The Principles of Economics

Some Lies My Teacher Told Me

Lawrence Boland

• Publisher: Routledge
• Year: 2005
• ISBN:
  9781134827367
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book is about forming effective critiques of neoclassical economics. Its focus is on constructive criticism of the foundations neoclassical theory, beginning with what Alfred Marshall called the `Principles of Economics'. It concludes that there is still much that can be done to make neoclassical economics more realistic.

Part I
The essential elements

1
The neoclassical maximization hypothesis

At present the maximization postulate has an unusually strong hold on the mind set of economists… Suffice it to say that in my view the belief in favor of maximization does not depend on strong evidence that people are in fact maximizers… The main argument against the maximization postulate is an empirical one—namely, people frequently do not maximize. Of course, this standpoint argues that while postulates simplify reality, we are not free to choose counterfactual postulates. Hence, from this point of view a superior postulate would be one under which maximizing behavior is a special case, but non-maximization is accommodated for as a frequent mode of behavior.

Harvey Leibenstein [1979, pp. 493–4]

If by rational we mean demonstrably optimal, it follows that conduct in order to be rational must be relevantly fully informed.

George Shackle [1972, p. 125]

The assumption of maximization may also place a heavy (often unbearable) computational burden on the decision maker.

Herbert Simon [1987, p. 267]

The assumption of maximization is a salient feature of every neoclassical explanation. Obviously, then, if one wanted to criticize neoclassical economics it would seem that the most direct way would be to criticize the assumption of universal maximization. Several approaches have been taken. Harvey Leibenstein [1979] offered an external criticism. He argued for a ‘micro-micro theory’ on the grounds that profit maximization is not necessarily the objective of the actual decision-makers in a firm and that a complete explanation would require an explanation of intrafirm behaviour. He also gave arguments for why maximization of anything may not be realistic or is at best a special case. Similarly, Herbert Simon has argued that individuals do not actually maximize anything—they ‘satisfice’—and yet they still make decisions.¹ And of course, George Shackle has for many years argued that maximization is not even possible.

Some anti-neoclassical economists are very encouraged by these arguments, but I think these arguments are unsuccessful. For anyone opposed to neoclassical theory, a misdirected criticism, which by its failure only adds apparent credibility to neoclassical theory, will be worse than the absence of criticism. The purpose of this chapter is to explain why, although the neoclassical hypothesis is not a tautology and thus may be false, no criticism of that hypothesis will ever be successful. My arguments will be based first on the possible types of theoretical criticism and the logic of those criticisms, and second on the methodological status of the maximization hypothesis in neoclassical explanations.

TYPES OF CRITICISM AND THE MAXIMIZATION HYPOTHESIS

There are only two types of direct criticism of any behavioural hypothesis once its logical validity has been established. One can argue against the possibility of the hypothesized behaviour or one can argue against the empirical truth of the premise of the hypothesis. In the case of the neoclassical maximization hypothesis, virtually everyone accepts the logical validity of the hypothesis. For example, everyone can accept that if the consumer is a utility maximizer, then for the particular bundle of goods chosen: (a) the marginal utility is zero, and (b) the slope of the marginal utility curve at the point representing the chosen bundle is non-positive and usually negative.² That is to say, necessarily the marginal increment to the objective must be zero and falling (or not rising) whenever (i.e. without exception) the maximization premise is actually true. Of course, one could substitute the word ‘profit’ for the word ‘utility’ and the logic of the hypothesis still holds. With either form, (a) and (b) are the ‘necessary conditions’ for maximization. Note again that there are no ‘sufficient conditions’ for maximization. Rather, the maximization premise is the sufficient condition for (a) and (b).

Parenthetically, I should note that economists often refer to the conjunction of (a) and (b) as a sufficient condition for maximization. This is a common error.³ Even if (a) and (b) are both true, only local maximization is assured. However, maximization in general (i.e. global) is what the premise explicitly asserts and that is not assured by (a) and (b) alone. I will return to this below when I discuss the methodological uses of the maximization hypothesis.

THE LOGICAL BASIS FOR CRITICISM

As stated above, there are two types of direct criticism of the maximization hypothesis: the possibilities criticism and the empirical criticism. In this section I will examine the logical bases of these critiques, namely of the possibilities argument which concerns only the necessary conditions and of the empirical argument which concerns only the statements which form the sufficient conditions. In each case I will also discuss the possible logical defense for these criticisms.

The possibilities critique: can the necessary conditions be fulfilled?

The possibilities critique builds on the difference between necessary and sufficient conditions. Specifically, what is criticized is the possibility of fulfilling all of the necessary conditions for maximization. Of course, this type of critique begs the question as to what are all the necessary conditions. Are there more conditions than the (a) and (b) listed above? Shackle, following Friedrich Hayek and John Maynard Keynes, argues that maximization also presumes that the knowledge necessary for the process of choosing the ‘best’ alternative has been acquired.⁴ For Shackle, maximization is always a deliberate act. Shackle argues that for maximization to be a behavioural hypothesis (i.e. about the behaviour of decision-makers), the actor must have acquired all of the information necessary to determine or calculate which alternative maximizes utility (or profit, etc.) and he argues that such an acquisition is impossible, hence deliberate maximization is an impossible act.

Although this argument appears to be quite strong, it is rather elementary. A closer examination will show it to be overly optimistic because it is epistemologically presumptive. One needs to ask: Why is the possession of the necessary knowledge impossible? This question clearly involves one’s epistemology— that is, one’s theory of knowledge. The answer, I think, is quite simple. Shackle’s argument (also Hayek’s and Keynes’) presumes that the truth of one’s knowledge requires an inductive proof. And as everyone surely knows today, there is no way to prove one’s knowledge inductively whenever the amount of information is finite or it is otherwise incomplete (e.g. information about the future).⁵

The strength of Shackle’s argument is actually rather vulnerable. Inductive proofs (and hence inductive logic) are not necessary for true knowledge. One’s knowledge (i.e. one’s theory) can be true even though one does not know it to be true—that is, even if one does not have proof. But I think there is an even stronger objection to the ‘true knowledge is necessary for maximization’ argument. True knowledge is not necessary for maximization! Consumers, for example, only have to think that their theory of what is the shape of their utility function is true. Once a consumer picks the ‘best’ option there is no reason to deviate or engage in ‘disequilibrium behaviour’ unless he or she is prone to testing his or her own theories.⁶

In summary, Shackle’s inductivist argument against the possibility of a true maximization hypothesis is a failure. Inductive proofs are not necessary for true knowledge and true knowledge (by any means) is not necessary for successful or determinate decision-making. Maximizing behaviour cannot be ruled out as a logical impossibility.

The empirical critiques: are the suffficient premises true?

Simon and Leibenstein argue against the maximization hypothesis in a more straightforward way. While accepting the logical validity of the hypothesis, they simply deny the truth of the premise of the hypothesis. They would allow that if the consumer is actually a maximizer, the hypothesis would be a true explanation of the consumer’s behaviour but they say the premise is false; consumers are not necessarily maximizers hence their behaviour (e.g. their demand) would not necessarily be determinable on that basis. Leibenstein may allow that the consumer’s behaviour can be determined, but it is an open question as to what is the determining factor—utility, prestige, social convention, etc.? Simon seems to reject as well the necessity of determinate explanation although he does discuss alternative decision rules to substitute for the maximization rule.⁷

A denial of the maximization hypothesis on empirical grounds raises the obvious question: How do the critics know the premise is false? Certain methodological considerations would seem to give an advantage to the critics over those who argue in its favour. Note that we can distinguish between those statements which are verifiable (i.e. when true, can be proven true) and those which are refutable (i.e. when false, can be proven false) on purely logical grounds. Furthermore, strictly universal statements —those of the form ‘all Xs have property Y’—are refutable (if false) but not verifiable (even if true). On the other hand, strictly existential statements—those of the form ‘there are some Xs which have property Y’—are verifiable (if true) but not refutable (even if false). At first glance it would seem that the maximization hypothesis —‘all decision-makers are maximizers’—is straightforwardly a universal statement and hence is refutable but not verifiable. But the statistical and methodological problems of empirical refutation present many difficulties. Some of them are well known but, as I shall show a little later, the logical problems are insurmountable.

The methodological problems of em...

Table of contents

• COVER PAGE
• TITLE PAGE
• COPYRIGHT PAGE
• PREFACE
• ACKNOWLEDGEMENTS
• PROLOGUE: UNDERSTANDING NEOCLASSICAL ECONOMICS THROUGH CRITICISM
• PART I: THE ESSENTIAL ELEMENTS
• PART II: SOME NEGLECTED ELEMENTS
• PART III: SOME MISSING ELEMENTS
• PART IV: SOME TECHNICAL QUESTIONS
• EPILOGUE: LEARNING ECONOMIC THEORY THROUGH CRITICISM
• BIBLIOGRAPHY