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ECONOMICS 

Whats Missing From Current Economic Models 

By: CIFER | Updated Mar 3rd 2020

OVERVIEW

Neo classical economics, or sometimes referred to as orthodox economics is at the core of undergraduate economic teaching. The models used in micro and macroeconomics are effective in analysing the topic as a science however they rely on many assumptions, some of which are not quantifiable and omit many real-life factors that influence both consumer choices and policy decisions. 

Alternative economic models exist, some of which give a more accurate analysis of the real world. Heterodox economics is a study which focuses on the economic aspect of human behaviour and considers social factors that can have great impact on the economy. Heterodox and mainstream economics are hard to compare as they take different approaches, however the current methods and theories being taught to academics have come under criticism in recent years as it is believed the future generation of economists will have developed a limited perspective due to the current curricula, creating a need for a more diverse method of teaching (PPE society).

 

A ONE - DIMENSIONAL METHODOLOGY

The underlying assumptions of neo- classical models are amongst the key concepts and reasons for the criticism on the model. The current curricula include mathematic models which are a crucial element of economics however they focus the student on the quantitative method, solving complex problems but without considering the underpinning assumptions. 

As economies are so incredibly complex, simplified models are used for answering specific questions however many details must be left out and the focus is only on the most important factors. Furthermore, a bigger emphasis should be put on dynamic analysis as the current static form excludes the time delay in the equilibrium changes (J.Parker 2012).

 

Consumption is a fundamental principle in modern economics, the study of microeconomics looks at individual decisions that the general population make on a daily basis about consumption, borrowing, working and production; all of which are affected by varying factors, some of which are not measurable (J.Parker 2012). As rationality is such an important assumption especially when making policy decisions, there is a need for further analysis to be incorporated into the model. Or, perhaps the model could assume that humans are not perfectly rational and there are other factors that influence their decisions. The latter would be a more realistic assumption and thus would give more accurate results within the models. 

Mainstream economics uses utility to measure preferences of consumers however how can we be sure this is the best method of analysing welfare? (PCES 2014) Changes in income may affect the marginal rate of substitution for some wealth classes but it’s possible it has no impact on a large portion of the population in regard to their consumption choices, yet the model has this figured out as an exact science. Whereas in comparison, Heterodox economics can consider other factors like geographical inequalities which may help to explain the consumption choices better than the orthodox model.

 

In the study of macroeconomies we analyse aggregates in the economy. However, the current methodologies of the topic taught to academics also omit certain important factors (J.Parker 2012). Due to globalisation, world economies are much closer interlinked in the modern day, in particular when considering the flow of capital across borders. Neo classical models do not include any details about financial markets, asset prices, global debt or speculative investments. There should be considerations for market and pricing imperfections which can change the dynamics of money demand geographically and amongst different wealth classes. Such considerations would be extremely useful when considering monetary and fiscal policy changes. 

As financial details are omitted from the model, bubbles formed through excessive demand cannot be incorporated into neo-classical economics and this is an issue when trying to predict a future crisis. Although, history has shown that discrepancies in the bond market to be a useful indicator for predicting future recessions. The long-term treasury yield curves typically remain above the shorter-term yield curves when economies are in good shape, however in the situation when the curves cross, the term used is ‘inverted’. In fact, inverted yield curves have predicted every financial crash dating back to the 1950’s so it begs the question why there is no inclusion of finance in economic models. Or, to be specific, a model for incorporating treasury yield curves into modern models, given their past predictions (M.Phillips 2018). What If we had a mathematical model we could use as a method of incorporating financial asset pricing into economic models, as a means of detecting pricing imperfections? 

 

Neo-classical macroeconomics assumes that we operate in a perfectly competitive economy in which even although we can still have equilibrium – the economy isn’t fully optimal. This is due partly to consumers split between wealth classes and although the market is completely indifferent as to why certain goods were not purchased, we have equilibrium anyway.

Considerations of productivity and efficiency are incorporated in neo-classical models however going back to the topic of geographical inequality, it’s not accurate to assume the model can apply to developing countries in the same manner as it does in developed countries. 

Developing countries may not have the same resources and so they would be subject to different levels of growth than developed countries. Government intervention can give a false indication of growth in developing countries as without the necessary resources the government may bring in foreign companies to carry on operations. However, this doesn’t actually show the real development of the workforce within the country even though GDP could be increasing. The outsourcing of unskilled labour can cause deflation amongst lower wealth classes at the same time higher wealth classes are experiencing inflation, making policy decisions extremely difficult and unpredictable. A useful tool that could help would be to use more than one basket of goods used to measure inflation. Baskets of goods for different wealth classes could give a better indication of the spending power of the majority of the population, and as the upper classes tend to buy luxury goods and assets, it is likely that policy measures don’t influence their consumption choices as they can afford them anyway.  

 

SUMMARY

It is clear that mainstream economics leaves a lot of unanswerable questions due to the complexity of the system. The model relies on too many assumptions should be further analysed also it makes use of unmeasurable variables, perfect human rationality and does not consider social influences or financial markets. 

Instead of comparing models, it would be wise to find a way to combine different models and incorporate some of the missing pieces that have heavy influence on consumption choices and policy measures into the future teaching of economics. Qualitative methods should be applied and incorporated into the current curricula emphasizing the need for pluralist approach and updating the current methodology of economics teaching.

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