Tuesday, March 14, 2006


Economics and Knowledge

Friedrich von Hayek was a brilliant economist and (I think) the only Austrian economist to win the Nobel Prize. Every student of economics is, or should be, familiar with Hayek's "The Use of Knowledge in Society," where he convincingly argues that any attempt to structure a whole society like a firm (socialist planning) will fail because of an intractable knowledge problem: no central planner can ever have the vital specific knowledge of time and place.

But not every economics student knows some of the fundamental differences between Hayek's economics and more mainstream economics.

The natural way to start is with his critique of the perfect competition model. Hayek believed that economic thought had gone too long without trying to answer a simple question: Why do we assume perfect knowledge?[1] From Hayek's Economics and Knowledge:

"...the tautological propositions of pure-equilibrium analysis as such are not directly applicable to the explanation of social relations..."

Click here for more Hayek-like critiques of the perfect competition model.

Perhaps a more important question is: Why have we ignored the nature of knowledge and the meaning of the word "datum"? Hayek of course takes a very individualistic and subjectivistic stance on this fundamental issue. He contends that, in the past, the term "datum" referred to a piece of information that was "given" or learned at the individual level, that is, something far more subjective than we usually mean by "datum." Basically, that the same objective facts can be observed by two different people and they can each come to a different conclusion. Also, the idea of "changes in the data" only has meaning once we introduce the element of expectation.

For example, if the weather were to stay the same from now through the summer, that would not be a change in the objective data (temperature highs?). But in terms of expectations it would definitely be a change, since I expect the weather to get warmer. I hope this illustrates how Hayek's definition of "datum" might be different than, dare I say, you expected.

It follows that it's impossible to know if there's been a "change in the data" since the change can only truly be understood in terms of expectations (subjective data), and it's impossible to know exactly what everyone expects will happen with the objective data.

Hayek has a way of zapping my brain, so I'm going to sleep now. I'll try to follow up on any comments.

[1] Maybe Dallas can chime in here with something on the value of prediction. Also, feel free to make me look foolish by showing that mainstream economics has come up with whole fields devoted to imperfect knowledge: risk theory, game theory, asymmetric information, mono-duo-oligo- poly theory, etc. But here I'm mainly concerned with the perfect competition model, which is used all the time.

I was under the impression that he deviated away from economics rather early on and focused on history, philosophy, and poli-sci. Have any more historical info on him?
Well, as you anticipated, I agree with you, but think the critiques of imperfect information have already been absorbed by the mainstream. ;) So there isn't much else for me to say. Though I would like to point out my aim is never to make anyone look foolish.
It's true, but he can't help it if you end up looking that way...


I agree with Travis, that the perfect competition model is used too much or greatly out of context by non-economists. Since the other models aren't as mainstream as the simplistic perfect competition model, most people find many things that aren't really there in their analysis (like my public policy class).

I dunno who you should fault with that misuse.
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