Sunday, July 22, 2012

More on microfoundations

Speaking of the stuff of the queue, Joseph and I have been talking about questionable defenses of economic rationality. Now Paul Krugman (who pumps this stuff out at an astounding rate) has another example of theory not matching reality:

So: I’m old enough (you kids get off my lawn) to remember the rise of self-service gas stations, which coincided with the oil shocks of the 1970s. Suddenly gas was much more expensive — and drivers, eager to limit the blow, were willing to pump their own to save a few pennies. 
At the time, being either in or fresh out of grad school, I thought, wait, this makes no sense: the decision to pump your own gas is about making a tradeoff between money and your own effort, and should have nothing special to do with the price of gasoline per se. Yet people acted as if they had a limited budget for fuel, as opposed to an overall budget constraint, and responded to a rise in gas prices with a seemingly irrational effort to hold down the size of that sub-budget. 
What the new paper by Hastings and Shapiro does is to show that the same kind of behavior continues to apply, with consumers shifting to lower-grade gasoline when gas prices rise, to higher-grade when they fall; the upshift happens even if incomes are falling. 
What does this have to do with the macro wars? Well, if the assumption of perfect rationality breaks down even in the most standard of micro settings — if consumers behave in a way inconsistent with full maximization even when doing something as mundane as choosing which type of gas to put in their tank — how absurd is it to insist that, say, Keynesian stories about the economy can’t be right because we can’t fully derive them from intertemporal maximization?

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