Comments on: Idealisations in Economics

By: catallaxy » Blog Archive » Try on some new stereotypes

catallaxy » Blog Archive » Try on some new stereotypes — Mon, 01 Aug 2005 13:44:30 +0000

[...] Lippmann had a very broad definition of stereotypes. For him they included things like economic models. Milton Friedman wouldn’t have objected to this. In ‘The Methodology of Positive Economics’ he argued that it didn’t matter if a model’s assumptions were falsified. What did matter was whether the model was good at predicting things (Popper would have been appalled). [...]

By: bill carone

bill carone — Fri, 05 Mar 2004 21:33:53 +0000

Brian, Forgive me, but I don’t see how your first three points are relevant. I am arguing that if the rationality-assumption works well-enough in one model, that provides evidence that such an assumption will work in the next model. You are arguing the reverse. Correct? “First, we’d need a lot more examples (I mean a lot more examples) of successful models before we’d say that 85% of cases can be modelled without accounting for departures from full maximisation.” True (although I think you and I have different views on how many “success” stories there are), but irrelevant; a new success would still move us towards the 100% point, while a new failure would move us towards the 0% point. Therefore, a new success increases our probability for the next success, and a new failure decreases it. Imagine a set of propositions, C0 to C100, where Cx = “Before we study an economic situation, we should assign x% chance that the rationality assumption will lead to good-enough predictions about the situation.” We can then assign probabilities on each Cx. Each time a model based on rationality is confirmed, the probabilities of low Cx decrease and the probabilities of high Cx increase. Therefore, the probability that rationality will work in the next situation increases. (The inverse is also true; failures lead to lower probabilities). “Second, if we know 85% of cases can be so modelled, and we know which 85% they are, that doesn’t tell us a lot about the other 15%.” True but irrelevant. All I am saying is that we increase our probability of rationality working for the next case, nothing about what we should do if we find that rationality doesn’t work. “Third, even if we know 85% of cases can be so modelled, if we know something about the other 15%, that extra knowledge will probably be more helpful.” Again, true but irrelevant. The idea is that rationality is a good-enough assumption, not that other assumptions can’t work marginally better. What assumptions should we use in our models? It depends on what we are using the models for, the costs of using different models, and the consequences of being right or wrong. Better modelling can lead to more precise results, but might not be worth it. “Is it really plausible to infer that because irrational behaviour washes out in financial markets, it also washes out when it comes to racial or religious discrimination? ” I have not been arguing about “washing out.” I have been arguing about “doesn’t make enough of a difference to worry about.” The first implies the second, but the second doesn’t imply the first. As to the question, if we are discussing a model that predicts what people will do, then yes, it makes sense to me that if we show that irrationality can be ignored in one case, it provides evidence (not certainty) that it can be ignored in other cases. You might argue that the reasons that irrationality wasn’t important in one case don’t apply in another particular case; however, you need to make those arguments. Without them, the success of one case increases the chance of success in the next case. “Finally, the cases being covered, especially when we get into Chicago school style extensions of economics, just don’t look like natural kinds.” Economics predicts human action. One assumption that helps model human action is rationality. By observing how closely reality matches the models, we can see what predictive power the models have. I don’t see this as needing the philosophical heavy lifting of “natural kinds”. However, I am not a philosopher. “And induction can only be applied to natural kinds unless we want to fall into paradox.” How would you apply this to our current discussion? Can you produce a paradox?

By: Brian Weatherson

Brian Weatherson — Fri, 05 Mar 2004 17:59:52 +0000

Bill, there’s a few reasons why I don’t think C’ will be helpful. First, we’d need a lot more examples (I mean a lot more examples) of successful models before we’d say that 85% of cases can be modelled without accounting for departures from full maximisation. Second, if we know 85% of cases can be so modelled, and we know which 85% they are, that doesn’t tell us a lot about the other 15%. Third, even if we know 85% of cases can be so modelled, if we know something about the other 15%, that extra knowledge will probably be more helpful. Again, look at the example Friedman provides. Is it really plausible to infer that because irrational behaviour washes out in financial markets, it also washes out when it comes to racial or religious discrimination? Finally, the cases being covered, especially when we get into Chicago school style extensions of economics, just don’t look like natural kinds. And induction can only be applied to natural kinds unless we want to fall into paradox.

By: bill carone

bill carone — Thu, 04 Mar 2004 22:32:30 +0000

Brian, “Bill, I don’t think in this case P(B|A) > P(B). I think what’s happening is the following. Let C be the hypothesis that for all intents and purposes, people are ideally rational…” I was thinking along these lines, but not using C but C’: “Even though people are actually not ideally rational, this fact is usually irrelevant.”? I’d would want to know your evidence that p(C’) = 0; it is different than the evidence against C, which is easy to demolish (one good counterexample would do it, right?) “I don’t say models don’t have predictive value. A good model (like say Akerlof’s model for used cars) might be well-confirmed and quite reliable. I just don’t think it alone provides any reason to trust other models.” Right, and I am arguing that confirmation of one model does provide some reason to trust other models. It boosts the probability of C’, which boosts the probability that the “non-maximizing” fact is irrelevant in the next situation. It doesn’t provide the same level of support as a well-confirmed scientific study, but it does provide some support, and lots of examples provide lots of support. For example, after many economic situations have been studied, I might have quite a bit of evidence for something like the following “For an economic situation, before we do a scientific study, you should assign an 85% chance that the rationality assumption will give a good-enough answer.” (this is a more precise version of C’ above). Can you imagine having lots of evidence for this proposition? Or perhaps I am wrong here? Then, when I make my next decision, I should assign an 85% chance to the rationality assumption’s working, and a 15% chance to its failing. Then I can decide, based on the consequences of being right and wrong, whether to simply use the rationality assumption or to spend time and money doing a real study that gets the real answer.

By: Brian Weatherson

Brian Weatherson — Thu, 04 Mar 2004 21:36:25 +0000

Bill, I don’t think in this case P(B|A) > P(B). I think what’s happening is the following. Let C be the hypothesis that for all intents and purposes, people are ideally rational. I think A ‘boosts’ the probability of C, and that in turn might boost the probability of B. The problem is that we’ve got independent evidence that the probability of C is close enough to 0 that it’s not worth bothering about, and that screens off the evidentiary value of A to B. By the way, I don’t say models don’t have predictive value. A good model (like say Akerlof’s model for used cars) might be well-confirmed and quite reliable. I just don’t think it alone provides any reason to trust other models.

By: bill carone

bill carone — Thu, 04 Mar 2004 20:27:25 +0000

Brian, “The fact that people aren’t perfect maximisers is irrelevant to (say) the probability that various options will be exercised. Therefore, the fact that people aren’t perfect maximisers is irrelevant to (say) how much discrimination there is in various job markets. And this doesn’t even look like a good argument.” If we call the first sentence A and the second sentence B, you (sensibly, I think) say that A does not imply B. But don’t you agree that p(B | A) > p(B) In other words, if the maximizing assumption works in one economic situation, doesn’t that increase the probability that it will work in another economic situation? If so, since we don’t just have one example, but many examples of the “non-maximizing fact” being irrelevant, then it is highly probable that it will be irrelevant next time. So I disagree with your statement: “every single prediction must be tested anew, because these models have little or no evidential value on their own.” since simplified models can have quite a bit of “evidential value on their own” if they have worked well (or well enough) many times in the past, right? Also, “It’s rather something like X is irrelevant to lots of things, so it will probably be irrelevant to the next thing I come across. And that strikes me as very bad…” The fact that it was irrelevant in past situations does provide evidence that it will be irrelevant in the future. It isn’t perfect; you can make logical or scientific arguments why it will be very relevant in the next case, but you do need to make those arguments. Otherwise it seems quite sensible to assume irrelevance.

By: Roger Sweeny

Roger Sweeny — Thu, 04 Mar 2004 19:43:51 +0000

Or as economist Dierdre McCloskey said, “All models are metaphors, and all metaphors are lies.”

By: Jonathan Wilde

Jonathan Wilde — Thu, 04 Mar 2004 14:56:39 +0000

sid, From what I know, Boyle’s Law was one of the (three?) gas laws that led to the formulation of the ideal gas equation, PV=NRT, which gives a substantial amount of accuracy when it comes to quantifying changes in P or V (although it does make some assumptions about gases being ‘ideal’.) Yes, Boyle’s Law, Charles’s Law, and Gay-Lussac’s Law combine to form the Ideal Gas Equation. However, the numbers given by plugging into the equation are wildly inaccurate at conditions outside a small range. At high pressures, a calculation can be off by orders of magnitude. People have tried to come up with different, more accurate models using various “equations of state” and graphical methods, with varying accuracy. The Ideal Gas Equation is not something I would rely on to make any calculations in industrial processes. At best, it provides a simple illustration of relationships between variables, i.e., that volume is inversely related to pressure, that pressure is directly related to the number of moles present, etc.

By: Sid

Sid — Thu, 04 Mar 2004 05:25:07 +0000

What a brilliant discussion you’ve got going on over here – never have I encountered people so intelligent (and interesting, to boot!). All praise aside, just something I’d like to add to Mr. Jonathan Wilde’s post: he mentions that “- Although Boyle’s Law is pretty much useless for calculating actual numbers, i.e., “What is the volume of a gas when its pressure drops from X to Y?”, its strength is its demonstration that as the pressure of the gas increases, its volume must decrease, and vice versa.” From what I know, Boyle’s Law was one of the (three?) gas laws that led to the formulation of the ideal gas equation, PV=NRT, which gives a substantial amount of accuracy when it comes to quantifying changes in P or V (although it does make some assumptions about gases being ‘ideal’.)

By: Ric Locke

Ric Locke — Thu, 04 Mar 2004 03:51:14 +0000

Kenny: “… it seems that diffusion of gases depends merely on the frequency (and force) with which molecules pass through the boundary of their original location…” No, you’re describing expansion into a vacuum. In diffusion, there are already molecules (of something else) there, and the whole thing gets a lot messier. Regards, Ric Locke

By: Jack

Jack — Thu, 04 Mar 2004 03:33:06 +0000

An echo of the poster who said “All models are wrong. Some are useful.” The idea that people persue maxmimal transactions is a usually a good guess, but it isn’t always correct becuase their information is never perfect. As others pointed out with the gas example it works when there are a lot of people and you can average what they do over a long time. I’d compare it to stereotypes, they are useful right up until they aren’t. If you see a thuggish guy on a dark street at night you’ll cross the street, but if the same guy applies for a job at your company you change your model (here’s a thuggish guy looking for honest work, +1). As a personal example, I consider anyong walking down the street with a newspaper harmless (not the leaflet sized freebies). If you’ve seen a police blotter with the description “6’1, reading the Times” I might change my tune, but until then …

By: Kenny Easwaran

Kenny Easwaran — Thu, 04 Mar 2004 00:26:39 +0000

Bob – I had a similar thought to the one you start off with, that departures from idealization can be considered irrelevant when we have an antecedent explanation for what circumstances will render them irrelevant. I was thinking that this pointed up a major difference between the kinetic theory of gases and the rational optimization theory of economics – in the first case we have fairly well-supported theories explaining the composition of matter out of molecules, and explaining the interactive forces between molecules. Thus, it is in principle possible to perform the calculations and show that certain terms representing interaction and intermolecular collision approximately drop out. In the economic case however, I’m not aware of any more detailed theory that explains why assumptions that economic agents are rational optimizers are good enough in the certain cases in which they are. Of course, this just means that we’re at a similar point in explaining economic behavior as Boyle was in explaining gaseous behavior, except that Boyle fortuitously had a model that worked better to predict the phenomena. Also, one other point I didn’t understand in your comment – it seems to me that the diffusion of gases depends on the frequency of hits of gas against the boundary without additional evidence. That is, on the naive view I have right now, it seems that diffusion of gases depends merely on the frequency (and force) with which molecules pass through the boundary of their original location, just as pressure depends merely on the frequency (and force) with which they hit the boundary. I suppose in the diffusion case the boundary is constantly changing, but that doesn’t seem obviously relevant.

By: anno-nymous

anno-nymous — Wed, 03 Mar 2004 19:53:25 +0000

Hey Brian (or Henry Farrell), Could you send me the Message-ID and other header arcana for this ‘anonymous’ [sic] fellow’s comments? I’m wondering if it’s an old stalker or a new one. TIA, Carlos Hey Brian (or Henry Farrell)—no need. I’m pretty sure I’m a “new one”.

By: Antoni Jaume

Antoni Jaume — Wed, 03 Mar 2004 19:22:32 +0000

Carlos, allow me to disagree on your understanding of collision. You see, you and I collide in our interpretation. So when Brian report “[...]gas molecules never collide. Now this is clearly an inaccurate model, since gas molecules collide all the time,[...]”, he is correct. Yes, you can also say that “molecules collide with other molecules” but it is redundant. Remember that collide came from “com + laedere”, “strike together”, so it can be used just like converse, convene and some other that imply a plural subject. DSW

By: pw

pw — Wed, 03 Mar 2004 18:04:44 +0000

And here I’d always thought that the problem with assuming that people optimize utility was that no one knows (except by convoluted inference) what a utility function looks like, so that optimization just becomes a tautology. That Friedman uses discrimination in employment as an example is, of course, particularly telling because both employers and customers are known a priori to have messy utility functions in that area. The ideal-gas analogy is similarly telling, because the fundamental assumption that makes boyle’s law work (that collisions between gas particles can be disregarded because they are elastic and isotropic) is one whose equivalent many economists would desperately like to be true in their field. The tendency to assume frictionless transactions (as opposed, say, to the experimental evidence that market institutions can make a significant difference in clearing prices) shows not merely that there is a preference for theory over experiment—which may be OK —but that there’s a preference for a particular, tractable kind of theory over experiment.