Schoonmaker and Economics (long)

[jrz1972]

I've read Psychology of Poker and both of Schoonmaker's magazine articles. In a very general sense, I agree with the basic points he makes in each of those (people play poker for a variety of reasons; we shouldn't stigmatize competition; people tend to oversimplify things).

I earned my PhD in economics in 1998, with a specialization in industrial organization. I currently teach that subject and general microeconomic theory at a midwestern university. Schoonmaker's February column is the second time he takes a particular, miguided swipe at this discipline. Many people who have only a passing familiarity with economics and/or who were poorly taught in college pick up the impression that economists make a lot of wacky and rigid assumptions about how people/firms behave and thus think that economic models are worthless since they're based on such obviously "unrealistic" assumptions. A poker forum is hardly the right place to play "stick up for your discipline", though, so my initial instinct was just to let this go. (Although I have to wonder why somebody with a doctorate would feel so free to critique a discipline he obviously doesn't know much about).

Anyway, the more I thought about it, the more I realized that economic methodology actually supports Al's point, so maybe I can actually add something useful to his argument while correcting his misunderstanding of economics along the way.

Contrary to what Al asserts, we economists are very well aware that our models are oversimplified and based on assumptions that are dubious, at best. Take "supply and demand" for example. Technically, this model only applies to markets that are perfectly competitive (meaning that individual firms have ability whatsoever to influence the market price). Pefect competition approximately characterizes some agricultural markets and some financial markets, but that's about it. 99.999% of real-life markets are not perfectly competitive, and thus are not well-characterized by the model of supply and demand. (In most of these markets, there is no such thing as a "supply curve," for example).

So how come we spend so much time teaching "supply and demand" to undergraduates when we know it doesn't really apply to most real-world markets? The reason is twofold:

1. It's easy, while more sophisticated models are hard and beyond the grasp of principles-level students.

2. It's better than nothing.

Point (2) is especially worth grasping, as it relates most closely to Al's argument in this month's column. "Supply and demand" does a halfway decent job of making predictions about markets, even when those markets aren't prefectly competitive and thus not best represented by this model. For example, nobody would argue that the auto industry is perfectly competitive. However, if the price of steel rose, supply and demand would correctly predict an increase in the price of cars. Supply and demand gets it right, even though it's based on assumptions that don't technically hold.

The idea of a model being oversimplified but better than nothing and therefore worth studying crops up in other areas as well. Consider bridge (which I gather Al is familiar with, since he mentions it a couple of times in POP). All good bridge players would agree that rules like "eight ever, nine never" and "second hand low" are grossly oversimplified. But we teach those rules to novice players because they're better than nothing. If you blindly followed the "eight ever, nine never" rule, you would not be playing at an expert level, but you'd be playing better than you would if you just played your hunches every time you had to pick up a missing queen. Of course, what separates an expert bridge player from somebody who blindly follows simple rules is that they know when to deviate from "the rule."

Likewise with poker. Ed Miller recommends to "value bet the river with marginal hands" in small stakes games (the only kind I play). We would all agree that if you blindly say to yourself "I have a marginal hand; therefore, I am betting this river" every single time, you are not playing at an expert level. However, that doesn't make the rule worthless as a general guide. What separates the expert poker player from the pretender is that the expert knows when to deviate from the general guide.

Returning to economics, we see the same thing. Supply and demand is a useful, simple guide to understanding how markets tend to work. For most people, it's better than nothing. People who go on to major in economics see a wide variety of other models that are designed to study more complex situations, and the mark of a competent economist is knowing when to apply what model. The mark of a really expert economist is knowing when a model that might "seem" to apply doesn't actually apply at all.

To see an example of this, consider airline deregulation. At the time, many economists argued that airline routes represented "contestable" markets, meaning that even if there were only one firm serving a given route, it couldn't raise prices too high because it would be easy for another airline to enter that market to compete. In hindsight, it should have been easy to see that the airline industry is not even close to being contestable, because profit-maximizing firms (there's that profit-maximization assumption that Al hates so much) have a strong incentive to create barriers to entry, which they proceeded to do.

If you just want a basic understanding of how markets work, simple models like supply and demand are fine and they don't merit the scorn that Al seems to heap upon them. On the other hand, if you're going to make major public policy decisions, however, you need to be damn sure that you're looking at all the little idiosyncratic details of the market under consideration and NOT oversimplifying.

Likewise, if you just want a basic understanding of poker so you won't get buried in low-limit games, simple rules of thumb (like "bet your marginal hands for value on the river") are probably fine, which is why we see those rules explained in books. But if you're going to sit down in a 30-60 game at Bellagio, you had damn well better be sure you're looking at all the little idiosyncratic details of your table.

Simple rules of thumb have their place in economics, bridge, and poker. The key to developing as an economist or bridge/poker player is knowing when those rules apply and when they don't. Economic methodology thus provides an excellent example in illustration of Al's point, just not in the way he thinks.

[BarronVangorToth]

Holy cow is this a post and a half.

Great to hear from someone as learned as Dr. Al on this topic.

Barron Vangor Toth
www.BarronVangorToth.com (http://www.BarronVangorToth.com)

[alThor]

That was an excellent post. Few people ever "get it" when it comes to economics, and are left wondering why the field exists. You did a good job making it as clear as it can be made. I would not have had the patience to write more than "Part II was as good as Part I," so I tip my hat. I really have nothing to add to your well written response.

But I know there are plenty of college students who frequent these pages, so let me say this: if you want a job in business, or with a consulting company, or similar, they are not going to give you interview questions about "who feels happy today." They care about these "unrealistic" economic models, and they pay good money to those that understand them.

alThor

P.S. You wrote: [ QUOTE ]
I earned my PhD in economics in 1998... I currently teach that subject and general microeconomic theory at a midwestern university.

[/ QUOTE ]Coincidentally, I could write almost exactly the same thing (within one year!).

[Al Schoonmaker]

Thank you for an outstanding post. I rarely encounter anyone who takes so much time and thinks so carefully about my work.

I hope other people comment on these issues, and I will certainly have more to say later. I don't want to make any specific comments now because they might affect others. We've got two clearly stated positions. Let's see which others will be presented.

Thanks again,

Al

[benfranklin]

Good post. I hadn't read Dr. Al Part II yet, and went to it after seeing this thread.

I agree with Al about the average person's yearning for simplistic answers, and the danger thereof. But I think that he may be guilty of the same thing in his over-simplification of economics and the comparison to poker.

Some observations:

1. Economics deals with group behaviour and psychology deals with individuals. One discipline should not be judged by the standards of the other.

2. As the original poster stated, the simplified assumptions of Intro to Econ are a proven starting point to give beginners an understanding of how the economy works. (Few instructors are able to utter the "rational consumer" assumption with a straight face.) These assumptions are quickly dismantled in more advanced undergraduate courses. Even in the Intro courses, students are told that these assumptions are not true at the individual level, but that in the aggregate, the economy behaves as it would if they were true.

The basic assumptions are like telling a complete novice to never draw to an inside straight. The real answer, of course, is it depends. But never drawing to an inside straight is the optimal strategy until the new player learns about outs, pot odds, and implied odds.

3. The value of an economic model is its predictative ability, not its ability to describe reality. If you assume that all businesses are profit-maximizers /images/graemlins/wink.gif and if macroeconomic activity conforms to what that assumption would predict, then you have a useful tool.

[BarronVangorToth]

[ QUOTE ]
If you assume that all businesses are profit-maximizers /images/graemlins/wink.gif

[/ QUOTE ]


This is an amusing side point but while I imagine MOST businesses would say they want to maximize profit, a vast majority do things in order to do anything but maximize: mostly out of stupidity, some out of a desire for -EV effects (in my own shop, for example, before I sold it zero score and five years ago, I erected a black cube that took up 5% of the floor space and served no purpose whatsoever -- far from maximization).

Barron Vangor Toth
www.BarronVangorToth.com (http://www.BarronVangorToth.com)
Misses His Cube ... Sometimes. But Seldom.

[DyessMan89]

I would make an intelligent post ... but you would need to dumb down your post.

[ZeeBee]

Well, someone's gotta ask - what on earth was your cube for?

ZB

[ZeeBee]

Nice post. I was going to say something trite like "I feel you're being too harsh on economists" - but your post makes my thoughts look wholly inadequate.

Personally, I feel that the media are the biggest sinners in the "oversimplification" stakes. We often accuse them of left or right wing bias, but their biggest bias is probably to oversimplify.

ZB

[BarronVangorToth]

[ QUOTE ]
Well, someone's gotta ask - what on earth was your cube for?

ZB

[/ QUOTE ]

It served no purpose whatsoever except as a black cube covered on all sides by tarp. It was a great conversation piece and always kept new customers guessing as, well, you don't expect a black cube in a hobby shop that's big enough to hold many people.

Regardless, sorry about the potential hijacking with that offhanded aside...

This really is an important thread, my aforementioned digressions notwithstanding.

Barron Vangor Toth
www.BarronVangorToth.com (http://www.BarronVangorToth.com)

[Al Schoonmaker]

My collegue at Carnegie-Mellon's business school, Herbert Simon, won the Nobel in Economics precisely by pointing out that businesses do NOT try to maximize profits and that assuming they do has severely negative consequences.

Your remarks about not judging one discipline by the standards of another are particularly relevant here because Herb was trained as a political scientist. If he had been indoctrinated into the "people are profit-maximizers" mindset, he might never have done his revolutionary work.

One of the greatest things about being part of CMU's multidisciplinary faculty was being required to explain our research to people from other disciplines. I and others often found that we could not satisfactorily explain our work to "outsiders." We had been surrounded by others whose assumptions and experiences were similar to our own, and we did not know how to explain our work to people with different backgrounds.

Another poster made the point that the media are the worst simplifiers. I certainly agree.

I love the way this thread is developing, and I hope it continues. Thanks to everyone who has contributed to it.

Al

[jrz1972]

[ QUOTE ]
One of the greatest things about being part of CMU's multidisciplinary faculty was being required to explain our research to people from other disciplines. I and others often found that we could not satisfactorily explain our work to "outsiders." We had been surrounded by others whose assumptions and experiences were similar to our own, and we did not know how to explain our work to people with different backgrounds.

[/ QUOTE ]

This is one of the reasons why I think interdisciplinary dialogue is useful. Good point.

[alThor]

[ QUOTE ]
My collegue at Carnegie-Mellon's business school, Herbert Simon, won the Nobel in Economics precisely by pointing out that businesses do NOT try to maximize profits and that assuming they do has severely negative consequences.

[/ QUOTE ]

Name dropping and exageration aside, I think he did a little more than "point out" the obvious.

This observation is not the point. The point regards your flawed judgement of classical economics. Here is what you wrote in your article:

For over a century that desire for simplicity caused economists to ignore contradictory evidence and base their work on three ridiculous assumptions.

I can only assume you mean the 18th and 19th centuries, since...

...3. They work in perfect markets.

Wow, way to ignore entire branches of economics that have been around for decades. I'll be sure to tell my colleagues that the following fields and papers don't exist: General Equilibrium with imperfect markets (includes classics from the 70's, field still going strong); Game Theory, particularly with asymmetric information (Akerlof 1970, Spence 197? are classics, one could reference Harsanyi from the 60's, the field is huge); countless other papers in other areas that use market frictions...the list is almost endless. How many people in these fields have won Nobel prizes, since that seems to carry weight for you? Answer: more than 2.

"If [Simon] had been indoctrinated into the "people are profit-maximizers" mindset, he might never have done his revolutionary work."

I am probably wasting my time, but you still don't get it. This isn't about whose cult is better. The issue is not whether people "really" are profit-maximizers. The issue is whether economic models provide value (e.g. predict well, fit data, etc.). This point is repeated in the very post (benfranklin's) to which you are replying! Yet when you say "mindset" you seem to think of this as a clash of religions.

Bash all you want, but understand the field first. Don't worry; this will be my last post on the matter.

alThor

[benfranklin]

[ QUOTE ]


Your remarks about not judging one discipline by the standards of another are particularly relevant here because Herb was trained as a political scientist. If he had been indoctrinated into the "people are profit-maximizers" mindset, he might never have done his revolutionary work.



[/ QUOTE ]

Interesting that the subject of political science enters the discussion. Poli Sci, like Econ, is a study of group behavior. More interestingly, the two disciplines evolved (or diverged) from what was once called Political Economy. The classical assumptions used in Intro to Econ courses come from the classical works in Political Economy (Adam Smith, et al.). Smith's "invisible hand" is based on the assumption of individual maximizing behavior. These assumptions are as much political science as they are economics.

Modern economists do not believe that individuals are rational consumers, or that every business is a profit maximizer. They believe that in the aggregate, the economy more or less acts as if this was true, and that therefore, this is a simple, understandable model. It is a good place to start teaching Principles of Economics at a basic level, and it has good predictive capability.

Do chemists believe that molecules look like Tinker Toys:
http://www.high-blood-pressure.org/art/molecules.jpg

No. They believe that this is a good model, useful for teaching the basic concepts of chemistry to new students. It's a simplification /images/graemlins/blush.gif , a tool. It isn't reality. No economist believes that in reality all businesses (or even any one business) is driven 100% by profit maximization. But as a concept or model is a useful tool.

[Al Schoonmaker]

You wrote: "Don't worry; this will be my last post on the matter."

I certainly hope that you change your mind and continue to comment. I welcome all comments, even those which criticize me.

Thanks for commenting.

Al

[goofball]

I just wanted to add that models are a useful tool in all disciplines.

Almost everything one learns in fresman physics is technically incorrect, but there is no way to learn higher stuff without first learning the "wrong" concepts.

[Lawrence Ng]

[ QUOTE ]
Likewise with poker. Ed Miller recommends to "value bet the river with marginal hands" in small stakes games (the only kind I play). We would all agree that if you blindly say to yourself "I have a marginal hand; therefore, I am betting this river" every single time, you are not playing at an expert level. However, that doesn't make the rule worthless as a general guide. What separates the expert poker player from the pretender is that the expert knows when to deviate from the general guide.

[/ QUOTE ]

But this marginal bet represents a form of potential revenue increase (using a poker model that is). As I remember correctly from my Economics 100 studies, any business that seeks to maximize needs to have marginal cost = marginal revenue. So betting this hand (MC) because of +EV would make a lot of sense in terms of the extra bet gained (MR), correct?

Lawrence

[Lawrence Ng]

[ QUOTE ]
That was an excellent post. Few people ever "get it" when it comes to economics, and are left wondering why the field exists.

[/ QUOTE ]

I hold a Bachelor's in Economics, and I too agree that it is a field of study that is highly underrated. Economics is built around models that attempt to explain how things work in a perfect world, but so often is not the case making it a very impractical subject. But combined with a field of study in Commerce and a good understanding of Finance and Business and the study of Economics lends itself together forming a duo chain that is very useful.

Lawrence

[jrz1972]

[ QUOTE ]
[ QUOTE ]
Likewise with poker. Ed Miller recommends to "value bet the river with marginal hands" in small stakes games (the only kind I play). We would all agree that if you blindly say to yourself "I have a marginal hand; therefore, I am betting this river" every single time, you are not playing at an expert level. However, that doesn't make the rule worthless as a general guide. What separates the expert poker player from the pretender is that the expert knows when to deviate from the general guide.

[/ QUOTE ]

But this marginal bet represents a form of potential revenue increase (using a poker model that is). As I remember correctly from my Economics 100 studies, any business that seeks to maximize needs to have marginal cost = marginal revenue. So betting this hand (MC) because of +EV would make a lot of sense in terms of the extra bet gained (MR), correct?

Lawrence

[/ QUOTE ]

In a vaccuum, yes.

What I'm getting it is that good poker players don't just blindly bet the river with marginal hands because that's what the simple rule tells them to do. They evaluate whether their opponent is tight or loose, the texture of the board, whether there are other opponents in the hand, their own table image, etc. and then decide whether this is a time to follow "the rule" or whether this is a time to deviate.

Blindly following the rule = +EV
Knowing when NOT to follow the rule = ++EV

[mosquito]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
Likewise with poker. Ed Miller recommends to "value bet the river with marginal hands" in small stakes games (the only kind I play). We would all agree that if you blindly say to yourself "I have a marginal hand; therefore, I am betting this river" every single time, you are not playing at an expert level. However, that doesn't make the rule worthless as a general guide. What separates the expert poker player from the pretender is that the expert knows when to deviate from the general guide.

[/ QUOTE ]

But this marginal bet represents a form of potential revenue increase (using a poker model that is). As I remember correctly from my Economics 100 studies, any business that seeks to maximize needs to have marginal cost = marginal revenue. So betting this hand (MC) because of +EV would make a lot of sense in terms of the extra bet gained (MR), correct?

Lawrence

[/ QUOTE ]

In a vaccuum, yes.

What I'm getting it is that good poker players don't just blindly bet the river with marginal hands because that's what the simple rule tells them to do. They evaluate whether their opponent is tight or loose, the texture of the board, whether there are other opponents in the hand, their own table image, etc. and then decide whether this is a time to follow "the rule" or whether this is a time to deviate.

Blindly following the rule = +EV
Knowing when NOT to follow the rule = ++EV

[/ QUOTE ]

Knowing when to fold - $10
Knowing when to bet - $160
Knowing the difference between the two - Priceless

[gergery]

I find it kind of amusing that an article railing against oversimplification is itself grossly oversimplified.

There are principle in each of these areas which are almost by definition true:

--As price goes up fewer people will want something.
--When you have the best of it you want more money in the pot
--Rest will help you if you are sick
--Understanding your best alternative will help you negotiate more effectively

Then there are specifics to each situation which are completely situationally dependent. But even then there are almost always applications of the principles that make one decision path more correct than another. And understanding the principles enables you to understand when they don't apply.

--sometimes higher prices make things more valued as when they're proxies for value in luxury goods like perfume.
--sometimes you don't want more money in if you can't handle the variance
--sometimes light exercise is better than rest


So I don't really agree with a bunch of the examples in the article.

--Greg

[Kim Lee]

The article had three examples of oversimplification. The first involved a book on the pschology of business negotiation, something an industrial psychologist would understand. But the last two examples were badly wrong.

The article distorted the Chicken Soup series, writing "some people have killed themselves by eating chicken soup". Puhleeze. The Chicken Soup series is a collection of anecdotes and aphorisms to make you feel better ... kind of like Chicken Soup. They do not advocate Chicken Soup for medical use. Besides, how many people have really died from eating Chicken Soup?

The article also said economists assume people's primary motive is to maximize their profits. Wrong. Economists assume businesses maximize profits; people maximize utility. You can learn this in introductory economics texts. What is galling is the cavalier criticism of economic progress. How does it compare to the progress of psychology in say, psychotherapy, Mr. Ph.D.?

Basically Alan was too lazy to read stuff he criticized. Ironically the article illustrates it's premise of the dangers of oversimplification. He tried to come up with some examples but didn't do his homework.

[Exsubmariner]

I have been reading this discussion and find it intensly fascinating. I believe the way to express how I view the topics is to say that I need to understand the economics of the table before I sit down in a game (a broad view), but when I play a hand against an opponent I need to understand the psychology involved to make an optimal play (a very narrow view). Just as economics attempts to predict behaviours of large groups of people in an economy, psychology models individual behaviour. I think they are mutually exclusive, but share some basics. You need to be able to grasp both if you want to play good poker, run a business well, or invest. The key, I think, is recognizing a situational factor that makes the general rules nonapplicable or alters them slightly.
I am reminded somehow of Asimov's conception of Psychohistory.

[BarronVangorToth]

I'm hoping the March edition (due soon?) will have part 3...

This has been a fascinating thread, especially for those of us far less versed on the subject than others.

Barron Vangor Toth
www.BarronVangorToth.com (http://www.BarronVangorToth.com)

[Al Schoonmaker]

I most definitely did not state that eating chicken soup kills people. It is relying on it or any other all purpose cure that prevents them from getting prompt, appropriate health that kills them.

Ask any internist how many of his patients have failed to get prompt treatment because they were taking some all purpose cure. You will be shocked by their answers.

With many illnesses the major issue is time. For example, most forms of cancer can be treated successfully if you start soon enough. Wait too long, and you're dead no matter what treatment you get.

Businesses most definitely do NOT try to maximize profits. In addition, it is absurd to separate people from businesses. All business decisions are made by people, and they most definitely do not try to maximize their profits. Herbert Simon won the Nobel Prize in Economics for destroying that myth.

Although I disagree with you, I'm glad you contributed to the ongoing debate.

Regards,

Al