Air New Zealand kindly explained to us what the blog was about back in 2011 when they published the following in their domestic inflight magazine:

A one-stop-shop for discussion on topics as diverse as methodological individualism and whether chocolate will become as pricey as caviar (Conclusion?  No need to stockpile Dairy Milk just yet).  The Visible Hand Of Economics features the musing of several Kiwi economists; some named, like the prolific Matt Nolan, others anonymous.  Drawn together by their shared belief that the Government has a role to play in the economy, they haven’t turned their backs on the free-market philosophy.  Drop in for a thought-provoking read.

Today a variety of economists from varying organisation will publish their candid thoughts on New Zealand, and global, economic issues.

Come and share your thoughts with us in the comments.

Just as a starting point here, if anyone comes on and goes “those neo-classical neo-liberals, like Friedman, this is all ideology – I’ve read Klein”, I am not likely to reply.  The key reason for this is because you’ve already shown a complete unwillingness to debate on reasonable terms, and are trying to base the discussion on prejudiced definitions that aren’t appropriate for this definition of neo-classical economics.

In this context, neo-classical is a description of economists who applied a certain set of methods at a  point in time – economics is a discipline with “many models”, and the development of these tools is of huge value.  The start of this method came with the “marginalist revolution”.

The Marginalists in this case were Jevons, Walras, and Menger.  Those who work in certain areas will recognise some of the names (eg Walras law, Menger as a founder of the Austrian school of Economics).  Fundamentally, the purposefully use of the concept of “marginal” gains and losses (rather than average) allowed us to consider individual choice more directly.  More than that, value switched from having “objective” value in its labour time/cost of production to having “subjective” value (potentially on the basis of “satisfaction” or “utility”).  Note:  This is not to say classical economists didn’t think in this way as well, John S Mill was a student of Bentham and wrote a book called utilitarianism!  But the change in focus did help to “solve” many of the perceived paradox of classical economics (eg Giffen goods).

It is no coincidence that at this time sociology and psychology were ramping up as disciplines.  With the growing acceptance of the idea of a “science of society” a number of ways of discussing social facts were being described.  Within economics, the recognition that it may be useful to think about action stemming from individual choice had found its time, and the mechanistic tools of calculus had a place to help us consider certain assumptions about this choice (methodological individualism) – this compares to the classical use of factor shares, and some prices (wages) being set by social convention.

You will find me say critical things in here, and talk about this literature as a “starting point” to real analysis.  So let us consider it in this way.

Note:  Unlike the previous essays, this one is relatively full of comments from me – rather than just the essay.  That would likely be because this and GE (which gets a post later on) are closest to the form of analysis I would use for these types of questions (aggregate production function as shorthand, GE as a more disciplined form of analysis).  Sorry if it makes this long

Still, enough history.  I was going to talk about the essay

The change in focus regarding factor shares in neo-classical economics is nicely described at the start of the essay:

Surplus to landowner or to capitalist was to the classicist, the result of privilege, ownership, and exploitation.  The neo-classicist shifted the main concern from distributive shares to the allocation of scarce resources, and to the linking of input rewards to productive contributions.

However, my view is that this can exaggerate what is going on by mixing normative views of authors with the descriptive form of the analysis – essentially, both classicists and neo-classicists are defining “types”, endowing them with a choice rule, and deducing outcomes.  They are then asking how these idealised types relate to reality, to ask if we can inductively infer anything for the analysis of these “types”.

So having recently discussed the classical types in recent posts, what is neo-classical?

Neo-classical models started with the idea of marginalism (marginal utility, marginal product) and went about discussing outcomes as the result of the simultaneous solution of a system where individuals follow a “no-arbitrage” condition – thereby choosing to equate relative marginal utilities/marginal products to relative prices.  Previous models of factor shares had “kept things fixed” to discuss what is going on (eg capital-output ratios or real wages) – however, with a marginalist model this wasn’t the case.  Relatedly, there was no need for anything to be a “residual”, as factors of production within this framework were fundamentally substitutable!

Neo-classicals as dismissive to distributional issues?

There is a common complaint that some neo-classical economists were themselves dismissive of distributional issues.  As Schumpeter is quoted as saying:

And it means on the other hand, that, in as much as costs to firms are income to householdss, the same marginal principle, with the same proviso, automatically covers the phenomena of income formation or of “distribution”, which really ceases to be a distinct topic.

However, these types of quotes are not saying distributional matters aren’t important – just that they should be thought of within the same framework as other economic issues.  The importance of endowment in the allocation of resources was often mentioned (Edgeworth boxes, the second fundamental welfare theorem).

But we also need to remember the neo-classical economists were coming up with a new type of “idealised world” to discuss issues of social allocation.  In that environment there were conclusions that sound dismissive of distributional issues, but that is due to the type of counterfactual world they were discussing – and the assumptions that embodied.

However, it is this process of simultaneity that is focused on.  As Wicksell says:

workers and the means of production are separate factors but all on the same footing, without regard to the differences in their social relationships.

Sidenote:  Simultaneity illustrates the “cooperative” nature of production, as opposed to the conflict based focus of class analysis.  This also illustrates one of the key shortcomings when it comes to political economy and this type of analysis – the lack of description about the development of endowment and opportunity which was presumed in class based analysis.

Aggregate production functions

It is at this point we start moving towards a more modern view of considering factor shares, and the long-term aggregate economy – aggregate production functions.  This direct framework started with J. B. Clark (1899) we have a perfectly competitive world with a single wage rate, single interest rate, a linear homogenous production function, homogenous capital, and fixed supplies of productive services.

Yes these assumptions are strong, and many of them will drive the resulting analysis he has of factor shares – but I think we sometimes forget just how strong the classical assumptions were (as many of these are equivalent).  Furthermore, this is a great example of a situation where assumptions have been continuously loosened over a long period of time.  In the end the framework helped to show that given assumptions about perfect competition and set endowments, factor shares were simply the result of individuals earning their “share” of production.

Another neat quote in this chapter:

The Ricardian concept of unearned surplus, which derives from ownership of superior land or from the Marxian rate of surplus value or exploitation in the capitalist mode of production, is associated in neo-classical writing with imperfect markets or competitive markets in disequilibrium

As a result, discussions around factor shares in (macro) neo-classical work will tend to be focused on estimating the production function and the elasticity of substitution (between factors).  This is incredibly fraught, and arguably different parts of the discipline have handled this shortcoming in three ways:

1. Admitting that the issues of aggregating capital are too large and focusing on smaller, conditional, questions we can answer (mainstream economics)
2. Staying within this level of aggregation and testing out different forms of meso and macro assumptions to generate results (Post-Keynesian economics)
3. Reverting to class based analysis.

However, as I noted at the start the use of an aggregate production function can be a useful starting point for analysis.  In this context, the Cobb-Douglas production function was king – both because it matched data at the time, and provided an elasticity of substitution of 1 (which implies that labour and capital income shares are constant as production expands).  Furthermore, the income share to each factor (price times the factor to output ratio) appeared to be close to the estimate one would get from the Cobb-Douglas production function, as a result this was seen as a good stylized fact of the macroeconomy. [Note:  I believe it was Hicks who gave us the most complete and compelling first treatment of this in Theory of Wages, but I haven’t read it so am relying on what I’ve heard ]

For the starting point of much analysis this is used as a stylised fact (especially as it appeared to fit a lot of developed economies for some time), however in more recent times it has been more heavily questioned.  The key point is that this was a “stylized fact” that was observed, a single fact such as this could be the result of a myriad of “microrelationships” and potential “secular changes” – implying that the relevance for policy is unclear even if this holds.  We are still in the world of aggregation.

Here the author mentions Kuznets observation (among a large series of observations) that there are two stages of growth, one where a developing nation builds up capital pushing down the labour share, then a following stage where the economy is developed and labour’s share rises over time.  At this point he was explaining a “stylized fact” – one that has received a bunch of mixed evidence (here and here) and may not be appropriate to assume going forward (although what that means is also debatable).  This illustrates one of the issues with the production function approach, allow it allows us to think about specific shifts we don’t necessarily have sufficient data to mediate between competing arguments – we can build contradictory arguments, which provide different forecasts, from the same dataset.

For dealing with this, and trying to make a larger role for technical change, constant elasticity of substitution (CES) production functions become more popular.  Technical change can then be viewed as “capital saving”, “neutral”, or “labour savings”.  In this way the change in factor shares depends on the nature of the technical change as well as the elasticity of substitution.  Our prices of interest are the real wage rate and the interest rate (noting that we have issues measuring the stock of capital unless the interest rate is given – one of the key reasons why the interest rate is treated as exogenous and given often.  Note more so that Sraffa and more recently Mas Colell have pointed out that this makes the idea of a downward sloping factor demand curve for capital more difficult to justify), while our quantities are labour and capital inputs.

In this way, considering the factor shares in an economy is akin to asking about the “cost minimisation” problem for the economy as a whole.  However, this indicates one of the problems – we have increasing population, and often assume constant returns to scale in order to discuss our results.  In fact, part of the result may be due to the existence of increasing returns to scale.

Conclusion

Overall this has been a relatively quick tour of the idea of a “neo-classical” model of factor shares – namely thinking about factor shares through the lens of an aggregate production function.  It is a useful way to get some key concepts – but it both ignores the normative content of previous theories (both a blessing and a curse), and is vulnerable to the complexities that exist over an entire economy (specifically in terms of heterogeneous capital goods, factor demand, and the general difficulty of aggregation and valuation).  An interesting point raised in the essay was:

The critical problems of political economy relate more to the older classification of distributive shares than to the analytical income categories [ed that we now measure].

Modern GDP and GDP related statistics are based on this production function view of the economy, and as a result our ability to apply “value” regarding distributive shares based on older arguments is weaker than we may think at first glance.

While the author believes that we should then try to have that expresses the old categories, I would instead say that we need to think about data and measurement that represent the trade-offs we are interested in for current social arrangements.  Household microdata that combines groups based on characteristics, and then describes that, is the modern way of doing this – and in my opinion a useful and fruitful direction.

Neo-classical tools, especially given the additional 80 years of development from what we’ve discussed here, are useful for a wide variety of things.  Furthermore, the raw idea of a production function is a good “first start” when I’m sitting down with issues.  If we want to go further in “answering a given question” economists know it is important to loosen more assumptions – which captures part of the reason why my own lack of focus on factor shares as a means to interpret distributional data

At first brush I would like to note that we have a psychology lecturer suggesting that this implies more people should study psychology – it might be the economist in me talking but this sounds a bit like these recommendations are a touch self-interested themselves

But this would be a digression.  While I don’t disagree that economists do need to be humble about the conditional nature of their knowledge (a point that holds equally for other social, and physical, sciences mind you!) I stick by my general conclusion that:

Saying “we shouldn’t look at trade-offs because then we lose our sense of community” sounds strangely like “we shouldn’t study the natural world or we will lose our sense of faith” don’t you think

Economics is a descriptive discipline that uses specific counterfactuals to try to interpret our limited, and fuzzy, data on social co-ordination.  Just look at how often we discuss co-ordination here – and we fit into the “business economist” category that is most maligned by these articles!

Now much of the psychology today article relies on one reference that it links to repeatedly – ‘Does studying economics inhibit cooperation?” [REPEC].  This paper is about economics training 20 years ago, and discusses survey results.  You may wonder why survey results would matter – especially if you trust the papers that suggest there is no difference between how people act in hypothetical situations and in situations where actual money is on the line [an assumption I still view as up for grabs!].

Well I would still be a bit careful here!  After all, the size of the reward does have an impact on decision making.  And the differences in hypothetical and ‘real’ behaviour in of themselves differ based on the game being played!  This makes sense if we think of rule based, unconscious processes in the same way we think about a computer program – and that once the money on the line reaches a certain level there is a ‘break’ in the loop, and we go into conscious decision making mode.

Given this view of the individual, what are some of the hypotheses could we attribute to the gap in responses between economists and non-economists in these surveys?

1. Economists are inherently cold hearted people, and the training makes them even worse – the only hypothesis being claimed in the articles at the start.
2. Economists trust others less following the education (I suspect this does occur – and I suspect that if it was the case we would find it quite widely across anyone who spends all their time thinking about individuals eg psychologists)
3. Economics trains people to use rules, or break out of standard rules more quickly, than other individuals,
4. Economists are less prone to make mistakes,
5. After studying these games, economists view some answers as a form of image crafting, and as a result change their behaviour accordingly.
6. Economists recognise the hypothetical situation as a game – and as a result, value it completely differently
7. Update:  I missed one, economists may be more honest

Note, outside of the first two, and some instances of the third one, all these results would lead to an economist being just as co-operative for the big issues!

The sixth one is one of my personal favourites.  In 1st year I played the prisoner’s dilemma in class, I was first up, we did a practice game where we both co-operated.  I took that as a hint, co-operated on the real game, the other guy defected – I lost!  Burn.

Now nothing is on the line in these games, except your relative position.  Furthermore, we learn how to solve these for relative position.  As a result, when it comes to playing the hypothetical game you do play it differently.

For example, in third year we had a big lab going with many games – and you would move between them every 5 mins.  We had been studying repeated games, and how there will be some co-ordination early, and then people would start defecting – however, my goal was to get the best relative position, so I defected from the start knowing that each time I was competing against different people!

When we looked at the choices later, you could see that the people I’d played against immediately started defecting as well – they were annoyed at losing.  It was a big dark streak that got larger and larger as the game went on!

Now, if there was actual money I would not have been so quick to cause a mess – not just because I could have worked to get a slightly higher “payoff” myself (albeit with a lower relative position) but also because many of these people were my friends, so I would value them getting a return as well.

In fact, our entire economics education was focused on description, admitting that people value different things, and just trying to frame behaviour from an atomistic (individual) level – as that is where choice is made!  This isn’t, and never is, to say that an individual is independent of their society and doesn’t care about them – and to be honest I find the presumption that economists, and economic students, are making an assumption that this occurs and is true to be patently absurd and insulting.  You may fundamentally disagree with methodological individualism, or economists use of it, for some reason – as I believe some of the literature pointed at tends to – but at this point we are moving into policy, thereby explicitly invoking normative views, and we are debating those.  We should have those debates, instead of trying to discredit economists before they’ve even started

Now, the person at psychology today could have admitted there are a variety of reasons why economists behave differently when playing these games, and how this issue warrants further investigation (after all, there is still a lot of research to be done into how hypothetical results translate into real decision making activity – note my constant excitement about neuroeconomics and the empirical analysis in behavioural economics).  Instead, they chose to pick the hypothesis that placed economists in the worst light in order to sell their own discipline.

I don’t think you have to be an economist to see why this should be taken with a grain of salt, and why this isn’t “scientific evidence” of why you may believe that economists are douches

What I take from that is we need to think laterally, not literally. When we think about investing in particular sectors, we must realise we will need capabilities that aren’t necessarily obvious to us. We just won’t know what types of knowledge we are going to need to build particular parts of our economy.

The interesting thing is that many economists agree with some of what the author mentions in their piece, in terms of discussing scale and the inter-relationships of firms – but from this loose description there is no clear role for policy, or understanding.

In truth, we need to understand the idea behind inter-relationships in a way consistent with methodological individualism.  Then given that theory, we need to go back to data truly quantify what is going on – given the framework that this theory provides.  From there, we can try to decipher if policy can help of not.

And any such theory relies strong on relative prices – contrary to the inference the article appears to be making, we do not have a command and control economy, and the government is not trying to work out the allocation of resources.  Relative prices, both implicit and explicit, are the driving force of any description of what is going on in New Zealand – and our starting point, and final discussion in terms of policy needs to rely on these.

Think about it, we are told how these firms rely on each other, how they add value to each other, and in each others markets.  This doesn’t make an “externality” in the traditional sense, it just tells us that we have firms whose markets are interconnected – and as a result, there will be some implicit contracts between these firms (and implicit prices) that help to share the surplus of their trade.  In an extreme case, when the benefit is enough, and the outside contracting is weak enough, these firms would horizontally (or vertically depending on the relationship) integrate.

The fact that firms are inter-related doesn’t suddenly provide a role for government.  The fact that scale matters for output does not mean that FORCING an increase in the population distribution will increase welfare.

Update:  Bill discussed this here.  And Eric.  How did I miss it when I read both of those blogs daily … I blame my new Kindle for making me focus on Mill instead of my blog reading.

Sidenote:  I have to mention this statement:

Because New Zealand doesn’t have a truly large city by international standards, we must work harder at innovation to compensate for our economic geography and collaborate as if we were a city of four million people.

I have tried to be kind in the rest of the piece, but I have to admit that this statement is blatantly ridiculous.

Two things:

1. The benefits of population density in large cities come very much from population density – saying we are a city doesn’t do anything to change this.
2. More importantly, saying we need to “innovate more” because of our disadvantages doesn’t necessarily make sense – it depends on the marginal benefit of innovation relative to the cost.  If our distance from market reduces the marginal benefit from innovation, then this statement isn’t just wrong – its harmful if its followed through with.

I love to hear scientists describe the potentials for technology, and discuss the production possibilities they face.  But they really should get an economist to join the party when it comes to discussing issues of allocation – given that this is the economists area of expertise.

Reference dependence does explain a lot of the “why” I was looking for, as does “limited cognitive capacity”.  I think we still need to ask exactly how these processes work though.

And that is why reference dependence does not quite fully cover it off for me – undoubtedly because I am being fussy.  And this comes back to the logic behind why I decided to suggest “a choice of investment in a stock of habit” rather than just suggesting “that habits are described by a state variable that is a function of past action”.

What I really want to know is three-fold:

1. What is the initial endowment of human habits,
2. Can choices now relate to habits in the future in a purposeful way,
3. The Lucas critique – but applied to habits.

Treating a habit like a preference (which is what much of the literature implicitly does) might be sufficient – but I do not believe so.  And that is because I think that many people “choose” to build habits and rules of thumb explicitly, given the underlying endowments and social situation around them.

This is a very important issue when we actually come to look at policy, for example:

1. If habit formation adjusts to monetary policy settings that assume it, and we have put it in as a constant (eg rule of thumb consumer) then our settings will be inappropriate.
2. In terms of time inconsistency, the development of habits can be seen as investment into an optimal “time consistent” path to improve outcomes.

My question isn’t “do habits exist” or “do we model habits”.  It is “are we currently modeling the development of habits in a way that is consistent with methodological individualism – that is consistent with individuals that make choice”.  Merely assuming an exogenous preference, doesn’t do this.

While trawling the internet (in an environmentally sustainable way) I ran into a comment on the Dim Post blog by Lyndon.  This comment mentioned a book called “Critical Mass” which sells the idea of a “physics of society”.  The idea behind this is:

Over the past several decades, social, economic and political scientists have begun a dialogue with physical and biological scientists to try to discover whether there is truly a ‘physics of society’, and if so, what its laws and principles are. In particular, they have begun to regard complex modes of human activity as collections of many interacting ‘agents’ – somewhat analogous to a fluid of interacting atoms or molecules, but within which there is scope for decision-making, learning and adaptation.”

I find this interesting, mainly for the fact that this has been the explicit foundation of economic modelling for at least 150 years (in terms of the “thought process it has been like this for a lot longer).

The implicit appeal to methodological individualism is the same, and the concerns about the status of “free will” are also the same as what is being thought about in economic methodology – hell, even a know nothing blogger like myself has discussed these issues here (MI, FW, FW, FW).

In essence, when economists go out to build a model they are trying to understand how the interaction of individual agents leads to outcomes – given the constraints of scarcity, and given the constraint that individuals make choices.  IMO it is methodologically equivalent to a “physics of society”.

I have no doubt that, by coming at it from a different angle, a physics of society can add a lot of value – by helping to shine a light on methodological and practical issues with types of modelling.  However, the behavioural relationships in economics can be a lot more “subjective” than in the physical sciences – and being careful to make any implicit subjective assumptions explicit is a very important methodological issue in economics – in this sense any “social physicists” should make sure they talk carefully with economists regarding these issues … or else they may fall into the same traps that some economists have many many years ago. When looking help in to face the years to come, see here these blogpost about where to get good psychic readings.

Update:  Via Twitter Bill Kaye-Blake points to an article by Krugman where he discusses an engineer deciding to just “do economics” for us.  I am sure that the work in Critical Mass isn’t quite as blinkered

Methodological individualism and economics

When it comes to economics, how is methodological individualism applied?  The first step in such an endeavor is to try and create models that are incredibly general – avoiding assumptions regarding individual preferences as much as possible.  As a result, when describing a phenomenon, economic models can use a myriad of assumptions to reach a result from this general model – such as changes in expectations through time, changes in preferences through time, and choice with respect to fixed preferences and expectations given a behavioural rule.

The important assumption to start with is that individuals make choices.  The fact that economists widely study state-dependence and multiple equilibrium shows that economics accepts that expectations (and even to a degree preferences) can be influenced by the current set of social actions – however, the equilibrium we are at is still the result of a set of individual actions.

I like to stress this point strongly – individuals are the ones making the choices.  Yes, these choices are subject to the environment around them, the social situations they find themselves in, and the information they have available – but it is individual action that drives choice, and it is these choices that lead to the aggregate outcomes we observe.

This point in itself implies that we should be able to reduce social action to the choices of individuals – and I have always seen the goal of reducing social action to the sum of individual action as the primary justification for claiming that a subject is implementing methodological individualism.

Why is the individual the important actor, why shouldn’t we go further?

This is a good question, and one that is raised in the MR post when Neuroeconomics is discussed.

I think Neuroeconomics is exciting – it provides a more objective base for discussing preferences and choice – which makes it a different (but complementary) discipline to “positive the initial objective step of economics analysis”.

But, even so does this change the fact that it is still the individual making choices?  As we have discussed, this debate is between determinism and free will (here and here) – and economists tend to fall on the side of free will.  Given this, Neuroeconomics gives us information on how people make choices and how preferences are formed – which can in turn be incorporated into theories of choice.  However, it is still individual choice that is the driver of individual action – and thereby social action.

This seems sort of tautological, and pointless, why do you/we care?

In order to understand why this is so important lets think about the idea of complex systems, chaos theory, and societal collapse.

These ways of viewing social action are interesting, important, and useful.  However, one hole I see people fall in when they describe “social systems” is that they fill a complicated relationship to describe “ex-post” (observed) outcomes – and then state that this implies things about the future without describing why.

Building a complex system without a clear description of action – namely without an underlying and testable theory – makes it easy to accidentally make implicit assumptions that are unsatisfactory.  As a result, even if your model “fits” ex-post data it is not clear if it is true, or whether it will be able to describe anything in the future.  This is especially important for complex systems – given their incredible sensitivity to initial assumptions.

In truth, an increasing push towards complex systems without appropriate development of theory should be subject to the Lucas critique.

Conclusion

The use of methodological individualism as a frame to model potential “explanations” of phenomenon has real value – and in many ways this is what economists try to do.

Picking between equilibrium, either for descriptive or predictive, is not an area economists are really trained in – and is more a matter of personal value judgments than anything else.

As a result, I still believe methodological individualism is the appropriate frame for economics, and in fact all social sciences.  However, with models of individual choice able to offer up a whole range of potential explanations (backed by sensible and justifiable theory) for observed phenomenon we require A LOT more before we can reach any sort of conclusion about how to describe observations – let alone predict future ones.  This “lot more” is of course “value judgments”

Popper’s critique of historicism, then, can be rephrased as a compelling critique of the model of the natural sciences as a meta-theory for the social and historical sciences. History and society are not law-governed systems for which we might eventually hope to find exact and comprehensive theories. Instead, they are the heterogeneous, plastic, and contingent compound of actions, structures, causal mechanisms, and conjunctures that elude systematization and prediction. And this conclusion brings us back to the centrality of agent-centered explanations of historical outcomes.

Agreed with this 100%.  Fundamentally, the usefulness associated with the study of economics comes from its framing and discussion of tendencies – not from the precise value of its predictions.

An understanding of individual actions and incentives allows us to describe what has happen and inform policy – but it does not give us a crystal ball with which to see the future, or figure out exactly what will maximise social happiness.

That is why we economists never seem to agree with each other.  But when we do agree, it is probably a good idea to listen, as there must be a rare combination of compelling factors driving such an unlikely event

Note:  To clarify what I think the quote says that I’m agreeing with.  I believe it says that we can’t come up with some holistic model of society that will spit out nice predictions – we can only try to understand society through the behaviour of individuals given observed actions.  This sounds like methodological individualism to me …

Economics:  The branch of social science that deals with the production and distribution and consumption of goods and services and their management

This differs from the Robbins definition of economic science:

Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses

And it differs from the broadest possible definition that we discussed earlier:

The study of how humans/societies allocate scarce resources.

Given no mention of “human behaviour” or incentives this definition is wider than the Robbins definition.

Is the Wolfram definition any different to our broadest definition?  Well if certain elements are defined correctly I would say they are equivalent.  As a result, it doesn’t tell us what economists do, or what the dominant school of economic thought is.  Wolfram is simply giving us a definition of the broadest scope of what “economics” can be (and has been) seen as – as long as we define the “outputs” (goods and services) as widely as humanly possible.

So, given that the Robbins definition is the one that more fully captures the essence of what economists currently do (with our obsession with methodological individualism) I tried typing “what is economic science” in.  But it told me:

Wolfram Alpha isn’t sure what to do with your input

Economics aims to understand one thing, and one thing only. Scarcity. It is the study of scarcity, every concept in economics is based on scarcity. As a result, we should define scarcity:

Definition: Scarcity: A state where, when something is free, humans want more of it than is avaliable.

However, economists are even narrower than that. We don’t study why things are scarce persee, we don’t study how resources are formed or how people’s desires for these things evolve.

Economics is a specific type of social science. What we do study is:

Definition: Economics: The study of how humans/societies allocate scarce resources.

This is a definition of economics that ALL economists should agree on. Every type of economist will believe there are bits missing. But if we want to capture the essence of all schools of economics, this would be the fundamental nugget that binds them together.

Neo-classical economics (which is what I mystically perform ) makes a few more assumptions. These assumptions were mentioned and discussed here namely:

1. They believe in methodological individualism – fundamentally when an economist analyses the economy he believes the whole is the sum of its parts.
2. People have preferences.
3. People act at the margin to maximise net “happiness” – fundamentally this suggests that make choices based on the associated additional costs and benefits associated with the action.

When these are introduced we get the concept of “opportunity cost” – as we are stating that actions are derived from individuals, not a social whole.

Definition: Opportunity cost: The “next best” alternative to your best choice in a situation.

In this case, the fact that there is an “opportunity cost”, and that people can recognise it implies that, in a situation people make a choice between their best and second best alternative.

If something happens, to reduce the desirability of the best alternative, the person may switch to their “second best”. This would be a person acting based on a change in incentives.

Definition: Incentives: Something that drives an individuals choice – outcome oriented as it relies on the idea of a “payoff”.

In this case the idea of “choice” is essential. Effectively, people make choices based on incentives. As a result, when studying the allocation of resources, we are looking at the choices of people who are allocating time, goods, etc. The allocation of these things that people provide will depend on the initial amount of things (endowment), their ability to trade, and the choices they make.

In the case of economics, people are driven to make choices to “satisfy their preferences” – as a result, this acts as the driver of their actions.

So in this case, economics is the study of:

Definition: Neoclassical economics: The study of the allocation of resources given scarcity, when humans makes choices to satisfy their preferences.

Now if I have made any horrendous errors – or if there is debate surrounding anything I’ve said, go for it in the comments.