Don't let the students know! What we teach them in our intro classes bears little resemblance to how we do economics ourselves. The great mid twentieth century thinkers - John Maynard Keynes, Friedrich Hayek, and John Nash – initiated a process that eventually transformed how we now understand the economy, in three ways. Only one of them made it into the intro course.
Just a dozen years after the publication of Keynes' The General Theory, aggregate demand became a core concept in a new textbook written by Paul Samuelson, an introduction to economics that would displace Alfred Marshall's Principles (1890) as the dominant English language introductory text. Samuelson quickly became the standard for what every economist ought to know, inaugurating what Thomas Kuhn termed a new paradigm. By this he meant a set of concepts basic to how a group of scholars understand the world as embodied in the introductory textbooks that are widely accepted in the field, exemplified by the works of Marshall and Samuelson, and John Stuart Mill's Principles of Political Economy (1848) before them.
Hayek's main idea – that information is incomplete and asymmetric and that the market is an information processing system – became the foundation of new theories of the competitive process and of incomplete contracts in labour and credit markets. Drawing on ideas of John von Neumann and Oskar Morgenstern, Nash pioneered the development of game theory to model strategic interactions among economic or political actors. His work provided a new lens for the study of economic situations in which rather than interacting with a fixed set of prices (as a “price taker”), people take account of the likely responses of others to the actions that they take.
The contributions of Keynes, Hayek, and Nash – aggregate demand, the central economic role of limited information, and strategic interactions modeled by game theory – were extended by many others and have become foundations of economic thinking. Before the end of the 20th century, all three innovations had become the standard content of post graduate economic instruction.
Things are radically different at the undergraduate level. The Samuelsonian paradigm is basically Marshall plus Keynes, and this remains the basic content of the dominant textbooks today. Asymmetric and local information and strategic social interactions modeled by game theory are typically introduced at the end of the introductory course, if at all. (Von Neumann had commented – surely ungenerously – about Samuelson that “...even in 30 years he won't absorb game theory.”)
Understandably students see these approaches simply as refinements of the standard model, not as challenges to two of its foundational precepts – namely price taking as the benchmark competitive behavior and complete contracts (and hence market clearing in competitive equilibrium) made possible by complete information.
CORE's new introductory text, The Economy, the result of a global collaboration of economic researchers and educators, seeks to address these problems. This open access online interactive e-text and conventional book (from OUP) attempts to do for information economics and strategic social interaction what Samuelson did for the concept of aggregate demand. CORE has made these concepts part of the foundation of an economic paradigm taught to introductory students.
It is already being taught as the standard introduction to economics at many top universities including University College London, Sciences (Paris) and the Toulouse School of Economics. The University of Siena, where I have had the pleasure of lecturing for many decades, offered an Italian translation of a beta version of CORE course to their first year students for the past three years and are now working on both an online Italian e-text and a conventional book.
In taking on board the fundamental ideas associated with the innovations of Hayek and Nash we have not adopted the thinking of either in its entirety. Problems of market failure and economic instability provide reasons to reject Hayek's insistence that governments should limit their activities to enforcing property rights and other fundamental rules that permit markets to function. Nash-inspired modeling of interactions among individuals who are at once able to calculate the highly complex consequences of their own actions, while being incapable of cooperating amongst each other to arrive at solutions to their problems has been questioned by modern behavioral experiments and research on human cognitive capacities. We have also provided both models and evidence that question Keynes' optimism that government demand management policies could substantially eliminate involuntary unemployment in the long run.
The emerging paradigm that CORE teaches provides a very different vision of the economy than does the Samuelsonian benchmark. An illustration is the view of competition. In his essay “The meaning of competition” Hayek pointed out that assuming a state of equilibrium of price taking traders effectively precludes a serious analysis of competition, which he defines, following Samuel Johnson, as “the action of endeavoring to gain what another endeavours to gain at the same time.” He continued as follows:
Now, how many of the devices adopted in ordinary life to that end would still be open to a seller in a market in which so-called “perfect competition” prevails? I believe that the answer is exactly none. Advertising, undercutting, and improving (“differentiating”) the goods or services produced are all excluded by definition— “perfect” competition means indeed the absence of all competitive activities.
To study the process of competition we replace the passive price taker of perfectly competitive equilibrium with what Makowski and Ostroy termed the “perfect competitor”. This active competitor exploits available (but incomplete) information to appropriate any possible rents that may exist when an economy is not in equilibrium, under some conditions driving the dynamic process to a Pareto efficient equilibrium, even when there are impediments to competition. The new paradigm provides a more convincing story about how an economy might reach a competitive equilibrium.
Wendy Carlin, who directs the CORE, project will say more about the new introductory course in a subsequent column.
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