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Justin Fox says that yesterday's Nobel Prize is part of a longer trend in which the Nobel committee has stopped rewarding economists who make the world look elegant and begun favoring economists who prove that the world is messy:

Diamond wasn't out to further prove the perfection of markets. He was trying instead to show how, with the injection of the tiniest bit of reality, the perfect-market models he'd learned so well in grad school began to break down. Today he won a third of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (it's not technically a "Nobel Prize"), mainly for a paper he wrote in 1971 that explored how the injection of friction between buyers and sellers, in the form of what he called "search costs," prices would end up at a level far removed from what a perfect competition model would predict. The two economists who shared the prize with him, Dale Mortensen of Northwestern University and Christopher Pissarides of the London School of Economics, later elaborated on this insight with regard to job markets (as did Diamond).

The exact practical implications of this work can be a little hard to define -- although Catherine Rampell makes a valiant and mostly successful effort in The New York Times. What this year's prize does clearly indicate is that the Nobel committee believes economic theory is messy and getting messier (no, I didn't come up with this insight on my own; my colleague Tim Sullivan had to nudge me). The last Nobel awarded for an all-encompassing mathematical theory of how the economic world fits together was to Robert Lucas in 1995 for his work on rational expectations. Since then (with the arguable exceptions of the prizes awarded to Robert Merton and Myron Scholes in 1997 for options-pricing and to Fynn Kydland and Edward Prescott in 2004 for real-business-cycle theory) the Nobel crew has chosen to honor either interesting economic side projects or work that muddies the elegance of those grand postwar theories of rational actors buying and selling under conditions of perfect competition. The 2001 prize for work exploring the impact on markets of asymmetric information, awarded to George Akerlof, Michael Spence and Joseph Stiglitz, was probably most similar to this year's model (and, not coincidentally, Akerlof and Stiglitz were also MIT grad students in the 1960s).

By Ezra Klein  | October 12, 2010; 9:06 AM ET
Categories:  Economics  
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Economists have known pretty much forever that the elegant models were about finding something that was tractable using available mathematical tools and computational power. It's good to see that the Nobel (um) committee is catching up.

Posted by: paul314 | October 12, 2010 9:55 AM | Report abuse

This very messiness is probably part of what the GOP distrusts, e.g. in their suspicion of behavior economics. Messiness can leave room for government intervention in markets.

Posted by: jduptonma | October 12, 2010 10:16 AM | Report abuse

I don't think even most free market economists believe in market perfection. Rather, they view markets as the best way for society to solve complex problems.

As Arnold Kling puts it, "markets fail, use markets."

"I also reject what I call the naive Austrian view, which is that the only information problem that markets cannot solve is that of seeing through the distortions caused by government money. Yes, the monetary authorities can mess things up. But there are also many naturally-occurring information problems that markets have difficulty solving. I do not believe that markets would work perfectly if only there were no government.

On the other hand, I do not believe that government intervention is called for whenever the market trips over an information problem. Government does not have an automatic advantage in solving information problems. On the contrary, the Hayekian view suggests that government is at a disadvantage in solving information problems."

Posted by: justin84 | October 12, 2010 10:39 AM | Report abuse

"the arguable exception[] of the prize[] awarded to Fynn Kydland and Edward Prescott in 2004 for real-business-cycle theory) ... muddies the elegance of those grand postwar theories of rational actors buying and selling under conditions of perfect competition." is absurd. The word "aguable" makes the claim as much of an understatement as "the military situation has worked out not necessarily to Japan's advantage."

RBC theory goes much further in asserting the centrality of rational actors buying and selling under conditions of perfect competition than any economy theory ever had before.

Compared to RBC, Milton Friedman is a heterodox economist emphaisizing the instability of market economies and the importance of irrationality.

This is absolutely entirely not an exaggeration (google "Milton Friedman" and "Edward Prescott" at say to see huge respect for Friedman and none for Prescott).

I think what happened here is that Fox considers the Black and Scholes exception "arguable" (I sure don't) and thinks that if a word applies to one of two cases it should be applied to both.

Yes I am saying that Fox hasn't mastered the English language. This is much more plausible than the view that Kydland and Prescott when working on RBC had less respect for "rational ..." than Arrow, Samuelson or Hicks. The word "arguable" in the quoted passage is the most absurd thing I have read on the web.

Posted by: rjw88 | October 12, 2010 9:19 PM | Report abuse

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