31 Aug 2013

My Thoughts on Formalism in Economics

Economics, Game Theory, Mises, Shameless Self-Promotion 60 Comments

Recently many econobloggers have offered their thoughts on what is often called “mathematics in economics,” but I think is really more about formalistic model building in economics. Here’s a very interesting post that has links to some of the other people in this dispute. For my part, just some scattered observations with no necessarily overarching lesson:

==> When discussing my thoughts on the Misesian “pure time preference theory of interest,” it was very easy to communicate a key distinction–a preference for earlier goods versus a preference for earlier utility–in the language of mathematical economics; it was the discount on future utils (often denoted by beta) versus the marginal rate of substitution between a good available at time t versus t+1. In contrast, Austrians use the same phrase–”time preference”–for both concepts, which made it very difficult to get anywhere. (If you want to read more of my views on this, check out the links at this post.) So this is exactly the kind of thing that the proponents of mathematical formalism cite–there are ambiguities and imprecision with spoken language that can be alleviated with symbolic modeling.

==> But don’t take the above point to be an award of victory to the formal camp. At the crucial point–going from the formal model to the spoken-language interpretation of what the model means–the formal economists lapse into whatever they want the result to be. For example, when I was at NYU I spent a good deal of time trying to get the mainstream professors to appreciate Bohm-Bawerk’s critique of the “naive productivity theory” of interest, and to see the dangers in teaching (as they did) that “interest equals the marginal product of capital” in equilibrium. At their encouragement, I stopped saying it in words and built little models to illustrate the problem. One guy finally “saw” it and said, “Well, assume you can turn tractors into bananas one-for-one.” I am not joking; that’s how he dealt with my concerns. And then another guy told me, “Yes, I agree there is more to it than just taking the derivative of the production function…but somehow we know.”

==> Continuing in the above vein, go look at the appendix to my dissertation if you can handle it. In my mind, this was analogous to Einstein’s special relativity; I came up with a more general framework that had the mainstream “r = MPK” as a special condition case. But, so far as I can tell, I’m still the only person on Earth who thinks I’m this much of a genius. The proponents of the formal approach don’t usually stress this aspect of things: You can come up with the most brilliant model ever, which shows in crystal clear fashion how your critique of the orthodox approach is valid, but if nobody cares, and just ignores your model, then there’s not much you can do about it except whine on your personal blog for years to come.

==> Let me give another example. When Bryan Caplan chimed in to this discussion, he proved his bona fides by linking to one of his theoretical papers. It’s titled, “Standing Tiebout on his head.” Here’s the abstract:

Much of the public finance literature argues that local governments behave competitively due to residents’ ease of exit and entry. The model presented here challenges this widespread conclusion. Though it is costless to relocate to another locality, the presence of tax capitalization makes it impossible for land-owners to avoid monopolistic pricing of public services by moving; land-owners can only choose between paying the tax directly, or paying it indirectly in the form of a lower sale value for their housing if they exit. In consequence, the only real check on local governments comes through imperfectly functioning electoral channels.

Now my first reaction to the above is, “Huh? That sounds like it’s standing Tiebout on his feet. It shows that workers can indeed escape the clutches of the taxman, whereas landowners can’t, since–duh–you can’t move land out of the jurisdiction of the taxing authority. By the same token, if workers were only allowed to sell their labor in their current jurisdiction, then they wouldn’t have much scope to vote with their feet. Yet that insight hardly refutes Tiebout.”

Now maybe Bryan is actually saying something more profound than what I think he’s saying; the way to be sure would be to read his paper. The virtue of a formal model is that it would be crystal clear how he was achieving his result. However, we once again come back to the problem that the interpretation of the result is not something the model itself can give you: whether this is standing Tiebout on his head, or whether it’s an obvious extension of Tiebout, is something that we have to discuss in words, not symbols. (It’s also possible that the title is just to be provocative, and really Bryan’s claim is an empirical one on whether the immobile land effect outweighs the mobile workers effect. Again, I would have to sit down and read the paper to be sure, but even here, the crucial step would be in interpreting what his model “means” in the grand scheme of things.)

==> Austrians need to be a little careful when they make sweeping condemnations of the “unrealistic models” of their opponents. After all, when “our side” teaches comparative advantage, we use the completely unrealistic 2-good 2-country model. When we explain Menger’s theory of the origin of money, we tell simplistic stories that have no basis in history. When we explain Bohm-Bawerk’s views on capital accumulation, we often start with ludicrous Robinson Crusoe tales. And even Mises himself pounds home the fact that his “evenly rotating economy” is not only false, but internally inconsistent.

==> Last point: Until I saw it with my own eyes, I would not have believed how much the people in top-ranked economics programs are great at math, but bad at basic economics of the kind that I learned by reading op eds from Walter Williams and Thomas Sowell growing up. For example, one of our professors went through the Solow growth model and then concluded that it was a great mystery why the return to investment had been so low in the former Soviet Union, since after all their engineers trained at Western universities so they had the same production functions. (!) Our game theory professor relayed an anecdote in which all but one person (Aumann) at a game theory conference said he or she would offer “0″ in the Ultimatum game, since this was the unique subgame perfect Nash equilibrium. (And just remember, these were the guys helping to design strategy during the Cold War.) I And my all-time favorite: I didn’t witness it personally, but apparently at a meeting when the United Auto Workers were trying to unionize our grad students, a guy who was really good at math in our program piped up and told the provost that NYU owned some apartment buildings, and so it could offer to give them at zero price to the grad students since it wouldn’t cost NYU anything. To repeat, this was a guy who would go on to get a PhD in economics from what was, at the time, probably ranked about 15th in the world.

60 Responses to “My Thoughts on Formalism in Economics”

  1. guest says:

    No such thing as Utils.

    • guest says:

      … which means that using them in equations would be meaningless:

      On the issue of Utils:

      The Birth of the Austrian School | Josep T. Salerno
      [WWW]http://www.youtube.com/watch?v=dZRZKX5zAD4#t=4m49s

    • Keshav Srinivasan says:

      What if you used von Neumann-Morgenstern utility functions?

      • guest says:

        First time I’ve heard of it.

        Some cursory research suggests that the variables aren’t meant to represent quantities; For example, the claim is made that specific outcomes aren’t what’s being predicted.

        And what happens when people’s preferences change?

        It doesn’t sound like math, to me (but then, math is essentially just logic, isn’t it).

        Anyone want to help me out with this one?

        • guest says:

          Did Rothbard do anything but write?:

          Toward a Reconstruction of Utility and Welfare Economics – Murray N. Rothbard – Mises Daily
          The Neo-Cardinalists: the von Neumann-Morgenstern Approach
          http://mises.org/daily/2205#2d

          The errors of this theory are numerous and grave:
          1.None of the axioms can be validated on demonstrated preference grounds, since admittedly all of the axioms can be violated by the individual actors.
          2.The theory leans heavily on a constancy assumption so that utilities can be revealed by action over time.
          3.The theory relies heavily on the invalid concept of indifference of utilities in establishing the numerical scale.
          4.The theory rests fundamentally on the fallacious application of a theory of numerical probability to an area where it cannot apply. Richard von Mises has shown conclusively that numerical probability can be assigned only to situations where there is a class of entities, such that nothing is known about the members except they are members of this class, and where successive trials reveal an asymptotic tendency toward a stable proportion, or frequency of occurrence, of a certain event in that class. There can be no numerical probability applied to specific individual events.[39]

          Yet, in human action, precisely the opposite is true. Here, there are no classes of homogeneous members. Each event is a unique event and is different from other unique events. These unique events are not repeatable. Therefore, there is no sense in applying numerical probability theory to such events.[40]

          5.The neo-cardinalists admit that their theory is not even applicable to gambling if the individual has either a like or a dislike for gambling itself. Since the fact that a man gambles demonstrates that he likes to gamble, it is clear that the Neumann-Morgenstern utility doctrine fails even in this tailor-made case.[41]
          6.A curious new conception of measurement. The new philosophy of measurement discards concepts of “cardinal” and “ordinal” in favor of such labored constructions as “measurable up to a multiplicative constant” (cardinal); “measurable up to a monotomic transform” (ordinal); “measurable up to a linear transform” (the new quasi-measurement, of which the Neumann-Morgenstern proposed utility index is an example). This terminology, apart from its undue complexity (under the influence of mathematics), implies that everything, including ordinality, is somehow “measurable.” The man who proposes a new definition for an important word must prove his case; the new definition of measurement has hardly done so.

          Measurement, on any sensible definition, implies the possibility of a unique assignment of numbers which can be meaningfully subjected to all the operations of arithmetic. To accomplish this, it is necessary to define a fixed unit. In order to define such a unit, the property to be measured must be extensive in space, so that the unit can be objectively agreed upon by all. Therefore, subjective states, being intensive rather than objectively extensive, cannot be measured and subjected to arithmetical operations. And utility refers to intensive states. Measurement becomes even more implausible when we realize that utility is a praxeological, rather than a directly psychological, concept.

          A favorite rebuttal is that subjective states have been measured; thus, the old, unscientific subjective feeling of heat has given way to the objective science of thermometry.[42] But this rebuttal is erroneous; thermometry does not measure the intensive subjective feelings themselves. It assumes an approximate correlation between the intensive property and an objective extensive event — such as the physical expansion of gas or mercury.

          No arithmetical operations whatever can be performed on ordinal numbers; therefore, to use the term “measurable” in any way for ordinal numbers is hopelessly to confuse the meaning of the term.

          If an object is extensive, then it is at least theoretically capable of being measured, for an objective fixed unit can, in principle, be defined. If it is intensive, then no such fixed unit can apply, and any assignment of number would have to be ordinal. There is no room for an intermediate case. The favorite example of quasi-measurability that is always offered is, again, temperature. In thermometry, centigrade and Fahrenheit scales are supposed to be convertible into each other not at a multiplicative constant (cardinality) but by multiplying and then adding a constant (a “linear transform”). More careful analysis, however, reveals that both scales are simply derivations from one scale based on an absolute zero point. All we need to demonstrate the cardinality of temperature is to transform both centigrade and Fahrenheit scales into scales where “absolute zero” is zero, and then each will be convertible into the other by a multiplicative constant. Furthermore, the actual measurement in temperature is a measurement of length (say, of the mercury column) so that temperature is really a derived measure based on the cardinally measurable magnitude of length.[44]

          Jacob Marschak, one of the leading members of the Neumann-Morgenstern school, has conceded that the temperature case is inappropriate for the establishment of quasi-measurability, because it is derived from the fundamental, cardinal measurement of distance. Yet, astonishingly, he offers altitude in its place. But if “temperature readings are nothing but distance,” what else is altitude, which is solely and purely distance and length?[45]

        • Keshav Srinivasan says:

          Here is Bryan Caplan’s response to Rothbard’s critique.
          :

          econfaculty.gmu.edu/bcaplan/ausfin2.doc

          • guest says:

            OK, I’ve now read it, and have some thoughts, but let me first share a link to a partial response by Hoppe:

            Must Austrians Embrace Indifference?
            http://mises.org/daily/2003

            From what I can gather, the issue of indifference matters for the Austrians’ foundation, and the neoclassicals rely on the concept a lot for some reason.

            It seems to me that the issue of indifference should only matter at the moment of action, but that, at that moment, it is impossible to be indifferent: Whether it’s because one shirt is closer, or because you want to prove to yourself that you don’t HAVE to pick the first shirt that comes to mind, these are still ends requiring abandonment of any indifference that may have been present before the choice was made.

            I’m not sure that Austrians need to deny that indifference exists at any time.

  2. Tel says:

    It shows that workers can indeed escape the clutches of the taxman, whereas landowners can’t, since–duh–you can’t move land out of the jurisdiction of the taxing authority. By the same token, if workers were only allowed to sell their labor in their current jurisdiction, then they wouldn’t have much scope to vote with their feet.

    Isn’t that exactly what happened to Detroit? Especially when you consider skilled workers (who were most able to move) and business (often leasing a factory and also able to move).

  3. Bala says:

    “a preference for earlier goods versus a preference for earlier utility”

    Looks like a distinction without a difference to me.

  4. Jonathan Finegold says:

    To be fair, there’s people who read Sowell, et. al., and also have very poor economic intuition.

  5. Greg Ransom says:

    Reify the model, misunderstand the world.

    The whole game is to mistake the model for the world.

    The key to the fake game of fake science it to assume that the ‘data’ you give to yourself in the ‘model’ is ‘given’ univocally in the world and is equally given to any mind, Butmin fact no such ‘data’ exists anywhere — and can exist univocally — but in the model.

    Economists have an immense professional interest in being blind to this basic fact.

    And an immense professional interest in making sure that all economists are all making the same reification mistake.

    The contruction and interpretation of ‘models’ generating bad science / pseudo-science has immense professional rewards in economics.

  6. thinkingotherthings says:

    Bob,

    Would a fair summary of your thoughts here be that formalistic model building is not inherently bad, but can lead economists astray when not buttressed by sound economic reasoning, and should be framed by (and taught only in conjunction with) said economic reasoning?

  7. Tel says:

    As a general statement on this subject: mathematics is a tool for a job. Its purpose is to help you get work done. The same hammer you can use to build a house, can also hammer your thumb, or knock someone on the head, It isn’t the fault of the hammer, it comes down to how you use it.

  8. Adrian Gabriel says:

    I agree with Tel here, yet after having read Man, Economy and State, I finally understood how time-preference is so important at any point in the discussion of economics. It seemed that Rothbard did a very good job demonstrating how this was the only appropriate way to delineate human action. Most importantly, Rothbard’s arguments came from a man that was suma cum laude in Mathematics at Columbia. It seemed as though he set out to prove to all economists that using mathematics in economics was a dead end before you even began.

    This was important, especially from an Austrian perspective, to have done. It showed how economics became monopolized by the Keynesians, and is thus full of useless circular arguments today, of the kind you describe in your post here. Anybody can use the model to fit their basic perspective on how an economy works, but the reality is that their model will never be seen in the same light as the creator of the model in the first place. This is the problem with mathematics in economics, that the very application of it to explain how humans act is such a wild stab in the dark, that everyone can change a few variables to describe the scenario they are trying to describe. I see these problems coming out of the Selgin, White and Horwitz camp all the time.

    Finally, it was important that Mises and Rothbard stress that their delineation of economics was simply an explanation in the abstract when using the evenly rotating economy. What is most essential in Austrian Economics is their logical descriptions of the world, and of human action (motivated action). Through this important theoretical base, an economist or even an investment banker can understand the limits of his models, as well as look at the world in a much more realistic sense and perhaps from another angle. Indeed there are many models in finance, and the free-market nature of competition allows the best model to render the highest profits, or so the creator of the model believes. Realistically it is the intuitive reasoning and ability to see the economy for what it is, that allows certain investors to make decisions that render them extraordinary profits.

    Some would be curious of Buffet’s ability to be such a good investor, and it seems his ability to calculate intrinsic value has become a unique process, but I’m sure it is nothing different than that of any other investor that realizes the limits of mathematics on human action. It is most likely Buffets intuition to see how asset prices inflate, or to him, how stocks are over or under valued. And it is the most surprising thing to see him over and over calling for intervention in the market. His most recent profits were rendered through derivatives. This is a silly clambering of desperation. He must basically be looking for all ways to seize on the price spreads and can’t find any. His theoretical base is missing, but his intuition on noticing under-valued stocks is impressive.

    Buffet’s game is up like many of the other investors using over-simplified models, but so are other investors’ games that have relied on their models as truth and their intuition as second best to the numbers. One important fact about a test like the CFA exam is that they make the disclaimer over and over, that financial models are only as good as the analyst who ‘interprets” them. Not builds them, but interprets them. Nicola Tesla made the case that scientists have become “model building” mathematicians and less experimenters, getting lost in formulas and numbers and innovating or creating nothing. I’m sure Wozniak never sat in his garage when inventing the computer thinking, “Geez, I need to study more derivatives…”

    I think Rothbard does a great job explaining mathematics in economics in this part of MES: http://mises.org/rothbard/mes/chap5a.asp#2._Evenly_Rotating_Economy

  9. Philip George says:

    Whether complex mathematics is used or not, whether theories are realistic or not in their assumptions, ultimately everything must be submitted to the test of the real world.

    That is one reason it is difficult to take the Austrians seriously. Take their operational definition of money. It goes on rising through recessions and booms, a sure sign that something is seriously wrong with it.

    Now take a look at the definition of money as M1 + Sweeps – Business and Commercial Loans. The graph for the period 1959 to 2012 can be seen at http://www.philipji.com/busloans/

    See how closely it mirrors or predicts recessions. The drop during 1966-67 may seem like a false positive. But there was actually a mini-recession during the time and even papers saying it was actually a full-fledged recession.

    The theory behind it is close to Austrian. And the mathematics is elegantly simple as should be the case in good theories.

    • guest says:

      Whether complex mathematics is used or not, whether theories are realistic or not in their assumptions, ultimately everything must be submitted to the test of the real world.

      Let me see if I can walk you through this.

      Austrians acknowledge that certain claims need to be submitted to the test of the “real world”, by which you actually mean “science”.

      But we reject that laws of logic need to be submitted to the test of science.

      Take, for example, your claim that “ultimately everything must be submitted to the test of the real world”; Notice that you didn’t say “perform such and such scientific test to determine whether or not it’s true, in all cases, that everything must be submitted to the test of the real world”.

      So your claim is not a scientific one, but a philosophical one about the nature of how we come to know something (epistemology). And yet your claim makes sense in the real world (insofar as it pertains to claims about physical laws).

      SOME claims require science to test, but others don’t.

      The Austrians are saying that, since the pursuit of subjectively valued ends is the reason people engage in economic activity, almost all of economics is of a philosophic nature, and therefore science (depending on how you define it) isn’t the right tool to assess the veracity of economic claims.

      • Anonymous says:

        If Austrians are all about deducing from simple axioms, why are they so bad at it? Like claiming the minimum wage must increase uneployment, disproven by a simple thought experiment.

        • Razer says:

          How was it disproven? I know Keynesians don’t believe in the Law of scarcity, at least their philosophy violates it, but how does raising the price of something not affect its demand, all things being equal?

          What simple thought experiment shows the Law of scarcity being repealed?

        • UYT says:

          “What happens to the quantity exchanged of that good at the new price?”

          That depends on the entrepreneurs’ appraisements. A minimum wage isn’t going to mean entrepreneurs will just pay more. They may undervalue the good just as much or more as before. They also may not. If they don’t, they would’ve done it without the minimum wage.

          I don’t know any Austrian who denies a price floor won’t cause a surplus if the floor is higher than what the market price would’ve been otherwise.

        • Matt Tanous says:

          The claim is not that the minimum wage MUST increase unemployment. It is that, ceteris paribus, the minimum wage will EITHER increase unemployment or AFFECT NOTHING. The claims regarding the minimum wage are no different than those of any other price floor.

          Gene is wrong, as there is no way to know the equilibrium wage, and this would further automatically be sought if the current wage really is below that (people would ALREADY be hiring and employment would already be rising). Even in this (strange and impossible to discover) case, the minimum wage would actually mean nothing – if not simply slowing down the increase in jobs.

          The equilibrium wage is also different for each person, and here Gene treats it as an (at least roughly) uniform aggregate.

          But even regarding this argument::

          “In truth, there is only one way to regard a minimum wage law: it is compulsory unemployment, period. The law says: it is illegal, and therefore criminal, for anyone to hire anyone else below the level of X dollars an hour. This means, plainly and simply, that a large number of free and voluntary wage contracts are now outlawed and hence that there will be a large amount of unemployment. Remember that the minimum wage law provides no jobs; it only outlaws them; and outlawed jobs are the inevitable result.

          All demand curves are falling, and the demand for hiring labor is no exception. Hence, laws that prohibit employment AT ANY WAGE THAT IS RELEVANT TO THE MARKET (a minimum wage of 10 cents an hour would have little or no impact) must result in outlawing employment and hence causing unemployment. “

          • Matt Tanous says:

            Quote is from Rothbard. Don’t know why the attribution was dropped. Sorry.

      • scineram says:

        If Austrians are all about deducing from self-evident axioms, why are they so bad at it? Like claiming the minimum wage must increase unemployment, disproven by a simple thought experiment.

        • guest says:

          Like claiming the minimum wage must increase unemployment, disproven by a simple thought experiment.

          http://consultingbyrpm.com/blog/2013/08/i-knew-this-would-happen-minimum-wage-shenanigans.html?replytocom=72730#respond

        • Richard Moss says:

          Perhaps they are bad at it, but seeing as you buy into Gene’s argument, you are also saying they are right that economic laws are deduced from premises accepted as true., not hypotheses that require testing…

        • Ken P says:

          Most people assume equilibrium conditions and “all things equal” when they make such arguments. They aren’t saying it is impossible.

          Wages seem to be more sticky downward than upward, so wages are more likely to be above equilibrium than below, especially during an economic downturn.

        • Tel says:

          Gene did not prove anything from first principles, he merely demonstrated that by assuming what you set out to prove you can logically conclude what you have assumed. Logically correct but meaniness, and certainly says nothing about Austrian logical deductions because Austrians start from completely different axioms.

          Logic is nothing more than yet another mathematical formalism. This is merely boolean algebra rather than some other sort of algebra, it has its uses, yet the real world will never neatly divide into black and white, right and wrong, true and false.

          The people who are bad at logic are the ones who don’t understand this. Just like every other mathematical model, logic is strictly no better than the assumptions you start with and one of those assumptions is deciding fitness for the purpose at hand.

          • Gene Callahan says:

            That first paragraph Tel is the most empty blathering I have encountered lately.

            What I asked was “What happens to unemployment if the current wage for unskilled labor is below equilibrium and a minimum wage moves it towards equilibrium?”

            How is that “assuming what I set out to prove”? How is anything there based on “completely different assumptions” than Austrians use?

            • Tel says:

              You assumed what you set out to prove. Read your own assumptions.

              Calling names does not fix anything.

            • Major_Freedom says:

              You set out to prove that men with guns who coerce others to pay no less than the gun weilder’s desired wage price floor, can increase employment.

              The way you “proved” this is “logically possible” is by imagining a schizophrenic bipolar dimensional world where there are “equilibrium” wage rates successfully being set in one dimension, and a messy imperfect world where individuals are setting wage rates that are less than these “equilibrium” rates.

              Your thought experiment is silly, because it is holding constant the equilibrium wage rates in a context of a social change, such as pointing guns at people who impose price floors, and it assumes that an “equilibrium” can actually be reached at all, and not only that, but by coercion.

              As Hayek taught us many years ago, the only source of information that we have from which you can even understand what it means for there to be a “market” for labor, is through the market process itself. Wage rates are rates that individuals subjectively hold to be optimal to their self-interest. You can’t know if wage rates should rise or fall, unless you inquire into the subjective preferences of those individuals who set those wage rates you’re referring to, using the market process, not guns.

              Imposing price floors is not forcing employers to hire more workers. You can’t duplicate the intersection of a hypothetical supply and demand chart for wage-labor by using guns.

              Even if prevailing wage rates have room to increase, it does not mean that imposing a universal price floor can increase employment. The supply and demand graph is a hypothetical tool. The only real world data is the intersection. The lines that extend outward from the intersection are imaginary. And no, you aren’t observing a movement along a line by observing history of prices and supply changing. You could very well be observing NEW supply and demand intersections each with their own unique angles and slopes of lines extending out from them.

              Your post is a textbook example of mathematical tools leading one astray when they are not predicated on individual activity in the real world.

              • thinkingotherthings says:

                MF,

                The way you “proved” this is “logically possible” is by imagining a schizophrenic bipolar dimensional world where there are “equilibrium” wage rates successfully being set in one dimension, and a messy imperfect world where individuals are setting wage rates that are less than these “equilibrium” rates.

                Gene is not supposing another dimension where wage rates are in equilibrium. He is saying that in this messy and imperfect world, wages may not be at their equilibrium levels.

                Your thought experiment is silly, because it is holding constant the equilibrium wage rates in a context of a social change,

                His thought experiment does not necessitate holding the equilibrium wage rate constant, nor did he imply otherwise. His premise is simply that the market rate is below the equilibrium rate. Nothing he said excludes the possibility that the equilibrium rate changes over time, he is only assuming that, even if it changes, it remains above the observed market rate.

                You can’t know if wage rates should rise or fall,

                Sure, but it’s at least possible that wage rates should rise, in which case a minimum wage increase would be expected to increase employment in the standard supply and demand framework.

                Imposing price floors is not forcing employers to hire more workers.

                This sentence suggests that you do not understand the though experiment you are criticizing. The minimum wage in his example is not supposed to increase employment by “forcing employers to hire more workers”. Rather, by pushing the wage above its current level, the price floor increases the benefit of working and thereby attracts more labor to whatever industry. In other words, in the market for labor, as the price rises suppliers (workers) are willing to supply a greater quantity (of labor).

                Firms, meanwhile, will be willing to pay these higher wages because it will still be the case that for all workers willing to supply labor at the higher wage rate, their marginal revenue product (value to the firms) exceeds the firms’ costs of hiring them.

                The supply and demand graph is a hypothetical tool.

                It is a tool grounded in the logic of human action. If you believe that resources are scarce and that humans act to satisfy their preferences in order of urgency/intensity, then the law of demand – that there is an inverse relationship between quantity demanded and price – follows logically. And the law of supply follows necessarily from the law of demand.

                The only real world data is the intersection.

                Real world data reveals trades executed at particular price-quantity combinations. We can know for sure that the buyer’s marginal benefit exceeded the supplier’s marginal cost plus transaction costs, but without more information we cannot conclude that any particular trade took place at an equilibrium price.

                Your post is a textbook example of mathematical tools leading one astray when they are not predicated on individual activity in the real world.

                His experiment requires only the logic of human action and real world markets that are not perfectly competitive.

              • guest says:

                The way you “proved” this is “logically possible” is by imagining a schizophrenic bipolar dimensional world where there are “equilibrium” wage rates successfully being set in one dimension, and a messy imperfect world where individuals are setting wage rates that are less than these “equilibrium” rates.

                I like your response better than mine, because what if the farmer WANTS to let 30 apples go to waste; That’s his right to do so.

                And, now that I think about it, as soon as the farmer REALIZES that he has 30 extra apples that he’s not currently using, the challenge is no longer of a ceteris paribus nature;

                For, even if he does actually have the 30 extra apples to increase employment under a Minimum Wage, he will act without that knowledge and reduce employment.

                The challenges, as offered, change two things, not one: 1) the introduction of the Minimum Wage, and 2) the introduction of the knowledge that he CAN afford to increase employment.

                Again, this is not ceteris paribus.

              • Major_Freedom says:

                thinkingotherthings:

                “Gene is not supposing another dimension where wage rates are in equilibrium. He is saying that in this messy and imperfect world, wages may not be at their equilibrium levels.”

                Where is this equilibrium? In another dimension. You’re not really contradicting my assessment with that comment.

                “His thought experiment does not necessitate holding the equilibrium wage rate constant, nor did he imply otherwise.”

                Yes, it does. He argues that imposing minimum wages, which takes time, might change employment, which also takes time, so that prevailing wage rates are equal to this “equilibrium” set of wage rates.

                The only way this can happen is for equilibrium wage rates to stay the same while empirical wages rise and unemployment (allegedly) falls.

                “His premise is simply that the market rate is below the equilibrium rate. Nothing he said excludes the possibility that the equilibrium rate changes over time, he is only assuming that, even if it changes, it remains above the observed market rate.”

                OK, but this is a distinction without a difference. Instead of the equilibrium itself going unchanged, you’re replacing that with an unchanged placement of it in relation to empirical wage rates. In order for empirical wage rates to get closer to equilibrium rates, the equilibrium has to have a “stability” to it.

                My point however is that there is no stability to it, not absolutely and not even relatively.

                “Sure, but it’s at least possible that wage rates should rise, in which case a minimum wage increase would be expected to increase employment in the standard supply and demand framework.”

                No, that is wrong. Standard supply and demand does not “prove” that imposing a price floor for a thing will raise the nominal demand for that thing, nor does it prove that it will increase the supply of that thing.

                “Imposing price floors is not forcing employers to hire more workers.”

                “This sentence suggests that you do not understand the though experiment you are criticizing. The minimum wage in his example is not supposed to increase employment by “forcing employers to hire more workers”. Rather, by pushing the wage above its current level, the price floor increases the benefit of working and thereby attracts more labor to whatever industry.”

                Haha, no. You are fallaciously assuming that raising the price floor for wages will in fact raise the nominal demand for labor, and then imputing that assumption into Callahan’s example as if it’s so true it doesn’t need to be made explicit. You can’t make that assumption. If employers find it in their interests to pay X, then it doesn’t matter if you believe they are “wrong” in relation to an ideal “equilibrium.” It does not force higher wage payments.

                Also, if wage payments end up increasing, after minimum wage price floor was instituted, then you cannot claim this proves Callahan’s theory is possibly true. For then you would again be holding constant that which is not constant.

                “In other words, in the market for labor, as the price rises suppliers (workers) are willing to supply a greater quantity (of labor).”

                But you’re assuming employers will pay more for labor. You can’t assume that.

                “Firms, meanwhile, will be willing to pay these higher wages because it will still be the case that for all workers willing to supply labor at the higher wage rate, their marginal revenue product (value to the firms) exceeds the firms’ costs of hiring them.”

                No, because if that were true, then employers would already be paying those higher wages.

                If wage rates are “too low” relative to some market clearing set of rates, then there will arise a shortage of labor, and employers would compete to raise wage rates and eliminate the shortage.

                You’re ignoring the gun in the room and what it really entails.

                “The supply and demand graph is a hypothetical tool.”

                “It is a tool grounded in the logic of human action.”

                Not the values. The overall shape is. But the values are the key here. The values do not follow from the laws of action. They are subjectively determined, and not constant.

                “If you believe that resources are scarce and that humans act to satisfy their preferences in order of urgency/intensity, then the law of demand – that there is an inverse relationship between quantity demanded and price – follows logically.”

                Sure, but this doesn’t tell you what those values actually are. That is an ex post, revealed preference phenomena. It cannot be deduced.

                “The only real world data is the intersection.”

                “Real world data reveals trades executed at particular price-quantity combinations.”

                Each with their own practically infinite number of supply and demand “curves” that are extrapolated away from the observable intersections,

                Example: If I buy one hamburger for $5.00, and then later on when they drop the price to $3.00 I buy 2, you cannot infer from this that I am “moving along the demand curve.” The one has no necessary relation to the other. The supply and demand schedule for hamburgers in the past is not the same schedule for today. You would have to include the possibility of there being two supply and demand “crosses”.

                “We can know for sure that the buyer’s marginal benefit exceeded the supplier’s marginal cost plus transaction costs, but without more information we cannot conclude that any particular trade took place at an equilibrium price.”

                You can never get that “more information.” The only information you have is supply and demand. The “equilibrium” is unobservable.

                “Your post is a textbook example of mathematical tools leading one astray when they are not predicated on individual activity in the real world.”

                “His experiment requires only the logic of human action and real world markets that are not perfectly competitive.”

                No, it requires far more than that. You’re overlooking it.

              • Tel says:

                Not the values. The overall shape is. But the values are the key here. The values do not follow from the laws of action. They are subjectively determined, and not constant.

                Since a market has many participants, those prices are not even single unique values at any point in time, which is why you can have micro-arbitge even in modern trading systems. We can argue some other time about how to deal with this and whether arbitage is an industry that should be encouraged or discouraged, but anyhow it is observable.

            • Tel says:

              Here’s the long winded answer.

              Case A: Physicists say that gravity keeps people on earth, and stops them flying off into space, but suppose some guy started levitating? Well, gravity isn’t pulling him down so logically the physicists must be wrong.

              Case B: People think they want to make their own decisions but just suppose I’m the smartest guy on earth and I know what everyone else should be doing much better than they could ever know. Logically I have proven they must all do what I tell them.

              Case C: People say that the market price of Wibble (the argument is the same regardless of the commodity) is the price where buyers and sellers reach an equilibrium between them such that the buyers are not willing to pay more and the sellers are not willing to sell for less. Just suppose the market worked differently and for no particular reason the sellers of Wibble sold at a completely different price, logically I have proven that I could fix that for them.

              • thinkingotherthings says:

                Tel,

                Gene’s premise is not as far-fetched as you make it out to be.

                Of course there is a tendency for free market prices to move toward their equilibrium values, but it is far from a seamless process.

                If firms have significant monopsony power, say due in part to high costs of switching jobs because workers acquire firm-specific/ job-specific human capital, information necessary to match job candidates with employers is costly to communicate, or workers (and their families) have built up social capital in their local communities and may have to move to find other work, then it is conceivable that wages could be below their equilibrium level for some time.

                I’m not saying this *is* the case, or that a minimum wage hike is justified, but I don’t think Gene’s premise is inconceivable.

                By the way, I responded in the climate change thread a couple days ago if you’re interested in continuing that discussion.

              • Major_Freedom says:

                Thread winner.

              • Major_Freedom says:

                thinkingotherthings:

                “Of course there is a tendency for free market prices to move toward their equilibrium values, but it is far from a seamless process.”

                Who ever said it was seamless, such that you feel compelled to ensure to everyone that it is not seamless?

                Even if prevailing wage rates are currently not at market clearing wage rates, it still does not follow that pointing guns at employers and potential employees not to agree to a wage below a price floor, might possibly potentially raise employment, or wage rates.

                The whole “logic” rests on wise overlords knowing what the unobservable “equilibrium” wages rates are that for elude 300 million morons who only have to work with knowledge derived from empirical wage rates.

              • Tel says:

                Gene’s premise is not as far-fetched as you make it out to be.

                Regardless of how far fetched it might be, never the less his entire conclusion is nothing more than an alternative way of stating the premise. His whole logical deduction is that if we suppose he knows better than the market participants, then we can conclude that his market fixing price is an improvement over the market price.

                That’s it. That’s the great breakthrough that scinoram is using to demonstrate Austrian are bad at logic.

                I’m quite aware that if monopoly or monopsony powers exist then the market price will differ to what a competitive market might offer, but Gene skipped right past any need to even discuss mechanisms, or evidence, or settling time or anything at all. Just make it your axiom that the market price is wrong, then use this to prove the market price is wrong. Easiest logical deduction you ever will see.

                Even if we do want to duscuss how to ensure markets stay competitive, the minimum wage fails to address that, and it is highly questionable that government does a good job of addressing that in any situation. A whole lot of related problems crop up, such as corruption, fraud, political favours, etc. Gene didn’t bother even glancing past any of that either, why bother when you just assume your conclusion?

              • thinkingotherthings says:

                Regardless of how far fetched it might be,

                The plausibility of the assumptions matter, at least with respect to your claims:

                [...] Logically correct but meaniness,(sic) [...] logic is strictly no better than the assumptions you start with and one of those assumptions is deciding fitness for the purpose at hand.

                Continuing:

                his entire conclusion is nothing more than an alternative way of stating the premise.

                No it isn’t. His conclusion follows logically from the premise, something that is true of all logical arguments. That demand curves (ceteris paribus) slope downward follows logically from the premise of human action as well – that is not reason to discredit an argument.

                I’m quite aware that if monopoly or monopsony powers exist then the market price will differ to what a competitive market might offer, but Gene skipped right past any need to even discuss mechanisms, or evidence, or settling time or anything at all.

                But if these mechanisms justify the plausibility of his premise, why does it matter if he didn’t state them explicitly?

                Even if we do want to duscuss how to ensure markets stay competitive, the minimum wage fails to address that, and it is highly questionable that government does a good job of addressing that in any situation. A whole lot of related problems crop up, such as corruption, fraud, political favours, etc. Gene didn’t bother even glancing past any of that either,

                From Gene’s post:

                “Of course the above is not an argument for a minimum wage or an increase in a minimum wage. First of all, it completely ignores any moral case for or against a minimum wage. Secondly, before we could use the above to justify a hike in that wage, we would have to show that it is likely the current wage is below the equilibrium wage. Then we might ask, “Why is it so?” We might find it is better to handle that reason directly.

                Personally, I think the minimum wage is a rather clumsy way to try to help low-wage workers even if the above conditions were true in the case in question. I prefer addressing more fundamental, structural issues if possible. Nevertheless, it is simply false that raising the minimum wage must cause employment to remain unchanged or drop: under the right conditions, it could increase employment.”

              • thinkingotherthings says:

                Who ever said it was seamless, such that you feel compelled to ensure to everyone that it is not seamless?

                You implied as much when you wrote:

                “No, because if that [MRP>W] were true, then employers would already be paying those higher wages.”

                If we are not in the world of perfect competition or the ERE, then it is entirely possible that market wages could deviate from their equilibrium levels.

                Even if prevailing wage rates are currently not at market clearing wage rates, it still does not follow that pointing guns at employers and potential employees not to agree to a wage below a price floor, might possibly potentially raise employment, or wage rates.

                In Gene’s example, it absolutely does follow that a price floor between the current wage and the market-clearing wage would lead to greater employment. If you actually draw out the graph you can see for yourself that Gene’s conclusion follows logically from his premise for reasons I’ve stated in other posts here (namely that quantity of labor supplied will increase at higher wages, and because it will still be the case that MRP>W, employers will be willing to pay those higher wages even as they take on more workers).

                The whole “logic” rests on wise overlords knowing what the unobservable “equilibrium” wages rates are that for elude 300 million morons who only have to work with knowledge derived from empirical wage rates.

                No, it doesn’t. It only rests on reason to suspect that the equilibrium rate is higher than the current market rate. Knowing the exact equilibrium rate is not required. And actually, as a pure thought experiment even this is not required, because he only asked is it *logically possible* that a minimum wage could increase employment, and he clearly shows that it is. Again, I encourage you to draw out the graph for yourself to see this.

              • Major_Freedom says:

                thinkingotherthings:

                “Who ever said it was seamless, such that you feel compelled to ensure to everyone that it is not seamless?”

                “You implied as much when you wrote:”

                “No, because if that [MRP>W] were true, then employers would already be paying those higher wages.”

                That is not the same thing as “seamless.” That is a statement about the now, given your assumptions. It isn’t a statement of what the real world actually is at this moment.

                “If we are not in the world of perfect competition or the ERE, then it is entirely possible that market wages could deviate from their equilibrium levels.”

                Empirical wages ALWAYS differ from equilibrium wages. They’re supposed to. Equilibrium analysis was derived in order to understand the world. To think of what the real world is not, helps in understanding what the real world is.

                “Even if prevailing wage rates are currently not at market clearing wage rates, it still does not follow that pointing guns at employers and potential employees not to agree to a wage below a price floor, might possibly potentially raise employment, or wage rates.”

                “In Gene’s example, it absolutely does follow that a price floor between the current wage and the market-clearing wage would lead to greater employment.”

                No, it does not follow at all. All it implies is that a certain set of wage rates will be made illegal. Taking out of contention a possible set of prices does not imply that other, higher prices will be paid.

                “If you actually draw out the graph you can see for yourself that Gene’s conclusion follows logically from his premise for reasons I’ve stated in other posts here”

                The premises are internally flawed. That’s the problem that you seem to not be able to get here. One of the premises that collapses the whole example is the assumption that employers will actually go out and pay higher prices.

                You don’t seem to be able to see the contradictory position you’re in. If you claim that the market is capable of having wage rates that are persistently lower than equilibrium wage rates, then you are saying that given the opportunity to profit, employers and employees for whatever reason are not choosing to do so. You have to explain why making illegal certain lower wage rates will all of a sudden make employers and employees realize profitable opportunities that they did not foresee before.

                Imagine you and I are exchanging your labor for my money. Say $10 an hour. Suppose the rate we agree to is not an “equilibrium” wage rate. Since we cannot OBSERVE this equilibrium wage rate, we are blind to it. We are making a “mistake.” This is what “wages are out of equilibrium” means.

                So tell me, how in the world would Mr. Smith, who wears a badge, threatening us with violence if we trade below $12, make us realize that we were trading in error before, and what makes you believe that I will agree to pay you $12 going forward?

                See, the problem with your reasoning is that you aren’t thinking practically. You are presuming a lot of false assumptions, and you seem to want to believe that these presumptions are a posteriori, that they somehow pop out from the graphs.

                You need to do some more self-reflection.

                “The whole “logic” rests on wise overlords knowing what the unobservable “equilibrium” wages rates are that for elude 300 million morons who only have to work with knowledge derived from empirical wage rates.”

                “No, it doesn’t. It only rests on reason to suspect that the equilibrium rate is higher than the current market rate.”

                No, it rests on exactly what I said it rests on. The notion that empirical wage rates differ from equilibrium wage rates is inconsequential. It does not imply that price floors will raise empirical wages. That is the false assumption you keep believing in, out of some misunderstanding of how to read charts.

                “Knowing the exact equilibrium rate is not required.”

                It would be required if those imposing a price floor are going to not bring about unemployment. The only way that they could not bring about unemployment is if the price floor they set, is the market rate, which of course would make the price floor not a floor at all, but a verbal statement.

                “And actually, as a pure thought experiment even this is not required, because he only asked is it *logically possible* that a minimum wage could increase employment, and he clearly shows that it is.”

                No, he did not. Again, clearly the assumption that price floors raise the demand for that which has a price floor, is fallacious.

                “Again, I encourage you to draw out the graph for yourself to see this.”

                Your error is in your understanding of said graph. You don’t seem to realize that the graph doesn’t say anything itself. You must understand it, and your understanding of it is lacking.

              • guest says:

                MF …

                It does not imply that price floors will raise empirical wages.

                … I was wondering if you caught this, earlier:

                http://consultingbyrpm.com/blog/2013/08/my-thoughts-on-formalism-in-economics.html#comment-72845

                The challenges, as offered, change two things, not one: 1) the introduction of the Minimum Wage, and 2) the introduction of the knowledge that he CAN afford to increase employment.

                Again, this is not ceteris paribus

                COULD a Minimum Wage not be sufficient to lower employment in certain scenarios? Yes – but not ceteris paribus.

                They are misrepresenting our argument.

            • Matt Tanous says:

              “What happens to unemployment if the current wage for unskilled labor is below equilibrium”

              How is there only one wage for unskilled labor? Even people without skills have different degrees of natural aptitude for various things. I’m just as unskilled at landscaping as my neighbor, but the fact that he is significantly stronger than me would earn him a higher wage at it were we both employed doing so.

    • Bob Roddis says:

      There are significant differences between:

      a) Self evident axioms of human action;

      b) Empirical evidence;

      c) Algebraic FUNCTIONS applied to human action (because there can be no constants or unmotivated behavior in the equations as there is in physics); and

      d) Employing statistical analysis to help make informed guesstimates of future events and behavior.

      It is (c) that is rejected by Austrians.

      Further, both math and algebraic functions are irrelevant to the existence of the essential nature and importance of economic calculation and voluntary exchange by human beings which is objectively the basic phenomena of economics. What is important to understand is this chart created by Bob Murphy for his lecture on the Value of Money (slide 5 of the Power Point):

      http://www.flickr.com/photos/bob_roddis/9646722001/

    • Bob Roddis says:

      The entire Bob Murphy lecture and Power Point (PPT) on the Value of Money is found here:

      http://mises.org/media/7383/The-Value-of-Money

  10. Richard O. Hammer says:

    I take a tangent, reacting to frustration expressed by Bob Murphy. Bob wrote, “I came up with a more general framework… . But, so far as I can tell, I’m still the only person on Earth who thinks I’m this much of a genius.”

    I have similar feelings with works which I have published, and I guess it is common for academics to feel unrecognized. But maybe I err in extrapolating from my data. Maybe Bob and I really are the only two geniuses since Einstein. Can anybody tell me where I may find data on this question, concerning the propensity for academics to feel themselves to be unrecognized geniuses?

    • Yancey Ward says:

      I thought it was an axiom.

  11. Ken Pruitt says:

    Let me show you how silly a lot of people (not everyone, but a lot of people) are:

    If I have two cubes laying on the ground, and I proceed to draw a circle around those cubes, then I will have two cubes inside the circle. Now, if I place two more cubes inside the circle, I will have four cubes inside the circle, or to put more simply: 2+2=4.

    Is the equation 2+2=4 empirically testing anything? No. The fact that 2+2=4 is true apriori. The equation is simply a visual aide, and nothing more, but far too many people (quite wrongly, and from my experience the majority of them are in the mathematics profession) believe that equations actually test proposals.

  12. Gene Callahan says:

    “When we explain Bohm-Bawerk’s views on capital accumulation, we often start with ludicrous Robinson Crusoe tales.”

    Thank God I avoided that, and instead started with ludicrous tales of Rich from the TV show Survivor!

  13. thinkingotherthings says:

    MF, (also Tel, see my addendum at the bottom of this post)

    Where is this equilibrium? In another dimension. You’re not really contradicting my assessment with that comment.

    The equilibrium is not in another dimension. It is the equilibrium wage in the real world market at a given time. The fact that it may not be the wage actually paid does not mean it doesn’t apply to this dimension. Suppose the equilibrium wage rate – the rate at which the quantity of labor demanded would exactly equal the quantity of labor supplied – is $8/hr, while the wage actually paid is $5/hr. The equilibrium wage rate is still very much in this dimension even if it is not the observed market rate. Unless you believe that we have reached the evenly rotating economy, it is entirely possible for a market to be out of equilibrium.

    Yes, it does. He argues that imposing minimum wages, which takes time, might change employment, which also takes time, so that prevailing wage rates are equal to this “equilibrium” set of wage rates.
    The only way this can happen is for equilibrium wage rates to stay the same while empirical wages rise and unemployment (allegedly) falls.

    Period 1: market wage = $4/hr, equilibrium wage = $8/hr. Period 2: market wage = $5/hr, equilibrium wage = $7/hr.

    OK, but this is a distinction without a difference. Instead of the equilibrium itself going unchanged, you’re replacing that with an unchanged placement of it in relation to empirical wage rates. In order for empirical wage rates to get closer to equilibrium rates, the equilibrium has to have a “stability” to it.

    The difference is that the claim you made – that Gene is assuming a constant equilibrium wage rate – is virtually impossible to hold in real life, whereas the claim that his thought experiment actually supposes – that a gap between the equilibrium rate and the market rate can persist – is much more plausible.

    My point however is that there is no stability to it, not absolutely and not even relatively.
    “Sure, but it’s at least possible that wage rates should rise, in which case a minimum wage increase would be expected to increase employment in the standard supply and demand framework.”

    No, that is wrong. Standard supply and demand does not “prove” that imposing a price floor for a thing will raise the nominal demand for that thing, nor does it prove that it will increase the supply of that thing. [...] Haha, no. You are fallaciously assuming that raising the price floor for wages will in fact raise the nominal demand for labor [...]

    I never used the word “proved”. More importantly, if you actually draw out the graph for Gene’s thought experiment, you will see that the increase in employment does not depend on raising nominal demand. At a wage rate below the equilibrium, it would already be the case that the quantity of labor demanded exceeds the quantity supplied. So, while a wage increase would reduce quantity demanded, even with the floor in place quantity demanded would still exceed quantity supplied. Quantity supplied, meanwhile, would increase because the higher wages would attract more workers to the industry, hence greater employment.

    Also, if wage payments end up increasing, after minimum wage price floor was instituted, then you cannot claim this proves Callahan’s theory is possibly true. For then you would again be holding constant that which is not constant.

    It’s a thought experiment. The title of his post was “Is It Logically Possible for a Higher Minimum Wage to Increase Employment?” so appealing to empirical evidence would be pointless. His post clearly demonstrates something logically possible in a situation that is not unrealistic.

    But you’re assuming employers will pay more for labor. You can’t assume that.

    I can because in the thought experiment, both before and after the wage increase the marginal worker’s revenue product still exceeds the wage, and so it will still be profitable for employers to employ those workers. For example: before the wage increase, suppose MRP = $9/hr and W = $5/hr. The price floor is then imposed at $6/hr. At the higher wage, more people are willing to work and the MRP of the last worker is $7/hr. From the employer’s perspective,even though he has to pay the workers more, it is still worthwhile to hire all the workers – even the additional ones he wasn’t previously employing – because they still bring him more revenue than they cost him.

    No, because if that were true, then employers would already be paying those higher wages.

    So you believe that labor markets are always in equilibrium then? Do price adjustments occur instantaneously when conditions change? Have we reached the evenly rotating economy? Are there no market frictions? No transaction costs or information costs? If the real world is not as clean as the perfect competition model assumes, then it is possible for wages to be out of equilibrium.

    If wage rates are “too low” relative to some market clearing set of rates, then there will arise a shortage of labor, and employers would compete to raise wage rates and eliminate the shortage.

    While this would be expected to happen, switching jobs is not as quick and fluid a process as switching your lunch spot from McDonald’s to Burger King. There are substantial transaction costs, information costs, a worker might have to uproot their family and put their kid in a new school system.. which isn’t to say that these adjustments can’t be made, just that the wage rate could be below the market clearing rate for a substantial period of time given how costly it is to reallocate labor.

    You’re ignoring the gun in the room and what it really entails.

    How so?

    “The supply and demand graph is a hypothetical tool.”
    “It is a tool grounded in the logic of human action.”

    Not the values. The overall shape is. But the values are the key here. The values do not follow from the laws of action. They are subjectively determined, and not constant. [...] Sure, but this doesn’t tell you what those values actually are. That is an ex post, revealed preference phenomena. It cannot be deduced.

    The shape is all we’re talking about here. Demand curves slope downward and supply curves slope upward. Those are the only assumptions necessary for Gene’s thought experiment. The actual values along the demand and supply schedules would, hypothetically, let us quantify the employment increase, but only the directional relationships are needed to show why an employment increase would be expected by economic logic.

    Each with their own practically infinite number of supply and demand “curves” that are extrapolated away from the observable intersections,
    Example: If I buy one hamburger for $5.00, and then later on when they drop the price to $3.00 I buy 2, you cannot infer from this that I am “moving along the demand curve.” The one has no necessary relation to the other. The supply and demand schedule for hamburgers in the past is not the same schedule for today. You would have to include the possibility of there being two supply and demand “crosses”

    Yes we all know ceteris isn’t paribus in the real world. What does this have to do with Gene’s thought experiment, or my note that real world trades are executed at particular price-quantity pairs and do not necessarily tell us the equilibrium price?

    You can never get that “more information.” The only information you have is supply and demand. The “equilibrium” is unobservable.

    You are now arguing my point and contradicting your earlier claim, which was:

    The only real world data is the intersection.

    The intersection of supply and demand is the equilibrium price. Now you are saying that the equilibrium price is unobservable, which was my point and why I wrote that all we know for sure is MB>(MC+transaction costs) at the observed price.

    ———–

    Also, I would like to note that I have been sloppy in my use of equilibrium. Gene’s example is even more robust if we include not just markets out of equilibrium, but markets that deviate from perfect competition in which the market wage could be an equilibrium, but because MC<MRP, a different equilibrium with greater employment could be achieved with a price floor.

    This also applies to my response to Tel above. Monopsony power, transaction costs and information costs, worker heterogeneous human and social capital, are actually reasons not for the wage to be below the equilibrium wage, but rather for the market to be stuck in an equilibrium with lower employment, in which case a minimum wage could bring the market to a new higher employment and higher wage equilibrium.

    Of the reasons I listed, slow information dispersion would be the main reason why a labor market may not adjust quickly to the equilibrium wage. Another important reason a market would not quickly adjust the equilibrium wage rate is long-term contracts.

    • Major_Freedom says:

      thinkingotherthings:

      “The equilibrium is not in another dimension. It is the equilibrium wage in the real world market at a given time. The fact that it may not be the wage actually paid does not mean it doesn’t apply to this dimension.”

      Equilibrium is never reached in the real world. It is a mental tool of thought. This is what I mean by “another dimension.” It isn’t ever the real world dimension. Every “other dimension” story, myth, line of thought, etc, was always in the mind.

      “Suppose the equilibrium wage rate – the rate at which the quantity of labor demanded would exactly equal the quantity of labor supplied – is $8/hr, while the wage actually paid is $5/hr. The equilibrium wage rate is still very much in this dimension even if it is not the observed market rate. Unless you believe that we have reached the evenly rotating economy, it is entirely possible for a market to be out of equilibrium.”

      No, that equilibrium is not in this dimension at all. This dimension consists of wage rates actually paid, in this case $5/hr.

      “Period 1: market wage = $4/hr, equilibrium wage = $8/hr. Period 2: market wage = $5/hr, equilibrium wage = $7/hr.”

      Which period are we in, and which equilibrium wage is “the” equilibrium wage, that is, which equilibrium wage is being held constant in the course of the state establishing a minimum price floor for wage-labor?

      There is a constancy here that you are overlooking. It is the constancy IMPLIED in the very act of the state setting a minimum price floor, given a particular imagined equilibrium wage rate.

      “The difference is that the claim you made – that Gene is assuming a constant equilibrium wage rate – is virtually impossible to hold in real life, whereas the claim that his thought experiment actually supposes – that a gap between the equilibrium rate and the market rate can persist – is much more plausible.”

      It isn’t plausible at all, unless the set of wage rates you have imagined are persistently different from empirical wage rates. But your imagined set of wage rates are less informed than those actually buying and selling wage-labor throughout the market.

      “My point however is that there is no stability to it, not absolutely and not even relatively.”

      Yet in your two period example, your chosen equilibrium wage rate remained relatively higher than empirical wage rates. That is a fixec conception as well.

      “I never used the word “proved”.”

      You didn’t have to say that specific word. It’s the fact that you think B necessarily follows from A. Use whatever word you want. My point is that imposing a price floor for a thing will not raise the nominal demand for that thing, nor does it increase the supply of that thing. It just makes a certain set of alternative options illegal. Making B illegal does not mean A will be chosen. Neither A nor B would be chosen.

      “More importantly, if you actually draw out the graph for Gene’s thought experiment, you will see that the increase in employment does not depend on raising nominal demand. At a wage rate below the equilibrium, it would already be the case that the quantity of labor demanded exceeds the quantity supplied. So, while a wage increase would reduce quantity demanded, even with the floor in place quantity demanded would still exceed quantity supplied. Quantity supplied, meanwhile, would increase because the higher wages would attract more workers to the industry, hence greater employment.”

      No, that is also wrong. That is just a blatant contradiction. Yes, a wage rate increase will decrease the quantity of labor demanded. That means fewer labor hours purchased, not more. You can’t then say in the next sentence that the quantity demanded rises. You’re saying two opposite things there.

      “It’s a thought experiment. The title of his post was “Is It Logically Possible for a Higher Minimum Wage to Increase Employment?” so appealing to empirical evidence would be pointless. His post clearly demonstrates something logically possible in a situation that is not unrealistic.”

      No, he did not demonstrate that it is logically possible in the real world. All he did was “prove” that if we lived in a world where individuals did not act according to their own self-interests, then using coercion against them might potentially benefit their self-interest. He didn’t show it is possible in the real world, because in the real world, you can’t abstract from real world facts if you’re going to say it’s realistically possible.

      “I can because in the thought experiment, both before and after the wage increase the marginal worker’s revenue product still exceeds the wage, and so it will still be profitable for employers to employ those workers.”

      No, you can’t just assert that employees and employers are setting wage rates that you claim are not optimal, such that coercion will increase wages. You keep making the false assumption that setting a minimum price floor will actually lead to higher wages being paid.

      “For example: before the wage increase, suppose MRP = $9/hr and W = $5/hr. The price floor is then imposed at $6/hr. At the higher wage, more people are willing to work and the MRP of the last worker is $7/hr.”

      What higher wage? You haven’t shown any higher wages actually being paid.

      “From the employer’s perspective,even though he has to pay the workers more, it is still worthwhile to hire all the workers – even the additional ones he wasn’t previously employing – because they still bring him more revenue than they cost him.”

      No, the employer does NOT “have to pay the workers more.” You are ignoring the employers simply not paying more. You keep ignoring the fact that making lower prices illegal does not mean that employers will pay higher prices. Making X illegal does not imply people will do Y. They could do neither X nor Y. You keep assuming that if X is illegal, then Y ipso facto occurs.

      “So you believe that labor markets are always in equilibrium then?”

      No.

      “Do price adjustments occur instantaneously when conditions change?”

      No.

      “Have we reached the evenly rotating economy?”

      No.

      “Are there no market frictions?”

      There are.

      “No transaction costs or information costs?”

      There are.

      None of these questions, and certainly none of the answers, shows that setting a price floor will increase the supply of the thing.

      “If the real world is not as clean as the perfect competition model assumes, then it is possible for wages to be out of equilibrium.”

      Wages are ALWAYS out of equilibrium. Equilibrium is NEVER achieved.

      You’re not showing what you think you’re showing, and you’re not showing Callahan’s example to be showing what you think it’s showing.

      You are smuggling in assumptions that require justification and cannot be taken as given.

      “While this would be expected to happen, switching jobs is not as quick and fluid a process as switching your lunch spot from McDonald’s to Burger King.”

      Nobody said it was.

      “There are substantial transaction costs, information costs, a worker might have to uproot their family and put their kid in a new school system.”

      You can’t know any of this without access to market information, which is always empirical.

      “which isn’t to say that these adjustments can’t be made, just that the wage rate could be below the market clearing rate for a substantial period of time given how costly it is to reallocate labor.”

      Wages are always and everywhere not at equilibrium. You’re not proving what you think you’re proving.

      “How so?”

      Me pointing a gun at you, telling you that if you trade with Bob at prices I find are too low, I will shoot at you, does not imply that you both will trade at higher prices. Me making illegal certain prices does not mean you will trade at higher prices.

      “The shape is all we’re talking about here.”

      No, we’re talking about values. The numerical values of equilibrium wage rates, and the numerical values of empirical wage rates, and your claim that the numerical values of equilibrium wage rates can remain persistently higher than the numerical values of empirical wages, such that imposing a price floor numerical value, will increase the numerical value of employment!

      “Demand curves slope downward and supply curves slope upward.”

      This is not observed.

      “Those are the only assumptions necessary for Gene’s thought experiment.”

      No, there are a lot more assumptions required, only a few of which I have spoken about because they are problematic and deal breakers.

      “The actual values along the demand and supply schedules would, hypothetically, let us quantify the employment increase, but only the directional relationships are needed to show why an employment increase would be expected by economic logic.”

      No, you cannot claim to be observing values “along” a demand and supply schedule. You’re only ever observing the intersections. At each subsequent moment in time, when you make an observation of the intersection, you could very well be observing the intersection of a NEW hypothetical supply and demand schedule. Think of a series of crosses on an x-y axis.

      “Yes we all know ceteris isn’t paribus in the real world. What does this have to do with Gene’s thought experiment, or my note that real world trades are executed at particular price-quantity pairs and do not necessarily tell us the equilibrium price?

      See above.

      “You can never get that “more information.” The only information you have is supply and demand. The “equilibrium” is unobservable.”

      “You are now arguing my point and contradicting your earlier claim, which was:”

      “The only real world data is the intersection.”

      That makes no logical sense. That was not your point. That was my point, and the second quote you have cited of me, that you claim contradicts the earlier quote, is in fact entirely consistent with the first quote. In both cases the equilibrium values are unobservable. In both cases the only information that you can acquire of others, is observed intersection data points, what I call empirical wage rates.

      There is no contradiction there at all.

      “The intersection of supply and demand is the equilibrium price.”

      You mean the intersection of equilibrium supply and equilibrium demand is the equlibrium price. But we’re never at equilibrium. You keep reifying a mental tool of thought.

      “Now you are saying that the equilibrium price is unobservable, which was my point and why I wrote that all we know for sure is MB>(MC+transaction costs) at the observed price.”

      I have always said equilibriums are unobservable. The fact that they are unobservable does not prove what you think it proves. It does not all of a sudden imply that because empirical wage rates differ from equilibrium wage rates, that Callahan’s example might be possible. For you would AGAIN be smuggling in the assumption that making illegal certain wage rates leads to a higher demand for labor. That is the false assumption that your belief system rests on.

      “Also, I would like to note that I have been sloppy in my use of equilibrium. Gene’s example is even more robust if we include not just markets out of equilibrium, but markets that deviate from perfect competition in which the market wage could be an equilibrium, but because MC<MRP, a different equilibrium with greater employment could be achieved with a price floor."

      No, that is also false. Making illegal a set of potential prices does not imply people will pay higher prices, and it does not imply that the supply of that which they purchase, will rise either.

      "This also applies to my response to Tel above. Monopsony power, transaction costs and information costs, worker heterogeneous human and social capital, are actually reasons not for the wage to be below the equilibrium wage, but rather for the market to be stuck in an equilibrium with lower employment, in which case a minimum wage could bring the market to a new higher employment and higher wage equilibrium."

      False. Making illegal wages below $5 does not mean employers will agree to pay higher wages. If it was to their self-interest to pay higher wages now, they would be doing it already.

      "Of the reasons I listed, slow information dispersion would be the main reason why a labor market may not adjust quickly to the equilibrium wage. Another important reason a market would not quickly adjust the equilibrium wage rate is long-term contracts."

      Imperfections in the market does not imply violence makes it better.

    • Tel says:

      Suppose the equilibrium wage rate – the rate at which the quantity of labor demanded would exactly equal the quantity of labor supplied

      In every real world transaction, exactly equal hours of labour are sold as the number of hours purchased. Demand always exactly equals supply, and cannot be otherwise. This is also true of aggregates, and any economic simulation you care to create.

      • Gene Callahan says:

        Tel, you are just demonstrating that you don’t know what “quantity supplied” and “quantity demanded” mean.

        • Tel says:

          Please provide a reference (and actual specific reference that can be followed) for a transaction where the quantity demanded was different to the quantity supplied.

          I mean the quantity actually demanded, and actually supplied, not an imaginary figure, a measured figure.

    • Tel says:

      No, he did not demonstrate that it is logically possible in the real world. All he did was “prove” that if we lived in a world where individuals did not act according to their own self-interests, then using coercion against them might potentially benefit their self-interest. He didn’t show it is possible in the real world, because in the real world, you can’t abstract from real world facts if you’re going to say it’s realistically possible.

      He didn’t even do that much. He just declared that some “equilibrium” price exists (with no definition of what he means by “equilibrium” and no we don’t have a single agreed definition) based on no basis at all. To start finding an explanation of this is to invent information that never was in Gene’s original piece.

      Let’s suppose there’s an economy run by Keynesians, and it runs really badly. There you go, I have just “proven” Keynesian economics is terrible, using Gene’s style of proof.

      In a normal world of proof you would have to start with some axioms, but it seems now we skip over that bit and just start by supposing an outcome. It saves time I guess.

      • Gene Callahan says:

        ‘He just declared that some “equilibrium” price exists (with no definition of what he means by “equilibrium”’

        Tel, check ANY micro I textbook. Even one by Austrians like Boettke and Prychitko.

        The demonstration I gave is just a very standard use of supply and demand analysis. I am sure Bob accepts it as sound: ask him if you don’t believe me. The fact it has you utterly befuddled is very good evidence that you should stop spouting off about economics for a while and try studying it.

        • Tel says:

          It is pretty easy to demonstrate that you are the one who is befuddled here, but as I already pointed out since all you do is name calling, and don’t present any real argument it seems like I’m putting a lot of effort in for your benefit.

          Anyhow, since you will accept “any textbook” I choose Wikipedia which has a traditional supply/demand curve right here:

          http://en.wikipedia.org/wiki/Economic_equilibrium

          Please don’t bother coming back and telling me you really mean something different, because you said “any textbook” and you provide no other reference yourself.

          What I point out above (and you clearly fail to grasp) is that the green line D “demand curve” and the red line S “supply curve” do not exist at any point in time in a real economy. It is physically impossible for only 50 workers to sell their labour and for employers to simultaneously employ 100 workers.

          You will never find a real executed transaction where supply does not equal demand, if I buy 5 apples for a dollar, then the supply is 5 apples and the demand is 5 apples and the price is 20c per apple. You may hypothetically believe that potentially I would buy 6 apples if that price had been cheaper, but what I did was bought 5 apples, and the price wasn’t cheaper, and everything else is guesswork.

          Having said that, I’m supposed to sit and bang my head and play silly games, so let’s all suppose those supply and demand curves are real, and let’s suppose Gene says the economy is sitting the the green triangle “A” labelled “excess demand” where P < P0. Why would this happen? No one knows, and we can't argue about it because Gene has declared it an axiom.

          OK, so because P < P0, and because that red line "S" slopes upwards (please keep referring back to the diagram on Wikipedia) we know from the red line that the available number of workers is lower than the equilibrium point (just draw across to where P meets the red line).

          Because it is physically impossible for employers to hire more labour than actually exists, we know from that other curve "D" that employers now offer a price that is higher than P0 in order to attract workers. It is easy to find the price on the graph, just draw a vertical line at the supply of workers that you had based on Gene's silly axiom, and meet the green "D" line as you go upwards.

          Now you are sitting on the bottom corner of the red shaded "B" triangle just on the edge of excess supply. How did we get here? Because there weren't enough workers to meet the demand so the price went up. But oh no! The axiom says the price cannot go up… the axiom says that P < P0.

          But… but… what that means is the red line does not really indicate demand in this imaginary Gene economy, something else is going on. No one know what, but anyhow the axiom is that P < P0 and that's what we set out to prove so thus ends the proof. Mind you, if the red line does not represent demand, then demand must be something else, so the equilibrium must also be something else, so then P0 has moved, but the axiom says P has to keep getting smaller to run away from the now moving P0. Gosh what a riddle. Good thing it wasn't my idea.

          Useless. But there you go. That's what happens when you use the Wikipedia definition of economic equilibrium.

          Which definition were you using, Gene? You still haven't told anyone.

    • Tel says:

      This also applies to my response to Tel above. Monopsony power, transaction costs and information costs, worker heterogeneous human and social capital, are actually reasons not for the wage to be below the equilibrium wage, but rather for the market to be stuck in an equilibrium with lower employment, in which case a minimum wage could bring the market to a new higher employment and higher wage equilibrium.

      Since none of this fits Gene’s original presumption, he can safely ignore the lot of it for his so called, “logical proof”.

      It’s a fair point though, (back in normality, and ignoring Gene’s attempted logic) if you take “equilibrium” to mean whatever the system settles to after a medium length of time with no additional external interference, then yeah, by that definition it is impossible for a real wage to come out not being the “equilibrium” wage (other than for a brief time). Gene provided no explanation for his meaning of “equilibrium” but as I’ve already pointed out, if a market is uncompetitive, then price fixing by central authority does not make the market more competitive. What generally happens is the government strikes a deal with the largest player and gets some campaign donations in return. This too is “equilibrium” in as much as it settles to a stable situation, corrupt, but everyone knows the deal.

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