Category: Economics

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 it 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”

Don Boudreaux on Externalities

I have long held the belief that a reasonably educated person — regardless of his professional specialization or occupation — should be familiar with the basic principles of the natural sciences (physics, biology, etc.), the social sciences (psychology, economics, etc.), know how to do arithmetic, know something about law and history, philosophy, etc.

I confess that I was not “reasonably” educated when I graduated from engineering school. Other than what I was minimally required to learn — the basics of science, engineering and math — I knew hardly anything else. Today I would judge my 20-something year old self as a barely educated, mostly ignorant person. Fortunately for me, I am naturally thoughtful, curious and quite intelligent, which allowed me to overcome some of my deficiencies. I was doubly fortunate in being able to learn economics — first neoclassical and eventually Austrian. Now I consider myself a reasonably educated person. And getting more educated by the day. Continue reading “Don Boudreaux on Externalities”

Hayek on the Impossibility of Designing Society

This week in my online class “How the World Works – an Introduction,” I introduced a few basic economics concepts — starting with the easy to understand law of demand and supply. We call it a law but it is not the same sort of thing we call laws in the natural sciences. Social sciences are qualitatively different from the physical sciences like physics and zoology. Societies are not machines made of inert matter engineered by designers; societies are ecosystems of organisms that have minds which have volition and act purposefully to achieve their goals.

Social engineering — the deliberate transformation of an entire society according to some design — is doomed to failure because people are not inanimate objects that can be manipulated at will. The basic difficulty boils down to a lack of knowledge and the open-ended nature of the future. Nobody has the required knowledge of the present conditions of every person in society and the future state of the society. Continue reading “Hayek on the Impossibility of Designing Society”

A Bit about Trade

Economists are uniquely qualified in their understanding of one particular aspect of human activity, and that activity is unique to humans. No other animal trades, or exchanges, among its kind. Adam Smith wrote that “the propensity to truck, barter and exchange one thing for another is common to all men, and to be found in no other race of animals.” And no other discipline focuses on trade as much as economics does. Indeed, the most parsimonious description of economics is that it is the systematic study of trade, and trade-offs.

The story of human civilization can be told as a tale of ever-expanding scale and scope of exchanges. Foraging tribes of the distant past produced very little of what they consumed. They lived in groups of 100 to 150 people, and subsisted on whatever they could hunt and gather. What little exchange they did was limited to one’s kin and neighbors, and did not extend to strangers. Continue reading “A Bit about Trade”

Tom Sargent on a Few Lessons of Economics

Here’s a graduation speech that won’t tax your time and, without taxing your brain, will remind you of what is worth remembering. In 2007, Thomas J. Sargent, one of the two winners of the 2011 Nobel Memorial Prize in Economics, delivered a graduation speech to UC Berkeley (my alma mater) undergrads. Here’s the entire speech — just 355 words. Continue reading “Tom Sargent on a Few Lessons of Economics”

Don’t Ask me About the Economy

When people get to know that I am an economist, for instance on a flight, I often get asked about the economy or even the stock market. I just make up some stuff if the mood strikes me but sometimes I tell them that I don’t know. You tell me, I say.

As it happens, I am not interested in the economy per se. I am a serious student of economics but am only marginally interested in the economies of countries. What’s reported in the media regarding macroeconomic variables such as inflation, unemployment, GDP growth rates , etc., are to me mostly noise that can be profitably ignored. News is mostly noise anyway. It’s literally noise in the case of TV news but also figuratively speaking news is noise because the signal is hard to discern in the meaningless drivel that gets shoveled around. Continue reading “Don’t Ask me About the Economy”

Two Kinds of Capitalism

Ayn Rand is thoroughly despised in leftist circles. The leftists are justifiably incensed because Rand tirelessly criticized government control of the economy, while the coercive power of the government is the primary instrument leftists rely upon to achieve their Utopian dreams.

One does not have to agree with every aspect of Rand’s philosophy. Decent people can reasonably disagree with her on many of her positions. But it is impossible to deny the force of her arguments against government’s interference in the economy. Countries that don’t understand her point are doomed to be poor. Indians suffer because they are incapable of understanding the evil consequences of government — even well-meaning — control of the economy. Continue reading “Two Kinds of Capitalism”

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