Why are modern economic theories so fallacious?

[SilentXtarian]

Okay. Until this point in time I’ve just been reading austrian economcs and reading their criticism of mainstream economics with only a high-school education of economics. I’ve read 16 chapters of Human Action and 've decided to take a break from it so I can get more of an understanding of the core concepts of regular economic theory.

First of all, I found a bunch of stuff about modern economic theory on this website http://www.basiceconomics.info/

I’ve found a number of flaws in it. I’m no economist but I learned a lot more from reading about AE than reading regular economic theory. I’m going to be highlighting in quotes what I find troublesome with modern economic theory and how it conflicts with AE. I think that modern economic theory is very fallacious… and I think you’ll see what I mean in a moment.

First, what struck me is that they still haven’t figured out the subjective theory of value.

Principles of Economics:

1. People face trade-offs.

Every decision involves choices, and more of one good means less of another good. Income and wealth are not limitless, since there is only so much time available. Trade-offs apply to individuals, families, corporations and societies.

2. Cost of something is what you give up to get it.

When we make a decision we implicitly compare the costs and benefits of our choices. Opportunity cost is whatever must be given up to obtain something. Some costs are obvious – out-of-pocket expenses; other costs are less obvious but must be included in total opportunity cost.

3. Rational people think at the margin.

Basic economics assumes that people act rationally and try to act so as to gain the most benefit for themselves compared to the associated costs. Microeconomics focuses on small or marginal) changes, and it is often rational to consider the marginal rather than the average effects of decisions.

4. People respond to incentives.

If rational people compare costs and benefits, then changes in either one may change decisions. An example of an incentive that people respond to, are changes in prices. In general, people are more likely to buy something if it is cheaper. If an action becomes more costly, then there is an incentive to switch to other choices. Note that all actions have substitutes.

I agree with their theory on cost and benefit analysis… but as we know the consumer isn’t necessarily a rational being. The consumer acts purposefully. The acting man is not guided by some purely mystical phantom wisdom. They make decisions based on what they think is most valuable to them. If something will satisfy their needs… they will get it.

#2- Principle of Economics #5: Trade can make everyone better off.

This is fallacious. It doesn’t always make people better off. Some people can lose things from trade. It doesn’t have to make people better off… there may be drawbacks from it. People trade to be better off than they were before the trade… they give up something to get something in return… but they don’t necessarily have to be better off than they were before. This can be true… but it’s not always the case.

Law of Supply

As the price of a product rises, ceteris paribus, suppliers will offer more for sale. This implies that price and quantity supplied are positively related. The major factor that influences supply is the “cost of production”, and includes:

1. Input prices - As the prices of inputs such as labour, raw materials, and capital increase, production tends to be less profitable, and less will be produced. This leads to a decrease in supply.
2. Technology - Technology relates to methods of transforming inputs into outputs. Improvements in technology will reduce the costs of production and make sales more profitable so it tends to increase the supply.
3. Expectations - If firms expect prices to rise in the future, may try to product less now and more later.

Why would the ability to make more of a product necessarily mean that you’d earn less profit? Sure you might not make as much as others do since more people can make it. But… does cause necessarily equal effect? And why would they try to produce less if prices are supposed to rise in the future? Wouldn’t they want to produce more so when the prices rise they could sell more? That doesn’t make sense. This is what they say about the law of supply and demand.

Supply Curves and Schedules

The relationship between the price of a product and the quantity supplied, holding all other things constant is generally sloping upwards. Supply is represented by the entire curve and not just one point on the curve. When the price of the product changes, the quantity supplied changes, but supply does not change. When cost of production changes, supply changes, and the entire supply curve will shift.

Market Supply is the summation of all the individual supply curves, and is the horizontal sum of individual supply curves. It is influenced by the factors that determine individual supply curves, such as cost of production, plus the number of suppliers in the market. In general, the more firms producing a product, the greater the market supply.

When quantity supplied at a given price decreases, the whole curve shifts to the left as there is a decrease in supply. This is generally caused by an increase in the cost of production or decrease in the number of sellers. An increase in wages, cost of raw materials, cost of capital, ceteris paribus, will decrease supply. Sometimes weather may also affect supply, if the raw materials are perishable or unattainable due to transportation problems.

Oh really? Then how does the supply and the demand theory explain the Nintendo Wii? Consumers still demand even more of the Nintendo Wiis when more is made. The supply does change. I don’t think of this as a law…

Reaching Equilibrium

We can analyze how markets behave by matching (or combining) the supply and demand curves. Equilibrium is defined as the intersection of supply and demand curves. The equilibrium price is the price where the quantity demanded matches the quantity supplied. The equilibrium quantity is the quantity where price has adjusted so that QD = QS. At the equilibrium price, the quantity that buyers are willing to purchase exactly equals the quantity the producers are willing to sell. Actions of buyers and sellers naturally tend to move a market towards the equilibrium.

Excess Supply/Demand

Excess Supply is where Quantity supplied > Quantity demanded, and results in surpluses at the current price. A large surplus is known as a “glut”. In cases of excess supply:

• price is too high to be at equilibrium
• suppliers find that inventories increase
• suppliers react by lowering prices
• this continues until price falls to equilibrium

Excess Demand occurs when Quantity demanded > Quantity supplied, and results in shortages at current prices. In cases of excess demand:

• buyers cannot buy all they want at the going price
• sellers find that their inventories are decreasing
• sellers can raise prices without losing sales
• prices increase until market reaches equilibrium

How do you expect for the market to go to a state of equilibrium? if anything it goes to a state of disequilibrium. I don’t see how the demand could intersect with the supply… unless you’re lucky you won’t usually meet this state of equilibrium. I’d say that with the constant changing of the demand in the market that it’s rare that thisi s met… so the market has a tendency to go towards disequilibrium.

Oh and it’s laughable what they say about budgeting.

Consumers’ Optimal Choice

We must combine what a consumer can obtain (budget constraint) and the preferences (indifference curve). The optimum is the highest point on the indifference curve that is still within the budget constraint. This will usually occur where the indifference curve is tangent to budget constraint. At the optimum point, MRS = relative prices of goods since MRS = slope of indifference curve, and relative price = slope of budget constraint. The marginal rate of substitution is the rate at which consumers are willing to trade-off, and is equal to rate at which they can trade.

Changes in income will undoubtedly affect the optimal choice. The budget constraint will shift parallel to the original - upwards for an increase in income, and downwards for a decrease in income. The new equilibrium for a higher income will be on a higher indifference curve, and since income is higher, more of both products could be consumed. For normal goods, as income increases, more of the good will be preferred. For inferior goods, as income increases, less of the good will be chosen.

This is just hilarious. Do modern economists really think that people actually try to stay within their budget? They’ll do anything to get what they need… they may even go in a little debt here and there. Don’t make me laugh.

Income Elasticity of Demand

There are factors other than price that influence the demand for a product. Income elasticity of demand is calculated as the percent change in quantity demanded divided by percent change in income, ceteris paribus. There are two possible relationships. If demand increases when income increases, elasticity is positive and good is normal. If demand decreases when income increases, elasticity is negative and good is inferior.

The main influence on income elasticity of demand is whether a good is a luxury or a necessity. When goods are luxuries, elasticity is usually highly positive (greater than one). When goods are necessities, elasticity is usually lower (less than one). When goods are very basic, they can even be inferior (less than zero), such that demand falls when income rises.

They still think that income is the main influence on people buying a product or not buying a product. Yes… it’s true that when people make more money they’ll buy more. But as a regular citizen and non-economist this just makes me laugh. People will buy even when their income isn’t increased… this doesn’t make sense to me.

I want for this part for you to pay key attention to the bold parts…

Taxes and Their Incidence

Who pays taxes levied on products? What happens to the equilibrium price? It depends on the shape of the demand and supply curves, but generally price does not rise as much as the tax rises. Tax drives a wedge between the price paid by the consumer (gross price) and the price received by the producer (net price). Note that “net price” equals “gross price” minus “tax per unit”.

Incidence of tax again depends on the relative shape of the curves and is calculated by:

1. Consumers pay gross price - original price.
2. Producers pay original price - net price.

In a perfectly competitive market, it makes no actual difference whether the tax is levied on the consumer or the producer. So what determines the distribution of the tax? If consumers can easily substitute away from the good which is taxed, they will avoid the tax and the producer will pay more (demand is elastic). If consumers cannot easily substitute away from the good which is taxed, they will be forced to buy it anyway and will pay the bulk of the tax (demand is inelastic).

Generally speaking, when demand is more elastic than supply, the producer pays more. When demand is less elastic than supply, the consumer will pay more.

While the economy is becoming more global, some factions in developing countries are against the merging of markets. This has lead to violence in some parts of the world. Ambassadors and other officials traveling to foreign nations are normally supplied with body armor and a convoy for protection against hostile groups.

Here they say that if people are taxed more but can’t get away from a good they’ll still buy it anyways. Not true. If the good was taxed or if the consumers were taxed so much so that it hurt what they could or couldn’t buy thy would probably go buy things off the black market. The black market would be where they buy things that are cheaper and they could buy it… but they wouldn’t be doing it on the regular market.

I really don’t understand why they think tariffs are a good thing. It would protect the businesses yes but the consumers wouldn’t get the benefits of the lower prices of goods from the other nations. It would just hurt relations between us and other nations… we can still compete with foreigners… we just need to change our business habits… they change theirs so we should change ours too.

Tariffs and Quotas

Tariffs are taxes levied on businesses for imported goods. Tariffs raise the domestic price above the world price by the amount of the tariff. The increase in the domestic price will lead to a decrease in domestic quantity demanded, and an increase in domestic quantity supplied. Before the tariff, the domestic price is the same as world price. After the tariff, the domestic price rises.

Quotas are restrictions on the maximum amount that may be imported, and have a similar effect as do tariffs. They restrict the amount available to domestic consumers and push up the price, resulting in a deadweight loss similar to that of a tariff. The main difference is the distribution of the surplus. A tariff raises revenue for the government, whereas import quota creates surplus for licence holders. The government could capture surplus from import quotas by charging a fee for the licences. If licence fee equals difference in prices, then import quota works same as tariffs.

How is the quota distributed?

1. It can be auctioned off to the highest bidder - In this case, the revenue goes to the government and the result is exactly like that of an equivalent tariff.
2. It can distribute quota without payments - The extra surplus goes to those who get the quota, and may lead to large expenses for lobbying the government for the quotas. In this case, the deadweight loss is usually larger than a tariff due to cost of lobbying.

Arguments for Restricting Trade1. The Jobs Argument

• jobs are created as well as eliminated
• not possible that a country can be out-competed in all products owing to comparative advantage

1. National Security Argument
   • products such as weapons and military equipment should be produced domestically
2. Infant-Industry Argument
   • temporary protection while firms have a chance to learn to compete
   • economists are skeptical that govt can pick “winners” and argue that industry with real promise does not need protection
3. Unfair-Competition Argument
   • if firms sell at below cost, they are subsidizing our consumption
4. Protection as a Bargaining Chip Argument

This section is kind of long- http://www.basiceconomics.info/market-failures-and-externalities.php- but it’s basically saying that there are things that the free market can’t do that the government can. That’s false. It’s saying along the lines like we need to police everything the market does. We don’t necessarily need to. We can have private courts backed by police power enforce the market and punish those wrong doers who commit fraud on other people… or those that hurt others… we don’t necessarily need the government to put up a no smoking sign in a restaurant… restaurants can have smoking rooms and no smoking rooms if they so please and they can call the police to come there and take anyone away who smokes in a no-smoking room if they wanted to.

Now as for what it says about the factors of production. It assumes that the factors of production are fixed. We know otherwise. We know that they can change depending on the times.

Product and Cost curves

To go from production to cost, we assume that the costs of inputs are fixed (i.e. a firm can hire all the labour it wants at the going wage). Cost are divided into two broad categories:

• Fixed costs - costs that do not vary with output, such as cost of plant or some fixed inputs
• Variable costs - costs that vary with output, such as cost of labour or other variable inputs.

Total costs (TC) is the sum of Total Fixed Costs (TFC) and Total variable Costs (TVC). Graphically, TFC is represented by a horizontal line since costs are fixed. The total cost eventually gets steeper as more is product is produced. Average cost (AC) is how much a typical unit costs and is equal to TC divided by number of units produced. Mathematically we have,

AC = (TFC + TVC)/Q = AFC + AVC
AFC: average fixed costs
AVC: average variable costs

Note that AFC will constantly fall as output increases. AVC will fall and then increase due to diminishing returns. Marginal Cost (MC) is the change in total cost divided by change in output, and addresses the question: how much will it cost to produce one additional unit of output?

You can see how fallacious that is I gather.

I don’t get this. It says MR=MC. Wouldn’t it make sense if MR>MC? I don’t think that it would make sense for a firm to have reached maximum profit if the revenue equaled the costs. This is what it says.

Profit Maximization

To maximize profit, we need to know the revenue and costs of the business. Profit is maximized when marginal revenue = marginal cost, and marginal cost is rising. To see why, recall that marginal revenue is the additional revenue from 1 additional unit. Marginal cost is the additional cost from 1 additional unit.

When MR > MC, revenue is increasing faster than costs and the firm should increase production. When MR < MC, revenue from the additional unit is less than additional cost, and the firm should decrease production. As such, A firm maximizes profits when MR = MC.

So what happens to output at various prices? Since MC is upward sloping, as price increases, quantity produced will increase too. As price falls, quantity produced falls. In each case, the marginal cost curve determines how much the firm is willing to produce at each price, so it translates into the supply curve.

Does that make any sense to you?

Okay. I’m done. I hope someone else finds modern economics as fallacious as I do. It’s no wonder people don’t think of economics as a science when the people who lead the science seem distant from human daily life.

[Snowflake]

Well. I think I speak for everyone when I say I’m not going to read all that.

I did read/glance over some of it though. A major difference between AE and the mainstream is that AE takes market processes as ongoing, dynamic events that are moving towards some equilibrium price level… The problem with equilibrium is that it would be a completely undesirable condition since nothing new is being produced or invented, so the economy never actually gets there.

[Cam_Nedland]

Three words: John Maynard Keynes

[Vitor]

@Wanderer

Three words: John Maynard Keynes

I would say that positivism/socian enginering is the main problem of mainstream economics, Keynes just being an example of that.

[DD5]

@Wanderer

Three words: John Maynard Keynes

So if his mother never gave birth to him, Laissez-faire economics would be mainstream?

[HtutAlexander]

The problem with equilibrium is that it would be a completely undesirable condition since nothing new is being produced or invented, so the economy never actually gets there.

I don’t know if I would agree with this - a feature of equilibrium is that the subjective expectations and value scales of individuals are perfectly normalized, no one believes that any alteration in their current scheme of things could possibly bring improvement. This could describe a kind of Hell, but it could also describe Heaven.

[DD5]

@SilentXtarian

Okay. Until this point in time I’ve just been reading austrian economcs and reading their criticism of mainstream economics with only a high-school education of economics. I’ve read 16 chapters of Human Action and 've decided to take a break from it so I can get more of an understanding of the core concepts of regular economic theory.

First of all, I found a bunch of stuff about modern economic theory on this website http://www.basiceconomics.info/

I read your comments regarding the “core concepts” of mainstream economics, and while there is plenty that is not right with mainstream economics, I don’t think your comments have correctly identified those “wrongs”, and they are also somewhat misguided.

Human Action is brilliant but not the best place to start with. I strongly recommend to you to take even a longer break from Human Action and switch to Rothbard’s “Man, Economy, and State” instead. Afterwards, you will go back to Human Action and enjoy it much more.

[Cam_Nedland]

@DD5

@Wanderer

Three words: John Maynard Keynes

So if his mother never gave birth to him, Laissez-faire economics would be mainstream?

Why wouldn’t be? Marxism would never have caught on en masse, that’s for sure.

[DD5]

@Wanderer

@DD5

@Wanderer

Three words: John Maynard Keynes

So if his mother never gave birth to him, Laissez-faire economics would be mainstream?

Why wouldn’t be? Marxism would never have caught on en masse, that’s for sure.

Karl Marx didn’t invent Socialism. If a guy by the name of Mises stepped up to the plate instead of Marx, they would have called it Misesian.

[Juan]

Theories are fallacious because consumers like them that way.

[Cam_Nedland]

@DD5

@Wanderer

@DD5

@Wanderer

Three words: John Maynard Keynes

So if his mother never gave birth to him, Laissez-faire economics would be mainstream?

Why wouldn’t be? Marxism would never have caught on en masse, that’s for sure.

Karl Marx didn’t invent Socialism. If a guy by the name of Mises stepped up to the plate instead of Marx, they would have called it Misesian.

No, but he codified and legitimized it. Socialism was never coherent or unified before him. Keynes legitimized his nonsense much to the same degree, but much more successfully than Marx did.

[bloomj31]

Neoclassical economics has more appeal, in my opinion, because it gives politicians a way to promise things that they otherwise wouldn’t be able to. In short, I think there’s a strong political motive behind current mainstream economic thought.

[Snowflake]

@bloomj31

Neoclassical economics has more appeal, in my opinion, because it gives politicians a way to promise things that they otherwise wouldn’t be able to. In short, I think there’s a strong political motive behind current mainstream economic thought.

All the things the administration wants to do just happen to be justified by macroecon…

[DD5]

@Wanderer

@DD5

@Wanderer

@DD5

@Wanderer

Three words: John Maynard Keynes

So if his mother never gave birth to him, Laissez-faire economics would be mainstream?

Why wouldn’t be? Marxism would never have caught on en masse, that’s for sure.

Karl Marx didn’t invent Socialism. If a guy by the name of Mises stepped up to the plate instead of Marx, they would have called it Misesian.

No, but he codified and legitimized it. Socialism was never coherent or unified before him. Keynes legitimized his nonsense much to the same degree, but much more successfully than Marx did.

Socialism isn’t more coherent after Marx then before him. It’s a theory that breaks down the minute one begins to scrutinize it.

The point is that there will always be men who provide a “code” or “theory” for anything that there is a demand for.

The State is inherently a collectivist institution. The State will therefore, out of pure self interest, use its enormous power to advance all those ideas that glorify itself and advocate for more State power. In other words, there is a clear conflict of interest between the institution of government and the free market, although most intellectuals do not recognize it.

The battle of ideas was lost the minute Statism triumphed. The rest are just consequences; Karl Marx, Keynes, and whom ever.

[zefreak]

To be honest, I don’t think you understand the theories that you consider fallacious. Your very first example (regarding marginal utility and rationality) betrays a misunderstanding of rationality in the context of economics. Rationality as used in neo-classical (and Austrian) economics refers to responding to incentives and attempting to satisfy the highest priority needs (broadly construed). Individuals being driven by emotional urges involving incomplete information (often dubbed irrational) does not contradict the fact that the agent is attempting to maximize the satisfaction of his desires (whatever they may be) and hence, acting rationally.

Neoclassical thinkers may propose naive policy and some theorems may indeed be fallacious, but the ones you assert (I admit to not reading all of them) aren’t. Austrians do have a case against mainstream economics in many areas, but this is really a stretch.

[cr113]

One thing I’ve noticed about most mainstream economists is that they seem to completely disregard debt as a problem.

[SilentXtarian]

@DD5

@SilentXtarian

Okay. Until this point in time I’ve just been reading austrian economcs and reading their criticism of mainstream economics with only a high-school education of economics. I’ve read 16 chapters of Human Action and 've decided to take a break from it so I can get more of an understanding of the core concepts of regular economic theory.

First of all, I found a bunch of stuff about modern economic theory on this website http://www.basiceconomics.info/

I read your comments regarding the “core concepts” of mainstream economics, and while there is plenty that is not right with mainstream economics, I don’t think your comments have correctly identified those “wrongs”, and they are also somewhat misguided.

Human Action is brilliant but not the best place to start with. I strongly recommend to you to take even a longer break from Human Action and switch to Rothbard’s “Man, Economy, and State” instead. Afterwards, you will go back to Human Action and enjoy it much more.

Maybe it was in err of me to say that they were fallacious. I just found many of them to be unrealistic. Like that one about the budget and how it said that people try to stay within their budget. I disagree on that point. I don’t think that people let their budget constrain them. They will get it if they can get it. That was my point. And with taxes-- if the good costs so much on the market they’ll just get it off the market on the black market or some online website like ebay. Perhaps I shouldn’t have said that they were fallacious… but that they didn’t make sense to me. And with the idea of tariffs, I was saying how they could just lower the prices of goods to compete with the foreign goods. You don’t need the government to do that… and we just need a police force to do those kinds of regulations that they said that only the government could do. We could do that in a system without the state.

Exactly how did you think my views were misguided and what do you think I missed-- you said I didn’t identify what was wrong correctly. I would like to know where I was wrong. I’ll check out Man, Economy and the State… I’ve been afraid to read Rothbard since I read Libertarian Manifesto because of well really… I don’t know… I was put aback by some of the things he said.

@zefreak

To be honest, I don’t think you understand the theories that you consider fallacious. Your very first example (regarding marginal utility and rationality) betrays a misunderstanding of rationality in the context of economics. Rationality as used in neo-classical (and Austrian) economics refers to responding to incentives and attempting to satisfy the highest priority needs (broadly construed). Individuals being driven by emotional urges involving incomplete information (often dubbed irrational) does not contradict the fact that the agent is attempting to maximize the satisfaction of his desires (whatever they may be) and hence, acting rationally.

Neoclassical thinkers may propose naive policy and some theorems may indeed be fallacious, but the ones you assert (I admit to not reading all of them) aren’t. Austrians do have a case against mainstream economics in many areas, but this is really a stretch.

I think I get what you’re saying. However AE really doesn’t say that people act rationally. AE just says that people act purposefully. It’s not about if they act rationally or irrationally. It’s as Ludwig Von Mises says- it’s all subjective to the critic. Individuals are driven by their wants to fulfill their desires. That doesn’t necessarily mean they’re rational or irrational. They’re acting purposefully-- I think that’s the point.

[Catalan]

A rational action in economics is strictly defined as an action in which the benefits outweighed the costs.

[SilentXtarian]

@Jonathan M. F. Catalán

A rational action in economics is strictly defined as an action in which the benefits outweighed the costs.

I’m not disagreeing with that. I was just saying that it is my interpretation of what Ludwig Von Mises said that it doesn’t matter if someone acts rationally or irrationally. What matters is that they are acting purposefully and that they’re trying to fulfill their desires, or fulfill their wants and make them feel better about something. One could easily say that someone is acting irrationally but they may disagree and they’re acting with logic and reason. It’s just what the critics think of the choice if it’s rational or irrational… that’s my understanding of what he said.

[Catalan]

I haven’t read the relevant passage of Ludwig von Mises, but economic rationality shouldn’t be confused with logic. A criminal can murder a man and believe that in some sense the benefits of that action were higher than the costs, thus making it a rational decision within the confines of economic theory (morals and ethics aside, for the purpose of the example). Yet, we can all agree that the decision was probably not logical (or rational within the confines of logic). I guess my point is that you shouldn’t look too much into the textbook’s usage of the word “rational”.