Economic theory assumes people maximise utility but we can't. How does this effect the validity of the theory

Question

We don't get the best price when we shop, we settle for good enough. We don't choose the number of hours a week to work, most jobs require 40 and you may prefer 45 or 35. When we chose a place to live we must pick among current vacancies etc.

The theory predictions for labor markets don't agree well with emperical studies on minimum wage, and immigration effects. In a recient interview a labor economist Card said that in general theory does not work well for labor markets. What I would like to know is, are labor markets different or does emperical work not agree with theory in other markets also.

Answer 1

First off if you look at other theories they are not 100% accurate or require so many criteria to be met. Gas laws and fluid laws and conservation of matter are some examples. Should we throw them out? Hell even that things fall at 9.8meters per second squared is wrong it assumes no air and that while you are falling you are not getting closer to the earth etc.

So how do we decide what a good theory is? There are several answers to this question. In economics the usual answer is how well it predicts. Take your examples. Places that offer lower prices get more customers (totally predicted by the theory). Second higher wages result in more hours worked and more people applying to the job.

Finally there is no disconnect between utility maximization and not looking all over the place trying to save one dollar. In fact utility maximization would predict that. People take short cuts, use rules of thumb, and heuristics when making a decision. This is only logical when there is a cost to gathering information

reply to reply
Sometimes minimum wage is not binding completely in line with theory. Look at emperical studies about the affect of min wage on minorities, Highschool students etc. Don't just choose one.
Card and Krueger are one study. Card was trying to promote his book. There is often a time lag on these things. If the minimum wage increases employers are not going to fire people immediately. S and D become more elastic over time. look up rent controls as another example where policy seemed to have not effect until a few years later. Labor is funny, you have backward bending S curves. and other difficulties. Yes economic theory predicts well. Even better in the long run. Take the dot.com bubble economists were screaming this was not going to last. Take freidmans prediction of the breakdown of the phillips curve. Take economists prediction of the effect of the luxury tax........
If you are terribly interested in the failure of economics examine experimental economics. In some experiments economists have done a terrible job predicting how people would behave. This has led to some new theories. This I guess is my point if a theory does not predict very well it gets dismissed.

Answer 2

oil countries should all be taken over by the rest of the world so we can all share int eh oil and its wealth
instead of letting a few countries hold the whole world as hostage for oil
that's what I think