The Failure of Econ 101

Since starting a graduate program in economics this year, I've become increasingly disillusioned with the state of the discipline in American culture. The research literature rarely reflects the public's image of how markets work. Different schools within the field might have different interpretations of data and theory, but few economists would argue that the basic supply and demand model holds up in all but a few specific markets.

Most Americans have an idea of supply and demand even if they've never taken a course in economics. The classic equilibrium graph looks like this:

  Parkin, Michael. "Demand and Supply."   Microeconomics  . 12th ed. 77. . Pearson Ser. in Economics.

Parkin, Michael. "Demand and Supply." Microeconomics. 12th ed. 77. . Pearson Ser. in Economics.

As prices decrease, the public wants to buy more of some good and firms want to sell less of it due to the costs of production. When the curves intersect, there's an equilibrium price and quantity that clears the market. It's an elegant explanation that completely neglects the complexity of society. 

The natural conclusion is that markets operate efficiently and government can only get in the way of a good thing. A typical undergraduate microeconomics course covers topics that undermine this framework, including elasticity and monopolies, but few Americans ever take such a class. In the popular imagination, markets work. 

The failure of the Econ 101 model becomes obvious when you examine specific products. Goods markets depend on voluntary participation and perfect information. Health insurance cannot reflect the simple supply and demand paradigm because people don't decide whether or not to be sick; mortgage lending requires perfect credit markets, where discrimination based on things other than credit do not exist; used car sales are susceptible to deception from the previous owner. There are countless everyday examples of market failure, yet our policymakers sell proposals to the public based on the misleading idea that equilibrium can be achieved if we let the Invisible Hand guide us. This approach has been a disaster for working class Americans.

One of the foundational aspects of Neo-Classical economics since the 1980's has been the belief that the labor supply curve is elastic; unemployment is a result of unreasonable workers demanding wages that the market cannot support. If only working people and the unions that represented them could agree to fewer hours and/or lower pay, we could avoid the problem of mass unemployment. People should want to work more hours when demand is high as a result of technological progress and less when demand is low. There is no involuntary unemployment. The Great Depression and Recession were just excuses for a lot of people to take a long vacation

Anyone who has ever had to work to pay a bill can tell you that this is nonsense. But this extreme view, derived from the same flawed Econ 101 model above, has been the primary economic policy of the United States for most of the last 35 years. Economists connected to reality like Joseph Stiglitz have done ground-breaking research that suggests there is a "stickiness" to wages. Instead of being subject to the whims of the business cycle, workers seek to maintain a baseline level of wages and working hours in order to guarantee a consistent lifestyle. Unemployment happens when there is a negative shock to demand and workers can't negotiate their wages down because it would cost them their homes. Firms then cut hours and, if necessary, lay workers off. This nuanced explanation does more to explain the world than any Econ 101 model ever can.

Economic policy makers need to abandon the Neo-Classical beliefs that have led to low growth and lower wages. In order to accomplish this, the public's understanding of the economy must be freed from the Econ 101 model that gets so much wrong. It's not just that it is an over-simplified version of reality, but that it is actively incorrect in so many cases. As with the wage example, this failure can have a profoundly negative effective on workers' livelihoods. 

The debate over economic policy needs to shift away from fables and towards the empirical evidence. By appreciating the complexity of the economy and how people interact with it, we can make better policy that reflects the needs of every American.