History of economic thought
Petr Wawrosz
Some mistakes in economic
thinking
Ceteris paribus condition (principle)
• Ceteris paribus = other things (variables)
constant
• Economics very often supposes ceteris paribus
condition, however in a dynamic world many
things can happen and things can change.
Lucas critique
• Connection with ceteris-paribus condition:
• The Lucas critique, named for Robert Lucas'
work on macroeconomic policymaking, argues
that it is naive to try to predict the effects of a
change in economic policy entirely on the
basis of relationships observed in historical
data, especially highly aggregated historical
data.
Thomas Maltus: overpopulation
• An example of relying on the ceteris-paribus condition:
• Malthus believed that there was a tendency for human
populations to grow more rapidly than the food supply
could be increased.
• Land was fixed in amount, and more food could be
produced either by tilling it more intensively or by
adding less-productive land to tillage. In either case an
extra hour of labor brought less than an average return
of food. The implication of these two different growth
rates is clear--eventually a segment of the population
would face starvation, and this would cut the growth
rate of population.
Thomas Maltus: overpopulation
• Suppose that society aids its most needy
members by giving them food. As a result, they
can survive and reproduce.
• Helping the poor would, according to Malthus'
argument, increase population and in the future
lead to even larger numbers on the verge of
starvation. Hence, charity would be selfdefeating. All attempts to improve society seem
doomed to failure, according to a strict reading of
the Malthusian argument, a truly "dismal"
conclusion.
Malthusian trap
• See:
• http://www.youtube.com/watch?v=NkLPe8EH
TtM
• What Malthus did not take into account?
The possibility of the change to the condition
and the fact that the change affects people
behavior.
Malthusian trap - homework
• Read the file „From the Malthusian Trap to the
Industrial Revolution.docx “ in Information
system (Study materials – Learning materials)
• Read the article and answer the question. I
want to discuss it next lesson (Please print and
bring the article with you).
Good intentions do not guarantee
desirable outcomes
• Intentions have direct and indirect effects.
• The Road to Hell is Paved with Good
Intentions.
Good intentions, bad results - example
• In 1919 US government instituted Prohibition
of alcohol with the intention of reducing crime
and other social problems associated with the
consumption of alcohol. The intentions were
excellent but the cure was far worse than the
illness.
Good intentions, bad results - example
• In the 1970's, farmers in the US introduced Asian
Carp into their fisheries with the good intention
of keeping the water clear of plankton and algae,
allowing for healthier catfish.
• The voracious and aggressive Asian Carp, which
can reach over a hundred pounds, fly through the
air, injuring boaters, and decimate native fish
species. It has now overtaken the Mississippi and
Ohio Rivers and threaten to do the same to the
Great Lakes.
Good intentions, bad results - example
• For the past few decades, US government has
waged a massive war against drug use. This has
led to a multi-billion dollar drug industry and a
commensurately expensive governmental drugfighting establishment. Many political analysts
and social commentators, and even some officers
who work in drug enforcement, insist that the
worldwide drug problem and the related crime
and violence are the ultimate result of our war
against drugs.
Good intention, bad results - examples
• Minimum wage
• Community Reinvestment Act and other
legislation connected with mortgage lending.
Good intention, bad results
• Viktor Chernomyrdin (Prime Minister of Russia
from 1992 to 1998):
„We wanted the best, but it turned out as
always.”
Correlation does not imply causation
• Two effects occurred in same time can be
independent.
• Situation when effect A precedes effect B does
not necessarily mean that effect A causes effect
B.
• See:
http://www.buzzfeed.com/kjh2110/the-10-mostbizarre-correlations
http://moz.com/blog/correlation-vs-causationmathographic
The fallacy of composition
• The fallacy of composition: what is true for
one might not be true for all.
The fallacy of composition – some
examples
• Atoms are not visible to the naked eye.
Humans are made up of atoms.
Therefore, humans are not visible to the naked
eye.
• You like the taste of ice cream.
You like the taste of scrambled eggs.
Therefore, you like the taste of scrambled eggs
mixed with ice cream.
• One and three are odd numbers, so four is and
odd number, because one and three are part of
four (1+3=4).
The fallacy of composition - example
• Elasticity of individual and market demand or
supply curve
• Market demand curve can have small elasticity
but id does not mean that individual demand
curve has also small elasticity.
• See:
ftp://ftp.uibk.ac.at/pub/uniinnsbruck/wirtschaftstheorie/stocker/mikro/02_s
lo_b14.pdf
The fallacy of composition - example
• Prisoner´s dilemma
• Prisoner´s dilemma can be defined as a
paradox in decision analysis in which two
individuals acting in their own best interest
pursue a course of action that does not result
in the ideal outcome.
The fallacy of composition
Prisoner´s dilemma
The fallacy of composition
Prisoner´s dilemma
• Real example – arms race, duopoly race
• Advertising with only two major competitors. If the
two companies produce equal products, revenue
depends on the amount of advertising that is done.
Both companies would be profitable doing very little or
no advertising. If Company A advertises and Company
B doesn’t, Company A would benefit greatly, and vice
versa. The worst scenario would be for both companies
to advertise extensively and neither company receive
larger market shares, (only increase costs).
Experiment about Prisoner´s dilemma
among prisoners and among students
• Who according to your opinion collaborated
more? Try to explain your opinion!
• See than paper and discuss the results!
John Nash and Prisoner´s dilemma
• See:
http://www.youtube.com/watch?v=FdAIXil-ttE
Paradox of thrift as the wrong example
of fallacy of composition
• The essence of paradox of thrift:
• The paradox of thrift refers to how—in the
Keynesian model of the economy—an increase in
saving reduces production and employment.
• This supposedly occurs because a decrease in
spending leads to a decrease in employment,
which leads to a further decrease in spending,
which leads to a further decrease in employment,
which leads to a yet further decrease in spending,
and so on.
Factors against paradox of thrift
• When demand falls (aggregate demand moves
to the left), prices (price level) fall and real
value of the money increase. These could
cause that people are more likely to spend
money.
Factors against paradox of thrift
• Putting money in savings accounts does not
remove it from the economy. When you put
money in a savings account, it becomes
money that the bank can then lend out to
businesses. Thus, when more people save, the
banks have more resources to pump out to
businesses, and when the businesses have
more resources, they employ more people,
innovate new products, and find new ways to
sell.
Factors against paradox of thrift
• Aggregate demand is a function of current and
future consumer spending. Businesses make
investing and hiring decisions based not solely on
current consumer patterns, but what consumers
will want to buy in the future, months or years
from now.
• Firms use the increased savings to invest in new
capital goods, technology, research and
development and to replace old equipment.
Factors against paradox of thrift
• There could be time discrepancy (time lag)
between:
-savings and results of investments
- even between decision of consumer to save and
decision of firms to invest (start new production).
• Do not forget that many final goods need for
their production roundabout method of
production.
• The discrepancy (lag) is always only temporary
(although it can take several months or even in
years).
Paradox of thrift - hoarding
• Hoarding:
= to keep hundreds of dollars in his mattress or in
his safe, or to bury them in his back yard.
• People take money from banks, keep them
outside economic system and do not use them.
• See
http://www.youtube.com/watch?v=GtmZ5-eE0xY