What is the practical importance of microeconomics

Claudius Graebner
Rethinking Economics: Blind Spots in Textbook Economics, 2016

The role of the concept of equilibrium in microeconomic education

Claudius Graebner

Source: van Treeck, Till, and Janina Urban. Rethinking the economy: blind spots in textbook economics. iRights Media, 2016. The book can be ordered here: http://irights-media.de/publikationen/wirtschaft-neu-haben/.

 

Reviewed books:

Pindyck, R.S./ Rubinfield, D.L. (2013): Microeconomics,8th edition, Munich: Pearson, 1013 pages. In the following cited as PR. (Fig: Pearson)

Schumann, J./Meyer, U./Ströbele, W. (2011): Fundamentals of microeconomic theory, 9th edition, Berlin: Springer, 559 pages. In the following cited as SMS. (Image: Springer-Verlag Berlin-Heidelberg)

Varian, H.R. (2011): Basics of Microeconomics, 8th edition, Munich: Oldenbourg, 892 pages. In the following cited as HV. (Fig: De Gruyter Oldenbourg; Fig. Shows the 9th edition)


 

Introduction and motivation: the role of the equilibrium concept in economics

Often the demand for pluralism is answered with reference to the diversity of the mainstream. Of course, however, the undoubtedly very different research orientations within the mainstream show important similarities. Two theoretical concepts are of particular importance here. On the one hand the optimization concept: It allows economists to model the decision problems of subjects as optimization problems under constraints. On the other hand, there is the concept of equilibrium: the vast majority of models in both micro and macroeconomic research are equilibrium models. From a pluralistic perspective, the question now arises as to what role these concepts should be assigned in training and how alternative approaches should be dealt with that do not make use of one or both of the concepts.

Lecturers are faced with a major challenge: They have to introduce young people to a completely new science and prepare the initially quite abstract approach to economic theory in an educational way. To what extent should the most fundamental assumptions be questioned again? However, if there is no reflection at all, the students could get the wrong impression that economic thinking is to be equated with thinking in terms of optimization and equilibrium.

Textbook authors have a decisive advantage over lecturers here: They can easily engage in more in-depth discussions and reflections in their works without overwhelming students. Each reader can skip the critical-reflexive passages and concentrate on the craft in order to then reflect on this craft accordingly. The argument that one overstrains students by critically examining one's own approaches in textbooks is therefore not convincing.

Let's examine how three of the leading microeconomics textbooks introduce and use the concept of equilibrium. The optimization concept is examined in detail elsewhere (see the article by Torsten Heinrich in this volume). After we have made some theoretical preliminary considerations on the role of equilibria in economics, we will then briefly present the three works and comment on each one. Finally, we will draw a comparative conclusion.

Theoretical preliminary remarks

At this point we want to summarize some important fundamental findings on the equilibrium concept in economics. We will later examine how these - quite critical - results are taken into account in the textbooks. On the one hand, this will show us how reflective the authors are with the presented theory. On the other hand, the results presented here offer a direct motivation to discuss alternative approaches in economics that are not based on equilibria.

The results relate to the following questions:

  • How is a static equilibrium analysis different from a dynamic equilibrium analysis?

  • Which mechanisms lead to an equilibrium? How can these mechanisms justify a static equilibrium analysis?

  • To what extent is the fully competitive market model, with its unique equilibrium, the best neoclassical reference model for welfare analysis?

We will look at the three questions from both a neoclassical (i.e. intra-paradigmatic) and a pluralistic perspective.

Static and dynamic consideration of equilibria

Microeconomic textbooks usually start with the analysis of static equilibria. This approach is usually justified by the fact that the dynamic analysis of equilibria is too demanding and the results of the static analysis could also be helpful in a dynamic context.

Unfortunately, there is much to suggest that a dynamic analysis of the economy often leads to qualitatively different conclusions than a static one. In particular, the crucial question of the stability of equilibria arises in the context of a dynamic analysis. It is often said that unstable equilibria should only play a subordinate role in economic theory, since they can hardly be observed in reality.1 Above all, they would be a completely unsuitable starting point for assessments of welfare theory. Unfortunately, in the course of the history of general equilibrium theory, the existence of a stable equilibrium could not be proven even in the competitive model - on the contrary (see for example Debreu 1974; Kirman / Koch 1986). Positive results regarding the stability of equilibria in general equilibrium setting could only be achieved in the recent past by Gintis (2007) and Mandel / Gintis (2016) - however in a completely different methodological framework than the method case presented in the textbooks (namely with the help of agent-based simulations and replicator dynamics). Against this background, it seems highly questionable to confront students exclusively with a static equilibrium concept and its welfare-theoretical results, where these would lose all meaning in a dynamic and more realistic setting.

How can equilibrium come about?

Suppose there is a theoretical equilibrium in economics. How can it be achieved or under what circumstances is it clear? Microeconomic textbooks tend to leave out the related processes. Most of the time, students are told that supply and demand are usually in equilibrium - if they weren't, the price would fall if there was excess supply and if there was excess demand, it would fall until the equilibrium price is realized. The catch with this argument is that it actually requires a dynamic perspective on markets, but the adjustment processes just mentioned no longer work at the latest for markets with more than two goods (see also Blatt 1983, Hildenbrand / Kirman 1988). Alternative pricing mechanisms can lead to very different results (see for example Miller / Tumminello 2015).

The welfare-theoretical implications of competitive equilibrium

The third point concerns the welfare-theoretical implications of competitive equilibrium. It is the equilibrium in perfect competition that is applied in almost every microeconomic introductory textbook like a prayer wheel to examples such as the minimum wage or rent brakes - despite questionable empirical evidence (see the beautiful summary in Myatt 2010, Chapter 3). There are also numerous voices within the neoclassical school who advocate replacing the model of perfect competition as the standard model. Stiglitz (2002, p. 477), for example, argues that the monopoly model should always be preferred to the competitive model as soon as the smallest information costs exist. The arguments of Sraffa (1926) about the lack of independence of the supply and demand curve in the competitive model are still valid and suggest the use of a different standard model even within the purely neoclassical analysis - with completely different economic policy and welfare theoretical implications (see the article by Hansjörg Herr in this volume). The problems that arise from a dynamic consideration of possible equilibria also have important welfare-theoretical implications: for example, with every adjustment process, there is necessarily also trade at imbalance prices. Since when trading with non-equilibrium prices one side wins compared to trading with equilibrium prices and the other side loses, the result is a real shift in relative wealth. This would not only change the equilibrium price, it would also have important distribution-theoretical implications that considerably challenge the concept of efficient equilibria (Albin / Foley 1992; Foley 2010).

From a pluralistic perspective, however, the criticism of the equilibrium concept is only a first step: It identifies weaknesses of the neoclassical approach and thus provides - in addition to basic epistemological arguments (e.g. Kapeller / Dobusch 2012) - a justification for considering alternative perspectives, e.g. evolutionary-institutional economics or complexity economics, the implications of which are discussed in more detail in Wolfram Elsner's contribution in this volume.

The individual reviews

Two US textbooks and one German textbook are discussed below. On the one hand, we are concerned with Hal Varian's “Grundzüge der Mikroökonomik”, now in its 8th edition (2011) published by Oldenbourg Verlag. Pearson Verlag publishes Robert Pindycks and Daniel Rubinfeld's “Mikroökonmie” in the 8th edition (2013). There are clear similarities in content and pedagogy between these two American books.

The third book, the “Introduction to Microeconomic Theory”, is an original German production by Jochen Schumann, Ulrich Meyer and Wolfgang Ströbele. The 9th edition of the book was published by Springer Verlag in 2011.

All three books are intended as introductory works. They address students without any prior knowledge of microeconomics. Nevertheless, the content goes beyond the scope of a semester. This allows the reader to explore further topics independently and to see “what else there is to discover in microeconomics”. In the following, however, we also want to ask critically whether the books do not narrow the students' view by the fact that everything “that can still be discovered in microeconomics” can be assigned to a very specific approach. This would only reinforce the feeling that microeconomic research has to function in a very specific way.

Hal Varian's "Basics of Microeconomics"

Varian's “Basics of Microeconomics” enjoys enormous international popularity. Varian is not only one of the most influential economists of our time, but with his job as chief economist at Google also refutes the prejudice that economists can only make little constructive contribution to everyday corporate life.

Right from the start, Varian makes the focus of his textbook clear. He writes on page 1:

"The usual first chapter of a microeconomics book is a discussion of the 'scope and methods' of economics. Although this topic can be very interesting, it seems rather inappropriate to start the study of economics with it. The value of such a discussion is to be assessed as rather low before one has become acquainted with examples of applied economic analysis. "

This statement is not entirely wrong: we cannot reflect on the concept of equilibrium without basic knowledge of equilibrium analysis. However, against the background of the theoretical preliminary remarks formulated in the last section, it seems to be just as problematic to completely omit a critical reflection taking into account alternative approaches.

It's nice that Varian starts with an illustrative example of traditional microeconomic analysis. It introduces the idea of ​​modeling and offers a good orientation, but leaves it with a decidedly neoclassical perspective. Here Varian is very explicit about the pillars of this perspective. He explains that the optimization and equilibrium principle are the basic principles of economic analysis. He also points out that the equilibrium principle is “a little more problematic” than the optimization principle: a divergence between supply and demand is theoretically possible and can be destabilizing (cf. HV, p. 3). However, he does not go into this further and ignoring the facts presented above, he simply postulates: "But usually it does not happen."

In any case, little is critically questioned in the first chapter. And even if his example from the housing market is illustrative, it does not contain any references to the above-mentioned fundamental problems of a comparative-static analysis of equilibria or the empirical difficulties of the competitive model - unfortunately one will look for such information later in vain.

Varian refers to the importance of dynamic analyzes, but takes the view, which is highly problematic against the background of the facts presented above, that “we first have to learn to walk before we walk” (HV, p. 9). The term "dynamics" does not even appear in the subject index and none of the problems mentioned above is mentioned in any way - just as little as alternative schools of thought. So not only do readers not learn to walk - they also don't learn why it is actually important.

We have the next encounter with the concept of equilibrium in the sixteenth chapter. Again, the justification for the importance of equilibrium prices is that if non-equilibrium prices existed, people would change their behavior - a problematic argument, as we have shown above. Varian doesn't care. On page 565 (relating to the Cournot Equilibrium) he notes that the interrelated expectations of companies make modeling difficult and concludes, “Because of this, we will generally avoid the question of how to achieve equilibrium and we just concentrate on the problem of how companies behave in equilibrium. ”The only time that the concept of an imbalance is directly addressed is in Chapter 31 (“ Pure exchange ”). However, it is only pointed out here that an "auctioneer" will change this situation in favor of equilibrium - nothing to the above evidence that even this unrealistic process only works for the two-property example.

In the chapter on information technology we are then confronted for the first (and only) time with a situation with several equilibria: On p. 759 ff., The necessity of a dynamic analysis is described using the example of telephones and faxes, as this allows a statement to be made about which equilibria are more plausible. A similar process is discussed in the same chapter using the example of bilateral markets. Unfortunately, these are presented more as an exception to the rule according to which the economy is in clear equilibrium.

The normative consideration of equilibria is limited to the conventional introduction of the two fundamental welfare theorems. None of the problems mentioned above is addressed, and alternative approaches to the welfare-theoretical analysis of markets are not mentioned.

In summary, it can be said that Varian is a superficial textbook (contrary to what it claims to be). The concept of equilibrium is used alarmingly unreflected and none of the theoretical problems addressed above is adequately mentioned. The introductory chapter is quite clear and clarifies the prevailing approach in economics - the approach is not reflected upon later, any more than alternatives to equilibrium analysis are even mentioned.

Robert Pindycks and Daniel Rubinfeld's "Microeconomics"

Pindyck's and Rubinfeld's “Microeconomics” sees itself as a low-threshold introduction to microeconomics and would like to pick up the readers with their everyday experiences. The level of the material reached towards the end is below that of the other two books reviewed here. There are numerous intuitive, but unfortunately also misleading examples of this.

Similar to Varian (but without its basic introduction to the neoclassical approach), the supply and demand analysis is introduced at the beginning. The authors admit that some markets will not be cleared quickly.However, it can be assumed that there is a tendency towards clearing the market (PR, p. 55). The reason given is that suppliers and buyers would change their behavior accordingly in the event of excess and scarcity. Although it is made clear that this mechanism only works in a competitive market environment, we know from the second part of the review that the mechanisms are highly problematic even in the competitive model. However, the readers do not find out about this here.

In general, the book remains very superficial. In the numerous examples, neither the fundamental approach of the equilibrium analysis is reflected, nor is any reference made to the empirical problems, especially of the competitive model. The reference to the competitive market model is excessive, as its practical relevance has meanwhile also been increasingly questioned in (neoclassical) research (see above). Against this background, statements such as: "Without externalities or without a lack of information, an unregulated competitive market leads to an economically efficient level of production" (PR, p. 444) are particularly problematic, especially since Pindyck / Rubinfeld do not address any of the possible mechanisms that lead to could lead to an equilibrium. This shows the obvious weakness of a static approach - since the authors do not address the topic of statics versus dynamics at any point, there is no possibility of pointing the reader to these potential difficulties.

Pindyck / Rubinfeld only introduce the general equilibrium on page 796. Again, the chosen entry is strongly narrative and again the authors make no statement about the mechanisms of price adjustment. The same problematic adjustment processes are suggested as in the partial market analysis. The use of the term imbalance on page 813 is similarly misleading. Pindyck / Rubinfeld state that there are prices for goods for which rational individuals are unwilling to exchange their goods even though they do not have the optimal equipment for them. However, they then postulate that an “imbalance should only be temporary” (PR, p. 814). We have already made it clear that the argument that in a competitive market prices would adjust very quickly in the event of excess demand or supply is theoretically unfounded.

The welfare-theoretical discussion of the competitive competitive market begins in Chapter 9. Here, the authors follow the familiar process of first demonstrating the efficiency of the competitive equilibrium in an ideal-typical manner and then, towards the end, explaining why such a result is often not directly relevant in practice, but rather as a (normative? ) Reference point is to be viewed. The reasons given in the theoretical preliminary remarks of this review why the static competitive model cannot be precisely this normative reference point are unfortunately not discussed. At least the authors say very clearly that their ideal-typical result in no way means that political interventions are bad per se (e.g. PR, p. 443).

A negative highlight is chapter 16 on welfare theory. With headings such as “The advantages of free trade”, a normative message is sent to the readers that would still be justifiable if a section on the “disadvantages of free trade” had been written afterwards. Unfortunately, this is not the case (see the article by Achim Truger on the subject of free trade in this volume). At the end of the section, the points why markets might not be competitive are briefly listed - but they seem more like appendages. Here the authors refute their own statement that economics is a “cold science” that does not include ethical questions in its genuine research area (cf. PR, p. 448).

In view of the fact that Pindyck / Rubinfeld do not adequately consider any of the problems of equilibrium analysis, which are well known even in neoclassics, it does not seem surprising that not a single alternative theory is even mentioned. In the quite extensive collection of further literature, there is no reference to alternative or heterodox literature at the end of the book. Due to the numerous weaknesses, Pindyck's and Rubinfeld's “microeconomics” is not recommended for use in teaching - this applies not only to pluralistic, but also to reflective-neoclassical teaching.

Jochen Schumanns, Ulrich Meyers and Wolfgang Ströbeles "Fundamentals of Microeconomic Theory"

The first glance at the table of contents shows that Schumann et al. claim to cover more than the standard repertoire of microeconomics: The usual chapters are preceded by “Chapter 0”, which describes the research field of microeconomics and explicitly introduces concepts such as needs, scarcity, self-interest, equilibria and market economy. In the preface to the 7th edition, the authors make it clear that their aim is to go beyond neoclassical theory.

In contrast to Varian and Pindyck / Rubinfeld, they regularly point out the importance of the sometimes very problematic assumptions. When describing an economic cycle, the authors write that the supply and demand curves shown are based on the assumption that "equilibrium already exists in all other markets and that their equilibrium prices are those that are assumed to be given for the market under consideration" ( SMS, pp. 31-32). For them, the total competitive equilibrium is only an example that proves that market-economy coordination is fundamentally possible. Immediately afterwards, the authors briefly discuss the implications of a disturbance of the balance, but refer to later chapters here. The fact that some difficulties of the equilibrium concept are already introduced at this point will hopefully help the reader to deal with this economic concept in a more reflective manner.

Following the introductory chapter, Schumann et al. into neoclassical microeconomics. They do this on an intellectually much more demanding level than Pindyck / Rubinfeld and Varian and repeatedly mention possible deviations from the standard assumptions. For example, external effects under the title “Demand Interdependencies” are taken into account right from the start and, for example, social imitation processes (“Veblen Effects”) are discussed in detail when determining demand (see Till van Treeck's contribution to the image of man in this volume).

Particularly noteworthy is the fact that Schumann et al. on p. 220 ff. make statements about the specific mechanisms that are necessary so that - even in a market with complete competition - the market equilibrium can arise. This is how the students with Walras ’ tâtonnement familiarize yourself with and learn Edgeworth's idea of ​​the recontracting know. Unfortunately, Schumann et al. Nevertheless, there is great potential here: You leave it at that to confront the student with the possible difficulties of the neoclassical approach, but give no indication of fundamentally different approaches in economics that dispense with the equilibrium concept.

It is positive that in Chapter 3 on the competitive market, problems of the existence, uniqueness and stability of the competitive equilibrium are discussed in detail. In particular, the need for dynamic analysis is pointed out and the concepts of Walras and Marshall stability are introduced. The explanations about the nature of balance are interesting at this point, but unfortunately kept very brief. From a pluralistic perspective one would have liked to have mentioned alternative approaches.

It is nice that the cobweb model is introduced on p. 231. This makes it clear to the students the importance of the chronological sequence of supply and demand adjustments. The introduction of different market forms (cash markets, futures markets) in the following section also gives the reader a more reflective insight into the world of markets than in Varian and Pindyck / Rubinfeld.

The normative analysis of the competitive equilibrium then unfortunately turns out to be very classic. The authors emphasize, however, that the equilibrium was developed without direct reference to the welfare consideration of this equilibrium. Schumann et al. also make it clear that the Pareto optimality of the equilibrium is very fragile and, for example, is no longer necessarily given in the presence of external effects.

The chapter that is most interesting for our topic has the promising title “New Microeconomics and Imbalance Theory”. Here the authors introduce the so-called New Microeconomics, which "states that in the real world the mismatch between supply and demand at a prevailing price is a normal phenomenon" (SMS, p. 460). However, here too there is no reference to one of the numerous non-orthodox theory schools that have made the analysis of imbalances their central research object (for example complexity economics or original institutionalism).

Schumann et al. then correctly state that the New Microeconomics likes to see itself as an “imbalance theory”, but strictly speaking this label is not applicable: The lack of coincidence of supply and demand is always a result of rational decisions by individuals maximizing their utility. The reference point of one is always in the background potential Equilibrium.

In the opinion of the authors, the situation is different with a certain interpretation by Keynes, in which transactions actually take place regularly at non-equilibrium prices. This example is discussed in detail. In the end, the authors correctly state: “While the New microeconomics is to be interpreted as a neoclassical continuation of the traditional equilibrium theory of a functioning market mechanism, the imbalance theory is to be seen as an attempt to identify reasons for a non-functioning of this mechanism and to propose economic policy measures for an improved functioning. "(SMS, p. 473)

At this point it is regrettable that this chapter receives so little attention. It can be seen here that, despite all the reflection, Schumann et al. is a textbook that is primarily intended to convey the tools of neoclassical microeconomics. It is pleasantly reflected, but different schools of thought - with the exception of the New Institutional Economics - are hardly taken into account.

Conclusion

All three books are primarily introductions to neoclassical microeconomics. Only Schumann et al. claim for themselves to go beyond the neoclassical and also fulfill this promise made in the foreword in many ways. Almost all critical points regarding the equilibrium concept, which we took up in the theoretical preliminary remarks, are taken into account (regarding the use of the optimization concept, see the article by Torsten Heinrich in this volume). For an introduction to neoclassical microeconomics, Schumann et al. therefore highly recommended. Varian and Pindyck / Rubinfeld, on the other hand, cannot be recommended, whereby the rating for Varian is even better than for Pindyck / Rubinfeld because of the more informative introduction and the chapter on information technology.

From a pluralistic perspective, however, Schumann et al. A lot of potential: The textbook shows weaknesses and problems of the prevailing approach in many places, but fails to at least refer to alternative approaches (let alone introduce them).

 

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