[ExI] Psychology of markets explanations

[Dan]

--- On Tue, 6/2/09, Stathis Papaioannou <stathisp at gmail.com> wrote:
>> I don't think they and I mean the same thing by
>> economic laws here.  It seems to me, and either can correct
>> me, that they see economic laws as provisional or not laws
>> at all, and reduce economic phenomena to psychology -- hence
>> my subject line.
> 
> Yes, and I don't see how this could be a point of
> contention.
> Economics *must* supervene on the interaction between human
> behaviour
> and the physical environment, just as the mind *must*
> supervene on
> brain processes, unless you believe there in a magical
> spirit that animates the mind or the economy.

I'm not exactly sure what you mean here.  Would you explain what you mean by economics supervening?

>> Earlier, it seemed to me that Stathis was offering up
>> a psychological explanation of the current crisis -- the
>> "animal spirits" of a lot of people suddenly got scared of
>> buying homes.  I actually think that type of explanation
>> (if that does justice to Stathis's position; I believe I
>> might have misinterpreted him here, but he can correct me)
>> is actually wrong and close to useless.
> 
> You can come up with a deeper explanation, such as an
> excess of
> liquidity causing asset price inflation, but in the end it
> is still
> peoples' reaction to the excess liquidity (or whatever it
> is) that drives the economy.

Here's where economics comes in handy.  As a general rule, when people have more of any good -- including money -- they are able to satisfy more wants that that good is useful toward satisfying.  E.g., imagine the classic case of a man on an island with five sacks of grain.  Let's say he has all sorts of wants -- including to eat bread during the current season, to plant for the next season, to feed chickens so he can have eggs, to ferment some of it to make beer, to feed cows for milk and cheese, and so forth.  Let's say he can use one sack to satisfy each of these desires.  If has more grain, he can do even more -- up to the point where he has so much that grain is no longer an economic good.  (That means not that there's an infinite supply of it, but that he's exhausted all that grain will do for him.)

As long as grain is an economic good, more of it will be better -- because it satisfies more wants and less will be worse because he will not only satisfy less wants but forced to choose between which wants to satisfy (e.g., the grain he uses to feed chickens can't be used for bread or to feed cows).  In fact, the Law of Marginal Utility states that he will, if he's forced to economize -- i.e., has more wants than can be satisfied with his means -- he will drop the least desired ends first.  In this case, and this is the classic example, let's say one sack is destroyed -- maybe a wild board breaks in and eats it while he's out getting sun.  Now, he's forced to give up one of his desires -- maybe he'll (as irrational as it might seem to some) judge beer to less valuable than having milk, cheese, eggs, bread now, and a harvest next year.  Or maybe he'll give up bread now.  This depends on his hierarchy values at the time he makes the choice.

Now you might say that if he changes his wants -- the psychological angle? -- then all of this changes.  Granted, but that doesn't annul economic laws.  In this example, I even mentioned that when a sack is destroyed, he no longer has the luxury of five ends.  He must choose four (or less) of the five.  Psychology might tell us why he chooses to drop beer or to drop eggs or drop whatever (or adopt a totally different set of ends), but the Law of Marginal Utility tells us he will drop whatever he values the least of the five.

(This would apply too if this lone grain user viewed grain as a status symbol or something like that.  In that case, he would have a scale of values where status figured in -- maybe knocking out other items from the list.  Imagine, e.g., he wants to show off that he has ten sacks of grain in storage and still needs five to satisfy his other wants -- beer, bread, feeding livestock, etc.  If he loses one sack, he must then decide what must go in his value scale.  He might decide that status isn't that important -- and let's say it matters having ten sacks for status; nine won't cut it -- and suddenly he's awash with nine extra sacks of grain.  Or he might decide status is so important that he gives up (again, as blatantly irrational as it might seem to some) beer to keep the ten grain status symbol.)

> An analogy from physics might help illustrate my point. We
> know that
> there are billions of gas molecules all jostling each other
> in an
> extremely complex way, but the relationship between
> pressure and
> volume for the gas as a whole can be approximated by the
> very simple
> Boyle's Law, PV=k. But we know that Boyle's Law *must* be
> due to the
> complex behaviour of the individual molecules, even if it's
> useless or
> impossible to try to follow those individual molecules in
> order to try
> to predict the behaviour of the gas.

I think you're getting at economic laws being statistical averages.  I disagree.  The Law of Marginal Utility apply even when there's just one person involved -- as noted from my example of using just one person and one means (grain).  That said, things do get complicated very fast when you have many people with different values scales interacting, but the same Law that applies to one person applies to many.  Economic laws of the praxeological sort are bottom up: they describe individual action.  The sort of statistical generalizations are, at best, clues to economic laws, but more usually they are just statistical generalizations that fail when conditions change.  (On the latter, think of the Phillips curve and its failure to predict stagflation.)

Regards,

Dan