Lecture One

Epistemology and Economic Methodology

Epistemology

Questions:

• Does an objective reality exist that is independent of our thinking?

• Do ultimate truths describe that reality?

Epistemology

Propositions• Realism: Yes, objective reality exists

– Absolutism: Yes, ultimate and unchanging truths describe that reality

– Relativism: Objective reality may exist, but truths describing it are relative to circumstances

– Example of difference: Usury debate• Subjectivism, Postmodernism: No, reality is not

independent of our individual or social thinking

Methodology

Defined: • Technique for discovery of knowledge. Assumes

that an objective reality does exist, and it can be explored.

Methodological questions: • What is science? What are the proper roles of

scientists?• What mix of empirical observation, logical

analysis, and intuitive insight is best used to strengthen our understanding of reality?

Methodological Approaches

Deductive Method• General propositions (positive or normative) lead to

specific logical implications

Early Practitioners/Proponents: • Aristotle (400 BC)• David Ricardo (1817)

Methodological Approaches

Inductivism, Empiricism• From specific observations, rooted in experience, to

general conclusions

Proponents: • John Locke (1690) • David Hume (1772)• Auguste Comte (1822)--(Positivism)• Carnap & “Vienna Circle” (1920s-30s)--Logical

Positivism• Karl Popper (1902-1994)—Falsificationalism• Thomas Kuhn (1962)--Scientific Revolutions

Hume’s EmpiricismDavid Hume, An Inquiry Concerning Human

Understanding, (1772)

“Nothing, at first view, may seem more unbounded than the thought of man… but … it is really confined within very narrow limits. All this creative power of the mind amounts to no more than the faculty of compounding, transposing, augmenting, or diminishing the materials afforded us by the senses and experience… When a child has felt the sensation of pain from touching the flame of a candle, he will be careful not to put his hand near any candle… If you assert, therefore, that the understanding of the child is led into this conclusion by any process of argument or ratiocination, I may justly require you to produce that argument…”

Positivism & Logical Positivism

Positivism (Comte, Hume, J.S. Mill, 19th Century)• Science can rise above superstition by specializing in

the description and analysis of observable phenomena, leading to discovery of natural laws.

Logical Positivism (Moritz Schlick and Rudolf Carnap, 1930s)

• Science progresses toward truth by observation, formulation of hypotheses, empirical verification, leading to additional hypotheses

• Distinction between positive (scientific) and normative (unscientific) questions

Karl Popper: What is a Science?

• Philosopher, raised in Vienna during collapse of Austro-Hungarian empire (1912-1919)

• Once convinced, then disillusioned by Marxist theory of history

• Characterizes these, psycho-analysis, astrology, etc. as “pseudo-science”

• Posed question: “'What is wrong with Marxism, psycho-analysis...? Why are they so different from physical theories...?' ... these ... theories, though posing as sciences, had ... more in common with primitive myths than with science...” [Conjectures & Refutations]

Karl Popper: What is a Science?

• Rejected conventional explanations (empirical inductive method) because pseudo-sciences (e.g. astrology) are heavily “empirical.”

• Noticed characteristic of pseudo-sciences: confirmation

– “admirers ... were impressed ... by their apparent explanatory power. These theories appeared to be able to explain practically everything that happened within the fields to which they referred…”

– “A Marxist could not open a newspaper without finding ... confirming evidence for his interpretation of history; ... in the news, ... its presentation …and especially of course in what the paper did not say.”

Karl Popper: What is a Science?

• Argued that confirmation meaningless: “every conceivable case could be interpreted in the light of [the relevant] theory”: they could not be refuted

• Therefore, by exclusion, a true scientific proposition is one which could be refuted.

• Every 'good' scientific theory is a prohibition: it forbids certain things to happen...

• Every genuine test of a theory is an attempt to falsify it, or to refute it...

Popper’s Continuing Influence: George Soros

• “Popper showed that totalitarian ideologies like communism and Nazism have a common element: they claim to be in possession of the ultimate truth, . . . juxtaposed with . . . another view of society, which recognizes that nobody has a monopoly on the truth; different people have different views … and there is a need for institutions that allow them to live together in peace..”

• Reflexivity: “Why does nobody have access to the ultimate truth? … We live in the same universe that we are trying to understand, and our perceptions can influence the events in which we participate.”

• “Whether the theory is valid or not, it has turned out to be very helpful to me in the financial markets.”

Popper’s Continuing Influence: George Soros• “A dominant belief in our society today … is a belief in the

magic of the marketplace. The doctrine of laissez-faire capitalism holds that the common good is best served by the uninhibited pursuit of self-interest. Unless it is tempered by the recognition of a common interest that ought to take precedence over particular interests, our present system -- which, however imperfect, qualifies as an open society --is liable to break down.”

• “I am not putting laissez-faire capitalism in the same category as Nazism or communism. Totalitarian ideologies deliberately seek to destroy the open society; laissez-faire policies may endanger it, but only inadvertently… Nevertheless, because communism and even socialism have been thoroughly discredited, I consider the threat from the laissez-faire side more potent today than the threat from totalitarian ideologies.”

Thomas Kuhn: Paradigms

• Scientific community wedded to its view of the world--its paradigm

• Anomalies--things which contradict theory--at first resisted

• Failure to resolve leads to revolution--often from outside

• Switch to new paradigm involves total change in “world view”

• Lakatos: Methodology of Scientific Research Programs (MSRP)

– Theories have “hard core” which adherents do not attempt to falsify

– Hard core surrounded by “protective belt” of hypotheses which may be adjusted to defend hard core

What is a Good Theory?

• Milton Friedman (supported by Fritz Machlup)

– Proper test of a theory is by its predictions

– All theory is abstraction. Good theory “abstracts from reality in a useful way.”

– “Realism” of assumptions irrelevant:• “the more significant the theory, the more unrealistic the

assumptions… a hypothesis is important if it ‘explains’ much by little”

• “as if” assumptions--firms behave “as if” maximizing expected returns, etc.--valid even if firms do not consciously do so.

• Paul Samuelson: Good theories are based on reasonable assumptions—against the “F-Twist”