Which concepts work in economics?

On Quora, I was asked where economics works. I changed the question to “which concepts work?” My answer was

The laws of supply and demand work. The principle of substitution works (we do not run out of resources—we substitute away from resources as they become scarce). The idea that economic growth involves creative destruction works. The idea that specialization and trade are fundamental elements of economic behavior works.

Concepts that do not work, in my opinion: aggregate demand and aggregate supply; neoclassical model of income distribution; theory of public goods–it is clearly wrong as a positive theory of how government behaves, and because it is wrong as a positive theory its normative value is also quite dubious.

I would be curious about how other economics bloggers might answer this question.

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17 Responses to Which concepts work in economics?

  1. Jon says:

    I believe that the “idea that economic growth involves creative destruction” is better described as two observations: (1) that competition in a market drives improvements in quality and efficiency; and (2) competitors which fall behind in quality and/or efficiency eventually fail.

  2. Matthew Gelfand says:

    Two concepts that work well are aphorisms: “Don’t put all your eggs in one basket,” and “keep your options open.” These sayings translate into Markowitz’s work on diversification and Sharpe’s CAPM, and (loosely) the Black-Scholes options pricing model. These models work pretty well in broad brushstrokes if they miss in some of the very fine detail.

  3. jack pq says:

    Generally, micro and applied micro work well, and macro does not. Or if you prefer, economics is good at explaining, poor at forecasting. Labor, environment, resource, and financial economics work pretty well.

    Progress in macro and monetary is harder because the data are not as rich. A 200-observation time series is not at all like a cross section of 200 households. As a non-macroeconomist, I would have thought there would be success at exploiting the 50 US States “as if” they were 50 mini-countries in an open border economy. The same way in finance you can’t learn much by looking at the time series of one stock price, but we use a cross-section of stocks (portfolio sorts) and figure out what common risk factors are priced.

  4. Richard Fulmer says:

    Comparative advantage works. Government correction of “market failures” doesn’t.

  5. Matthew Young says:

    We don’t like waiting in line.

  6. Lord says:

    The non neutrality of money, which at its heart is what AS AD attempts to explain while omitting the very variable responsible.

  7. Tom G says:

    What works in economics is describing normal free market behavior most of the time, plus the “expected unknown” disruptions.

    What does not work is any model which allows top-down gov’t to control & direct the behavior, and get both the desired & controlled for outcome, without getting unintended and undesirable side-effects.

    Macro’s false promise is that it allows policy makers to control the economy, without controlling the people. Free people will always change their behavior to avoid or minimize some of the control of the gov’t.

    However, tax cuts + deregulation to increase short term economic growth is a pretty good economic winner for the last 100 years.

  8. Charles W. Abbott says:

    Off the top of my head (still waking up):

    The Political Economy of Taxation doesn’t work. Schumpeter said something about social science theories of taxation and how they simply display the under-developed nature of theory.

    I suspect he was getting at this: Governments collect taxes they are able to collect. They then spend on programs and policies that make political sense. Well meaning scholars sometimes then treat the tax payer as a customer of government. One might say the tax payer is more like livestock being reared for the long term. This would be Mancur Olson’s view of the dictator as a stable, long run rancher…

    • Charles W. Abbott says:

      Just in case anyone is interested, this issue (How economics theory deals with taxation and government spending) is going to be more important as government becomes larger.

      It was one thing to treat taxation and the public sector as a minor distraction to pristine theory when the public sector was 4% of GDP, as it may have been in the UK in 1900. It’s another thing to do that when most OECD countries have at least 30% of GDP pass through government hands.

    • Charles W. Abbott says:

      Just in case anyone is interested, this issue (How economics theory deals with taxation and government spending) is going to be more important as government becomes larger.

      It was one thing to treat taxation and the public sector as a minor distraction to pristine theory when the public sector was 4% of GDP, as it may have been in the UK in 1900. It’s another thing to do that when most OECD countries have at least 30% of GDP pass through government hands, and transfer payments may provide a genuine “moral hazard” so that they may start crowding out paid work, retirement savings, and things that used to be norms.

  9. B.B. says:

    Does the quantity theory of money (money growth sets inflation) count as a widespread and reasonable economic theory? Its roots are ancient. The quantity theory is far broader than any AD-AS theory, which can embody the quantity theory but is not the same thing as it.

    • Arnold Kling says:

      The quantity theory of money is a disaster, in my view. Go back and check my posts on monetary economics. Or read my book, Specialization and Trade.

  10. Becky Hargrove says:

    Supply, demand and substitution do function, but of late they have generated partial equilibrium for non tradable sector services, housing and amenities, which means some forms of substitution aren’t efficient. This is why aggregate supply and demand have resulted in mostly disequilibrium for non tradable sector activity, as well.

  11. Various says:

    Let’s see, I would say the concepts that work include supply, demand, marginal utility, elastisities of supply and demand, how elastisities change depending on time horizon, the whole notion of incentives leading to behaviors. I think there are probably many more I can’t think of right now.

  12. Scott Gustafson says:

    Thinking at the margin works better than thinking about totals or averages.

  13. Maximum Liberty says:

    I’m aware of your criticism of the neoclassical production function. Is your criticism of the neoclassical model for distribution of income based on that criticism?

  14. Charles W. Abbott says:

    1. Capture Theory works. Once you create an agency, it gets captured by the actors who find it most valuable, who sometimes use it for objectives quite different than the ones that the creators wanted and expected.

    in the USA such agencies, laws, and regulatory agents as

    ICC
    NRC fit this theory.

    You could even make the case with “Urban renewal,” which someone (James Baldwin?) said was “Negro removal.” Urban renewal becomes captured by developers.

    2. Ecological niches exist. I don’t know if this is a theory–it’s kind of an observation that flows from the theory of the firm / household and the profit motive (for firms) or the utility function (for the household). AFDC and was not supposed to result in an expansion of families of never married women, especially not in a way that you would see a landscape like the old Robert Taylor projects in Chicago–it was supposed to go to “widows of coal miners with five small children” or the widows of loggers or ironworkers.

    Markets for all kinds of things exist–drugs, prostitution–and it’s easy to arrest the street level drug dealer or the illegal drug merchant / distributor but somehow another one seems to pop up like you are playing whack-a-mole.

    Both of these, in some ways, go back to incentives. Every law or policy or regulation you enact changes incentives.

    You can’t see the incentives, but they exist.

    In the utility of the consumer, other consumers have preferences you never dreamed of. Figuring that out is messy and complicated and non-trivial–you need to go back to revealed preference data, which is non-trivial and shows you only a partial insight into the underlying preferences.

    To quote Prof. Murray Brown from UB, “You can’t see people’s utility functions. Not even with their clothes off.”

    With respect to that theme, don’t listen to what people tell you–watch what they do.

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