Henry, You said:

“It is what Nick said. And if he meant something else, then it is anybody’s guess.”

My mistake. Nick is a smart guy, and I was assuming that he understood the difference between assuming that the duopolists expect each other to produce the same quantity and have conclusive reason to expect each other to produce the same quantity. For the Cournot solution to obtain, all that is necessary is that each duopolist expects the other to produce exactly the same quantity that it plans to produce. They could have that expectation because they both know what the other duopolist’s cost is, or they could have that expectation because they simply assume or guess that the other duopolist’s costs are the same as its own. Either assumption would work, but you are correct that I don’t know if that’s what Nick had in mind.

“And your logic in this paragraph twists all over the place and is replete with contradiction.”

I agree that that is one possible explanation for your failure to understand what I wrote; I don’t agree that that is the only possible explanation.

You quoted me:

” You have no basis for saying that there is no time in the perfect competition model. ”

You then responded:

“When there is perfect knowledge/foresight, equilibrium can only but be instantaneous.”

Well, I continue to deny that perfect knowledge and foresight is a necessary assumption in the perfect competition model.

You asked:

“What do you mean by regular economics? What is it?”

“Regular economics” is a term used by Robert Barro a few years ago in a Wall Street Journal op-ed in which he compared Keynesian economics to “regular economics” and found Keynesian economics didn’t measure up.

Kevin, Thanks for the references. I forgot about Grandmont, but he is worth looking at again.

]]>“Perfect rationality,” …….. “Perfect foresight,” ……… I see no connection between those two concepts.

I didn’t say there was a connection.

“I don’t think that’ what Nick meant. ”

It is what Nick said. And if he meant something else, then it is anybody’s guess. And your logic in this paragraph twists all over the place and is replete with contradiction.

” You have no basis for saying that there is no time in the perfect competition model. ”

When there is perfect knowledge/foresight, equilibrium can only but be instantaneous.

“Walrasian tatonnement is not the same as the perfect competition model.”

I agree.

“There may be circumstances in which it is a legitimate assumption, but often it is an illegitimate assumption.”

Maybe. But we are talking about Muth and Lucas as best as I can gather – you do range all over the place and can be difficult to follow.

“…they misunderstand what regular economics really is.”

What do you mean by regular economics? What is it?

“That’s the gross error of the REH hypothesis. Agents can’t know the outcome of the model. ”

It’s an assumption of the model as you have said. If you’re saying it’s not realistic, I would agree with you.

“There is a difference between making a behavioral assumption about what agents actually know and a conditional assumption about what would happen if expectations were such and such.”

I agree. In the first case, I would argue, you end up with a circularity and in the second case it’s just an assumption.

“It’s circular if you assume that agents know the equilibrium, it’s not circular if you ask what would happen if they were to expect the equilibrium.”

As far as I am concerned, it’s the other way around. Where there’s an assumption there is no logic. If there’s no attempt at logic there can be no circularity.

“….it’s not circular if you ask what would happen if they were to expect the equilibrium.”

It is if the equilibrium is dependent on their expectations.

“Your citation of the Wikipedia article on “economic man” referencing Robbins assumption of rationality based on complete knowledge misconstrues the ambiguity in the phrase “complete knowledge.””

The point is not about complete knowledge but that economic agents are assumed to be rational. Just endeavouring to show that all the assumptions which you say are not applicable to perfect competition have been used by various economists.

]]>“My whole point was that the idea of rational expectations was implicit in the Cournot/Nash and it was precisely that assumption that enables the solution to be characterized with such elegance. Whether the model works empirically is another question.”

“The equilibrium model is not a causal theory of how equilibrium is achieved it is a strictly logical analysis of what conditions would be necessary for an equilibrium to obtain. It was Hayek who made that all clear in his 1937 paper.”

“they misunderstand what regular economics really is…That’s the gross error of the REH hypothesis. Agents can’t know the outcome of the model. But that doesn’t mean you can’t ask what would happen if agents somehow did expect prices to be what the equilibrium price vector of the model.”

Unfortunately what you have produced is a primer on confusion and non sense.

On the basis of what you imagine economy or capitalism is and of what you imagine reh should be you develop your personal model, which is a legitimate operation, though a diversion and distraction. No doubt Hayek made it clear about metaphysical neoclassical approach but at least he was in his way coherent ending up in mysticism, since his prejudices wouldn’t allow him to understand capitalism.

The fact that in capitalism you might have sometimes maybe a sort of equilibrium according to your personal meaning it doesn’t mean general equilibrium is of any help.

Henry, “Perfect rationality,” which is a very ambiguous term has a very precise meaning in economic theory: a complete and consistent ordering of preferences over all possible choices. “Perfect foresight,” as I understand it, means the power to predict the future unerringly. I see no connection between those two concepts. I do not deny that perfect foresight was an assumption used by some economists in the early 20th century in describing the conditions for general equilibrium. Another condition for general equilibrium was perfect competition. The two assumptions are parallel but not identical and I deny that either logically entails the other. Your general citation of various economists who mentioned the idea of perfect foresight in their writings establishes nothing except that they may have fully understood what they were talking about. That happens frequently. The problem with perfect foresight (or perfect knowledge) is that it is too strong an assumption. If you assume perfect foresight/perfect knowledge, you have assumed your conclusion. The key point is to recognize that an equilibrium entails the perfect consistency of all independently formulated plans. With complete markets that is accomplished via equilibrium prices in each market. We only know that there is at least one set of equilibrium prices that would support an equilibrium of optimized and mutually consistent plans. So for such an equilibrium to obtain, either the equilibrium price vector must discovered by some process, or it must be anticipated by the agents, i.e., all agents must somehow expect the equilibrium prices that would support the equilibrium. The equilibrium model is not a causal theory of how equilibrium is achieved it is a strictly logical analysis of what conditions would be necessary for an equilibrium to obtain. It was Hayek who made that all clear in his 1937 paper.

You said:

“As Nick has pointed out, both firms need complete KNOWLEDGE of each other’s production functions for equilibrium to be attained.”

I don’t think that’ what Nick meant. He was pointing out that if we are thinking of the Cournot model as a positive theory of pricing, it would require both firms to have considerable knowledge about each other to expect that the Cournot result would be observed in practice. That has nothing to do with what is logically necessary for the Cournot equilibrium to obtain. What is logically necessary is that both duopolists correctly anticipate the output chosen by the other. That says nothing about the likelihood that their expectations will converge.

You quoted me:

”Again, I must apologize for saying this but your conviction that time and decision-making over time cannot be accommodated in some very simplified and abstract way in a general equilibrium problem is totally unfounded.” And then you said:

“Where did I say this? I said there is no time in the perfect competition model and the Walrasian tatonnement model. When various assumptions are relaxed, time becomes an element of the models.”

And that is exactly what I am saying is unfounded. You have no basis for saying that there is no time in the perfect competition model. Walrasian tatonnement is not the same as the perfect competition model.

You said:

“When it is assumed that agents know the outcome of the model, there is no circularity. Remove the assumption, then I would argue that the REH is based on a circular logic.”

Assumed by whom? We both agree that RE theorists make this assumption in their models. There may be circumstances in which it is a legitimate assumption, but often it is an illegitimate assumption. I am quarreling with you because you are accepting their assertion that they are simply applying neoclassical assumptions in a routine fashion, that they are just doing regular economics. They aren’t; they misunderstand what regular economics really is.

You said:

“The REH says they know the same thing – the equilibrium outcome of the model. I make no reference to perfect knowledge here. This is the assumption that you yourself have said underlies the REH.”

That’s the gross error of the REH hypothesis. Agents can’t know the outcome of the model. But that doesn’t mean you can’t ask what would happen if agents somehow did expect prices to be what the equilibrium price vector of the model. Unless your model tells you that they get to the equilibrium of the model, there is something very wrong with the model. There is a difference between making a behavioral assumption about what agents actually know and a conditional assumption about what would happen if expectations were such and such.

You said:

“In your previous blog you said there was no circularity. Have I misunderstood you?”

It’s circular if you assume that agents know the equilibrium, it’s not circular if you ask what would happen if they were to expect the equilibrium.

Your citation of the Wikipedia article on “economic man” referencing Robbins assumption of rationality based on complete knowledge misconstrues the ambiguity in the phrase “complete knowledge.” The completeness of the agents’ knowledge only extends to their knowledge of the current prices at which they could either buy or sell. Aside from that they are clueless as the rest of us.

]]>The above is from the Wiki on Homo Economicus:

]]>Oskar Morgensten, the contemporary of Hicks and co., thought enough of perfect foresight to write a 15 page paper on the matter. He quotes Hicks, Knight, Fisher and Hayek all of whom make reference to perfect foresight in relation to perfect competition. Then of course he proceeds to attempt to argue that perfect foresight is not required except that he discusses non perfect competitive models, where foresight is not meant to apply. So there are well credentialed economists who disagree with you on perfect foresight. Perfect rationality is required in the formulation of indifference curves.

“My whole point was that the idea of rational expectations was implicit in the Cournot/Nash and it was precisely that assumption that enables the solution to be characterized with such elegance….”

As Nick has pointed out, both firms need complete KNOWLEDGE of each other’s production functions for equilibrium to be attained.

” Again, I must apologize for saying this but your conviction that time and decision-making over time cannot be accommodated in some very simplified and abstract way in a general equilibrium problem is totally unfounded.”

Where did I say this? I said there is no time in the perfect competition model and the Walrasian tatonnement model. When various assumptions are relaxed, time becomes an element of the models.

“It has been 30 or 40 years since I read Morgenstern’s article. I don’t remember it well, but I think he misunderstood the role of perfect foresight in general equilibrium models.”

I agree – he had himself in a nice tangle – but his paper does highlight that various theorists connected perfect foresight to the perfect competition model.

” It is not circular to say that a condition for equilibrium is that agents’ expectations converge on the equilibrium of the model.’

When it is assumed that agents know the outcome of the model, there is no circularity. Remove the assumption, then I would argue that the REH is based on a circular logic.

“I think that you are failing to see the difference between what the creator of the model knows and what the agents in the model are allowed to know. And I think that you fail to understand that distinction because of your entirely false belief that perfect knowledge is a necessary assumption of the standard GE model. ”

The REH says they know the same thing – the equilibrium outcome of the model. I make no reference to perfect knowledge here. This is the assumption that you yourself have said underlies the REH.

“Yes, I would agree that REH is making a circular argument, or at least a question-begging argument. And I think I did make that clear. ”

In your previous blog you said there was no circularity. Have I misunderstood you?

]]>Nick,

This sounds like perfect knowledge rather than rational expectations to me.

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