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Elemental Economics

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Microeconomics

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Dr. Harry Hillman Chartrand, PhD

Cultural Economist & Publisher

Compiler Press

©

h.h.chartrand@compilerpress.ca

215 Lake Crescent

Saskatoon, Saskatchewan

Canada, S7H 3A1
 

Curriculum Vitae

 

Launched  1998

 

 

Microeconomics

1. Introduction

 

1.1 Concepts *

1. Scarcity, Choice & Opportunity Cost [MKM C1/4 – 6: 2-4]

2. Expectations/Futurity/Time [MKM C4/73 & 78: 68 & 73]

3. The Big 'M' & Constrained Maximization [MKM C1/7-8/4-6]

4 Geometry, Calculus & Symbolic Equations [MKM C2/39-47: 35-45]

5. Demand, Supply & Markets [MKM C4/67-88: 62-82]

6. 10 Top 'Es' of Economics

i - Efficiency {MKM C2/26-7: 23-24; C7/160: 149]

ii - Effectiveness

iii - Elasticity [MKM C5/97-117: 90-110]

iv - Employment {MKM Macro C9/193-202: 178-97]

v - Endogenous/Exogenous

vi - Equilibrium [MKM C4/79-85: 74-80]

vii -  Equity [MKM C1/5:3; C12/264-70: 247-253]

viii - Ethics

ix - Excludability [MKM C11/236: 221]

x - Externalities [MKM C10/211-221: 198-209]

7. Is Economics a Science? [MKM C2/22-9: 19-26]  **
   
i- Sciences of the Natural & Artificial
   
ii – Induction & Deduction

iii - “Let Us Assume" & Ceteris Paribus [MKM Ch2/22-4: 19-21]

    iv - Positive & Normative {MKM C2/30: 27]
   
v - Observation & Measurement {MKM C2/22-4: 19-21]

v i– Modelling & Testing [MKM Ch2/24-9: 21-26]

vii - Conclusion

 

What I call the Standard Model of Market Economics did not just appear.  Rather it evolved over some 70 years between the 1870s and 1940s.  For those interested in its evolution, please see Observation #1: Origins.  The model employs many concepts and to introduce its construction, operation and critique, I present, in brief, some of the most critical.

 

1. Scarcity, Choice & Opportunity Cost (MKM C1/4–6: 2-4)

In the Standard Model human wants, needs and desires have and always will exceed the means to satisfy them.  Scarcity is thus a permanent part of the human condition.  One must choose which to satisfy and which not.  The consequence of choice is giving up the next best alternative.  This is the opportunity cost of choice.  In Economics all costs are opportunity costs.  This distinguishes economic from accounting or business costs (MKM Figure 13.1):

Market price measured in dollars, euros, pounds, renminbi, yen, etc., are useful but do not necessarily reflect the 'real cost' of a good or service. Take the opportunity cost of work. If one works an hourly job, one is paid a wage per hour that multiplied by hours worked equals income, e.g., 4 hours @ $10 an hour equals $40 of income. This does not, however, allow for the opportunity cost associated with preparing for, then re-creating after, work including commuting both ways, e.g., 2 hours.  The real wage per hour is now $40 of income divided by 6 not 4 hours or $6.67 per hour. 

We can also determine opportunity cost by calculating the 'relative price' of a good or service.  Relative price is the ratio of one price to another. For example, if the price of a Coke is $1.00 and chewing gum $0.50 the relative price of Coke is $1.00/$0.50 or 2, i.e. you could buy 2 packs of chewing gum for the price of one Coke. 

There are, of course, thousands if not millions of different goods and services all with different and changing market prices. Accordingly, relative price is usually expressed as the price of a standard basket of goods and services measured using a price index

Let us say overtime we observe the same basket of goods and services cost $100 in 2001 but $110 in 2011.  In this case, we divide the monetary price in 2011 by the price in 2001 finding the price went up 10%.   Such a basket of goods & services represents a measure of our well being. Relative to 2011 this means we need to earn 10% more income to maintain our standard of living.  The currency has suffered inflation - the same number of dollars buys less than before.  By contrast, if the price change reversed, $110 in 2001 but $100 in 2011 then the currency has deflated - less buys more.

In the microeconomics, price means 'relative price' of specific goods & services. Thus when the price of a good or service falls, we do not mean its monetary price but rather that price relative to other goods and services, i.e. it's opportunity cost falls.  In macroeconomics concern focuses on the aggregate price level of all goods & services within a national economy.  The question of international prices is even more complicated.   The income of a salaried executive in Saskatoon supports a certain standard of living.  To maintain that standard in Hong Kong or London or New York or Singapore or Tokyo how much would one's income have to increase to maintain that standard?  One widely used measure of purchasing power parity is the 'Mac Index' which measures the number of hours of work required to buy a 'Big Mac' in different countries.

 

2. Expectations/Futurity/Time (MKM C4/73 & 78: 68 & 73)

Choice, however, involves more than here and now.  Time plays multiple roles in Economics.  First, there is static and dynamic analysis.  Static involves a fixed moment in time; dynamic involves analysis of Past to Present to Future.

Second, John Maynard Keynes uses the term ‘expectations’.  People’s changing expectations of tomorrow alters their actions today.  John R. Commons uses the term ‘futurity’ meaning people live in the future but act in the present.  What we expect tomorrow determines what we do today.  Deferred gratification, i.e., waiting for tomorrow, is the source of savings - deferred consumption.

Third, there is the very short run, the short run and the long run.  In the very short run the quantity of all inputs (Capital, Labour and Natural Resources) is fixed, so is output.  In the short run at least one factor of production is fixed (usually Capital), while others (usually Labour and Natural Resources) are variable.  In the long run all factors are variable.  These time periods are functional, not chronologic.  The long run for a new Tim Horton’s is 6 months to a year but 10 years or more for a steel mill, hydro dam or nuclear power station.

 

3. The Big ‘M’ & Constrained Maximization (MKM C1/7-8: 4-6)

The question becomes: How to choose?  Flip a coin?  Consult the spirits?  Decision making in the Standard Model is done at the ‘margin’.  In daily conversation marginal means unimportant.  In Economics marginal defines the choice point.  The marginal unit is the last grain of sand tipping the balance.  In Newtonian calculus of motion the marginal is the derivative: first derivative - the rate of change; second derivative - change in the rate of change.  The marginal concept defines economic choice in the Standard Model.  For example:

marginal utility: the additional satisfaction of one more unit in consumption;

marginal product: the additional output of one more unit input;

marginal cost: the additional cost of one more unit output; and,

marginal revenue: the additional revenue from sale of one more unit. 

Examples in Macroeconomics include:

marginal propensity to consume: the part of an additional dollar in income spent on consumption;

marginal propensity to save: the part of an additional dollar in income retained as savings;

marginal propensity to import: the part of an additional dollar in income spent on imported goods & services; and,

marginal tax rate: the part of an additional dollar in income taken in taxes.

As will be seen economic choice involves constrained maximization.  Thus a consumer in striving to maximize happiness is constrained by income and price.  Similarly when a firms strives to maximize profits it is constrained by existing technology, input costs and the revenue earned for the output.  All decisions made at 'the margin'.

 

4. Geometry, Calculus & Symbolic Equations (MKM C2/39-47: 35-45)

Geometry is the West’s unique contribution to Mathematics.  In the hands of Euclid, Archimedes and Ptolemy the ancient Greeks used universal forms of the circle, square, triangle and their variations, e.g., the parabola, to explain two- and three-dimensional space including movement of the stars.  Those interested in further detail, please see Observation #2: Geometry

At the beginning of the European Enlightenment & Scientific Revolution Rene Descartes (1596-1650) introduced analytic geometry using a coordinated two-dimensional space defined by two axis: the X-axis or abscissa and the Y-axis or ordinate defining the location of every point, e.g., (600, 2200) a point 600 units to the right and 2200 units up

[MKM Fig. 2.2].  

Analytic geometry has since been extended to n-dimensional space.  Graphs in Cartesian Space will be used extensively in this course.

In the 1670s, what was known as ‘the geometry of infinitesimals’, i.e., geometric exhaustion, achieved a breakthrough with the independent invention of the calculus by Newton (1643-1727) and Leibniz (1646-1716).  Calculus provided a true mathematics of motion – changing spatial position through Time expressed in algebraic rather than geometric terms.  No calculus will be used in this course.

Finally, a symbolic equation is a generalized statement of a functional relationship between a dependent and independent variables.  No numbers or the nature of the functional relation is stated.   Examples in the Standard Model include:

The Consumption Function expressed as:

U = f (x, y) where: 

U (dependent variable) is the utility or satisfaction derived from consuming commodity combinations of x and y (independent variables); and,

f is the taste or preference function of the consumer; and, 

The Production Function of the firm expressed as:

Q = g (K, L, N) where:

Q (dependent variable) is the output;

independent variables include:

K is Capital plant & equipment;

L is Labour; and,

N is Natural Resources.

g is technology or ‘know-how’;

Throughout the course these and other symbolic equations will be displayed in Cartesian space defined by X- and Y-axes coordinates.

 

5. Demand, Supply & Markets (MKM C4/67-88: 62-82)

Demand, Supply & Markets are the high order concepts in both Micro and Macroeconomics.  In Microeconomics it is demand for and supply of a specific good or service.  Demand reflects the constrained maximization of happiness by a consumer faced with a limited budget, prices and the need for other goods & services.  Supply reflects the constrained maximization of profit by a firm faced with existing technology, input costs and revenue per unit.  In Macroeconomics it is Aggregate Demand for and Aggregate Supply of all goods & services in a national economy.  For purposes of introduction I restrict myself to Microeconomics.  The concepts, however, apply in Macro.

i - Demand

All other things being equal, the higher the price the lower the demand; the lower the price the higher the demand.  This is the Law of Demand.  The Demand Curve [MKM Fig 4.2] shows the relationship between price and quantity demanded of a good or service.  It shows a consumer’s willingness to pay different prices for different quantities of a good or service.  All things being equal, the Demand Curve is downward sloping reflecting the Law of Demand.

Assuming the taste of consumers, the price of other goods & services as well as income remain constant there will be movement up and down along the curve as price changes.  If any of the constants change, however, the Demand Curve will shift [MKM Fig. 4.4 a & b].  In Cartesian space adding horizontally how much each consumer is willing to buy at each price generates the Market Demand Curve. The Market Demand Curve is thus an aggregation of individual consumer demand curves.  As will be seen, and importantly, what can be aggregated can sometimes be disaggregated.

ii - Supply

All other things being equal, the higher the price of a good or service, the higher the quantity supplied; the lower the price, the lower the supply.  This is the Law of Supply.  The Supply Curve [MKM Fig 4.6] shows the relationship between price and quantity supplied.  It shows the willingness of a producer to sell.  All things being equal, the Supply Curve is upward sloping reflecting the Law of Supply.  Assuming the cost of inputs and technology remain constant, there will be movement up and down along the curve as price changes.  If any of the constants change, however, the Supply Curve will shift [MKM C4/78, Fig 4.7].  In Cartesian space adding horizontally how much each firm is willing to sell at each price generates the Market Supply Curve.  The Market Supply Curve is thus an aggregation of individual firm supply curves.  As will be seen, and importantly, what can be aggregated can sometimes be disaggregated.

iii -Markets

Markets exist anywhere, in real or virtual space, that buyers and sellers can transact business.  Put another way, Markets are where Demand meets Supply setting a price/quantity that clears the market; ‘X’ marks the spot where the willingness to buy exactly matches the willingness to sell [MKM Fig 4.8].  Markets can be:

- commodity-based, geographic or virtual;

- in or out of equilibrium [MKM Fig 4.9 a & b];

- sensitive or insensitive to changes in price, income, taste or technology;

- influenced by someone - consumer, producer or government - altering the price/quantity outcome by exercising market power.

In a Market, price regulates the quantity of goods and services demanded and supplied.  If price is too high, consumers demand less than producers are willing to supply.  A surplus exists.  To rid themselves of this surplus producers lower their price.  If price is too low, consumers demand more than producers are willing to supply.  A shortage exists.  To get more of the good consumers bid up the price [MKM Fig 4.9 a & b]The tendency of producers to lower price faced with a surplus and consumers to bid up price faced with a shortage is called Market Forces.  These tend to keep the market price/quantity where ‘X’ marks the spot.

 

6. 10 'Es' of Economics

By coincidence many of the key concepts in Economics begin with the letter ‘e’.  Here are what I consider the top 10.

i - Efficiency (MKM C2/26-7: 23-24; C7/160: 149

As will be seen efficiency has many meanings in Economics including: allocative, consumer, economic, exchange, producer and technical efficiency.  In introduction consider technical and economic efficiency.  Technical efficiency is achieved when it is not possible to increase output without increasing inputs.  Economic efficiency, on the other hand, occurs when the cost per unit output is as low as possible.  All economically efficient solutions are technically efficient but not all technically efficient solutions are economically efficient. 

ii - Effectiveness

For some goods and most services inputs and/or outputs cannot be directly measured and hence technical and economic efficiency cannot be calculated.  Accordingly, a less stringent test - cost effectiveness - is used.  Surrogates or proxy indicators of inputs and outputs are developed.  Consider the criminal justice system.  How do we measure its inputs and outputs or its success?  The number of arrests?  The number of convictions?  The “recidivism rate” measured as the percentage of repeat offenders?  The related rate of rehabilitation?  Case load per parole officer?  Or the more difficult to measure opportunity cost of resources in alternative applications, e.g., early education?

 

iii - Elasticity ([MKM C5/97-117: 90-110]

Elasticity refers to the sensitivity of one variable to a percentage change in another variable.  As we will be seen, in Economics there are many forms of elasticity including: income & price elasticity of Demand, price elasticity of Supply and cross-elasticity or the elasticity of substitution.  In all cases there are three types:

elastic when a 1% change in one variable results in a greater than 1% change in the other, e.g., a 1% increase in price results in a 5% decrease in sales;

unitary when a 1% change in one variable results in a 1% change in the other; and,

inelastic when a 1% change in one variable results in a less than 1% change in the other, e.g., a 1% increase in price results in a 0.01% decrease in sales.

iv - Employment (MKM Macro C9/193-202: 178-97

In daily life employment is usually associated with Labour.  In Economics, however, all factors of production including Capital and Natural Resources are subject to over-employment, full-employment, under-employment and unemployment. 

In the case of Capital, capacity utilization measures employment of physical plant and equipment.  Generally, 85% capacity utilization is considered full employment of Capital allowing for downtime and maintenance. 

Similarly, employment or exploitation of Natural Resources may be over, fully, under- or simply unemployed and left in situ.  Appropriate conservation methods are required to determine the appropriate level of exploitation.

In the case of Labour, the Labour force is defined as all persons between 15 and 65 years of age [MKM Macro Fig. 9.1].  The participation rate is the percentage of the Labour force that has or is actively seeking employment [MKM Macro Fig. 9.3].  There are various types of unemployment including:

frictional exists when there is a job available for every worker who wants one but some will always be between jobs, i.e., unemployed; 

seasonal characterizes industries like farming, fishing, forestry and skiing;

cyclical follows the business cycle, up and down;

structural reflects, among other things, the impact of technological change making existing skills redundant, e.g.,  the Canadian Maritime provinces were world leaders in sailing technology but the entire industry disappeared with the shift from wood and sail to iron and steam late in the 19th century; and,   

the natural rate of unemployment accounting for frictional, seasonal cyclical and structural unemployment.  The natural rate varies between countries due to structural and policy factors such as unemployment insurance programs [MKM Macro Fig. 9.4].

v - Endogenous/Exogenous

Economic models like the Standard Model are closed system.  Within the system variables are endogenous, inside.  Variables outside the system are exogenous, e.g., changes in the Law, political instability, civil unrests or calm.  Some variables may be both.  Take technological change.  In Economics technological change refers to the impact of new knowledge on the production function of a firm or nation.

Endogenous technological change emerges from the pursuit of profit.  Thus industrial research and development or R&D includes minor modifications or tinkering with existing Capital plant and products called ‘development’.  R&D varies significantly between firms and industries.  At one extreme, a change may be significant for an individual firm but trivial to the economy as a whole.  On the other hand, there are ‘enabling technologies’ such as computers or biotechnology that influence all industries.

The source of exogenous technological change is outside the economic process.  New knowledge emerges, for example, in response to the curiosity of inventors and pursuit of ‘knowledge-for-knowledge-sake’, i.e., pure research usually conducted in universities.   Exogenous change, with respect to a firm or nation, falls like manna from heaven.

vi - Equilibrium (MKM C4/79-85: 74-80)

Equilibrium is a condition once achieved continues indefinitely.  In Economics there are different types of equilibrium but for our purposes only two need be considered

Stable Equilibrium: refers to a condition which once achieved self-adjusts to any change maintaining the equilibrium state - homeostasis.  Changes causing a shift out of equilibrium generate forces leading back to equilibrium.  Consider a ball resting at the bottom of a cup; shake it and the ball moves; stop shaking and it returns to the bottom of the cup.  As we will see, in market equilibrium price/quantity ‘clears’ the market - the quantity demanded exactly equals the quantity supplied.  If price rises above equilibrium supply exceeds demand - a surplus is created; if price drops below equilibrium demand exceeds supply - a shortage.  Market forces then drive the system back to the equilibrium clearing the market; and,                        [MKM Figs. 4.8]

Unstable Equilibrium: refers to a condition which once achieved does not self-adjusts to maintain the equilibrium state.   Consider a ball resting on the top of an overturned cup - shake it and the ball falls off never to return to the same place.

vii - Equity (MKM C1/5:3; C12/264-70: 247-253)

The economic concept of Equity evolved out of a distinct strand of English legal history.  Together with the Common Law, Equity emerged during the reign of Henry II (1133 –1189).  Those interested in the legal origins of Equity, please see Observation # 3: Equity.

The Common Law is concerned with right and wrong, guilt or innocence.  Equity is concerned with fairness.  Economic concepts of Equity derive from legal Equity.  Thus the Chancellor of the Exchequer (in Canada called ‘the Minister of Finance’) exercised concurrent jurisdiction in Equity with the Lord Chancellor’s Court. 

There are two economic definitions of Equity, each reflecting its historical roots.  First, there is Equity as the financial capital of a limited liability corporation which, after deducting liabilities to outsiders, belongs to the shareholders.  Hence shares in a limited liability corporation are known as equities.  This links back to the historical development of trusts under Equity.

Second, there is Equity as ‘fairness’.  While usually used with reference to taxation it is a general economic concept.  With respect to taxation Equity has three dimensions: horizontal, vertical and overall.  Horizontal Equity refers to ‘like treatment of like’.  Vertical refers to ‘unlike treatment of unlike’.  Overall Equity refers to the accumulated impact of all forms of taxation.  Crudely, it is the difference between earned and disposable income, i.e., income net of all taxes – income, excise, sales, et al.  Equity is also used to justify market intervention by Government, e.g., minimum wage and rent control. 

It is important to distinguish between equity and equality.  Equity is about fairness, given the facts of a situation.  Equity is part, not just of law and economics, but also of ethics, the science of morals.  It is not biased in favour or opposed to equal, egalitarian outcomes.  Outcomes simply must be fair.  The difference between equal opportunity and equal outcomes highlights, in a way, the difference between equity and equality.  In this regard, Kenneth Boulding entitled his Presidential address to the 81st meeting of the American Economic Association in Chicago, December 29, 1968:  Economics as a Moral Science.

viii - Ethics/Moral Sentiments

#8 of the Ten Humorous Reasons for studying economics reads: Although ethics teaches that virtue is its own reward, in economics we get taught that reward is its own virtue.  This, alas, from a now dark website: JokEc. 

While self-interest or ‘Me-ism’ lays at the heart of economics it is in fact qualified by moral considerations.  Thus while Adam Smith is remembered as the founder of modern economics with the 1776 publication of his Inquiry into the Wealth of Nations some 17 years earlier in 1759 he published The Theory of Moral Sentiments (1759) providing the  ethical,  philosophical,  psychological, and  methodological underpinnings of all his later works. 

Today such concerns are summed up as ‘market sentiments’.  Such sentiments include, among other things, trust.  Overtime buyers and sellers, producers and suppliers, employers and employees develop trust reducing what are called transactions costs.  Without such trust every exchange must be carefully and expensively scrutinized to insure all terms of a contract are fulfilled by both parties.  In times of recession, such as now, relations tend to break down with producers and/or their suppliers going out of business, employees laid off, etc.  Like a rug or woven sweater relations unravel and if this last long enough new supplier or new employees must be engaged who, at the beginning of the relationship at least, are subject to uncertainty and a lack of trust raising transaction costs.

ix- Excludability (MKM C11/236: 221)

Private goods exhibit excludability and rivalrousness.  If I buy a car I exclude you by lock and key.  Similarly, if I am driving I exclude you, i.e., driving is rivalrous.  Public goods, on the other hand, are non-excludable and non-rivalrous, i.e., it is hard to stop me from consuming and my consumption does not reduce the amount available to you.

If I watch a fireworks display it does not reduce the amount available to you.  Similarly, public goods are non-excludable, i.e. a user cannot be easily prevented from consuming it.  This creates the ‘free-rider’ problem.  Extending the fireworks example, while I will not pay to enter the stadium I can watch from my apartment balcony at no charge.  Allowing for externalities (discussed below) there is in fact a spectrum of goods ranging from pure private to pure public.

x - Externalities (MKM C10/211-221: 198-209)

The Standard Model assumes that market price ‘internalizes’ all relevant costs and benefits.  This means the consumer captures all benefits and the producer pays all costs at market price.  An externality means there are costs or benefits not captured by market price, e.g., the social benefits of higher education or the health costs of pollution.

 

7. Is Economics a Science? (MKM C2/22-9: 19-26)

Yes and no.  It depends on how one defines Science.  The word Science comes from the Latin scire “to know” which, in turn, derives from scindere “to split”.  One gains knowledge by splitting or reducing a question into smaller and smaller parts until a fundamental unit or force is revealed.  This is reductionism.

Until the Scientific Revolution of the 17th century such splitting and reducing was restricted to words.  With innovation of the experimental instrumental method, the Natural & Engineering Sciences (NES) exploded.  Ideally NES engages controlled experimental conditions.  It holds all factors constant, e.g., heat, humidity and air pressure, then changes one or introduces a new variable (cause) to see the result (effect).  Then repeat to confirm results.  Peer review then involves other scientists replicating the experiment and obtaining the same results under the same controlled conditions.

In the 20th century new disciplines of the NES emerged that I call ‘Synthetic Sciences’.  These include climatology, ecology and environmental studies.  Rather than reducing a question to ever smaller components (reductionism), the synthetic sciences weave them together into a functioning whole (synthesis).  This whole is usually represented in a highly complex mathematical model of the biosphere, climate, ecology or natural environment.  Controlled experimental conditions are possible only for some components and currently impossible for the functioning whole.  Replicability remains mathematical.  The effects, however, of modeled changes can be assessed against real world changes but on time scales varying from a day to 1, 5, 50, 5,000 or more years into the future.

i- Sciences of the Natural & Artificial

Both the traditional and emerging synthetic NES remain subject to the laws of nature.  Economics, however, is a Social Science.  It is, to use a term coined by economist Herbert Simon, ‘a science of the artificial’.  Economics and all other Social Sciences are primarily governed by human laws, not the laws of nature.  And human laws, unlike the laws of nature, are very mutable indeed.

Consider recent changes in banking law and introduction of new technology that transformed the definition of a successful business model.  Think of the so-called FANGs: Facebook, Amazon, Netflix and Google.  Think of negative interest rates. 

ii -  Induction & Deduction

Like the traditional and synthetic NES, the Social Sciences use two forms of logic: induction and deduction.  Induction involves reasoning from a particular observation to a general conclusion, e.g., from an observation comes a theory.  Deduction involves reasoning from the general to a particular.  In this course, deductive logic is the engine of analysis.  You will be given a set of fixed assumptions defining an initial equilibrium.  One assumption will be changed.  You must deduce the result.

iii – “Let Us Assume” & Ceteris Paribus (MKM C2/22-4: 19-21)

An expression often heard from economists is ‘let us assume’.  Consider the joke about the economist, mathematician and physicist marooned on a desert island with crates of canned food and no can opener.  The physicist says: I can start a fire and blow the top off”.  The mathematician says: “And, I can calculate the trajectory of the food so we can catch it.”  The economist says: “Let’s assume we have a can opener”.  Laugh, laugh, laugh, stupid economist!

But consider.  The physicist has no equipment to measure the energy content of the fuel for the fire, nor instruments to measure the can’s tensile strength and therefore cannot determine when it will blow.  The mathematician cannot, therefore, calculate the trajectory of the food.  The economist, on the other hand, looks for a sharp rock to act like a can opener.  One of my professors, Gilles Paquet, called economists tool-bearing animals with the head serving as the tool box.  The deductive logic of economics is one such tool and is used in other disciplines including Law and the NES. 

One of the most important and regularly used assumptions of Economics is ceteris paribus or ‘all other things being constant’.  Thus in analyzing a given phenomenon economists begin by assuming all factors or forces are constant and then changes one.  This is a critical in economic analysis.  For example, if the price of a good or service changes, analysis is nearly impossible if the price of all substitutes changed at the same time.  To determine the effects of a price change, economists assume all other prices remain constant (in the first round).

In effect, the controlled experimental conditions of the NES become a set of fixed assumptions in Economics, a model.  Changing one controlled condition or introducing a new variable (cause) leads to a result (effect).  Changing a fixed assumption of a model or introducing a new variable in Economics (cause) leads to a changed equilibrium (effect).

iv - Positive & Normative (MKM C2/30:27)

As a science of the artificial Economics answers two types of questions.  The first type ask: What is?  Such questions are called positive, i.e., they involve no value judgment.  The second asks: What ought to be?  Such questions are called normative, i.e., they involve a value judgment.  For example, it is a positive statement to say about 20% of Canadians live in poverty.  It is a normative statement to say, for reasons of Equity, we should redirect national income to help them.

v - Observation & Measurement (MKM C2/22-4: 19-21)

It is usually forgotten that the Scientific Revolution involved the design and construction of instruments that can measure and report experimental results.  Such instruments reach spaces and places above, below and beyond the reach of the human senses.  Ever tried to manipulate DNA by hand?  One of the strengths of the NES is that once calibrated such instruments report back without human mediation of the evidence. 

What distinguishes the Social Sciences (sciences of the artificial) from the NES is that every step of the evidentiary trail is mediated by human beings from marketing surveys to final data manipulation.  Consider the Census.

The Census is something that North American economists rely on for in-depth measurement of a range of economic phenomenon including the Census of Population (age and other demographic characteristics as well household expenditures and consumer capital goods) and the Census of Business Enterprise.   While there are technical limitations to the Census, e.g., does it ask questions that elicit meaningful answers, there are also social limitations.  In continental Europe, for example, the Census of Population is not very reliable because of traditional suspicion of government many, many people simply do not answer or even lie.  Similarly, different companies use different accounting methods and when answering the Census of Business do not necessarily use the same Generally Accepted Accounting Principles (GAAP).   

The bottom line: numbers, particularly in the sciences of the artificial, have quality.  They are collected using inherently imperfect methodologies.  They have parents who may have their own agenda, some abusive.  In the NES, this last point is referred to as ‘experimenter expectation’.  Again, what distinguishes Social Science evidence from that in the NES is that every bit is mediated by human beings from marketing survey to data manipulation. 

Economics is better off than other Social Sciences because evidence is generated by transactions that usually leave a record without interfering with individual behaviour.  Thus when one buys a chocolate bar, a car, a stock or bond or a house records are generated for tax and other purposes allowing statistical evidence to be collected.  In addition such transactions are conducted using the same unit of account: money.  Compare this to a sociologist studying the partying behaviour of first year university students.  He or she must rely on survey information provided by students and/or attend parties as a participant observer risking a ‘contact high’ and other forms of subjective engagement. 

vi– Modeling & Testing (MKM C2/24-9: 21-26)

The world is a very complex place.  Models are used to reduce this complexity.  For those interested in the historical and philosophical roots of modeling, please see: Observation #4: Modeling.

An economic model is a simplified description of the whole or some part of the economic system, e.g., Supply and Demand.  A set of assumptions or premises are made and conclusions deduced.  One thing both inductive and deductive model building share in common is ‘assumptions.  Assumptions are used to ignore or simply hold constant selected variables.  A model thus tries to explain how certain variables react to changes in other variables, but not all possible variables.  The world is simply too complex to be fully modeled.

Having constructed a model of some economic phenomenon, economist then attempt to test its predictions against empirical evidence including statistics and descriptive observation.  If the predictions accord with the evidence, the model or theory is held true (for the time being, i.e., until new evidence contradicts the model); if not, it is rejected. 

Many theories in Economics, however, simply cannot be tested.  For many we simply lack the technology.  For example, the theory of revealed preference developed by Paul Samuelson.  It says preferences of consumers are revealed by actually buying goods & services, not by what they say.  However, it is simply not possible to track a large number of consumers over time holding all other factors fixed, for example, age, income and education, all of which affect taste. 

Two recent developments - behavioural economics and social media - expand our potential technologies of measurement.  Behavioural economics uses small scale experiments to test selected microeconomic theories and assumptions, e.g., a narrow definition of rationality.  Findings have increasingly fed through to public policy as policy ‘nudging’.  In this regard, with an ever expanding internet and social media marketeers can formulate psychographic profiles of existing and potential consumers by data mining Big Data.  Such evidence, however, is not in the public domain.  It is proprietary.

Psychographic mining Big Data promises confirmation or rebuttal of revealed preference but it is proprietary and commercial in nature.  As such there is no published methodologies for outsiders to assess data quality nor access it for research purposes.  Other economic theories also could be put to empirical testing if such new technologies of measurement were made accessible to academic, business, non-profit and public sector economists.  It is not widely recognized that years of public sector austerity have had debilitating effects on Statistics Canada and other national statistical agencies on the quantity and quality of their products.  Private sector assistance could help compensate for the damage done and thereby foster public policy that is better evidence based.  Is the corporate sector willing?  How could privacy be protected?

vii - Conclusion

First, Economics is a ‘science of the artificial’, one of the Social Sciences.  As such it is primarily subject to mutable human law not the invariable laws of nature.  A bridge stands or falls based on the constant and unchanging laws of physics.  Economic theories, however, stand, fall or mutate with the changing cultural, historical, legal and technologic conditions of society. 

Furthermore, the Social Sciences are not, in general, experimental sciences.  Their social theories cannot be directly tested.  There are no replicable laboratory conditions for an economy let alone an entire society.  There are, in fact, strict laws limiting human experimentation.  Evidence is thus primarily generated by observation.  With respect to Economics I write ‘’in general’ to allow for behavioural economics which conducts small scale or micro-experiments whose findings while insightful do not currently permit construction of an overarching theory of Economics.

Second, without access to objective instrumental measurement as in the NES, the evidentiary trail in the Social Sciences is generated and mediated by human beings from beginning to end.  Unlike the other Social Sciences, however, Economics has access to the next best thing to a scientific instrument: Money.  Daily life leaves an evidentiary trail of monetary transactions.  Whether it is the bread we eat or the video streaming service to which we subscribe all can be counted using money as the unit of account.  You can’t compare apples and oranges but you can compare their price per dozen.

Third, the inherent limitations of the Social Sciences highlights the fact that Science means more than experimental science with replicability as its standard.  In fact, the rules of evidence and how it is collected, organized and systematized varies dramatically between knowledge domains: the Natural & Engineering Sciences (NES), the Humanities & Social Sciences (HSS) and the Arts.  Science, in this general sense, means an organized and systematized body of knowledge, a way of knowing.  Accordingly, in Economics as in the other Social Sciences many theories are accepted not because they can be tested but because they are ‘believable'.

Fourth and finally, the word 'economy' derives from the ancient Greek oikos meaning ‘house’ and nemo meaning ‘manage’, i.e. managing the house.  It shares this root with ‘ecology’ deriving from oikogie meaning modes of life and relations within and about the house.  Ekistics - the science of human settlement - also derives from oikos but in the sense of founding an ancient Greek colony like Syracuse or the numerous city states established by Alexander the Great in India at the end of the 4th century before the common era.

Economics as management of the household raises the question: What is the relevant household?  In its original sense it was the self-sufficient or autarkic rural estate.  Management, however, ascended to higher orders as the self-sufficient village, town, city and most recently the Nation-State.  A global society in which there is contiguous urban development separated only by natural barriers – mountains, oceans and deserts - has been called the Ecumenopolis – the World City - by urban planner Constantinius Doxiadis; its global reality is visible in a composite photograph of “The World at Night” published by NASA in the year 2000.  If seeing is believing then it provides visual evidence of humanity enframing its home planet.  We see a World City whose shimmering lights soar out into the infinite blackness of space.  It shows us one planet, one biosphere and one human race lighting up the darkness.  However, there is not yet a global economics, no generally accepted model for managing the planet.

 

 

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