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Sunday, April 29, 2007

Paul Ormerod and revising textbooks

He notes in a recent publication of Post-Autistic Economic Review:

"The problem, and it is a very big one, is that most economists continue to act as if very little has changed and that the rational agent postulate remains generally valid. Game theory, for example, has come to dominate much of economics. But outside the realms of auctions designed by economic theorists, it has few practical applications. The prisoner's dilemma, one of the most famous games where individually rational actions can give rise to an outcome that no one would choose, has been studied intensively for over 50 years. Yet, except in wholly trivial cases, the "optimal" - a word beloved by economists - strategy remains unknown. "

I second that feeling. Game theory really did cause a whole paradigm shift in microeconomics - but hasn't imop been used to its fullest potential. Game theory, like most of econ, is still stuck under the weight of its own assumptions of rationality. Still, teaching something like game theory which at least leads to the possibility of using boundedly rational (or even irrational agents) has got to be more useful that teaching just pure mainstream theory to our students.

Pretty much everything that standard micro texts teach can be thought of in terms of game theory, and yet, Prof. Mankiw - whose textbooks are the best at teaching mainstream econ, devotes a 'whopping' 12 pages to game theory in his "Prinicples of Microeconomics" text. And most of that is just with regards to Oligopoly behavior. There are no pages, to my knowlege on behavioral economics. Any econ student wanting to go 'beyond' the same old utilitarian framework has to take a completely separate course (if their school even offers it) in experimental econ, or game theory, and the like.

This means two things, to me:
1. Economists by and large are in love with form over substance, in the sense that utility theory and perfect rationality offer elegent models with little variation in behavior, but perhaps are limited in terms of real world application

2. Game theory, experimental econ, etc, have not done an adequate job of better formulating a consistent model to compete in the field - this may be largely due to the fact that perhaps "modeling" behavior is a somewhat futile effort at least at the extremes. The fact is, it is perhaps best to keep the models we have currenly in mainstream econ, but understand and appreciate that they situationally stray from reality and we need to incorporate other things.
I think textbooks are going to need more than 12 pages to really stress that point to students.

Interestingly, I think Macro (the younger of micro/macro) has come a longer way in terms of this. In macro we still talk about rational, equilibrating behavior, but we also talk about sticky prices, market failure, etc. Micro, sadly, tends to gloss over those things in favor of workable mathematcis.

I stand corrected. 1 commenter noted (my only one???) that in Mankiw's most recent micro text, he devotes part of his last chapter called "frontiers of microeconomics" to the study of behavioral economics. I would say that is too little too late, and that we should be incorporating these things into what we teach and learn, and notjust adding it on as an addendum for all practical purposes. I don't have a copy of this newer text, but I HAVE downloaded the powerpoint slides. I'm less than impressed. There are a total of 2 slides on the subject which say the following (if I may quote the publically accessible ppt slide):

•"Recently, a field called behavioral economics has emerged in which economists make use of basic psychological insights to examine economic problems.

People aren’t always rational:
People are overconfident
People give too much weight to a small number of vivid observations
People are reluctant to change their minds.
People care about fairness as demonstrated by the ultimatum game
People are inconsistent over time."


Anonymous said...

Actually, in recent editions, the Mankiw text has a section on behavioral economics. See chapter 22 "Frontiers of Microeconomics."

Garth said...

I'm glad its been updated. Maybe things are movin up in the world?! But I wonder, is behavioral economics, which has been with us now in earnest for a couple decades now at least, really a "frontier?" My overall point I guess is that we shouldn't be sticking this stuff in the back of a textbook and labelling it as if it is some fringe element. We should be trying to incorporate these things fully into our understanding (and our texts).

Economatheek said...

"Economists by and large are in love with form over substance"

This is a very elegant formulation of one of the most pervasive problems of mainstream economic theory. The continuing use of the Black and Scholes model is a good example. It's based, and even entirely dependent, on the assumption that prize movements follow a Gaussian distribution. We know for a fact that this is not true, but that prize movements rather obey a power law, but still economists persist in using the model. One plausible cause for this is the elegance of the model and the results it implies.

Game theory is widely considered the cure for the instability and uncertainty in economic models. It supplies a way of bringing order to seemingly disordered relationships, and of finding equilibrium where other methods fail. The problem is however, that, in most multi-player games, which the economy can, by all means, be said to be an example of, there is no game-theoretic equilibrium. Game theory is a great tool for many simplified games between two parties, but it fails in most more complex models.

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