Early Retirement Extreme Forums

Discussion of the curriculum McConnell, Brue, Flynn Economics text, chapter 1.

(I started working on a summary here, anyone can edit! It's not complete, so feel free to edit/add things)

This chapter was intended to just set the stage, but it was already quite interesting. Consider very first couple of sentences:

Biologically, humans need only air, water food, clothing and shelter. But in contemporary society we also seek the many goods and services associated with a comfortable or affluent standard of living

This immediately reminded me of the Need/Wants section of the ERE book. According to economic theory, we have few needs and infinite wants. According to ERE, needs and wants are the same, only differing in degree, not kind. And one can i) learn to be effective in ones live vis-a-vis 'want realising' and ii) learn to be content with (much) less.

Things I have issues with
I have issues with two central claims in this chapter:

1. We have infinite wants
2. Humans pursue actions only because of their rational self interest.

Infinite wants
I feel like positing that all humans have infinite wants is very strong assumption to make. First of all, I think that some people can be very content with very little. Second, from this claim it would follow that no matter how many resources one person has, they would always covet more, since there are still many, many, many unfulfilled wants.

Rational Self Interest of Humans
I feel like this is just plain bogus. Kahneman and Tversky have done a lot of research into human biases, and well, we have tons of them. We do have some bounded rationality, within small, contained domains (things game theory deals with), but in general I'm not sure it flies.

However, assuming that we are not (completely) rational makes a lot of the analysis very hard to do. Not sure what the solution is.

Things I found interesting
There are some very interesting concepts defined in this chapter:

1. Opportunity Cost
2. Marginal Analysis
3. Economics as a scientific field

Opportunity Costs
The idea that by doing one thing you are not doing another thing is so simple, but mind blowing! From this follows that often the things we don't do is what causes us grief (or prevents us from being happy). It also works well together with the system theory motto that "you can never do just one thing" (since not-doing is also doing).

Marginal Analysis
The concept of comparing two situations relative to each other is also quite interesting (and related to opportunity costs). It reminded me of the concept of first increasing and then diminishing return of putting more effort into something (the famous S-curve).

Economics As a Scientific Field
I thought it was interesting that they made the argument that economics is similar to harder sciences like mathematics and physics. I get that you can have nice equations when you consider rational agents in a mostly static environment ('other things being equal assumption'), but I'm not sure how easy it is in reality to prove/disprove economic hypotheses in real life, since it's so hard to really isolate scenarios. But I feel this is more due to a lack of knowledge on my part of how research works in the 'softer' sciences.

Quadelupe wrote: economics is similar to harder sciences like mathematics and physics

Not so much. According to Steve Keen in "Debunking Economics", some of the central theories of economics are not even internally consistent. For instance, it has been shown that the aggregate (market consisting of more than one individual) demand curve can be represented by any continuous polynomial function;it does not have to only slope down. So, there may be more than one imaginary equilibrium point with no means to determine which is more optimal.

Also, to assume optimal social utility is achieved at intersection of supply and demand, it is necessary to assume merit-based income distribution. However, if there is any difference in consumption preferences among individuals, say one prefers cookies and the other prefers potato chips, a change in price structure such as bumper potato crop will effectively provide the chip eater with more disposable income at same level of utility vs. the cookie eater, yet this isn't accounted for in demand curve which relies on assumption that preferences are identical and identically proportional to income.

I am deeply relieved this thread is not about Mitch McConnell's economics.

I enjoyed the first chapter. I thought this sentence was interesting:

Instead, economics ultimately examines problems and decisions from the social, rather than the personal, point of view.

The "Pitfalls to Objective Thinking" was a nice review and it was interesting that within the "Fallacy of Composition" section, they ended with:

The fallacy of composition reminds us that generalizations valid at one of these levels of analysis may or may not be valid at the other.

It was also interesting to see the "we use the scientific method" balanced with the "Other-Things-Equal Assumption" needing to assume other things are equal/fixed within a comparison yet in reality they are not (example given was about the cost of a Pepsi -- market data to compare the price of the Pepsi will inherently have the price of those things it is being compared to also change yet for for analysis, it is easier to assume the variables/others are fixed). This was interesting to me because it talked about how much economics relies on data but that data/input is different from other fields where one can hopefully do a reproducible experiment. It basically seemed to set the stage for "we use the scientific method" however "we are not like other sciences due to ..." which leads to "less certain and less precise than those of laboratory science". I ended up appreciating that perhaps economics was more scientific than I had been led to believe in the past (although perhaps we have a biased source ).

However, as a software developer, this sounded like a challenge:

The full scope of economic reality itself is too complex and too bewildering to understand as a whole.

I wonder how much the application of computing power to economics has changed the field?

Sorry I'm late to the party y'all.

This Chapter outlines some basic concepts in economics. It introduces the consumer's budget constraint, the production possibilities curve, marginal analysis, the marginal benefit and marginal cost curves and the concept of utility. It also mentions some assumptions that are needed to make the economic model hold.



@Quaduple:

I really liked your commentary on the economics concepts introduced. I'll spill some beans and admit that I've completed the coursework for a PhD in economics. I think it's healthy to discuss the flaws in economics, especially in a place like this, but for learning the material it's better if you just take the assumptions as well, assumptions. A lot of of the assumptions are sort of obviously wrong or at least flawed*, but they are necessary for the model to work.

*If anyone else is super into economics these are potentially fighting words, so let's just consider this an opinion.

Personally I think it's important to keep an internal dialogue of skepticism when studying economics, even if you are accepting the assumptions to learn the model. Having come from the PhD world, the assumptions really do influence the culture of economists.

@SWB:

Computing power definitely advanced economics, although most of the heavy lifting that I experienced is using it to do empirical research, using larger data sets to run fancier statistical models. The accepted neo-classical model (which is what we are learning) was worked out before computers and uses mostly "relatively simple" calculus.



The problem is human behavior is hard to model. This is why economics is a "soft" science and why the book says it's too complex to fully explain. My understanding is that mathematics and the hard sciences operate on pretty basic assumptions about the world. Economic assumptions are much more easily debated. Kahnemen and Tversky are famous because they are (were) trained economists who rigorously tested economic assumptions and showed them to be flawed. Believe it or not (at least at the R1 university PhD level as of 2016) their work is still considered the last major theoretical break through in economics and it is still debated.

I guess the conclusion is while economics models its methods after the hard sciences, it doesn't have anything like gravity and it does have physics envy.


@7w5: Interesting, I don't see why those assertions are true. I will have to read that book.

Jin+Guice wrote: ↑

Wed Dec 18, 2019 6:27 pm

Having come from the PhD world, the assumptions really do influence the culture of economists.

Also the case if you come from the ecology field that has fundamentally different assumptions. Or physics where the habitual instinct is to focus on questioning/changing the assumptions and calculating the logical consequences of breaking them(*). Reading econ books always seem to cause a bit of cognitive dissonance for me, especially if it gets too dogmatic.

(*) Assuming the horse is spherical is a real thing ...

I have issues with two central claims in this chapter:

1. We have infinite wants
2. Humans pursue actions only because of their rational self interest.

These are tough pills for everyone to swallow. Especially, when one has a novice's idea of what Economics is about. It's easier, if you think about what Economics was doing at the time those assumptions were made.

Today, we think of Economics as the Science of Money and Business. CPI, GDP, Fed rates, etc.

At the time these models (that require these assumptions) were made, Economics was addressing bigger issues. At that time, it was more the Science of How Society Chooses Who Gets What.

For questions that big, one needs to make models from very simple objects. Yes, Homo Economus is clearly a simple caricature of a human. But she has to be, because the human mind is finite. One can have scale or detail, but not both.

Rational self interest isn't universally viewed the same way by economists. Rational self interest exists but that doesn't mean it's based off of logical assumptions or objective reasoning. Everyone has a different "mythology" of what is logical. This "mythology" drives their rational self interest. For example, a drug user values getting high over other alternatives; this behavior may not be logical but it's rational for a drug users that believes getting high is something desirable. Economist can be somewhat predictive of economic activity via this lens.

Economist may not be able to accurately model the economic choices and preferences for all drug users but in aggregate one can assume that most drug users will lean towards drug consumption to varying degrees.

@Jin+Guice:

I don't agree with everything Keen suggests, but some of his arguments are pretty interesting. Basically, his mathematical/logical argument based on the 'Sonnenschein-Mantel-Debreu conditions' results in Law of Demand only applying in situations of only one commodity and only one consumer.

I will abstain from commenting further on this thread until/unless I pick up a cheap copy of McConnell.

Infinite wants can also be tempered in a few ways without fucking up the model. Economics assumes diminishing returns to everything so in practice the infinite wants assumption is tempered by the budget constraint plus your love of both heroin and cocaine. Once you have a certain amount of cocaine you'll switch over to heroin.

You can also say "infinite wants in the domain of interest." If you want to get fancy you can introduce a "satiation point," after which indifference curves become concave, which in this thread is basically the same thing as saying, just roll with this infinite wants to learn the model.

@Campitor: Rational self-interest in the model means that you will always take the better deal and you know what you want. Remember, basically all we care about from the individual consumer standpoint is decisions about what goods or services money is spent on. The rational self-interest assumption means that the consumer maximizes their utility when choosing between goods. From the economic perspective, if you spend all your money on drugs, that's your choice and it is rational.

An assumption that hasn't been introduced yet is "complete information." In reality information is almost never complete so it's hard to actually exercise your self-interest.

Even with this specific and narrow definition rational self-interest was shown to not hold in experiments by the early behavioral economists (circa 1970).

However, again you just need to assume for the model will work.



@7w5: I feel like we may have vaguely talked about this in an upper-level class. IIRC, we either didn't talk about it or the professor didn't fully grasp the argument.

I would encourage you to participate in this activity because I always value your input. This chapter was super basic though, and from what I can tell, everyone grasps the concepts. I think the outside the box discussion actually helps clarify them. Also I'm glad people are questioning the assumptions because the way economics is presented in textbooks only makes sense to someone who's never questioned anything about the status quo.




For econ only, if anyone is struggling I should be able to help clarify things or point you in the right direction. This will be less true with accounting and not true at all for finance.

I had a lot of similar thoughts about unlimited wants as other readers in this thread, but also understand the need to make assumptions for a complex model. One of the Buddhist vows is, "Desires are inexhaustible, I vow to put an end to them." I think this demonstrates that unlimited wants are fundamental to human nature. It may be possible to recognize them or control them, but they will always be there.

What struck me most while reading these basic concepts, is thinking of how much of society is economically illiterate. We hear that "more education is a good thing" and yet I suspect there are many college undergraduates who have never considered the opportunity costs and marginal utility of a college degree. I myself didn't really do that sort of analysis until reading about it in one of Jacob's blog posts.