How much of the economy can be considered variable?

In theoretical economics it is common to specify objective functions for optimisation, which are quantities dependent on certain values chosen by people or organisations. For example, a person decides how much of a good to buy to maximise utility, or a company decides on its prices to maximise profit, or a government decides on the interest rate to get inflation as close as possible to a target value.

The optimised quantity is likely to be influenced by values not chosen by the parties concerned. These values may be considered fixed or variable, and the assumption can affect the quantitative or qualitative validity of the model. For example, if there is assumed to be a trade-off between inflation and unemployment, an idea associated with the 1950s and 1960s, then the model implicitly assumes that major factors influencing inflation outside of the trade-off mechanism are held constant. For example, it is required that labour supply constraints do not change much, and oil prices do not undergo sustained increases.

The model may itself be considered variable. For example, governments may no longer wish to target inflation, or the supply (price-quantity) curve for a good may vary. In many cases, it may be possible to include model variability by adding new changeable values to the basic model.

Economic research often proposes models and estimates values without assessing how subject to human adjustment they are. The approach may be viewed as politically liberal, accepting people’s behaviour as a given and working around it. More controlling approaches, such as those adopted by several communist states in the 20th Century, take much more of the economy as variable. In some cases, even economists were taken as variables.

Even within liberal economics, assuming that certain quantities are variable or fixed is rarely politically neutral. An instance is in currency unions. Currency unions work best when capital, goods, and people can move easily and cheaply between different parts of the union. If it is observed that people tend to stay in their own region, we could say that the currency union will not work as well as it could. The position would be correct if people’s mobility is taken to be a constant, but their mobility could change if the union is put in place with sufficient commitment.

Support for the view that quantities are invariable may follow from several intellectual or ideological positions. The view may be based on empirical measurements, but as noted these are relatively infrequently made and are quite difficult to make too. The view may be rationalised by an assumption that short run behaviour and long run behaviour will be identical. The view may be founded on a liberal political view that political decisions should not substantially influence the behaviour of individuals. Ideology may encourage people to take some of these positions in the absence of compelling evidence.