Increasing Marginal Utility

A blog so good it violates the law of diminishing marginal utility.

Tunneling with Hedgehogs

This months Cato Unbound continues to be the best I’ve read in a long time. I agree with much of what Cochrane says in his reaction essay, until we get to what amounts to his main point.

Focusing on “one analytical tool”—basic supply and demand, a nose for free markets, unintended consequences, and regulatory capture—is essential. People who use a wide range of analytical tools, mixing economics, political, sociological, psychological, Marxist-radical and other perspectives end up hopelessly muddled.

I would agree that if you don’t understand supply and demand, you won’t have good intuition about anything in public policy. The same goes for those other tools he names. But they are not everything.

What all economists, especially Austrian economists, should understand by now is that people are very poorly modeled using the logic of Gary Becker or George Stigler. You cannot reasonably argue anymore that people maximize utility in some way that is readily observable, such as through wealth maximization. If you want to predict accurately, even performing what Cochrane calls “conditional” forecasting, you need to understand the systematic ways people are biased, even if you want to say that they are still “really” rational in some cosmic sense.

You also cannot go about assuming supply and demand (and everything else) will hold in some straightforward way when you drastically change the institutional environment. For example, while I favor free banking, I am very concerned how people would respond to deregulating banks everywhere. In the medium run, even decades perhaps, many would prefer 100% reserves. We wouldn’t be able to explain why they would using the tools Cochrane lists, but they would.

And of course in my work, I am pulling together different things from evolutionary psychology, things that are called mere “sociological” or “psychological” factors, that constitute changes in arguments within a utility function. And these things are real- you can’t just put your head in the sand, screaming PREFERENCE ARE MOUNTAINS and returning to rational choice theory.

Don’t forget this, either.

Economics is an excellent starting point. But in the words of Alfred Marshall, it is a “partial view of life.” Figuring out where real life departs from our models (supply and demand count as a model) is important for a truly “robust” political economy. Tunnel vision using economics is (almost) as bad as tunnel vision with anything else.

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