What’s Wrong with Economic Models?

Author(s): 

John Kay's thought-provoking essay The Map is Not the Territory: An Essay on the State of Economics argues that economists have been led astray by excessive reliance on formal models derived from assumptions that bear too little similarity to the world we live in. And it is surely true that at least at times, disastrous decisions have been made through reliance on models that proved to be incorrect. Some of the statistical models used by financial institutions to value derivative securities based on mortgages just before the recent financial crisis provide a case in point.

But I do not believe that the route to sounder economic reasoning will involve an abandonment of economists’ penchant for reasoning with the use of models. Models allow the internal consistency of a proposed argument to be checked with greater precision; they allow more finely-grained differentiation among alternative hypotheses, and they allow longer and more subtle chains of reasoning to be deployed without both author and reader becoming hopelessly tangled in them. Nor do I believe it is true that economists who are more given to the use of formal mathematical analysis are generally more dogmatic in their conclusions than those who customarily rely upon more informal styles of argument. Often, reasoning from formal models makes it easier to see how strong are the assumptions required for an argument to be valid, and how different one’s conclusions may be depending on modest changes in specific assumptions. And whether or not any given practitioner of economic modeling is inclined to honestly assess the fragility of his conclusions, the use of a model to justify those conclusions makes it easy for others to see what assumptions have been relied upon, and hence to challenge them. As a result, the resort to argumentation based on models facilitates the general project of critical inquiry that represents, in my view, our best hope for some eventual approach toward truth.

AttachmentSize
Note-9-Woodford.pdf385.16 KB

Comments

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.

I am only a PhD student who

0

I am only a PhD student who is trying to get a PhD in Political Economics. By the way, I am interested in this field of research.
In my opinion, the main evolution of economic research will be how to get a real microfoundation of macroecomics.
The expectation is a key element for decision making at an individual stage. Then, interaction and the environment lead to macro properties which are different from the micro properties.
It could be worthwhile to say that economists should define a network to find a way to study the micro level behaviour.
Is it a dream (something impossible) to join - in some ways - neuroeconomists, behavioural economists, field researchers, someone who is supporting new tools to merge micro and macro and so on?
In my opinion (it is also a hope), it is possible. In a model, a researcher could use the result of a study for his / her purpose but it could sound different whether it come from a behavioural study or field study.
It is the main issue of econophysics: is it possible to find a power law whether someone is analyzing Dow Jones index or an african tribe who is trading? It's a provoke-thinking by which I want to say that it is important the explanation of a phenomenon even though it could be some "fingertips" who tell something about the complex system.
All these issues are related to find new hypotheses for models, not "to delete" models in economics and even social sciences. This is what I have in mind, this is what I write.

This is an excellent piece by

0

This is an excellent piece by Professor Woodford. I think there is much of misunderstanding in economic modeling regarding rational expectation hypothesis as well as rational behavior.
Also, I believe that blaming models for economists’ wrongdoing is like “putting the horses after the horses”. As far as I understand simple models also had to do with computational limitations back in time that currently we don’t have.
Maybe it is time to make economist think more on a philosophical way, and have mathematicians and engineers devising and resolving the models that capture the facts economist sees as relevant economic behavior.
Something like going back to the times of Hume, Smith, Ricardo, Say, Walras, Wicksel, Marx and the like, those economists that wrote from their thought’s and not trying to set a model. If we economist persist in the search for something like the perfect model, we are doomed to fail.

Economics is not the same

0

Economics is not the same like a natural phenomenon. Prof Woodford and I as well as you the reader, we all are part of the economics. We all make decisions in the economic cycle. We are consumer, producer, trader - depending on the context. This is different from a natural scientist standpoint: he can observe an organism and study it state after state, and actually that is the only way to obtain knowledge. We need to understand that any kind of models developed and based on a purely "observational"/from outside basis will not make sense. Such kind of thinking is not new, but really must be understood as being outdated and wrong when it comes to economics, where human decisions are the basis of all. We stand inside that organism.

Ben Goldacre invited me to

0

Ben Goldacre invited me to write an endorsement for his book, and my words are printed on the back cover: "This shocking book shows how people have suffered and died because the medicial profession has allowed industry's interests to trump patients' interests."

Another imagination: to

0

Another imagination: to rebuild the microeconomic
For centuries, the imagination to the process of the economic that we learned is still the same, what changed is just more and more beautiful, not right. This is the general equilibrium theory. Today, the question we faced from the Great Depression where is the boundary of the government and the market is still a question. Despite many economists try to give the answer, no one succeed. There are too many theories about the economic crisis and every school want to build a theory to explain the crisis, but no one succeed,even the most famous school. The reason is they are the same. They believe that we will get a beautiful future by the power of the government or the market. That’s the reason why they can’t succeed on the way to explain the economic. The economic of today is failed. And at the same time, many economists want to get the answer from other subjects and build some branches of economic, such as the Behavioral Economics and The Game Theory. But the directions are wrong, economic is always the economic, the question is always the question of the economic, not others, we can’t get the answer from other subjects. We need to rebuild the microeconomic.
Despite we will rebuild the microeconomic, what’s wrong with the microeconomic. It’s the logic and the principle, not the tool. Next what we will write include the perfect compete, the full employment, the demand curve and the supply curve, the general equilibrium theory, the consumer surplus and the producer surplus, the international trade theory. In the end, we will see the future of the economic, not the uncertain future we described in the perfect compete market we learned.
The perfect compete market
In here i will give the new assumptions to replace the old that we often used. In fact, the new perfect compete market is just the real market, the difference is more clear than the real to learn know the market. And at the same time, i won’t talk about the wrong of the old perfect compete market and try my best to describe the new. The difference of them is the assumption. The first assumption is the number of firm is not limited,even that’s one or two. The second assumption is the goods could be different. The third assumption is the firm could enter or exist the market freely, not be stopped by the government ,but pay for the cost. The forth is the firm only know the information of the cost and profit ,include the cost of the progress of technology. By the help of the assumption of the information we could the certain of the model, and by the help of the economic man we could get the direction of the change of the firm. The first and the second is just used to be recognised the difference with the old. Despite we described the new, the people still don’t understand what’s the meaning, we will drawn the demand curve and the supply curve to make the model clearly, and at the same time we also talk about the new define of them and the the importance of them.
The demand curve and the supply curve
The define of the demand theory and the supply theory we used is to talk about the relation of the price and the production, just like when the price change, what the production will be,can’t show us the change of the price in a long time. The new define will show the price, not the quantity. In fact, the demand curve and the supply curve we see in the perfect compete market should be static, but what we learned is dynamic, the change of price cost time and we can’t use the model in the perfect compete market. In the new model, the curve what we see in the final is the equilibriums of every sellers and buyers, not the relation between the price and quantity. So the demand curve means the array of the first high price, the second high price and so on; the supply curve means every firm’s marginal cost (because the marginal cost equal the marginal price, so we can use the marginal cost replace the marginal price) and they are independent, the production of every firm is different and every firm has themselves’ equilibrium, so the supply curve is made up of a series horizontal lines. In the final, let us see the chart (1).
P

F
S
Pe E
B C
A
D

0 a a+b a+b+c Q
Qe
(1) the demand curve and the supply curve
in the perfect compete market
In this chart, the D is the demand curve,the S is the supply curve, the E is the point of the equilibrium, the P is the price, the Q is the quantity, the Pe is the price of the equilibrium, the Qe is the quantity of the equilibrium, the A is the producer surplus of A, the B is the producer surplus of B, the C is the producer surplus of C, the F is the consumer surplus, the a is the production of the A, the b is the production of the B, the c is the production of the C. So we can use the new chart to talk about the consumer surplus and the producer surplus. When the capital or the labor add, because the cost of the firms is different, the dominant firms could get more capital and profit than others, the profit of the disadvantage firms is less, even compare in the technology, so the winner become more and more strong, the loser exist the market until the last one, the monopoly will be the last form of the market. The process of the change just like the chart (2). And in this chart, we won’t get anything about the quantity, what we could get is just the winner and the loser. Who’s efficiency is the best who is winner, not to let everyone get the profit and to be a price taker.
P
F2 S
Pe B2 E
A2 D
0 Q
a2 a2+b2
Qe
(2)
2.The consumer surplus and the producer surplus
When we talk about the questions about the consumer surplus or the producer surplus, we often think about is how to get more and more surplus, we think the firms and consumers will try their best to get more surplus and haven’t told about others. Today what we talk about is the change of the surplus, when the price of a good goes down, what will happen to the consumer surplus and the producer surplus. Of course, most people think that the consumer surplus will add and the producer surplus will decline. But not that, what we will talk about is not the total of the surplus, the consumer surplus of everyone is the most important, not the total. We want to get from it is not the welfare, is the trend of the price. The willingness to pay of a buyer is based on the equilibrium price, when the price change, the willingness also change. By the effect of the decreasing cost, the price will be decreasing, so what will the price be. We will have two kind assumptions of the recourse to talk about the trend of the price. First, if the recourse is limited, the cost include two parts, one is the rent of the recourse, the other is the wage of the labor and the interest of the capital, by the help of progress of technology and the capital accumulation, the part of the wage and interest is declining and will be zero on the extreme, the price of the good will be the rent of the recourse in the long time in the perfect compete market (look at the the chart (3), the demand curve and the supply curve coincide, the surplus is zero). And at the same time, the willingness to pay equal the price the buyers actually pay. Second, if the recourse is unlimited, just like we have said, the part of the wage and interest will be zero, at the same time, the rent of the recourse also become zero, so the price of the good will be zero in the long time in the perfect compete market (look at the chart (4), the demand curve and the supply curve and the horizontal axis of p = 0 coincide, the surplus is zero and the price is zero). Final, the willingness to pay equal the price the buyers actually pay and equal zero. So the end of the perfect compete market is the price is zero and the surplus is zero, no one could get any profit from the market. But we still have a question, the price is certain and zero, what’s the quantity, the curve of the demand and the supply coincide and any one point maybe the quantity of the equilibrium. Really? The answer is no and we could get a certain quantity in the next.

P P

Pe D(S)
Pe D(S)
0 Q 0 Q
(3) (4)
The full employment
When we talked about the perfect compete market, we did not talk about the factor of production. We have two assumptions about it, one is the capital could flow freely; the other is the labor can’t flow freely and the limit is the ability of the labor, not the government. Because of the limit of ability and technology, the kind of goods that we could produce is limited, that means the scale of market is limited, we can’t assume everyone have the ability and the kind of good we could produce is unlimited, By the help of competition, the labor try their best to have a job, the labor who have a higher ability have a higher wage, the labor who have a lower ability have a lower wage or no wage, so we will see the model of the wage is a pyramid, just like the chart (5), the labor who has the highest ability on the top of the pyramid, the labor who have a little or no ability in the bottom or the floor that can’t be a part of the pyramid. At the same

(5)
time, by the effect of the progress of the technology, we will see two different results, one is the top get more and more profit; the other is the unemployment of the bottom, because the production efficiency improve, we could use less labor to complete the task and the labor that lost job can’t find another job, the trend is not a short-term phenomenon and always exist, if the labor won’t have the creative ability, they will lost their job, the situation is more and more grim. With the development of the automation technology and the cost declines, the machine could be used more and more industries, the unemployment will improve significantly in recent ten years. In the process of this change, we will see a employment add in the developed countries and a unemployment add in the developing countries, next the unemployment add in the developed countries and can’t be stopped. This is the effect of the progress of technology. If we can’t have the creative ability, we will lost jobs; if the creation have the boundary, we all lost jobs, the machine will replace us. In a word, the freedom is prosperity, is grave. Finally, we could tell the answer of the question that we have given in the final of the 2 part. In the free market, we face the future that everyone lost their jobs, so everyone can’t get any income and can’t buy any thing, even the price of the good is almost zero. In the book that i have read, when we talked about how the full employment could achieve when the machine is used, the reason that they gave always is the wage of workers could decline and the price of good also decline and the income of the workers could fulfill the life, but that’s unilaterally. We always talk about the wage of worker and the price of good, but never talk about the change of the machine, if the cost of machine is always lower than the cost of workers, what will we do. The answer of the quantity of equilibrium in the perfect compete market in the long time is zero.Look at the chart (6).
P

E (0,0)

0 (Pe,Qe) Q
(6)

The relationship between the market and the government
In this model, the market is failed, whether that means the government intervention is right? No, what the government could do now is just to help the jobless and until the cost could be accepted we could take the measure of nationalization. The way of free market is to fail, the government must play the role to help the jobless. The rencounter between Keynes and Hayek should have a result, they are all failed, one think the market is defective and we can improve the market by the power of government; the other think the market is perfect and the government intervention is failed, they still effect the opinion of us today. But it’s time to say goog bye. The economic should be built on a more solid foundation, not so many unrealistic assumptions.
6.The international trade
Based on the theory we have written, the free trade can’t be accepted, especially the the trade between the developed countries and the developing countries. How to deal with the relationship becomes a big challenge, if we can’t do well, the free trade may be stopped. Especially like China and India, the economic transformation haven’t complete and have too many population, the critical point that the cost of robot is cheaper than the labor is coming soon, how to face the challenge will decide the future.
This is what i am thinking. Because of the bad English and the lack of data, what i could do is just try my best to think the logic of the economic and write down. In fact, i’m not good at writing, maybe the content can be accepted, but i still hope someone could get something from it.

Post new comment

The content of this field is kept private and will not be shown publicly.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
  • Allowed HTML tags: <a> <blockquote> <br> <cite> <code> <dd> <div> <dl> <dt> <em> <h2> <h3> <h4> <img> <li> <ol> <p> <span> <strong> <sub> <sup> <table> <tbody> <td> <tr> <ul>
    Allowed Style properties: display, float, height, margin, margin-bottom, margin-left, margin-right, margin-top, width
  • You may insert videos using embed codes like these:
    • [video_large:KoqLu5CKx-o]
    • [popupvideo_mini:KoqLu5CKx-o right]
    • [lightboxvideo_mini:KoqLu5CKx-o]
    • [text_popupvideo:KoqLu5CKx-o nostart noicon|Click here to open the video.]
    • [text_lightboxvideo:KoqLu5CKx-o|Open this video in a lightbox.]
    To learn more, please click on the "More information..." link below.

More information about formatting options

Type the characters you see in this picture. (verify using audio)
Type the characters you see in the picture above; if you can't read them, submit the form and a new image will be generated. Not case sensitive.