What is Economics About - California State University ...



What is Economics About?

Economics is about the wealth of nations. That phrase comes from the title of a book published in 1776 by Adam Smith, the father of economics. The full title of the book is An Inquiry into the Nature and Causes of the Wealth of Nations. In simpler words, that title is asking an important question: Why are some nations rich and others poor?

...the savage nations of hunters and fishers...are so miserably poor that, from mere want, they are frequently reduced, or, at least, think themselves reduced, to the necessity sometimes of directly destroying, and sometimes of abandoning their infants, their old people, and those afflicted with lingering diseases, to perish with hunger, or to be devoured by wild beasts. Among civilised and thriving nations, on the contrary, though a great number of people do not labour at all, many of whom consume the produce of ten times, frequently of a hundred times more labour than the greater part of those who work; yet the produce of the whole labour of the society is so great that all are often abundantly supplied, and a workman, even of the lowest and poorest order, if he is frugal and industrious, may enjoy a greater share of the necessaries and conveniences of life than it is possible for any savage to acquire. (Smith, 1776)

Today, rich nations have grown even richer, while some poor nations are no better off than they were in Smith’s time. Annual per capita income in 2006 ranged from a high of $76040 in Luxembourg to a low of $100 in Burundi.

The wealth of nations like Burundi has hardly changed since Smith’s time, while the wealth of nations like Luxembourg has increased hundreds of times. Why? Smith’s answer was that economic progress is greatest in countries that allow people to peacefully pursue their own best interest.

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things. (Smith, 1776)

By “the natural course of things”, Smith meant people’s natural tendency to seek their own best interest: to own the most profitable business, to work at the best job, and to shop for the best products at the best prices. Smith found that a nation’s wealth would be promoted by free trade policies. The government should keep taxes low, avoid burdening businesses with excessive regulations, should not dictate prices or wages, and should not restrict imports or favor exports. This is usually known as a libertarian or laissez faire philosophy. The story goes that in 1680, the French finance minister asked a group of merchants how the government could promote the economic health of France. The leader of the group, M. Le Gendre, answered “Laissez nous faire.” (‘Leave us be.’). By 1750, a popular slogan among free trade advocates was "Laissez faire et laissez passer, le monde va de lui même!" ('Let do and let pass, the world goes on by itself!').

a. The Invisible Hand

One of Smith’s most important ideas was his concept of the invisible hand.

...every individual necessarily labors to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. (Smith, 1776)

In other words, if you want to make a living, you have to produce something that people want to buy. The better you serve your customers’ interests, the richer you will become. Leave people alone, and their own greed will drive them to serve others the best they can.

The invisible hand is a theme that appears again and again in economics, and it is worth noting how the same idea has been expressed by other writers.

Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes, the supply of all the things made of tin, and their substitutes, and so on; and all his without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes. (Hayek, 1945)

And in case you thought that the idea of the invisible hand originated with Smith, here is some sound economic advice from an ancient Chinese philosopher:

If people are hungry, it is because the government is taxing and interfering too much; this is why people rebel. If goods and trade are free and not restrained, black markets won't develop and the people needn't be criminals. When the way of nature is ignored, regulations, codes and hypocrisy emerge. The people are rebellious when rulers meddle in their affairs. The more laws, the more violators. Therefore, that leader is best who governs least. If we keep from meddling with people, they take care of themselves. If we keep from commanding people, they behave themselves. If we keep from preaching at people, they improve themselves. If we keep from imposing on people, they become themselves. The way is like an invisible hand, a spirit guide that leads without interfering. Here is the way: set people free. (Lao Tzu, 450 BC)

b. Central Planning Versus Free Market Capitalism

In the twentieth century, the most serious challenge to the free market philosophy was the central planning philosophy of socialism and communism.

Intellectuals everywhere take for granted that free enterprise capitalism and a free market are devices for exploiting the masses, while central economic planning is the wave of the future that will set their countries on the road to rapid economic progress...The facts are very different...The most obvious example is the contrast between (communist) East and (Capitalist) West Germany. ..People of the same blood, the same civilization, the same level of technical skill and knowledge inhabit the two parts. Which has prospered? Which had to erect a wall to pen in its citizens? ...On one side of that wall the brightly lit streets and stores are filled with cheerful, bustling people...(On the other side) the streets appear empty; the city, gray and pallid; the store windows, dull; the buildings, grimy. (Friedman, 1979)

Milton Friedman, the most prominent advocate of free markets of the twentieth century, wrote those words in 1979, in his best-selling book Free to Choose. That book, more than any other, can take a good deal of credit for the worldwide collapse of central planning in the 1980’s. India, China, Russia and its satellites, all began to move away from central planning in favor of free markets, and as a result saw their rates of economic growth jump from 0-3% per year under central planning into the range of 6-10% per year under free markets.

Most American children have heard the story of the first Thanksgiving: the Pilgrims’ arrival at Plymouth in December, 1620, their suffering in their early years, and their later celebration of a good harvest. Children have not heard as much about the Pilgrims’ experiments with communism and capitalism. The Pilgrims found, then as now, that communal property ownership led to poverty, while a capitalist system of private property led to prosperity. William Bradford, the governor of the colony, described the colonists’ experience in 1623:

...they began to think how they might raise as much corn as they could, and obtain a better crop than they had done, that they might not still thus languish in misery. At length, after much debate of things, the Governor (with the advice of the chiefest amongst them) gave way that they should set corn every man for his own particular, and in that regard trust to themselves; in all other things to go on in the general way as before. And so assigned to every family a parcel of land, according to the proportion of their number, for that end, only for present use (but made no division for inheritance) and ranged all boys and youth under some family. This had very good success, for it made all hands very industrious, so as much more corn was planted than otherwise would have been by any means the Governor or any other could use, and saved him a great deal of trouble, and gave far better content. The women now went willingly into the field, and took their little ones with them to set corn; which before would allege weakness and inability; whom to have compelled would have been thought great tyranny and oppression.

The experience that was had in this common course and condition, tried sundry years and that amongst godly and sober men, may well evince the vanity of that conceit of Plato's and other ancients applauded by some of later times; that the taking away of property and bringing in community into a commonwealth would make them happy and flourishing; as if they were wiser than God. For this community (so far as it was) was found to breed much confusion and discontent and retard much employment that would have been to their benefit and comfort. For the young men, that were most able and fit for labour and service, did repine that they should spend their time and strength to work for other men's wives and children without any recompense. The strong, or man of parts, had no more in division of victuals and clothes than he that was weak and not able to do a quarter the other could; this was thought injustice. The aged and graver men to be ranked and equalized in labours and victuals, clothes, etc., with the meaner and younger sort, thought it some indignity and disrespect unto them. And for men's wives to be commanded to do service for other men, as dressing their meat, washing their clothes, etc., they deemed it a kind of slavery, neither could many husbands well brook it. (William Bradford, 1623)

c. Specialization and Comparative Advantage.

A barber and a bricklayer might earn about the same income, and might have comparable levels of skill and training, each in his own field. But let a bricklayer try to cut your hair, or let a barber try to build a brick wall, and you will soon find that it is best for people to stick to their own field. Adam Smith called this the principle of the division of labor, and it is often called the law of comparative advantage.

The state of Washington has a climate that is good for growing apples, while Georgia is best for growing peaches. Figure 1.1 shows hypothetical production-possibilities curves for Georgia and Washington. These curves show the different combinations of apples and peaches that the two states are capable of producing. The curves show, for example, that Washington has a comparative advantage at growing apples, while Georgia has a comparative advantage at peaches.

If farmers in Georgia specialized in peaches they could grow 60 per day, while if they specialized in apples they could only grow 30 per day. Washington farmers should specialize in apples and grow 40 per day, since if they specialized in peaches they could grow only 20. With specialization, Washington and Georgia could produce a total of 40 apples and 60 peaches. Assuming apples and peaches both sell for $1 each, the total income of Georgia farmers would be $60, while the income of Washington farmers would be $40. If consumers in Georgia want to buy some apples, they should buy them from Washington for $1. Georgia farmers could have grown that apple, but only at a cost of 2 peaches—peaches that could have sold for a total of $2. Similarly, Washington consumers who want peaches should buy them from Georgia for $1.

But suppose that people in Georgia start to worry about all the apples they buy from Washington. They might think it is unpatriotic to buy ‘foreign’ apples from Washington. They might be inspired by “buy local” rhetoric. They might be worried that Georgia is in danger of becoming a ‘one-crop’ economy, or that Georgia should “diversify its agricultural base”. They might believe in discouraging ‘imports’ in order to keep jobs in Georgia or to reduce their ‘trade deficit’ with Washington. For any of these reasons, Georgia’s government might use some combination of taxes, subsidies, or regulations to diversify its production. Instead of specializing and producing 60 peaches, Georgia diversifies and produces 30 peaches and 15 apples. Georgia politicians might not notice, but farmers’ income would drop from $60 to $45.

People in Washington might have the same concerns about all the peaches they import from Georgia. Furthermore, they will be outraged by Georgia’s unfair restrictions on the purchase of Washington apples. If Washington takes similar steps to diversify, it could end up producing 20 apples and 10 peaches. The incomes of Washington farmers would fall from $40 to $30. The two states’ combined production of apples would have fallen from 40 to 35, while their combined production of peaches would have fallen from 60 to 40. Small wonder then, that economists almost always favor free trade, and oppose restrictions on imports.

For anyone who still needs convincing about the benefits of specialization and trade, and the coordinating role played by the invisible hand, consider Leonard Read’s remarkable story of the manufacture of an ordinary pencil.

I, Pencil, simple though I appear to be, merit your wonder and awe, a claim I shall attempt to prove. In fact, if you can understand me—no, that's too much to ask of anyone—if you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing. I have a profound lesson to teach. And I can teach this lesson better than can an automobile or an airplane or a mechanical dishwasher because—well, because I am seemingly so simple.

Simple? Yet, not a single person on the face of this earth knows how to make me. This sounds fantastic, doesn't it? Especially when it is realized that there are about one and one-half billion of my kind produced in the U.S.A. each year.

... My family tree begins with what in fact is a tree, a cedar of straight grain that grows in Northern California and Oregon. Now contemplate all the saws and trucks and rope and the countless other gear used in harvesting and carting the cedar logs to the railroad siding. Think of all the persons and the numberless skills that went into their fabrication: the mining of ore, the making of steel and its refinement into saws, axes, motors; the growing of hemp and bringing it through all the stages to heavy and strong rope; the logging camps with their beds and mess halls, the cookery and the raising of all the foods. Why, untold thousands of persons had a hand in every cup of coffee the loggers drink!

... Observe the labeling. That's a film formed by applying heat to carbon black mixed with resins. How do you make resins and what, pray, is carbon black?

My bit of metal—the ferrule—is brass. Think of all the persons who mine zinc and copper and those who have the skills to make shiny sheet brass from these products of nature. Those black rings on my ferrule are black nickel. What is black nickel and how is it applied? The complete story of why the center of my ferrule has no black nickel on it would take pages to explain.

...There is a fact still more astounding: the absence of a master mind, of anyone dictating or forcibly directing these countless actions which bring me into being. No trace of such a person can be found. Instead, we find the Invisible Hand at work. (Read, 1958)

d. Scarcity and Competition

Some goods are not scarce. Air is free for the breathing. Sunsets cost nothing to see. But if you want food, clothing, housing, or thousands of other goods, you usually have to pay for them. When goods are scarce, people will compete for them. In a modern economy, competition often takes the form of price competition, where the good goes to the highest bidder. You don’t usually think of yourself as ‘bidding’ for a gallon of gasoline for your car, but that would not be a bad description. You got that gallon of gasoline because you were, in effect, the high bidder for that gallon.

In 1973, the U.S. government tried to suppress price competition in the market for gasoline. The free market price of gasoline was about 60 cents per gallon, but government officials felt that this price was too high, and that only the rich would be able to afford gasoline. A price of 60 cents was considered ‘gouging’, and it created ‘windfall profits’ for big oil companies. So the officials established a price ceiling of about 40 cents per gallon.

The results were disastrous. Most gasoline stations stopped selling gasoline. The few open stations had lines of cars stretching for blocks, and drivers typically had to spend two hours in line before they could fill their tanks. Government officials had ignored an obvious fact: Gasoline was a scarce good, and it could not be made ‘un-scarce’ by official decree. When the officials suppressed price competition, people merely switched to another form of competition: waiting in line. Instead of a gallon of gasoline going to the person who was willing to pay the most money for it, that gallon now went to the person who was willing to wait the longest for it. Compared to price competition, waiting in line is inefficient. If a customer has to pay an extra 20 cents per gallon, then the customer loses 20 cents while the seller gains 20 cents. But if a customer spends 20 cents worth of his time waiting in line, the customer still loses 20 cents, but the seller does not gain that 20 cents, it is simply lost.

People competed for gasoline in still other ways. When fights broke out in gas lines, people were competing for gasoline by violence—an even more wasteful form of competition than waiting in line, when you consider injuries and medical bills. When gasoline sellers let friends and family members buy gasoline after-hours, those people were competing by their social and family connections. When gasoline sellers gave favorable treatment to the prettiest customers, those customers were using their beauty to compete. If you think price competition unfairly favors the rich, think how much more unfair beauty competition is. A rich person who competes for a good by spending a lot of money on it has less money as a result. But beauty is not used up. The most beautiful people would always be able to out-compete the less attractive.

e. The No Free Lunch Principle

University presidents claim that they will hire professors who are better teachers—but not at the expense of research activity. Environmentalists claim that we can have a greener world without sacrificing economic growth. Stock promoters claim that if you will spend $60 to buy a share of stock today, then that share will be worth $70 next month. Feminists claim that women are underpaid relative to men, and do not receive equal pay for equal work. What do all these people have in common? They are all ignoring the No Free Lunch principle. If women really earned only 80% as much as men for doing the same work, then what rational employer would pass up the chance to cut labor costs by 20% by replacing male workers with women? If smart stock traders really expect a stock to rise by $10 next month, then the stock price would have already risen $10 in anticipation. Pollution can certainly be reduced by installing filters on smokestacks, but does anyone imagine that those filters cost nothing?

The no-free-lunch principle can be illustrated with the production-possibilities curve (PPC) in figure 1.2. This curve shows all the combinations of apples and oranges that some community is capable of producing. This time the PPC is shown bowing out from the origin. This reflects what economists call the Law of Diminishing Returns: As you pick more apples from a tree, you have to reach higher and work harder for each additional apple, since you would have picked the easiest apples first. The diagram shows that in the time that you took to pick the 20th apple from a tree, you could have picked three oranges.

The community could locate at point A, producing 12 apples and 8 oranges. But the community can clearly do better. Moving to point B would yield 3 extra oranges without sacrificing any apples. Moving to C would yield 4 extra apples with no sacrifice of oranges. We say that A represents inefficient production, because it is possible to produce more of at least one good without sacrificing any other good. Points B and C—and all the points on the production-possibilities curve—are efficient. Once apples and oranges are being produced efficiently, the only way to get more apples is to produce fewer oranges.

So when a university president announces that he will hire new professors who are better teachers, without sacrificing research activity, you can use figure 1.2 to analyze his claim. Just replace ‘Apples’ with ‘Research’, and ‘Oranges’ with ‘Teaching’. If the president is telling the truth, he is saying that the university in currently at a point like A, producing an inefficient combination of research and teaching. But it is more likely that the president is not facing up to the fact that hiring better professors is not easy. If the university is already doing the best it can—locating at a point like C, then the only way to get better teaching is to sacrifice some research and move to a point like B.

f. The Broken Window Fallacy

Frederic Bastiat’s story of the broken window describes a shopkeeper whose window is broken by a little boy. Everyone sympathizes with the man whose window was broken, but pretty soon they start to suggest that the broken window provides a job for the glass man, who will then buy bread, benefiting the baker, who will then buy shoes, benefiting the cobbler, etc. Finally, the onlookers conclude that the little boy was not guilty of vandalism; instead he was a public benefactor, creating economic benefits for everyone in town.

The fallacy of the onlookers' argument is that they ignored the cost to the shopkeeper. As the shopkeeper was forced to spend his money on a new window, he obviously could not have spent it on something else. For example, the shopkeeper may have spent the money on bread and shoes for himself, but now cannot pay his money to the baker and cobbler because he must fix his window.

It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented. (Bastiat, 1850)

Thus, the child did not bring any net benefit to the town. Instead, he made the town poorer by the value of one window.

The broken window fallacy appears surprisingly often, sometimes even from economists who should know better. Writing after the terrorist destruction of the World Trade Center, economist Paul Krugman wrote:

Ghastly as it may seem to say this, the terror attack—like the original "day of infamy" which brought an end to the Great Depression—could even do some economic good. [...] the driving force behind the economic slowdown has been a plunge in business investment. Now, all of a sudden, we need some new office buildings. As I've already indicated, the destruction isn't big compared with the economy, but rebuilding will generate at least some increase in business spending. (Krugman, 2001)

Would you make yourself richer by destroying your own house? Clearly you would provide employment for yourself in rebuilding the house, but you could have spent that time building yourself a second home. Similarly, the resources spent rebuilding the Trade Center could have been spent on new buildings. Then America could have had the new buildings and the Trade Center.

We often hear that the Great Depression of the 1930’s was ended by World War II. The war, it is said, provided jobs for millions in building ships, planes, and other weapons. This is the broken window fallacy all over again, on a massive scale. But what is a student to think when most history teachers, and even many economists, claim that it is true? What about the plain fact that the Depression did, in fact, end at about the time WWII started? On the other hand, how can anyone accept the absurd claim that the wealth of a nation is increased by putting people to work building weapons, and sending them off to be blown to bits?

Currently, the most widely accepted resolution to this puzzle involves money—paper dollars issued by the Federal Reserve and checking account dollars issued by private banks. The Great Depression probably happened because a combination of bank runs and tight money policies by the Federal Reserve led to a large reduction in the total quantity of money. This reduction in the money supply made it difficult for people to do business, and economic activity slowed. WWII forced the government to print a great deal of money in order to pay for the military buildup, and the resulting increase in the money supply ended the Depression. (This is covered in more depth in the chapter on money.) Note that if the government had issued more money without entering the war, the Depression would have ended just the same, but the resources spent on weapons could have been spent building houses and cars instead.

g. Cost-Benefit Analysis

Economists are trained to think in terms of costs and benefits. Should new cars have air bags? An economist will ask how many lives will be saved, and at what cost? Air bags save lives, but at a cost of about $1.8 million per life saved. Seat belts save lives at a cost of about $30,000 per life saved. So if the $1.8 million spent on saving a life with airbags had instead been spent on seatbelts, 60 lives could have been saved for the same expense. Economists have examined many different ways to save lives. Colo-rectal cancer screening saves lives at a cost of $400,000 per life saved. Asbestos removal from old buildings costs $145 million per life saved. Estimates like these help decision-makers choose where to focus their efforts, and where to leave things alone.

Should cars be built to get better mileage? That question too requires cost-benefit analysis. Congress has forced carmakers to improve fuel economy, but this comes at a cost. To get higher mileage, cars must be built lighter. People who drive lighter cars are more likely to be killed in an accident. Economists estimate that the result of U.S. fuel economy standards is that an additional 3000 people per year are killed on U.S. roads each year. Is that cost worth the benefit of using less fuel? Economics gives us tools to help answer that question.

Environmental issues are a frequent subject of cost-benefit analysis. An economist would start by trying to put a dollar value on the costs of pollution. One way to do this is to compare property values in polluted areas and unpolluted areas. By measuring how much higher property values are in unpolluted areas, economists can put a reasonable dollar figure on the environmental cost of each additional ton of air pollutants. For example, economists have estimated that the environmental damage done by burning one ton of carbon is about $43. If correct, that would put the environmental damage from burning gasoline at 12 cents per gallon. This suggests that a gasoline tax of 12 cents per gallon would motivate people to consume the optimal amount of gasoline, since the tax would automatically force drivers to pay for the environmental damage caused by driving.

h. Why Study Economics?

It’s all well and good to discuss the wealth of the nation, but what about your wealth? A college student should be thinking about how to make a living. Economics graduates often find jobs working for government agencies, banks, or other financial institutions. The table below shows that the starting salaries of economics graduates rank fourth of the majors shown. So should you study economics? That depends. If you are smart enough to understand engineering, computer programming, or mathematics, then you would earn more in those fields. On the other hand, most students find economics to be easier than those fields, so they are willing to trade away some income for an easier life. But economics is more difficult than other business-related fields like accounting and finance, and this shows in the higher incomes earned by economists.

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Of course, salary is only one part of the picture. Art and philosophy won’t get you much of a salary, but the people who choose those fields might care little about money and more about spending their time in the way that they choose. Elementary school teachers earn a low annual salary, but they only work 9 months of the year. If they worked year-round their incomes would be close to $41,000.

Beware! College majors with low salaries tend to offer easy grades to attract students. At the University of Pennsylvania, for example, the average grade in humanities classes is 3.4—a high B+. In social sciences the average grade is 3.3, while in the natural sciences it is 3.0. The numbers are similar at universities across the country. At the University of Wisconsin the average grade in liberal arts classes is 3.6. In business it is 3.25, and in engineering it is 3.13. A recent study of classes at Harvard found that 78% of students taking introductory women studies classes get an A, while only 12% get A’s in introductory biology.

It doesn’t take an engineering major to figure out the pattern here: majors that offer poor job prospects (like humanities and social sciences) give high grades in order to attract students. Professors in those fields keep their jobs by attracting students, and it is no skin off their nose if their graduates can’t earn a decent living. Majors that offer students good job prospects (like engineering and economics) give lower grades. As a student, you might be tempted to major in sociology instead of economics because you will get A’s instead of B’s. You will have an easier time getting through college, but you will pay for it later with a 22% reduction in your salary!

If you don’t do well in economics, then by all means, choose another field. If your grades are low in other fields too, then it is possible that you have enrolled at a university that is too competitive. For example, a student in a liberal arts program at a top-tier university is probably smart enough to complete an engineering degree at a middle-rank university. Which to you think will get you a better job: An English Literature degree from Harvard or an engineering degree from Ohio State? Of course, if you are already at a low-ranked university and you are still struggling, then you should face the fact that many students do not belong in college. You might be in that group, and if you are, you are not doing yourself any favors by staying in college, especially in a low-salary major. You would do much better choosing a career that does not require a college degree. Below is just a small sample of the jobs you are missing out on:

Nursing $60,000/year

Dental Hygienist $60,000/year

Computer Support $40,000/year

Paralegal $43,000/year

Radiology Technician $43,000/year

Jobs like these require 2 years or less of schooling, and they often pay more than the highest-paid college majors. It is true that college degrees often offer more chances for advancement than vocational degrees, but if you are struggling in college, or taking classes with poor job prospects, there is a good chance that you would be better off dropping out of college. (Personal note: The richest person I ever met was a garbage man!)

i. Questions

1. “Before Tianenmen, we believed that freedom is 90 percent political and 10 percent economic. A few years later, we came to realize that freedom is 90 percent economic and 10 percent political." What is meant by ‘economic freedom’?

2. A group of officials from the former Soviet Union toured American farms. They persistently asked who told the American farmers how much of each crop to grow, in order that the right amount of each crop would be produced. The American farmers answered that nobody told them what to grow. The Soviets refused to believe them, saying that without central direction, farm production would be chaotic, with farmers blindly planting too much wheat, too little corn, etc. What would you have told the Soviets?

3. "This issue of energy and global warming has the promise of creating millions of new jobs in America. It can be a win-win, if we do it right."—Sen. Hillary Clinton

What economic fallacy is being committed here?

4. Students compete for admission to college based on intelligence, religious background, looks, income, race, national origin, and skin color. Do you think colleges should be prohibited from allowing students to compete in some of these ways? Why or why not? People compete for marriage partners in the same way. Should these kinds of competition be prohibited? Why or why not?

5. “What is economic freedom? The freedom to be a parasitic capitalist? The freedom that matters most is freedom from want. Without that kind of freedom, economic freedom is meaningless.” Evaluate this statement, with particular attention to what is meant by ‘freedom’, and ‘parasitic capitalist’.

6. “Market signals tell you where you are most valuable. The highest-paying job is likely to be the job where you contribute most to general welfare...Generally speaking, it's morally safer to work for money than to work for a cause. People who are fanatical about causes do much more damage.” Give some examples to support or refute this statement. Hint: Who does more good in the world? A missionary or a plumber?

7. “men who engage in business with the object of making as much money as possible are no better than pirates or robbers.“ Can you think of any difference between businessmen and robbers?

8. St. Thomas Aquinas taught that if a rich man refuses to share his wealth with the poor, his surplus should be taken from him. Do you agree or disagree? What would happen to the wealth of the nation if this became official policy?

9. “Every American has a right to the best health care possible.” What would happen to the wealth of the nation if this became official policy?

10. You are a better speller than you roommate, but he is a more creative writer than you. You are both assigned to write a paper. Would your grades be better if you worked on your two papers separately, or if you wrote two papers cooperatively?

11. Comment on the following ‘Customer Complaint’ letter. Why do you think the seller of this defective product sold it? Why do you think the buyer bought it in the first place?

Dear President Crow:

I am writing this letter to notify the Office of the President of Arizona State University — as well as the College of Liberal Arts and Sciences — that I am thoroughly dissatisfied with the Bachelor’s of Arts degree in English Literature that I purchased from your institution via layaway in August of 2003.

Despite repeated attempts in different situations (job interviews, ice cream socials, blind dates, carnivals, etc…) the product I purchased from you fails to live up to the promises extended to me. The thing flat-out does not work. It has garnered me not one iota of respect, admiration, or financial gain and I would appreciate a full or partial refund at your earliest convenience.

I would also ask to have my refund sent to me by way of cash or money order since I am currently sorting through some personal banking issues and unable to use checks.

If your return policy disallows full or partial refunds, I may be interested in an exchange of some sort — perhaps either a Bachelor’s of Sciences degree in Computer Engineering or a Master’s in Business Administration (I believe it’s also referred to as an MBA). I’ve heard some pretty good things about those products.

Note: Please do not send me an exchange degree in Art History, or Political Science, or any other “liberal arts” (whatever that means) subject, as my experience with the English degree has really kind of turned me off of those.

Again, I am very dissatisfied with my B.A. in English Literature degree that I purchased from you in August of 2003 and would appreciate — and expect — either: a) a full or partial refund (again, in cash or money order form); or b) an exchange degree (preferably in Computer engineering or some type of Doctorate).

Please send response or payment to my parents’ address as I am sort of in-between residences at the moment and “couch-crashing” with some friends:

12. Evaluate the following discussion:

Student A: “I could have gone into the film industry and made tons of money, but I chose to study economics instead because I couldn't live with the idea of standing idly by while so many people continue to suffer from poverty.”

Student B: “If you would make more money making films than being an economist, then you would contribute more to the world as a film-maker than as an economist. If you think making films amounts to standing idly by, then you are forgetting that (1) People do not live by bread alone. Poor people need entertainment along with food. (2) Somewhere there is a farmer who works a little harder and grows a little more food because he wants to buy a video. Someone got fed because of that video. (3) Rich filmmakers have more money than poor economists with which to fight poverty.”

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The Top Ten The Bottom Ten

Income per person in Income per person in

the ten richest countries the ten poorest countries

|  |2006 |

|Luxembourg |76040 |

|Norway |66530 |

|Switzerland |57230 |

|Denmark |51700 |

|Iceland |50580 |

|Ireland |45580 |

|United States |44970 |

|Sweden |43580 |

|Netherlands |42670 |

|Finland |40650 |

Economic Freedom and Economic Growth

If the invisible hand really is a significant economic force, then we should see significant differences in wealth between countries that promote free trade and those that suppress it. In a decades-long study, economists have attempted to rank various nations according to an index of economic freedom, and to observe the correlation between economic freedom and wealth. The results of this study are plotted in Figure 1.1.

[pic]

Figure 1.1: Economic Freedom and Wealth

This study examined 42 variables that each measured some aspect of economic freedom—things like taxation, size of government, strength of private property rights, and business regulations. Clearly, greater economic freedom is correlated with greater wealth, just as Adam Smith said. Of course, one could object that ‘economic freedom’ is impossible to measure accurately, or that the results were tainted by the researchers’ biases, or that the study confuses cause and effect. Unfortunately, empirical work is always vulnerable to these kinds of objections, especially in economics. That is why economists spend a great deal of time doing econometric work--collecting and analyzing data, in the hope of arriving at sound conclusions.

|Niger |260 |

|Rwanda |250 |

|Sierra Leone |240 |

|Eritrea |200 |

|Guinea-Bissau |190 |

|Ethiopia |180 |

|Malawi |170 |

|Liberia |140 |

|Congo, Dem. Rep. |130 |

|Burundi |100 |

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