Wednesday, October 27, 2010

The upside of bad textbooks

Mainstream introductory economics textbooks have so many weaknesses it's hard to know where to start listing them. But for the sake of context let's just have take a scatter gun approach. So, in no particular order these weaknesses include:
1) the pretense that people are rational and disciplined.
2) the pretense that more things make us happy.
3) the pretense that markets are mostly perfectly competitive.
4) the pretense that the economy can be studied in isolation from the political and legal systems.

Don't worry. I haven't run out of weaknesses. But my point in this blog actually isn't to discuss the weaknesses per se. Rather it is to wonder whether bad textbooks aren't a blessing in disguise for the good teacher. After all, they provide a wonderful focus for critical commentary. And in the process  of critiquing the textbook, perhaps students become aware that just because something is written in a textbook, that doesn't mean to say it is true. Perhaps the process of having a bad textbook, and a lively critique of the book in class, provides critical awareness of how the subtle process of persuasion operates.

What do you think? Is there an upside to bad textbooks?

Production and costs, real and imagined

I don't know about you, but for me the dreariest part of any microeconomics course is the part dealing with production functions and cost curves. I've reached that point in a managerial course I'm giving and, for once, I have a text that gives a reasonably good discussion of the empirical evidence (Paul Farnham's Economics For Managers, 2nd ed.). Of course, the text first spends most of its space setting out the usual stuff, devoid of empirical content. But a few pages (pp.132-135) at the end explain some of the problems with the simplistic U-shaped average cost curves and upward-sloping marginal cost curves.
  One of the first confusions of the traditional textbook production function Q = f(L,K) is that it's really a story about the production of value-added, not output. Students often wonder where raw materials are, or electricity, and so on, all products purchased from other firms. They are not there because value added is the value of the firm's output less the value of the inputs it buys from other firms, leaving the value added by the labour and capital employed in the firm itself.
  Farnham's text doesn't mention this issue, but an even more important confusion is well explained. It is a confusion of stocks and flows.
  Properly interpreted, Q is a flow of value-added that comes from a flow of labour services (L) and a flow of capital services (K). Yet in the story of the "short run", we are told that K is "fixed". But what is meant is that the stock of capital is fixed, not the flow of services from it.
  Once this is clear, then it's easy to understand why the so-called "law" of diminishing marginal returns is not observed in practice. To quote Farnham (p.134):  
Much research has indicated that inputs in these settings [ie manufacturing and industry] are likely to be used in fixed proportions up to the capacity of the plant. Although the stock of a fixed input is fixed, the flow of services from that stock may be varied and combined with the services of the variable input in fixed proportions. The size of a machine may be fixed, but the number of hours it is put in operation can be varied. Both capital and labor services are variable in the short run and can be changed together in fixed proportions, thus preventing diminishing returns and rising marginal costs from occurring in many manufacturing operations.
  Naturally, almost every other cost curve in the rest of the book reverts back to the 'textbook' model that lacks any solid empirical support, the usual practice of 'note-and-forget' that we point out in the Anti-Textbook as a favourite technique of authors who don't want the facts to get in the way of a useful story. Still, Farnham's treatment is far better than is normally found in most texts.
  Farnham also discusses a reason for the deviation of the text's model from reality. He suggests that the text's model of production is really a model applicable to agricultural production, where we can imagine a crop (perhaps Halloween pumpkins?) being grown on a fixed amount of land with labour working the land. He writes (p.132): "There is no need to distinguish between the stock of the fixed input, land, and the flow of services derived from it. The land provides services continuously and is not turned off at night."

  So, to sum up in the form of a supplementary "Question for your professor" to add to the questions in Chapter 5 of The Economics Anti-Textbook:

Isn't the short-run production function in the text confusing the stock of capital with the flow of services from it? If we properly make the stock-flow distinction, doesn't the story of diminishing marginal returns fall apart?


Friday, October 22, 2010

"The Skeptical Economist"

As we were finishing The Economics Anti-Textbook, Jonathan Alred published a very fine book -- The Skeptical Economist: Revealing the Ethics Inside Economics (Earthscan, 2009). ('The Skeptical Economist' was also a title that we had considered when developing the Anti-Textbook.)
You can have a peek via google books. This, and Moshe Adler's Economics for the Rest of Us (mentioned here recently), and others, made me think that we were catching a wave, that something about the times was prompting these critiques of the way mainstream economics is presented.

Monday, October 18, 2010

Should people voluntarily take external costs into account in their actions?

From what I've seen the microeconomics texts don't ask this question. They simply make the assumption that the rational narrowly-self-interested person does not do that and has to be compelled to do so by a Pigovian tax, for example. Does this assumption of socially irresponsible behaviour subtly legitimate it and influence students' own attitudes and behaviour?
  I only really thought about this implicit assumption myself when I saw a book that was different: Avi Cohen and Ian Howe's Microeconomics for Life: Smart choices for you (2010, Pearson Canada), a new introductory book that is also unique in having no diagrams(!). They state that people should take all costs into account, both those they face privately and those they impose on others. Writing about 'smart choices' for businesses, they say: "Be sure to count all additional benefits and additional opportunity costs, including implicit costs and externalities." (p.194)
  Oddly enough, they don't discussing why a firm (or a person) should do this. Isn't the firm supposed to be maximizing profits? Apparently they're assuming something beyond narrow self-interest. (If a government had already imposed an appropriate Pigouvian tax, that would appear as an explicit cost like any other, and would require no special consideration.) Of course, a class using the book could be prompted by the instructor to think about this in more detail. To what extent to businesses have leeway to raise their own costs voluntarily? How would they know what the appropriate action is in the absence of a price signal like the Pigouvian tax?


Wednesday, October 13, 2010

Moshe Adler's "Economics for the Rest of Us: Debunking the Science that Makes Life Dismal"

Anyone having a look at this Economics Anti-Textbook blog will want to have a look at Economics for the Rest of Us: Debunking the Science that Makes Life Dismal by Moshe Adler, an elegantly-written and accessible book (as well as being very nicely produced). It can be read by someone even without introductory economics, but can be read with profit by anyone.
You can have a preview by looking it up at Google books: You'll see that it is divided into two parts. The first examines the concept of economic efficiency that dominates the textbooks in a way that I found very original and insightful. The second half of the book is a critical examination of theories about the most important prices in the economy (wages) which get the back-of-the-bus treatment in the theory textbooks, which spend much more time on output prices.
  I'd like to have the time to write a proper review of this book, but I'm a bit swamped right now. In any case, you should just get yourself a copy: the hardcover is a mere $22 on (The paperback edition will be out next June.)


Friday, October 8, 2010

Well-meaning policymakers and unintended consequences

I'm giving a course on economic inequality these days and as part of it I listened recently to an hour-long lecture on YouTube by Richard Wilkinson and Kate Pickett, the authors of The Spirit Level: Why Equality is Better for Everyone ("Inequality: The Enemy Between Us?" in 8 parts, highly recommended). At one point, Richard Wilkinson mentions the growth of inequality in the UK during the Thatcher years that resulted, in part, from changes in taxes and transfers and a reduction in trade union power. He notes that, according to the evidence put forward in The Spirit Level, this had long-term consequences that those responsible for those policies did not intend or foresee: a growth in social dysfunction, as reflected in growing problems with such things as obesity, violence, and teenage pregnancies.

   The example reminded me of how the textbooks use examples of such unintended consequences in a different way -- to make a rhetorical point of their own in favour of 'free market' policies. Is something like the following familiar? The apparently short-sighted or economically ignorant, policymaker who thought that rent controls were a good idea, but did not realize that it would make it harder to find an apartment as excess demand developed. Or the well-intentioned raising of minimum wages by politicians, not realizing that an excess supply of labour would develop -- at least according to the perfectly competitive model. Or the claim that requiring people to buckle up and use their seatbelts will have a more-than offsetting effect of inducing them to drive more carelessly, leading to an increase in accidents and injury and death. (OK, no text I know of is crazy enough to try that one out, but I could not make it up; it's in the professional literature. See Sam Peltzman, “The Effects of Automobile Safety Regulation,” Journal of Political Economy 83 (1975), 667–725. For evidence that it's not true, see studies such as Anindya Sen, “An Empirical Test of the Offset Hypothesis,” Journal of Law and Economics 44:2 (2001), 481–510, or Alma Cohen and Liran Einav, "The effects of mandatory seatbelt laws on driving behavior and traffic fatalities", The Review of Economics and Statistics, November 2003, 85(4): 828–843.)
   These are cases of what the great economist Albert Hirschman, in his 1991 book The Rhetoric of Reaction: Perversity, Futility, Jeopardy, called 'The Perversity Thesis'. One form that conservative or reactionary arguments take is to say, in effect, 'Yes, policy X is undoubtedly well-intentioned, but don't you realize that it will have perverse effects leading, in fact, to undesirable outcomes?'
   Hirschman comments (pp.39-40):
For example, those who emphasize the perverse incentives  contained in unemployment benefits or welfare payments never mention that large areas of social assistance are fairly impervious to the 'supply response' that is at the bottom of whatever perverse effect may be at work: people are unlikely to gouge out their eyes in order to qualify for the corresponding social security or tax benefits.When industrial accident insurance was first introduced into the major industrial countries of Europe toward the end of the nineteenth century, there were many claims on the part of employers and various 'experts', that workers were mutilating themselves on purpose, but in due course these reports were found to be highly exaggerated. 
    Do some textbooks really offer examples of a 'perversity thesis'? You can see if you can find some examples yourself, but here's a quote from Baumol and Blinder's Microeconomics: Principles and Policy, 10th Ed. (2006) which I found with no effort:
Any government that sets out to repair what it sees as a defect in the market mechanism runs the risk of causing even more serious damage elsewhere. As a prominent economist once quipped, societies that are too willing to interfere with the operation of free markets soon find that the invisible hand is nowhere to be seen.