Economists *Do Not* Assume There Are No Interdependencies, or that We Are Independent of the Living World
Part 4 in my series on "Doughnut Economics"
Introduction
Last week, I began my critique of Kate Raworth’s “Doughnut Economics” approach to economic policymaking, as explained in her book Doughnut Economics: 7 Ways to Think Like a 21st Century Economist.
While doing so, I stressed I see merit in most of her ways of thinking about economics, but they are not as revolutionary as she claims. To put it another way, while I believe she made an important contribution to economic thought and policymaking, she is being too harsh regarding how we approach our discipline, especially recently.
However, my post today is more complementary of Raworth because in her third way of thinking like an economist in the 21st century — nurture human nature — she justifiably criticizes economists’ historical overreliance on the “rational man”, or Homo Economicus. In other words, she criticizes the fact that basic economic theories tend to assume perfect rationality.
Why do we make this assumption? As with other simplifying assumptions, it is made to help us make realistic predictions without making analyses too complicated. But again, there are many ways in which this assumption is overly simplistic, and thus leads us to erroneous conclusions.
Even so, I still think Raworth is showing some ignorance of what we teach in basic economic courses — even principles courses — so I still feel defensive. Specifically, she argues assuming perfect rationality is in opposition to not only nature, but also to interdependence, and to being social. She also claims it means we are precluding approximation, and that we assume people are independent of the living world.
On the contrary, we teach Game Theory in Principles of Microeconomics — first year — courses, which is all about interdependent behaviour, even when we assume perfect rationality. Therefore, we do not believe people are independent of the living world.
The closest we get to arguing independent behaviour is when we teach the theory of perfect competition, because then competitors are so small and insignificant that they have no effect on the market. Thus, they do what is best for themselves given what they see going on around them. But we also teach that perfect competition is not reality, but rather an ideal against which we measure the harms of market failures.
We also teach that a more realistic — and much more common — market structure is oligopoly, where there exists a small number of competitors who strategically interact with each other. Notice the phrase “strategically interact”, because that means we do not assume away interdependence.
Anyway, Raworth still has a point that economists need to put less focus on perfect rationality when developing more realistic models, and for that reason I want to write more than one article on this point.
For that reason, today’s post — cowritten by my wife and partner in everything,
— will be an introduction to Game Theory; next week, I will devote time and space to showing what economists have been doing over the last few decades in the field of Behavioural Economics — a very important field, and one for which Psychologist Daniel Kahneman won the Economics Nobel Prize back in 2002, even though he never took an economics course.I also want to stress that while this post keeps the assumption of perfect rationality, it is simply because it is an introduction; we need to start with the simplest models and then add complications to them. But rest assured complications will be introduced in future posts.
On a personal note, these fields truly excite me, even though my favourite Economics courses as an undergrad and an M.A. student were actually macroeconomics-oriented. In fact, I once dreamed of working at the Bank of Canada.
However, that preference changed after I started worked at the Competition Bureau in 1999. My work there on abuse of dominance cases, as well as merger and cartel cases, led me to absolutely love microeconomics since studying strategic human interaction — and strategic interaction between businesses and governments operated by humans — thrilled me to no end! This is why I like to tell people that, contrary to popular opinion, economics is not all about money.
My love for the study of strategic interaction is also why my favourite topic to teach is Game Theory, and I found my students tended to find it most interesting, too, even when they otherwise did not care for economics. It is truly thrilling for me to think logically about how a person, business, or government will react to their counterparts, based on how they expect those counterparts to react to that reaction.
In fact, I got my job as an Assistant Professor in a previous life largely because of my teaching demonstration on Game Theory, so that is yet another reason why this topic means so much to me.
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