Blackboard Economics

In his blog post "Ten Things Every Economist Should Know," Dr Pirie includes an important observation: "Modeling has limitations. Some economists like to produce neat, clean models of how economies work. The problem is that the real world is not neat and clean; it is messy." This statement sparked an idea I had been meaning to write about for a long time—the concept of Blackboard Economics as critiqued by Nobel Laureate Ronald Coase. Building on Dr Pirie’s blog, this article serves as a complementary perspective on the role and misuse of economic modeling.

What Is Blackboard Economics?

Ironically, the famous Coase Theorem was never something Ronald Coase himself fully endorsed. In fact, Coase stated in an interview that it should have been called the Stigler Theorem (Libert Fund, The Intellectual Portrait Series: Ronald Coase). Why? Because it illustrates the very issue he sought to expose—how economists often construct theoretical models that assume away real-world complexities.

Coase described Blackboard Economics as follows:

“The policy under consideration is one which is implemented on the blackboard. All the information needed is assumed to be available, and the teacher plays all the parts. He fixes prices, imposes taxes, and distributes subsidies (on the blackboard) to promote the general welfare. But there is no counterpart to the teacher within the real economic system.” (The Firm, the Market, and the Law, p. 19).

Coase’s intellectual project was to highlight the importance of market institutions in a world characterised by transaction costs, uncertainty, and imperfect information. To do so, he first constructed a hypothetical world without transaction costs—not as a policy prescription but as a thought experiment to better understand how real-world institutions function.

However, the neoclassical interpretation of Coase’s work often ignored this crucial point. Instead, it focused on the idealized, frictionless world he had drawn, treating it as a benchmark. Once economists framed the real world as a series of deviations from this imagined perfection, they naturally concluded that government intervention was necessary to correct these "imperfections." But such perfection exists only on the classroom blackboard, not in reality. The result was a cycle of increasing interventions that often made markets worse off.

The Use and Misuse of Models

Hayek, Mises, and even Adam Smith never defended markets on the basis of Pareto efficiency, perfect information, or general equilibrium. Yet critics of classical liberalism often conflate these thinkers with the post–World War II neoclassicals, who embraced these assumptions. This distinction is crucial: Austrian economists never claimed markets were fully efficient, but they emphasized that markets function as discovery processes.

Through profit and loss signals, entrepreneurs identify inefficiencies and uncover opportunities for improvement. The market is not a static state of perfection but a dynamic process of continuous adjustment.

This does not mean classical liberals like Hayek and Frank Knight rejected the use of models. Rather, they used them differently—as tools for intellectual exploration rather than as blueprints for policy. For instance, in Risk, Uncertainty, and Profit, Knight begins by constructing a world without risk, uncertainty, or profit. Only after establishing this baseline does, he introduces these real-world factors, allowing us to see how market institutions address such fundamental challenges.

The Lesson: Models as Tools, Not Utopias

The key takeaway is that economic models should not serve as blueprints for achieving utopian outcomes through state intervention (as in the New Keynesian approach) or as unrealistic justifications for markets based on perfect efficiency. Instead, they should help us understand how economies actually function—how price signals, property rights, and market institutions enable social coordination in a world of uncertainty.

Coase’s critique of Blackboard Economics remains relevant today. If economists continue to prioritise mathematical elegance over institutional reality, they risk creating policies that fail to address real-world problems. Models should illuminate, not dictate. They should guide us toward understanding, not mislead us into pursuing impossible ideals.