Kenny Workman, building tools for computational biology. Brianna GoPaul, “17 y/o learning fusion energy.” Justin Glibert, from Belgium near Liege, nanotechnology and cryptography and space manufacturing. Andrew Tate Young, custom audio from blogs, and to create audiobooks from science information in the public domain. Rasheed Griffith, Barbados, podcast on China in the Caribbean, and Substack […]
You can trace my earlier jobs here, my next job, which I believe started at age nineteen, involved giving summer talks to high school debaters. The program was called Economics in Argumentation, and it continues today in a much broader form under the name Economic Thinking, led by the excellent Gregory Rehmke, who was program […]
“Economics is really about two stories. One is the story of the old economist and younger economist walking down the street, and the younger economist says, ‘Look, there’s a hundred-dollar bill,’ and the older one says, ‘Nonsense, if it was there somebody would have picked it up already.’ So sometimes you do find hundred-dollar bills lying on the street, but not often—generally people respond to opportunities. The other is the Yogi Berra line ‘Nobody goes to Coney Island anymore; it’s too crowded.’ That’s the idea that things tend to settle into some kind of equilibrium where what people expect is in line with what they actually encounter.”
― Paul Krugman
I love this quote. These two jokes do sort of describe economics, at least what you might call “pure” or celestial economics, where there are no real world frictions to worry about. If we add frictions to the mix we get terrestrial economics, the economics of the real world.
Krugman’s first joke gets at the way economists think about information. It’s essentially epistemology, about whether to believe something is true. The second joke is about behavior, about how we model the response of people to changes in their environment. At the end I’ll add frictions, and try to give you a sense of how economists like me think about the world. So here’s my 4-minute course on economics.
1. Information: Imagine a giant encyclopedia, written in Japanese. It contains a vast amount of information about the world. But to read it one must first learn Japanese. By learning economics we are able to read an enormous amount of information from prices, if we assume that people are rational utility maximizers. Thus if conventional Treasury bonds yield 7% and indexed bonds yield 3%, we can infer that optimal forecast of inflation is 4%. If that were not true, there would be $100 bills lying on the sidewalk for investors to pick up.
Here’s another example. Suppose there’s a neighborhood of cookie-cutter homes on the Irvine/Lake Forest boundary, here in Orange County, CA. If we compare two similar houses on each side the border, we can infer the difference in value that people see in living in each city, capitalized into the home value (actually land value.) Most likely, this reflects differences in the perceived value of the two school systems, with Irvine viewed as superior. If the price gap didn’t reflect amenity differences then homebuyers would take advantage of any mis-pricing.
Here’s another example. Assume that Mexican farm workers in California earn $11/hour on average while Central American farm workers earn $10/hour on average. We can infer that the Mexican farm workers are probably about 10% more productive, on average, otherwise California farmers would choose to hire Central Americans, not Mexicans. Again, no $100 bills on the sidewalk.
The economy contains billions of such pieces of information, all embedded in prices, for those who know how to “read economics”. It’s like a giant encyclopedia.
2. Behavior: Economists assume that rational people will keep doing X up until the point where the benefit of one more (marginal) unit of X no longer exceeds the marginal cost of X. This is the “equilibrium”. X could be any activity: units consumed, hours worked, dollars invested, etc.:
Urban planners often suggest that expanding highways does not reduce traffic congestion. That’s wrong. If you widen a highway, more people will travel on the highway. That part is true. But traffic congestion will be reduced; indeed it must be in order to induce more people to travel on the highway. Why do urban planners get this wrong? Because they noticed that traffic did not seem to improve when places like Orange County built more highways. But that’s because both lines were shifting at the same time, as Orange County’s population was growing rapidly when it was building new roads. It is still true that, other things equal, building more highways reduces traffic congestion. Recently, Orange County’s population stopped growing. Now if they were to build more highways in OC, it really would reduce traffic congestion.
Or consider how firms respond to a change in the cost of inputs. Most students understand that firms will respond to cost increases by raising prices, but often fail to see that firms will respond to price decreases by cutting prices. But the model is symmetrical; a shift up in the MC curve has the opposite effect of a shift downward, even for a 100% monopoly. In both cases, cost curve shifts move the optimal output point, which requires a price change. And we know that firms don’t want to leave $100 bills on the sidewalk.
So that’s celestial economics in a nutshell. It describes a world where inefficiencies should be quickly eliminated, as utility maximizers do deals to improve efficiency and share the gains. No $100 bills left on the sidewalk.
3. Frictions: Here in the real world, things don’t work so smoothly. One friction is transactions costs. In principle, inefficiencies related to externalities (pollution, etc.) and monopoly could be eliminated through negotiations. Pollution victims could bribe factories not to pollute. Monopolies could negotiate perfect price discrimination with consumers. But such negotiations are often costly and hard to do, for all sorts of reasons. Another friction is sticky wages and prices, which result in nominal shocks having real effects. Bad real effects, such as high unemployment. Another friction is illiquidity, which explains why the TIPS spread may not perfectly measure the public’s inflation expectations. TIPS are less liquid, and hence less desirable. Furthermore, information is costly. So there may be a few $100 bills on the sidewalk because no one spent the resources to look for those $100 bills. And there’ll be lots of coins on the sidewalk.
Left leaning economists focus more on frictions. Right leaning economists focus more on celestial economics. I’m somewhere in the middle, but definitely leaning to the right.
I’ve already posted about my chess teaching, and my grocery store work (here and here), my next job was as managing editor of the Austrian Economics Newsletter, for 1980-1981. I was only eighteen (and nineteen) then, so for me this was a big step up. I was responsible for commissioning content, making sure authors got […]
The post My job as managing editor of the Austrian Economics Newsletter appeared first on Marginal REVOLUTION.
We find that the WTP [willingness to pay] for in-person instruction (relative to a remote format) represents around 4.2% of the average annual net cost of attending university, while the WTP for on-campus social activities is 8.1% of the average annual net costs. We also find large heterogeneity in WTP, which varies systematically across socioeconomic […]
The last chat was with Brian Armstrong about bitcoin, this one started with Isaac Newton and bit coins (really). Here is the audio, video, and transcript. Here is the CWTeam summary: Patricia Fara is a historian of science at Cambridge University and well-known for her writings on women in science. Her forthcoming book, Life After Gravity: […]
Bryan Caplan has a new post where he claims that people can avoid poverty with three simple steps:
If you live in the First World, there is a simple and highly effective formula for avoiding poverty:
1. Finish high school.
2. Get a full-time job once you finish school.
3. Get married before you have children.
This made me wonder if Bryan was confusing correlation with causation. He denies this:
A more agnostic criticism doubts causation. Sure, poverty correlates with failure to follow the success sequence. How, though, do we know that the so-called success sequence actually causes success? It’s not like we run experiments where we randomly assign lifestyles to people. The best answer to this challenge, frankly, is that causation is obvious. “Dropping out of school, idleness, and single parenthood make you poor” is on par with “burning money makes you poor.” The demand for further proof of the obvious is a thinly-veiled veto of unpalatable truths.
I am not at all convinced by this argument. Indeed I don’t see any real argument being made here. It seems equally plausible to me that the sort of person who doesn’t finish high school is different, on average, from those who do. The dropout may (on average) be less smart, less interested in classes, less motivated, and/or perhaps a bit anti-social. None of those traits are normally associated with financial success. If you put a gun to their heads and forced this cohort to finish high school, would that by itself change those personal characteristics? Maybe slightly, but how much? Would this group then become identical to other high school grads? I doubt it.
As for marriage, the Nordic countries tend to have a much higher share of births out of wedlock, and yet typically have relatively low rates of poverty:
You might argue that their culture is different, and that in Scandinavia even unmarried men often take an interest in raising their children. I accept that, but again it just makes me wonder if it’s marriage that is the key, or if the deciding factor is the personal characteristics of those who fall into poverty.
I certainly agree that working hard and being responsible are useful traits, and that some people are poor due to unfortunate life choices. I would push back, however, against any suggestion that there are simple public policy fixes, such as policies that discourage people from dropping out of high school or encouraging marriage. Those policies might work, but simple correlations don’t prove that. (BTW, I lean toward policies that make work more attractive, such as low wage subsidies and housing deregulation, as opposed to basic income programs that might discourage work.)
Also keep in mind that definitions of poverty are based on “households”, where the poverty line increases only modestly each time a person is added to a household. Thus if two single people making $10,000 each decide to double up and live in the same apartment, that pushes them above the poverty line. It’s not obvious their situation improved (otherwise no one would ever chose to live alone), but the US government treats the decision to share an apartment as an improvement of living standards. This biases the statistics toward the conclusion that marriage improves one’s economic well being.
Thus you might just as well argue that poverty could be almost eliminated if everyone lived like Chinese college students in the 1980s, with eight people per apartment.
Even with minimum wage jobs, a household of eight will earn far more than $47,650. But would those “households” be better off, or would people get on each other’s nerves? (My wife shared a room with 7 other college students in the 1980s, in Beijing.)
Finally, most women have a strong preference to have children. Finding a suitable husband is not always a “simple” process.
Here is another request: What is the hardest manual labor you’ve ever done? I love intellectual policy wonk commentary, but I can’t help but feel some small amount of disdain for people who SEEM (a possibly faulty assumption) to have never really suffered trying to solve problems in the physical realm. There’s so much abstract […]
Schools in Oregon, Washington, and much of the west coast are slow to reopen, even with teachers getting vaccinated: Marguerite Roza, a Georgetown University school finance expert based in Seattle, points out that Washington, Oregon and California “all have more left-leaning leadership that is cozier with the unions.” But Boston, Chicago and New York also […]
The mere passage of time as an explanatory factor is underrated in public choice and regulatory economics, though Mancur Olson understood it well. Here is an update on the new CDC guidelines for school reopening: For months, President Biden has been urging schools to reopen, and promised that guidelines from the Centers for Disease Control […]