1. Confessions of a Theorist: Why Reality is
Overrated1
Bart Lipman
Boston University
March 28, 2013
1
Very loosely based on Dekel and Lipman, “How (Not) to Do Decision
Theory” (2010).
3. Quotes about Economic Theory:
‘Pure theorists’ sometimes . . . prefer a theory that is so
pure as to be uncontaminated with any material content.
—Joan Robinson
4. Quotes about Economic Theory:
‘Pure theorists’ sometimes . . . prefer a theory that is so
pure as to be uncontaminated with any material content.
—Joan Robinson
Page after page of professional economic journals are
filled with mathematical formulas leading the reader from
sets of more or less plausible but entirely arbitrary
assumptions to precisely stated but irrelevant theoretical
conclusions.
—Wassily Leontief
5. Quotes about Economic Theory:
‘Pure theorists’ sometimes . . . prefer a theory that is so
pure as to be uncontaminated with any material content.
—Joan Robinson
Page after page of professional economic journals are
filled with mathematical formulas leading the reader from
sets of more or less plausible but entirely arbitrary
assumptions to precisely stated but irrelevant theoretical
conclusions.
—Wassily Leontief
An economist is someone who sees something that works
in practice and wonders if it would work in theory.
—Ronald Reagan
6. Ironically, the only one of the three who gets it right is the one
who’s not an economist.
Reagan’s line is correct about how theory (often) works and how it
should work.
7. Ironically, the only one of the three who gets it right is the one
who’s not an economist.
Reagan’s line is correct about how theory (often) works and how it
should work.
In my view, economic theory is not about figuring out what facts
are true in the world. That’s what empirical work is for.
8. Ironically, the only one of the three who gets it right is the one
who’s not an economist.
Reagan’s line is correct about how theory (often) works and how it
should work.
In my view, economic theory is not about figuring out what facts
are true in the world. That’s what empirical work is for.
When empiricists find a new fact, it might be an interesting fact to
think about from a theoretical point of view.
9. Ironically, the only one of the three who gets it right is the one
who’s not an economist.
Reagan’s line is correct about how theory (often) works and how it
should work.
In my view, economic theory is not about figuring out what facts
are true in the world. That’s what empirical work is for.
When empiricists find a new fact, it might be an interesting fact to
think about from a theoretical point of view.
The relationship between economic theory and reality is tenuous.
18. Incorrect Responses:
1. From economic theory, we know that people have utility
functions. Hence such behavior cannot occur.
19. Incorrect Responses:
1. From economic theory, we know that people have utility
functions. Hence such behavior cannot occur.
In mathematics, names are free. It is perfectly allowable
to call a self–adjoint operator an elephant and a spectral
resolution a trunk. One can then prove a theorem,
whereby all elephants have trunks. What is not allowable
is to pretend that this result has anything to do with
certain large gray animals.
—Hector Sussman
20. 2. Economists believe that people have utility functions and hence
economists are idiots.
21. 2. Economists believe that people have utility functions and hence
economists are idiots.
Correct Response: People don’t have utility functions, but if it’s
a useful hypothesis, go for it.
23. So how can false theories be useful?
[A] theory is not like an airline or bus timetable. We are
not interested simply in the accuracy of its predictions. A
theory also serves as a base for thinking. It helps us to
understand what is going on by enabling us to organize
our thoughts. Faced with a choice between a theory
which predicts well but gives us little insight . . . and one
which gives us this insight but predicts badly, I would
choose the latter . . .
— Ronald Coase
24. General principles are unlikely to be accurate but may be more
comprehensible and hence more useful than detailed, accurate
specifications.
25. General principles are unlikely to be accurate but may be more
comprehensible and hence more useful than detailed, accurate
specifications.
All understanding is generated by deciding which aspects of reality
to ignore.
The world never repeats exactly, so if everything is relevant, we
can’t learn from one situation about another.
26. General principles are unlikely to be accurate but may be more
comprehensible and hence more useful than detailed, accurate
specifications.
All understanding is generated by deciding which aspects of reality
to ignore.
The world never repeats exactly, so if everything is relevant, we
can’t learn from one situation about another.
I have a full-size map of the world. At the bottom it says
‘1 inch = 1 inch.’ I hardly ever unroll it.
—Steven Wright
28. Implication: Because models are always false, we should not be
surprised when they are refuted.
If they aren’t refuted, it’s only because we don’t have enough good
data to reveal the inaccuracies we know are there!
29. Implication: Because models are always false, we should not be
surprised when they are refuted.
If they aren’t refuted, it’s only because we don’t have enough good
data to reveal the inaccuracies we know are there!
Experimental/empirical observations refuting the “serious” parts of
the theory should concern us, but not those that refute the details
we chose to ignore. Refutation per se is not surprising.
30. Implication: Because models are always false, we should not be
surprised when they are refuted.
If they aren’t refuted, it’s only because we don’t have enough good
data to reveal the inaccuracies we know are there!
Experimental/empirical observations refuting the “serious” parts of
the theory should concern us, but not those that refute the details
we chose to ignore. Refutation per se is not surprising.
Hence the question should not be “Is the theory true?” since the
answer is always “no.”
The question should be “Is the theory useful?”
32. Uses of Theory:
First: Creating a language.
Have to name the relevant objects and create a basic taxonomy.
An important first step, but only a first step.
33. Uses of Theory:
First: Creating a language.
Have to name the relevant objects and create a basic taxonomy.
An important first step, but only a first step.
I admit that these terms (“final utility,” “marginal
production,” etc.) . . . repel some readers, and fill others
with the vain imagination that they have mastered
difficult economics problems, when really they have done
little more than learn the language in which parts of
those problems can be expressed. . .
—Alfred Marshall
37. Second: Checking an intuition.
Intuitive reasoning is often wrong.
What I did at the time, a very economist thing to do,
was to build myself a little model to prove the point that
I believed. So I built a little intertemporal optimizing
whatever and to my shock — and this is the point, of
course, of doing models — it actually gave me the
opposite answer.
—Paul Krugman
39. Third: Finding unexpected results which trigger new directions and
new insights.
Example. Earliest work on auctions considered independent
private values.
40. Third: Finding unexpected results which trigger new directions and
new insights.
Example. Earliest work on auctions considered independent
private values.
Revenue Equivalence Theorem: A very wide range of auctions
give the seller same expected revenue.
41. Third: Finding unexpected results which trigger new directions and
new insights.
Example. Earliest work on auctions considered independent
private values.
Revenue Equivalence Theorem: A very wide range of auctions
give the seller same expected revenue.
So why are English auctions so much more common than many
auctions which would have same revenue?
42. Third: Finding unexpected results which trigger new directions and
new insights.
Example. Earliest work on auctions considered independent
private values.
Revenue Equivalence Theorem: A very wide range of auctions
give the seller same expected revenue.
So why are English auctions so much more common than many
auctions which would have same revenue?
This led to research on common value auctions which have
surprisingly different properties.
43. Third: Finding unexpected results which trigger new directions and
new insights.
Example. Earliest work on auctions considered independent
private values.
Revenue Equivalence Theorem: A very wide range of auctions
give the seller same expected revenue.
So why are English auctions so much more common than many
auctions which would have same revenue?
This led to research on common value auctions which have
surprisingly different properties.
Doesn’t “prove” facts about reality, but suggests interesting
connections between nature of objects and auctions for them.
45. Fourth: Developing an intuition for how things might work.
Example: Knowles, Persico, and Todd, “Racial Bias in Motor
Vehicle Searches: Theory and Evidence,” JPE, 2001.
46. Fourth: Developing an intuition for how things might work.
Example: Knowles, Persico, and Todd, “Racial Bias in Motor
Vehicle Searches: Theory and Evidence,” JPE, 2001.
Empirical observation: Comparing white and black male drivers,
blacks are stopped more often but the rate at which they are found
to be carrying drugs is the same as that of whites.
47. Fourth: Developing an intuition for how things might work.
Example: Knowles, Persico, and Todd, “Racial Bias in Motor
Vehicle Searches: Theory and Evidence,” JPE, 2001.
Empirical observation: Comparing white and black male drivers,
blacks are stopped more often but the rate at which they are found
to be carrying drugs is the same as that of whites.
Stop Not
drugs 0, 10 10, 0
noncriminal work wt − 5, 4 wt , 5
where 5 < wt < 10.
48. Implication: If police enjoy stopping a particular type, that type
should carry drugs less often and be stopped equally often as a
type with same wages.
49. Implication: If police enjoy stopping a particular type, that type
should carry drugs less often and be stopped equally often as a
type with same wages.
Group that satisfies this property: white females.
50. Implication: If police enjoy stopping a particular type, that type
should carry drugs less often and be stopped equally often as a
type with same wages.
Group that satisfies this property: white females.
This doesn’t prove police aren’t prejudiced against black males or
that they enjoy stopping white females.
This just gives an intriguing interpretation of the data.
53. Fifth: Developing tools.
Example: Spence, “Job Market Signaling,” Quarterly Journal of
Economics, 1974.
Spence considers how agents may signal their private information,
focusing on potential workers signaling abilities to potential
employers.
54. Fifth: Developing tools.
Example: Spence, “Job Market Signaling,” Quarterly Journal of
Economics, 1974.
Spence considers how agents may signal their private information,
focusing on potential workers signaling abilities to potential
employers.
Basic idea is that higher ability students find school easier and
hence go longer; so more schooling signals higher ability.
55. Fifth: Developing tools.
Example: Spence, “Job Market Signaling,” Quarterly Journal of
Economics, 1974.
Spence considers how agents may signal their private information,
focusing on potential workers signaling abilities to potential
employers.
Basic idea is that higher ability students find school easier and
hence go longer; so more schooling signals higher ability.
Spence assumes: education has no effect on ability,
56. Fifth: Developing tools.
Example: Spence, “Job Market Signaling,” Quarterly Journal of
Economics, 1974.
Spence considers how agents may signal their private information,
focusing on potential workers signaling abilities to potential
employers.
Basic idea is that higher ability students find school easier and
hence go longer; so more schooling signals higher ability.
Spence assumes: education has no effect on ability, there are no
grades,
57. Fifth: Developing tools.
Example: Spence, “Job Market Signaling,” Quarterly Journal of
Economics, 1974.
Spence considers how agents may signal their private information,
focusing on potential workers signaling abilities to potential
employers.
Basic idea is that higher ability students find school easier and
hence go longer; so more schooling signals higher ability.
Spence assumes: education has no effect on ability, there are no
grades, all else equal, every student prefers less education, etc.
58. Fifth: Developing tools.
Example: Spence, “Job Market Signaling,” Quarterly Journal of
Economics, 1974.
Spence considers how agents may signal their private information,
focusing on potential workers signaling abilities to potential
employers.
Basic idea is that higher ability students find school easier and
hence go longer; so more schooling signals higher ability.
Spence assumes: education has no effect on ability, there are no
grades, all else equal, every student prefers less education, etc.
None of these things are true, but they make it easier to see the
concept he’s exploring. This helps us understand signaling in a
general way so that we can see how it could work in many very
different settings.
59. Example: Gul and Pesendorfer, “Temptation and Self–Control,”
Econometrica, 2001.
60. Example: Gul and Pesendorfer, “Temptation and Self–Control,”
Econometrica, 2001.
What behavior would indicate that choices are due to temptation?
61. Example: Gul and Pesendorfer, “Temptation and Self–Control,”
Econometrica, 2001.
What behavior would indicate that choices are due to temptation?
Not enough to observe unhealthy choices. Maybe the person is
just a regular utility maximizer who likes fattening foods.
62. Example: Gul and Pesendorfer, “Temptation and Self–Control,”
Econometrica, 2001.
What behavior would indicate that choices are due to temptation?
Not enough to observe unhealthy choices. Maybe the person is
just a regular utility maximizer who likes fattening foods.
Even harder question: What behavior would indicate that the
chooser is subject to temptation but exerted self–control?
64. Gul and Pesendorfer’s answer: Consider the choice of menus.
Suppose someone with a choice between a restaurant with only
healthy dishes and another with all those same dishes plus some
unhealthy dishes chooses the former.
Natural interpretation: He knew he’d be tempted by the unhealthy
dishes.
65. Gul and Pesendorfer’s answer: Consider the choice of menus.
Suppose someone with a choice between a restaurant with only
healthy dishes and another with all those same dishes plus some
unhealthy dishes chooses the former.
Natural interpretation: He knew he’d be tempted by the unhealthy
dishes.
Suppose it turns out that the first restaurant is closed, so he has to
go to the second one and he chooses something healthy.
66. Gul and Pesendorfer’s answer: Consider the choice of menus.
Suppose someone with a choice between a restaurant with only
healthy dishes and another with all those same dishes plus some
unhealthy dishes chooses the former.
Natural interpretation: He knew he’d be tempted by the unhealthy
dishes.
Suppose it turns out that the first restaurant is closed, so he has to
go to the second one and he chooses something healthy.
Natural interpretation: He exerted (costly) self–control.
67. Gul and Pesendorfer’s answer: Consider the choice of menus.
Suppose someone with a choice between a restaurant with only
healthy dishes and another with all those same dishes plus some
unhealthy dishes chooses the former.
Natural interpretation: He knew he’d be tempted by the unhealthy
dishes.
Suppose it turns out that the first restaurant is closed, so he has to
go to the second one and he chooses something healthy.
Natural interpretation: He exerted (costly) self–control.
Can’t know that this is what causes such behavior, but gives an
intriguing interpretation.
68. Last point: We develop these tools in the hopes that we’ll be able
to use them to do better in the future. We do understand some
things better now than economists 50 years ago did.
69. Last point: We develop these tools in the hopes that we’ll be able
to use them to do better in the future. We do understand some
things better now than economists 50 years ago did.
I expect that 50 years from now that what we do now will look
pretty primitive.
