The Pope, said God, was dead.

Justin Fox said this during a podcast programme with Tom Keene, on demand newscaster from Bloomberg Economics. (Check it out on itunes! It’s a really really fine program). He was one of the first guys I heard criticising Robert Shiller. Being a huge Bob fan myself, I decided to hear what he has to say. Went to buy his latest book “The Myth of the Rational Market” a few days ago to hear what he has to say. That book, as Fox himself described, details the rise and the fall of the Efficient Market Hypothesis, or what I would call the Fama Stuff (Eugene Fama, one of Chicago School’s most prized assets till approximately 2 years ago). Pretty interesting book. It’s like the occasional light rock n roll that I listen to after experiencing diminishing returns from listening to Bach and Stravinsky. (Oh yes I love them. Mainly the father Bach. Less of the little sons. Some of them are great, but none match up to the dad).

In his podcast, Keene first brought up the phrase “The Pope, said God, was dead”. Pretty interesting concept. Fox then went on to tell the story of how, in medieval times, the church thought that the price paid for some items were not fair, because the farmers ought to earn more. Of course, such a system collapsed in no time. They realised that the market price is then the fair price. The price that the buyer and the seller agrees on, through interactions of demand and supply, is the fair price. Very interesting illustration. Barring issues of inequity and justice, I agree with them fully. Aside from all moral issues that make us civilised, I concur. (Amartya Sen’s new book The Idea of Justice looks interesting to me. Should go try it after the As)

Today Shell was discounting petrol at 1 dollar a litre. Queues stretched for more than 500m, jamming buses and delaying my journey to Hwach for the Cambridge TSA test. A very clear illustration of what happens when prices are artificially low and quantity demanded outstrips quantity supplied. Just an interesting observation.

Had a lot of fun recently doing economics mathematics with Ben. Managed to prove the profit maximisation condition, MC AC condition. Showed that a perfectly competitive firm can never make profits, and that consumer surplus is maximised when quantity demanded = quantity supplied. Sure I know that people are more than willing to tell me that “look one of the 30+ key assumptions of PC theory almost never holds” and that “who the heck gives a damn about MC in real life?”. They’re asking me a question that’s been answered many times before since JS Mill. But today I shall just tackle one argument that they commonly use – rationality of economic agents. The classical theory of rationality assumes that economic agents seek to maximise their own utility. It also assumes that the agents know the exact means through which their utility can be maximised, and do so without any uncertainty. Unrealistic as it seems, such a theory should not be dismissed entirely just because of this minor setback. I would refer you critics to Roger Myerson.

“Nash Equilibrium and the History of Economic Thought” (Myerson, 1999) would be a good read for you guys. In it he says that there are three main reasons why such theories are still accepted. First, because we have no better theories. I would contest that to a certain extent. Bounded rationality makes much more sense to me. However, if we were to complicate every single calculation with the set theory used by Herbert Simon in his initial development of the theory, we would convolute our argument without making significant improvements to the results of the theories. We might end up with several equilibriums in the case of market theory with bounded rationality applied. However, to illustrate a point such as the allocative efficiency inherent in perfectly competitive markets, simple PC theory, with the assumption of rational agents, will more than suffice. The second reason, he says, is that though individuals might be irrational, society as a whole is rational. Of course Rob Shiller will have tonnes to say and show about this. His herd behaviour theory, using models of epidemics and anecdotes from Black Friday to the 1987 crash, actually shows that society as a whole might be as irrational as the individual. I have nothing to say to that, and personally I do not agree with Myerson’s statement here. However, Myerson’s third reason takes the cake. He argues that the purpose of economics is not only to predict what the stock market tomorrow will be like. Rather, it should also look at current institutions and organisations and analyse them, finding out if they should be corrected and how they can be improved. In this case, there are two separate roles – the institution and the agents who operate within the institutions. If we do not assume that the agents who operate the organisations are rational, we find ourselves confounded and caught up in trying to profile the individual agents. It is then difficult to conclude with improvements for these organisations, since much of the analysis is burdened by the characterisation of the agents. Should we then assume that agents are perfectly rational, we can shift the analysis to the institutions and how they work, thereby creating regulations such as anti-competition policies, and institutions such as central banks, to govern the behaviour of individuals. We will hence spend more effort correcting the institutions rather than attempting to characterise individual agents – the job of perhaps psychologists. This allows for more progress to be made in using economics as a tool to govern individual behaviour and achieve optimal allocation of resources. With that third reason, it seems only logical that, in analysis, the rationality assumption be used, for it is only through such usage can institutional improvements be made.

Too tired to write a conclusion. Back to chem tys.