First, what do “economic laws” even mean? Economic “laws” are certainly not like laws of nature. No person can simply jump into the air (unaided by technology) and violate the law of gravitation. Yet it is possible in both theory and practice for people to violate the law of demand.
If this were not so, then how do speculative bubbles ever emerge and develop in economies? If the price of houses is rising sharply, the law of demand tells us that demand should fall. People will substitute some other good for expensive houses. But that is not what happens during speculative bubbles: the demand for houses increases, and increases sharply, even as prices soar. In fact, the rising prices are clearly a causal factor in the increased demand, because the increase in value, and the desire make money, is what attracts people.
Already we see that the “law of demand” has little or no explanatory power with respect to the prices of, and demand for, durable goods or assets bought and sold on markets where there are vast secondary stocks (consisting of “used” or “second hand” goods) of such goods/assets, in addition to the newly produced versions of the same good/asset.
Secondly, the expression “economic law” is misleading. Most economic laws – as in “laws” in the social sciences generally – are observed regularities in phenomena and human behaviour. But “regularities” are not necessarily universal. This is perfectly clear in social relations. It is an observed regularity that parents look after their biological children in human societies. One might even describe this as a type of “social law” of human society. But everyone knows there are exceptions: grossly negligent, irresponsible or immoral parents who do not care properly for their offspring. Some parents may even abandon their children or put them up for adoption. The “social law” is not like a hard law of nature at all. It is an empirical observation, and a human behaviour that has both biological/genetic and environmental/cultural causes, which there can be exceptions to.
I doubt whether most “economic laws” are much different from “social laws.” Although one might be able to point to a core of economic laws that are truisms – e.g., you can’t have consumption without prior production – these are usually trivially true propositions that do not take us very far.
Since economic behaviour is governed not only by human impulses, nature and psychological traits (caused by “nature,” as it were), but also by institutions, culture and social structures (environmental or general cultural factors), we should not expect absolute universality of all currently observed economic “regularities” in the past or in societies with different institutions and cultural practices (but note that I am most decidedly not endorsing fashionable postmodernism or cultural relativism by these remarks). No doubt there are some “regularities” that do hold true in almost all human societies in all times, but there is no a priori reason to expect all such “economic laws” do, even in a modern society.
So what about the law of demand? Certainly there must be many commodity markets where prices and demand do indeed behave like supply and demand curves: that is, demand will rise as the price falls (Keen 2011: 72–73). But it is likely that there are a significant number of markets where the law of demand does not apply.
Anyone who has done even an undergraduate degree in economics knows that the law of demand cannot really be universal, e.g., the possibility of Giffen goods already invalidates its claim to universality.
In fact, we can draw attention to these exceptions to the law of demand already well known in economics textbooks:
(1) Giffen goods/inferior goodsBut even more radical criticisms of the law of demand can be made.
(2) Veblen goods/”snob” goods
(3) goods/assets on speculative markets
(4) psychological bias relating to relationship between price and quality
Some consumers evaluate the quality of a good from its price. That means that some consumers could in theory prefer higher priced goods to lower priced goods and shun cheaper goods under the impression that cheaper goods are inferior (even when they are not).
(5) Demand during times of scarcity or fear of scarcity
Fear of expectation of shortages or scarcity during abnormal times (disaster or war) can cause people to buy more of a good even as their price rises, to stock up in the expectation of insufficient supply in the future.
(6) Necessities
The basic staples of everyday life often have a stable demand even when prices rise.
One can see a good critique of the law of demand in Keen (2011), but I will leave this for another post.
BIBLIOGRAPHY
Keen, Steve. 2011. Debunking Economics: The Naked Emperor Dethroned? (rev. and expanded edn). Zed Books, London and New York.
Interesting post, Lord Keynes. I've been reading your blog for a while and have learned quite a lot about economics and the various schools of economic thought from doing so. What are some favorite texts that you feel that anyone who wants to delve far more into Post-Keynesian economics should read, especially for someone who isn't that familiar with heterodox economic thought?
ReplyDeleteDebunking Economics sounds great, but I wanted a couple of other texts to read and conduct research.
I recommend Joan Robinson, "Economic Philosophy" for a very general overview, written in witty prose for a mainstream audience.
DeleteSome good introductions to Keynes and Post Keynesianism:
ReplyDeleteDavidson, Paul. 2009. The Keynes Solution: The Path to Global Economic Prosperity (1st edn). Palgrave Macmillan, New York and Basingstoke.
Skidelsky, R. J. A. 2010. Keynes: The Return of the Master (rev. and updated edn.). Penguin, London.
While I probably agree with the statement that 'Most economic laws – as in “laws” in the social sciences generally – are observed regularities in phenomena and human behavior' I don't agree with much else.
ReplyDeleteYour argument is a bit like citing birds and airplanes as reasons to dismiss the law of gravity.
There are perfectly logical economic explanations for all the "exceptions" you identify based on an understanding of how people's subjective valuations of goods drive demand and how dynamic interactions between various factors in the market can cause the demand curve for a specific good to change through time.
Examples:
An increasing money supply and lowering interest rates can explain housing (and other asset-based) bubbles.
The income effect explains Giffen goods.
Subjective valuation explains the additional demand for "snob" goods
There is a big difference between saying "demand curves are not always static and don't always slope up" to saying that "the laws of demand don't always apply", which would only be true if you had identified the laws of demand too narrowly. I'm pretty sure that Giffen (and probably Veblen) goods are taught in econ 101 classes so I think this is known even new students of economics.
"Your argument is a bit like citing birds and airplanes as reasons to dismiss the law of gravity. "
DeleteThe analogy with gravity is utterly inappropriate. Why? The reason is that gravity is caused by - as far as we can tell - uniform and universal physical properties of the universe.
Human behaviour, being malleable, is not like a physical process strictly governing behaviour of matter and energy.
You correctly cite "subjective value" as a characteristic of human nature, but that is one of things that destroys these notions of the law of demand as some universal law analogous to nature.
"Your argument is a bit like citing birds and airplanes as reasons to dismiss the law of gravity."
DeleteEconomists making statements like this shows that, not only are they not scientists, but that their training has led them to repress/forget the physics lessons they likely received in their secondary level education.
Without going into it too much, comparing asset price bubbles -- which happen consistently and have enormous macroeconomic consequences -- with a gravity-based analogy would be more so akin to every now and then people floating off into space unexplained. The "constant" in the case of the law of demand is the behavior which is synonymous with the demand schedule itself -- if the behavior changes, the demand schedule does and vice versa as they are logically connected in a way that makes them one and the same thing. The "constant" in the law of gravity is the gravitational constant. If the constant -- i.e. behavior/demand schedule -- changes in empirical experience, it is equivalent to the gravitational constant randomly changing from time to time. If that happened in physics, Newton's law would fall. If it happens in economics we make ad hoc excuses. Different conception of what "law" means with one interpretation being held by a bunch of cloistered priests who has isolated themselves from the rest of the scientific community.
Statements like these also make economists laughing stocks in the eyes of the scientific and engineering community. Something which only people like Steve Keen have begun to remedy.
In other news, LK nice post. Now, wait for this to be formalised by your's truly in the next few months!
I think that economic laws are much more conditional upon assumptions that have not been fully proven to hold in the real world. Physical laws rest upon assumptions that have been shown to hold in the real world beyond any reasonable doubt.
DeleteTo believe that the things LK describes violates the "laws of demand" simply tell us that his version of the "law of demand" is not particularly useful in explaining the real economy where all the things he describes occur. It is fairly easy to come up with a "law of demand" based on reasonable assumptions that explain all the things LK lists. Surely such a law would be much more useful as a analytical tool than LKs implicit law (which seems to be something like "the law of demand says that all demand curves shall slope downwards").
If one believed that the statement "no object can defy the laws of gravity" meant that no object could "float off into space" then your understanding of how the world works would be faulty in a similar way and you would believe that hot air balloons disproved the law of gravity,
I looked in wikiepdia to see what it had to say on the matter
Deletehttp://en.wikipedia.org/wiki/Law_of_demand
It accepts LKs definition of the law, but explicitly lists its assumptions and exceptions (almost identical to LKs)
So in as much as the "law of demand" is a generally accepted economic law then I now agree (as LK and Wikipedia state) that its a one to which the real economy throws up many exceptions (that is: the assumption don't hold.
But so what ? Everyone already already knows that stuff and there are plenty of models out there (including Minsky's) that factor all those exceptions to this "law" with no problems.
Then its not a scientific law. End of story. It's just a rule of thumb. Or an apriori assumption. Or a tautology. Its not a law. Economists should cut the pretentious language.
Delete"Then its not a scientific law. End of story. It's just a rule of thumb"
DeleteIt's actually a stereotype - since it applies to a set of people. So it's just like Yorkshiremen are tight or Irishmen are drunks.
And therefore it suffers from the same problem as any other stereotype.
I think even learner economists are taught that the "law" only works with the given assumptions.
DeleteI look forward to LKs next post "The Sky - is it really blue?", that will set all those silly scientists straight.
"Then it's not a scientific law."
DeleteNobody is claiming this. #strawman #hair-splitting
"It's just a rule of thumb"
One that holds true in nearly every market. Btw, you must not have much faith in the entire field of statistics if you believe that all useful propositions about the world must have 100% accurate explanatory power w/o any exceptional cases.
[Don't launch into praxeology, anti-empirical Austrians, etc; I'm not a Rothbardian.]
You are correct on one point, Philip: economists are definitely sloppy with terminology (e.g. "capital"). The law of demand is certainly not a scientific law in the sense that it tolerates absolutely zero exceptions. But the word "law" is certainly pithier than the phrase "the near-universal tendency."
If "law" is not to your liking, what word do you suggest? "Principle"?
It's at best a tendency - like all stereotypes.
DeleteThat's why it gets warts on its warts as people widen the definition to keep the whole thing from falling apart from the number of exceptions to the rule.
You get the same with 'inflation' and 'saving'.
Certainly it is no good drawing upward and downward sloping lines and pointing to an intersection. The intersection is in fact anywhere in a huge area.
@John S
DeleteRawlings compared it to the law of gravitation, thus comparing it to a scientific law. This is not surprising given that economics uses pretentious terminology persistently in order to give itself an "aura" of scientificness. And then economists -- I've seen this a million times before -- make comparisons like Rawlings just did in a pretentious attempt to move their discipline further from sociology and closer to physics.
"One that holds true in nearly every market."
The issue is far more complicated than that. The inverse relation between price and quantity demanded holds to some extent in many markets. But it is by no means a general principle and it does not explain much about how shops actually sell goods and services. For example, if we increase the price of a good and move its position in the supermarket we can probably sell more.
Perhaps we can call it a rule of thumb, like the idea that people will generally save more as their income increases. But it does not really explain anything. And the way it is taught to students is pretentious and misleading in the extreme and only serves to fill the population with superstitious dullards who worship simple geometrical forms as if they contained some Eternal Truth.
"There are perfectly logical economic explanations for all the "exceptions" you identify"
ReplyDeleteThere are perfectly logical explanations why the planets retrograde and why the orbits can always be considered circular in an earth centred universe as well.
The mathematics are very complicated but the Aristotle purity of the circle is similarly maintained.
When Einstein discovered relativity did he think it disproved the laws of gravity or just extended them to make them more accurate in explaining reality ?
DeleteWTF? Einstein's theory didn't contradict the law of gravitation. It extended and amended it. The objections LK points out contradicts the "law" of demand. It doesn't extend and amend it. Therefore it is not a law.
DeleteEinstein didn't say "Oh! I have contradicted the law of gravitation entirely, now let us see how I can get my results to conform back to the original law to ensure that this law remains standing."
He said: "Aha! My thinking has led me to interesting conclusions about the curvature of spacetime, but this doesn't contradict the theory of gravitation. Instead we simply move the point at which gravitation occurs from a physical body to a curvature in spacetime."
As you can see, the reference point is the same, but it is, in a sense, moved. In the "law" of demand example, the "law" is contradicted outright. Totally different.
I'm not 100% sure where economists get their terminology or their epistemology but it strikes me as being made up to suit their own purposes.
Einstein did indeed find that the Newtonian understanding of the law of gravity was flawed.
DeleteAre you going to reference or explain that or is that just an assertion?
DeleteHere's Wiki, if you care to actually read up on this:
http://en.wikipedia.org/wiki/General_relativity#From_classical_mechanics_to_general_relativity
If you actually read that you'll see that, for Einstein, Newton's theory is simply a special case of a more general theory of gravitation -- Einstein's general theory.
Einstein's theory does not CONTRADICT Newton's theory, but merely finds that it is a special case of a more general phenomenon. Certainly there is nothing in Einstein that CONTRADICTS the law of gravitation, as there certainly is in LK's post that CONTRADICTS the "law" of demand.
As I said: economists are operating here with a completely arbitrary and ad hoc methodology. Which is why they're laughing stocks in the scientific community. They do not follow scientific method in constructing their "laws" and their methodology is, in all seriousness, more similar to theologians in the middle-ages than to scientists.
I'm not a physicist but I still think I am correct to think that Einstein provided a theory of gravity that differed from Newton's and has been shown empirically to have more accurate predictive power.
DeleteSee
http://en.wikipedia.org/wiki/Newton%27s_law_of_universal_gravitation
"Newton's law has since been superseded by Einstein's theory of general relativity"
End of story.
"Certainly there is nothing in Einstein that CONTRADICTS the law of gravitation, as there certainly is in LK's post that CONTRADICTS the "law" of demand."
DeleteBTW: You are incorrect about this too - LK doesn't show anything that contradicts the "law of demand" once one takes its assumptions (at least as described in Wikipedia) into account.
Rob Rawlings@January 16, 2013 at 10:26 AM
DeleteI far as remember the theoretical and real world possibility of Giffen goods (e.g., Battalio, Raymond C., Kagel, John H. and Carl A. Kogut. 1991. “Experimental Confirmation of the Existence of a Giffen Good,” American Economic Review 81.4: 961–970) already invalidates the law of demand's claim to universality, without violating its ceteris paribus assumption.
That is explicitly acknowledged in textbooks.
@ Rawlings
DeleteIf you genuinely believe in what you're saying then I'm afraid I'll never get through to you. You're too insulated in the perverse methodology of neoclassical economics. ("X doesn't contradict Y so long as we all agree that Y contains X as its own self-negating contradiction" etc.). Everyone who has not been trained to think in logical contradictions (as every other scientific and rational discipline is), I'm sure, will see my criticisms as valid. Perhaps you can find allies with the medieval scholastics. ("God does exist if we take into account that the existence of the idea of his non-existence is proof of his existence due to it already being contained in God's existence in its own self-negating being" etc.)
@ RR
DeleteRegarding the Einstein thing as I've pointed out at least three times now: Einstein's law does not CONTRADICT Newton's law, it counts it as a special case. LK's post CONTRADICTS the law of demand -- insofar as we don't engage in the word games that you do to "prove" that it does not contradict it (because the law of demand contains its own contradition etc.).
You don't seem able to see that logical contradictions are considered errors in science because you have been trained to think in muddled contradictions, like the theologians (and the Hegelians, by the way...).
"Everyone who has not been trained to think in logical contradictions... will see my criticisms as valid."
DeleteReally? Let's say we ask 100 people, "If an item goes on sale at Walmart, will shoppers buy more of it?"
Do you believe most people would say no?
LK, OK, I will concede that one, (I didn't read the wikiepdia article closely enough and thought that one of the assumptions was real income, and not money income , remaining constant).
DeletePP, It seems odd that I find myself "insulated in the perverse methodology of neoclassical economics" as I do not consider myself an adherent of that school. In any case, I think I must have skipped the "logical contradictions" class - maybe it was too full of post-Keynsians ?
"Some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of price determination and of distribution, all that used to be the backbone of economic theory, and in consequence, in my opinion, to have ceased to understand any economics."
DeleteF.A. Hayek
"Some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of..."
DeleteNo doubt supporters of the geocentric theory complained along similar lines about supporters of the heliocentric theory...
"Really? Let's say we ask 100 people, "If an item goes on sale at Walmart, will shoppers buy more of it? Do you believe most people would say no?"
DeleteSo now you're appealing to this as a common sense principle? That's pretty crass. The same people would likely say that if the central bank increases the money supply in the banks the currency would devalue. Not true.
You're now trying to appeal to the man in the street. This, again, is beginning to sound like theology. This time the theology of George Berkeley who used to appeal to the common man and common sense in his arguments with Newton at al.
@RR - It's implicit in the methodology.
State a "law" -- say "law X". Then state exceptions to the "law" -- says exceptions A, B and C. Then continue calling X a law. This trains the student to give up the scientific method and think in logically contradictory terms. The "law" X now contains its own logical contradictions. But these are somehow self-negating as they exist within the "law" but do not overturn it.
The next step is that the economists begin to look at the other sciences, as you did with physics, and assume that the practitioners are engaged in the same thing. But they're not. In other sciences and disciplines such thinking would be considered a simple logical error and the proponent would not get a qualification.
Getting beyond the logical fallacies I do think it can be redrafted.
Delete(i) Consumers when faced with two items that they consider to be substitutes will choose the cheaper one.
(ii) Producers will use every psychological trick open to them to ensure that their product is in a market of one. (That is what 'unique selling proposition' means).
So the usual situation in most products is one of monopoly that exploits the 'status quo' cognitive bias (and a few others to do with group identity).
You see this all the time in the supermarkets.
I've stood and watch two old dears comparing two bottles of milk - identical except one had a green label priced at £1.55 and one a lilac one priced at £1.00. The conclusion was 'stick with what you know Doris' and the £1.55 one went in the basket.
So a 50% mark up is not sufficient to break that monopoly perception.
Similarly with plain flour - identical nutritional read outs on a standard graded product. The only difference is in the packaging, where one bag has the words 'everyday value' on it. 'Value' is 0.60 and the other is £1.11 - an 85% mark up.
The final one is good old Weetabix. Even the chairman of the company that makes it can't understand why people still buy the stuff in the branded yellow boxes rather than the 'supermarket own' blue boxes. It is literally the same product. Yellow box - £2.39. Blue box - £1.69 - a 41% markup.
There clearly is a point where profit gouging breaks the monopoly perception.
But if we had economic theory based on this idea rather than pure 'demand and supply' ideology then perhaps we wouldn't have had policy designed badly.
Like we have in the electricity and gas 'markets' where lots of people are scratching their heads wondering why people don't switch to cheaper suppliers.
Phil,
Delete"So now you're appealing to this as a common sense principle? That's pretty crass."
I was objecting to your use of the word "Everyone." Incidentally, I'm quite sure that a group of 100 MIT/Caltech profs would also agree that when toilet paper goes on sale, ppl buy more of it.
Perhaps we can call it a rule of thumb, like the idea that people will generally save more as their income increases. But it does not really explain anything.
It doesn't explain anything? So the LoD & price competition has nothing to say about why VCRs became massively cheaper and more widespread in the 80s? Or why Android tablets will soon overtake overpriced iPads in market share? Or why China's share of world auto exports will dramatically rise over the next decade? Perhaps I'm missing something, but I don't see how you can explain these phenomena w/o invoking the LoD.
LK,
Geocentric, heliocentric models
LK, you're better than this. The geocentric model doesn't have a shred of evidence to support it. The LoD can be seen in action every day (even in your own life--you've never bought something that was on sale explicitly because it was on sale?) Comparing belief in the LoD to geocentrism is just silly.
I have found many of your posts enlightening, e.g. Australian free banking, the Long Depression of the 19th century US, criticisms of ABCT, the relationship btw debt and GDP growth, etc. But I find these criticisms of the LoD to be unconvincing and shallow. If they are central to the entire Post-Keynesian framework, then that tempers any enthusiasm I might have for that as well. Certainly, Post-Keynesian views won't make any headway with the mainstream using this line of attack.
"The geocentric model doesn't have a shred of evidence to support it."
DeleteIt had the same level and quality of evidence supporting it as the 'law of demand'. The sort of thing you believe in - which are really just the same sort of excuses to explain why the underlying belief has to remain intact.
And that evidence was there every day - the sun came up in the East and set in the West.
The observations were pretty clear and the mathematics irrefutable.
They were replaced in time by a model that better explained the observations with less 'ifs', 'buts' and 'ands'.
And it will be the same in this case as well. We will evolve onto a more sophisticated understanding of how trade works - at both a micro and macro level.
So explain why consumer electronics have steadily and dramatically declined in price w/o citing the LoD.
DeleteTell me why iPad will lose its mkt share lead to cheaper Android tablets w/o citing the LoD.
Cite 5 current, real-world examples of Giffen goods.
Until you address these issues, I will treat your silence as tacit admission of defeat.
Empirical confirmation of the law of demand (now it's your turn for epicycles): http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1173642
Your previous comment on branded products was one of the few that wasn't completely asinine and made a few interesting points. But you've reverted to your normal, pathetic form here.
http://yourlogicalfallacyis.com/ad-hominem
Deletehttp://yourlogicalfallacyis.com/special-pleading
http://yourlogicalfallacyis.com/burden-of-proof
http://yourlogicalfallacyis.com/strawman
Nice try. Too bad you can't read:
DeleteBurden of proof: "we must assign value to any claim based on the available evidence, and to dismiss something on the basis that it hasn't been proven beyond all doubt is also fallacious reasoning."
So how do you justify categorically rejecting the LoD, when I just gave you an empirical study confirming it?
I do apologize for not presenting any evidence as scientifically rigorous as a conversation between two old ladies at the supermarket.
"It doesn't explain anything?"
DeleteNo. It doesn't EXPLAIN anything in a scientific sense. This is obvious to anyone who has even touched upon real science -- as most of us hopefully have. Why? Because its contradicted by other events. Scientific laws only EXPLAIN anything on the basis that they're NOT contradicted.
How many times do I have to state this? Honestly, I feel like I've been transported back to 1210AD or something. I do not under-exaggerate when I say that you people are absurd. You really do want to wind the clock back to a time of primitivism and pre-Enlightenment. Honestly, I would usually find it below my standards to even interact with you and would assume that society would chalk you up as cranks. But unfortunately not, apparently... depressing, that the intellectual equivalent of creationism is today spread in our universities... truly depressing...
To everyone else I would just say that THIS is the form that real, tangible regressive thought has taken. Think whatever you like politically. This is really primitive stuff. And it is being taught in our classrooms. Frankly, I'm disgusted every time I see this sophistry.
How many times do I have to say it? The "law" of demand is not a scientific law, it is shorthand for "near universal tendency." Stop engaging in this semantic hairsplitting. Call it a "theory of demand" if you prefer.
Delete"Scientific laws [and theories] only EXPLAIN anything on the basis that they're NOT contradicted."
What about the theory of reciprocal altruism in evolutionary biology? Surely, it doesn't explain the behavior of every single species (and certainly not the behavior of every single individual organism). Yet would you say that this concept is also pseudo-science and gives us no useful insight? By your criterion, we would.
"I do not under-exaggerate when I say that you people are absurd. You really do want to wind the clock back to a time of primitivism and pre-Enlightenment."
Strawman much? I thought hard-core Austrians were the most sanctimonious bunch in economics, but you've upped the ante. Yes, I want to roll back the Enlightenment and return to the Middle Ages. FFS
"the intellectual equivalent of creationism"
Oh, please, the LoD describes nearly all markets, it is you who is grasping at exceptions which don't even actually exist, like Giffen goods. Again--here's empirical confirmation of the LoD: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1173642
Re: financial bubbles--this isn't a fair test of "free markets" b/c we don't have a free market in money, credit, and banking (as described by Selgin & White).
"I would usually find it below my standards to even interact with you and would assume that society would chalk you up as cranks."
You've summed up my thoughts about you perfectly.
Wealth effects explain why more housing is bought when the price of housing goes up-- so it doesn't contradict the "law", it buttresses it. Bubbles happen because of "animal spirits", but Shiller and Akerlof have written about that.
ReplyDeleteIf you think about it, the "law" of demand applies pretty well-- think about your own life. Plus, the "law" is about a state where everything else is held equal, and doesn't take into account countervailing forces. The problem with your criticism is that you don't take into account preferences, elasticities, or income/substitution effects. Mainstream folks never claim to know peoples preferences. And, food, for example has fairly inelastic demand, so a rising price won't reduce the amount consumed that much-- if any.
But, as a counter example, when you make more money, you will substitute (more times than not) higher quality food for lower quality food. And, giffen goods have never been empirically found, so while it is a logic counterexample, it isn't an empirical counterexample.
I don't think any serious mainstream economist takes the "law" as a physical law. They might be elitists, but they aren't stupid.
"Plus, the "law" is about a state where everything else is held equal, and doesn't take into account countervailing forces. "
DeleteIndeed. That "ceteris paribus" assumption is crucial.
The law of demand is formulated at a level of abstraction so high and unrealistic, how can one seriously think that it is universal?
Economic “laws” are certainly not like laws of nature.
ReplyDeleteYes. Unlike scientific laws, which do not allow for any exceptions, economic "laws" are observed regularities (as you put it). This addresses the strawman arguments of Neil and Philip who state that *any* exception somehow "invalidates" the law of demand.
Moving on to your six exceptions:
1. Giffen goods. Economists are not even sure that real-world examples exist. I do not think that very many goods exist for which there are no good substitutes (a necessary condition for Giffen goods). Can you cite, say, 5 current, real-world examples of Giffen goods?
2. Veblen goods. Let's look at a typical example--luxury cars. Even here, we can see a relationship between price and demand. Ferraris are outsold by Porsches, which are in turn massively outsold by BMWs. While fancy sports cars are certainly more highly desired than standard models, we can't say that demand for expensive cars is higher since demand also depends on ability and willingness to pay.
3. Speculative goods. Two points: first, demand for assets rising in price does not increase indefinitely--all bubbles eventually burst. Second, in the specific case of the subprime bubble, Austrians would cite the low mortgage rates (and easy money Fed policy) of the early 2000s as fueling the bubble.
4. Psychologically overvaluing of products by consumers. If consumers want to pay extra to feel some psychological connection with, say, Marilyn Monroe via Chanel No5, why should we stop them? Also, even here, Chanel can't wantonly raise its prices forever b/c consumers will start to defect to competitor options (CK, Donna Karan, etc). If it is true that demand for Chanel No5 would increase with a higher price, then why doesn't Chanel do so?
5. As you say, these cases are "abnormal." Also, LoD applies ceteris paribus. The case with an expectation of reduced future supply can't be compared with generally prevailing conditions.
6. Yes, staples tend to be highly inelastic. However, if the price of coffee doubles, coffee consumption will surely drop off at the margin.
So you're just making up another definition of law? Okay, then this is pretentious rhetoric.
DeleteBut you're actually not making up another definition -- which shows that you don't understand the original definition (which makes your arguments about this suspect from the outset).
In the natural sciences too laws are "observed regularities". However, they are dropped when they are consistently contradicted in any fundamental way (Popper's falsifiable criteria).
Let's take asset price bubbles again. Every 10 years or so, probably less, an asset bubble bursts somewhere in the world leaving significant macroeconomic turbulence. This contradicts the law of demand in the most fundamental way.
Now, let's take the scientific equivalent. Every ten years or so large amounts of people and objects just float off the earth. This contradicts the law of gravitation in the most fundamental way.
In the former case the economists keep intact their law of demand and make ad hoc justifications. In the latter case do you think the physicists would do the same?
I'll let you answer that yourself. But if you answer "yes", consider this: why are economists laughing stocks among the physicist and engineering community? Seriously. Answer that.
The "observed regularities" point is well-established in the natural sciences since David Hume. So, you cannot arbitrarily distinguish between the two. The question is the response both communities give to persistent major contradictions of their "laws". One response resembles the response of enlightened human beings, the other resembles the response of medieval scholastic theologians.
A scientific law implies an invariant causal relationship that results from consistent hypothesis testing such that the law is not only explanatory but predictive. Does the "law" of demand meet that test?
DeleteObviously human beings will not behave with perfect uniformity and predictability in the same way that gas molecules do. Does this mean that we should make no attempt to discern general patterns of human (including economic) behavior? This entire line of argument is a giant strawman.
DeleteEvery time you see the phrase, "law of demand," mentally substitute the phrase, "the strong tendency for consumers to buy more of a good when its price is lower and less when its price is higher (ceteris paribus)."
Philip, yes, you are correct. Explaining the behavior of asset bubbles is difficult, and the law of demand by itself is insufficient to explain their behavior. What is your explanation of how asset bubbles arise and how to identify, prevent, and contain them? I will be sure to notify the Nobel Prize committee when you post your response, since you will certainly be a worthy candidate if you can answer these questions with complete accuracy.
In the meantime, please address these points:
1. Identify 5 current, real-world examples of Giffen goods
2. Explain why BMWs massively outsell Porsches, w/o resorting to price differences as a cause
3. Explain why Chanel does not double the price of its No.5 perfume since, as a Veblen good, price increases should automatically lead to increases in demand
Good luck!
Re: asset bubbles--experimental economics has shown that loose money leads to larger bubbles.
DeleteHere's behavioral economist Vernon Smith on his results: http://bigthink.com/ideas/18200
Larry White, George Selgin, Steve Horwitz, Richard Timberlake, and others associated with the Free Banking school have been attacking loose Fed monetary policy for a long time.
John S@January 16, 2013 at 4:53 AM
Delete"Every time you see the phrase, "law of demand," mentally substitute the phrase, "the strong tendency for consumers to buy more of a good when its price is lower and less when its price is higher "
That is more or less what I am saying above.
I take it that, after all your comments here, you are basically agreeing with this post?
John S@January 16, 2013 at 5:00 AM
Delete"Re: asset bubbles--experimental economics has shown that loose money leads to larger bubbles. "
It does not need to if financial sectors are properly regulated. You mistake an intermediate cause for the fundamental cause. A more fundamental cause is human psychology, the desire to get rich in a way perceived to be easy.
Also, I see no reason in theory why an asset bubble could not happen even with a zero change in the money supply.
I take it that, after all your comments here, you are basically agreeing with this post?
DeleteI listed my disputes with all six of your "exceptions" to the law of demand. So we clearly disagree on the applicability of the LoD wrt economic analysis. I believe that the law of demand holds in nearly every market. If you can address my points, then I will have to reconsider my stance on the law of demand.
Re: asset bubbles--this is obv a very complicated topic. For example, with housing, what was being bought clearly wasn't just "housing" in the sense of "shelter" or "a place to live"--it was the prospect of future capital gains.
To home buyers of the early to mid-2000s, it must have seemed that borrowing cheaply and selling later (in what was perceived to be a perpetually rising market) would provide a greater return than other investment options (while enjoying the side benefit of living in a larger house than one would have been able to afford in the absence of cheap loans).
This case still conforms to the law of demand--housing was selected b/c of the perception that it was the cheapest way (in terms of effort and money) to achieve some desired level of future cash flows (as opposed to stocks, bonds, advanced degrees, or working harder).
For homeowners who sold at the peak, this was in fact a successful strategy. The homeowners who were left holding the bag were still acting in accordance with the LoD, but they were mistaken in their belief that housing prices would rise indefinitely (or at least long enough for them to get out safely).
[Note: I am NOT saying the housing boom/bust was a good thing.]
I see no reason in theory why an asset bubble could not happen even with a zero change in the money supply.
You may or may not be right, but Vernon Smith has concluded that loose money leads to larger bubbles. I am of course in no position to evaluate his work, but I think it's entirely reasonable to give greater credence to his experimental results than to your theoretical speculation.
Just to clarify: Do you disagree that loose money exacerbates asset bubbles (ceteris paribus re: regulatory framework)?
"Just to clarify: Do you disagree that loose money exacerbates asset bubbles "
DeleteNo, I do not dispute that in a poorly or ineffectively regulated financial system, easy money might exacerbate asset bubbles.
"What is your explanation of how asset bubbles arise and how to identify, prevent, and contain them?"
DeleteThe "causes" of asset bubbles are completely contingent. The driver in the gold market at the moment, for example, is fear while the driving in the housing market in Ireland from 1999-2007 was rising income and exuberance. Tulips in Holland, on the other hand, seemed to be due to novelty.
We cannot, as I've said here in the past, explain WHY asset price price bubbles occur. But we can explain in what type of markets they MAY occur and in what type of markets they CANNOT occur and under what conditions. I'm pretty sure I have a solid theory of this and when it is published I'm sure you can nominate it for a Nobel -- although they won't listen (see below). This is actually more useful information because it shows what type of markets policymakers should monitor.
"I will be sure to notify the Nobel Prize committee when you post your response, since you will certainly be a worthy candidate if you can answer these questions with complete accuracy."
On this front, I'm afraid, you're quite wrong. They don't give the prize to people who completely contradict certain precepts of neoclassical economics -- and my paper will contradict pretty much all of them. This isn't a science we're dealing with, after all. I'm hoping to have influence not on the clown-like economics profession but on good, rational people in high finance.
Wonderful post and examples. You seem to be referring as well to Marshall's 1890 textbook, the first time we heard of this "law of demand."
ReplyDeleteIn the text it is noted: "The term 'law' means nothing more than a general proposition or statement of tendencies, more or less certain, more or less definite...a social law is a statement of social tendencies; that is, that a certain course of action may be expected from the members of a social group under certain conditions."
Alfred Marshall, Principles of Economics, 8th ed. (New York: Macmillan, 1948), p.33. (Cited by a text I have.)
"...may be expected..." "...under certain conditions..." This almost suggests that they're guessing. He seem to be suggested that these social laws were different from real world laws.
I would like to eventually culminate the various reasons people have given for why economics is not a science some time. (One of my favorites given in most textbooks is that economics is too complicated; it'd take too much time to replicate and conduct experiments would be too hard, yet they seem to have an inordinate amount of time to blog.)
--successfulbuild
Marketers who are choosing price for a new product test various prices and different positioning to determine the price/volume ration that yield the maximum profit. Very often reducing the price beneath a certain point drastically reduces demand, apparently due to lack of product credibility. People are suspicious of stuff that is too inexpensive, suspecting it is cheap as well. There is no law that allows pricing without testing.
ReplyDeleteA friend of mine owned a chain of specialty stores that sold a lot of imported goods that cost pennies on the dollar. My friend had a prince rule of no more than 20X markup over cost of goods including shipping, etc. He was constantly finding things that were marked up 30 to 40X and when he confronted the pricing manager, the answer was always the same. "We can't price goods that far below perceived value and be credible. People think that there is something wrong with them and don't buy them."
"Very often reducing the price beneath a certain point drastically reduces demand, apparently due to lack of product credibility"
DeleteAnd profits too.
Yes, I have noticed that people in marketing departments at universities are usually far more aware of this than economists - no doubt because marketing academics/researchers must have at least some familiarity with what happens in the real world, as opposed to fantasy world of dynamic stochastic general equilibrium theory that is expounded by their colleagues in economics departments down the hall.
Not much to add, except a standard 'urgh' at economists trying to make appeals to physics when they quite clearly don't know enough about it.
ReplyDeleteLord Keynes:
ReplyDelete'If this were not so, then how do speculative bubbles ever emerge and develop in economies? If the price of houses is rising sharply, the law of demand tells us that demand should fall."
This is not correct. The law of demand does not say that if the price of X rises over time, that there has to be a decline over time in the quantity of X demanded.
The law of demand applies to ceteris paribus conditions. In the real world, there is central banking, which adds to the money supply and spending. There are other factors as well. Thus, if the price of X is rising over time, then an absence of a fall in the quantity of X demanded does not mean there is a violation to the law of demand.
If all else were held equal, INCLUDING the quantity of money and spending, then it would in fact be the case that if the prices of houses kept going up over time, then the quantity demanded would eventually fall over time.
Anonymous@February 19, 2013 at 1:29 PM
Delete(1) yes, the ceteris paribus does indeed limit the law of demand. But this is my point: what price change in the real world ever occurs with the ceteris paribus condition holding true?
(2) also, you do not need central banks as a precondition for asset bubbles. Just look at 19th century economies, e.g., Australia:
http://socialdemocracy21stcentury.blogspot.com/2012/05/free-banking-in-australia.html