[ExI] Psychology of markets explanations

Dan dan_ust at yahoo.com
Wed Jun 3 15:18:49 UTC 2009

--- On Wed, 6/3/09, Stathis Papaioannou <stathisp at gmail.com> wrote:
[snip of explanation of Law of Marginal Utility]
> I don't disagree with any of this, but you have just been
> describing
> what will happen as a result of the man's behaviour. That
> there are
> reliable patterns of behaviour and reliable consequences of
> the
> behaviour, for example giving rise to the Law of Marginal
> Utility,
> does not negate the fact that behaviour is due to
> psychology.

I think that particular Law would apply to any acting entity that values and has limited means -- viz., means that are incapable of achieving all its values.  If you're going to say that broadly speaking this is psychology, fine, though I don't think economics need dip into the particular psychologies of various actors.  Economics need only start from the conditions that people act -- have particular values (what these are is the stuff of psychology perhaps), limited means, and must use the latter to achieve the former.

I also believe this will, to a great extent, explain market phenomena, such as inflationary booms, price ceilings (below the market price*) causing shortages, and the like.  One need not, in these cases, call up anything else to explain the particular outcomes.  (The "all else being equal," of course, applies here.  Obviously, for instance, a price ceiling will create shortages only if the market clearing price remains above the ceiling -- i.e., if supply and demand remain the same (or close enough).  Were demand to drop (say, because people's tastes change) or supply increase (say, because some entrepreneurs do discover a way to make more of the good for less).  And, of course, setting a price ceiling below the current market price and hoping that either the demand will fall or the supply increase (or both) is wishful thinking.  That's like censoring a book and hoping no one would want to read it anyway -- or outlawing homosexuality and hoping that all
 gays will change to being straight.)

So where would, for you, psychology enter into the discussion of, say, the current financial crisis in a way that would actually add something to the explanation?  Simply saying that had people changed their preferences is not enough in my view.  (Recall, too, the problem with an inflationary boom is not so much preferences as such as conditions that created contradictory expectations about preferences -- specifically that one can increase both consumption and savings at the same time.  (Artificially low interest rates or an increased money supply, initially, sets up the expectation that the supply of loanable is higher than it really is.  This simultaneously creates a disincentive to save (or lowers the incentive to save) and an incentive to spend and borrow.**))



*  A price ceiling above it would make no sense.

**  Of course, inflation expectations enter the picture too.  Inflation, however, is highly path dependent, so it creates many problems for those attempting to forecast its rate and the relative price changes.  (And, inflation expectations at the beginning tend to be zero or very low while near the end they tend to be very high.  A hyperinflation seems to happen not when inflation reaches infinity, but when inflation expectations becoming so that people simply stop using the inflated money all together.)


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