The Joy of Counter-intuitive Truths

I think one of the main reasons why I find economics so fascinating is that I am a contrarian (adj. taking an opposing view, especially a view opposite to that taken by the majority; n. a person who habitually takes a view opposite to that held by the majority.)

Many of the findings of economics are counter-intuitive. When I come across those results, the delightful “Aha!” moment follows. I realize that I was wrong about something and enjoy being less wrong than I was previously.

One of the earliest such realizations was related to the population problem. I had been persuaded by Paul Ehrlich’s books (The Population Bomb, and The Population Explosion) that more people meant more poverty and misery. Julian Simon’s argument demolished that notion. I realized that I had been wrong. In that, I did better than Prof Ehrlich: he still believes that human population is a problem. He did not understand Simon’s argument, even though he lost a famous bet with Simon.

Why did I think that population was a core problem? Because basic common sense says that if the number of people increases, and there is only this much stuff, then each person’s share will decrease. That’s absolutely true because arithmetic says it is. What I had missed was the role of technology. Technology increases the amount of stuff produced. And under appropriate conditions that are easily met, more people means more technology. When I recognized the dynamic nature of the world, and understood that technology grows with population, I realized that Ehrlich’s thesis was wrong.

Having learned Stuff = f(technology(g(people))) my new “commonsense” is exactly the opposite of what I thought was true. Once I understood the term “technology” I saw the world from a totally different perspective that is alien to the vast majority of people. I had one very powerful arrow in my contrarian quiver.

Being a contrarian doesn’t make one popular except among other contrarians. If popularity is your objective, you’re well advised to be a conformist, not a contrarian.

Ehrlich is a biologist and Simon was an economist. Ehrlich was very popular because his arguments made sense to the average Joe. Simon’s arguments were not complicated but they went against common sense.

Here’s another pair of notables. Paul Samuelson and Friedrich Hayek. Samuelson literally wrote the book on economics. Tens of millions of his economics textbook were sold, and used in thousands of college and university courses. But that book did not age well. Samuelson praised the successes of Soviet central planning. The Soviet Union collapsed as a consequence of central planning.

Friedrich Hayek kept insisting that central planning is a recipe for disaster and that free markets are the only instrument for economic prosperity. Hayek was a contrarian. His popularity comes nowhere close to Samuelson’s but Hayek’s argument ultimately proved right, and Samuelson was disastrously wrong. Samuelson won the 100 meter sprint but surely lost the more important 10 km marathon.

The most important tool for understanding one of the deepest lessons of economics also happens to be one of the simplest. That’s the supply-demand diagram. With just a few lines, you can put on a piece of paper a fantastic amount of information. You start with some obvious truths and by reason alone you end up with some conclusions that are apparently contrary to common sense.

Obvious truth: Price goes up, the amount people are willing to buy comes down. High coffee prices will lead people to buy less coffee. Because they have limited budgets and/or they will buy substitutes like tea.

Less obvious truth: Price goes up, the amount that suppliers are willing to sell goes up. This is somewhat harder to explain than the simple buying behavior.

Put those two together, and you see that markets arrive at a price. There is a price which more or less equates the amount available to be sold and the amount people actually buy. So what’s the surprising lesson? It’s that if instead of letting the price emerge from the interaction of market participants, some third party (not the buyer or the seller) imposes a price. That leads to losses in the system.

Lesson: Prices emerge in the dynamic interplay of innumerable interactions that cannot be “controlled” in any meaningful sense. But that doesn’t prevent bureaucrats and politicians from fixing prices. And when they do, that little supply and demand graph clearly shows why that’s wrong-headed.

Every disaster in the world — floods, fire, earthquake, pandemic — causes harm. That harm is compounded by ignorant policymakers and their stupid “anti-price-gouging” policies. Like all market interferences that are supposed to help the public, anti-gouging policies hurt public.

Kahneman noted two distinct modes of thinking which he called System 1 and System 2. The former is fast, emotional and intuitive; the latter is slow, logical and deliberate. (His book is essential reading.)

Thinking fast, anti-gouging laws appear to do good; thinking slow shows that they are actually bad. Why so? Because prices convey information to market participants.

Higher prices tell consumers to conserve, to make do with less. And at the same time high prices tell producers to produce more. They signal a necessary change in behavior. Anti-gouging laws tell consumers and producers that it’s business as usual.

Bonus question: Why does a higher market price increase the quantity supplied to the market?

An example of anti-gouging law: There was a major flood that left the people of a town without electricity. The stores had run out of portable generators.  A guy from a distant town bought a whole bunch of generators and hauled it to the affected town. Then he ran up against “anti-gouging” laws. He was turned away. I leave it as an exercise of your System 2 to figure out why that made a bad situation worse.

A more topical example. Some guy bought a whole bunch of cleaning supplies — thousands of units — with the idea that he would sell that at a premium when the stores run out. He’s been vilified and called a monster, and his behavior an indictment of capitalism. Dead wrong. Why?

As I finish this piece, I note see the following tweet, posted just half an hour ago:

I will listen to them podcasts sometime. Without even listening to them, I recommend them because Russ is truly superb.

 

Author: Atanu Dey

Economist.

3 thoughts on “The Joy of Counter-intuitive Truths”

  1. What if the private player doesn’t act on the “information” conveyed by prices and decides to curtail the supply of sanitizers(say) in order to keep the prices high? Wouldn’t that validate the thesis of anti-gouging laws?

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    1. If the private player decides to curtail, he is taking a risk in case the situation defuses tomorrow and people get less interested in buying sanitizers.

      What happens if the situation worsens tomorrow? Then the hoarder has just served a very useful purpose of rationing the stock for needier people.

      What happens to the poor? That is where society has to show its compassion, not the hoarder. The society, as a voluntary collective (not government) can pool money and make sanitizers available for those who cannot afford it.

      I do believe that anti-gouging laws are an artefact of thinking-fast on part of the majority of the population.

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    2. First of all, Karthikeya, it is generally advisable to avoid corner cases when trying to understand some fundamental principle. It’s tempting to concoct examples that lie at the tails of distributions, and hence that are highly unlikely. Those examples do not invalidate the fundamental principle.

      As mentioned previously, it takes some effort (System 2 thinking) to overcome our natural, instinctive (System 1 thinking) reactions. Economists have known and argued against anti-gouging laws, but the public don’t know those arguments. Therefore price-gouging laws play well with the public, and politicians who enact PG laws are popular. Thankfully these days if one is interested in getting the answer to the question “Are price-gouging laws good”, just do a search on the internet. I just did and came up with dozens of simple articles that answer that question with a “no.”

      Now to that bit about a person who “decides to curtail the supply of sanitizers” — perhaps Bezos can but not the average Joe because Joe cannot corner the market.

      I will address that point in some detail in a post. Thanks.

      Liked by 2 people

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