A DEFENSE of EQUILIBRIUM REASONING in ECONOMICS by Jennifer Soyun Jhun BA in Philosophy and Economics, Northwestern University
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A DEFENSE OF EQUILIBRIUM REASONING IN ECONOMICS by Jennifer Soyun Jhun BA in Philosophy and Economics, Northwestern University, 2008 Submitted to the Graduate Faculty of The Kenneth P. Dietrich School of Arts and Sciences in partial fulfillment of the requirements for the degree of Doctor of Philosophy University of Pittsburgh 2016 UNIVERSITY OF PITTSBURGH KENNETH P. DIETRICH SCHOOL OF ARTS AND SCIENCES This dissertation was presented by Jennifer Soyun Jhun It was defended on May 27, 2016 and approved by Robert Batterman, Professor of Philosophy, University of Pittsburgh Sheldon Smith, Professor of Philosophy, University of California, Los Angeles Dissertation Advisor: Mark Wilson, Distinguished Professor of Philosophy, University of Pittsburgh Dissertation Advisor: James Woodward, Distinguished Professor of History and Philosophy of Science, University of Pittsburgh ii A DEFENSE OF EQUILIBRIUM REASONING IN ECONOMICS Jennifer Jhun, PhD University of Pittsburgh, 2016 Copyright © by Jennifer Jhun 2016 iii A DEFENSE OF EQUILIBRIUM REASONING IN ECONOMICS Jennifer Soyun Jhun, PhD University of Pittsburgh, 2016 Critics both within and outside of philosophy have challenged economics wholesale as unscientific. In particular, economics seems unable to predict future events because it relies on assumptions like equilibrium conditions, which stipulate that the economy tends to stay in its current state absent external forces. The popular background view that gives rise to this criticism is that the job of science is to uncover laws of nature, by appeal to which we can determine (usually deductively) the future behavior of a dynamical system as it evolves. I argue that lawlike statements in economics have a very different role than this: they provide a means of understanding in terms of how efficient a particular system is. This account is more faithful to the history and the practice of economics. Perhaps surprisingly, it also accounts better for the explanatory power of some laws of physics. By reinterpreting ceteris paribus assumptions, and equilibrium assumptions more generally, as tools both for articulating constraints on a system as well as for identifying opportunities for a iv particular system, I am able to take into consideration the ways in which both engineers and policy makers aim to design or test such complex systems for stability. Macroscopic properties such as stability cannot be reduced to details about the individual atoms that make up bulk material or the individual agents that make up the economy. Yet, the behaviors of the micro- constituents and of the macroscopic aggregate are related. In order to address this lacuna between the micro and the macro, I explore the possibility of exploiting newer methods in the material sciences, namely multi-scale modeling, that have been useful in talking about these interesting and desirable macroscopic properties. These methods use not one but multiple models at different temporal and spatial scales to describe a system, without prioritizing any particular one. Given the substantial methodological and formal analogies between thermodynamics and economics, the success of the multi-scale framework in the former suggests it will be similarly useful for the latter. v TABLE OF CONTENTS PREFACE .................................................................................................................................... IX 1.0 INTRODUCTION: SOME PERCEIVED PROBLEMS OF ECONOMICS ......... 1 2.0 WHAT’S THE POINT OF CETERIS PARIBUS? (OR: HOW TO UNDERSTAND SUPPLY AND DEMAND CURVES) ............................................................. 8 2.1 CARNOT CYCLES AND SUPPLY-DEMAND CURVES ............................ 13 2.2 A LESSON FROM THE HISTORY OF ECONOMIC THOUGHT: ALFRED MARSHALL ON CETERIS PARIBUS PROVISOS ..................................... 21 2.3 SCIENTIFIC UNDERSTANDING IN TERMS OF EFFICIENCY............. 28 2.4 AGAINST ORTHODOXY: REJECTING THE SEMANTIC COMPLETER ACCOUNT .......................................................................................................................... 33 2.5 CONCLUDING REMARKS ............................................................................ 43 3.0 DYNAMIC AND DISEQUILIBRIUM BEHAVIOR .............................................. 45 3.1 PRELIMINARIES ............................................................................................. 45 3.2 DIAGNOSTIC REMARKS .............................................................................. 47 3.3 A SECOND LESSON FROM THERMODYNAMICS: FALSE EQUILIBRIA AND FINANCIAL CRISES ..................................................................... 54 3.4 THE 2007-2010 FINANCIAL CRISIS............................................................. 59 3.5 CONCLUDING REMARKS ............................................................................ 65 vi 4.0 MODELING STABILITY ........................................................................................ 67 4.1 STABILITY, EQUILIBRIA, AND AGGREGATION .................................. 68 4.2 OBSTACLES TO EQUILIBRIUM BEHAVIOR........................................... 73 4.3 CORRECTIVE MEASURES AND CONTROL THEORY .......................... 81 4.4 MEANWHILE, IN ECONOMICS................................................................... 83 4.4.1 DSGE Models .............................................................................................. 83 4.4.2 Heterogeneity and Meso-Structure ........................................................... 88 4.4.3 Policy Design as an Optimal Control Problem......................................... 94 5.0 CONCLUDING REMARKS: WHAT DOES THE LUCAS CRITIQUE CRITIQUE? ................................................................................................................................ 99 5.1 ECONOMICS VS. ECONOMETRICS, STRUCTURAL VS. REDUCED- FORM ........................................................................................................................... 102 5.2 MULTISCALE MODELS TO THE RESCUE? ........................................... 108 BIBLIOGRAPHY ..................................................................................................................... 110 vii LIST OF FIGURES Figure 1. Supply and demand equilibrium. ................................................................................... 10 Figure 2. Post-supply shock. ......................................................................................................... 11 Figure 3. A Carnot Engine. ........................................................................................................... 15 Figure 4. A Pressure-Volume Diagram for a Carnot Engine. ....................................................... 16 Figure 5. Deadweight loss............................................................................................................. 20 Figure 6. A Perfect Crystal Lattice. .............................................................................................. 50 Figure 7. A Crystal Lattice with Dislocations. ............................................................................. 50 Figure 8. Before and After: A Crystal Lattice Subjected to an External Force. ........................... 51 viii PREFACE I am especially thankful to the following individuals. For their patient, encouraging, and insightful mentorship: Robert Batterman, Marciano Siniscalchi, Sheldon Smith, Mark Wilson, and James Woodward. For minding the state of my wellbeing: Agnes Bolinska, Kathleen Cook, Kathryn Lindeman, Tyke Nunez, Jasmin Özel, Meghan Page, Patricia Palacios, Benjamin Schulz, and Kathryn Tabb. For comic relief: Ray Jhun. For reasons to look forward: Rade Radjenovich. ix 1.0 INTRODUCTION: SOME PERCEIVED PROBLEMS OF ECONOMICS A common criticism (even from economists) is that economics is not useful – nor, even more surprisingly, does it even aim to be. The culprit is an over-reliance on and misuse of “idealization”: too much formalization without justification has made economics a field that seems unconcerned with giving a true or accurate representation of the real world. Most of economic analysis is centered on the equilibrium concept. The state of equilibrium is generally described as the state from which the market players have no incentive to deviate, or from which the economy has to tendency to change once reached given that there are no outside influences, the state towards which the economy will gravitate towards...All are descriptions of the state where “economic forces are in balance.” The equilibrium concept in economics is tied to other concepts, some them normative, e.g. rationality and efficiency. For example, in competitive markets, should a supplier or a buyer stray from the equilibrium state, they could do better by returning to equilibrium. In the case of competitive markets, this means that one couldn’t do better without making someone else worse off. The equilibrium problem is thus a problem of optimization under constraints. What it is better (“rational”) to do is to behave in the relevant optimizing fashion. The rational economic state is the state of equilibrium where resources are allocated efficiently. It shouldn’t surprise us that what happens in the world fails to align with our theoretical calculations. To criticize economics simply on that basis is to react to an oversimplified picture 1 of economics, and in fact of science in general. I argue that this critical view only results from a commitment to a narrow conception of what