A relevant feature of the current crisis in economic knowledge is the recurrence of the  Ricardian Vice. Joseph A. Schumpeter coined this term in his book History of Economic Analysis when he criticized the habit assigned to Ricardo to represent the economy by a set of simplified assumptions and to use tautologies to develop practical economic solutions. Indeed, Schumpeter rejected the kind of economic thought that mainly favours deductive methods of inquiry – based on mathematical reasoning- because the  habit  known as the Ricardian Vice generates analytical unrealistic results that are irrelevant to solve the real-world economic problems.

Also Keynes warned that the understanding of the economic phenomena demands not only purely deductive reasoning, but also other methods of inquiry along with the  study of other fields of knowledge- such as History and Philosophy. In his own words:

The study of economics does not seem to require any specialised gifts of an unusually high order. Is it not, intellectually regarded, a very easy subject compared with the higher branches of philosophy and pure science? Yet good, or even competent, economists are the rarest of birds. An easy subject at which very few excel! The paradox finds its explanation, perhaps, in that the master-economist must possess a rare combination of gifts. He must reach a high standard in several different directions and must combine talents not often found together. He must be mathematician, historian, statesman, philosopher – in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the present in the light of the past for the purposes of the future. No part of man’s nature or his institutions must lie entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician.” (Keynes, Collected Writings, vol. X: Essays in Biography)

Today, Schumpeter’s and Keynes’s criticism could be certainly addressed to those economists whose beliefs ultimately privilege the deductive method of inquiry in Economics. Due to these beliefs,  mainstream economists favour the adoption of a nominalist bias. And as a consequence, the trouble is that the dialogue between economic theories and the economic reality turns out to be abandoned not only in academic research but also in the policy making process.

This dialogue is complex and should be considered in any attempt to build realistic economic theories, as Keynes warned. Indeed, the changing environment of real-world markets through time -that is irreversible-  refers to a certain degree of ontological indeterminacy that should be considered in realistic economic theories and in the study of Economics.

This is an outline of the lecture 3 in Advanced Microeconomics — expands somewhat on the slides available from the link. This should be useful to heterodox economists looking for ways to teach an alternative course, radically different from conventional approaches. First two lectures consisted of some preliminary math, and can be skipped without lack of continuity.  Video of the lecture (90m) is available at the bottom of the post.

Supply & Demand is Central to Economics: This is the modern Theory of Value. The market price determines the value – this is in conflict with classical conceptions of value.

BUT, this theory is WRONG!  The central question in theory of Value is: HOW are prices determined? Why are water and tomatoes cheap, and why are diamonds expensive?

Current answer is the Supply and Demand theory of economics. Classical economists’ answers were  Labor Theory of Value.

Modern Answers are seriously deficient. Classical Schools had substantially more insight into these questions. We will be discussing classical thinking (Adam Smith, Ricardo, Marx, Sraffa) later in the course. This lecture deals with: Failure of Supply & Demand in Labor Market. This failure was the Raison-d’etre of Keynesian Economics

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Recent active learning experiences have been associated with “flipped” or “inverted” classroom (Norman and Wills, 2015). Indeed, this method has been receiving increasing attention by professors that search for alternatives to traditional lectures so as to cover some topics of the course content.

By adopting the flipped  classroom in economics instruction, professors out to enhance a larger pre-class involvement of the students not only by reading the selected bibliography but also by watching instructional videos.

Before the class, professors provide instructional short videos (five to fifteen minutes) that cover the main ideas related to a selected topic of the syllabus. The videos generally emphasize theoretical approaches, definitions, formulas and graphs. Recent evidence shows that many professors actually record a narration of the lecture slides and notes.

As students should watch the video before the class, professors can privilege active learning methods during class time. Therefore, the class activities aim to apply the material that was covered in the videos in order to enhance a real-world approach to economics education. These activities- that are supervised and oriented by professors – can include, for instance:

  • Presentation, analysis and discussion of real-world problems
  • Team–work exercises oriented to solve practice problems followed by class-room discussion of the main results.

Indeed, internet technologies are also affecting the economics classroom. Topics in macroeconomics, microeconomics, international economics, financial economics, among others, can certainly benefit from flipped classrooms since this teaching practice does not mean the replacement of professors with videos.

 

References

Bishop, J. L., & Verleger, M. A. (2013, June). The flipped classroom: A survey of the research. In ASEE National Conference Proceedings, Atlanta, GA.

Honeycutt, B. (2013). Looking for ‘Flippable’ Moments in Your Class. Retrieved from http://www.facultyfocus.com/articles/instructional-design/looking-for-flippable-moments-in-your-class/

Norman, S, & Wills, D. (2015). Flipping your Classroom in Economics Instruction: It’s not all or nothing. Retrieved from http://faculty.washington.edu/normanse/uploads/2/9/8/5/29853431/flipping_your_classroom.pdf

In my paper entitled “Empirical Evidence Against Neoclassical Utility Theory: A Survey of the Literature,” I have argued that neoclassical utility theory acts as a blindfold, which prevents economists from understanding simple realities of human behavior. The paper provides many examples of this phenomenon, which I will illustrate briefly with one simple example in this post.

Consider the two player Ultimatum Game. The Proposer (P) has ten dollars in single dollar bills. He makes an offer of $m to the Responder (R), which allows him to keep $(10-m). The responder can either Accept or Reject. If Responder Accepts than P get $10-m, and R get $m as proposed; it is convenient to denote this outcome as (P:10-m,R:m). If Responder Rejects, then both get $0: (P:0,R:0)

Here are four predictions made by Game Theory, based on utility maximization behavior.

  1. Responder will be indifferent between the two choices Accept and Reject if he is offered $0.
  2. Responder will Accept an offer of $1, resulting in outcome (P:9, R:1). R prefers 1 to 0.
  3. Proposer believes that Responder is a Utility Maximizer; that is, he will behave in accordance with propositions 1 & 2 above.
  4. Proposer will therefore offer $1, as it maximizes his share at $9. If he offers $0, the outcome is uncertain because both responses A and R are possible maximizing responses, which is why an offer of $1 is the unique utility maximizing offer.

All four of these propositions are false. Furthermore, every layman will easily be able to see that all four of these propositions are false. However, economists have great difficulty in seeing that they are false and in understanding why this is so. This is because economic theory teaches economists to “think like economists” which means modelling humans as being homo economicus: cold, selfish and callous (Vulcans, for short). This makes economists unable to understand real human behavior. As everyone (except economists) knows, the responder will reject the offer of $0; he will not be indifferent between accept and reject. Empirical studies conforming to our intuition about human behavior show that in situation 2, the vast majority of responders will reject the offer of a 10% share, preferring to get $0 rather than accepting injustice or an unfair offer.

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Before proceeding with Re-Reading Keynes, I would like to clarify the issue of exogeneity and endogeneity, which he understands, but most of his followers failed to understand.  This is to clarify a segment of a phrase he uses in describing the four ways in which level of employment can increase within the framework of the classical theory of economics. The fourth factor listed by Keynes appears somewhat mysterious in the original text:
(d) an increase in the price of non-wage-goods compared with the price of wage-goods, associated with a shift in the expenditure of non-wage-earners from wage-goods to non-wage-goods.
== in the previous post (P9: Theory of Employment) I re-stated this as an exogenous increase in real wage, to clarify what Keynes wanted to say. However, (d) above is what Keynes actually wrote, and I want to explain why Keynes wrote in this way. This involves an excursion into the supply and demand model, and the concepts of exogeneity and endogeneity.
What Keynes is saying here is that if there is an increase in demand for luxury goods consumed by aristocrats, and an associate decrease in demand for necessities purchased by laborors, then the real wage will rise and that will increase employment. Keynes is very careful to create a scenario in which the real wage rises due to EXOGENOUS factors shift in demand by non-wage earners — the aristocrats.  What Keynes understood is something basic which is not understood by modern economists like Varian when they discuss the supply and demand model — ONE CANNOT CONTEMPLATE VARIATIONS IN AN ENDOGNEOUS VARIABLE (because endogenous variables are not free to move; they can only change if some of the exogenous variables which affect them change). This means that asking what consumers will demand if the price changes is a WRONG question — prices are endogenous and they cannot change by themselves. An increase in price cause by shortfall in supply would lead different consequencs from an increase in price caused by an upward shift in the demand. If a consumer is asked what he will do when the price changes, he should ask WHY did the price change, because his response to the price change DEPENDS on cause of the price change. He cannot provide a response to the question without learning about the cause, and whether or not this is a temporary or permanent change.

 

Comments on Varian: Intermediate Microeconomics. Chapter 1, which sets up a simple supply and demand model.

Brief Summary of Post:

These comments are about the first few pages of the chapter. Quotes from Varian are in italics. Criticisms are made in this post about the concepts of models, optimization, equilibrium, and the concept of exogeneity, as dealt with by Varian. Models are used without explicit discussion of the relationships between model and reality, which is essential to understanding how models work. For an extended discussion see my lecture on Models Versus Reality. The post explains why optimization, taken is tautological by Varian, is false as a description of consumer behavior. For an extended discussion of the conflict between axiomatic theory of consumer behavior and actual human behavior, see my one hour video: Behavioral Economics Versus Neoclassical Economic Theory.  Similarly, the decision to study only equilibrium behavior handicaps economists, making them blind to disequilibrium events like the Global Financial Crisis.

Detailed Discussion

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By 2020, the largest pools of pension fund assets are projected to remain concentrated in the US and Europe. In North America, pension fund assets reached $19.3 trillion in 2012 and PwC estimates that by 2020, pension fund assets will rise by 5.7 percent a year to achieve over $30 trillion of the $56.5 trillion in total global assets, more than 50 percent of the global total.

Indeed, according to the PwC report, Asset Management 2020: A Brave New World, demographic changes, accelerating urbanization, technological innovations and shifts in economic power are reshaping the asset management environment where pension funds have been playing and  will play an outstanding role in the global saving and investment process.  Three key factors seems to stimulate the global growth in assets: i) changes in government-incentivized or government-mandated retirement plans that will turn out to increase the use of defined contribution (DC) individual plans; ii) faster growth of high-net-worth-individuals in South America, Asia, Africa and Middle East regions up to 2020; iii) the expansion of new sovereign wealth funds.

However, in spite of the pension funds’ power to centralize huge amount of “savings from workers”, in this scenario of financial globalization, workers do not seem to have strong defense against the impacts of the current global scenario on the savings of workers and the flows of workers’ income.

In a context of uncertainty, the pension funds’ portfolio management is based, as Keynes warned, on precarious conventions.  Pension funds are part of a set of interrelated balance sheets and cash flows between the income-producing system (hedge, speculative and Ponzi firms) and the financial structure that affect the valuation of the stock of capital assets, the evolution of credit and the pace of investment. Current pension funds’ performance ultimately relies on the endogenous nature of financial instability.  Throughout the business cycle, when profits decline, as they inevitably do, credit and external sources of funding generally become restricted and the price of assets also fall. This scenario affects the performance of these institutional investors and reduces the value of the stock of workers’ savings in pension funds.

As a matter of fact, the connection between pension funds and speculative finance is one of the contemporary features of the management of the working savings. Continued low interest rates would impact the future profitability of pension funds, particularly in those portfolios where income-fixed assets predominate.

Among other current challenges to the management of pension funds is the evolution of austerity programs. In many countries, austerity programs have also relied on changes in retirement plans. Soon after the global crisis of 2007-2008, many European countries  announced austerity measures that included  changes in retirement age and pension payments. As a result, loss of retirement rights has turned out to become part of the new set of public policies.

Indeed, many governments, under global investors’ pressure, should meet budgetary targets and pursue further structural reforms- also related to age and amount of pension within retirement plans.  In truth, the current era of financialization and austerity – and its impacts on retirement plans and job creation – is certainly affecting day-to-day life of workers and the future of pensions. In other words, it is affecting the flows of workers’ income and the savings of workers.

 

Joan Robinson (1903- 1983) studied microeconomic issues, such as pricing, consumer demand, producer supply, competition and monopolistic strategies. Her first major book was The Economics of Imperfect Competition, published in 1933. In the same year, Edward Chamberlin published The Theory of Monopolistic Competition.

Robinson restates the Marshallian contribution to price theory so as to examine the outcomes of imperfect competition. In her understanding, perfect competition is considered to be a very special case where buyers should have the same preferences and each buyer should deal with only one firm at any one time. If these conditions are fulfilled, an increase in the price of one firm would lead to a complete cessation of its sales if the prices of other firms remained the same.

Considering the markets where imperfect competition dominates, Robinson starts the analysis with a single firm in an industry. She clarifies that physical differentiation is not a necessary condition for market imperfection because two commodities may be alike in every respect except the names of the firms producing them. However, the market in which they are sold will be imperfect if different buyers have different scales of preference as between the two firms.

Imperfect competition in the markets affects the slope of the demand curve of an individual firm and of the industry. The first prerequisite of perfect competition is a product clearly demarcated from others, that is to say, the characterization of a perfect market depends on the clear demarcation of the commodity that is sold and bought. In particular, she examines how price discrimination and market segmentations policies influence the slope of the curve of the individual firm and the market equilibrium. Competition will be less perfect the lower is the elasticity of the total demand curve. Indeed, the form of the demand curve represents the degree of competition between the product of this industry and other products.

 

Besides, in a context of imperfect competition, the firm’s supply curve could express increasing, decreasing, or constant costs. As a result, the equalization of the marginal cost curve and the price as a condition of equilibrium is considered as the main problem in those imperfect markets.  According to Robinson, competition will be less perfect the higher is the ratio of the output of one firm to the output of the industry. If competition is imperfect, an increase in the output of one firm by one unit of its good would change the output of the industry and this may lead to a relevant change in the price of this good.

Robinson addresses that it is empirically true that a high level of normal profits will often be found where competition is imperfect.           The normal level of profits will be different according to the industry and the scales of production in the same industry because  the level of normal profits will depend upon the conditions of supply of the firm. An old-established firm enjoys a “good will” which turns out not only to enable the firm to influence the price of the commodity but also to set increasing costs of entry to new rivals. Powerful firms which use methods of “unfair competition” to strangle rivals are unlikely to sell in perfect markets. In these powerful firms, managerial decisions, including price discrimination and market segmentation, for instance, are practices oriented to increase market share and profits.

Joan Robinson’s microeconomic approach is still relevant to show the failures of a theory of value and distribution based on the assumptions of either perfect competition or perfect monopoly. In truth, her analysis of the monopolistic trends in contemporary capitalism sheds light on how powerful firms fix prices and strengthen  their power in the markets.