated the strength of the falsification message. Their message pretty much amounts to “Those doing economic theory should be much more critical”.

From the wikipedia page on the Duhem-Quine thesis:

Instead, deriving predictions from the hypothesis typically requires background assumptions that several other hypotheses are correct; for example, that an experiment works as predicted or that previous scientific theory is sufficiently accurate. For instance, as evidence against the idea that the Earth is in motion, some people objected that birds did not get thrown off into the sky whenever they let go of a tree branch. Later theories of physics and astronomy, such as classical and relativistic mechanics could account for such observations without positing a fixed Earth, and in due course they replaced the static-Earth auxiliary hypotheses.

Although a bundle of hypotheses (i.e. a hypothesis and its background assumptions) as a whole can be tested against the empirical world and be falsified if it fails the test, the Duhem–Quine thesis says it is impossible to isolate a single hypothesis in the bundle. One solution to the dilemma thus facing scientists is that when we have rational reasons to accept the background assumptions as true (e.g. explanatory scientific theories together with their respective supporting evidence) we will have rational — albeit nonconclusive — reasons for thinking that the theory under test probably is wrong in at least one respect if the empirical test fails.

It is worth noting that Popper did reply to the Duhem-Quine problem. From SEP:

These problems arise generally, and Popper proposes that they be solved by a methodological decision to regard a failure of the deduced testable implication to be a failure of the theory. But in economics the subsidiary assumptions are dubious and in many cases known to be false. Making the methodological decision that Popper requires is unreasonable and would lead one to reject all economic theories.

Under a Popperian understanding, economic theories are rarely falsifiable. When they are, these theories are not subject to stringent testing. Even if these theories fail testing, they are rarely repudiated. We now face the problem that if we were to apply falsification to economics, we could quite feasibly reject all of economic theory.

Is there a synthesis, which applies some of Popper's principles but doesn't lead to the annihilation of economic theory?

The Hungarian philosopher Imre Lakatos offered one such solution:

Lakatos insists that testing is always comparative. When theories face empirical difficulties, as they always do, one attempts to modify them. Scientifically acceptable (in Lakatos' terminology “theoretically progressive”) modifications must always have some additional testable implications and are thus not purely ad hoc. If some of the new predictions are confirmed, then the modification is “empirically progressive,” and one has reason to reject the unmodified theory and to employ the new theory, regardless of how unsuccessful in general either theory may be. Though progress may be hard to come by, Lakatos' views do not have the same destructive implications as Popper's. Lakatos appears to solve the problem of how to appraise mainstream economic theory by arguing that what matters is empirical progress or retrogression rather than empirical success or failure. Lakatos' views have thus been more attractive to economic methodologists than Popper's.

But, Lakatos' attempted solution also has some problems:

It is questionable whether neoclassical economics has demonstrated much empirical progress. An example is the replacement of “cardinal utility theory” by “ordinal utility theory”. The latter can be interpreted as weaker than the former, in the sense that under ordinal utility we cannot observe the utility derived from a good.

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    The SEP continues from where you left off to point out that "Lakatos' views do not provide a satisfactory account of how economics can be a reputable science despite its reliance on extreme simplifications. For it is questionable whether the development of neoclassical economic theory has demonstrated empirical progress." You make it sound like Lakatos has got the answer, when SEP concludes with "writers on economic methodology have in recent years become increasingly disenchanted with Lakatos' philosophy." (Due to problems with meaningful testing.) – Rex Kerr Apr 10 '15 at 9:26
  • Thanks for pointing out my error, I have now corrected it. Although it wasn't my intention to portray Lakatos as some sort of arbiter of truth, I now realise that what I posted may have implied something along those lines. – Five σ Apr 10 '15 at 9:51
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    Popper had an answer to the Duhem-Quine problem, see Section 29 of Logic of Scientific Discovery. – alanf Apr 10 '15 at 11:35
  • Also, the SEP is not under some super-open copyright provision as far as I can tell, and what you've quoted probably goes way beyond fair use. (Not that I have any reason to think that they mind, but they're probably allowed to mind if they wish to.) – Rex Kerr Apr 10 '15 at 11:53
  • @RexKerr How about now? – Five σ Apr 10 '15 at 12:22
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The reason there's not much criticism of Weintraub's cartoon version of neoclassical economics is that it's silly to waste time criticizing cartoons.

In particular, note Weintraub's third assumption:

People act independently on the basis of full and relevant information.

This might be a standard assumption in freshman and (sometimes) sophomore level economics classes, but it is certainly not a standard assumption among practitioners of neoclassical economics --- as you can plainly see for yourself by flipping through the pages of any current research journal.

  • Please kindly define the practitioners Who are they? – Kentaro Tomono Apr 12 '15 at 1:33
  • @KentaroTomono: The practitioners are, by and large, the people who publish in the recognized research journals. – WillO Apr 12 '15 at 4:03
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    Uh then, we should call them commentators not practitioners. Once one of the commentators, Iwata, Kikuo, the advisor to Finance Ministry of Japan now, turned into the practitioner, preached by Friedman, and our currency ratio dropped ----60%--- to the dollar within 2 years and real wage ( wage/consumer price index ) has been decreasing for 22 months in succession, and our GDP growth was minus 2times this year! only one time a plus a quarter. Thank you for your good job the main stream economists! – Kentaro Tomono Apr 12 '15 at 9:05

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