CREDIT FOR YOUR EXPLANATION.

I was notorious for instilling in economics students that any good answer to an essay question began with "it depends" with credit for identifying the essential elements influencing the outcome.

Pepperdine economist Gary Galles now suggests that the same caveat applies to multiple choice questions.  At least, I think that's where he's going.

Again, the initial answer to what should be done in an uncertain world is “it depends.” Then, done right, it opens up the most interesting part of the analysis — what it depends on and how important the various considerations are.

Alternatively, think of the demand and supply curves not as typically shown in economics textbooks — well-defined and known — but as relationships surrounded by clouds of indeterminacy. At the time real-world producers must decide their price and output plans, they do not, in fact, know what the demand curve will be, a typically unnoticed-but-false assumption snuck in by drawing a specific, implicitly assumed-to-be-known, demand curve at the beginning of the analysis.

Without such a well-defined demand curve, known in advance, a producer cannot actually know how much total revenue will change for an additional unit of output (the marginal revenue, which microeconomics books assume producers will adjust output until it equals marginal cost). With uncertainty, marginal cost can’t be known in advance, either. Many unanticipated things could change it, from disasters to health problems for workers to accidents to hacking attacks to changes in government policy. As a result, the neat MR = MC equation of economics principles texts can no longer tell a producer what to do in order to successfully maximize his profits, as Armen Alchian pointed out long ago in his “Uncertainty, Evolution, and Economic Theory.” And I can still remember what he said to my graduate school class in summarizing this point: “I have been an economist long enough to recognize that ‘I don’t know’ is an intellectually respectable answer.”

So that might be, and yet the blackboard models of supply and demand, and producer behavior under price-searching conditions capture enough of the essential elements to grasp big chunks of reality, if not all of the nuances.  "Yes, that sometimes requires the presenter to defer some questions to take up later (I would caution new students to be careful about sailing outside the breakwater without a life jacket, or suggest that some topics were better tackled over a cup of coffee), but that's the way in which learning is emergent."

Consider that "cloud of indeterminacy."  Yes, the real-life entrepreneur or manager receives only a noisy signal of how well a decision worked:  inputs x produced output y and py - wx sufficed to pay the bills, but to introduce the "cloud of indeterminacy" to beginning students in the form of multiple probability distributions (has anybody ever combined both demand uncertainty and production uncertainty in a single theoretical paper?) let alone dispense with the probability distributions and see if the boundaries of the feasible set {x|y can be produced with x} can be discovered ab initio, and if there is sufficient price discovery such that an equilibrium price, let alone an equilibrium price vector among price searchers, can be derived from simple equations of motion in a Lyapunov basin. "To be precise, swabbies, it's a market so vast that the Lyapunov attractor is the core is the competitive equilibrium."

The caution economics students ought pay attention to is the limitations of the Welfare Economics Paradigm, as laid out on the blackboard.

On such exams, there are typically unique, correct answers to virtually all questions. But that is only because all the necessary information to find a single correct answer is almost always provided in the questions. There is no guarantee of that in the real world, where decision-makers typically do not begin with all the necessary information for a single “right” answer to be determined. We not only lack at least some of the information we need (particularly because the future is uncertain), but we also know a great deal of information that may or may not be relevant to a particular decision, and we need to determine which, as a prelude to the actual analysis.

In other words, by simply providing all the relevant information (and only relevant information), typical objective economic exams skip the initial real-world step of asking yourself, “What do I need to know to answer this question,” or “What do I need to know, or make judgements about, that I do not yet know,” or “What information, from the vast ocean of it we swim in, can I ignore as irrelevant for this question?” But those sorts of questions about what the most appropriate choice depends on are frequently necessary to arrive at useful real-world judgments.

It's the time of year for final examinations, and may there be lots of "it depends" answers correctly explained.  Unfortunately, the political class lacks the epistemic humility to be able to answer any of the questions in the paragraph immediately above.