Knowing and Making

If conventional economic theory is so wrong (as we are repeatedly told ) why does it survive so well? This post by UnlearningEcon  prompted me to think again about why economics, despite widely accepted empirical data from behavioural econ, is broadly taught in the same way as before, and why its basic assumptions still underpin much modern research. Some have a sociological explanation for this. In this view, economists are invested in the old approaches, have spent decades honing specific mathematical skills, and effectively collude to make sure new ideas do not displace the old. The top journals only accept papers that cite the same old work, perpetuating the models. Science, as they say, advances one funeral at a time. No doubt there's something to this, but I don't think economists are quite so closed minded. There is a clue in the above article: "...Euclidean geometry, despite being incorrect, is more effective than non-Euclidean geometry in some engineerin...

Economics is useful not when it makes broad, one-sided assertions (markets are good; externalities are bad) but when it uses a model to give a firm, quantitative answer to a specific question. What difference will it make to the price in the milk market if one new supplier enters, producing 3 million litres a year? If I buy this piece of land and build a gas station, will I make a profit? What's the optimal price for me to sell my consulting services if I value my free time at £40/hour? Standard economics gives us models which - if we can find the right data to calibrate them - will answer all these questions for us. Behavioural economics does not. It can show us the existence of certain phenomena: hyperbolic discounting, framing and priming biases, misperception of risk, anchoring. But can it answer questions like these? How high a price should I post in my shop window to maximise the benefits of anchoring and minimise the number of customers who are put off from enter...

The Conservatives apparently think a " new economic model " is needed to restore the strength of the British economy. I wonder what they mean. I assume they aren't talking about a model in the way an economist would think of it: a simplified representation of the operations of the economy. Probably they mean "we need to run the economy in a different way". This is how businesses use the word "model" when they talk about choosing a business model, or a revenue model. So maybe he just wants to use a different set of rules for taxes, employment or general economic incentives. This speech  gives some clues - it's tricky to read through the rhetoric to find any common underlying model, but what he seems to want is to set three "priorities" for government economic policy. But taking him literally reveals a more interesting way to think about the question. What if he really does want to change the descriptive model that we use to think abo...

Warren Meyer at Coyote makes a familiar argument against the stimulus : At the end of the day, businesses and individuals have a felt need to deleverage.  That is going to cause a recession, end of story.  The Congress’s and Obama Administration’s obsession with short-circuiting this sensible desire to reduce debt is not only counter-productive, it is offensive.  Banks are sensibly trying to strengthen their balance sheets, but the government wants to stop them. Individuals are trying to cut back on spending, reduce debt, and save more.  Again, the government wants to stop them, by going to debt and spending for them if consumers won’t do it on their own. This sounds intuitively sensible, but is it correct? As often is the case, a simple model sheds some light on the argument (retrospective note: the model is simple, but the analysis turned out longer than expected. I still think it's worth reading). Imagine a very small economy with just two people in it. A is a baker and B is a b...

A fair bit of the economic research I do is speculative and it's gratifying when it ends up in a useful commercial output. This is one good example. The work I've done on how people evaluate prospective utility and make decisions has led to the concept of structured value modelling. This in turn allows us to consider how people influence each other's models of value. And the outcome of that is that we have created a new category of software: Client Value Management or CVM software. Traditional CRM systems are good for high-volume marketing - especially to consumers. They are not very popular amongst business-to-business services providers - for instance professional services firms. The reason being that CRM is a reductionist tool - its concept is to allow the simultaneous management of large numbers of people by making simplifying assumptions. If we assume that people fall into one of four demographic groups then we can send them messages at a cost of 4p each and hit a mill...