Chapter 3: Uncertainty and Decisions
Standard microeconomics is a powerful theoretical tool that postulates a well-defined maximand, such as profits or utility, constrained by a perfectly known state of the world, which is normally taken to be wealth or prices and the budget. If a firm knows all its input costs over time, if all future discount rates are known, and if all future prices are known, then any decision that the f r makes will follow im arithmetically, perhaps after a dollar value has been put on any personal preferences for some of the choices. The constraint is known exactly because there is perfect knowledge, and so the reaction to any changes in the constraint can be quantified. The desire of rational market players to optimize subject to the constraint then leads to a predictable relationship between behaviour and the constraint. The object of economic theory is to describe how external events and government policies shift this constraint, and to analyse the consequences of it. We have noted that despite the insights offered by this theory, the assumed information almost never exists. The only way to obtain it would be to have a full and exact knowledge of the intertemporal preferences and constraints faced by all other decision-makers, who would need to have the same information, and to be able to solve a general equilibrium system in which all preferences and constraints interact. It would also be necessary to attach exact quantitative probabilities to the likelihood of all the possibilities that had economic implications....
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