I gave you last time a kind of overview
of the classical project and the idea
was to contrast it as much as I could
with the neoclassical project as and
that level of generality that the issues
are not ones of algebra or empirical
evidence per se but really about the
vision when I first came to the new
school I was hired by Robert Hale burner
and you may know and he was in a sense
my mentor and eventually the history of
thought course which I taught for so
many years historical foundations was
his course and one of the central points
he made in that wonderful book called
the worldly philosophers is that there
is a huge difference in how people in
economics in different traditions
approach capitalism and that difference
shows up every step of the way so that's
what I'm going to try and show you and
today we're going to try to look at the
fact that how that difference shows up
in microeconomics
now the microeconomics as it is
conventionally discussed in Orthodox
economics is understood to be the theory
of consumer behavior and the theory of
the firm so if you pick up any textbook
I like variants textbook but then that
shows you that's an age-related thing
they're newer textbooks but they all
split into this two parts consumer and
the theory of the firm and the important
thing is that at that basic level these
are treated as essentially the same
tools applied to two different domains
the the principles of application of the
same so if you remember your micro and
you should if you are in this class
consumers take prices is given and then
they maximize utility subject to a
budget constraint so there are three
elements there passive with respect to
prices they take them as given they are
passive in their maximization because
they focus entirely on their own utility
and our
the point I'm going to come back to and
they are given a budget constraint on
which they also accept as given firms on
the other hand are treated or rather
firms are also treated in the same
manner they take prices as given they
maximize profits subject to a budget
constraint so again the same principle
maximization constrained maximization
with prices given and you know that when
you do this mathematically and even
geometrically you draw exactly the same
shapes only some case you cause of
consumers and other cases you call it
the firm's you have Isaac wants a budget
line and the firm's that price is given
or you have utility curves indifference
curves a budget line and prices given
and the most elementary presentation of
orthodox micro emphasizes the fact that
the same principle is operative on both
now in addition both sets of agents as
they're called in Orthodox economics the
the firm and consumers are can are
treated as hyper-rational the
hyper-rational is my term for what the
behavior is supposed to be you're
supposed to have individuals who make
rational choices defined in a particular
way with perfect knowledge rational
expectations and purely self referential
behavior that applies both to the firm
and to the individual the firm doesn't
take other firms into account
individuals don't take other individuals
into account directly they only take
them into account insofar as they affect
the variables that they're concerned
with which are either prices or
commodities this notion especially of
the consumer as responding only to
things and not to other people is what
Marx calls commodity fetishism the
reduction of social relations among
people to relations among people between
people and things
and so people interact with people only
through the things and that is the
fetishism of commodities if you're not
familiar with that you should look that
up it's a very important concept in Marx
but it's important I think for you to to
get a sense of what that means so
imagine that I would draw a diagram of
individuals now in your case your
individuals who don't necessarily have a
connection to each other but let's say
individuals in the community if I draw
this as a neural network or is a network
diagram then each one of you will have
connections to other people people who
are in your family people who are
friends in your ethnic and religious
group in your neighborhood all of these
are real connections so I had to draw
lines going from you to those
individuals and perhaps if they get
further away the lines might be weaker
and if their family members or line
might be stronger but they're definitely
not and these lines represent
connections why is that important
because what they do affects you and
what you do affects them that's a point
of that connection then we can think of
a layer above that which is institutions
religion culture ethnicity your location
all kinds of things and they're
therefore lines going from each one of
you there and coming back down because
of course it's a mutual relationship and
then there's another set of things which
are another set of elements which are
things commodities I'm leaving out
production for now just commodities so
each one of you has a set of lines going
from you radiating out to each one of
the commodities and those lines
represent the connection between you and
the commodities any kind of behavior of
sociology anthropology any studies of
interaction of humans and of course in
our own personal experience would
indicate that this is minimal
representation of the way that people
interact with each other and with things
and we do interact with things but now
imagine that I go through and I erase or
I cut literally all the lines between
each of you and be
- in your family members and between you
and your ethnicity and culture all of
that gets suppressed into one variable
cost tastes and the only connection that
remains is a relationship between you
and the things the commodities so you no
longer interact with each other in any
way you don't care about each other
you're not affected by each other in
your family group your nationality
anything like that and that is the
neoclassical representation of the
consumer and when you look at it that
way it is so astonishingly bizarre that
you have to ask how could you anybody
derive that how could anybody arrive at
that notion of the individual
unconnected not just unconnected but
deliberately disconnected from others
now if you put it that way then of
course the question was becomes why why
did that happen and I won't have time
here to elaborate too much on that but
it's very clear if you study the history
of the rise of new class economics it is
because it is the only way to ensure the
representation that the market responds
perfectly and passively to what
individuals want because individuals are
not affected by each other and hence the
market becomes the thing standing behind
the commodities you want them you of
course cannot get them all that's a
scarcity principle and that's the only
principle allowed in there so you make
your choices subject to a constraint and
the market responds to that the other
side is the firm doing exactly the same
kind of thing and from this you get the
idea that capitalism is the perfect
optimal social system that was very
important in the construction of this
from the rise of Germans and minger and
all of that it's astonishing to me that
these people are writing wallrock at a
time when capitalism was in a severe
social crisis called the Great
Depression of 1873 to 1893 and they were
sitting around constructing this no I'm
not saying they were constructing this
because of that but they got picked up
these ideas got picked up in May general
because they represent
system in an ideologically appropriate
manner and for that same reason
criticizing these elements of it is not
going to make a difference because these
are not dependent on the detail they're
dependent on the conclusion at some
point I will open up the discussion talk
about behavioral economics and game
theory and all of those things whose
idea is to build on this framework but
not give it up what I want to argue
today is that you can give up the
framework you can in fact move to a
framework which doesn't require this
absurd starting point and yet you can
derive all of the observe laws of
consumer economics so that's the first
an important step second in this
framework when you get to the macro
level you're talking about firms and
consumers at macro level then you know
that you have to suppress diversity
literally suppress diversity because the
idea at the macro level is the current
dominant idea is that you can represent
all consumers by one individual called a
representative consumer and all firms by
one forum called a representative firm
now it is extremely well known and has
always been known that you can't do that
because as soon as individuals differ
then their differences will mean that
the collectivity will depend on the
mixture of the differences and their
responses so you cannot go from a set of
individuals that are different to a
representative agent now this is an
obvious and trivial point and neoclassic
anomic deals with it in the usual way
which says well let's assume there's a
representative agent many people have
written about this many new classical's
have written about it you cannot do it
but it's done anyway same thing for the
firm you have micro production functions
you have aggregate production functions
you have the representative agent any
good neoclassical economist who tell you
it's not possible but you cannot do
modern macro without that and as they
say since you cannot do modern macro
without that you must assume it and what
are you assuming you assume that the
kuroh economy consists of two entities
all-knowing perfect information rational
and rational expectations consumer and a
firm which has the same properties and
capitalism is portrayed as the result of
the interaction of these two
extraordinary assumptions and these are
not just assumptions that some crazy
mathematical economists are doing these
are the assumptions of all modern macro
lucas gets his nobel prize for exactly
this kind of assumption for including on
top of the standard thing the idea of
rational expectations i will come back
to that at some moment so if you look at
the orthodox framework it's what i like
about it I actually do like something
about it though it doesn't sound like
that here but is that it's consistent it
consistent even in its inconsistent
treatment of heterogeneity and
representation representative agents and
all that it's consistent in that it has
a framework that is applied consistently
to the world and that is not true of
most of the modern developments against
this framework which are partly inside
of macro inside them or orthodox
microeconomics which are called based on
imperfections deviations from this and
is also not true of heterodox economics
which is principally based on deviations
now what do I mean by that if the the
consistent framework has individuals
behaving and it and firms behaving in a
way that consistent with this basic
principle of maximizing and under
perfect knowledge and rational behavior
and rational expectations and it comes
to a set of results which is one
principle one the course at capitalism
is an ideal and optimal system and it
produces the ideal and optimal results
you cannot then have a little
imperfection here and a little
imperfection there and another one there
and another one there each one of them
only on the margin of the framework and
still
the framework when I was in graduate
school we used I asked our professors so
for what's the general theory of
imperfections and the answer is there
isn't time because all imperfections are
only understood as deviations now I
think of this is essentially a religious
way of looking at the world you have
this vision of heaven
it's a judo Christian Jude a Christian
way not every culture has this idea but
the idea of the origin myth in
perfection there's some imperfection
that drives you out and real life is
understood to be dominated by the
imperfections so perhaps it's not
surprising that this comes from the
Western tradition but you cannot have a
general theory of imperfections you
cannot add up the imperfections and
still retain the whole because all of
them depend on the rest of it still
operating they're all deviations and
that point will become clear when we get
more into the alternative so let me move
now to the idea of classical economics
how does it approach the same issue
which is microeconomics and the first
thing to understand is that in classic
economics there is an fundamental
asymmetry between the theory of the firm
which is the theory of capital and the
theory of the consumer the dominant set
of outcomes a dominant set of relations
in capitalism and the outcomes that are
then determined by these come from the
profit-making activities of the firm so
that's a very different notion because
these profit-making activities produce
regulating outcomes and I'm going to
repeat that term throughout the course
regulating outcomes that override the
imperatives of individual or override
the preferences of individuals to
produce specific types of outcomes now
this is the notion behind Adam Smith
idea of the invisible hand
if Adam Smith understood perfectly well
that firms have different incentives and
objectives individuals of different one
different classes have different one and
yet he argues that they are standing
behind them a set of forces that shape
and structure outcomes in a way that we
can understand and observe without
making reference to the Preferences of
the individuals and that's something I
want to show you can be done so in this
notion of the firm I want to call this
the the the set of activities that
regulate the firm something which I
brought up last time which is real
competition not perfect competition not
imperfect competition but real
competition because this is an older
notion and this is derived from the
observation of firms rather than the
idealization of them which becomes
dominant in Orthodox economics and
unfortunately becomes dominant also in
heterodox economics so what is that set
of properties first of all I mentioned
before that in the theory of Orthodox
microeconomics firms take prices is
given and consumers take prices are
given but then there's nobody left
there's nobody to determine prices and
you say well the prices at the market
but what is a market market is firms and
consumers but neither one of them sets
prices and so you have to invent as well
Ross does the fiction of a third entity
that is the trading entity that makes
the adjustment the the auctioneer and
many people like Franklin at Cambridge
have pointed out he by the way the
prominent or preeminent micro economists
promit points out that there is no
theory of the price in neoclassical
theory because there's no agency no
agent that can set prices this is
important because from the beginning and
the classical tradition it's taken as
obvious that firms set prices
somebody has to sell the product the
person selling the product or the
entity selling the product offers it at
a price and then reacts to the
consequences of that offer Marks has a
nice phrase on it he says of course firm
set prices every object has a ticket on
the whole on it a price tag and that is
what a price is it's an offer at a price
but that means that there's an agent
there an agency involved in just the
price setting second point in the
classical tradition is that no firm is
guaranteed a profit real competition
involves warfare and warfare involves
losers and winners and in that you
cannot say I will assume I will come out
of it with the average for the whole
point is the average is a mixture of
losers and winners and the losers can
have negative profits go out of business
Donald Trump will tell you is always a
winner but to the other side of Donald
Trump there have been losers and those
losers are part of the process by which
winners are generated this is relevant
because it means that you can't no firm
can take for granted that it will get
even a positive profit let alone a
normal profit and we'll come back to
that issue when we talk about the theory
of the firm in more detail there is no
optimization no maximization in this
notion in the classical notion there are
set of firms trying to get as much as
they can through strategy and tactics
that's a different notion it's a notion
closer to warfare they have tools that
they can do they have prices they have
technology they have information and
they have this information which is very
important in warfare telling propaganda
and lies are absolutely crucial all of
that is a natural part of competition in
the classical tradition and that leads
to a certain set of outcomes which do
not depend on the individual preferences
for instance Smith and then Ricardo and
marks and Malthus emphasized that the
mobility of buyers leads to pressure
to make prices more equal now that's an
obvious point but it's important because
if firms set prices there's no reason
for them to set prices to be equal to
other firms prices they want to see if
they can get more and we'll see when we
come to the theory the firm that they
generally cut prices in order to attract
customers but the mobility of the
customers that puts pressure on other
firms to match or drop out and that
pressure is what leads to a narrowing of
the range of prices until and you set a
price comes in you set a price cuts
comes in and the process continues
actually it's continuous in some
industries it's discontinuous but if you
look at the economy as a whole that's
happening all the time and that creates
this movement which narrows the range of
feasible prices and if you look at
anything anything you want to buy a pen
or an iPhone you will see a range of
prices always that's exactly what you'd
expect you will see that the firm's that
can offer lower prices will attract more
customers and that becomes a very
important thing in keeping prices in
line nobody's gonna buy an iPhone for
seven thousand dollars or a thousand
dollars or five hundred dollars but when
you start to get within the range that
it is give me 350 250 if you're very
lucky but more like three hundred and
375 that range is more concrete and that
is exactly the equalization process of
prices that applies to commodity prices
which I just discussed interest rates
same thing this is arbitrage in Orthodox
economics but doesn't produce and our
increased equality it produces a
pressure to keep the the differences
narrow stock and bond prices and
exchange rates and in this course I will
show you that each one of those subjects
can be understood in this way and from
this we can derive the underlying
regulating principle of interest rates
exchange rates commodity prices and so
on and we'll look at this empirically
it's not just a theoretical principle in
every case we will look at the
confidence on the mobility of workers in
the classical tradition is to be
understood as again putting pressure on
the wage dispersion but not eliminating
on the contrary you can argue that the
tendency to go from low wage to high
wage opportunities puts pressure here
because people move out the wage rises
because of the scarcity of labour
leaving and the labor coming in the
additional supply of labour pushes
prices wages down so that keeps wages in
line it's easy to show that that does
not imply that wages will be equalized
but rather that they'll produce a
persistent distribution and one of the
things at the very end of the course I'm
going to talk about is how you can use
this principle to explain piketty's
results this mobility of wages can
produce an distribution of wage incomes
which is exactly the observed
distribution that you find in econo
physics and so on you can find it on the
IRS database for incomes an exponential
distribution what the physicists call an
additive distribution the mobility of
capital leads to another kind of
Equalization which is equalization of
rates of return so am Rachael return a
hire here and there lower here more
capital will flow or capital flow more
rapidly because everything is growing so
it's always entering but it'll enter
more rapidly there than here that will
bring the supply up here and bring
prices down and supply will shrink here
relative to demand and prices will rise
and that keeps in this case the
regulating principle is not the
equalization prices with the
equalization of profit rates of rates of
return now keep that principle is a
principle that overrides preferences for
instance I will show you that that
principle can be used to explain stock
market prices and bond prices interest
rates and people often say with stock
markets well people have different ways
of going into the stock market some
people use this principle summer-long so
I'm a short some are households some are
doing it for security some are close to
retirement so their portfolio
are all different in their preferences
are all different and that is absolutely
true so how can that be if their
preferences are different and their
actions are different how can you get in
equalization and how can you get a
principle of stock prices and the answer
is if all of these preferences create in
themselves a difference in rates of
return between stocks and bonds between
real investment and financial investment
capitals people whose job it is to take
advantage of the difference in rates
return will move where the returns are
higher and they will push them down they
may push them up at first creating a
bubble but they will eventually bring
them down and that process will create
equalization of rates of return now this
is standard in finance theory this is
called arbitrage but it's a different
idea here because it does not apply
there equal there implies that they're
subject to Equalization and that's a
different principle and we will again
see this very empirically I tried to
show you some examples last time and the
last point is that in the classical
notion of the theory of the firm which
is not what I'm going to talk about
today there is an extinction principle
firms that do not survive in real
competition get extinguished they die
they go out of business their capital
gets thrown away or bought up by another
firm and that extinction principle means
that they are subject to a very strong
regulating principle they must conform
to the the fight to the warfare then
they must succeed in that and of course
many lose most capitals by the way
within the first three years seventy
percent of businesses fail in good times
not talking now at times are bad in good
times and so this extinction principle
is very important that means that in the
classical tradition there is not the
same rules applying to consumers that
as they are applying to firms there's no
extinction principle for firms for I'm
sorry for consumers
no one will kill you well that's not
true in in many neighborhoods
no one will kill you for wearing the
wrong colors and suddenly but they will
kill you for wearing the wrong colors
but that's because they are related to
gang colors but generally speaking if
you're out of fashion and so on they may
be social disapproval there may be some
pressure but there's no extinction
principle except through that much more
subtle thing all societies have rules
about what you can't do definitely but
within that the heterogeneity of
consumer behavior is far greater for
because the principle of feedback is
different
especially in advanced capitalism so
here you have a domain where personal
choices and hence consumer preferences
which are a subset of personal choices
are shaped and structured by social
context class race gender ethnicity
personal beliefs family and actually
life paths because part of a good part
of what you do depends on how you got to
where you are that is such a trivial and
obvious point that one has to wonder why
am i emphasizing this it's because you
it does not exist in Orthodox economics
in Orthodox economics the consumer is a
set entity with set preferences and
reacts in the same way to those set
preferences all the time it is a machine
but a very bizarre machine because the
machine disconnected from all other
human activity so if you approach the
question of consumer behavior from a
classical point of view you have to have
a framework that will accommodate all of
these things because these things are
the facts of the existence of
individuals I mean anyone who's been in
any country and immediately recognize
that their national differences people
behave how they feel or they think even
in
capitalist countries that's absolutely
true what they eat and these are not
just personal preferences these are
socially structured we are people as
individuals we are heavily structured by
the environment I know that when you're
young you like to think that you are
unique it's absolutely not true and as
you get older you realize how not true
it is but you also see it when you
observe people acting as a collectivity
and suddenly you see the collectivity
part come out and the individual
differences in their proper place which
is that they are second order small so
you have to accommodate immediately
diversity based on the socially
structured not diversity coming out of
your bubbling out to your nature with
that is a part of it but socially
structured diversity you have to
accommodate new preferences and choice
structures including those that are
generated by the system itself now this
is an important point the idea that the
system generates and shapes your
preferences is trivial and obvious of
your sociologist or an anthropologist
but it seems like a very strange thing
if you're an orthodox economist because
you take these things as given and
you're not allowed to say that firms can
shape them in a fundamental way and of
course that I would argue it's fairly
obvious that firms do change them and
shape them so the market adapts to
choices that individual is socially
structured and socially created
individuals make but the market also
operates on their preferences
it doesn't just take them for granted
advertising is an obvious case and I
would argue that advertising is a weapon
in competition just as propaganda and
information and disinformation is a
weapon in warfare it's a necessary
weapon so I want to show how you can
take this real framework of socially
structured individuals and derive from
it the same outcomes that Orthodox
economics emphasizes demain
curves angles curves and consumption
functions and all of that without
relying in any way on the standard
assumptions of this fictitious and
bizarre individual the orthodox consumer
that Amartya Sen properly calls what we
think of as economic man andum artisan
properly calls a social moron but it's
not quite right a social moron moron in
any sense it's still connected this is
something much worse a completely
disconnected entity a set of entities
disconnected from each other and only
connected through preferences so that
raises an interesting question why can't
we just generalize neoclassical theory
and say each individual depends on every
other individual so perhaps not equally
but this is back to the neural network
idea that their connections right so
what you do affects someone and that
effect has an effect on you
so you have to take that into account
think of the Edgewood bully box diagram
I don't know how many people are
familiar with that it's a two person
interaction in which you have two people
with indifference curves and then you
try to figure out the optimal
interaction exchange between them what
would happen to that if what one person
does affects the shape of the others
prisons and vice versa the broad answer
is you cannot come up with the right
representation that capitalism is ideal
of course you can come up with an answer
that's not the point you can't come up
with the right answer and that is why
it's not going to be possible as a
generalization you can add an
imperfection here there one person can
act and not the other like in Becker's
model of marriage but you cannot make it
general because then general equilibrium
falls apart it's all based on this
independence of individual feelings
about things unfortunately don't have
more time to do to focus on that but I
will come back to it only talk about
the theory when I do a critique of a
more detailed critique of micro standard
micro foundations so the purpose of this
lecture now is to show you can do you
can take agents who make choices under
social constraints and derive all the
necessary all the observed elements of
standard consumer micro behavior now
notice I'm not talking about the theory
of the firm because the theory of the
firm is a separate construction which I
will focus a lot of time on and when
we're finished with that it should be
hopefully at the end of the semester we
will have microeconomics we'll have a
theory of the consumer and the theory of
the firm but a different theory of both
as opposed to orthodox economics and a
question I'm going to try to ask you to
think about as we go through this course
if you were given the task of
constructing a micro economics textbook
in which you answered the same questions
that they did but from a different
framework how would you write it and
it's not just an abstract question right
now textbook people producers are asking
this question they want to know can you
produce a textbook that is different
because there's so much reaction to the
Orthodox notions you might take a look
at some heterodox textbooks which are a
mixture of people don't behave like this
at all and then let's go back to utility
and indifference curves in order to how
can you do that you just finished saying
that people don't behave like this and
the answer is because they don't have
the tools to make that transition from
what people do behave like to the demand
curves and the theory of the firm so and
these things have been around for a long
time I just want to show you that they
can be applied so that's point number
two point number three I need to focus a
little bit more on what's wrong with
Orthodox microeconomics because it is
unfortunately like criticizing someone's
religion no matter what you say it when
they walk out of class is still gonna go
back to church and so though you think
that you reject it
in another class you'll be sitting there
drawing indifference curves or doing
game theory and thinking oh this is
completely different I'm overthrowing
the world with game theory you're not
you're just part of the same religion
only you're doing it in a algebraically
more complicated way so the first
question is what is this foundation why
is there the assumption of rational
behavior so-called self-centered selfish
behavior calculating maximizing but not
only that but knowing what the correct
outcome is so you have to have perfect
knowledge and rational expectations and
so it's interesting to ask when people
are challenged or an Orthodox economists
are challenged why do you do it there's
a set of answers and the answers are
quite diverse but they always end up
saying you have to do it one is well if
you're gonna be an economist that's what
you have to do well that's not an unfair
answer you're gonna be a Catholic you
have to believe some things if people
can ask well what if you don't believe
those things but their answer is well
then you won't get a job in economics
and that's a an answer which has some
weight it's not a scientific answer but
is an answer which has an implicit
threat in it and that does help people
concentrate their attention a less
threatening answer is that it's a good
approximation to how people behave now
that's something that is widely rejected
even within Orthodox economics because
without that behavioral economics will
fall apart in fact the whole industry of
showing that people don't behave that
way is the big industry now and that's
where your future is - if you want to
stay within that side of the profession
is to take a small variation of it and
show people don't behave that way
publish and get a job you will not in
any way threaten the structure if
anything you will support the structure
in doing that but at least you can say
that you did some critical thing and
that's what behavioral economics is
really all about a third answer is that
it's convenient it's very
easier it's easier to have a simple
principle from which you can derive
results and it is often said gives you
tractable results someone has pointed
out that that's like saying well I look
for my car keys where there's some light
even though actually I lost them in the
parking lot where there is no light but
since it's dark there I might as well
look where I have some light and that is
not a scientific answer though it is an
answer that works a more interesting
answer is Friedman's what's called
Friedman's F twist which is that in any
case assumptions are not relevant all
that matters in any Theory Friedman says
is the empirical implications of that
theory obviously cannot be tested
empirically then you can't say anything
about the assumptions and Samuelson
after all another in fact more famous
micro and macro economists economic
theory says that is absolutely nonsense
because assumptions themselves are
statements about empirical properties
and moreover every set of assumptions
carries implications that you don't
necessarily want to argue about don't
want to accept so you are not science
does not let you run away from the
implications of your assumptions you can
make any assumption you want but then
once you do it anybody else can take
that assumption and show look it totally
contradicts a set of phenomena and then
you're in trouble you're no longer
justified unless you can modify that
assumption that's how science proceeds
and so it's an amazing answer because
it's so unscientific and that's
Friedman's I mean that Samuelson's term
another argument another step in this
argument is to say that all behavior can
be interpreted as self-interested and so
therefore we might as well assume that
everybody's self-interested because
after all I can always say that what you
do is self-interest so if you help some
one else that's your self-interest if
you hurt someone else it's your
self-interest and it's been pointed out
many times that that is a non-answer
that's a non-answer because it is means
that you can explain nothing by
something that can explain everything
it's well known in science if something
is tautological that explains nothing
whatsoever if I say God is good in every
instance then the meaning of God is good
it disappears because there's no way to
say the opposite but science is about
falsification about distinction about
clarification and you cannot do that if
there's no possibility of saying that
and nobody who actually says this
tautologically says it very seriously in
a scientific sense though there are
people who actually believe that you can
interpret everything as self-interest in
which case you cannot say that it's
useful right or wrong because you can
also interpret it as non self-interest
in the same way another argument is that
rationality can be unintentional now
this is more interesting because it says
look you don't even know what you're
doing but you're being rational when
you're doing it and I'll kind of like
that I don't believe it for a moment but
I'd like it because it says that I'm not
responsible then I as a neoclassical
theory I'm not responsible by showing
that you're behaving rationally just
because when I ask you you'll give me
these dumb answers because I observe how
you behave and it's essentially rational
as I said behavioral economics is having
a field day showing that that's not true
but this is an older argument been more
the game theorist says fish and spiders
are behaving in the same way as if they
were rational so we can count them under
the game theory rubric of making
rational choices the difficulty with
that is obvious if fish and spiders can
be viewed as rational then I don't need
rational to explain fish and spiders
because Darwin already did it and he
doesn't rely in any way on that notion
he relies on behavior he relies on
response he relies on evolution and
extinction principle
to shape that but it does not require
calculus calculation of the sort that we
call rational and by that same notion if
I'm not able to distinguish between
agents which are that are clearly not
engaging in the behavior assume for
rational and the agents which are then
what is the meaning of rational it's
only that you can mimic behavior that's
a bit more point bimmers point is long I
can build a model of a rational fish and
that fish will behave in a way that I
observe real fishes so therefore it
follows something and I don't never
understood exactly what that we can
therefore use this model to explain many
phenomena because it mimics them well
that's quite true but in every science
there's more than one explanation of the
phenomenon and you have to distinguish a
god among them by distinguishing where
they disagree and that's where the
problem arises Newtonian physics and
relativity theory came to a point where
they agreed on most things by the way
and they disagreed with the churches on
almost everything so you could
distinguish there but between them
the distinction boiled down to something
very small that distinction when tested
was decisive and as it shifted to
relativity theory the domain in which
relatively theory could explain things
that Newtonian physics could not got
wider and wider and eventually it's
obvious that that domain is something
that you cannot explain from Newtonian
physics any longer you cannot try so if
you're talking about mimicking some
phenomena yes you can do that but since
you can do it I'm going to show you can
do it without that the question that
arises if I can do it without assuming
rationality and I know from observation
and questioning of individuals and so on
that they don't behave that way then why
would I need it what is the need for
this principle
the last one which was actually
something said to me by a colleague of
mine a fellow graduate student wasn't
how a professor well reasonably well
known so he won say isn't him and he was
a student of Gary Becker's also and he
said well if what you're saying is true
then everything will fall apart so
therefore we have to have this framework
to keep everything together and in some
sense that is true any new set of ideas
will have that impact on the older set
that they makes them fall apart but that
is not an argument against having new
ideas that is really a defense an
emotional defense of the existing order
and perhaps they're right perhaps
existing order superior but I don't know
of any way to judge that except to
compare it to something else even
stronger problem appears with the
question of rational expectations which
is really a stronger idea an idea in
which agents know the future they know
the structure of the model that you're
constructing and they behave in line
with that so that they can anticipate
the outcomes of any changes in the model
because they know the model and they
also know they're correct stochastically
about the outcomes that is an assumption
that Lucas correctly pointed out is
inherent in your classical theory it's
an assumption that even in your
classical theory many people find
extremely hard to swallow and
empirically very hard to swallow but one
argument is that look there are
processes that have weed out individuals
or agents that are not rational no you
could apply that to the firm because the
firm does get weeded out if it makes the
wrong move
it doesn't imply that it's making
rational moves in this sense of
rationality there's another rationality
rationality of war that is logic of some
sort a game of some sort a contest
that's a different notion of rationality
but you could argue that there are some
principle guiding that but what is the
principle that weeds out
people who make wrong choices at the
personal level at the consumer level
well there's some feedback sometimes
they end up doing perfectly well anyway
there's no very few societies in which
you execute people or force them to
change their behavior because it doesn't
conform to some notion of rationality
and so when it comes to that the
neoclassical really don't haven't any
justification for irrationality in that
sense in being enforced they have to
assume that its inherent I want to say a
little bit about game theory you may
have deduced that I'm not a big fan of
game theory and the reason I'm not a big
fan of game theory is not because I have
a low opinion of algebra or any of that
I have rather high opinion that it's
because the presumptions of game theory
are essentially extensions of this
framework the framework of the selfish
rational all-knowing individual and game
theory had tried to move away from that
by allowing for strategic interactions
so that instead of assuming a large set
of an infinite set of individuals
interacting and that's usually one of
the possible outcomes in a in the game
if it's large enough if the participants
are large enough but you can deal with
smaller interactions that in itself is
fine the problem is how you deal with
them how you represent that inter set of
interactions and there you're back again
in the world of neoclassical Theory
you're back in the world of selfish
individuals and you make a set of
assumptions that you get in order to get
results you have to make these
assumptions because once you have
interacting agents you may not be able
to get results unless you make specific
assumptions and these assumptions are
made up to get the results and then
treat it as necessary because they are
necessary to your argument but they're
not necessarily not necessary to some
other argument rationality common
knowledge of rationality consistent
alignment of beliefs and a whole set and
knowing what other people know and they
know that you know and they you know
that they know and so on so on these are
very old and widely criticized
assumptions but game theory for in the
last twenty years became huge and became
part of the syllabus everywhere and you
should know it but then in my opinion
you should approach it critically but I
have another difficulty other than these
which I see clearly as simply ways of
building on the standard framework and
therefore I'm staying within it is that
if game theory is to talk about
strategic interactions among individuals
then how could you possibly leave out
violence how could you study society how
could you study interaction mind
individuals in any time any moment of
history and leave out the costs of going
against others the the penalty that can
be extracted exact it on people who
disagree today's New York Times has a
article about Donald Trump you should
look it up and if I misquote you can
correct me but it says the Donald Trump
put up at the Trump power tower on a
famous landmark building and he wasn't
going to get permission and he called up
this the city person the man who was
blocking it he said
I'm a rich and powerful man in this city
and have you blocked me you will never
forget it I will get you I will punish
you and then suddenly that man change
his mind and Trump got the permission
and that man ended up working for Trump
today's times that is the normal way
that social interactions among people
with unequal powers take place and that
is the history of group interactions the
interaction between men and women very
fundamental violence plays a huge
historical role how can you possibly
then talk about this in terms of game
theory what are the game theorists doing
when they leave out violence they are
representing capitalism again in this
ideal form they're conforming to this no
and in fact serving it so what they end
up doing is to try to reduce human
behavior to a series of voluntary
contractual bargains and human behavior
is not about that how can you talk about
human behavior without question of
threat how can talk about slaves
peasants castes women most of all the
historical subordination the threat of
violence which takes place when cultures
interact when football teams interact
I mean it's bizarre to me that you can
leave out all the important elements in
order to reduce them to the form that is
acceptable to this paradigm I always
remind people of this essay which is on
your reading list which was written by
my predecessor here at the new school
Steve heimer and it's called Robinson
Crusoe and the secret of primitive
accumulation now Robinson Crusoe as you
know is the is the paradigmatic economic
man and heimer points out that he is
exact opposite first of all he's a
British born slave trader
that's what Robinson Crusoe is and he
happens to land on that Island because
his slave trading ship filled with
slaves crashes and he's marooned and he
becomes the ideal human in your classic
economics why because he's on this
island and he's making some choices and
by separating out other people so he's
again the ideal human because there are
no other humans but this is a very
bizarre representation and as himer
points out he's a British man he has old
British cultural
racist imperialist attitudes built into
him and it's in the book it's not in the
Disney version but it's in the book if
you want to read Robinson Crusoe go back
to Daniel Defoe and read what he had to
say about the neoclassical economic man
and I'm not even getting into his
capture of the man whom he gives the
name Friday to remind him of his
liberation from his captors and his
subordination to his new ruler the name
comes from Crusoe's deliberate attempt
and gives him Christianity he threatens
him with the gun he shows him that if he
doesn't act as his servant he can be
killed he hides the secret of the gun
from him because he's afraid that he
will figure it out I mean this is a
absolute story of imperialism lead clear
to many other things of our games here I
don't like her but the last one is a
tomb Oh two more you can't if you talk
about strategic interactions you have to
talk about all those things that take
place process back in the brain the
so-called lizard brain in which you
react without thinking now behavioral
economists have suddenly discovered oh
my god people do react without thinking
so what it was obvious from the start
but the important point is that that
calculation device that device is not
calculation in the rational choice way
at all many things that we do in fact
are done automatically and if you think
about them you can't do them you play
sports if you play tennis which is one
sport I do know a little bit about you
really can't think about your stroke if
you're gonna do it if it's not there
it's there you stop to think about it
you're dead and yet we do it extremely
well a child walks we still can't teach
robots how to walk without thinking it
doesn't think it does it because we have
mechanisms built into us to learn and to
act and to reproduce behavior which are
evolutionary mechanisms they've
developed over a long period of time but
they don't go away if you think anyone
who plays chess if you think that chess
is all calculation you're absolutely
wrong yes computers can do a huge amount
of calculation but people have a
different way of playing because they
have abilities that are accessed in a
different way
last second the other point what about
games here is payoff matrices what are
these things
payoff matrices are either money in
which case you have to assume that
everybody only cares about money which
even in your classical would tell you is
wrong because we're all the commodities
or thereabout utility but then the
utility must be the same for everybody
it must be comparable to anniversary
Cardinal and Cardinal utility is
impossible because Cardinal utility
leads to a terrible conclusion which is
point from Bentham found out which is
that if you assume Cardinal utility and
it's comparable then you can say that I
can take money away from someone who's
rich and give to someone who's poor and
they will gain more from that amount of
money because they are poor so it raises
them up and then the rich will if the
utilities are comparable so you have to
say they're not comparable and they're
not comparable then you can't use them
for making choices now again these are
not things I'm just saying these are
things have been said by game theorists
the last point is game theory has been
contradicted by the empirical evidence
from the start so people who discover
get a big grant and then go out and show
that people don't behave that way are
absolute humbugs because they're talking
about something that's well-known but of
course careers can be made that way by
showing again these small marginal
deviations from the framework Becker's
theory of the family is another example
of introducing interactions and I don't
have time unfortunately go into that but
I asked you to look up how is it that
Becker's theory the family gets around
the idea how does it introduce the idea
that individuals care about what happens
to other individuals or at least take it
into account care is not quite the right
word but take it into account and is
that the same thing as generalizing
interactions among individuals and it's
not we know that it's not it's
restricted in a particular way so it
does not contradict the basic
foundational elements and the last for
me most bizarre
it's something called analytical Marxism
John Romer and John Elster
Gerry Gerald Cowan now passed away at
Oxford and that arose out of a time when
Marx was a terrible burden so to speak
to the left and a set of people on the
Left thought the best way to to save
that tradition is to translate it into
neoclassical economics and try to show
that neoclassical economics can be used
to derive things like class for instance
from the rational economic man making
choices under certain constraints so
they saw themselves as anti dialectical
anti holistic and they stated that the
neoclassical economics is essentially
sounds so they accepted micro and macro
theory of the firm and these are people
I know personally so I remember these
discussions they rely on rational choice
game theory mathematical techniques of
neoclassical general equilibrium theory
and they want to show that aggregate
phenomena what Cohen calls molar
phenomena can be explained by reference
to micro constituent and micro
mechanisms so that we don't need
anything more except understanding how
the behavior at the individual level
operates and that's of course the same
principle that any neoclassical macro
economist would say so they are in that
sense utterly neoclassical but they
wanted to show they can derive some
assumptions about inequality and
structural differences from this
framework so what they deny is the idea
that the whole has properties different
from the sum of the individuals and I
want to talk about that and I don't want
to run out of time so let me illustrate
that
they want to deny what is would be
called in present terminology emergent
properties what used to be called an
earlier time dialectical properties that
is to say the the whole has properties
different from the sum of its parts now
you have to say why under what
conditions is a whole different than the
sum of its parts and the answer is if
the hole is constituent is built up from
parts that interact with each other in
such a way that that's necessary for the
whole then the whole has properties
which cannot be derived from the
individual elements because their
interactions creates other properties
and these are the properties can give
rise to a very different aggregate
outcome now this is a elementary point
is well known in science well-known in
the classical tradition well-known by
Smith and Ricardo and Marx but it's
always astonishing to me that then a
group of people coming from that
tradition would throw it away and again
by the way they lost that battle because
Orthodox economics accepted that it
wasn't valid either what do I mean by
emergent properties let me give you the
simplest example possible imagine that I
have a glass container and I put a gas
in it and I heat up that gas and I
observe the pressure at different
temperatures now this was already
observed there's a called the gas law
that there is a relationship between
pressure temperature and volume and a is
the product of the first two I think is
PV is RT that particular gas law I may
have the symbols wrong but I believe
this is right this is the gas law
so pressure volume this is a constant
parameter that related to that and T's
temperature this is a log linear
relationship right but it doesn't apply
to any of the particles
it only applies to the whole because it
comes from the interaction of particles
what is the pressure come from
you'll heat up a gas the particle is
moving around more they hit more often
against the container sides and you can
measure the pressure on there and you
can hypothesize about that measure too
so you can derive from a model of
particles as billiard balls hitting the
sides you can derive this law but the
law was there before the derivation
because the law was observed Boyle's law
is observed before the idea of particles
in a gas of gas being composed of
particles and the law is still true even
though now we believe that gases are not
composed of particles gases are composed
of entities I'm trying to be careful of
my terminology here they don't actually
exist as such but come in and out of the
existence they don't have a rigid notion
of individual billiard ball as it used
to be called and physicists will tell
you that you cannot conceive of the
particles in a gas as solid entities or
tiny solid entities but rather something
quite different and so now it's very
difficult to derive this law it's very
difficult to find a micro foundation for
this law the way we normally do it is
assume that the particles are little
billiard balls
Robert Laughlin in his book which is on
your readings talk as a physicist and
Nobel laureate in physics who talks
about the fact that we teach it as a
series of interactions but when someone
says but didn't you just finish saying
that atoms don't really exist as such
and they're in and out and he goes yes
but then we can't derive the gas law the
point there is that the micro foundation
necessary for the gas law may not be
there but it's still the law anyway and
secondly it's obviously consistent with
more than one micro foundation it's
consistent with the idea of particle is
as billiard balls which is the original
idea of gas and now particle is in the
relativistic sense it has to be
consistent with both but then we can
choose between them by look
more concretely at the differences in
their assumptions in their implications
one of which is we can look at atoms and
see that they're not billiard balls
anywhere right away we have a problem
now he in his book mentions many many
different principles in physics which
are not grounded in micro foundations or
in grounded in multiple micro
foundations and then you have to choose
among them by some notion by some
principle the most important thing is
that this is an emergent property it
doesn't apply to individual particles it
only allows to the collectivity in a
constrained environment I mean the gas
has to be inside a box has to be some
container holding it so it comes from
the interaction of the particles and in
the box and it's a very stable result
very widely easily replicated result
everybody's done it somewhere in physics
in in in high school but it is therefore
inconsistent with the standard
neoclassical foundation that the
representative the whole is a
representative of the individual element
because it isn't and that is the general
principle it was widely known that you
the behavior of the whole cannot be
modeled as the equivalent of a single
entity all the more so of the entity is
exactly alike because then you'd really
have a problem if the particles are all
exactly alike
you couldn't have the bouncing off the
walls it's because they move around in
unalike ways that you get the evening
out of the hits and you get pressure
secondly that implies that interaction
is robustly transformational it creates
a set of outcomes which are not very
dependent on the details for instance
the individual particles paths vary a
lot and we can sometimes tag them and
see them but the fact is that the result
doesn't depend on that if we even change
the behavior of individual particle
paths you're not going to change this
result in any
fundamentally the same issue or and the
last point is that the average particle
if there is any meaning to this is a
particle that represents this and is no
individual particle that has a property
so the average is not a representative
of the individual to put another way the
average is not a representative agent
the average agent is necessarily
different as soon as agents interact and
that's true for firms as true for
consumers it's true for particles so
then you can ask the question under what
conditions will an individual micro
economic agent of the neoclassical
consumer type act as a single individual
at the whole gorman in 1953 works out
the answer and that is that the
responses of the individual agents must
be identical and linear at the margin in
other words they must behave as if they
are exactly the same if they do that
then you can say that the aggregate is a
result of this single individual
effective single individual but of
course you can only do that if the
individuals are essentially the same
because as soon as you allow for variety
which I'm going to do shortly in a in
the next step then you cannot say that
individuals are likely and you cannot
say that the average is representative
of the individuals the same problem
appears in the idea of an aggregate
production function which is the other
side you have individual firms all
having individual micro production
functions you need to represent them in
the aggregate and you simply make the
breathtaking leap that they have the
same shape aggregate production function
cobb-douglas or but it has to be well
behaved has to satisfy these properties
and it is well known that you cannot
derive it Franklin Fisher at MIT with
some neoclassical economists absolutely
as solid at Franklin was at Cambridge
has pointed out again again that you
cannot go from the micro to the macro
and get the right aggregate results so
what's the reaction the profession okay
let's assume an aggregate production
function totally ignored even within his
own cohort if you believe in emergent
properties then emergent properties are
perfectly consistent with in fact
require generally speaking heterogeneous
agents and that as a result the emergent
property is fairly stable under wide
varieties of constructions and
interactions of the individual agents
except under dramatic circumstances if
you put enough pressure on the box it'll
burst well that's where that emergent
property disappears their limits so in
human behavior we have the same thing
collectivities of people interacting
produce remarkably stable results unless
they decide to interact in a different
way let's say all go on strike or all
demonstrate against a government that's
what I call Tahrir Square effect when
enough people act in a unitary way then
the heterogeneity which acts to create a
sort of whole disappears or sufficiently
so that the outcome has changed
obviously if people go on strike then
outcome has change if you decide not to
buy collectively French wine because
France did not support America in the
war in Iraq while the demand for French
wine drops because that's a collective
response but by and large the property
the demand for French wine are very
understandable and that's how
advertisers work because of all these
small interactive effects which add up
to a fairly stable result now if that's
true then the average is different from
the representative agent because there
is no representative agent you cannot
speak of one if you have heterogeneous
individuals but you can speak of an
average agent but that average agents
outcomes are not intentional
they are emergent property so you cannot
treat them as a decision-making outcomes
their outcomes of multiple decisions
conflicting decisions among people with
conflicting opinions and directions so
you cannot treat them as if they are
optimal outcomes or desired outcomes of
individuals in fact that's the whole
point of the invisible hand and Smith
that the outcomes you get are not
desired outcomes the outcomes imposed by
the interaction of individuals for that
same reason if I can say that I have
multiple ways to create the same
understanding of demand curves it seems
as if it doesn't matter but that's not
true if I have multiple ways to create
the same understanding same outcomes of
demand curves and so on then it matters
a lot which one of them is better than
the other because the interpretation of
the outcome depends on how people feel
if I say that every person who makes a
choice in New Jersey to drive across the
bridge in a particular time made an
optimal choice and they cannot be angry
at the governor for having intervened in
that because that's just one of those
constraints you take its given you know
it happened to be there however as the
governor knows that's not a good way to
proceed politically because people can
be extremely angry about the outcome
because they care about how it was done
and they care about how it differed from
what they expected they care about how
they feel about the whole thing how
other people feel about it all of those
things which are essential political
life so you cannot tell a politician
that your basic individual is a micro as
an so-called economic man they would
throw you out of the room because by the
way they're better micro economists then
certain economists are because their job
is to pay attention to that feedback to
fundamental to their existence so it is
for this reason very important not to
misrepresent
behavior because how people feel and how
they react to what happens is
fundamental to the process so I'm not
saying that because there are ten
different ways to derive the same
outcome
it doesn't matter on the country it
matters even more which is the better
way this is a to most of you should be
familiar framework this is the budget
line so you can think of two goods one
is a luxury good x2 and the others are
necessary good and I the only adjustment
I made to Becker's framework was that I
included I insist on the idea that ain't
necessary good if this is the
distinction between the two has to have
a minimum level that's because when I
first saw Becker's presentation which
blew me away was brilliant I had also
just come from my development course we
were talking about hunger and minimum
wage and all of that stuff or minimum
cent living so he seemed to be pretty
obvious now that means that if this is a
budget line this part is where you spend
all of your income you have a certain
amount of income which is divided into
expenditures on one good and
expenditures on the second good if you
put all of it into one good then
depending on the price you will be up
here this is if you know if you put all
the money into good too then your income
is the good the amount of your budget
which is whatever it is divided by the
price of good too and that's your income
up there that's your maximum consumption
of good to same time good one you can
see if your income level is why and the
price of one is p1 then this is the
maximum of one you can get and that
allows you to draw your possibility
space the budget line right then if
there's a minimum point the realistic
the actual possibility space is the
heavy part because you can't go below
the minimum so this introduces
analytically a non-linearity which plays
an important role in the outcomes in
some of the outcomes now suppose I
consider this to be representing one
individual it doesn't matter for me this
is the average individual
so I'm talking about the average but the
average is composed of many individuals
who are different some will they have
different attributes they have different
methods of choosing they have
interactions with each other it doesn't
matter what matters all that matters is
that they produce a set of choice in
which they choose X 2 and X 1
on average they have a distribution of
choices because they're different they
have a mean and this is the mean choice
and that defines a point a on this
budget line so all I need to proceed
from here is the idea that people act in
complicated ways which nonetheless
produce stable aggregate distributions
and once you do that everything else
follows pretty straightforward I can
define this point a by a ratio and that
ratio can be defined as let me make sure
I get the it's the average described
discretionary propensity to consume and
it's a ratio of the consumption of the
discretionary consumption the first good
which is anything above the minimum
level so it's anything from here to here
the amount that you can consume of the
first good is the amount that is above
the minimum so that's it that's the
range of discretionary consumption and
the amount of discretionary income is
the income that you have - what you must
set aside for the minimum good so that's
the income that you can spend and this
is the quantity of the first good that
you can buy the ratio of the two defines
a variable and this variable will be
between 0 and 1 and it basically
characterizes that point a or any point
representing the
average outcome of the system so from
this from this definition I can rewrite
the demand for Goodwin as a function of
this ratio and of the real income
expressed in Goodwin terms I'm just
taking this definition and right solving
for x 1 and I get this I can define
because X 2 and X 1 are linked since I
have to spend my money on 1 what I spend
on one I have only leftover to spend on
the other I can derive in the same way
the demand for X 2 and it's going to be
a function of this variable a single
property of the average the average
discretionary propensity to consume and
I have to demand cars but notice that
I'm in deriving these demand curves I've
made no assumption about what motivated
this average they follow from the fact
that there is an average and an average
in this case defined this way will give
me a very straightforward set of demand
curves you can do it from different
averages you'll still come out with the
same No what's interesting about this is
that notice that if I raise the price of
Goodwin the demand for Goodwin will go
down that's your negatively sloped
demand curve right that follows just for
straight forward from this if I raise
the price of good to the demand for good
2 will go down because the the price of
good 2 shows up here and here and the
curve will also shift so you have a
negatively sloped demand curve without
any assumption and let me show you how
that works in the diagram here the good
one has gone up in price
so therefore I can consume less of it at
the maximum so the whole curve is
shifting down and you notice that what's
happening is that the demand for Goodwin
goes down the demand for good 2 also
goes down
but in a different way lesser way and I
get some kind of line here which is the
elasticity response I'm going to
elaborate on that in a minute
and in fact I can take these algebraic
equations which are just statements that
there there's an average and I can turn
them into elasticity's because I can
take the rate of change of good one with
respect to price one and I can derive
this elasticity which will be less than
one it's a price elasticity of necessary
goods the very important point one of
the empirical observations is that
necessary Goods have a price elasticity
of less than one and now this follow is
simply from the fact that it is
unnecessary good not from any utility
assumptions about the behavior of
individuals the elasticity of luxuries
is absolute value is 1 in this case so
that can be changed by making a little
bit more detail assumption the cross
elasticity of x1 respect to x2 is 0 in
the simplest case and the cross
elasticity of luxuries is negative so
you have 0 and negatively less cities
all of these fulfill the basic
conditions of demand curves in fact many
observed demand curves from this you can
also say that you can talk about the in
Camille acid these are the price
elasticity 'z which I derive here but
you can talk about the income elasticity
s by taking the same relation of having
an average and hence the demand curves
implicit in that and I can say I can
derive the income elasticity s by
changing by asking how much does the
demand for x1 change if I change income
Y and you can show that you have an
income elasticity of less than 1 for
necessary goods a well-known finding
empirically and an income elasticity of
more than 1 for luxuries these are
called Engles law and they are often
considered an indication of social
preferences of individuals but the point
I'm making here is that they
not necessarily that they follow from
the structure which is a budget line and
a minimum consumption that's all the
only assumptions I've made here and a
stable distribution of outcomes and in
fact you can develop this argument also
to show that if income Rises these
elasticity's imply something about
saturation for necessary goods because
Alessa is less than one if you pick up
more necessary goods at a slower rate
and that's a well-known property of
empirical curves the share of
expenditures are necessaries as your
income Rises will go down which people
spend less percentage of their income
unnecessary goods but again this derives
from no assumption about the individuals
only about the fact that's a budget line
and that there is a mean outcome from
the heterogeneous individuals and
necessaries expenditure on necessaries
will rise with income though the
expenditure share will fall so you
you'll buy more of necessary goods in a
slowing rate and therefore the share
that you spend of your income
unnecessary as well these are again as I
said extremely well established
properties if this is the property
you'll get an angles curve which looks
like this and both of them again very
well established properties of groups
let me show you here these are the
actual working actual expenditure share
on food working class budget from Allen
and Boley and you see that the
expenditure share on food goes down as
the income of workers goes up as higher
in as you look at higher income workers
and the as average income goes up the
amount of money spent that didn't work
out very well what does that say on
income goes up
the share goes down that the amount goes
up and that's again de Rivel without any
assumption about preferences only
assumptions about social structure and
general properties of the average of the
average there's no representative agent
here I can use the same framework to
derive something very familiar I can
take that framework and say instead of
calling one good necessary and the other
luxury I can call one good consumption
good and the other financial assets then
you know the trouble with Max is that
they take all the symbols and they
change them so this should be a delta
not a V unfortunately it's showing up as
a V but should be a delta FA these are
financial assets so what is saying you
spend your income on consumption or
financial assets whose prices PF right
from the idea that there's an average
expenditure from the group that pi
I'll have consumption is a function of
the minimum consumption because
consumption is the equivalent of the
necessary good here and financial assets
equivalent of a luxury good so I can
transpose that and I'll get savings is
the price of the change in financial
times the change in financial assets and
it'll be this property but you'll notice
that these are identical to Keynesian
textbook consumption functions right and
I haven't done anything except make that
assumption that there's an average in
the economy as a whole
now this framework is the most
elementary version and you can certainly
build on it in a variety of ways I can
add wealth there we could add debt there
and so on but notice that then you have
a parallel set of explanations of demand
curves of angles curves of income
elasticity of price elasticity of the
right magnitudes that we observe and are
derived typically by making specific
consumptions about utility curves and
there
behavior and so on but I haven't made
any such assumptions and so the question
is why do I then need all of that
apparatus if I can do it from just a
budget line and the idea that there is a
emergent property ie a stable propensity
to consume a discretionary propensity
consume which itself may vary with
income level or class or gender that's
easy to build in but I don't need
anything about preferences here what I
want to do next is to show you that
these results don't depend on the
assumptions I make about the micro
foundations and so for years and years I
waited for a graduate student who was
able to help me and I finally found one
his name is Amir Agha B's graduate now
he's professor and what he did he helped
me set up four different micro
foundations one of these let me show you
get these right because I don't want to
misrepresent them service week one is a
standard textbook Micro Foundation and
the only one in which there's a
representative agent in which each of
you has a utility function which you
maximize utility with a budget consent
in this case a cop Douglass utility
function but all of you are identical so
the parameters of your cop Douglass
function have to be identical because
otherwise you wouldn't be identical so
this case one the standard textbook
micro model in which every individual is
identical so of course the average is
the same as a single individual because
there's only one individual really
strictly speaking and that gives you
demand curves and all of these
properties so that's a standard micro
foundation so it's what you find in most
textbooks if they are trying to
aggregate up the second one is that each
one of you is a neoclassical agent
rational choice utility curves but your
cobb-douglas coefficients are different
now that one cannot be made into a
representative agent
not be made into general equilibrium get
into a macro model because it won't
aggregate up but nonetheless it's a
purely neoclassical micro model the
third is what Becker calls impulsive
consumers what I like to call whimsical
consumers that today you do this thing
and tomorrow you do another you're not
tied to behaving exactly the same way as
with a utility function you are tied
every day you are variable and you know
random what looks like to the outsiders
random you may have internal processes
that are structuring this Freudian
processes personal processes whatever
but from the outside your behavior
collectively looks like a series of
random choices made by individuals but
the whole point of random choice is they
have very stable aggregate outcomes so
this is your impulsive consumer that
behaves differently every day and yet
you get in the aggregate an average and
that's obviously formally true if you
think of this in terms of sarcastic
theory and the last is a model
deliberately designed to be as different
from the neoclassical assumptions as
possible in which you have two sets of
individuals one set that adapt their
preferences to those in their social
neighborhood in agent-based simulation
you can define a neighborhood as being
close by in some space not necessarily
physical space but it's similar so these
are people who conform or individuals
who conform to others who are like
themselves or similar in their community
let's say and then as another set who
are trying to be different innovate
that's pretty obvious the first set is
older people and the percent and the
second set is younger people they create
new structures and try to break free
from or differentiate themselves the
point is you can do this an agent-based
simulation these can be you know
thousand people of one type and a
thousand people another type it doesn't
matter for the model a small number
pretty much generated and you can ask
them all so that's all they do if I
change prices it's going to change their
budget line if I change incomes are
going to change their budget line their
budget lines
by the way if I change those what's
going to happen and what you discover
because you can show it already formally
from my previous apparatus is that you
get all of them give you identical
results in the aggregate so this figure
10 is the theoretical line is hidden in
there it's the line that I get from my
property my budget line and average
propensity so that's a line I derived
before so this is the demand curve for
necessaries which I already derive
before and it downward sloping because
if I increase the price I will buy less
I will find them the aggregate will buy
less of the good individuals may buy
more by the way that's perfectly fine
the aggregate will buy less of the good
and each one of these dots represents
one of the models so there is a
neoclassical homogeneous buried in here
there's a neoclassical heterogeneous
there's the whimsical and there is the
imitate innovate one and they all give
you the same one because we've already
shown that as long as they give you a
stable distribution they have to give
you the same outcome but this shows very
concretely that we cannot tell by
looking at the outcome which one of
these models was a source of it we
cannot judge the putative micro
foundations by looking at the aggregate
result conversely you cannot say that
because my micro foundation this one
gives me this it follows my foundation
is correct because I can immediately
construct dozens of others it will give
me that and I can ask you then well what
do you think yours is correct mind gives
you the same answer
and moreover mind is closer to
individual behavior than yours so you
shouldn't be having that model at that
point you lose your job and end up
working somewhere else but anyway you
can try to make that argument not a new
job talk and this is the other side of
that which is the luxury good again you
have the theoretical line and then you
have all the individual models and as
you can see they give you the same line
now I can keep on doing this
but not for long because I want to wrap
up now these are the elasticity is
derived from the different models and
the theoretical value is here the
theoretical values come from those
equations which I derived from just
assuming that there is a stable
propensity to consume and you can see
that all the different models give you
essentially what you would expect from
the theory and yet obviously it matters
which one of these models is correct
when you want to talk about micro
foundations so one last point if this is
true then what Laughlin the physicist
calls robust indifference of the
aggregate to its micro details it's true
because these very very different and
really antithetical assumptions give you
identical macro outcomes so what we need
what we have therefore is a space for
real consumer behavior we don't need any
longer to try to talk about indifference
curves because we know people don't
behave that way rational choices we know
that people don't behave that way we can
actually talk about how people behave
and we can still retain the fundamental
assumptions of fundamental observations
of consumer theory and that's a first
step in micro to do that the second step
is to fill in the models of how people
do behave and I urge you to think about
this as a possible paper topic choose
what you think is a good model of
consumer choices I personally would go
immediately to advertising and look in
that business literature because they
know psychologists through little
experiments here in their game theories
little expended meaningless compared to
the people whose job it is to determine
your income your your preference
structure to structure it
shape it so find out how they think
about it it make an excellent paper and
the excellent part of a book on
alternative micro economics
you
