The Economic Way of Thinking

What Else Is Wrong With This Picture?

Over at Division of Labour, Frank Stephenson shows the following graph to his readers and asks them what's wrong with it:

He then provides a carefully thought out answer here. 

My guess, which was made before reading his answer, is below the fold. 

What Word Would You Scrap?

I can remember Richard Wagner of George Mason University once making a good argument for why economists should stop using the word "rationality."  Following in Wagner's footsteps, I'm going to toss out the word "optimality" as a word we should abandon in economics.  If we must keep using the word, I beg people to always and everywhere use "subject to that person's preference set" after saying "optimal."   

To illustrate my point, here are a few examples of people using optimal in a way that makes me want to throw my EWOT textbook at them:

(1) "The optimal time to have children is X."

(2) "The optimal size of a person's 'emergency' or 'rainy day' fund is X."

(3) "The optimal size of our university is X." 

(4) "The optimal amount to be putting in your retirement account each month is X."

(5) "The optimal number of children to give birth to is X."

Looking back at this post, I suspect it's exceeded the optimal length...

EWOT Question Of The Moment

Are "scarcity" and "poverty" two sides of the same coin?

EWOT Question Of The Moment: Price Gouging

Here goes:

Do you have a useful definition of price gouging?  When is a demand-induced price increase considered price gouging, and when isn't it?  Does your answer depend on the speed or level of the price increase?  Does it depend on the type of good?  When real estate prices surged a few years ago (the so-called "housing bubble"), why wasn't that called price gouging? (p. 151).

For useful discussions about the lack of economic sense behind the term, and more important, for the coordination properties of price spikes, take a listen.

Mises Made Easier

Have you ever wondered what some of those words or phrases mean in the writings of Mises?  Well, check this classic out.

EWOT Quote Of The Moment: Only Individuals Trade

    What... does it mean when we say that the United States trades with Finland, Germany, Canada, or Asia?  It means U.S. citizens trade with citizens of another country.  Finland doesn't produce and export Nokia cell phones.  People do.  There's nothing necessarily wrong with the terms interstreet trade, intercity trade, intercounty trade, interstate trade, international trade (or, perhaps someday, even intergalactic trade, although your authors have their doubts about that possibility). Economists are often called upon to discuss complex international trade issues and do so with various degrees of sophistication.  It is convenient to say that the United States trades with Finland, for example.  It would be prudent to keep in mind, however, that this is a shorthanded expression for a fantastic number of exchanges among a huge number of people, many acting in the name of larger organizations, across different regions and political borders (p. 31).

Economic Doublespeak

Words matter.  Once upon a time the phrase “big bang” meant something many of us would’ve been excited about.  We may not have all agreed on the details or legitimacy of the bang, but at least the ends of greater economic freedom and a smaller state were viewed as desirable.   

Fast forward to the present, and you’ll see that Barack Obama is getting set to introduce his own big bang into the US economy.  Though the mainstream apparatchiks (see, for example, here and here) continue to debate the size of the new bang and want to believe it’s medicine for a sick patient, the means and ends of the 2009 bang are hard to stomach. 

For what it’s worth: Though public opposition to the big bang does not appear to be mattering to politicians, my friends in Georgia appear to be opposed to the idea. 

Word Of The Day: Catallactic

From my Shorter Oxford English Dictionary:

Catallactic:  n.  Economics as the science of exchange.  From katallasein (Greek).

Hayek uses the word "catallaxy" to connote the economic system, first coined by Archbishop Richard Whately.  Catallaxy is not in the dictionary.

Is "It" Really Caused By Greed?

I've been suggesting to my students since the beginning of the semester to treat greed as a constant.  We can't measure it -- we'll let the sociologists and social psychologists attempt that -- and it is unclear how it works as a causal force. 

I'm skeptical of its explanatory power.

Weren't the capitalists and speculators just as greedy (whatever that means) last spring, last year, last decade, last century?  Why explain the crisis without also explaining stable financial markets on the basis of that same greed?  Was there some kind of quantum leap during the past few years?  It all seems ad hoc to me.

But I found myself using this analogy in a recent class lecture:  What, is greed like a pot of boiling water, steaming and gurgling for years, shaking and pushing the lid, and has only now burst open? 

And as I said these words I realized, of course, that my analogy doesn't support my skepticism.  Yes, it acknowledges greed as a simmering constant but it also supports the claim that explosive greed can help explain the crisis.

I wish one of my students raised this analogy to challenge my own argument.

Quantities Supplied and Demanded

Just what do these words mean?  Entry-level students have quite a bit of trouble distinguishing those terms from Supply and Demand. So we keep repeating:  Qd is the amount demanded at the Po price; Qs is the amount supplied.

In our textbook -- and this is something we've added after Heyne departed -- we consider Qs and Qd differently.  Yes, what I've said above is true and worth a repeat.  But we go further by asking just what do Qs and Qd really stand for?

They represent plans. 

Consider Qs to represent the plans of sellers at any given price, and the Supply curve represents a general pattern of changing sellers' plans as the price changes.  Consider Qd to be the purchasing plans of buyers at any given price, and the Demand curve represents a general pattern of changing purchase plans at different prices.  (Indeed prices themselves represent plans, price changes stem from plan changes.)

Market "equilibrium" is okay to speak about at this level, but that focuses our attention on the end of plan changes, where they are all settled.  Better that we also call it market clearing.  Why better? When the market clears, the plans of sellers and buyers are fully coordinated, they dovetail, and that's why no further change occurs in the market, thats why the market is now in a state of equilibrium. 

And this market-clearing coordination is an unintended consequence of people pursuing plans.

Issues that compare producer and consumer surpluses are fine if one wants to discuss the welfare characteristics of market equilibrium.  We can try to compare marginal rates of substitution in equilibrium, but we often lose site of the more important coordination problem, which is what any economy is really about -- including, of course, a comprehensively planned economy.  I lament our general judgment of what is important and what isn't. 

By the time students move into upper-division courses, as well as grad courses, they've lost the idea that some institutions allow for greater plan coordination, and some don't.  (And that assumes students were clearly exposed to the idea.) Institutions influence choices, plans of actions, and they causally influence the tendencies and patterns of changing plans.  But we spend more time attempting to discuss the final equilibrium welfare characteristics of differing institutions against an empirically impossible benchmark.  The benchmark serves as a normative standard to judge the efficiency properties of alternative economic systems.

Maybe we spend so much of our efforts on welfare properties of the market because the profession takes for granted the market's strong tendencies toward full plan coordination.  Maybe, but I don't think so. Consider the Post Keynesians, for example.

This is the comparative systems economist in me (and Pete) speaking.  I wonder how many intro courses study the issue of plan coordination.  Take a good look for a discussion in your textbook.