Why I Love Economics

Over at Simple Justice, Gritsforbreakfast left this comment:

My college major was economics, and I was downright angry when, after learning all the theory, it became clear that nearly every “assumption” economists said make free markets “work” was actually, demonstrably false. E.g., people have perfect information, make rational choices that maximize their self-interest, etc.. For such an important topic, there’s a lot of voodoo and crap in that discipline.

I’m only an amateur economist at best, but as someone who relies on economic arguments a lot, I felt compelled to explain myself. (I left a comment there, but I’m elaborating a bit here.)

Grits is right that the assumptions of economics are not literally true, but that’s why they’re assumptions. The real world is complicated and messy, so science and engineering disciplines use simplifying assumptions to make the problems easier to solve.

Sometimes this leads to grave errors which are often discovered only when disaster strikes. The builders of ancient churches had for centuries neglected the effects of mild winds to no ill effect. However, once they started to build really tall churches, the daily winds would push the brickwork back and forth, causing the mortar between the bricks to slowly grind away until the walls fell.  For this reason, the history of church architecture proceeds from short churches to tall churches that collapsed to churches with buttressed walls…and eventually to churches made of sterner stuff.

The trick is to recognize when the simplifying assumptions are no longer applicable.  If the assumptions are carefully chosen—and the conditions of their use are understood and respected—the results are often good enough. A structural engineer designing a building can simplify his calculations by assuming the Earth is flat, and he will have no cause for regret.

When it comes to the market economy, I think the theory of free markets is good enough in most cases. It’s true that the market only produces perfect resource allocations under perfect conditions, but there is reason to believe that many small deviations from perfect conditions lead to only small deviations from perfect results. In addition, competition tends to correct long-term deviations.

Finally, When it come to free-market economics, I have to admit I’m emotionally attached to the assumption that people are rational utility maximizers.  That bit of jargon is an economist’s way of saying that people know what makes them happy, and they will act intelligently to obtain that happiness, within the limits of their abilities and circumstances.

On an individual basis, this is obviously not true: We all screw up all the time and make ourselves miserable.  But there’s some pretty good evidence that on average we do a pretty decent job.

More importantly, despite any mistakes you may make, when it comes to making decisions about your life, you have more information than anyone else, and you are more motivated to make the right decision than anyone else.

So while people make bad decisions about their lives from time to time, they are less likely to screw up than any one else making decisions for them, including legislators, government bureaucrats, and cops.

Contemporary economics therefore encourages a principle of public policy that is breathtakingly respectful towards ordinary people:  To the greatest extent possible, people should be allowed to control their own lives.

I like that a lot.