Category: Economics

IRS

Isn't she a beauty?
Airbus A380. Click to embiggen in a new tab.

I love IRS. Not the “Internal Revenue Service” but “increasing returns to scale”.

Understanding the economic concept of “returns to scale” is useful for understanding the tremendous increase in the production of wealth in our modern world.

A bit of vocabulary first. The stuff that goes into production are called “factors of production.” The vocabulary is the same as in basic arithmetic where the product is derived from factors — for instance, the factors 2 and 3 when multiplied yield the product 6.

When you increase the factors, the product increases. That is, the “scale” or the size of the operation increases and therefore the product increases. If the increase in production is proportionate to the increase in the factors, then we have “constant returns to scale.” Continue reading “IRS”

CORE – The Economy

CORE – Curriculum Open-Access Resources in Economics

It’s hard to overestimate the importance of public understanding of the fundamental principles of economics and some of the many uncontested facts (facts that are generally accepted by acknowledged peers of experts) of economic history. The lack of public understanding — worse still a misunderstanding — invariably leads to awful misery that could have been avoided by teaching the public a few essential details of the nature of our social world and how it works.

We have to be taught and we have to learn how to think about our world, just like we have to be taught how to read, write, reason logically and do arithmetic. Unlike comprehending and speaking natural languages, we cannot instinctively read, write, reason or do arithmetic; we have to learn. Reading, writing and doing arithmetic is “unnatural.”

Let’s recognize that the basic principles of economics are unnatural and therefore run counter to our intuition. Our natural instincts lead us to think and believe in ways that are almost always at odds with the facts and the true nature of our economic (therefore social) world. Briefly stated, this is so because our instincts evolved over evolutionary time-scales of tens of millions of years when humans lived in small groups of a few dozen people, hunting, gathering and foraging to survive. Only in the very recent past of around 200 years — the blink of an eye compared to hundreds of thousands of years — the world changed so dramatically that nearly everything that made sense in the long past was rendered totally irrelevant and wrong. Continue reading “CORE – The Economy”

Economists as Camp-following Whores

“The inverse relationship between quantity demanded and price is the core proposition in economic science, which embodies the presupposition that human choice behavior is sufficiently relational to allow predictions to be made. Just as no physicist would claim that “water runs uphill,” no self-respecting economist would claim that increases in the minimum wage increase employment. Such a claim, if seriously advanced, becomes equivalent to a denial that there is even minimal scientific content in economics, and that, in consequence, economists can do nothing but write as advocates for ideological interests. Fortunately, only a handful of economists are willing to throw over the teachings of two centuries; we have not yet become a bevy of camp–following whores. “

That’s a favorite quote from James M. Buchanan. He wrote that in the 1990s in response to a Wall Street Journal interview in which the disemployment effect of minimum wage legislation was questioned.

The theoretical case that minimum wage laws adversely affect low-skilled workers is as sound as anything else in economics. The empirical evidence is also as sound as the empirical evidence for “dog bites man.” What makes the news is when “man bites dog.” That exception does not invalidate the general case that dogs bite men. Continue reading “Economists as Camp-following Whores”

On Monopoly

“I am confused about the correctness of government interference to break monopolies. Sometimes I think this is good. I do believe that a free market without competition is terrible. But if the government starts deciding what a “monopoly” is and what is not, we have just let in a thin wedge that can corrupt free markets beyond any limit. But then, if the government does not break monopolies, who will? Can the free-markets self-correct? Has it ever happened in practice?”[1]

Those are not easy questions to answer in a blog post since the issues involved are many and far from trivial. Volumes have been written on the definition and analysis of the economic concept of monopoly, and experts frequently disagree on what, if any, harm monopolies do, and what should the policy response be.

My thinking has evolved since I first began learning economics. Trained in the neoclassical tradition, I used to think that monopolies were harmful for the economy, and therefore government intervention was required to break them up for economic efficiency and consumer protection. However, the more I studied Austrian economics, the more I realized that monopolies weren’t the great threat to economic health as they were made out to be. Continue reading “On Monopoly”

Honoring Those Who Serve Us

Cherry blossomsI came across an interesting bit in a video I was watching yesterday. “How many health care providers are in the room?” asked the kind lady in it. After a show of hands, she said, “Thank you, thank you, thank you. I feel like a lot of the work both of us care about so much is in service of others and all of you are dedicating your life for that same purpose.”

The dedication to the “service of others” part caught my attention. It’s curious that healthcare providers such as doctors and nurses, and other people like firefighters, military personnel, etc., are popularly held in higher esteem than sanitation workers, bus drivers, computer programmers, sales people, etc. Somehow some occupations are more “selfless” than others. Sorry to be contrarian but it’s simply not true that occupations can be categorized that way.

Certainly occupations can be justifiably categorized as immoral or moral, legal or illegal, intellectually hard or easy, physically challenging or easy, and so on. But as long as one is getting paid and not doing voluntary work, there’s no selflessness involved. That is not to imply people in various paid occupations are narrowly selfish and lack human decency; it is only that all of us are most of the time primarily — though not solely — motivated by self-regard and not by self-denying altruism. Continue reading “Honoring Those Who Serve Us”

People, the Ultimate Resource

oil rigsQuite often I enjoy the pleasure of shocking people with my contrarian viewpoints. For some people, the shock is replaced with the pleasure of understanding something that goes against plain common sense. When that happens, I am very gratified but when it doesn’t, I feel sad.

One of the many contrarian ideas I have is that there are no “natural” resources and that all resources are creations of the human mind. As economist and professor of business administration Julian Simon (1932 – 1998) argued that “the most important of all resources is human beings.” (The Ultimate Resource 2. Page 581). The more humans, he insisted, means more abundance and less scarcity.

We are all concerned about facing scarcity. Not all of us face the same scarcity, though. The good news is that scarcity is going down. To understand why that is so requires we define scarcity in some broad sense. We intuitively understand that prices have something to do with scarcity.

If the price of something is going up, it means that (1) the quantity available is decreasing, or (2) the quantity demanded is increasing, or (3) a combination of both. If the price is trending up, it is likely that scarcity is increasing, and vice versa. The price trend is a proxy measure of scarcity. If the trend is falling prices, then we conclude that scarcity is decreasing. Continue reading “People, the Ultimate Resource”

The Best is not Optimal

good fast cheapIt would be best if we had zero crime, or zero pollution, or zero inequality (of wealth, income, health, beauty, intelligence, lifespans), or zero transportation deaths, et cetera. That is, it would be best if we could obtain the best and not have to pay too much for it. But, alas, the real world refuses to comply with our wishes. For anything good that the real world grudgingly gives us, it exacts a cost.

To gain any benefit one has to pay a cost. The best may come at such a high price that it may not be worth it. How much of a good thing we actually end up having depends on a cost-benefit analysis. That particular amount of a desirable good for which the cost balances the benefit at the margin is the optimal amount of that good. The optimal amount is almost never at one or the other extreme of the case.

As an aside, the Buddha recognized this universal truth and advised against extremes. He preached moderation in everything, and therefore Buddhism is known as the “Middle-wayed Way.” I think that the Buddha would have made a pretty good economist. He thought at the margin. Continue reading “The Best is not Optimal”

A Bit on Rent Seeking

Cherry BlossomsThis is a continuation of two previous posts: Is Competition Always Good, and Competition in Free Markets.

Prabhudesai referred to JEE (Joint Entrance Exam) in a comment and wrote, “An examination that has too much of competition resulting to very high cost of producing one engineer. For a poor country like India it is a massive blow.”

Is that type of competition good? That is socially wasteful competition. It belongs to a broad class of activities that are technically known as “rent seeking.”

One of the principal ways of obtaining wealth is by earning a profit. Profits are the difference between the cost of producing something and the price obtained from its sale. Profits indicate that wealth has been created and value delivered. Rent seeking occurs when one attempts to obtain some wealth without actually creating wealth. 

Continue reading “A Bit on Rent Seeking”

Competition in Free Markets

wine tomato

I ended the previous bit with the claim that competition in a second-best world can be bad.

Competition in a free market is nearly always good because it is that process which provides the incentive to market participants to do the best they can, which leads to all the advances we all enjoy.

Remember that every one of us is a market participant. Therefore we all have to compete. It doesn’t have to be cutthroat but we cannot avoid competing.

 

But what about cooperation? Doesn’t that matter? Yes. It matters enormously. We even have to compete in our cooperation. Individuals who are good at cooperating out compete those who are bad at cooperating. This holds true for higher levels of aggregation too. More cooperative, high trust cultures do better than cultures that mistrust and don’t honor their word.

In a perfect world, which in our case we don’t have, competition would always be good for everyone. Even those who lose out in their particular competition would nevertheless be better off in this world of competition because competition raises the general level of welfare, than they would be in a world without competition.

Continue reading “Competition in Free Markets”

The Cost of Things

Mountain streamWe humans value economic goods. But everything we value doesn’t necessarily have to be an economic good. What’s the defining characteristic? The demand for the good has to exceed the supply for it to be thought of as an economic good.

Let’s look at some goods and ask if they are economic goods or not. You are walking along a clear mountain stream in the wilderness. Is the water an economic good? No, because the demand for the water in the stream (only you are the consumer for miles around) is much less than the supply. Is the water of value to you? It certainly is: you can drink the water or take a bath. A thing of value need not be an economic good but any economic good has a positive value (and conversely, an economic bad has a negative value.) Continue reading “The Cost of Things”