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Principles of Economics for a Post-Meltdown World

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Principles of Economics for a Post-Meltdown World

A Critique of Samuelson and Nordhaus’s Economics 19th edn

A WEA Press ebook by John Komlos


John describes his book:

My main goal in this volume is to emphasize the ways in which introductory economics textbooks are misleading insofar as they sing the praises of free markets, keeping any demurrals muted. I am convinced that current principles books are inadequate for the post-Meltdown world and students know it, as evinced by such events as the walkout from Econ10 in Harvard and by the global Rethinking Economics movement. Actually, they are more than inadequate: they are misleading and hence “toxic” for a large number of reasons including:

  1. they rely on the rational agent model thereby completely disregarding the work of Herbert Simon and Kahneman and Tversky; in an important sense the standard assumptions in economics are pre-Freudian and pre-Pavlovian.
  2. they disregard the effects of incomplete and asymmetric information on choice and on allocation by overlooking the path-breaking work of scholars such as Ackerlof and Stiglitz. In other words, the standard economics principles textbook is plainly anachronistic.
  3. they assume that tastes are exogenous, which, of course, is utterly misleading. This is important because conventional economists do not consider the extent to which there is a feedback effect from the business community to influence individual tastes.
  4. they provide examples of simple choice between two goods disregarding that choice almost always involves a sequence of decisions which is computationally much more demanding than the no-brainers they offer as examples. They overlook the fact that path-dependence is a major hindrance to optimization.
  5. they overlook interdependencies. There are all sorts of externalities not only in production but in consumption as well. Just think of Veblen goods.
  6. they pretend to be scientific and value free but end up being fully ideological.

These examples are not meant to be exhaustive by any means but illustrative of the many ways in which mainstream principles of economics textbooks distort our worldview with immense political and cultural consequences. Students of principles deserve a more complete perspective. Thus, my goal is to critique the conventional worldview and provide an alternative perspective. My version of free-market economics emphasizes that the human element should be paramount and moral judgments should override market outcomes to the extent these are not to the benefit of the common weal. In other words, what is important is not GNP as much as the quality of life. Not institutions but how people live and fare in them.

To illustrate John’s approach, here are three extracts. S&N’s statements are in italics, followed by John’s critique:

“A cool-headed analysis indicates that the minimum-wage debate centers primarily on issues of interpretation rather than fundamental disagreements on empirical findings.” (S&N p. 78)

The actual cool-headed analysis indicates that this is a sensitive issue that turns on ideology and on which model one applies to the problem. In their analysis, S&N use a perfectly competitive model without any imperfections (in their Figure 4.12, p. 79). Of course, that model is completely irrelevant to the current economy insofar as there are hardly any perfectly competitive markets left. Thus, an oligopolistic model would have been the correct model to use in their analysis.

Today the low wage employers are almost all oligopolies such as in the fast food industry or the “big box” stores such as Walmart, Target, or Lowe’s which  earn a lot of profits. In such an oligopolistic market an increase in the minimum wage comes out of profits and does not lead to unemployment. Hence, an oligopolistic model would have been called for.

“Inefficiencies associated with the minimum wage.” (S&N p. 79)

S&N claim to be scientific and promised to tell the students the truth but instead they mislead and obfuscate at every turn to suit their ideology. This is an excellent example. The matter of fact is that: there does not have to be any inefficiency associated with the minimum wage at all. That is a myth. There may be, but it does not have to be. That makes a world of a difference. Their analysis of the minimum wage would be applicable to a perfectly competitive labor market and with full employment. Of course, if that were the case and the wage were increased the demand for labor would decline creating unemployment. But the last time we had full employment was in 1944! That was a long time ago. In other words, the model they apply is irrelevant to today’s economy.

Discussing price controls at a time of gasoline shortage S&N suggest that: “If the free market were allowed to operate, the market would clear with a price of perhaps $3.50. Consumers would complain but would willingly pay the higher price rather than go without fuel.” (S&N p. 80)

It is absurd to jump to the conclusion that consumers would be willing to pay the higher price without providing any evidence whatsoever to support that assertion. To be sure, some would be able to afford the higher price but others would not have the money to do so. Admittedly, the market might work better if incomes were equally distributed but that is far from being the case and as a consequence, the increase in the price of fuel would hurt the poor much more than it would the wealthy. Again, S&N show no sympathy whatsoever to the plight of the poor. As a matter of fact, there are no poor people at all in their models although there are no less than 45 million poor in this country, hardly a slight oversight.

S&N continue by suggesting smugly that politicians would “fret” about the high prices of gasoline. Yet, these are legitimate concerns, because at a time of national calamity it is not fair to have the rich more advantaged at obtaining gasoline than the poor for whom a rise in gasoline prices can be a painful development. Hence, the concerns of the politicians are legitimate. Letting queuing up for gasoline do the rationing is much more democratic in such an emergency, because time is the only resource that is distributed equally. In contrast, money is extremely unevenly distributed.

Obviously, letting market processes do the distribution in such an emergency favors the wealthy unduly unveiling the imbedded hidden biases of mainstream thinking. Hence, depicting government’s helping the poor as “interference” (p. 79) in the free market is a distorted interpretation of the problem. Price controls on necessities such as gasoline are legitimate in a market in which there is a skewed distribution of income, particularly if other policies to redress the inequalities are not open to the policy makers.

From: pp.10-11 of World Economics Association Newsletter 5(5), October 2015


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2 responses

  • David Butcher says:

    “Discussing price controls at a time of gasoline shortage S&N suggest that: “If the free market were allowed to operate, the market would clear with a price of perhaps $3.50. Consumers would complain but would willingly pay the higher price rather than go without fuel.” (S&N p. 80)”
    “It is absurd to jump to the conclusion that consumers would be willing to pay the higher price without providing any evidence whatsoever to support that assertion.”
    – Having been a Minister of Energy who deregulated liquid fuel prices my experience was that after a few weeks petrol prices were lower and more stable without price controls than they were with them (New Zealand had price controls for more than 40 years). Why would this be?
    – Under price controls companies had to apply to the government for permission to increase prices. Governments did not want the political responsibility for the increase so delayed in the hope that the need would go away. Eventually, officials would study the issue and recommend a price increase. Maybe several months had passed. Therefore, companies had to be allowed to claim extra to cover the revenue lost. This meant that retail prices were higher than they needed to be. Even when the recovery was fully recovered the price would not go down. The next time there was an increase the increase would be based on the artificially boosted price. At my first meeting with the oil companies (there were 5) each had their CEO, CFO and top legal adviser present. On my side I had one senior official from the ministry, a good friend from university days and the official in charge of the calculations who had failed school certificate 30 years before, but nobody could understand it as well as him. Almost immediately, I concluded that it was better to have the companies fighting each other rather than them ganging up against me! Part of the deregulation process was ending protection for the one refinery in the country. They claimed competition would cost them $400 million. We offered them $80 and they accepted. Even that reduced level was completely unnecessary – it underwent intensive cost cutting and became the most profitable company in the country. In the last 25 years nobody has advocated returning to price controls!!

  • Paul Grignon says:

    I have another to add to the list:

    g. They (and the author of this piece) ignore money and banking completely.

    Try refuting ANYTHING in the simple cartoon (2 minutes 17 seconds) linked to below. No one has been able to do so since 2009. At the same link you can also read about my experiences trying to get economists to actually look at money and banking (futile).

    I am the author of Money as Debt (2006) and Money as Debt 2 (2009) feature length cartoons that predicted and explained the Crash of 2008 and the subsequent ongoing debt crisis as features baked into the growth-addicted DESIGN of banking.

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