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Post-Autistic Economics Review - Issue No. 13

In Defense of Basic Economic Reasoning

Bruce J. Caldwell

In issue number 12 of the Post-Autistic Economics Review, Bernard Guerrien poses the provocative question, “Is There Anything Worth Keeping in Standard Microeconomics?” His answer seems to be, “Not much.” Guerrien complains about the highly formalized nature of modern microeconomic theory, about the use of assumptions that describe neither the world nor the actions of the people that populate it. He finds much formal theory useless and irrelevant for helping us to understand how the world works.

I agree with many of Guerrien’s criticisms of formal, highly mathematicized microeconomic theory. I disagree, though, with his conclusion that the irrelevance of the theory undermines microeconomics. In my opinion, there is a body of economic reasoning, something that might be called “basic economic reasoning” that can and should be separated out from what might be called “formal microeconomic theory.” Much of basic economic reasoning is in fact microeconomic in nature, but it preceded the latter temporally in terms of its development and it does not depend on formal economic theory for its validity or usefulness. It is my contention that basic economic reasoning is truly important. My fear is that if we take Guerrien’s advice, we will throw out the standard economic reasoning “baby” with the formal economic theory “bathwater.”

I will elaborate on these claims by citing some personal examples. In recent years I have taught both a one semester “everything you want to know about economics” course as well as the principles of microeconomics course to American undergraduates. I use very little mathematics in either course. With the exception of a little algebra for calculating elasticities, all other concepts are handled graphically, with production possibilities curves and supply and demand diagrams being the chief graphical tools employed. Even with this elementary set of tools, by the end of the course students have learned a lot about how the world works. Their education is a practical one, one that allows them to read a paper better and to understand economic issues that are discussed in the news. Of course what I am doing in the classroom is not unique; many other economists do the same things in their own principles courses.

Basically, I use the graphs to tell stories about the world. The graphs alone are useless without the stories, and similarly, the stories lose all focus without the graphs. So, for example, in discussing price fixing we use a supply and demand diagram to distinguish between price ceilings and price supports. When price ceilings are binding, one can expect to see excess demand, or shortages, and one also often encounters such things as non-price rationing, deterioration in product quality, and black markets. With these general concepts, we can them explore such diverse phenomena as rent controls in New York City, black markets for tickets to the theater and sporting events, the use of ration coupons during times of war, lines at gasoline stations in the U.S. in the 1970s (when gas prices were controlled), and the ubiquitous lines that one used to observe in East Bloc countries under communism. The price support diagram is useful for analyzing current policies (like agricultural price supports or the minimum wage law) as well as those that have been proposed (comparable worth policies). Once the concept of elasticities has been introduced, the diagrams can be used to analyze everything from the incidence of taxation to the “paradox of plenty” in agriculture (good growing seasons can lead to a reduction in farmer’s revenues if demand for their product is inelastic) to the reason why a successful “War on Drugs” that managed to reduce the supply of illegal drugs would put more revenue into the pockets of drug dealers. (If the demand for drugs is inelastic, a rise in the price of drugs causes a less than proportionate fall in quantity demanded, so total revenue increases.) Production possibilities curves can be used whenever the discussion focuses on opportunity costs and the necessity of making trade-offs.

Basic economic reasoning and simple diagrams can also be used to tell stories that go beyond economics to what might be called political economy. The recent history of agricultural price supports in the U.S. provides numerous insights into how politics and economics interact. In 1996 a law was passed that was supposed to gradually phase out agricultural price supports, so that they would be gone by 2002. In order to induce farm interests to accept the law, payments in the initial years were quite generous. But as we got closer and closer to 2002, and prices for agricultural products began falling (this was exactly what was supposed to happen, of course), farm interests declared a “crisis” in their industry. For the past few years, “emergency” farm legislation was passed by Congress to help agricultural interests survive their “crises.” The recurring crises have in turn prompted calls for a “comprehensive” farm bill to deal with the problems on a permanent basis. And sure enough, after September 11 some have begun referring to the new proposed legislation as a Farmland Security Bill. A few years ago, a dot.com at the end of a company name was supposed to ensure that investors would love it. Now in Congress putting the word “Security” into a bill’s name will help to ensure its speedy passage.

Many other examples could be given. The recent decision by the Bush administration to place tariffs of about 30% on steel imports was analyzed in one newspaper under the wonderful byline, “In Big Steel States, the Bush Democrat May Be Born.” Ohio, West Virginia and Pennsylvania are major steel-producing states, and the outcome of mid-term elections there may be crucial in deciding who controls the Congress. So again steel has gotten help, even though it is one of the most protected of all American industries: past studies have estimated that it costs American consumers about $750,000 (in terms of higher prices paid) for every steelworker’s job saved. That number will need to be updated in the light of this recent event, especially given that other nations have begun retaliating with tariffs of their own that will further raise the prices that consumers face.

Though basic economic reasoning is simple, it is not simplistic, and indeed, it often leads one to results that are not at all obvious. For example, the idea that the incidence of taxation depends on the elasticities of supply and demand, and not on whether a tax is initially paid by a buyer or a seller of a good, is not at all intuitive, but is crucial if one wants to understand who actually bears the burden of a tax. Similarly, the idea that there can be gains from trade even when one country has an absolute advantage in the production of goods – the fundamental idea of comparative advantage – is not one that many non-economists have mastered.

Some will say that basic economic reasoning is not valid because it rests on faulty foundations – one must assume that agents are perfectly rational, with complete information, trading in perfectly competitive markets to get its results. This simply confuses formal mathematical theory with basic economic reasoning. In my opinion, basic economic reasoning does not depend on formal microeconomic theory for its validity. Now, to be sure, economists have not been very good at identifying just what it does depend on. That is a topic for economic methodology, and over the years various contending views have been advanced. My own intuition is that there may well be multiple “foundations” that help to explain why different parts of the theory may work. In any event, my own confidence in basic economic reasoning has less to do with the fact that I know why it works, then with the fact that it does work: as my examples hopefully demonstrate, it can prove to be extremely useful in organizing and understanding various and often very diverse social phenomena. The proof of the pudding is in the eating, and in this regard basic economic reasoning seems to me to provide much upon which to feast.

There will of course be the complaint of those who believe that basic economic reasoning is simply ideology dressed up as science. For them, to say that “we live in a world in which scarcity makes choice necessary” is an ideological statement; or to assert that “producing goods for which one has a comparative advantage permits gains from trade” is a not-so-covert defense of globalization; and so on. To this I would reply that I think of the statements of basic economic reasoning as being positive rather than normative claims. (This is not to say that they are easily testable claims.) I would further rejoin that those who think that basic economic reasoning is simply a defense of capitalism should look once again at the socialist calculation debate, and in particular at the positions articulated by the defenders of market socialism, or for those who would like to go back further, at the Austrian economist Friedrich von Wieser’s Natural Value. These economists recognized that an understanding of economic reasoning was necessary even if one was in favor of organizing a socialist economy. As one wag put it on the recent television production of the book Commanding Heights, ignoring how markets operate is much like ignoring the winds and the tides – you do so at your peril.

In conclusion, I join with Bernard Guerrien in lamenting the turn of the profession towards microeconomic models of ever increasing formal complexity. Explaining why the profession has gone down this road is something that has increasingly captured the attention of (our ever diminishing number, alas, of) historians of economic thought. But we should not conclude that microeconomics is of no value. Basic economic reasoning was there before the advent of such modeling, and it remains a powerful tool today for understanding how the world works.

 
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