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

[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 [img]/images/graemlins/wink.gif[/img] 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 [img]/images/graemlins/wink.gif[/img]

[/ 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
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