1.7 Abstraction: Absurd AND Necessary

You thought we were done talking about abstraction. Sorry – one last discussion. It is that important. Here’s a relevant joke:

A chemist, a physicist, and an economist are stranded on a desert island. They have an ample supply of canned food, but alas, no can opener.

The chemist suggests that they should light a fire under the cans so that they would burst open.
The physicist suggests dropping the cans from the cliff to its rocky bottom to smash them open.

The economist declares: “Let’s assume we have a can opener.”

Financial and economic theory makes, what may appear at first, some absurd assumptions. But that is only because the social world, the world inhabited by people, is far more complex, in many ways, than the real world, the world of the hard sciences.

Are the chemist’s molecules motivated by fear and greed? Will ambition or altruism affect the trajectory of the falling cans? Economists cannot keep track of every alternative that the human mind may consider, so it abstracts by looking into the outcomes or choices that are usually independent of human foibles, or dare I say, are “logical.”  Without abstraction, economists would never arrive at any generalizations. We would therefore learn nothing! Zilch.

Suppose you just arrived in New York City for the first time. If you wish to find Times Square, would you use a map (imagine that there is no GPS or Waze) that details all the streets, or just the main arteries? No! You would not be concerned with all the confusing, and mostly useless, details.

A burgeoning field, Behavioral Economics and Finance, deals with the human condition and its interaction with traditional, “objective” economics. However, first things first.