Positive Economic theory

March 20, 2017
Positive economic theory

Source: Essays in Positive Economics (1953) publ. University of Chicago Press. Just part of one essay is reproduced here.

V. Some Implications for Economic Isuses

The abstract methodological issues we have been discussing have a direct bearing on the perennial criticism of “orthodox” economic theory as “unrealistic” as well as on the attempts that have been made to reformulate theory to meet this charge. Economics is a “dismal” science because it assumes man to be selfish and money-grubbing, “a lightning calculator of pleasures and pains, who oscillates like a homogeneous globule of desire of happiness under the impulse of stimuli that shift him about the area, but leave him intact”; it rests on outmoded psychology and must be reconstructed in line with each new development in psychology; it assumes men, or at least businessmen, to be “in a continuous state of 'alert, ' ready to change prices and/or pricing rules whenever their sensitive intuitions ... detect a change in demand and supply conditions;” it assumes markets to be perfect, competition to be pure, and commodities, labor, and capital to be homogeneous.

As we have seen, criticism of this type is largely beside the point unless supplemented by evidence that a hypothesis differing in one or another of these respects from the theory being criticised yields better predictions for as wide a range of phenomena. Yet most such criticism is not so supplemented; it is based almost entirely on supposedly directly perceived discrepancies between the “assumptions” and the “real world.” A particularly clear example is furnished by the recent criticisms of the maximisation-of-returns hypothesis on the grounds that businessmen do not and indeed cannot behave as the theory “assumes” they do. The evidence cited to support this assertion is generally taken either from the answers given by businessmen to questions about the factors affecting their decisions — a procedure for testing economic theories that is about on a par with testing theories of longevity by asking octogenarians how they account for their long life — or from descriptive studies of the decision-making activities of individual firms. Little if any evidence is ever cited on the conformity of businessmen's actual market behaviour — what they do rather than what they say they do — with the implications of the hypothesis being criticised, on the one hand, and of an alternative hypothesis, on the other.

A theory or its “assumptions” cannot possibly be thoroughly “realistic” in the immediate descriptive sense so often assigned to this term. A completely “realistic” theory of the wheat market would have to include not only the conditions directly underlying the supply and demand for wheat but also the kind of coins or credit instruments used to make exchanges; the personal characteristics of wheat-traders such as the colour of each trader's hair and eyes, his antecedents and education, the number Of members of his family, their characteristics, antecedents, and education, etc.; the kind of soil on which the wheat was grown, its physical and chemical characteristics, the weather prevailing during the growing season; the personal characteristics of the farmers growing the wheat and of the consumers who will ultimately use it; and so on indefinitely. Any attempt to move very far in achieving this kind of “realism” is certain to render a theory utterly useless.

Of course, the notion of a completely realistic theory is in part a straw man. No critic of a theory would accept this logical extreme as his objective; he would say that the “assumptions” of the theory being criticised were “too” unrealistic and that his objective was a set of assumptions that were “more” realistic though still not completely and slavishly so. But so long as the test of “realism” is the directly perceived descriptive accuracy of the “assumptions” — for example, the observation that “businessmen do not appear to be either as avaricious or as dynamic or as logical as marginal theory portrays them” or that ”it would be utterly impractical under present conditions for the manager of a multi-process plant to attempt . . . to work out and equate marginal costs and marginal revenues for each productive factor” — there is no basis for making such a distinction, that is, for stopping short of the straw man depicted in the preceding paragraph. What is the criterion by which to judge whether a particular departure from realism is or is not acceptable? Why is it more “unrealistic” in analysing business behaviour to neglect the magnitude of businessmen's costs than the colour of their eyes? The obvious answer is because the first makes more difference to business behaviour than the second; but there is no way of knowing that this is so simply by observing that businessmen do have costs of different magnitudes and eyes of different colour. Clearly it can only be known by comparing the effect on the discrepancy between actual and predicted behaviour of taking the one factor or the other into account. Eve the most extreme proponents of realistic assumptions are thus necessarily driven to reject their own criterion and to accept the test by prediction when they classify alternative assumptions as more or less realistic.

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