April 11, 2013


Neo-classical economists present a variety of models that are meant to predict human behavior in a marketplace and, therefore, allocate resources accordingly. Unfortunately, most of these models assume that human beings will behave according to the assumptions within the models. The choices and predictions that are made are based on various variables that are presented in equations, which are represented by curves in the model. It is my understanding that the world does not quite operate in this way. Rather than human beings acting mechanically to fulfill assumptions and variables in an equation; I’m quite certain that human action is based on something more real. Humans do not act in order to maximize utility subject to a budget constraint, although this is what the consumer preference model is telling us. Humans act, rather, to change the world from what they perceive it is, into what they perceive it ought to be.

Why then, is so much market analysis based on these models that describe human action in a way that is not consistent with reality? The equilibrium form of economic analysis is fallacious and the assumptions broad. Equilibrium itself can never be achieved. Hayek, in his essay “Economics and Knowledge” describes the impracticality of equilibrium analysis. Hayek asserts that economic equilibrium analysis only has a use when applied to a single individual. Once other individuals and aspects are tied into the analysis, the method becomes flawed. This is because equilibrium analysis implies an absence of time and perfect knowledge of the future.

            The models that are used in modern equilibrium analysis act as tools; tools that economists use to understand how the world works. They have implicit truths within them. For example: a demand curve has to be downward sloping. As the price increases, the demand for the good or service decreases. However, economists have taken these tools and used them in an attempt to make objective quantitative measurements regarding the future state of the economy as a whole and the respective market resources. Because the world is dynamic and changing, the models include false assumptions, and to attempt to make such precise calculations based on such fallacious assumptions poses a potential threat to the future health of the most important economy: the economy of the individual.

Equilibrium itself can only be reached by an individual, and only for a moment in time. As soon as the expectations of the individual, or other individuals, change, then there can no longer be equilibrium. If the world wasn’t changing, and there was “perfect knowledge” and no passage of time as the model assumes, then the world would be in a constant state of equilibrium and no one would need to change their expectations. This, of course, is an absurd state that can never take place in our world. Our world is unpredictable, as are the choices that individuals make regarding the allocation of various resources.

While the tools that neo-classical models allow us can be useful in our understanding of how the world works, today’s economists should not put their focus on using them to make precise economic measurements and predictions. The role of economists should be; understanding the role of knowledge and how to use the division of knowledge so as to improve the well-being of both the individual, and society as a collective. This involves using common-sense analysis instead of complex, mathematical analysis. In this way, economists can use deductive reasoning subject to facts when applied to the real world problems that society is so desperate to solve.

“if the tendency toward equilibrium, which on empirical grounds we have reason to believe to exist, is only toward an equilibrium relative to that knowledge which people will acquire in the course of their economic activity, and if any other change of knowledge must be regarded as a "change in the data" in the usual sense of the term, which falls outside the sphere of equilibrium analysis, this would mean that equilibrium analysis can really tell us nothing about the significance of such changes in knowledge, and it would also go far to account for the fact that pure analysis seems to have so extraordinarily little to say about institutions, such as the press, the purpose of which is to communicate knowledge.” –F.A. Hayek “Economics and Knowledge”

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