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Wednesday, October 10, 2007

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Lafayette

From Chapter 1: "... our general impression is that so far
rather few economic elements have been brought into psychology."

They can say that again.

It is curious that, in a science that bases a great deal of its fundamental principals upon consumer demand, and relates to that factor employing the word "propensity", then it is surely opening itself to a psychological dimension.

Consider present history, i.e., the speculative sub-prime frenzy. Was that not psychological in nature? Even though elliptical comments posted regarding the subject tried to analyze the phenomenon in a purely scientific way.

Any marketeer knows that they must "seduce" the consumer to buy their product and neither assuring its availability (supply) nor prompting consumer interest (demand) determines -- really and truly -- price. (In fact, the Supply/Demand model is a purely academic explanation of a far more complex interactive function between the two variables.)

Even in business, we like to think that investments respond to a well articulated R-O-I analysis -- when in fact most FDI depends upon a herd-instinct to do what others have done, because it seems less risky if others are already doing it. (This behaviour has been observed in mice as well.)

So, I would not remain with psychology alone as an influence on economics but add sociology as well. Maybe we have the birth, thereby, of a new science? Called Socio-psychological Economics?

Lafayette

Also from Chapter 1: "If an individual buys, sells, or produces more of a good, an individual j might either have an incentive to decrease her demand or supply (i.e., strategic substitutability prevails between actions) or to increase it (i.e., there is strategic complementarity between actions). With strategic substitutability, a minority of rational agents can be sufficient to produce a rational outcome ,while with complementarity a small fraction of irrational agents can lead to strong deviations from market fundamentals, as observed with the stock market bubble in the late1990s."

Economists should be taught (1) plain English, (2) never repeat words that have synonyms – it’s lazy writing and (3) use concrete examples to explain abstract notions.

Apparently “complementarity” is important to the authors, they repeat it twice, just like “substitutability”. But, they never explain what the words mean by simple examples that the uninitiated, like me, can understand in a given context.

We are supposed to comprehend from the context because …. like them, "we speaka da lingo”. Bollocks.

Anyway, if all the above somehow explains the psychological stock market frenzy referred to in the very last sentence … I’m a monkey’s uncle. (He wrote, scratching his armpit. ;^)

Martijn Boermans

You have a good point that economists implicitly keep their analysis abstract thereby making a strong assumption about the context. Every analysis in current economics assumes equilibria, rational actors and optimizing behavior.

The incorporation of uncertainty and imperfect information has led to a
fundamental paradigm shift in economics (e.g. Stiglitz, 2002; Kuhn, 1970). Traditional economics
holds that supply and demand forces gravitate the economy towards a general equilibrium. Total
welfare of society is determined and derived from decisions and actions of individual agents. On
the basis of information individuals choose and behave in order to obtain maximum utility.
Understanding how decision-making agents think about problems is a new area of economics

Yet, this idea of optimal cognition suffers from an infinite regress problem: if cognition is costly, then optimizing cognition is also costly, leading one to optimize the optimization, and so on ad infinitum (Conlisk, 1996; Lipman, 1991). Decision-making requires cognitive operations, including information acquisition and information processing, which often happen under suboptimal (non-rational) conditions. The analysis of cognitive processes creates elementary doubts to the traditional assumption of rationality. Agents are assumed to act bounded rational.

I myself am a graduate student in Multidisciplinairy Economics and I pray the authors of this book for laying a new foundation within the economic discipline and beyond. Aside from the formalistic presentation, I agree with a analytical science which incorporates both psychology and economics, Rigor analysis is fruitful and people who need examples from everyday life might not understand the beautiful world of hyperspace.

For example, many psychologists know about the phenomena of the "self serving bias". Ask an economist what this means and you have low chance of finding any experts. However, a short mathematica presentation of this interesting phenomena (formalistic language, sorry for the repetition, but by definition a necessity) and "the economist will understand it most deeply". [see eg. Kaplan and Ruffle, "The Self-serving Bias and Beliefs about Rationality", in Economic Inquiry, 2004, vol. 42, issue 2, pages 237-246.]

A free exhange of ideas between psychologists and economists can only continue if psychologist dare to encapulate mathematical language. Economists must understand that humans are not automatic rational calculating machines, but embrace insights from psychology into the beauty of human 'automatic' irrationalities (I wrote a thesis on Fear Appeals)

Martijn Boermans

[edit: I have made two quotes from my working paper "The Microeconomics of Information Acquisition"]

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