Infernal Ramblings
A Malaysian Perspective on Politics, Society and Economics

Economists and Their Assumptions

Written by johnleemk on 3:00:03 am Nov 10, 2007.

A frequent criticism of economics is its predication on assumptions. One of the very first things anyone taking an introductory economics course learns is the assumptions underlying whatever theory is being thought.

Every fundamental idea of economics is introduced with the caveat of an assumption — including the theories of supply and demand. The simple idea of a perfectly efficient market-determined equilibrium between demand and supply rests on a number of assumptions: that everyone has perfect information, that everyone is held fully accountable for the costs they impose, and rewarded for the benefits they provide, that there are no barriers to entering the market, and so forth.

Of course, as you learn more, you end up relying less on these assumptions. But assumptions are almost always there. When we consider inefficient markets, or the varying types of efficiency, we simply categorise the market into different types, and assume certain things hold true for each type of market. A monopolistic market, for instance, is one where only one entity supplies all the goods demanded in that market.

Naturally, people protest this reliance on assumptions. It's simply too precarious, they say. In an economist's theoretical world, where everyone is a rational homo economicus, these assumptions may hold true, but in the real world, we do not know everything there is to know about what we buy and sell (many a Nobel Prize has been awarded for work in this area, known as "asymmetrical information"), firms frequently try and succeed to prevent the entry of potential competitors, and so forth.

This is a very neat, tidy criticism. But its tempting simplistic nature ignores the reason why economists make these assumptions: they do them to abstract overarching principles from a complicated world, where it can be difficult to see what is important and what is not.

Physics is one good example: in the real world, friction acts to slow down a rolling ball, air resistance slows a falling ball somewhat, and so forth. But when we want to consider simply the fundamental forces at work, we often ignore the friction, or the air resistance.

Sometimes, in physics, we don't even need to apply an accurate theory or principle. In rocket science, you literally do not need know any of the innovations Einstein made in physics. For NASA's purposes, Isaac Newton's theories work just fine, even though Einstein proved them wrong.

The same applies in economics. Economists make assumptions to tease out what they think are the more important factors; some degree of simplification is needed to look at the effect each variable has. You can't learn very much about gravity or friction unless you separate them out, and the same is true in economics.

A valid criticism, however, is that while physicists eventually do bring these isolated variables together, considering the combined effect of, say, gravity and friction, economists are not always able to predict how the complex market will turn out.

In all fairness to economists, physics is pretty simple: the mathematics you use is a natural way to break down the natural world. But in the strange world of humans, mathematics can only provide a rough approximation to human nature; in other words, we are stuck with a Newtonian theory, a theory which we know is wrong at the most complex levels, but one we rely on to a large extent because we know it gets the broader things right.

Economics is unfairly criticised for its assumptions — the simple truth is, we have to simplify and abstract a complicated situation if we want to tease out the effects of different things. And to do that, you have to assume certain things about the world which don't hold true. Without assuming, you can't reach the important, broad fundamental principles.

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Infernal Ramblings is a Malaysian website focusing on current events and sociopolitical issues. Its articles run the gamut from economics to society to education.

Infernal Ramblings is run by John Lee. For more, see the About section. If you have any questions or comments, do drop him a line.

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