Critiques of Economics

[Michael]

Speaking of critiques of economics, here is a very good one, though it is in the form of a book review. The article is however a darn good one - with many surprising gems (especially the one about Larry Summers at the top of page 3 of the article).

The opening paragraph is particularly of interest as it mentions two very significant books as 'seminal works' of 20th century economic theory.

In 1944 two very different but related books were published. The first was F.A. Hayek’s The Road to Serfdom. In a world that seemed to be succumbing to the socialist ideal, where planned economies represented a glorious future, where the turmoil of the market would be replaced by the peace of a directed economy, Hayek’s was a lonely voice warning that a command economy would necessarily entail the loss of freedom. With the demise of the Soviet Union and the apparent victory of market capitalism, Hayek’s views appeared to be vindicated. The second book painted a very different picture. In The Great Transformation, Karl Polanyi argued that a self-regulating market was a utopian fantasy. Polanyi, an economic historian, attempted to show that a market economy required a market society where all things were reducible to market terms. With this homogenization of reality, the very things that once provided a cushion against market forces were absorbed into the market. Where Hayek worried that socialism would jeopardize freedom, Polanyi worried that market forces themselves would erode the social and cultural contexts that made freedom possible.
Article (http://www.firstprinciplesjournal.com/articles.aspx?article=1218&theme=home&page=2&loc=b&type=cttf)

It is Polanyi's view that has always driven my study of politics & economics (Polanyi has been one of Toronto's most notable intellectual celebrities). I certainly accept Hayek's position 'as a given', but I'm increasingly less afraid of socialist authoritarianism than I am of the erosion of liberty through the power of markets. I've always described my politics as being predicated on an equal fear of governments and corporations as equally dangerous, both having great potentials for good or ill for the liberty of the individual.

Anyway, the cited article is a rather good critique of the way market theory has been able to dominate all political discourse. I agree with this critique and it is not good for politics or human society. It has always been my view that government policy ought to consist of more than just trying to get the DowJones index to rise and budget keeping on taxation. That being said, I'm a hardcore deficit hawk because I don't like having the Government being in hoc to bondholders and market traders - which only serves to bind future generations to present policies. That has always struck me as categorically unfair to the next generation.

My essential critique of the field of economics is that I've never accepted the "rational man" thesis at all - indeed, I've always fought against this idea in every manifestation I've found it. I've always viewed human beings as a combination of rationality and irrationality, a mixture of noble virtures and animal passions. I consider it absurd to expect humans to always act rationally. Economic theory that is predicated on individual rationality is doomed to fail. I accept only the most general of macroeconomic principles as they deal only in the largest aggregate numbers of national economies where the effect of individual irrationalities are reduced. (Though of course, larger scale irrationalities become harder to spot!)

Another quote from the cited article to sum it up...

According to Marglin, the ideology of economics posits a truncated philosophical anthropology—the individualistic consumer; it posits an inadequate theory of knowledge—rationalism; and it posits a false conception of community—the nation.

I agree completely with this critique.

[Michael]

This article makes what I consider to be the definitive critique of modern academic economic theories. I think this is the critique that Dominick wanted (or tried) to make. It is to be noted that Dominick's specific key argument is part of this critique (and easily accepted) - but it is only one part, and doesn't shoot down what Dominick claims it did, which is why I rejected his critique and strongly endorse this one. I believe Dominick had the wrong target. Classical economic theory (Smith, Ricardo, Keynes, etc) has not failed at all and doesn't contain the logical flaws that are being raised here - these flaws apply to a departure from classical economic theory, not because of it. What does appear to be flawed, are a set of 'new' assumptions that seem to have taken over and now dominate the modern fields of academic economics and the related field of applied economics (commerce).

Was Adam Smith an economist? Was Keynes, Ricardo or Schumpeter? By the standards of today’s academic economists, the answer is no. Smith, Ricardo and Keynes produced no mathematical models. Their work lacked the “analytical rigour” and precise deductive logic demanded by modern economics. And none of them ever produced an econometric forecast (although Keynes and Schumpeter were able mathematicians). If any of these giants of economics applied for a university job today, they would be rejected. As for their written work, it would not have a chance of acceptance in the Economic Journal or American Economic Review. The editors, if they felt charitable, might advise Smith and Keynes to try a journal of history or sociology.
Article (http://www.prospect-magazine.co.uk/article_details.php?id=10683)

That's only the first paragraph. It is a short essay that lays out most of the key theoretical problems with the way modern economics is taught and applied in academia. The argument mirrors my own - a rejection of the 'rational actor hypothesis', a rejection of the obsession with mathematics and probability models and an approach to the topic that posits economics into the context of history, politics, sociology, philosophy and psychology. Economics is one with the humanities, it is not a science, never was and never will be.

[Daktoria]

...That's only the first paragraph. It is a short essay that lays out most of the key theoretical problems with the way modern economics is taught and applied in academia. The argument mirrors my own - a rejection of the 'rational actor hypothesis', a rejection of the obsession with mathematics and probability models and an approach to the topic that posits economics into the context of history, politics, sociology, philosophy and psychology. Economics is one with the humanities, it is not a science, never was and never will be.

I think your confusing the condition of rationality with the conditions of perfect information and sensibility in the model of homo economicus. Even when we succumb to Keynes' "animal spirits" we are still behaving rationally because we're optimally responding to the stimuli we're exposed to with the resources and talents we're willing to dedicate. Such dedication is preceded rationally as well due to how we decide what priorities, resources, and talents matter in conjunction with our previous experiences and our cognitive a priori interpretations of reality.

Still, there is some wiggle room for dismissing rationality in practical economic modeling since it's impossible to know with complete certainty what certain economic actors are pursuing. That's why economists always say ceribus paribus in the assumptions that homo economicus pursues the optimization of wealth, income, value, etc.

[Michael]

I think your confusing the condition of rationality with the conditions of perfect information and sensibility in the model of homo economicus. Even when we succumb to Keynes' "animal spirits" we are still behaving rationally because we're optimally responding to the stimuli we're exposed to with the resources and talents we're willing to dedicate.

I don't think even that much is true. Humans do tend to behave irrationally in response to some stimuli.

Investing in mortgage bubbles for example. Or getting mad at the table (or apologizing to the table) when one stubs one's toe on the table-leg.

Those are not very rational responses to stimuli. It is not rational to talk to inanimate objects.

In many cases, people do act irrationally, but because we cannot know their interior state of mind, we pretend/assume that the action was rational. There is no proof of the rationality we pretend/assume. I suspect it isn't always there.

Such dedication is preceded rationally as well due to how we decide what priorities, resources, and talents matter in conjunction with our previous experiences and our cognitive a priori interpretations of reality.
That's all well and fine for rationally minded people, but what about the quasi-irrational ones? Do they do that? I don't think so.

Still, there is some wiggle room for dismissing rationality in practical economic modeling since it's impossible to know with complete certainty what certain economic actors are pursuing. That's why economists always say ceribus paribus in the assumptions that homo economicus pursues the optimization of wealth, income, value, etc.
But sometimes it doesn't end well (such as now).

The mortgage bubble and banking crisis (for example) was caused by pursuit of the optimization of wealth, income, value, etc., and that was irrational. It is not rational to pretend zero risk to investments and it is not rational to assume that US housing prices would always rise and never fall.

I think it is pretty obvious that rationality is not exactly a human strong suit. I think humans try to be rational, but that is likely only an occasional result.

My point here is primarily driven by the assumptions of rationality driving the regulatory process. This is a flawed model.

[Daktoria]

Again, it's a matter of the difference between rationality and sensibility. Just because we make decisions that have "bad" results doesn't mean that we've made "wrong" decisions (especially since terms such as bad and wrong are defined subjectively in their entirety).

Considering your examples, investors don't know that mortgage bubbles are bubbles until after the fact, and we get mad at the tables we stub our toes on because we impulsively appreciate that the most efficient method for releasing our frustration is by blaming the obstacle which hurt us. Even though it doesn't make sense to hold a table culpable or invest in a market that would appear to have a net loss in investment given perfect information, we can't assume that perfect information or culpability are the priorities at hand. Sometimes, our rationality is dedicated towards the simple goal of just wanting to feel good at a cheap price in terms of time, energy, and attention.

To be fair, I don't like macroeconomic models either (which is why I'm an Austrian school fan but not a neoclassical school fan) because they try to model things without acknowledging the fractally dynamic behavior of human nature (even Elliot's Wave Model gets rejected by the Efficient Market Hypothesis). Considering the burlesque nature of hindsight though, they are useful for extrapolating a predictor's expectations and showing how wrong he was about reality after the fact. :D

[Michael]

Again, it's a matter of the difference between rationality and sensibility. Just because we make decisions that have "bad" results doesn't mean that we've made "wrong" decisions (especially since terms such as bad and wrong are defined subjectively in their entirety).

Considering your examples, investors don't know that mortgage bubbles are bubbles until after the fact, and we get mad at the tables we stub our toes on because we impulsively appreciate that the most efficient method for releasing our frustration is by blaming the obstacle which hurt us. Even though it doesn't make sense to hold a table culpable or invest in a market that would appear to have a net loss in investment given perfect information, we can't assume that perfect information or culpability are the priorities at hand. Sometimes, our rationality is dedicated towards the simple goal of just wanting to feel good at a cheap price in terms of time, energy, and attention.

To be fair, I don't like macroeconomic models either (which is why I'm an Austrian school fan but not a neoclassical school fan) because they try to model things without acknowledging the fractally dynamic behavior of human nature (even Elliot's Wave Model gets rejected by the Efficient Market Hypothesis). Considering the burlesque nature of hindsight though, they are useful for extrapolating a predictor's expectations and showing how wrong he was about reality after the fact. :D

I disagree about the bubbles. I spotted the dot-com bubble and I spotted the credit bubble and I spotted the real estate bubble all while they were in progress. It isn't hard to do. The difference is that I didn't have a vested interest in 'not seeing the bubble'. And I didn't buy into the rational markets hypothesis (neoliberal nonsense) that Greenspan was spouting.

In other words, if you had an irrational faith in the rational market hypothesis, you couldn't see the bubble by definition. If one rationally rejected the rational markets hypothesis, the asset bubbles were indeed, easy to spot.

Ergo, asset bubbles are defacto proof of irrationality. Sure some rational and clever investors might play 'game-theory' with identified asset bubbles, but this is an exception that proves the rule that asset-bubbles can be rationally identified.

[Americano]

I disagree about the bubbles. I spotted the dot-com bubble and I spotted the credit bubble and I spotted the real estate bubble all while they were in progress. It isn't hard to do. The difference is that I didn't have a vested interest in 'not seeing the bubble'. And I didn't buy into the rational markets hypothesis (neoliberal nonsense) that Greenspan was spouting.

Agreed, I went through the same thing and was chided by some fellow investors during the .com bubble for being 'too conservative'. Most of them went tits up because they stayed in too long. I still had unpleasant memories of the 1987 crash. With the credit and real estate bubbles I was labeled by some forum posters (USPOL in particular) as negative, unamerican and a fool for not staying in the Bush Administration 'robust economy' driven by credit and falsely inflated assets right up to the bitter end.

In other words, if you had an irrational faith in the rational market hypothesis, you couldn't see the bubble by definition. If one rationally rejected the rational markets hypothesis, the asset bubbles were indeed, easy to spot.

Ergo, asset bubbles are defacto proof of irrationality. Sure some rational and clever investors might play 'game-theory' with identified asset bubbles, but this is an exception that proves the rule that asset-bubbles can be rationally identified.

[Daktoria]

Ergo, asset bubbles are defacto proof of irrationality. Sure some rational and clever investors might play 'game-theory' with identified asset bubbles, but this is an exception that proves the rule that asset-bubbles can be rationally identified.

Uh, you're confusing me here. What are you trying to say? If game theory can be applied, then it would be evidence that markets not only CAN be engaged in rationally, but that they MUST be engaged in rationally (must meaning that markets are contingent upon rational decision making, not that participants are obligated to behave rationally).

I disagree about the bubbles. I spotted the dot-com bubble and I spotted the credit bubble and I spotted the real estate bubble all while they were in progress. It isn't hard to do. The difference is that I didn't have a vested interest in 'not seeing the bubble'. And I didn't buy into the rational markets hypothesis (neoliberal nonsense) that Greenspan was spouting.

In other words, if you had an irrational faith in the rational market hypothesis, you couldn't see the bubble by definition. If one rationally rejected the rational markets hypothesis, the asset bubbles were indeed, easy to spot.

This doesn't really count because you're inductively assuming the consequent that you "saw" a bubble. Even if you read the fundamentals and understood that the market wasn't going to last very long, it could be argued that you behaved irrationally by not staying in the market until the last possible moment for the sake of wealth optimization. Those investors who stay on bubbles do so because they want to ride the momentum and speculate in accordance with their predictions on when the bubble is going to burst, investors like Joseph Kennedy (JFK's dad) before the Great Depression; speculation is what drives all markets onwards via entrepreneurism, so it would be foolhardy to claim that speculation is an inherently irrational activity.

Also EMH doesn't equate to markets being rational. What it does claim is that varying degrees of perfect information are available in the marketplace (pending on whether we're acknowledging the weak, semi-strong, or strong version of EMH). Ultimately, what this means is NOT that you can ever know if you're right about market efficiency (such that prices accurately reflect all available information), but that you CANNOT ever know if you're WRONG about market efficiency (such that the benchmark you're using to depict accuracy is accurate or not). This should make intuitive sense since different investors treat information differently in accordance with different strategies (such as the basic "value" versus "growth" dichotomy), so even if all of the world's information (including information about those strategies) was made available, it would still be impossible to recognize how accurately prices reflect information. Even a fractal simulation wouldn't account for accuracy since markets would perpetually fail if a fractal simulation was made available.

For example, consider that a fractal simulation exists that is accessible for all participants in the orange commodity market. If everyone knows what everyone else wants as well as what the patterns of their strategies are, then they will adjust in order to anticipate each other's patterns and create entirely new systems ad infinitum. The only way to reconcile this, therefore, would be to employ a Walrasian Auctioneer who receives all of the participants strategies and figures out a way to distribute oranges such that general equilibrium can be reached among the entire market. Unfortunately, employment of a Walrasian Auctioneer is a cost unto itself, so a secondary market is created that presents a new aspect into the fractal simulation since participants would only agree to work with the Auctioneer if the cost of affording the Auctioneer is less than the expected savings of working with the Auctioneer (upon which the Auctioneer would respond by trying to optimize his own utility by maximizing his price with respect to the expected savings).

Even if the Walrasian Auctioneer exists as a machine, robot, computer, etc. that does not have personal interests at stake, there are still operation costs and maintenance overhead which need to be afforded by the orange commodity market; and even if the community realizes that respect for the Auctioneer's results will bring about the greatest possible utility such that additional competition would only result in a mutual decrease of utility, there will always be an extortionist who demands more by holding the system hostage. For example, say that you and I are engaged in an auction where you receive less utility than I although we both receive the greatest amount of utility possible from our strategy inputs. As a rational actor, you should demand that I pay you more or else you will refuse to engage in the agreed upon exchange.* In turn, I should agree to your demand in order to optimize the amount of utility that I will receive. This extortion should continue until one of us becomes morally aggravated (which can still be treated as a rational behavior due to long term insight and appreciation) and just refuses to engage in the exchange.

*Legality doesn't matter here because law enforcement is yet another cost that could be accounted for in a Walrasian Auction since guardianship of a social contract is dependent upon employment of power wielding institutions, forces, specialists, etc.

Ergo, the ultimate solution towards reaching general equilibrium is decentralized and multilateral negotiations where IMPERFECT information is available such that extortion doesn't take place because extortionists are afraid of tarnishing their reputation and losing their ability to approach future participants.

[Michael]

Uh, you're confusing me here. What are you trying to say? If game theory can be applied, then it would be evidence that markets not only CAN be engaged in rationally, but that they MUST be engaged in rationally (must meaning that markets are contingent upon rational decision making, not that participants are obligated to behave rationally).
1. That a speculative 'asset bubble' existed is proven (after the fact) by its collapse.

2. Actors or agents involved in that speculation may be acting in what they presume to be a rational manner - seeking to maximize/optimize their gain - right up to the last moment before the bubble gets 'popped'.

3. Speculative 'asset bubbles', in some cases, may be rationally understood (but can't be proven) based on contemporary interpretation of the data. It it is thus rational for some people to pursue gain by investing in what is assumed to be a rationally increasing market and it is also rational for some people who understand an 'asset bubble' to be occuring to pursue gain by following some 'game theory' strategy (or perhaps short-selling). Similarly, it is also rational for some of these people who understand that an asset bubble is occuring to withdraw from the market - believing that 'a bird in hand is worth two in the bush' - prefering the safety of the known gain to the danger of bubble-popping loss to come in the near short term.

4. The very fact that each of the above approaches can be defined as 'rational' is evidence of the fact that 'rational' has a fairly wide definition when applied to human beings. Pure mathematical maximization/optimization is only one method of analysis. There are other 'yardsticks' that humans may rationalize to. Humans are not perfect predictors of risk and there will be subjective (and rational) variations in the reactions to it.

Bottom line here is that one cannot rationally predict (or assume) that human beings are in fact acting rationally at all times. One must recognize that humans are capable of acting in a way that they believe is rational, but yet may in fact be irrational when looked at over a different time perspective. And of course, there are different standards one can judge rationality to, profit maximization/optimization is only one of them.

This doesn't really count because you're inductively assuming the consequent that you "saw" a bubble. Even if you read the fundamentals and understood that the market wasn't going to last very long, it could be argued that you behaved irrationally by not staying in the market until the last possible moment for the sake of wealth optimization. Those investors who stay on bubbles do so because they want to ride the momentum and speculate in accordance with their predictions on when the bubble is going to burst, investors like Joseph Kennedy (JFK's dad) before the Great Depression; speculation is what drives all markets onwards via entrepreneurism, so it would be foolhardy to claim that speculation is an inherently irrational activity.
I never claimed that speculation is inherently irrational activity. In some cases, financial speculation is extremely rational behavior. No doubt of that.

My point is not to deny rationality, only to point out that it is far from being an absolute where humans are concerned. Humans just aren't all that rational. Humans certainly have rationalizing tendencies, but they have highly subjective value systems and often have really poor judgement (and often get blinded by love, lust, greed or some hatreds).

Also EMH doesn't equate to markets being rational. What it does claim is that varying degrees of perfect information are available in the marketplace (pending on whether we're acknowledging the weak, semi-strong, or strong version of EMH). Ultimately, what this means is NOT that you can ever know if you're right about market efficiency (such that prices accurately reflect all available information), but that you CANNOT ever know if you're WRONG about market efficiency (such that the benchmark you're using to depict accuracy is accurate or not). This should make intuitive sense since different investors treat information differently in accordance with different strategies (such as the basic "value" versus "growth" dichotomy), so even if all of the world's information (including information about those strategies) was made available, it would still be impossible to recognize how accurately prices reflect information. Even a fractal simulation wouldn't account for accuracy since markets would perpetually fail if a fractal simulation was made available.
I'd say that human markets are themselves, apparently rational. Its the humans playing along that aren't always acting with full rationality and cause the failures of the market.

For example, consider that a fractal simulation exists that is accessible for all participants in the orange commodity market. If everyone knows what everyone else wants as well as what the patterns of their strategies are, then they will adjust in order to anticipate each other's patterns and create entirely new systems ad infinitum. The only way to reconcile this, therefore, would be to employ a Walrasian Auctioneer who receives all of the participants strategies and figures out a way to distribute oranges such that general equilibrium can be reached among the entire market. Unfortunately, employment of a Walrasian Auctioneer is a cost unto itself, so a secondary market is created that presents a new aspect into the fractal simulation since participants would only agree to work with the Auctioneer if the cost of affording the Auctioneer is less than the expected savings of working with the Auctioneer (upon which the Auctioneer would respond by trying to optimize his own utility by maximizing his price with respect to the expected savings).

Even if the Walrasian Auctioneer exists as a machine, robot, computer, etc. that does not have personal interests at stake, there are still operation costs and maintenance overhead which need to be afforded by the orange commodity market; and even if the community realizes that respect for the Auctioneer's results will bring about the greatest possible utility such that additional competition would only result in a mutual decrease of utility, there will always be an extortionist who demands more by holding the system hostage. For example, say that you and I are engaged in an auction where you receive less utility than I although we both receive the greatest amount of utility possible from our strategy inputs. As a rational actor, you should demand that I pay you more or else you will refuse to engage in the agreed upon exchange.* In turn, I should agree to your demand in order to optimize the amount of utility that I will receive. This extortion should continue until one of us becomes morally aggravated (which can still be treated as a rational behavior due to long term insight and appreciation) and just refuses to engage in the exchange.

*Legality doesn't matter here because law enforcement is yet another cost that could be accounted for in a Walrasian Auction since guardianship of a social contract is dependent upon employment of power wielding institutions, forces, specialists, etc.
The Walrasian Auction concept is flawed in exactly the same way most economics 'thought experiments' are flawed.

This is because it theoretically assumes that all of the actors/agents can all perfectly define their own demand with mathematical precision and accuracy. This is the starting point (first principle) for the Walrasian Auction.

I think it is absurd to assert that human agents are capable of doing that. I admit, the logic of the Walrasian Auction holds, but that is if and only if, the initial conditions are fulfilled exactly - which I consider impossible.

Ergo, the ultimate solution towards reaching general equilibrium is decentralized and multilateral negotiations where IMPERFECT information is available such that extortion doesn't take place because extortionists are afraid of tarnishing their reputation and losing their ability to approach future participants.
Why can't an extortionist retire after one good hit? Why does your example REQUIRE the extortionist to become addicted to playing the game?

I'd say that perfect equilibriums require an absence of human beings.

[Daktoria]

1. That a speculative 'asset bubble' existed is proven (after the fact) by its collapse.

2. Actors or agents involved in that speculation may be acting in what they presume to be a rational manner - seeking to maximize/optimize their gain - right up to the last moment before the bubble gets 'popped'.

3. Speculative 'asset bubbles', in some cases, may be rationally understood (but can't be proven) based on contemporary interpretation of the data. It it is thus rational for some people to pursue gain by investing in what is assumed to be a rationally increasing market and it is also rational for some people who understand an 'asset bubble' to be occuring to pursue gain by following some 'game theory' strategy (or perhaps short-selling). Similarly, it is also rational for some of these people who understand that an asset bubble is occuring to withdraw from the market - believing that 'a bird in hand is worth two in the bush' - prefering the safety of the known gain to the danger of bubble-popping loss to come in the near short term.

4. The very fact that each of the above approaches can be defined as 'rational' is evidence of the fact that 'rational' has a fairly wide definition when applied to human beings. Pure mathematical maximization/optimization is only one method of analysis. There are other 'yardsticks' that humans may rationalize to. Humans are not perfect predictors of risk and there will be subjective (and rational) variations in the reactions to it.

Bottom line here is that one cannot rationally predict (or assume) that human beings are in fact acting rationally at all times. One must recognize that humans are capable of acting in a way that they believe is rational, but yet may in fact be irrational when looked at over a different time perspective. And of course, there are different standards one can judge rationality to, profit maximization/optimization is only one of them.


There's a difference between being rational and being correct at multiple levels here. Just because the person doesn't know what the best possible strategy or objective for him to be pursuing is doesn't mean that he is irrational since the discovery process OF optimality is part of executing a rational strategy (due to how reality's circumstances can be divided ad infinitum). We receive stimulus in the present, we have memories of capabilities in the past, and we attempt to use intuition to derive the most enjoyable future possible. As actors with an infinitesimal proportion of the world's information, it would be miraculous for us to ever actually succeed in this process, so it doesn't make sense to associate market failures with bad consequences (or even misguided intentions) at the ultimate level. Such is why economists use the phrase ceteris paribus when describing homo economicus. You're right, the models don't always apply, but models are normative establisments centralized around assumptions for what direction rational decisions are headed towards. If you approve of the assumptions, you accept the model. If you don't, then you reject the model. If you expect a model to reflect positive notions, then you're in the wrong place because it's impossible for human subjectivity to reflect positive notions (as you already described with your admittance of human imperfection). Furthermore, strategies are planned responses to stochastic systems with deterministic circumstances, so just because a relative maximum was achieved instead of an absolute maximum (http://en.wikipedia.org/wiki/Maxima_and_minima) doesn't mean that rational decision making wasn't involved in strategization.

Like I said about EMH before, the premise is that you can't ever know if you're wrong, not that you can ever know if you're right, about market efficiency, an intuitive truth since deduction is about eliminating inconsistent members from a set until only consistent members remain, not about highlighting naturally luminous members within a set. Highlighting is what entrepreneurism is for (as opposed to investor savvy), rejection of the principle of explosion such that illuminations are tested via the assertions of beliefs which are fractally dispersed throughout a community and/or environment. Basically, the entrepreneur tells the world, "BUT YOU TOLD ME SO!" and if the entrepreneur exerts enough power, the world will fall apart, possibly in realignment with the entrepreneur's wishes if he behaves auspiciously enough. If he doesn't, then the entrepreneur will fall apart.

(This might sound a little nuts, but I'm taking a casual approach here in how I explain things.)

I never claimed that speculation is inherently irrational activity. In some cases, financial speculation is extremely rational behavior. No doubt of that.

My point is not to deny rationality, only to point out that it is far from being an absolute where humans are concerned. Humans just aren't all that rational. Humans certainly have rationalizing tendencies, but they have highly subjective value systems and often have really poor judgement (and often get blinded by love, lust, greed or some hatreds).You can't judge rationality this deeply. Human decision making is based on applying limited information and limited control upon the margin, and shallower successes have to be achieved before deeper ones can be secured. For example, someone who's hormonally infatuated all of a sudden, despite being a savvy investor beforehand, failed when his maturity was checked by his environment. Such failure could have resulted from a lack of awareness, a lack of self-control, some sort of ensnarement, a combination of such, or maybe something that we don't even know about. Regardless, actors can only take initiative by believing in the reliability in their senses and taking a leap of faith (such as by denying Descartes evil demon). It wouldn't be fair to accuse the actor of being irrational just because he didn't respond to circumstance he wasn't aware of whether they're environmentally external or structurally internal (just as how children, teenagers, and even adults don't understand all of psychology, neurology, physiology, medicine, and genetics even though they all are human beings).

I'd say that human markets are themselves, apparently rational. Its the humans playing along that aren't always acting with full rationality and cause the failures of the market.At a macroscopic sense, this is completely correct. At a microscopic sense, this is completely wrong. Again, we can't blame humans for not acting in accordance with what they aren't aware of.

The Walrasian Auction concept is flawed in exactly the same way most economics 'thought experiments' are flawed.

This is because it theoretically assumes that all of the actors/agents can all perfectly define their own demand with mathematical precision and accuracy. This is the starting point (first principle) for the Walrasian Auction.

I think it is absurd to assert that human agents are capable of doing that. I admit, the logic of the Walrasian Auction holds, but that is if and only if, the initial conditions are fulfilled exactly - which I consider impossible.An astute auctioneer wouldn't be focused on the content of the supply and demand schedules, but would instead focus on the structure of how they were submitted and evaluate their personalities similarly to how a human resource handler interviews job candidates, a detective interrogates witnesses, how a doctor counsels patients, etc. In a completely mechanized system where only marginal analysis was engaged in, you'd be right, but you'll remember that the aforementioned account referred to fractal simulations which implies that character patterns are being assessed as well such that it doesn't matter if you're honestly, dishonestly, expertly, or naively responding to inquiries.

Why can't an extortionist retire after one good hit? Why does your example REQUIRE the extortionist to become addicted to playing the game?The appearance of an addiction is a mirage. What's happening is that the extortionist is making repeated value judgments to discover how far the system's benefactors will bend in order to derive the most amount of excess utility possible. The only reason his victims keep conceding is because the extortionist appears to be a madman who's unaware of the default lose-lose consequences, so the victims appease him in order to retain the maximal amount of utility from employing a Walrasian Auctioneer. With imperfect information, extortionists instead become intimidated as to how far they can push the rest of the group before it gets upset and the victims can cut their losses, retaliating in the future by making less and less information publicly available. Unfortunately, this increases the costs of running a Walrasian Auctioneer, and it makes more parties more willing to engage in hostage taking due to anticipations of future insecurity, so the longevity and productivity of the community is ultimately grounded in their faithful character, not empirical intellect (something which would still take place without the employment of a Walrasian Auctioneer).

I'd say that perfect equilibriums require an absence of human beings.Heh. Doesn't everybody.:cheers:
Kind of a sad story, but the old adage reigns true. The more you want something, the less you get, so you better learn that you can't have your cake and eat it too.

OK, I made the first half up, but I'm just working "opposites attract" into the mix. If a society wants to be economically prosperous it needs to live honestly (which includes defending itself from aggressors). Unfortunately, yes, this means enduring inhibitive security dilemmas, but sometimes morality can't make up for the restrictions of natural law combined with random talent and resource distribution AKA original position.

If you can't beat the world, join it; better to die a quick death than remain enslaved forever; blah, blah, blah.

[Michael]

There's a difference between being rational and being correct at multiple levels here. Just because the person doesn't know what the best possible strategy or objective for him to be pursuing is doesn't mean that he is irrational since the discovery process OF optimality is part of executing a rational strategy (due to how reality's circumstances can be divided ad infinitum). We receive stimulus in the present, we have memories of capabilities in the past, and we attempt to use intuition to derive the most enjoyable future possible. As actors with an infinitesimal proportion of the world's information, it would be miraculous for us to ever actually succeed in this process, so it doesn't make sense to associate market failures with bad consequences (or even misguided intentions) at the ultimate level. Such is why economists use the phrase ceteris paribus when describing homo economicus. You're right, the models don't always apply, but models are normative establisments centralized around assumptions for what direction rational decisions are headed towards. If you approve of the assumptions, you accept the model. If you don't, then you reject the model. If you expect a model to reflect positive notions, then you're in the wrong place because it's impossible for human subjectivity to reflect positive notions (as you already described with your admittance of human imperfection). Furthermore, strategies are planned responses to stochastic systems with deterministic circumstances, so just because a relative maximum was achieved instead of an absolute maximum (http://en.wikipedia.org/wiki/Maxima_and_minima) doesn't mean that rational decision making wasn't involved in strategization.

I agree with your general point here, but it seems to sidestep the fact that many actors involved just arn't acting rationally at all. You are making the argument of relative rationality amongst a group of people assumed to be acting generally rationally (all with an identical goal of optimization of their investments/profits). So I agree that even if some actors fail to maximize their rationality, this doesn't 'harm' the model.

My critique is much deeper than that. I'm attacking the essential assumption that humans generally are rational creatures in the first place. Yes, humans have rationalizing tendencies, but the complexities of human motives for action are almost infinite in variety and impossible to objectively observe.

The formal mathematical models of economic theory require the assumpition that humans are mostly rational and always trying to be rational creatures. Economic models can adapt to the various failings of humans trying to be perfectly rational but failing due to lack of information - that can be modeled.

But no model can process irrational human subjectivity so they just pretend its not there - pretending that 'failure to act rationally' is due to an understandable shortage of information rather than the possibility that rationalizing the maximization of profits might be the last thing some actor is actually doing. Some people really are stupid idiots. Some people are quite brilliantly clever. Most are somewhere in between.

Sometimes life interferes with rationality - a person might have a brilliantly rational investment strategy that they follow religiously - then fall madly in love on wild affair and forget to even pay attention for a few weeks as the markets change drastically - or a close relative dies, or his house burns to the ground. In such a case, observers of the market (according to the model) must assume that this brilliant investor's strategy is conscious and rational - even when he's not even paying attention (or may even be dead).

Economic models require profit-optimizing rationality to be the default option of human behavior. Economists are obviously going to defend this because their whole system of modeling requires it. I just can't accept that concept. Everything I know and understand about human nature and human society is based on the fact that humans are an amazing combination of rational advantage seeking motives and irrational emotion-driven feelings.

I'm talking about people acting without entirely different levels of rationality - or none at all. For example, it is irrational for a small investor with zero information and zero insider knowledge to engage in what appears to be a rising market. But lots of them do enter the market with zero information.

They may do this based on a) faith in an ever-rising market (which is irrational, but is heavily emotively pushed by the mass media), b) envy of a rich successful neighbor, c) misplaced faith in an investment advisor because he's handsome, well-dressed, looks trustworthy and uses lots of big words, etc.

These are the suckers that make housing or other asset bubbles possible. I suspect that such asset bubbles would be much less likely to occur without the involvement of these non-rationally acting actors to supply the 'windfall' profits for the more lucky or astute ones involved.

Like I said about EMH before, the premise is that you can't ever know if you're wrong, not that you can ever know if you're right, about market efficiency, an intuitive truth since deduction is about eliminating inconsistent members from a set until only consistent members remain, not about highlighting naturally luminous members within a set.
Yes, I agree that one cannot ever know if one is right or wrong about market efficiency. Objective observation of subjective motives is impossible by definition. ;)

And that's my key point here isn't it? Economic models require a particular 'subjective motive' to be always present when there is no way to observe that it is generally there at all. One just assumes it because it is necessary for the model to function.

I am reminded about how difficult it is to convince a man about something when his particular livelihood depends upon not seeing it. :lol:

(This is not a personal jibe, meant to be a joking comment) :)

Highlighting is what entrepreneurism is for (as opposed to investor savvy), rejection of the principle of explosion such that illuminations are tested via the assertions of beliefs which are fractally dispersed throughout a community and/or environment. Basically, the entrepreneur tells the world, "BUT YOU TOLD ME SO!" and if the entrepreneur exerts enough power, the world will fall apart, possibly in realignment with the entrepreneur's wishes if he behaves auspiciously enough. If he doesn't, then the entrepreneur will fall apart.

(This might sound a little nuts, but I'm taking a casual approach here in how I explain things.)
Yes it does sound a little nuts. :D

But I follow your point (I think). Btw, that's a good illustration of how entrepreneurialism is driven by faith or emotion, not rationality. :fence:

You can't judge rationality this deeply. Human decision making is based on applying limited information and limited control upon the margin, and shallower successes have to be achieved before deeper ones can be secured. For example, someone who's hormonally infatuated all of a sudden, despite being a savvy investor beforehand, failed when his maturity was checked by his environment. Such failure could have resulted from a lack of awareness, a lack of self-control, some sort of ensnarement, a combination of such, or maybe something that we don't even know about. Regardless, actors can only take initiative by believing in the reliability in their senses and taking a leap of faith (such as by denying Descartes evil demon). It wouldn't be fair to accuse the actor of being irrational just because he didn't respond to circumstance he wasn't aware of whether they're environmentally external or structurally internal (just as how children, teenagers, and even adults don't understand all of psychology, neurology, physiology, medicine, and genetics even though they all are human beings).

True, it isn't 'fair' to accuse an actor of acting irrational just because they didn't respond to circumstances they were not aware of.

But it is fair to accuse admirers or observers of the economic model of making the error of of assuming rationality and/or information is driving all the collective actions of the market when it is obvious that it isn't so. There are many non-rational motives and accidential circumstances that are as powerful as any 'profit-maximizing' motive when humans are involved. Assuming a common motive is a flaw in the model.

At a macroscopic sense, this is completely correct. At a microscopic sense, this is completely wrong. Again, we can't blame humans for not acting in accordance with what they aren't aware of.

But we can fault humans for engaging in a high risk activity that requires substantial insider or specialized knowledge when they know they don't have any of that information and are not inclined to go about looking for it.

It is not a moral or human failing to be ingnorant of some fact, but it is a human failing to act foolishly by assuming one is knowledgeable about those facts. Ignorance is not a flaw - acting on an unjustified assumption of knowledge is.

An astute auctioneer wouldn't be focused on the content of the supply and demand schedules, but would instead focus on the structure of how they were submitted and evaluate their personalities similarly to how a human resource handler interviews job candidates, a detective interrogates witnesses, how a doctor counsels patients, etc. In a completely mechanized system where only marginal analysis was engaged in, you'd be right, but you'll remember that the aforementioned account referred to fractal simulations which implies that character patterns are being assessed as well such that it doesn't matter if you're honestly, dishonestly, expertly, or naively responding to inquiries.

You admit that a machine processing the information would not produce a perfectly rational result... so aren't you just using additional human subjectivity here in order to assume a 'filter' on other human subjective inputs? And that this is necessary to 'save' the model from my critique? :ummm:

I thought the Walrasian Auctioneer model was fully rational all by itself and meant to illustrate the rationality of equilibrium of markets? If it requires such selective and subjective interpretations to function, it isn't all that useful for rationally predicting outcomes or demonstrating rationality.

Seems to me that the Walrasian Auctioneer model only reproduces the rationality that is assumed as the basis of the model. A nice theoretical 'toy' to play with for various purposes, but I'd say it was dangerously unrealistic.

I think theory becomes useless when it becomes too far disconnected from plausible reality.

The appearance of an addiction is a mirage. What's happening is that the extortionist is making repeated value judgments to discover how far the system's benefactors will bend in order to derive the most amount of excess utility possible. The only reason his victims keep conceding is because the extortionist appears to be a madman who's unaware of the default lose-lose consequences, so the victims appease him in order to retain the maximal amount of utility from employing a Walrasian Auctioneer. With imperfect information, extortionists instead become intimidated as to how far they can push the rest of the group before it gets upset and the victims can cut their losses, retaliating in the future by making less and less information publicly available. Unfortunately, this increases the costs of running a Walrasian Auctioneer, and it makes more parties more willing to engage in hostage taking due to anticipations of future insecurity, so the longevity and productivity of the community is ultimately grounded in their faithful character, not empirical intellect (something which would still take place without the employment of a Walrasian Auctioneer).
But why should the extortionist bother? If the extortionist successfully swindles a million dollars from some foolish victim, why wouldn't the extortionist fuck of to the Bahamas and live a live of comparative ease on the beach, savoring his ill-gotten gains, hopefully far from the reach of the law?

Sure, some extortionists are going to be greedy and try for more, but some of them will likely run away with the goods and hide out rather than risk 'all or jail' on another play, no matter how 'low-risk' that next play might be - or be perceived as.

Your model seems to imply that the latter case just doesn't exist.

Heh. Doesn't everybody.:cheers:
Kind of a sad story, but the old adage reigns true. The more you want something, the less you get, so you better learn that you can't have your cake and eat it too.

OK, I made the first half up, but I'm just working "opposites attract" into the mix. If a society wants to be economically prosperous it needs to live honestly (which includes defending itself from aggressors). Unfortunately, yes, this means enduring inhibitive security dilemmas, but sometimes morality can't make up for the restrictions of natural law combined with random talent and resource distribution AKA original position.

If you can't beat the world, join it; better to die a quick death than remain enslaved forever; blah, blah, blah.

But the economic theories you are defending here are precisely the kind of economic theories that have been used to create the illusion of 'eating cake and having it too'. I'm referring to the option-derivative supported risk-reduction strategies that turned out to be a joke (and a major cause of the present financial crisis).

This is what is at the core of this thread and my critique of contemporary 'neoclassical' economic theory with its obsession with mathematical models. Almost all of these models have exactly the same flaw with regard to the assumption of general rationality driving them. Garbage in, garbage out.

[Daktoria]

(You might want to read the very end of what I have to say before starting at the beginning if you don't ordinarily read an entire post before responding. Not that I think you do, but just in case.)

I agree with your general point here, but it seems to sidestep the fact that many actors involved just arn't acting rationally at all. You are making the argument of relative rationality amongst a group of people assumed to be acting generally rationally (all with an identical goal of optimization of their investments/profits). So I agree that even if some actors fail to maximize their rationality, this doesn't 'harm' the model.

My critique is much deeper than that. I'm attacking the essential assumption that humans generally are rational creatures in the first place. Yes, humans have rationalizing tendencies, but the complexities of human motives for action are almost infinite in variety and impossible to objectively observe.

The formal mathematical models of economic theory require the assumpition that humans are mostly rational and always trying to be rational creatures. Economic models can adapt to the various failings of humans trying to be perfectly rational but failing due to lack of information - that can be modeled.

But no model can process irrational human subjectivity so they just pretend its not there - pretending that 'failure to act rationally' is due to an understandable shortage of information rather than the possibility that rationalizing the maximization of profits might be the last thing some actor is actually doing. Some people really are stupid idiots. Some people are quite brilliantly clever. Most are somewhere in between.

Sometimes life interferes with rationality - a person might have a brilliantly rational investment strategy that they follow religiously - then fall madly in love on wild affair and forget to even pay attention for a few weeks as the markets change drastically - or a close relative dies, or his house burns to the ground. In such a case, observers of the market (according to the model) must assume that this brilliant investor's strategy is conscious and rational - even when he's not even paying attention (or may even be dead).

Economic models require profit-optimizing rationality to be the default option of human behavior. Economists are obviously going to defend this because their whole system of modeling requires it. I just can't accept that concept. Everything I know and understand about human nature and human society is based on the fact that humans are an amazing combination of rational advantage seeking motives and irrational emotion-driven feelings.

I'm talking about people acting without entirely different levels of rationality - or none at all. For example, it is irrational for a small investor with zero information and zero insider knowledge to engage in what appears to be a rising market. But lots of them do enter the market with zero information.

They may do this based on a) faith in an ever-rising market (which is irrational, but is heavily emotively pushed by the mass media), b) envy of a rich successful neighbor, c) misplaced faith in an investment advisor because he's handsome, well-dressed, looks trustworthy and uses lots of big words, etc.

These are the suckers that make housing or other asset bubbles possible. I suspect that such asset bubbles would be much less likely to occur without the involvement of these non-rationally acting actors to supply the 'windfall' profits for the more lucky or astute ones involved.

It feels like we're just playing ping pong now over the recognition of what makes people rational, so I feel that a new approach is owed.

Following is Keynes' quote on animal spirits (with accurate secondary citation) (http://en.wikipedia.org/wiki/Animal_spirits_%28Keynes%29):Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.
As a follow up, I'd like to note that I recognize animals as being rational beings as well that optimally respond to stimuli in accordance with impulsive strategies towards marginalist objectives. Actually, I go so far as to say that it's impossible for any living creature to behave fundamentally irrationally since it's impossible to take actions which do not coincide with a dynamically accepted strategy (although such acceptance might be limited to the subconscious level which does not engage in rationalization itself). This is a pretty radical idea that not too many people believe in since it personifies non-human characters and grants mankind an incredible benefit of the doubt for cognitive capability, so it's definitely something worth clarifying about my personal perspective.

However, I still don't see how you distinguish between "irrational" and "insensible" because I don't know whether or not you're acknowledging that decision making is a perpetual process that is constantly adjusted in accordance with perceived opportunity costs. Could you explicitly define, and distinguish between, the two?

In response to what you did say about economic modeling, Ludwig Wittgenstein noted, "The limits of my language are the limits of my world." (http://www.iep.utm.edu/w/wittgens.htm#H2) Economists are not perfect, and the models they create are not always accurate constructs. Just because a model fails doesn't mean that homo economicus is irrational nor does it mean that an actual human actor is irrational either. Such theoretical modeling is one of the things that some economists aim to perfect, and such aim is the same sort of pursuit which every artist, scientist, musician, athlete, and practitioner of every art, science, music, athlete, and practice pursues in the refinement of their own work.

But I follow your point (I think). Btw, that's a good illustration of how entrepreneurialism is driven by faith or emotion, not rationality.

Another thread, another time, broken down to the degree that we've done so far, emotions and beliefs can be identified as rational constructs.

But it is fair to accuse admirers or observers of the economic model of making the error of of assuming rationality and/or information is driving all the collective actions of the market when it is obvious that it isn't so. There are many non-rational motives and accidential circumstances that are as powerful as any 'profit-maximizing' motive when humans are involved. Assuming a common motive is a flaw in the model.See the above comment (and the original notions about animal spirits and economic modeling), rationalization yes, rationality no.

But it is fair to accuse admirers or observers of the economic model of making the error of of assuming rationality and/or information is driving all the collective actions of the market when it is obvious that it isn't so. There are many non-rational motives and accidential circumstances that are as powerful as any 'profit-maximizing' motive when humans are involved. Assuming a common motive is a flaw in the model.I'm surprised that you brought up this point since it not only excuses savvy speculators but also goes so far as accuses the State of spoiling the naive masses who claim dependence upon wealthy elites for jobs, pensions, credit, consumer goods, etc. Speculators understand that the market isn't strongly price efficient, and the masses presume that everything in the market is just going to keep working out, so if anybody's here to blame, they are, dare I say it, the working class and the bureaucrats it supports?

http://www.politicalcrossfire.com/forum/images/smiles/icon_twisted.gif:shrug::angel:


(Hold up for a sec.)

But we can fault humans for engaging in a high risk activity that requires substantial insider or specialized knowledge when they know they don't have any of that information and are not inclined to go about looking for it.

It is not a moral or human failing to be ingnorant of some fact, but it is a human failing to act foolishly by assuming one is knowledgeable about those facts. Ignorance is not a flaw - acting on an unjustified assumption of knowledge is.Well first off, insider trading is illegal and it rightly should be since it would entirely manipulate a public securities market. As long as a security is only privately traded, insider info is fine, but you gotta play according to the same opportunities as everyone else when engaging in public markets.

Second off, pensions are built so non savvy individuals can still play securities markets with their trust being directed towards the a secondary source - the reputation and track record of their broker. Yes, wealth is ultimately exposed to market conditions, but the primary decision of the principal account holder is to choose an agent to work with. Sometimes, there's nothing you can do about this, but if you suddenly get some information or a feeling about the market, you're welcome to adjust your account at any time subject to the terms of your contract with the broker (which only very rarely bear penalties after working with the broker for a minimal amount of time such as a month or a quarter of one year and as long as you give the broker a decent amount of time to liquidate your account which depends on the securities you're invested in).

Lastly, there are limits to how much we can afford to be confident about within an acceptable degree of significance. You're right, it isn't justified to act on unjustified assumptions, but now we need to define what's justifiable and how it can be unjustified to act thusly when justifiability isn't sensibly affordable upon which sensibility needs to be defined yada, yada, yada.

This is why I feel spirituality is a vital complement to business and politics. Without it, the public finds it very difficult (if not impossible) to connect to a community without suspecting everyone of vouching for an ulterior motive, and elites find it very difficult (if not impossible) to appreciate the humanity of less fortunate (but not necessarily less competent or capable) community members. Private contracts become grounded in marginal welfare provision, and social contracts become grounded in marginal security provision, both of which are fulfilled and enforced only due to fear of default expropriation from that which is unknown. Spirituality though catalyzes faith and initiative via moral resolve (as opposed to moral understanding) such that individuals divert attention from handling power to refining power. Life is no longer about achieving the best ends possible, but is about achieving the best means possible (in line with what's already been said about constrained maximization). In the case of investment, clients learn to not blame brokers for when the market goes through slumps, and the brokers continue to act in their clients best interest. Furthermore, clients don't gang up on broker market by establishing State bound failsafes supported through taxation of the successful while brokers don't lobby the government for loopholes.

You admit that a machine processing the information would not produce a perfectly rational result... so aren't you just using additional human subjectivity here in order to assume a 'filter' on other human subjective inputs? And that this is necessary to 'save' the model from my critique? :ummm:

I thought the Walrasian Auctioneer model was fully rational all by itself and meant to illustrate the rationality of equilibrium of markets? If it requires such selective and subjective interpretations to function, it isn't all that useful for rationally predicting outcomes or demonstrating rationality.

Seems to me that the Walrasian Auctioneer model only reproduces the rationality that is assumed as the basis of the model. A nice theoretical 'toy' to play with for various purposes, but I'd say it was dangerously unrealistic.

I think theory becomes useless when it becomes too far disconnected from plausible reality. Nobody's God, and that includes Walrasian Auctioneers as well as governments. Auctioneers are programmed and trained according to experience, and the only time intuition can be applied is when either the auctioneer is programmed by more mature programmers while applied to less mature clients, or the auctioneer is granted a certain amount of managing or governing power such that he is a neutral party among his clients who only wants his community to fare as well as possible with respect to the rest of the world. In effect, he serves not only the legal role of an adjudicator, but also the investigative role of a scientist.

In any event, I'm not advocating for Walrasian Auctioneers. I'm just saying that even in the best possible scenario, extortionists still have an incentive to take the system hostage in the case of perfect information which is the best possible condition for employing a Walrasian Auctioneer to assist in reaching general equilibrium.

But why should the extortionist bother? If the extortionist successfully swindles a million dollars from some foolish victim, why wouldn't the extortionist fuck of to the Bahamas and live a live of comparative ease on the beach, savoring his ill-gotten gains, hopefully far from the reach of the law?

Sure, some extortionists are going to be greedy and try for more, but some of them will likely run away with the goods and hide out rather than risk 'all or jail' on another play, no matter how 'low-risk' that next play might be - or be perceived as.

Your model seems to imply that the latter case just doesn't exist. My scenario is only a first degree model, but you're exactly right that it's possible that an extortionist would behave... risk-contra-neutral (?). Again, basic economic models are based on ceteris paribus risk aversion, but if an extortionist had a limit on how much wealth he wanted to accumulate for accepting any more risk, then you're right, he would run away after accumulating that amount.

Regardless, the first problem I can think of in a world with perfect information is that the rest of the community would identify his accumulation limit and pressure him away from reaching it since the rest of the community wants to retain as much wealth as possible. Performed effectively enough, the community could force the extortionist back into the community since they whittle him down in negotiations to receiving what the extortionist feels to be a negligible reward.

But the economic theories you are defending here are precisely the kind of economic theories that have been used to create the illusion of 'eating cake and having it too'. I'm referring to the option-derivative supported risk-reduction strategies that turned out to be a joke (and a major cause of the present financial crisis).

This is what is at the core of this thread and my critique of contemporary 'neoclassical' economic theory with its obsession with mathematical models. Almost all of these models have exactly the same flaw with regard to the assumption of general rationality driving them. Garbage in, garbage out.Well if you wanted to talk about derivatives, why didn't you just say so? :popcorn::bounce:

The thing with derivatives is that they're straight up gambling, and while that isn't necessarily a bad thing, it becomes a problem when the market as a whole is based on a lack of underlying assets since no real economic growth takes place. Instead, you just get a bunch of gambling with winners withdrawing wealth from the market for consumption while losers get more and more desperate to make up their losses (which is why Las Vegas doesn't collapse despite all of the casinos).

Basically (in case you don't know how they work), derivatives are based on whether or not an economic EVENT actually occurs such as in interest or exchange rate reaching a certain level, and they're used as hedges by calculating a price in comparison to the amount of securities are owned. Similarly, you can think of it as betting on (or against) a sports team that you own stock in. If the team does well, you make money on the stock. If you bet against the team and it does poorly, you make money on bets (with profits subject to whichever performs more drastically). If you bet on the team and it does well, you make money on both the stock and the bets (which you might do if you have a good feeling BUT NOT INSIDER INFORMATION ESPECIALLY IF YOU HAVE A SAY IN MANAGEMENT UNLESS YOU WANNA GET ARRESTED, :lol:). Some comparable financial examples include investing in national interest rates while invested in national bonds and investing in exchange rates while holding foreign currencies.

Obviously, the problem (like I said earlier) is when portfolios are invested too heavily in derivatives, usually because they view derivatives as a reliable profit opportunity in themselves as opposed to just something used for hedging. Not only does this introduce incredible volatility to the market and to portfolios, but it also drains the market of wealth as described earlier.

Expanded to your complaint about neoclassical model obsession, you should know that Keynesian schools are obsessing over general equilibrium macroeconomic models as well via microeconomic extrapolation (http://en.wikipedia.org/wiki/New_Keynesian_economics) which I find to be even more frightening. However, I share your concern in both areas because I feel that rationality becomes too hard to define at the macroeconomic level especially when you're making so many assumptions about human motivation. The rationality still exists, but defining it is just... astronomically difficult especially since human beings are so suspicious, dishonest, immature, and sensitive due to imperfect information and just human nature's tendency to be lazy out of risk-aversion.