, According to Dr Hammer
What are we talking about? What does “economics” even mean? You are not alone in asking that, because pretty much no one agrees. It is easy to say what it is not. It’s not finance, or the stock market, which is usually what people say to me. (The second most common thing I hear “my least favorite class in college”, hopefully will also prove false.)
Looking at the professional literature doesn’t help narrow things down much, either. We see articles on consumer choice, tax policy, markets for cars, ethics, space exploration, evolution, inflation, warfare psychology… everything up to and including the kitchen sink. Oh, and an ever increasing amount of mathematics. A remarkable amount of mathematics.
What thread ties these themes together is at best “things humans do”. Which is actually a pretty good place to start a definition: economics is the study of things humans do. Of course, humans do a lot of things (citation needed) and a lot of those things are pretty clearly not economics: cellular biology, the functioning of the gastro intestinal tract, reproduction. They are definitely economics adjacent, however, as the vast pile of Google Scholar results for the economics of medicine or birthrates suggests. This helps narrow down the definition a bit from “things humans do” to “decisions humans make about things humans do”. Economists aren’t really looking at the wet, sticky bits, but how we decide to do things regarding wet sticky bits. We start with humans doing the sorts of things humans do when they are alive, and then think about why they do somethings instead of others at various times.
It isn’t just about money, either.
The word “economics” comes from the Greek eco (where do I live?) and nomos (where is my money?). (My own rough translation.) The class you might have heard about in high school called Home Economics or Home Ec. Is there for both redundantly and accurately named: it is about the management of the household and its accounts or finances. Economics is about decisions you make about your homelife, what you make vs. buy, what you buy, what you fix vs. what you throw away, etc.
Of course, different people have different households with different needs, and indeed even the very same people will have different households and different needs over time. My life as a child was very different from my life as a college student, which was different than that as a young adult, which was vastly different than my life as a father of three young children. For starters, I spend significantly more money on princess related paraphernalia now than I did as a 20 year old.
Hoping to capture the fluid and dynamic state of the decisions people make about what humans do, Nobel Prize winner Friedrich A. Hayek and Ludwig von Mises preferred the term “catallaxy”, which the internet tells me comes from the Greek words for exchange, admitting into the community, and changing things from one thing into another in general. Same root as the catalytic converter in your car. Possibly also catastrophe. I don’t know, I don’t speak great Greek.
What I do know is that very few other English speakers speak great Greek, and so catallaxy never really caught on as a replacement for economics. Which is a shame, because changing things from one thing to another is really important to humans. We look at a meadow and think “Sure, the flowers are nice, but there is hardly anything to eat” and change it into a farm. We look at all our grain and say “This is really not very entertaining” and exchange it into a book. We look at a lifetime of grinding agricultural labor and say “I should go back to school” and change careers. The word economics does not suggest all the changes constantly happening in the same way as catallaxy. But that’s what we’ve got to work with, so let’s make the most of it.
Economics then is the study of how people made decisions about how to change their lives, from the very small to the very large. More succinctly one might say economics is the study of how to get the most out of life. (Russ Roberts does, anyway.) A principles of economics class should then be the MOST interesting class you ever take. Who doesn’t want to know more about getting the most out of life? Who doesn’t care about why people are rich or poor? Why the Department of Motor Vehicles is so miserable to deal with compared to just about everything short of the Post Office? Why the price of goods or foods changes around? Why do people wear jeans with holes in them some years and not others?!
Can we answer these questions definitively? Of course not! The world and human society is way too complicated for that. But we can come remarkably close by disciplining our thinking, so let’s get to it!
(Incidentally, I understand my students instituted a drinking game around my saying “Well… it’s complicated.” Probably good that I don’t do many video lectures.)
** Some might ask “Wait, what about scarcity!?” Well… yes. Scarcity exists, and people make decisions under scarcity, and how people make decisions under scarcity is a common definition for what economists study. I would take that further: humans do not make decisions without scarcity, because when you can have everything there is no decision to make. Given that, and the fact that scarcity is the default state of reality, I find that definition of economics to be about as useful as how people make decisions while living on Earth and breathing oxygen. More on scarcity when we talk opportunity costs.
Economics’ Greatest Hits
Wait, so what does “disciplining our thinking” mean? Who talks like that? Well, here’s the thing… economics, despite being the king of the social sciences (fight me), isn’t a science. Sure, we use lots of math, make pretty graphs, talk as though we have a better track record than predicting seven of the last five recessions, but we are not a science. We can’t reproduce experiments under controlled conditions, holding all sorts of things constant, for instance. We only have one economy, so we can’t have one version of the USA where we regulate nuclear power into the ground and compare it to what happens where we don’t, holding everything else constant. Even if we did, holding everything else constant is impossible, it is just too complicated. Yet economics is in practice very useful for understanding, modeling and predicting this complex mess. How?
Economics is a discipline, which means it is a set of rules for how things work that you apply to mental models of how things work, so that you can simplify complex things and figure out how they work. Key ideas let us understand how things work in simple chunks of a complex process, and if we carefully chain those simple chunks together we can understand a pretty big chunk of process. Not all of it, but hey, we’re only human. Screwing up because we think we know everything is pretty much our super power.
The most important rules and concepts follow. I will talk about each in its own (shorter) post, but here’s the set: three big patterns and ten core concepts that tie it together.
Economic Way of Thinking: Greatest Hits
3 Patterns of Thought
The Seen and Unseen – Don’t just focus on the obvious, easy to measure effects, but consider the hidden and difficult to measure, as well as long term effects.
Corollary: Just because it can’t be measured doesn’t mean it isn’t important, and just because it can be measured doesn’t mean it is.… And then what? – Always think of what happens next. People respond to changes by changing their behavior, and other people respond to that, etc. Changing one thing always leads to changing the world.
There are No Solutions, Only Trade Offs! – There is never a “fix” without any sort of downside. Always consider the costs and the benefits, and be honest about how they actually stack up against each other.
10 Core Concepts to help think in the 3 Patterns
Incentives Matter – people change their behavior in response to carrots and sticks, regardless of what the designer of the incentives hopes for.
Opportunity Costs – The question is never “Is this situation good?” but rather “Is this choice better than the next best choice?” The next best choice is what you are giving up, not Nirvana.
How Markets Work – Markets allocate goods and knowledge to those who demand them the most, by way of supply and demand creating prices.
How Prices Emerge – Prices emerge from the interactions of buyers and sellers and not the dictates of either.
Comparative Advantage – Opportunity costs are what determine who is the most efficient producer, i.e. who can make something the cheapest, not just input costs.
The Division of Labor – Individual brains are limited. Through specialization we gain new knowledge (innovation) by relying on others to know things we don’t.
The Extended Order of Cooperation – The market prices act as signals allowing us to coordinate the production activities of billions of people to serve the desires of billions of people, most of whom never meet.
Externalities – All of our actions affect others. If we do not pay for the bad effects we are likely to do too much of that, and if we are not rewarded for the good effects we are likely to do too little. Dangerous concept when pushed too far, but important in policy considerations.
How Politicians Behave / What Politicians Can and Cannot Do – Politicians are not omnipotent, omniscient or otherwise god like. They are humans with sets of incentives, constraints and limited knowledge, within which they seek to further their personal goals. Just like everyone else.
Marginal Thinking – Most things are good in some amount and bad in another amount. If we think of the small steps we can find those cross over points, as well as better predict the effects of different sized changes.