1. Marshallian Intuition

One type of reaction involves a recitation of some Marshallian intuition about rents or quasi rents and a request for clarification about what this intuition misses. My suggestion is that if you are stuck, try approaching the problem from a new angle. In this case, a good way to do so is to work through the logic of the proof based on Euler’s Theorem and try to see whether its assumptions fit the example you are considering. Even if you are “crappy at math” give it a try. The theorem requires little more than calculus.  You may have fun discovering why specific Marshallian intuitions fail to carry over to a full equilibrium context where things have to add up.

2. Profit Maximization

Waldman does not understand what I have written and my rule is that if the reader misunderstands it is my fault.

Let me try to clarify. In attacking “denialism,” I am not making any claim about the right way to model behavior in an economy. In particular, my critique of mathiness does not imply that anything about whether or not profit maximization by firms is a good assumption to use in modeling an economy. All I am saying is that IF an economist assumes that economic behavior is characterized by a competitive equilibrium, WHICH BY DEFINITION includes the assumption that firms maximize profits, THEN the logic of Euler’s Theorem has to apply.

Waldman is correct that my analogy is not perfect.

Statistical mechanics, which implies the second law of thermodynamics and the impossibility of a perpetual motion machine, is taken by most physicists to be a coherent logical theory that gives a reliable guide to the behavior that we observe at the scale and energy density of everyday life.

In contrast, many economists (and I am one of them) think that the theory of a competitive cannot capture important aspects of everyday life. Economists like me point to the returns that are routinely captured by innovators and say that competitive equilibrium theory is not a good description of the world because it does not allow for this to happen. The deniers want to claim that competitive equilibrium theory is the right way to describe the world and that it does allow for behavior that as a matter of simple logic cannot occur if the theory is correct.

The deniers can’t have their cake and eat it too. If they really want to say that competitive equilibrium theory is the way to understand the world, they have to accept the logical implications of this theory.

If Waldman wants to assume something else, perhaps that firms do not maximize profits, my response is “go for it.” State your assumptions. Use logic to derive your conclusions. State your conclusions clearly. See if your theory better captures what we observe.

All I’m asking is that you state transparently what your assumptions are, what your conclusions are, and the logic that gets you from the assumptions to the conclusions.

So here is the basis for the analogy:

Case 1: A physicist says that he/she believes in the descriptive accuracy statistical mechanics, which is the foundation for thermodynamics AND that he/she believes that it is possible to have a perpetual motion machine.

Case 2: An economist claims that the behavior we observe in the economy is well captured by the theory of a competitive equilibrium AND that this theory does not imply that Euler’s Theorem applies for rival inputs so that it is easy to explain how innovators earn profits on ideas.

My point: Case 1 and Case 2 involve the same failure of logical consistency.

Waldman’s point: In case 1, the physicist is right that statistical mechanics is a reliable guide to everyday life whereas the economist is wrong to believe that competitive equilibrium theory is a good guide to aggregate economic activity.

My reaction to Waldman’s point: Exactly! Now we are getting somewhere.