Economics and Simulation - Complementary not Competitive!

Economics and its Realm of Action is Based on a Simplistic (and Outdated) View of Reality.

• The Utility function represents the individual, and it is set to reflect her preferences.
• A paradigm based on the individual: an exogenous entity.
• Key assumptions: markets exist for all possible goods, markets are perfectly competitive, and transaction costs are negligible.
• Pareto Optimality: The optimum you get to where there is no way of making anyone happier without hurting someone else.
• Economics is in dire need of a fundamental overhaul to bring it into alignment with 21st Century real world science!

But, wait a minute…you can’t assume utility functions are ‘outside’ of the system. They are part of the process and key to all social systems. They are part of the REAL HUMAN WORLD. What does this mean for economics? Well, it’s time for an overhaul. Way more than 90% of PhD programs in economics solely teach this patently and unnecessarily simplistic view of the world. Our utility functions are not accidental; no, indeed, we are the years of millions of years of evolution and there is a reason why we have so many instincts, memes, and histories. We don’t have the free will or free agency to which we often try to force ourselves to believe. True freedom is indeed a very, very hard thing to find. Our history (and our future) truly, truly matters.

In economics, there is no way to make judgments about the interaction between individuals/agents. The impenetrable individual is god in economics often to the detriment of the community and long term health of the individual and super organism. Yup, in all of economic theory, we never try to explain ‘why’ people do things, all we have is revealed preference – economists currently look at the preferences that people reveal – and from that we construct a utility function that are consistent with those preferences. Then, economists use those utility functions to make predictions about the demand function.

1. They don’t explain why the preferences are that way.
2. The old way of thinking that each agent is independent of other agents – a very bad assumption only made to make the models tractable using linear mathematical techniques
3. Economists don’t allow for any intrapersonal comparisons – part of normative economics and left to philosophy – think of taking money from the rich via taxation to help the poor. The implication is that all of Economics is based on Pareto optimality – that is ALL that they strive for – to arrive at Pareto optimum. That is an (1) an unclear proposition and (2) is not really useful in the real world.

We believe the science of the 21st century will go significantly beyond what classical economics (Adam Smith – think of his ideas regarding the 'invisible hand') based on the idea of the impenetrable individual. Classical economics was overturned by the Great Depression. Then came John Maynard Keynes who developed Keynesian economics where the government played a much more active role – popular from the 1930’s to the 1970’s – some people today are still embracing this idea which goes against the laisez faire ideas of classical economic theory. Keynesian economics -- the government hires some people to dig holes and then hires other people to fill them! Or, as I look to put it, "Keep them busy so they don't rebel!"

After the stagnation of the 70’s high unemployment and high inflation resulted in the attack of Keynesian economics which resulted in a neoclassical economics which is more related to classical economics than Keynesian, but does recognize that prices can sometimes be sticky and that sometimes the involvement of government can be good. The successful and pragmatic tenure of Alan Greenspan as chairman of the Fed is reflective of this neoclassical economic paradigm.

Pareto optimality represents the core of Neoclassical economics’ welfare theorems. The Pareto optimum is therefore nothing more than a sacred cow that must be slaughtered to save Economics (and our world) from itself. It’s a great concept in theory, but in reality, in the messy real world, people are not rational, there is asymmetry of information, transaction costs are not negligible and sometimes you have to hurt people (by putting them in prison or even killing them) to save the larger collective.

Everything that our model embraces would be considered esoteric by a standard neoclassical economist of today (the vast majority of today’s economists are neoclassical).

© 2005 Justin Lyon. All Rights Reserved.
Reproduction permitted with permission of author: Justin Lyon.