Some economists think the 1871 revolution was a big mistake, and led economics down the wrong path. They take their inspiration from pre-1871 economics, especially Ricardo and Marx, and proceed from there. Many of them are very smart and knowledgeable people. They think that most academic economists ignore them and know little or nothing about their work. I think they are right about that. And I think that many of them get frustrated because they think they've got something important to say and the people who most need to hear it don't listen or don't even know they exist and so continue down their wrong path in blissful or even willful ignorance.
One of the problems in the economics of search is that you need to form some sort of estimate of the probability that search will be successful. And how can you know that probability before you've done a thorough search and found out what proportion of rocks contain gold? It's a bit like that in deciding what to read. You won't know if it was worth reading until after you've read it. But there are far more things that might be worth reading than you can possibly read. So you follow various rules of thumb that seem to have worked for you in the past. You read a new book by an author whose previous books you had read and liked. You follow the recommendations of other readers who have read and liked the same books as you. But rules of thumb like this can be self-replicating. You can get stuck in a genre. There must be some very good authors out there that nobody reads simply because nobody reads them. And different circles read different authors simply because different circles read different authors. Search equilibria may be path-dependent.
I didn't take a gap year between school and university. I took a gap year in the middle of my PhD program, when I should have been writing my thesis. I didn't tell anyone I was taking a gap year. It's hard to monitor what PhD students are doing when they have finished their courses.
Probably like most, my gap year was a wasted year, when looked at ex-post, and even ex-ante, from the perspective of what was good for my career. I should have spent the time sticking to my knitting and banging out three money/macro essays for a quick thesis. But I needed to do it.
When I told Ian Steedman (he was visiting Carleton in the 1980's) how I had spent my gap year he could articulate my reasons and how I felt at the time better than I could. It was partly just sheer curiosity and looking for something new, because maybe the economics I had learned might not be the whole story, even in broad outline, and had probably left a lot of interesting stuff out. And it was partly inspired by taking David Laidler's History of Thought class. But it was also an almost existential self-doubt, when you wonder if everything you think you know and identify yourself as believing might be totally wrong. And I had vaguely heard about those economists who thought that economics had taken the wrong path in 1871. And they weren't just saying that post 1871 economics needed improvement, or wasn't a perfect fit empirically (so what else is new?); they were saying that post-1871 economics was logically flawed. That was an existential challenge.
So I gathered up my courage and started reading, more or less at random. It had to be more or less at random, because the very nature of the problem was that I might be stuck in a path-dependent search equilibrium reading the same genre as all the people I knew, and I couldn't trust any guide, even if I knew one.
Eventually I abandoned my search and went back to writing my thesis. I didn't abandon my search because I became certain that the critics were wrong, though my search did eventually increase my subjective probability they were following a path that would lead nowhere very interesting. There was always the possibility that I would find gold if I just looked under the next rock, or dug deeper under a rock I had already looked at. But I was running into diminishing expected returns, and there was an opportunity cost to my search as well. Not just writing my thesis, but spending the time reading about asymmetric information or thinking about doing macroeconomics with imperfect competition seemed more valuable alternative uses. Time spent searching in one area has an opportunity cost. It wasn't a waste of time, because I did learn stuff. And it forced me to think through stuff that I thought I understood so I could understand it better than I did before. But it didn't seem worthwhile on the margin to continue any further.
The 1871 revolution in economics (Jevons, Menger, Walras,.. and Marshall, when classical economics became neoclassical economics) is usually called the marginal revolution. Which makes it sound rather trivial. Calculus wasn't exactly new in 1871, and if someone is choosing something to maximise something then looking at first derivatives (which is what things like marginal utility and marginal product are) seems sort of obvious. What was revolutionary about 1871 was the subjectivist revolution. Thinking about margins mattered only because thinking about margins made it possible to think about goods having subjective value. Otherwise you are stuck wondering why water should be worth less per gram than diamonds, when we would prefer living with no diamonds than dieing of thirst wearing diamonds. Water has higher total utility but lower marginal utility.
Goods don't have value; people value goods. It doesn't matter how much labour or other resources were used in the past to produce this good; if nobody wants it now or is expected to want it in future, it has no value. Why is the labour of a skilled soccer player worth more than the labour of a skilled cricket player, when both had to practice equally hard to create those rare skills? Because people prefer watching soccer to watching cricket. You cannot separate the theory of distribution from the theory of value, and both value and distribution depend on preferences. Is labour even a cost of production? Not if that labour is spent doing something that, at the margin, I find enjoyable, like fixing my car. Thinking about economics like that was a revolution.
If people were all converted by some millennial cult and suddenly stopped caring about the future, and only cared about the present, then the prices of all assets, both real and financial, that could not be physically converted into goods that created immediate pleasure, would immediately drop to zero. Nobody would pay anything for any future benefits those assets might create. Both saving and investment would go as far negative as is physically possible. You simply cannot talk about capital and interest without talking about people's subjective preferences for future goods.
Right now there is a stock of capital goods of many different types. And if markets are competitive those capital goods, like all the different types of labour and different types of land, either individually or in combination with other resources, are earning rents equal to their value marginal products. (Or marginal revenue products if markets are imperfectly competitive.) And people have expectations about the streams of rents those assets will earn in future. And asking how much we value those assets is to ask how much we value those streams of future rents. And the answer, in part, is inherently subjective. How much do we value the expectation of those future streams of goods that the expectation of those future streams of rents will let us buy? And our subjective evaluations of those future goods will in part determine the current price of capital goods, which influences the current production of new capital goods, which will influence the future stocks and the future value marginal products of capital goods. So, if we are rational, our expectations of streams of future rents will take into account the current and likely future production of capital goods.
I just don't see how you can talk about value, capital, and interest, without talking about people's subjective preferences for current and future goods and people's subjective expectations about the future. Far from leading economics down a fundamentally flawed and logically incoherent path, the 1871 subjectivist revolution seems to me to be an essential pre-requisite of any coherent understanding of value, capital, and interest.
How do people form their subjective expectations about the future? Good question. But we can't duck it by ignoring those subjective expectations. They matter. If everybody expected that all capital goods would fall apart tomorrow, or they thought that people would suddenly stop wanting the particular goods those particular capital goods could produce, the current prices of those capital goods would drop to zero. Unless you could eat the capital goods now.
It was over 30 years ago now, my memory is not good, and it was a random search, and so I can't remember what I read and didn't read, or read part of and abandoned. And I didn't understand some of what I tried to read and understand. I abandoned Sraffa's book, which isn't exactly user-friendly, because he just jumps right into the algebra. My attempt to understand his quest for Ricardo's invariable measure of value was a bit like an atheist trying to understand the quest for the Holy Grail. Not just "Why are you looking?", but "If you did find it, how would you know you had found it?" and "what would you do with it if you did find it?"
I'm pretty sure I understand why "The rate of interest is determined by the marginal product of capital" is wrong, except under very special assumptions. But a simple Irving Fisher diagram is sufficient to show that that is wrong. Or a simple model where there is no capital and no investment and only consumption loans tells you it can't be generally right. Or a model where there is only land that produces wheat and wheat is measured in tons and land is measured in acres so the marginal product of land has the units tons per year per acre which can't possibly be equal to the rate of interest, which has the units per year, and how you need to talk about people's preferences between wheat today and the stream of future wheat an acre of land can give you to determine the price of land in terms of wheat and thus the implied rate of return on buying land.
A few years later Luigi Pasinetti lent me one of his papers which, IIRC, had a pure consumption economy with no capital where the rate of interest was determined by people's subjective preferences for future vs current consumption. His paper seemed right to me. It was simple and clear. And it was consistent with my prior beliefs. But it was the only such paper I remember from those who think 1871 was a mistake, and it was a paper that seemed to be saying that 1871 wasn't a mistake, because it showed that subjective preferences matter??
My gap year was a very confusing year. I still can't really figure out what it was all about. Apart from the occasional flashback, I have moved on, because other things seem more worthwhile. But I really did try to listen, and understand.
Addendum: I was reading through the Wikipedia for Luigi Pasinetti, just to refresh my memory and see what I might have missed. It's a very good Wikipedia, which someone has clearly taken the time to do well.
Some notes:
1. There's a typo in equation 1.1 or 1.5. The X should be Y or vice versa. (No big deal. Just to show I was paying attention and understanding what I read.)
2. Consider these two sentences:
"At the same time, prices though of course not equal to, are exactly proportional to the quantity of labour embodied in each commodity. This is a perfectly clear labour theory of value."
The first sentence is missing an absolutely crucial three words, and that omission is the only thing that makes it appear that the second sentence follows from the first. Those three words are :"at the margin". Because it is certainly not true in Ricardo's model that prices are proportional to the average quantities of labour embodied in each commodity. The total exchange value of wheat produced, divided by the total quantity of labour used to produce it, is greater (in Ricardo's model, and as presented in the Wiki) than the total exchange value of gold produced divided by the total quantity of labour used to produce it.
We normally interpret the labour theory of value to be about average, not marginal, quantities of embodied labour. In which case the labour theory of value is false in the Ricardian model.
If instead we interpret the labour theory of value to be a statement about the marginal quantity of labour embodied (the extra amount of labour needed to produce one extra ton of wheat) then the labour theory of value is also true in the neoclassical theory. Because the quantity of socially necessary labour embodied at the margin is just the reciprocal of the marginal product of labour. If that's how you define the labour theory of value, then the labour theory of value is true in neoclassical models. It's true for each and every different type of labour. And the land theory of value is true too. And the oil theory of value is true too. And the screwdriver theory of value is true too.
Gimme a break guys. We figured this all out in 1871.
Then my ADD kicked in again.
The best paper I read in my gap year was Herbert Gintis and Samuel Bowles "Structure and Practice in the Labour Theory of Value" (abstract, full article gated). Two Marxists (at least I thought they were sort of, at the time). They start out by laying out clearly and simply several devastating arguments against the labour theory of value. All the arguments I had previously heard of, and maybe a couple I hadn't. By this time they really had my full attention and massive amounts of credibility. "I have no idea where they are going with this, and how they can possibly escape like Houdini and still say there's some validity to the labour theory of value; but I sure do want to listen to what they say!" And I was handsomely rewarded by a presentation of what would later be called the "efficiency wage theory of unemployment".
There is some gold out there.
Worthwhile Canadian Initiative 
The way this post starts out, it nearly implies that your gap year occurred in 1871. I know you always make jokes about your being old, but this is ridiculous! 😉
Great post. I really enjoyed it.
Thanks Ryan! I was going to call it “1871 and all that”, but then I thought that only old Brits might get the joke.
“Goods don’t have value; people value goods. It doesn’t matter how much labour or other resources were used in the past to produce this good; if nobody wants it now or is expected to want it in future, it has no value. Why is the labour of a skilled soccer player worth more than the labour of a skilled cricket player, when both had to practice equally hard to create those rare skills? Because people prefer watching soccer to watching cricket. You cannot separate the theory of distribution from the theory of value, and both value and distribution depend on preferences. Is labour even a cost of production? Not if that labour is spent doing something that, at the margin, I find enjoyable, like fixing my car. Thinking about economics like that was a revolution.”
um…. that’s why it’s called “socially necessary labor time” not “random labor somebody just starts to do time”
In the first couple chapters of Capital Marx sets out pretty clearly that items only have value in a society (in the case marx examined, simple commodity production societies )through the particular social relations that items are produced and distributed in that society (production and exchange). This is very basic and certainly wasn’t discovered by the subjective marginalists.
Nathan: but once you add the “socially necessary” bit, and unpack it, and follow it where it leads, it leads right away from the labour theory of value. If some goods were “socially necessary”, even if they embodied no labour, and even if we had forgotten or were unable to reproduce them, would they still have value? And the answer is “yes”, if they have positive marginal utility. And even if we can reproduce them, it is equally true to say that the value of diamonds determines how much labour we will expend at the margin to find an additional diamond, rather than the reverse. Would people spend so many days digging for an extra diamond if we didn’t value them as much as we do?
@Nick: so? Marx never actually called his theory a labor theory of value. that’s an application of critics and enthusiasts alike.
you can analyze those goods in a framework that isn’t marginal utility theory. You’re also making a dig at Marx for essentially not having the logical method that you had. Marx starts at what he sees as the beginning and goes out from there. he never got close to finishing capital. not to mention that major important works weren’t published until the sixties and seventies. even more recently too. the first draft to volume three is finally being published in English next year!
The word “subjective” used above is a multiple pun — the word is used to do all sorts of DIFFERENT work, related by not the same.
Example, the logic of marginal valuation gets the label “subjective” but that logic is itself inter-personally & universally valid, and you can explicate it in the universally shared language of math. But individual perceptual judgments of local opportunity spaces in unique places and times is NOT inter-personal & universal.
But we use the word “subjective” for both of this. Ie the word subjective is equivalent to a pun.
If you want to make progress in this domain of problems, you have to punt the word “subjective” and replace it with clear articulations of the different issues at hand.
Note well that the revolution of 1871 applied the logic of relational valuation at the margin successfully only to consumption goods.
And the hints at how to apply that logic to production goods thru time found in Jevons & Bohm-Bawerk did not fall successfully to conquest by mathematics.
There is an interesting yet unwritten history of how folks attempted to successfully extend and complete the revolution of 1871 into production goods which took place from the 1920s to the 1940s.
The result was a huge fault line which opened up in marginalist economics — Hayek’s program to extend and complete the 1871 revolution into capital goods led to the work of Harrod and then Solow (see Hicks on this) which constituted essentially a giant retreat & FAIL for marginalist capital theory involving more than one capital good, ie involve the real sort of environment in which real production goods get their value.
What Hayek & others sensed in the 1920s — that Bohm-Bawerk’s “Average Period of Production” would fail as a cheat stand in for marginalism applied to multiple production goods across time proved out in further research across the next few decades.
So the first thing we need to reckon with is the fact that marginalism fails in the domain of multiple production goods by the standards of formal system building and proof dominant among economists in the 1950s.
So this formal/object type of “subjectivism” comes into play in thinking about the valuation of multiple production goods across time BEFORE the non-objective/formal aspect of ‘subjective” expectations comes into the picture.
Nathan: “Marx never actually called his theory a labor theory of value. that’s an application of critics and enthusiasts alike.”
Hmmm. Interesting. I didn’t know that.
Yep, if Marx had lived longer, and had started writing later, he might well have written something very different. But we work with what we have. And sometimes I do come across people who are sort of Marxists, who have nevertheless come to grips in some sense with 1871 (and also maybe methodological individualism). And they are very interesting writers. Jon Elster? Herb Gintis (or is it Sam Bowles, or both, because I get the two muddled)? But they are very different from other Marxists who haven’t come to grips with 1871.
Greg: OK. There are preferences, and there are beliefs. And I called both “subjective”, even though preferences and beliefs are not really the same. But for my purposes here, both matter for value theory.
The fact that the problem of ‘imputation” re production goods is insolvable formally both for the individual and within an equilibrium construct does nothing to obviate the fact that people are chosers between future focused alternatives at the margin, ie this fact does nothing to make objective cost theories true.
@Nick Rowe: I see we are still following down the narrative that those who reject marginal subjective utility theory don’t understand it.
It’s good to see you pointing out that nothing has any inherent value, but that as you say, people value things. Good start.
But you didn’t seem to take what seems to be the next step and point out that different people value the same things differently. Or is that what you mean by “utility”? If so it would have been nice if you’d explained that.
So there’s a problem with money as a measure of value. Physical objects don’t generally change their lengths randomly so we can define a “centimeter” and everyone can more or less agree that a given stick is x centimeters long and it works fine until we get down to the quantum level.
But how do you define the value of money when the thing you are measuring varies from person to person?
I think that Chartalism is the only sensible explanation of why fiat money has value as a medium of exchange. Can you point out the fallacy of Chartalism (assuming you think there is one, which you seem to)?
But of course if Chartalism is right isn’t Neoliberal economics pretty much wrong by definition?
Forgot to mention that the “labour theory of value” is, I agree, obviously wrong. Labour produces goods and services which people value or don’t value. If you are smart you produce stuff that lots of people value, but just producing something doesn’t make it valuable unless other people want it and are willing to give up something of value for it.
Take Emily Carr’s paintings (just to be patriotic I will ignore poor old Vincent). Lots of labour went into them but no one valued them much until well after she died. Now people value them in the hundreds of thousands. Without her labour they would not exist, but how did her labour produce the value we place on them today?
“Calculus wasn’t exactly new in 1871”
Yeah – like in the 1600’s?
http://en.wikipedia.org/wiki/Leibniz%E2%80%93Newton_calculus_controversy
Why so long for economics to use it?
Did neoclassical economics over-compensate for the late start?
Greg: so what’s wrong with the model I sketched out above, which does not assume a single capital good? (It’s hardly new or original). Are you saying a competent mathematician couldn’t build and solve that model, with say 2 capital goods? The only really tricky bit mathematically is taking into account rational expectations of future rents. If you assumed static expectations instead, it’s not that much harder than a single period model. Time preference gives you the relationship between rents and capital goods prices.
Even with perfect foresight/RE, it’s no different from an Irving Fisher diagram with lots more dimensions to the PPF.
“Greg: OK. There are preferences, and there are beliefs. And I called both “subjective”, even though preferences and beliefs are not really the same. But for my purposes here, both matter for value theory.”
Yes, both matter for economic explanation, but their explanatory role is very different, and the “belief/desire” model falsifies the causal role of rival & constantly adapting alternative judgments about current environments and the unfolding of physical and relative price relation across time.
Ed: “But you didn’t seem to take what seems to be the next step and point out that different people value the same things differently. Or is that what you mean by “utility”? If so it would have been nice if you’d explained that.”
I take it for granted that different people value things differently. But if you and I both eat apples and bananas, even if you and I have different preferences, it will still be true that the ratio of my marginal utilities for apples to bananas MUa/MUb will be equal to your ratio. That’s because both our ratios will be equal to the price ratio. I.e.
[MUa/MUb]Nick = Pa/Pb = [MUa/MUb]Ed
“I think that Chartalism is the only sensible explanation of why fiat money has value as a medium of exchange. Can you point out the fallacy of Chartalism (assuming you think there is one, which you seem to)?”
See my old post.
“But of course if Chartalism is right isn’t Neoliberal economics pretty much wrong by definition?”
No. I can imagine a Neoliberal who thinks that fiat money only has value because of state power to tax. They probably exist too. Maybe some gold bugs fit the description.
JKH: “Why so long for economics to use it?”
Good question. I don’t know the answer (though I think some might have used it in some applications before 1871). You need a real historian of thought to answer that one. Or try to.
Nick, here is one way to think about or get a grip in two very different things that most economists fail to distinguish between.
“Information” as a construct built out of intersubjective/object ‘givens’ in a model is a very different thing from unique rival understandings of the significance of unique never to be exactly repeated local environments and relative price conditions.
There are two ways to think about Hayek’s knowledge problem applied to production and consumption goods thru time — both of them called “subjective” perspectives by economists.
The first way attempts to come up with a math construct which purely formally ‘coordinates’ the relations between sets of ‘given’ information provided in different “agents” in the form of probability distributions.
The second way considers how individual judgments of local conditions and relative prices must constantly evolve and adapt through learning, working as a bottom up causal mechanism to create some degree of constantly adjusting plan coordination across time involving every changing production processes and consumption plans.
If you get the distinction you get that there are two radically different ways to conceive “subjectivism” as an explanatory program in economic science, the first of them non-causal and causally non-explanatory — misleading even to the point of leading countless economist to misapprehend what is just a model and what is the real work, mistaking a toy math construct for “the economy” (see for a similar critique Milton Friedman’s review of Abba Lerner’s The Economics of Control).
Ed: I like the Emily Carr example. But you might be amused by an earlier example, also Canadian. De Quincy (“Confessions of an English Opium Eater” guy) was an early precursor of subjectivist value theory. He said that the value of a musical snuff box in Birmingham(?) is determined by labour needed to make it. But the value of the same musical snuff box, in a canoe in the middle of Lake Superior(?) (the wildest place he could imagine) is determined by subjective value of those in the canoe.
Nick, enjoyed this post, must remember to forward it to David Laidler 😉
It seems to me that where econ is going right now is trying to explain where preferences come from – whether that’s neuro economics, behavioural economics, or evolutionary economics. Are we at the verge of a paradigm shift, where we no longer accept that it’s impossible to look inside people’s heads, read their minds, and know how/why they value things?
Frances: Oh God, this is just between you and me and the internet. For God’s sake nobody show it to David!
Yep, I think that’s what some people are trying to do, and I wish them luck! That’s all I can do. I have no idea if they will succeed, or what the answer will look like. I think the big question will be: what sort of feedback there is from the rest of the economy to preferences? That’s what might lead to a big paradigm shift. We know there’s almost certainly some feedback. Hey, just think of diamonds and deBeers and engagement rings!
Nick, you ask: “what’s wrong with the model I sketched out above, which does not assume a single capital good?”
In your model is their a uniform rate of profit on the capital goods? One of the responses to the 1960s debate was to use the Arrow-Debreu model which can handle heterogeneous capital goods. But heterogeneous capital goods are not substitutable and thus the notion of a long run equilibrium is lost. There is no uniform rate of profit is this approach. Have you solved that problem?
For those interested in another point of view, Matias Vernengo provides some useful comments here:
The capital debates: A brief introduction
Microfoundations and the capital debates
And, perhaps it should be pointed out that the prices in Sraffa’s 1960 model are simply long-run equilibrium prices-of-production, the book does not have a labor theory of value. Even Marshall thought that long run equilibrium prices were determined by production cost; utility determined only short-run price in Marshall.
“But the value of the same musical snuff box, in a canoe in the middle of Lake Superior(?) (the wildest place he could imagine) is determined by subjective value of those in the canoe.”
That’s actually pretty close to Ricardo’s story:
“There are some commodities, the value of which is determined by their scarcity alone. No labour can increase the quantity of such goods, and therefore their value cannot be lowered by an increased supply. Some rare statues and pictures, scarce books and coins, wines of a peculiar quality, which can be made only from grapes grown on a particular soil, of which there is a very limited quantity, are all of this description. Their value is wholly independent of the quantity of labour originally necessary to produce them, and varies with the varying wealth and inclinations of those who are desirous to possess them.” (from the fifth paragraph of his Principles)
Ricardo does seem to want to express scarcity values in labor terms, as he succeeds in doing for rent and interest. But can’t find a way. The American economist Henry Carey actually thought he had found a way in the 1840s: he said that the higher value of scarce or monopoly goods resulted from the “wasted” labor of all who worked to get possession and failed — Tom Hanks’s paycheck would be a measure of myriad failed actors’ labor. A rather charming theory, though not the most convincing.
“I can imagine a Neoliberal who thinks that fiat money only has value because of state power to tax.”
Correction: because the state that issued the money has ASSETS, one of which is its power to tax
Michael: lets take an even simpler example. Instead of two types of capital good, let there be two types of land. Clay land only grows wheat, and earns $10 per acre per year rent. Sandy land only grows veggies, and earns $5 per acre per year rent. I don’t know what the price of land will be, without knowing people’s time preference. But I do know that the price of clay land will be double the price of sandy land, (assuming people expect rents and land prices to stay the same). So the two types of land will have the same rate of return. Simple arbitrage. Everybody would want to sell clay and buy sandy if sandy gave a higher rate of return.
Now let’s change the assumptions slightly. You can clear more forest to create more land. Which means that “land” is now economically equivalent to “capital”. Does it change my story? No. Unless it changes people’s expectations of the paths of future rents and land prices, which it may. But the (expected) rates of return on clay and sandy land will still be equal. By simple arbitrage.
“Even Marshall thought that long run equilibrium prices were determined by production cost; utility determined only short-run price in Marshall.”
Notice those “…” before Marshall’s name, in my post 😉
Will: It does sound very similar. I wonder if Ricardo or de Quincey came first? Hmmm. I think Ricardo did.
You sound like you know history of economic thought. Do you want to take a crack at JKH’s question above?
Mike: OK! But you can imagine a Neoliberal who thinks that fiat money can only have value according to the state’s power to tax, and who doesn’t like that fact, and so doesn’t want there to be fiat money.
Hayek’s landmark work in mind/brain learning theory (see UCLA neuroscientist Joaquin Fuster on Hayek’s global brain theory) give us no reason to believe that science will be able to reduce each individuals constantly evolving unique judgments and theory laden perspective on thing to a formula usable as some sort of causal theory of “preferences” which can be plugged into economic “models” using fake model of “science” demanded by professors teaching economics in the top 30 economics departments.
Why should anyone expect there would be a “science” of this?
Why should anyone think there needs to be a science of this?
“I think the big question will be: what sort of feedback there is from the rest of the economy to preferences? That’s what might lead to a big paradigm shift. We know there’s almost certainly some feedback. Hey, just think of diamonds and deBeers and engagement rings!”
Hayek addresses this issue in his famous 1937 & 1945 essays on knowledge and learning.
Becuase of his background in neuroscience & the history of scientific explanation in the social domain Hayek indicates although he has identified learning in the context of changing local conditions and relative prices as the core explanatory mechanism in economic science, there is no reason to believe that further investigation of this topic will lead to very much more than all sorts of particular facts & insights about a process that is either already familiar to everyone who participates in the market or who which is fairly well understood by most economists.
There is a margin for better understanding and more complete understanding, but no reason of any kind to image paradigm smashing advance, for anyone who doesn’t have a false understanding of the role of the “rationality” assumption in economics.
Let me recommend Mirowski’s terrific More Heat Than Light on math/physics and classical vs neoclassical economics.
Mirowski is as much a conspiracy theorists & imaginative writer as he is an historican of economic thought — but you can’t but learn and have your understanding expanded by this wonderful book.
Note well that different treatments of capital theory (vis vi classical/neoclasical) in light of different models for
math & physics stand at the core of Mirowski’s classic More Heat Than Light
Nick, this is a brilliant post. I suspect the phenomenon of a “gap year” is fairly common (in my case, it was four years, that I spent outside academia, working in local government, and learning more about how labor markets actually worked than anything I had done before). And your unpacking of marginalisn (and Pasinetti’s value theory) seems to me to be absolutely correct.
Nick:
Very nice piece on marginalism.
All that Patrick, myself and anybody else with engineering backgrounds have to add is that when you have a margin and an original function, you cannot generate a logically consistent solution that instantaneously optimizes the outcome at every single time point.
This is basic calculus. It’s really easy to deal with when you add in Laplace Transformations to linearize everything back into simple algebra.
The combination of the function and its derivative creates lag.
It is my contention, easily derived, that savings and investment form a pair and therefore a function to logically and consistently describe production, consumption, savings and investment is a second-order equation, with direct counterparts to acceleration, velocity and position.
It follows from this that in response to any sort of shock, you will have a transitory response that won’t be optimal for some period of time. Change the savings/investment characteristic by any amount and you will change the response too.
Seen in this light its is readily and utterly apparent WHY economic fluctuations exist, why they are hard to control and why we so readily and often observe sub-optimal behaviour like unemployment, low savings or low investment.
Hey Determinant, don’t drag me into this. Apart from having nothing intelligent to add to Nick’s (as always) thought provoking post, I’m in the middle of my gap year. 🙂
@Determinant
Yep. Hence the use of Arrow securities and Samuelsonian unique-goods-across-time to squash all of the future into static analysis. In Samuelson-land, any goods with different prices are different goods, even if they are only separated by different positions in time (and price evolution over time).
Nick:
JKH’s question is tough. As far as I know, no economist before the 1840s or so uses math beyond basic arithmetic. The answer as to why could have to do with the mathematical literacy of the people who became economists (remember there were no academic posts in the subject prior to Malthus, and most of the heavy hitters were wealthy autodidacts), or the scope of early economists’ inquiry (preoccupation with aggregates, monetary issues, and tax and trade policy). I’m not sure either of these explanations suffices, though. Utility theory wasn’t remotely new in 1871, only the mathematical exposition was. So maybe the calculus is originally a winning sales pitch? I do agree with JKH that economists have overcompensated.
Instead of two types of capital good, let there be two types of land. Clay land only grows wheat, and earns $10 per acre per year rent. Sandy land only grows veggies, and earns $5 per acre per year rent. I
OK, let’s say that over the last 3 years, sandy land earned, per acre:
$5, $4, $3
And that over the last 3 years, clay land earned, per acre:
$3, $4, $5
What is the relative price of sandy land to clay land? Ask 10 people, and you will get 10 answers. But investment is a lot more like this than it is like the fixed ratio story. People disagree even on what future risk free interest rates will be, and they disagree on what inflation will be. The republicans, for example, are sure that hyperinflation is around the corner. How much more would they disagree on the relative price of sandy and clay land?
Donald: thanks!
Determinant: that’s not at all obvious to me. Are you assuming some sort of information lag, or inertia, or something? And when you talk of “optimal”, are you defining that subject to that same information lag, inertia, or whatever?
Will: OK. Makes sense to me. Economists were a bunch of artsie amateurs who didn’t know any math, so didn’t use any. I too agree that economics has gone overboard. But I might just be biased, because I’m no good at math myself.
rsj: let me suggest an even harder question:
There are two types of used sports cars: Mazda MX6’s and Ford Probes. Nobody knows how long they will last, and how well they will work in future, and how much they will cost to repair, etc. Different people have different opinions. Different people have different preferences. Etc. What determines the relative prices of MX6s and Probes?
We don’t even have any numbers. How can you possibly put anything so crude as a number on the sheer beauty of the MX6’s lines?
And yet the market does put a number on it. And all we can really usefully say is that the prices of the two cars will be determined by the whole distribution of preferences and beliefs and endowments of various potential owners, and by the distribution of the existing stocks of the two cars. And that the preferences and beliefs of the marginal buyer, who, at the equilibrium price differential, is indifferent between buying the prettier MX6 or the cheaper Probe, is what are crucial. (Though you need to know everyone else’s preferences and beliefs before you can figure out who that marginal buyer is).
I expect if you put everyone’s preferences and beliefs about MX6 and probes into a computer simulation it might spit out some sort of answer. If you could ever figure out what those preferences and beliefs were.
There is no fundamental difference between the theory of capital and interest and the theory of used car prices.
Of course e.g. Smith, Ricardo and Marx understood the notion of subjective value and expectations. They, however, did not believe that people could be viewed as selfish calculating machines.
Neither did Marschall. From the first version of Principles:
“Attempts have been made to construct an abstract science with regard to the actions of an ‘economic man’ who is under no ethical influences and who pursues pecuniary gain warily and energetically, but mechanically and selfishly. But they have not been successful . . .”
… and went on to talk about how a real economy would be completely dysfunctional if people actually acted that way (due to e.g. incomplete contracts). In Marshalls view, as far as I understood it, people act more in the form of rule of thumbs than according to some first order derivative of their utility function.
Marschalls principles is a thousend times better than any micro text that i currently seen in use.
You can read it here:
[link here good find NR]
Is marginal utility a concrete steppes manifestation?
Same question for calculus.
“Otherwise you are stuck wondering why water should be worth less per gram than diamonds”
Here’s Adam Smith: “The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it”
Marx: “Diamonds are of very rare occurrence on the earth’s surface, and hence their discovery costs, on an average, a great deal of labour time…If we could succeed at a small expenditure of labour, in converting carbon into diamonds, their value might fall below that of bricks.”
Looks like you did leave a lot of interesting stuff out.
Nothing material to add, but I’d like to this say to all: if you’re unfamiliar with Herbert Gintis, do yourself a favor and Google Scholar some of his work. I can’t think of another contemporary economist who has done more interesting work in as wide a field as he, nor with less BS. Even when he’s considering ideas or policies he’s clearly partial to, no prisoners are taken.
BenP: but what if diamonds were very rare but also very easy to find – say all of the diamonds in the world started out just lying on the ground? You would predict that their value would be low, but in reality it would probably be high.
“ince labour-time is the intrinsic measure of value, why use another extraneous standard as well? Why is exchange-value transformed into price? Why is the value of all commodities computed in terms of an exclusive commodity, which thus becomes the adequate expression of exchange-value, i.e., money? This was the problem which Gray had to solve. But instead of solving it, he assumed that commodities could be directly compared with one another as products of social labour. But they are only comparable as the things they are. Commodities are the direct products of isolated independent individual kinds of labour, and through their alienation in the course of individual exchange they must prove that they are general social labour, in other words, on the basis of commodity production, labour becomes social labour only as a result of the universal alienation of individual kinds of labour. But as Gray presupposes that the labour-time contained in commodities is immediately social labour-time, he presupposes that it is communal labour-time or labour-time of directly associated individuals.”
– http://www.marxists.org/archive/marx/works/1859/critique-pol-economy/ch02b.htm
re individual labor needing to be transformed into social labor through exchange ie sale.
There’s an un-gated PDF of the Gintis and Bowles paper: [link here good find Jed NR]
For some reason it doesn’t show up in Google or Google Scholar. You have to go to Gintis’ pub list on his web site and there it is. Either Google is excluding it for some reason (agreement with publishers?) or they are falling down on the job. Either way, symptom of something wrong.
I too would like Determinant to unpack his (?) interesting but opaque comment about lags. It sounds like they are intrinsic but I don’t know enough to see why.
“Can you point out the fallacy of Chartalism (assuming you think there is one, which you seem to)?”
See my old post.”
I read it carefully before and have read it again, just to be sure (thanks for the link). I don’t see that it refutes Chartalism. You merely point out that other mechanisms have an effect on the value of a fiat currency, and I will concede that they do. But that doesn’t mean that the fact that government taxation must be paid in the fiat currency also gives value to that currency. I don’t see how this affects the point the chartalists make. Heck, the very act of saying (and enforcing) that all currency transactions in the country must be made in the fiat currency must also give some value to the currency on it’s own. The enforcement the chartalist choose is taxation, which seems the most practical way to do it to me. I mean it beats armed currency police patrolling every square foot of land in the country making sure you only use the fiat currency.
I would enjoy being proved wrong, though.
“”But of course if Chartalism is right isn’t Neoliberal economics pretty much wrong by definition?”
No. I can imagine a Neoliberal who thinks that fiat money only has value because of state power to tax.”
Then is Steve Keene wrong when he asserts that the Neoliberal model does not consider money? If Keen is right then sure a neoliberal economist can still stick with his model that ignores currency and it’s effects even if he agrees with chartalism, but it seems rather pointless to do that since it will have no effect on his model of the economy.
However I’ll agree that I overstated my case here. If Keene is right then it makes neoliberal economics largely irrelevant. Yet as a chess player I know that any plan, even a bad one, beats no plan every time, and similarly I suppose any model, even a bad one, beats no model. Krugman seems to be able to make reasonable predictions with that model that actually come true, more or less, but then he seems to be somewhat aware of it’s weaknesses and use it as a tool rather than a religion.
What do you mean by ‘subjective’? My guess is: to be subjective, a function must be relative to a person and psychological.
But then note that total utility, not just marginal utility, is subjective. On the other hand, first derivatives exist for many functions that no one would consider “subjective.” Thus I don’t understand your statement: “Thinking about margins [i.e., first derivatives] mattered only because thinking about margins made it possible to think about goods having subjective value.” Total value is just as subjective as marginal value; the value to me of the (several gallons of) water I use today and the value to me of the last drop I use are equally subjective (because they are psychological and relative).
Also, I would take issue with: “Goods don’t have value; people value goods.” Individuals’ utility functions are more basic, but on that basis goods do attain value.
Historical question: People must have discussed the water-diamonds paradox long before 1871. What was the best prior account of it that anyone gave? (It’s hard for me to believe that no one figured it out before 1871.)
Philo: “Historical question: People must have discussed the water-diamonds paradox long before 1871. What was the best prior account of it that anyone gave? (It’s hard for me to believe that no one figured it out before 1871.)”
Yep. See the quotes from Adam Smith and Marx in BenP’s comment above.
Basically, since economists couldn’t see any relation between the total utility and total value of water and diamonds, they figured values had to be determined by labour/cost of production, and have nothing to do with utility. Once they figured out that it was marginal utitility that mattered, they could see the relation between utility and value.
BenP: you missed the point. See my response to Philo above.
Philo: “But then note that total utility, not just marginal utility, is subjective. On the other hand, first derivatives exist for many functions that no one would consider “subjective.””
Agreed. But once economists started looking at marginal utility, they could see the relation between utility and value.
Alex: Yep. Good thought-experiment.
It would be easier for us to explain it by drawing a supply curve and demand curve. The height of the supply curve is related to marginal amount of labour needed (or marginal amount of any other scarce resource needed) to produce one extra diamond. And the height of the demand curve is related to marginal utility. And the two curves together co-determine the price and quantity of diamonds. 1871/ECON1000.
My students tell me that some PoliSci and Soc profs are still teaching the labour theory of value as though it was the theory of value. It’s not quite as bad as science departments still teaching creationism, but close.
Edmund: I fully endorse reading more Herb Gintis. I spent a happy afternoon once reading his Amazon book reviews! (I wonder if he still considers himself a “Marxist”? Not that it really matters. Things move on. Old categories shouldn’t remain applicable in a progressive discipline. You keep some old stuff and ditch other old stuff for better.)
Ed: “Then is Steve Keene wrong when he asserts that the Neoliberal model does not consider money?”
I don’t think that Steve Keene would have said that. He might have used the word “neoclassical” instead of “neoliberal” (very different things). But that is wandering waaay off-topic.
Nathan: that passage of Marx you quoted (which I read 3 times, to no avail) reminds me of one of the reasons I so dislike Marx. That poncy Continental obscurantism. Pity he didn’t go to England much earlier in his life. Gimme Smith, Ricardo, Malthus (or Darwin, for that matter) any day. They want to be understood. And you can understand them.
JKH: I think MU and calculus are unrelated to concrete steppes. Neither pro or con.
nemi: “Marschalls principles is a thousend times better than any micro text that i currently seen in use.”
I’m trying to remember (Will or someone else may know the answer): wasn’t Marshall’s Principles in fact used as the main (intro?) text in UK universities for decades? Or am I muddled with JS Mill’s Principles?
Nick: I’ve read that Mill’s book was the standard text in the UK until around the turn of the century, and then Marshall’s text supplanted it until macroeconomics had to be added.