Methodology for a New Microeconomics (Routledge Revivals)

The Critical Foundations

Lawrence A. Boland

• Publisher: Routledge
• Year: 2014
• ISBN:
  9781317680895
• Edition: 1
• Topic: Economics
• Subtopic: Microeconomics
• Index: Economics

First published in 1986, this title argues that the successful development of a new microeconomics requires a deeper understanding of methodological individualism and its role in stability analysis.

Lawrence Boland expounds a critique of neoclassical models, which, he contends, often fail to include an explicit stability analysis. He demonstrates that much of the sophisticated theoretical literature over the past thirty years can be understood as ad hoc attempts to overcome the deficiencies of such models in the absence of cogent stability analyses. In conclusion, he explains the need to update the theory taught at universities, and to develop a truly individualist version of microeconomics that is consistent with the methodological principles of major neoclassical models.

An important contribution to economic methodology, this work is a highly valuable resource for all students and teachers of economics at the undergraduate level.

PART I

THE ECONOMICS OF SUB-OPTIMAL ECONOMIES

1

The State of Equilibrium as an Optimum

It has long been held on philosophical grounds that product must be a homogeneous function of the first order of all the variables, and that if this is not so, it must be either because of ‘indivisibility’ or because not all [inputs] have been taken into account. With regard to the first point, it is clear that labeling the absence of homogeneity as due to indivisibility changes nothing and merely affirms by the implication that ‘indivisibility’ does exist, the absence of homogeneity.

With respect to the second point, … [it] is a scientifically meaningless assertion that doubling all [inputs] must double product. … [T]he statement is meaningless because it could never be refuted, in the sense that no hypothetically conceivable experiment could ever controvert the principle enunciated. This is so because if product did not double, one could always conclude that some factor was ‘scarce’.

I suggest that … ‘inputs’ … be confined to denote measurable quantitative economic goods or services. The production function must be associated with a particular institution (accounting, decision-making, etc.), and must be drawn up as of any unique circumstances pertaining to this unit. …

So defined, the production function need not be homogeneous of the first order. If really homogeneous, marginal costs would always be constant. It is indicative of the lack of integration … that many writers assume U-shaped [average] cost curves in the same breath with homogeneity of the production function.

Paul Samuelson [1947/65, pp. 84–5]

Although it is not obvious, the viability of a narrow psychologistic individualist view of the world depends heavily on the possibility of a linear-homogeneous production function (i.e. one which is ‘homogeneous of the first order’ or equivalently, where there are ‘constant returns to scale’). Only if all inputs to all production functions are variable is it possible to explain all endogenous variables (including inputs) as being the consequences of only naturally constrained individual optimization, subject only to the psychologically given utility functions. If any input were not variable then it would be a non-natural, non-individualist constraint on the ultimate equilibrium and thus on the equilibrium prices. As we shall see, the primary endogenous variable is the price of any good or service. What concerns us here are neoclassical models which claim that all prices are equilibrium prices.

The centerpiece of neoclassical equilibrium economics has always been the claim that the prices we see in the ‘real world’ are equilibrium prices. To understand the significance of such a claim it might be helpful to consider some alternative explanations of ‘real world’ prices. One could say that (i) prices are ‘causally determined’ by natural forces, or that (ii) prices are accidental (perhaps within certain ‘reasonable’ ranges) at least to the extent that they are never precisely determined. Both of these explanations of prices can be found in the economics literature. The former can be seen in the classical labor theory of value and the latter in more modern macroeconomic models where the everyday price is considered a stochastic variable.

Perhaps both explanations of prices are plausible and should not be dismissed without consideration. Nevertheless, both of these alternative explanations of prices would be considered undesirable from a methodological individualist perspective of neoclassical economics since we would like to explain prices as endogenous variables, that is, as consequences of individuals’ choices. Alternative (i) might easily be alleged to be a denial of ‘free will’, and alternative (ii) might be alleged to be a denial of the possibility of explaining prices [see Boland, 1970, Latsis, 1972]. Stated another way, we will usually admit, rightly or wrongly, that the price is ‘determined’ when someone puts it on the price tag, we have no reason to expect any particular price to be placed on the tag. This raises an interesting methodological question. Is there a plausible way to reconcile these two alternatives to form a more acceptable option? One approach might be to modify alternative (ii) such that we can explain the limits on the range of possible (accidental) prices. We could combine (i) and (ii) by modifying alternative (i) such that the ‘natural forces’ are the ‘causes’ of the limits on any price decision. We could modify (i) by postulating that there are many possible ‘causal determinants’ of any price – which determinants considered to be relevant for the person selecting the price may be accidental or at best arbitrary.

The acceptability of any of these approaches depends on our theory of what constitutes an explanation. The theory of explanation that most economists take for granted is the one promoted by Adam Smith. It is one that can be traced back to a common belief that the famous eighteenth-century physicist Isaac Newton was undoubtedly successful in explaining the mechanics of the Solar System. Newton’s explanation was that the Solar System is in a mechanical equilibrium, one that is completely and rationally determined. Accordingly, if we know all the facts, then given the laws of mechanics, we could determine all the particular aspects of the state of equilibrium (position, velocity, etc.) by means of ordinary rational argument. The philosophical impact of his alleged success was that it led economists to believe that all economic phenomena could be explained relative to a given state of equilibrium (a balance of forces) by explaining each variable’s role in the maintenance of the equilibrium.

The ultimate failure of Newton’s mechanics to explain all physical phenomena (including magnetic forces) was recognized late in the nineteenth century [see Einstein and Infeld, 1938/61], at about the same time that economics was just being established as a serious academic discipline. The failure of Newton’s explanatory method presented a serious dilemma for anyone attempting to explain all aspects of any state of an economy. In particular, the dilemma was, how can we both recognize the apparent failure of Newton’s method and still advocate the use of his rational method of explanation? One response to this dilemma was to attempt to rationalize the apparent failure of Newton’s mechanics – that is, attempt to derive some sort of ad hoc mechanical explanation of the failure, thereby vindicating that method of explanation. Those who felt this was still possible continued to regard all explanations to be ‘rational’ to the extent that they could be represented by a mechanical equilibrium.

Not until the early twentieth century was it recognized that there is another ‘rational’ response which would allow for an alternative to Newton’s mechanics. One version of the new alternative allows us to give explanations by accepting the concept of what might be called ‘natural probability’ in place of ‘natural causes’ or ‘forces’. In this approach, to explain some event we need only to show that the event has a ‘sufficiently high probability’ of occurring under the circumstances [cf. Boland, 1977c]. In light of this new approach, Newton’s theory could be reinterpreted to be a good approximation with a high probability of success. Clearly this is a defeatist position for those who require causal determination although it does retain an air of ‘rationality’ – a ‘sufficiently high probability’ is declared to be ‘sufficient’ reason.

In economics the probabilistic or stochastic view of rational explanation led to the development of econometrics, although the meaning of the term ‘cause’ has been restricted to how we distinguish exogenous from endogenous variables. Moreover, the probability or approximation approach to explanation still allows for a ‘win-win’ methodology. Namely, it could still be said that either Newton’s theory, or any theory, is true (because it can be rationally or inductively justified with observed facts) or its truth does not matter. If it does not matter it is because any explanation is alleged to be only a rational approximation of observed facts, or it does not matter since we can never know all the facts anyway. Clearly, another approach is still possible. We could admit that Newton’s theory or any theory can be false and then set out to correct its flaws or replace it. But for those who believe in the ‘mechanical’ method of explanation, admitting that Newton’s theory is false would be equivalent to admitting that there is no rational method which could guarantee the success of any of our theories.

For some of us, any theory can be either true or false since all theories are conjectures or guesses [Popper, 1963/65]. Whether any theory is true or false does not depend on any extant human having a reliable method to prove the theory’s truth status. Our theories may be guesses about the ‘causes’ of events or guesses about the ‘probabilities’ of events occurring, or merely guesses about the relationships between various objects in the ‘real world’. But most important, any of these guesses may be false or they may be true. Of course, this view of theories applies equally well to our theories of explanation.

1. Methodological Individualism and Equilibrium Methodology

This brief tour of the philosophical origins of the neoclassical economist’s equilibrium-based mechanical theory of explanation leads us back to the various approaches to explaining economic variables such as prices. While recognizing that any specific price marked on a price tag must be decided by people, we have no. reason to expect any particular price to be placed on the tag. Despite the failure of the mechanical theory of the physical world, the concept of equilibrium has some attributes that make it even more interesting for economics where the question of ‘free will’ is a central concern. The concept of equilibrium seems to allow for any individual’s ‘free will’ at the same time as giving a rationalist explanation of the economy as a whole. However, it remains to be seen whether an equilibrium explanation of prices can be constructed such that both ‘free will’ is preserved and a mechanical determination of prices made.

Being able to juggle the apparently conflicting philosophical demands for ‘free will’ with the methodological demands of rational determination and explanation is an interesting challenge, which to a certain extent, has been accomplished within the textbook version of neoclassical economics. By carefully considering this juggling act we can understand such things as why traditional neoclassical theory separates the determination of demand from the determination of supply. Perhaps economists think that by separating demand from supply we can build in a minimum, but essential, element of ‘free will’ for autonomous decision-making. For any particular prices charged, the autonomous individual agent acts freely in deciding what, or how much, to demand or supply. Here we are viewing the separation of demand and supply as a decision made by the theorist – i.e. deliberate methodological individualism. Since this theoretical decision seems rather arbitrary, or at least overly convenient, textbooks attempt to rationalize why it is made. Much of traditional theory has been developed to justify this separation by showing that when demand and supply are separated in the ‘real world’, autonomous decision-making is preserved and the ‘real world’ will be the ‘best of all possible worlds’. Moreover, it certainly would not be the ‘best’ whenever individuals encourage collusion or are dependent on each other’s approval. As Adam Smith’s view of the world would have us believe, we should never depend on authorities such as the church or the state since the ‘best of all possible worlds’ will be achieved when everyone is independently pursuing self-interest and is not inhibited except by givens provided by Nature.

To understand clearly our modern economic concept of equilibrium let us consider it differently. Our equilibrium theory of prices says that prices are social institutions. To say this, however, brings up in a new form the dilemma concerning ‘free will’ versus explanation. There are two basic views of social institutions and they are diametrically opposed. On the one hand there is the strict methodological-individualist view which says that all institutions are merely aggregate manifestations of individual behavior and hence institutions are explained only in terms of the behavior of each and every individual [see Boland, 1979b]. For example, if prices are social institutions, then prices will be the equilibrium prices only if everyone agrees that they should not be changed. On the other hand, there is the strict holist view which says that some institutions have an existence (and hence a determination) beyond the individuals that use or help create them. For example, the real price may reflect its ‘natural value’ or its ‘just value’ or its ‘labor value’, etc. From the standpoint of explaining social institutions, it is strict holism that is specifically rejected when traditionally we reject ‘natural’ causes (such as labor embodiment) as sole determinants of prices.

Since most neoclassical economists today would immediately reject the holist view of institutions, their primary philosophical task is to reconcile a methodological-individualist concept of social institutions with the concept of equilibrium prices. The concept of an equilibrium price must be shown to be a strict methodological-individualist institution – that is, one which can be shown to be the result of the interaction of all individuals yet determined by no single individual or by no natural cause [cf. Arrow, 1951/63].

Almost all modern analytical studies of neoclassical equilibrium models are concerned with this task. Everyone seems to agree that the analysis of a static equilibrium alone will never be sufficient to explain prices in a manner consistent with methodological individualism. Instead, what is needed is a clear understanding of the process of reaching an equilibrium. Expanding our view of prices to include disequilibrium states as well as equilibrium states allows for individualism (the price tag marker) and at the same time recognizes prices as holistic and endogenous givens which constrain individual actions (e.g. by determining opportunity costs). The individual sellers can pursue what they think is in their own interest but in the long run (a run long enough for equilibrium to be obtained), they will find it in their own best interest either to all charge the going equilibrium price or to demand or supply the quantities that are consistent with the equilibrium price.

2. General Equilibrium and Psychologism

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