Posts tagged Economic Thought
Morality and ECON 101

In Fall 2018, I was assigned to teach International Economic Policy (Econ 385) at George Mason University, a trade class for non-economics majors.  As a student of Adam SmithFrederic Bastiat, and Don Boudreaux, I was excited to teach this class. The miracle of the market was such an eye-opener for me as a high schooler. I could not wait to share my love of economics with students!

My enthusiasm was immediately dampened as I realized I faced many students whose mindset seemed hostile.  Extolling the virtues of trade in the standard mutual-gains manner would not fly with this crowd.  I had to find another way.

These are the opening lines to my guest post on EconLog entitled Morality and ECON 101. Do check out the whole thing.

Today's Quote of the Day...

…is from Scott Sumner’s August 24th 2019 blog post at EconLog “There’s No Reason to Go Heterodox” (emphasis added):

During the 1970s, high interest rates did not seem to slow inflation. As a result, all sorts of heterodox theories of inflation were invented. Too much union power, crop failures, monopoly power, budget deficits, oil prices. And each one failed, because it was monetary policy that was driving 11% NGDP growth (1971-81), which made 8% inflation inevitable. As soon as Volcker did an orthodox tight money policy, inflation promptly came down and heterodox theories of inflation were abandoned. Heterodox macro theories are the result of bad macro policies.

JMM: Scott’s final sentence can be generalized: heterodox theories tend to be the result of bad policies. Oftentimes, people (including seasoned analysts) make the mistake of analyzing some event in a vacuum: Outcome X has occurred, standard theory does not seem to have an answer for X, therefore theory must be incorrect/incomplete. Thus, all sorts of theories come about. We’re seeing this with International Trade right now with all the various (and often competing) theories coming out of the White House.

Of course, none of this is to say that heterodox theories are necessarily bad. In a sense, all theories start out heterodox. Rather, this is to say to be careful of tossing out established theory without a darn good reason.

Today's Quote of the Day...

…comes from page 66 of “Miscellaneous Writings”, part of the Liberty Fund’s collection “The Selected Writings of Edmund Burke.” This quote in particular is from Burke’s 1795 treatise “Thoughts and Details on Scarcity”

First, then, I deny that it is in this case [of the laborer working for an employer], as in any other of necessary implication, that contracting parties should originally have had different interests. By accident it may be so undoubtedly at the outset; but then the contract is of the nature of a compromise; and compromise is founded on circumstances that suppose it in the interests of the parties to be reconciled in some medium. The principle of compromise adopted, of consequence the interests cease to be different.

JMM: One of them ore egregious mistakes people make when discussing economics is the idea that labor and management are at odds with one another, that labor is in competition with employers. But in reality, labor enhances employers (otherwise they wouldn’t be employed). Employees cooperate with employers and compete with other employees, not the other way around.

Today's Quote of the Day...

…is from Don Boudreaux and and Burt Folsom’s Fall 1999 Antitrust Bulletin article Microsoft and Standard Oil: Radical Lessons for Antitrust Reform:

It follows that the best available evidence for whether or not a firm enjoys monopoly power is the firm’s own record at satisfying consumer demands: Do real prices in markets in which the firm offers products fall? Does output in these markets expand? Are innovations in these markets regular? If so, the firm is likely not a monopolist. Like Standard Oil, Microsoft does not behave as though it possesses monopoly power. Therefore, we argue that it, in fact, does not possess monopoly power.

JMM: Economists and antitrust lawyers have developed all kinds of statistics and metrics to try and gauge, from an objective point of view, whether or not a firm is in a monopolist position. This is also true in other realms of economic regulation: trying to identify public goods, externalities, perfect compensation, etc etc. In the end, though, our best tool is to observe that which people do. How people behave tells us a lot about the econoomic conditions we are dealing with.

Economics is About Selflessness

If you walk down the street and ask any random person what they know about economics, I’d be willing to bet you’d get two potential responses: 1) supply and demand, and 2) people are self-interested. Both these responses are generally accurate, but a bit simplistic. To describe the former would require a 700+ page book. So, let me focus on the latter.

In economic models, people are assumed to be self-interested, which simply means that they are trying to improve their lot in life with the resources available to them. If people are motivated by this self-interest (which does not imply a lack of altruism), does this mean that economics is driven by self-interest? Absolutely not; our science indicates otherwise: economic behavior is driven by selflessness.

In order to get a voluntary exchange, both parties need to benefit. This means asking the question “what can I do for the other person?” It is true that the butcher is not benevolent enough to just give us our dinner; we must seek to give him something in return. Thus, we need to know what he wants in return and give it to him.

Free markets are often sold as being a meritocracy, but this is something of a misnomer. The confusion of this term comes up from time to time, especially when trying to examine wage gaps: “Person X is very good at Y. Why does he make less than Person Z who is doing Y’ “? In a free market, the person who earns the highest is not necessarily the person who is the absolute best at doing something, but the person who is best at providing what other people want. Jim may be the best salesman this side of the Mississippi, but if he’s selling encyclopedias door-to-door, we will likely earn less than middling salesman Jack who is selling high-end computers. The merit is based on who best serves others, not who is best.

The interesting implication of this is that markets inadvertently promote virtuous behavior. By encouraging and rewarding selflessness, markets foster virtues like justice and selflessness. This, to me, is a major insight of Adam Smith and liberal economics: the “invisible hand” promotes not just opulence but also virtue. It is a mistake to focus, as some economists do, on the edifice of self-interest; that is merely the beginning, not the end.

Along these same lines, I strongly recommend this article by Sam Fleischacker: “Economics and the Ordinary Person; Re-Reading Adam Smith.”

Against Economic Casuistry

In any science, there is a tendency to lay down rules for conduct following some theory or discovery. Economics is no different. However, I will argue here that, in economics, this tendency is not only wrongheaded, but doomed to failure. As economists, we should resist economic casuistry.

Casuistry is “endeavour[ing] to lay down exact and precise rules for the direction of every circumstance of our behavior,” (Adam Smith, Theory of Moral Sentiments, Pg. 329). Smith is writing in the context of moral philosophy and natural jurisprudence, referring to the moralists who attempt to have a rule for every aspect of human interaction, but his definition and description work for our purposes here.

Economic textbooks, especially at the principles level, has a tendency towards casuistry. Principles books tend to lay down certain rules for economics, especially in the realm of policy. Rules like “always do cost-benefit analysis,” or “if the market has failed in a certain way, government can intervene by doing X,” or “public goods should be provided by government,” etc. Policy conversation in the real world revolve around such rules: “we’ve identified problem X, and so recommend policy Y.” For example, Trump is using national security to justify tariffs. Dani Rodrik identifies all sorts of problems and recommends policy changes in his book Straight Talk on Trade.

But the issue Smith highlights in his discussion of moralistic casuistry, namely that identifying and knowing every rule for every situation is damn near impossible, applies to economics as well. Take, for example, the rule that if a market failure occurs, there is some action the government can take to address the failure. As I have written elsewhere, properly identifying market failures is extremely difficult. A “market failure” requires a comparison to a perfectly competitive market, a comparison which may not be valid with the existence of transaction costs. Furthermore, since benefits (and thus also costs) are subjective, identifying transaction costs themselves is a difficult, if not impossible, task.

John Nye also writes on the difficulties when trying to set polices for dealing with market failures. He discusses that there are already many small Coasian bargains going on around externalities and that policy prescriptions tend to fail to take these into account.

What all this adds up to is one simple fact: identifying market failures is not as straightforward as textbook models represent. As Ronald Coase says, paraphrasing Frank Knight, these discussions ultimately come down to a discussion of morals and aesthetics.

We can do this for all supposed market failures. Identifying public goods, for example, is extremely difficult as the definition relies heavily on the scope of the problem you are looking at. National defense, the quintessential public good, is a public good at a small scale (the Army protecting Washington DC from attack also protects Maryland), but at a large scale, it becomes a private good (the Army can choose whether or not to defend Mexico). So, is national defense a public or private good? Hard to tell. Thus, hard to set rules.

Classifying economic situations and outcomes is not as simple as classifying an animal in biology. A lot of it will depend not only on the actors involved, but the judgement of the spectator, the analyst. As such, it is very loose and vague. Precise rules, like those laid forth in economics textbooks, will tend to fail.

None of this is to say one should just through up their hands and do nothing. There can, indeed need, to be rules. But they should also be loose, more negative than positive. Rules such as private property, where people can do as they wish so long as they do not harm each other. Courts that can interpret issues when conflicts inevitably arise. In short, “thou shalt not” rules rather than “thou shalt.” As economists, we must resist the natural urge to lay down 10,000 commandments, rather going for rules more like the 10 Commandments.

How Do We Decide Who We Can Trust?

Writing for the AEIR, Art Carden has an excellent article entitled “Government is Not a Wise Steward.” In the article, Art is discussing differing ways to use tax dollars. Art writes:

Given its track record, it’s not at all clear to me that the U.S. government — or my state, county, or local government — would be a wise steward of any money I feel like I don’t need. You know those bumper stickers that say something like “It will be a great day when schools have all the money they need and the army has to hold a bake sale to buy a tank,” or something like that? I’m not sure I want more of my money going to an entity that spends so much on tanks and bombs.

Should they [government] give it [tax dollars] to charity? Maybe. Even then, the decision isn’t quite as clear-cut. There are a lot of nonprofits that seem to exist strictly to raise funds, not to actually solve any problems, as Tyler Cowen points out in his book Big Business: A Love Letter to an American Anti-Hero (which I discuss here). Even if we address the possibility that we end up joining a scam like the Bluth Foundation’s battle against TBA, Yoram Barzel famously argued that it is very difficult to give away money in a way that benefits the people we are trying to help. Even for the devoted humanitarian with resources like GiveWell at her disposal, “Give your money to charity” wouldn’t obviously deliver maximal bang for one’s benevolent buck.

The issue of which charity to give to, whether it be private or public money, is always tricky. The point of charity is to do good, and ideally you want your dollars going to purify water in Africa or protect the Icelandic puffins rather than pay someone’s salary in the US. But how do we get that sort of information? How do we get the knowledge needed to know who we can trust, whether it be to save the whales or sell us our dinner? After all, it is not from the benevolence of the brewer, baker, and butcher that we get our dinner.

Interestingly enough, that knowledge is gained through the competition process. Suppliers do not compete with other suppliers on price alone (same with buyers against other buyers). One of the things that they compete on is trust: You trust that the supermarket will sell you non-contaminated food. You trust the bank will not steal your money. You trust that the burger you get from Five Guys in Colorado will be just as good as the one you get in Maryland. As Hayek wrote in The Meaning on Competition, part of the competitive process is to teach us who will best serve us.

Thus, with government as steward, without a robust competitive process, there is no way to generate that kind of knowledge. And with government, it is hardly competitive. In other words, government is unlikely to be a good steward with funds (opting, say, for health care or education over bombs) because it lacks the very ability to get that form of local knowledge needed to know who the best recipients of funds should be.

Of course, the private sector competition is not perfect. As Art points out, there are a lot of difficulties in determining charities. But we only have the information that some charities are relatively better than others because of that competition.

If government were to be a good steward, it would need certain kinds of information, but that information is only available locally and through competition.

Does Economics Imply Liberalism?

Economics as a field of thought as we understand it today began with the Enlightenment period.* As such, the initial study of economics was done through a liberal lens. The economic policy recommendations that came out of this study, popularly known as laissez-faire certainly has a liberal feel to it. Indeed, Smith christened his system developed in The Theory of Moral Sentiments and The Wealth of Nations as “the liberal system.”

But does this foundation imply that economics is inherently liberal? I posit it is not necessarily the case. One can understand economics very well and be illiberal.

Let’s take, for example, a simple supply and demand model. This model serves as the foundation of much of economics (indeed, we can derive pretty much all of economics from one simple fact; resources are scarce. This fact leads us to opportunity cost, which leads us to demand curves, with leads us to supply curves, which gives us the foundation of modern economics). Liberals will often point to the supply and demand model, rightfully so, to show the unintended consequences of illiberal policies; according to the model, minimum wage will lead to unemployment (especially among the marginally employable) or price controls will lead to shortages. These outcomes of the model are cited by liberals.

But those outcomes were also initially cited by illiberals in support of those same policies. The fact that minimum wage kept marginally employable people out of work was a benefit to many initial proponents of the minimum wage (see the Congressional debates on the Davis-Bacon Act). It has been used recently for justification for minimum wage to keep immigrants out of jobs.

But there are other implications of the model. As A.C. Pigou showed, if there are costs that fall on other people, the model suggests that a tax can be imposed to correct for these costs. Ronald Coase showed this logic holds if there are transaction costs to negotiating. Paul Samuelson showed that one of the implications of the model is, given certain assumptions, international trade without barriers can actually harm a domestic nation’s overall economic welfare. More recently, some behavioral economics like Richard Thaler have shown now, again as implied by the model, that certain “nudges” can be applied to correct market failures. All of these are implied by the model and are illiberal in nature.

Liberals can, and do, object to some of the items discussed in the previous paragraph. They cite public choice concerns, or calculation and knowledge problem issues. They cite the self-interest of politicians or the problems of bureaucracy. All of these are important (and also implied by the model as well).

As we can see, the model itself (which we are using here as a segment of economic knowledge) does not imply in and of itself any liberal or illiberal bias. It is, in that sense, apolitical. How the model is applied, what exceptions or policies are proscribed, do not depend, thus, on the economic science but rather on the subjective and estimated probabilities of the individual using the model. For example, let’s say we have two people using the supply and demand model to recommend policy dealing with pollution. An analyst who puts relatively low probability on government’s ability to correctly set a Pigouvian tax would recommend no explicit policy (or, perhaps, something akin to cap-and-trade). Meanwhile, an analyst who has a relatively high probability of the government’s ability to correctly set a Pigouvian tax may recommend such a tax. Both these analysts are guided by the same model, but their recommendations and predictions based of the model are different. They’re not different because one is more ignorant than the other. The objective data being used is the same. What is different is the subjective data each analyst uses.

Economic knowledge does not imply a liberal outlook. Just like any science, it can be interpreted and applied in different ways.

*I am hesitant to give it an exact starting point, such as highlighting Adam Smith as many people do. Smith may have been the first systematic treatment of economics in English, but there were many other authors who were considering the problems of economics before him: David Hume, Francis Hutcheson, Gershom Carmichael, the French Physiocrats (who influenced Smith), and the Salamanca School, just to name a few.

Today's Quote of the Day...

…is from this EconLog post by David Henderson (emphasis added):

If you think that the government should provide truly public goods, that is, goods that are non-excludable and non-rival in consumption, then you should think that government should provide the public good of preventing an asteroid from hinting earth. Here’s the problem: The U.S. government, which has access to more resources than any other government on earth, is almost certainly underinvesting in the technology to deflect or destroy asteroids. Just as private actors don’t have much of an incentive to produce truly public goods, neither do government actors.

JMM: In standard economic treatment of market failures, governments are treated as something of a deus ex machina. They can just come in costlessly and effortlessly to solve any problem by applying just the right remedy. On paper, it’s a simple enough story. But what incentives do governments face to provide such solutions (assuming away knowledge problems)? It’s unlikely they face incentives from voters. Market failures tend to be characterized by free-rider problems, and free-riders do not suddenly want to start paying, even if they benefit. Furthermore, the problems are often dispersed, making them hard to observe. Perhaps they are motivated by “doing the right thing,” and that’s all fine and dandy, but are we ready to assume all judges, bureaucrats, and politicians are purely motivated by the Greater Good?

On top of the difficulties of identifying a true market failure, we need to keep in mind the incentives people face.

Are Public Goods Necessarily Undersupplied?

In economics, public goods are goods which are non-rival (a person’s use of the good does not reduce the ability of another person to use the same good, eg listening to the radio) and non-excludable (people who do not pay cannot easily be prevented from using the good, eg when a burglar is arrested, everyone in a neighborhood benefits, not just those who paid for the security service). Because of this definition of public goods, we tend to teach undergrads that public goods will therefore necessarily be undersupplied, that in a free market the amount of the good produced is less than the socially optimal level of production. As such, government may be able to step in and, though use of taxation, correct this underproduction (see, for example, Page 369 of Modern Principles of Economics by Tyler Cowen and Alex Tabarrok).

But is it necessarily the case that public goods are necessarily undersupplied in a free market? It does not seem clear to me that it is.

The first question we need to ask is “as compared to what?” What is the free market outcome undersupplied compared to? It is compared to what would be the socially optimal level where everyone who benefits pays the cost (the intuition here is this: if an individual can earn more producing something, they will produce more of it, all else held equal. Supply curves slope upward).

Now we need to ask: is this an attainable alternative? In a free market setting, it does not appear to be so. After all, as we argued above, given the characteristics of a public good, they will tend to be undersupplied. Getting people to pay for their use is difficult. A more technical way of saying this is the transaction costs are high. The marginal benefit of receiving the payments exceeds the marginal cost of obtaining those payments. In a zero-transaction cost world, the socially optimal level would be easily obtained. There is some bargain that could be reached where those who enjoy the benefit without paying the cost (free rider problem) could be incentivized to pay the cost and production would increase. This is just an application of the Coase Theorem.

If, however, as posited by the public goods problem, the transaction costs of solving the free rider problem are too high, then the socially optimal level is not necessarily an attainable alternative. It’s a fantasy alternative. Thus, it is an irrelevant comparison. It’d like saying “I’d be better off with a fairy godmother who grants wishes than needing to work for my well-being.” Sure, but given faeries don’t exist, that’s a meaningless choice. The choice is between working and living well or not working and living poorly.

If the socially optimal outcome of the model is not a real alternative, then the situation is already at an optimal outcome. There is no undersupply. Thus, public goods are not necessarily undersupplied.

A note of caution: none of what I just wrote should be taken to mean that the free market outcome is necessarily the best outcome. There may be better alternatives. Government (or some other non-market force) may be able to achieve an alternative arrangement that is superior to the free market outcome. For example, better defining property rights can lead to less undersupply of public goods. But in movement from one alternative to the other, we need to consider the transaction costs. Do the benefits of moving from the market alternative to the non-market alternative outweigh the costs?

With this article, I reiterate a point made by Ronald Coase, Carl Dahlman, Harold Demsetz, and many others before me: transaction costs matter. We need to compare attainable alternatives and consider how institutions actually work as opposed to an idealized version of them. Comparing a market outcome to an idealized, but unobtainable, alternative does not provide any guidance to our thought.

Today's Quote of the Day...

…is from this 1997 Reason Magazine interview with Ronald Coase:

Reason: Can you give us an example of what you consider to be a good regulation and then an example of what you consider to be a not-so-good regulation?

Coase: This is a very interesting question because one can't give an answer to it. When I was editor of The Journal of Law and Economics, we published a whole series of studies of regulation and its effects. Almost all the studies--perhaps all the studies--suggested that the results of regulation had been bad, that the prices were higher, that the product was worse adapted to the needs of consumers, than it otherwise would have been. I was not willing to accept the view that all regulation was bound to produce these results. Therefore, what was my explanation for the results we had? I argued that the most probable explanation was that the government now operates on such a massive scale that it had reached the stage of what economists call negative marginal returns. Anything additional it does, it messes up. But that doesn't mean that if we reduce the size of government considerably, we wouldn't find then that there were some activities it did well. Until we reduce the size of government, we won't know what they are.

JMM: Ronald Coase’s careful study of the data through the lens of theory is important for us to observe. Coase was unwilling to move to the conclusion that, just because the majority (if not all) the government regulation led to undesirable outcomes, it must therefore be true that all government regulation is necessarily harmful. He points out another answer that is contained within the very models used in the analyses: negative marginal returns.

Data cannot “speak for themselves.” Data without theory have no context and thus mislead. The man who looks only at data and ignores theory is not practicing science, but rather scientism.

From Spontaneous Order to Codification

A while ago, I did a blog post on the “Hayek Memorial Pathway,” one of a series of pathways that have developed on campus though people’s actions. Well, they’re doing a bunch of construction on campus and part of it includes paving the Hayek Memorial Pathway.

Some years from now, people will forget that the pathway was one unpaved and unplanned, that it was only by the constant movement of thousands of students that the path at all formed in the first place. All the “government” (i.e., George Mason University) did was codify what people already did.

Socialists and central planners often point out various institutions and state proudly “look at the good government is doing!” What they fail to see, however, is the spontaneous orders that predated those codifications. For example, they fail to see the development of the law that legislation merely codified. Or the development of money that legislation merely codified. These institutions were not part of government planning, but rather of government codification of already-in-action plans.

Likewise, this is why I disagree with “one-drop” libertarians (ie, those who oppose anything and everything government does, insisting it must inherently be inefficient). Not every institution the government codifies is inherently inefficient. When they merely codify what people are already doing, then that may not change the efficiency at all (indeed, given certain conditions, it may improve efficiency). GMU paving the Hayek Memorial Pathway does not in and of itself imply the pathway is in any way less a spontaneous order or less efficient.

Economic Growth and the Division of Labor

Tyler Broker, the Free Expression and Privacy Fellow at U. Arizona Law School (also my friend), has a very good article at Above the Law. There is much to like in Tyler’s article, but I do want to pick one important nit. Tyler writes:

Indeed, in near-Earth space one can easily visualize how the best aspects of capitalism will be utilized to lift humanity into a new age. Capitalism operates best when markets are allowed to continually grow and expand. This is in part why a capitalist system has been so successful (for some), here in the United States. This country began with 13 colonies and followed with continual territorial and population expansion for the next 200 and counting years. Of course, this expansion came at the great conquest and exploitation of human labor, including enslaving whole civilizations and generations of human beings. An unfathomable wrong yet to be fully acknowledged, appreciated in the scope of barbarity, or morally corrected.

Tyler is correct that markets are best when they can grow and expand. However, Tyler’s comment suggests this growth is in physical territory and labor. While those resources are important, they are not the only thing. Markets also expand by taking advantage of the division of labor and specialization. Early on in his famous book, Adam Smith shows how specializing allows a pin factory to become more productive. When people divide their labor, they can become more productive. This means they produce more with fewer (or the same number of) inputs.

However, the division of labor is limited by the extent of the market. On a deserted island, Robinson Crusoe cannot specialize. When Friday comes, he can. If more people can come to the island, Robinson can specialize more and more.

Expanding the market can mean, as Tyler discusses above, expanding land and labor. But it can also occur by trade. If the world were to discover an alien race beyond the stars and (assuming transaction costs overcome) began trading with them, that would expand our markets.

More land and labor can help markets flourish, but imperialism need not be an end-point for capitalism (I do not think Tyler is suggesting it is, but there are some out there who do argue imperialism is the only way to sustain capitalism). Rather, simply opening up trade, markets can expand, and prosperity can grow.

Who Are the Job Creators?

We sometimes hear about job creation in the economy and typically this is referenced toward business owners. Jeff Bezos created X number of jobs with Amazon, or some new company will move to an area and create Y number of jobs. There is a sense where these entrepreneurs created jobs since their actions are bringing the jobs into being.

But there is another way to consider who creates jobs: to whom does the job benefit? A job exists in a market because it looks to fill a hole, to satisfy some end. My mechanic has a job because I need him to work on my car. My grocer has a job because I want her to feed me. My doctor has a job because I want her to give me medical advice. In this sense, the consumers are the job creators.

A productive job exists to serve some end that someone is willing to pay for. A job that does not serve some end ceases to exist. To the extent entrepreneurs are creating jobs, it is because they are seeking to satisfy some desire; the “demand” for the service has created the jobs.

Jon MurphyEconomic Thought
Revealed Preferences Matter

Below is an open letter to Spectator USA:

Editor:

The Spectator USA report “Identity is Just as Important as Wealth. Why Don’t Economists Get That?” contains a number of errors and strawmen versions of economic theory. However, the largest error is the premise of the article stated here:

But apart from the needless fear [nationalism] generates, it is also slightly dubious to suggest that it is the gilets jaunes or the Five Star Movement or the supporters of Brexit or even Donald Trump who are acting intemperately. It is perfectly possible to argue that these movements are a sensible, overdue reaction against governments that have imposed economic globalization on the world at a pace that is entirely inconsistent with the human lifespan and the speed at which we can adapt to change. The free movement of people, the euro, large-scale immigration, the dissolution of the nation state — for that matter the admission of China to the WTO… all were imposed on the world by ideologically motivated elites with little public consultation. Regardless of whether you think they are good or bad, there is a perfectly sensible secondary question to be asked about whether they were too much too soon. Remember, such decisions are usually made by economists, who do not really understand either time or scale.

Globalization, by definition, cannot be imposed. What freedom of trade and freedom of movement means is people, not elites, not economists, not governments, choose how people choose to deploy their resources. Liberalization of trade no more imposes on people than freedom of religion imposes on people. You, your readers, and all other people are free to choose to buy local or choose not to. When China joined the WTO, it did not impose on anyone to conduct business with them, nor did the WTO impose anyone to deal with China.

The fact of the matter is, however, people were free to deal or not deal with foreigners and they chose to deal with foreigners. Given this was an action freely taken, we can conclude that no, nationalism isn’t preferred to globalization. People choosing freely chose more than identity, and for whatever reason. The revealed preferences of Americans and Britons was to trade with foreigners. Indeed, trade liberalization indicates that national identity is not as strong a force as nationalists believe, which is why nationalism, not globalization, needs to be imposed.

Despite your claims otherwise, economists are not “obsessed with the gains arising from scale.” Rather, we study the interactions of people and the gains from trade freely made. Scale is just one side benefit of that; the real benefit is people improving on their current position. Any intro textbook will explain that (indeed, I highly recommend William Allen and Armen Alchian’s newly-released “Universal Economics”).

Signed,

Jon Murphy

George Mason University

Fairfax, VA

Ruminations on the Law of Demand

Two events today caused me to start thinking on the Law of Demand and its power as an explanatory tool.

The Law of Demand in Medical Care

When I lecture on the Law of Demand, which simply states that all else held equal as price rises quantity demanded falls, I inevitably get the objection: “What about necessities like food, water, health care?”

Even for these supposed necessities, the Law of Demand applies. Relatively high prices cause people to search for alternatives. One such example of this is in the Bob’s Burgers episode “Sexy Dance Healing” (Season 6, Episode 8). The titular character, Bob Belcher, goes out on a walk to try and gain inspiration for his Burgers of the Day (a running gag in the show. Each of the Burgers of the Day are usually pun-named, such as the “Never Been Feta Burger” (comes with feta cheese)). While walking past a message parlor storefront, Bob slips on oil poured on the sidewalk and tears his labrum. Bob goes to the doctor who informs him he’ll need surgery and his deductible is super-high: “like, $6,000 high.”

As per the Law of Demand, Bob begins to consider different options to pay for the surgery he wants but cannot afford outright. He considers suing the store that poured the oil on the sidewalk. He even goes so far as to have his lawyer serve notice, but the masseuse offers Bob a deal: the masseuse insists he can heal Bob without surgery. If Bob is not healed after 10 sessions, he will pay for Bob’s surgery.

So, the lesson from this story: the relative price of Bob’s surgery was high. Even though Bob needed medical care, the high price caused him to search for alternatives (spoiler alert: the alternative Bob chose worked out well). The doctor’s price of surgery was too high. If he lowered the price, Bob would participate; in technical terms, if the price fell, Bob’s quantity demanded for labrum surgery would increase.

A high price of medical care causes people to seek alternatives. A diabetic may try to change their diet. A person suffering arthritis may seek holistic approaches. A person suffering from psoriasis may move to a more humid climate. Et cetera. That these people seek alternatives, thus implying that if the price was lower they’d consume more of the good in question, indicates that the Law of Demand holds even in the case of medical care.

The Law of Demand and Power over Consumers

The second example of the power of the Law of Demand comes from the realm of trade. Commenting on this Cafe Hayek post, Jorod Smith writes:

Voluntary exchanges are nice. Now what happens when one country becomes so dependent on imports from and exports to one other country? The other country actually controls the country that relies on it for imports and exports. This is exactly the problem we have with China. 

Mr. Smith’s fears are unwarranted. Imports and exports do not equate to “dependence” on another individual, regardless of how much they might make up your trade. Currently, 100% of my food comes from sources external to me, namely Wies Supermarket. I grow none of my own food. However, despite this, Wies holds exactly no sway over me. They cannot dictate to me in any way, shape, or form my behavior. If Wies were to try to jack up prices or exert some other kind of pressure on me, I could easily go to another competitor. But what if there is no other competitor? Then I would seek other alternatives: I could grow my own food or seek some other substitute (consume less food, switch to things that get me more calories per dollar, etc). In other words, they’d have no influence on my behavior as I could seek alternatives.

To bring this back to China, if the Chinese government were to try to impose some preferred policy on the US by threatening trade disruptions, it’d be as ineffective as the US blockade was in forcing the Castros out of power in Cuba or the Kims out of power in North Korea. Economic sanctions tend to be very ineffective. Why? Because of the Law of Demand. As relative prices rise, people start to seek alternatives. In the case of the Castros, it caused them to look toward the Soviet Union. In the case of the Koreans, it caused them to look toward the Chinese. If the Chinese were to try to threaten something, US consumers could seek other competitors. If none are available, they could turn inward. Indeed, this is why the attempt by the Chinese to jack up rare earth metals prices failed.

Conclusion

In his classic book, The Theory of Price, George Stigler writes of the Law of Demand:

How can we convince a skeptic that this “law of demand” is really true of all consumers, all times, all commodities?… Perhaps as persuasive a proof as is readily summarized is this: if an economist were to demonstrate its failure in a particular market at a particular time, he would be assured of immortality, professionally speaking, and rapid promotion while still alive. Since most economists would not dislike either reward, we may assume that the total absence of exceptions is not from lack of trying to find them. And this of course hints at the real proof: innumerable examples, ranging from the wife who cuts down on strawberries because they are out of season ( =more expensive) to elaborate statistical investigations, display this result.

Pgs. 22-23

The Law of Demand remains an extremely powerful tool. Indeed, one can build all of price theory off of it. My above two examples show its utility. A thorough understanding of the Law of Demand can get one very far.