The economist has peculiar methods (tools/principles)* for analyzing human action. This “economic way of thinking” is excellent at exposing the way events will unfold, uncovering the best course of action, and predicting the behavior of others. One small, perhaps seemingly trivial, caveat is that when economists study the actions of people, they study what they actually do, not what they say they will do. They use data of what people actually spend money on, not what they say they will spend money on. A survey can only reveal so much about the world because there are few consequences for how one answers the survey. However, a bank statement clearly reveals priorities and what one actually does with resources.
The bedrock principle of all economic reasoning, in my view, is scarcity. Put simply, scarcity is the idea that there is more desire to consume than there are things to consume. Imagine I have $20 burning a hole in my pocket. I want Thomas Sowell’s Wealth, Poverty and Politics, a new piece of mesh for my lacrosse stick, to surprise my wife with lunch at work, and to take my son to see Cars 3. There is no way I can do all that with $20. My resources are scarce or limited, but my desire is unlimited; therefore, I must make a choice. This choice necessitates something economists call tradeoffs. If I choose to surprise my wife, then I must give up the book, movie, and mesh. These options are my tradeoffs.
These two ideas lead to the concept of opportunity cost. The true cost of bringing my wife lunch was not the $20, but what I gave up to do so. Now, the opportunity cost is not all my tradeoffs, but only the most desired trade off. Why, because ultimately my choice is binary. I can either bring lunch or take my son to the movie. The opportunity cost is the benefit I could have enjoyed had I not chosen lunch. Because one can only enjoy one benefit, there is only one opportunity cost (a movie with my son.)
Once it is recognized that the true cost of any action is the action one chooses to not take, a very important concept is discovered: There Ain’t No Such Thing As A Free Lunch (TANSTAAFL). This common adage, popularized by Milton Friedman, is proven true when we see true cost is the opportunity given up. To eat a “free” lunch one must give up the opportunity to do something else. In fact, when cramming for an exam, or trying to make a deadline, that free lunch can be very costly indeed!
On a more practical level, if the United States government wishes to supply Health Care to all its citizens it must get the resources from somewhere. That is in choosing to provide Health Care the government is choosing to not do something else. Sometimes in America’s sea of wealth this is forgotten: the government does not have an infinite supply of goods and resources to do with whatever they please. Even the U.S. government has limits.
The next two ideas are intertwined and therefore are best discussed together. First, people face incentives when making decisions. For example, I may have chosen to bring my wife lunch because I knew she had a difficult morning, and brightening her day would make my day better as well. Alternatively, perhaps my son won his first lacrosse game, so I would choose the movie as a celebration of his victory, thus endearing him to me and that game I love. However, incentives do not exist in a vacuum. We all live among other people and so are influenced by institutions every day. Suppose that in our community the boys all rate each other’s value on whether or not they have seen the latest movie. That is to say, if you can’t discuss movies, TV shows, and video games you will find it difficult to have conversations with your fellow 7 year old boys, just imagine this. Then perhaps my son would prevail up me to choose the movie as I do not want him shunned by his mates.
To the practicum…taxes. Tax policy is perhaps the simplest example of an institution that creates incentives for society at large. Property taxes in suburbs are often twice as expensive as those in the city. The incentives that arise from this are many. Some families will choose to pay the extra tax to get into a better school system and some young single folk will enjoy city living with low taxes. The results of this are manifold and we shall digress no further. Currently, the institutions concerning trade with foreigners are being rethought in the United States. Should the government punish its people for desiring Chinese goods? If so, how much? Clearly if new tariffs are levied, or new restrictions are placed on Chinese imports, it will impact the amount of imports. This is classic institution creating incentive.
Briefly let us consider marginal thinking, voluntary exchange, and the Wealth of Nations. To think on the margin is to consider the cost/benefit of doing one more. That is to say, the Trump administration is not deciding whether to end all trade with China, they are deciding how much to pare back from the current amount. It is not an all or nothing decision. As someone has said, we are “tinkering toward utopia”, or so some think. Understanding that decisions in life are marginal and not all or nothing is huge. Just ask the “frog” how warm the water is.
Voluntary exchange is when two people choose to make a trade without any coercion. When I freely give to the local mission to feed our City’s poor, I have made a voluntary exchange. I value the good feelings I get from knowing I have cared for another human being more than opportunity I gave up to do so. When a government levies taxes on its people to provide health care for the nation at large, this is a coerced transaction. Voluntary exchange improves the two people involved in the trade because otherwise the transaction would not occur. Mistakes will occur, sure, but prior to the transaction the parties involved believe it to be beneficial. Therefore we can conclude that on the whole, voluntary exchange will improve society. (Note: externalities (+,-), the way the exchange impacts others, exist but are beyond the scope of this short blog.)
In 1776 Adam Smith sought to discover the cause of the wealth of nations. Yes, wealth is the anomaly, not poverty. Humans are born impoverished and must somehow gain wealth. Very briefly, wealth is derived from production. The more productive an individual, or group of people, the more wealth they will command.
Finally, let us consider the unseen, or as Thomas Sowell puts it thinking past stage one. As Frederic Bastiat said, the good economist does not merely see what has taken place, but analyzes what has not taken place. In Bastiat’s classic broken window fallacy he asks the reader to consider more than the extra business the glazier will gain from fixing the window. The economist must also consider the suit the tailor did not make because the shop owner had to fix his window. (Notice: opportunity cost)
Sowell’s idea is slightly different as he focuses more on the outcome of actual events. If the government chooses to provide Health Care to the nation at large, the economist must reason out how this decision will impact the nation in ten years’ time, not just how it will impact the nation immediately after the law is passed. In my analysis, Bastiat is asking us to consider opportunity cost, and Sowell wishes us to consider consequences. In order to adequately understand a choice made by an individual or a nation, the good economist must do both.
Comments are welcome and invited. These ideas are well worn, and I primarily write this post to exercise my ability to apply them. Secondarily, I will be presenting them to my 11th grade economics classes this year and wish to be clear about what “economic thinking” is.
* I have gleaned these ideas from sources such as N. Gregory Mankiw, Foundation for Teaching Economics, Thomas Sowell, Frederic Bastiat, and Milton Friedman (among others).