Are Economists Realists About Equilibrium?

16 September 2006 at 12:57 pm Nicolai Foss 3 comments

| Nicolai Foss |

Economists are not always entirely forthcoming about how economic models connect to economic reality. My own perspective is that good economic models are simplified redescriptions of reality that capture those mechanisms that are essential for understanding a certain phenomenon. A crucial part of most economic models is that of equilibrium. Do economists think of equilibrium as a “simplified redescription of reality”? Or to put it somewhat differently, do they think that equilibrium is a possible (albeit perhaps highly unlikely) property of economic reality? Or is equilibrium a strictly analytical concept, and any association with economic reality a fallacy of conceptual realism?It seems clear that most older economists were realists about equilibrium in this sense. Keynes very clearly was. Hayek would seem to me to hold a similar view. I would argue that Samuelson (of the correspondence principle) also belongs in this camp, as does Franklin Fisher (FF of this book).

However, some prominent economists seem to have held an opposite position, among them Mises, Machlup, and some modern mathematical economists. To Mises (of Human Action), the so-called “Evenly Rotating Economy” (Mises’ way of talking about general equilibrium) is an analytical “foil”, an “imaginary construction” and not something a real economy can conceivably attain. To Machlup it is a fallacy of conceptual realism (or misplaced concreteness) to associate equilibrium with states in the real world (I have in mind Machlup’s 1958 paper in the Economic Journal, “Equilibrium and Disequilibrium: Misplaced Concreteness and Disguised Politics”). I have been told many times by mathematical economist friends and colleagues that “equilibrium is simply the solution of the model.” They consider the notion of whether equilibrium corresponds to something to be “overly metaphysical.”

However, it remains hard to see how it is really possible to conduct a lot of applied economics, policy analysis, welfare analysis, etc. if one is not to some extent a realist about equilibrium. Whether we can think of observed prices as equilibrium prices or not obviously matters a great deal, for example, for cost-benefit analyses.

I know of no serious modern discussion of these issues. Can anybody help?

Entry filed under: - Foss -, Methods/Methodology/Theory of Science.

3 Comments Add your own

1. Peter Klein | 16 September 2006 at 3:33 pm

As far as I know the definitive history of the equilibrium concept in economics remains to be written.

Note that Mises described at least two other equilibrium concepts as well, the plain state of rest and the final state of rest. The plain state of rest (PSR) is a realistic concept, a label for the state of affairs that obtains continuously in the real world at the conclusion of every voluntary transaction. There’s an interesting discussion of this in Kirzner’s 1999 Cato Journal paper on Mises. Curiously, Kirzner first argues that PSR prices, while “market clearing” in this short-run sense, are trivial and not really relevant to the broader questions of efficient resource allocation. But he then goes on to show that for Mises, PSR prices are sufficient to justify consumer sovereignty. Kirzner’s historic position, as I read him, is that markets are “efficient” only to the extent that there exists a systematic tendency for PSR prices to move toward final-state-of-rest prices. For Mises this is not an important issue. (Some discussion of all this here.

Wicksteed introduced yet another equilibrium construct, an intermediate condition between the PSR and the final state of rest, in his fruit-market example.

I guesss my point is that before we can discuss the realism of the equilibrium construct, we need to specify what we mean by “equilibrium.” There is a lot of variety, and inconsistency, in the literature.
2. genericface blog » Is Equilibrium a Realist or Instrumental Notion? | 17 September 2006 at 7:32 pm

[…] Nicolai Foss wrote an excellent entry on whether economists hold are realist about the concept of equilibrium; that is, do economists think equilibriums describe an actual real-life phenomina? It seems clear that most older economists were realists about equilibrium in this sense. Keynes very clearly was. Hayek would seem to me to hold a similar view. I would argue that Samuelson (of the correspondence principle) also belongs in this camp, as does Franklin Fisher (FF of this book)… […]
3. Peter Klein | 18 September 2006 at 12:05 am

Joe Salerno reminds me that Arthur Marget’s Theory of Prices contains a detailed description of various equilibrium constructs and their significance for applied economics. Writes Marget:

The ultimate goal of any theory of prices, like that of any part of economics which undertakes to explain economic reality, is to explain why realized prices are what they are. “Quoted prices,” the prices which are included in the “ex ante” schedule of the general theory of value, “expected” prices, “equilibrium” prices (in most of the senses of the concept of equilibrium), or any kind of prices other than realized prices are to be introduced into the argument only insofar as they help to explain why prices actually realized on the market are what they are.

Salerno’s “Ludwig von Mises’s Monetary Theory in Light of Modern Monetary Thought” (Review of Austrian Economics,1994) compares Marget’s views on equilibrium to those of Mises and Wicksteed (see pages 97-106).