Hal Varian at Freakonomics

Google's chief economist, Hal Varian, answers readers questions over on the Freakonomics blog.

His take on mathematical models and behavioural economics:

Q: Do you feel that more traditional economic models do an adequate job of representing what economists would like them to? Do you think that emerging fields of study, like behavioral economics, will become increasingly important and/or potentially integrated into the core of economic focus? Given the assumptions we make in economics with respect to human rationality, optimal decision making, and large-scale generalizations, how can anyone in the field feel confident that a theoretical conclusion/result/finding is truly significant?

A: I think that the "traditional model" is a good starting point for economic analysis, but I don’t think that it is necessarily the ending point. You have to explore different alternatives to see which model seems to explain the data best. However, I will say that I think that formulating a model mathematically is quite important, as it serves as a check for internal consistency. Furthermore, a mathematical model allows you to draw out the consequences of an assumption that often allows for better understanding.

I do like his answer to this question.

Q: To what extent are "classical" economic models capable of accommodating the anti-competitive power of large corporations in terms of their ability to control consumer preferences and wield political power? Does the presence of a large corporate aspect to the current free market make it not quite an idealized free market anymore? If so, how do you account for this in economic models? Does the current "conventional wisdom" among economists account for the answer to these questions?

A: I think that the power of large corporations to control consumer preferences is vastly exaggerated. Look at all the new products from large corporations that fail. This isn't to say that large corporations don't pose a problem; but, in my opinion, the most problematic way they exploit their power is through direct manipulation of the political process rather than manipulation of consumer preferences.

And an interesting point about the California electricity crisis. Supply matters:

Q: In 2001, you wrote, "The reason for the California electricity crisis can be summed up in four words: demand grew, supply didn't." Given the evidence of market manipulation by Enron and others, do you still think the reasons were benign market forces, or something more sinister?

A: I think that the failure to invest in generation and transmission facilities led to a system that operated very close to capacity. This allowed for unscrupulous traders to push the system over the edge on some occasions. As such, I would still argue that it was lack of capacity expansion that created the environment that enabled manipulation.

The whole thing is an interesting read.