Tag: time matters

In Praise of GLS Shackle

You must have heard of the drunk who was searching for his keys under a streetlight. When asked why he is searching here, rather than the place where he had dropped the keys, the drunk replies that he can see well over here.

Haha and all that.

Here’s Kenneth Arrow writing about a person you likely have not heard of, GLS Shackle. Arrow is writing about why people aren’t interested in reading Shackle anymore:

The reason for the current lack of interest is probably not any denial that Shackle’s position is fundamentally correct; it is the absence of the analytic tools needed to make the exceptional approach capable of generating operationally meaningful conclusions.

https://www.journals.uchicago.edu/doi/abs/10.1086/257884

What was GLS Shackle’s position, and who was GLS Shackle?

GLS Shackle was an economist. Wikipedia tells us that he started work on a PhD under the supervision of Hayek, but that he later switched to “an interpretation of Keynes’s General Theory of Employment, Interest and Money”. Because we know that the truth lies somewhere in the middle, this is a most wonderful thing, of course. Note too that there is a correct way to handle a situation such as this, and Hayek was more than up to the task:

A student of Hayek’s at the London School of Economics in the 1930s, Shackle renounced his early Hayekian views and the doctoral dissertation on capital theory that he had already started writing under Hayek’s supervision, after hearing a lecture by Joan Robinson in 1935 about the new theory of income and employment that Keynes was then in the final stages of writing up to be published the following year as The General Theory of Employment, Interest and Money. When Shackle, with considerable embarrassment, had to face Hayek to inform him that he could not finish the dissertation that he had started, no longer believing in what he had written, and having been converted to Keynes’s new theory. After hearing that Shackle was planning to find a new advisor under whom to write a new dissertation on another topic, Hayek, in a gesture of extraordinary magnanimity, responded that of course Shackle was free to write on whatever topic he desired, and that he would be happy to continue to serve as Shackle’s advisor regardless of the topic Shackle chose.

https://uneasymoney.com/2014/01/22/g-l-s-shackle-and-the-indeterminacy-of-economics/

And what was his position? This is not an easy question to answer, and I will admit that I am not entirely sure of the correct answer. But given that disclaimer, here is the best I can do:

You can either reject rationality or time

What does this mean, and why does it matter?

A rational-expectations model allows for stochastic variables (e.g., will it be rainy or sunny two weeks from tomorrow), but those variables are assumed to be drawn from distributions known by the agents, who can also correctly anticipate the future prices conditional on any realization (at a precisely known future moment in time) of a random variable. Thus, all outcomes correspond to expectations conditional on all future realizations of random variables; there are no surprises and no regrets. For a model to be correct and determinate in this sense, it must have accounted fully for all the non-random factors that could affect outcomes. If any important variable(s) were left out, the predictions of the model could not be correct. In other words, unless the model is properly specified, all causal factors having been identified and accounted for, the model will not generate correct predictions for all future states and all possible realizations of random variables. And unless the agents in the model can predict prices as accurately as the fully determined model can predict them, the model will not unfold through time on an equilibrium time path. This capability of forecasting future prices contingent on the realization of all random variables affecting the actual course of the model through time, is called rational expectations, which differs from perfect foresight only in being unable to predict in advance the realizations of the random variables. But all prices conditional on those realizations are correctly expected

https://uneasymoney.com/2014/01/22/g-l-s-shackle-and-the-indeterminacy-of-economics/

I wouldn’t blame you if your eyes glazed over while reading this. But bear with me, and let’s go over this slowly:

  1. Imagine that you are a farmer, and you are going to harvest strawberries two weeks from now.
  2. If it rains at or around the time of the harvest, your harvest is going to be destroyed. If it doesn’t rain, you will have strawberries to sell. Should you assume that you will have a harvest ready to sell, or not?
  3. Imagine that your best friend has a shop that sells smartphones, and you’ve told him that you will buy a smartphone from his shop, once you’ve sold your strawberries. Should he assume the sale of a smartphone to you, or not?
  4. The strawberries from your farm are usually purchased by a jam manufacturing company. This company has, for the first time ever, won a contract to sell its famous strawberry jam to Walmart. They got this contract because of the quality of your strawberries. No harvest on your farm, no sale of their jam to Walmart.
  5. This firm has promised temporary employment to locals to make this jam, who in turn have promised their families a trip to their hometown once the jam manufacturing company pays them.
  6. Toy manufacturers in that hometown are anticipating a rise in sales when these families come visiting.
  7. We don’t know if it will rain in two weeks or not. Nobody does. But should we assume that we can forecast rain with x% probability?
  8. And should we therefore assume that we know today the prices of smartphones, the wage-rate for hiring workers to make jam, the price of a ticket to a village nearby, and the prices of toys in that village – all of these two weeks from now?
  9. Now read the last two sentences in that excerpt above:
    “This capability of forecasting future prices contingent on the realization of all random variables affecting the actual course of the model through time, is called rational expectations, which differs from perfect foresight only in being unable to predict in advance the realizations of the random variables. But all prices conditional on those realizations are correctly expected”

GLS Shackle was saying that there is no such thing as rational expectations, because, well, time. That is, if you accept rational expectations as a feature of your model, you must reject time. And if you accept time, you must reject rational expectations.

So, dear reader, do you accept the existence of time, or not?

But what does the “existence of time” mean, in the context of economics?

Note that I am going to keep things as simple as possible, both for your sake and mine. And the simplest possible answer to this question is this:

Acknowledging the existence of time necessarily implies that the future is always, and by definition, unknowable

You have two choices: to continue reading from here on in, or to stop reading at this point. You have created your future by choosing one of these two courses of action. And until you make that choice, your future is unknown.

If, after you stopped reading, you walked into a store and purchased a jar of strawberry jam, you changed the future of the store owner, the strawberry jam manufacturer, the part time employee of the strawberry jam manufacturer, the kid of the part time employee and the toy manufacturer. If you didn’t stop reading, and therefore ran out of time to buy that jar, you changed their future too! And of course, if it rains (rained?) in the next two weeks, there might not be any strawberry jam to buy in the first place! Oh, and of course you could sprain your ankle while stepping into that store. Or <insert random event of your choice here>.

We just don’t know what our future holds, and our future is being shaped and fashioned by the choices made by million of other people – in much the same way that their futures are being shaped and fashioned by the choices made by you.

Bottomline?

Acknowledging the existence of time necessarily implies that the future is always, and by definition, unknowable

Again, GLS Shackle was saying that there is no such thing as rational expectations, because, well, time. That is, because the future is inherently and by definition unknowable – not predictable, not modelable – there can be no such thing as rational expectations.

Is there any point, then, to building a rational expectations model?

If you say no, you are a newly minted member of Team Shackle. If, on the other hand, you say yes – well, I hope you find those keys of yours under this streetlight.

Good luck!

Short Term vs Long Term

Friday’s post contained this line:

“But that simply behooves us to accept the economic principle that Time Matters. Take the long term view, not the short term one!”

Here’s Stephen J. Terry, via Tyler Cowen, over at MR:

R&D investment reduces current profits, so short-term pressure to hit profit targets may distort R&D. In the data, firms just meeting Wall Street forecasts have lower R&D growth and subsequent innovation, while managers just missing receive lower pay. But short-termist distortions might not quantitatively matter if aggregation or equilibrium dampen their impact. So I build and estimate a quantitative endogenous growth model in which short-termism arises naturally as discipline on conflicted managers and boosts firm value by about 1%. But short-termism reduces R&D, and the social return to R&D is higher than the private return due to standard channels including knowledge spillovers and imperfect competition. So at the macro level, short-termist distortions slow growth by 5 basis points yearly and lower social welfare by about 1%.

https://marginalrevolution.com/marginalrevolution/2023/10/the-costs-of-short-termism.html

Here’s a simple (perhaps too simple) way to understand this point:

  1. Imagine you’re 18 years old. What is the best thing you can do to raise your income today? Drop out of college and start working, of course.
  2. What is the best thing you can do to raise your income over the course of your entire lifetime? Do not drop out of college and start working, of course.
  3. Investing in education today maximizes your chances of earning a higher amount of money over the course of your life. Or so the theory goes today, at any rate. That’s a bit like investing in R&D today.
  4. But the reason I added the caveat “perhaps too simple” because I acquiring an education today benefits me, not others (although there might be some spillovers, sure). But R&D today may not benefit only my firm, it might benefit other firms more. Ask ChatGPT to explain this sentence – “the social return to R&D is higher than the private return due to standard channels including knowledge spillovers and imperfect competition”. Which is why this analogy isn’t perfect.
  5. But even so, the point is (or should be) well taken. Think long term! (I struggle with this myself, by the way, but I console myself by saying almost all of us do).

Zero Sum Games and Evolution

I’m reading (and thoroughly enjoying) Alchemy, by Rory Sutherland. My thanks to Shashikant Kore for the recommendation.

It is a light but thought-provoking read, and if you are a relatively fast reader, you could finish it fairly quickly, even in one sitting. But I’ve resisted the urge to do so, and I read a little bit every day. It makes the process more enjoyable, and I also enjoy thinking about what I’ve read until I pick up the book again.

I may write a fuller review of the book later on (knowing me, don’t hold your breath), but for now, I wanted to talk about a particular excerpt that I read a couple of days ago:

For instance, as Geoffrey Miller notes, a tribe where males advertised their hunting prowess by conspicuously sharing meat from their kills would prosper, as a result of economically irrational behaviour. On the other hand, an otherwise identical tribe whose males signalled their strength by violently fighting each other would suffer as a consequence: even the eventual winners of these contests might end up badly wounded and with a lower life expectancy. The first one is a positive sum game, while the other is anything but. An extreme pessimist might suggest that, although competition for wealth markers is wasteful and harmful to the planet, it is a lot less harmful than many other forms of intergroup or interpersonal competition.

Alchemy, by Rory Sutherland, Location: 2,746, Kindle Edition

Such a wonderful paragraph and so much to talk about.

  1. Showing me the phrase ” positive sum game” is like showing a red rag to a bull. Of course I’m going to bite!
  2. What is the context here? This risks become a very long post, but I will provide a set of links here for background. Please read them later, if you’re so inclined.
    • Read about sexual selection: the idea that “for a gene to persist, the body that carries it needs not only to survive but to reproduce”.
    • Read about Fisherian runaway selection: “the exaggerated secondary sexual characteristics of animals could evolve by means of a runaway evolutionary process in which an initial small adaptive dimorphism was then further developed into a much more heightened trait by an ongoing interactive combination of female selective choice and increased male advantage.”
    • Long story short, how do genes persist across generations of species? By getting members of this species to reproduce. How should these genes “get” these members to reproduce? By being able to signal their worthiness. How should one signal one’s worthiness? Peacocks do so with their tail feathers, bullfrogs do it by being truly impressive croakers.
  3. And Rory Sutherland asks us to imagine a tribe of humans in which one’s worthiness is signaled by “conspicuously sharing meat from their kills”. That is, awesome hunters are able to hunt bigger and better animals, and these awesome hunters will find it easier to find mates, the more (and more conspicuously) they share the spoils from their hunts. Better hunters will get better mates, and the next generation will therefore produce even better hunters, and “soon” we will have a tribe of mostly (only?) awesome hunters.
  4. Rory Sutherland also asks us to imagine a tribe of humans in which one’s worthiness is signaled by “violently fighting each other”. Imagine the two best hunters in a tribe showing their worthiness not by laying out the proverbial feast, but by fighting each other to the death. Sure, the fittest will survive, but note two things. First, the slightly weaker hunter is dead. That’s bad news for the tribe in both the short and the long run. Second, the stronger hunter survives, but at a very high cost. Maybe the stronger hunter can’t survive himself for much longer after the fight. Or can’t reproduce. Or can’t hunt. He has “won”, but at what cost?
  5. Which approach is better? Obviously the conspicuous sharing of the spoils from hunts approach. This approach is the non-zero-sum approach (or the positive sum approach) if you prefer. This sort of competition gets more food for the tribe, and leaves the tribe with healthy hunters tomorrow, and lots of young hunters with possibly even more talent in the next generation. For a hunter to win at arranging the best feast, other hunters (and the rest of the tribe) don’t have to lose – in fact, they win!
    The other approach leaves you with dead or badly injured hunters – for a hunter to win, all other hunters (and therefore, eventually, the tribe) have to lose.
  6. As an economist, I have to protest the use of the phrase “as a result of economically irrational behaviour”. Rory Sutherland uses this phrase in the context of hunters sharing their meat. But why should this be economically irrational behaviour? In fact, over time, this may well end up being economically rational behavior! People who take only the short term view are being irrational, sure. But that simply behooves us to accept the economic principle that Time Matters. Take the long term view, not the short term one! And once you do so, sharing ain’t irrational at all!
  7. But in general, I love the point that positve-sum games are beneficial not just in and of themselves, but also from an evolutionary perspective. Very cool!
  8. “An extreme pessimist might suggest that, although competition for wealth markers is wasteful and harmful to the planet, it is a lot less harmful than many other forms of intergroup or interpersonal competition”. The opportunity cost of fancy yachts, in other words, is death and destruction.
    Imagine alpha males who signal how awesome they are by invading countries or killing each other in the name of religion, for example. What a horrible world that would be. No?

Why is it bad to be rich?

Navin asked this question on Twitter recently:

(My thanks to Mihir Mahajan for pointing the tweet out to me, and for requesting for a post on this topic)

My current plan is to answer this question over three posts. In today’s post, I’ll try and answer this question using a first principles approach. That is, without using Google, or ChatGPT3, or my notes and references, I’ll answer this question using nothing more than what I think are the basic, foundational principles of economics.

In tomorrow’s post, I’ll trawl through the internet (and make use of ChatGPT3), and throw in articles/blog posts I’ve bookmarked over the years that speak to this point. And finally, in the post the day after tomorrow, I’ll speak about books you might want to read about this topic.

But even before having written down a single word re: my first principles argument, here is my answer in short: it is wonderful to be rich.

Six principles, if you ask me, that you absolutely must learn if you are a student of economics (and note that whether you like it or not, everybody is a student of economics):

  1. Incentives Matter
  2. TINSTAAFL
  3. Trade Matters
  4. Costs Matter
  5. Prices Matter
  6. Externalities Matter

As I was telling somebody the other day, most – if not all – problems in economics can be thought of using these six principles. If you truly understand these six principles and all of what they imply, you will be able to reduce every economic problem you meet down to the application of these six principles. The applications may be nuanced, there may be more than one principle applicable, and you may have to supply a lot of caveats. But you’ll go a very long way towards tackling your problem of choice by starting with these six principles.

And I’ll fire my first salvo at Navin’s question by deploying the third principle in the list: trade matters.

People get rich by trading with other people. Sure, people have gotten rich in the past (and in some cases, even today) by expropriating property, through loot and through dacoity. But I hope you don’t think I’m ducking the issue by saying that’s not the focus of today’s post. My focus in today’s post is about people who get rich through peaceful, voluntary trade. This particular process of getting rich focuses on offering you, through entirely peaceful, non-coercive means, a trade.

You are free to evaluate the terms of this trade, and if they seem agreeable to you, you enter into this trade. Note that the only reason you do is because you think that doing so is to your advantage. You are better off for having done this trade, relative to the option of not doing so. And the person who offered this trade to you is presumably better off for you taking the other end of it, for why else would she have offered you this trade instead?

That’s a non zero sum game, and the more we play such games with each other, the better off we are. That’s what the principle of “Trade Matters” means, and that is what it entails: peaceful, voluntary trade leaves both parties better off, and the world is therefore better off for this trade having gone through. If, as a consequence, both parties get richer, that’s A Very Good Thing, and it is therefore good to be rich.

But remember that for some problems, the applications of these principles may be nuanced, and that there may be more than one principle applicable.

First, opportunity costs. TINSTAAFL stands for There Is No Such Thing As A Free Lunch, and even to a non-zero sum game, opportunity costs are very much applicable. In the context of international trade, your level of analysis matters. Trade might make sense at the level of the parties involved in the trade, but that doesn’t necessarily mean that everybody else is better off as a consequence:

Because in the case of trade between countries, as opposed to trade between individuals, there are people who will lose out. If a university in the United States of America hires me to teach online classes to the students over there, there isn’t a hypothetical amateur cook who is losing out. There is an actual person in that country who could have taught this course, but is no longer able to because of me.
The university that hired me is better off, because it is able to hire the services of a teacher for less money. To the extent that I do about as good a job as the person I replaced, the students are (at least) indifferent. And given how strong the dollar is, I am certainly better off!
But it is not enough to say that both parties in this trade are better off (I and the university). A complete economic analysis should also include the person in the USA who is out of a job, and I would argue that one should also include what I find myself unable to do here in India as a consequence of teaching that course abroad. Both of these are the opportunity costs of this trade, and a complete economic analysis should include these aspects as well

.https://econforeverybodyblog.wordpress.com/2023/01/10/so-no-one-loses-when-it-comes-to-trade-rightright-part-ii/

Trade might then, at the margin, cause an increase in inequality. You’d be surprised at how old (but still somewhat underrated) an idea this is, but the opportunity cost of more trade might well imply an increase in inequality. So you might well say that it is bad to be rich because the opportunity cost of you being rich is that somebody else is (comparatively) poor.

But be careful with how you proceed with this! It cuts both ways, this analysis. Is the opportunity cost of reducing inequality a reduction in the creation of wealth? When you attempt to reduce inequality by taxing the rich, you reduce their incentive to trade. And remember, they get rich by voluntarily trading with you, and if that trade leaves you better off, you’ve made yourself poorer in the bargain.

If you tax Amazon so much that Amazon decides it is better for them to shutter up altogether, have you made the world better off or worse off? I’d urge you to ignore your first, visceral take, and take a look at your Amazon app to find out how often you’ve ordered from Amazon in the past month before answering this question.

So I’d argue that it still is good to be rich – but it ain’t for free. But in my opinion, the price is worth it. One can, and one should, argue about what the appropriate level of taxation should be. One can, and one should, worry about tactics used by Amazon to make sure that they remain a monopoly provider of certain goods and services. One can, and one should, worry about whether Amazon pushes its employees a little bit too much. I’m not defending Amazon as a perfect company without flaws. But I very much am saying that the world is a better place because Amazon exists. There are costs that we bear for having Amazon in our midst, but those costs are worth it.

And I picked Amazon as a stereotypical example here, but the argument is about the underlying idea, not about the specific organization. Trade matters, even after acknowledging that there are opportunity costs involved with trade.

We’re trading right now, you and I. You’re paying me with that most precious of all commodities in the year 2023: attention. And I can’t begin to thank you enough for having given me your attention so far, because I know that reading this ain’t easy. Pleasurable, hopefully, and worth your while – but not easy. And you’ve chosen to continue to pay me with your attention because what you’re getting in return – the pleasure you feel in tackling my arguments – is worth your while.

But how do you know that it is worth your while? You could have been doing something else with this time. You could have been learning how to code. You could have finished at least part of some project or an assignment. You could have picked strawberries. You could have milked a cow.

The point is that you could have been doing something that actually earns you cold hard cash, instead of reading this article. And it is your assessment of your own opportunity costs that allow you to continue reading this article. You know that you can ‘afford’ to spare the time required to read this article.

But how do you know this? You know it because you are part of a national (and global) economic system that depends upon the principle that ‘prices matter’.You have at least an implicit valuation of how much a minute of your time is worth, and you have made the rational decision to ‘spend’ this time reading this blog.

What is my point? My point is that we know how much it costs to enter into a trade only if we know how much that trade is worth to us, and we only know how much a trade is worth to us by having a sense of what we’re worth to society. Trade matters is a principle that works only if we know the price of a good or a service, and we know the price of a good or a service best in a free market economy. Deciding how much to produce something, and deciding at what price to sell it is a truly difficult problem to solve in an economy that is not based on markets.

So yes, trade matters, but so do prices.

But speaking of prices, it gets trickier still.

  1. What if you set prices to not just lure the buyer into buying your product, but at a price which is so attractive to buyers that your competitors cannot afford to match it? What if they go out of business as a consequence, leaving you as the only game in town? What if you then raise prices?
  2. What if you use patents to make sure that others cannot sell the same goods that you are selling? What if you abuse the patenting process to stymie the competition? What if you then become the only game in town, and raise prices to eye-watering levels?
  3. What if the price at which you sell the product you are selling does not take into account the damage done to the environment?
  4. What if the buyer isn’t aware of further purchases she might need to make for having bought your goods? What if she realizes later that the true price of the good in question is much higher?
  5. What if the buyer is tempted into buying the product because of shady marketing techniques?
  6. What if you lobby with the government to make sure that nobody else but you can sell the product that you’re selling? Will you then be able to charge a higher price?

Each of these questions merits a much deeper exploration than is possible in this blogpost (for those who are interested, or wondering, here are the topics you want to think about in the case of those six questions: monopoly | propoerty rights and patents | externalities | asymmetry of information | microeconomics/ behavioral economics | public economics). These topics would just be the start, there are many nuances to consider in each of the six questions. But for having raised these six questions, and the two separate arguments I’ve made in the last two sections above, here is my answer to Navin’s question about why it is bad to be rich:

It is bad to be rich if you live in a world without a fully operative price system, and/or a world in which non-voluntary trades can take place.

Interpret that sentence however you like, but begin to worry if you are convinced that there is only one interpretation, or if you are convinced that your interpretation is the only correct one!

I write on this blog for many reasons, but chief among them is a very personal reason. I would like my thinking, and my writing, to be become clearer and better over time. I’ll be the first to put my hand up and say that there are days on which I think I succeed in this endeavor, and there are days on which I don’t. But taken as a whole, I am convinced that I am a better thinker and writer than I was in 2016, which is when I started this blog.

Far from perfect, in case it needs to be said, but the benchmark isn’t perfection, the benchmark is Ashish of 2016. And on any given day, it is the Ashish of the previous day. One day at a time, as it were.

And one thing that has happened over these past six years is that I have become better at distilling in my own head what economics ultimately comes down to. Six microeconomic principles, and three big picture questions. I have outlined the six principles above, and I have written about the three big picture questions before, but here they are once again:

  1. What does the world look like?
  2. Why does it look the way it does?
  3. What can we do to make the world a better place?

Students who have learnt from me these past six years will be familiar with this list. But there is a crucial component that is missing in this list of six principles and three big picture questions: time. On my blog, I have attempted to get around this problem by speaking of an alternative framework, which I have shortened in my head to the CHIC acronym: Choices, Horizons, Incentives and Costs:

The trouble is, our brain isn’t always the best at interpreting incentives correctly, which brings us to the third key concept in economics: horizons. Or, if you have had enough nerd talk for one day, we could also call it the instant gratification monkey problem. Call it what you will, the problem is that we tend to prioritize choices that payoff in the short run, but create problems in the long run. If you’ve ever had that last “one for the road” drink, or ended up actually eating that second dessert (and who hasn’t?), you don’t really need an explanation for this. We tend to choose those options that payoff over the short horizon, and ignore the long term consequences.

https://atomic-temporary-112243906.wpcomstaging.com/2018/05/03/choices-costs-horizons-and-incentives/

I have also written about time, and how it is ever-so-confusing to think about it in the context of economics. In my classes, I show students the circular flow of income diagram, and once they’ve understood it, I ask them to think of it as a video, rather than a still picture. That is to say, time matters.

Time matters.

Go and read the responses that Navin got on his original question on Twitter. I sent this essay that you are reading right not to some people, and they highlighted this same problem – they thought of intergenerational problems about being rich. Inheritance and the perpetuation of inequality across time, for example. Almost the entirety of my blogpost tomorrow, where I will share many articles that answer Navin’s question, focusses on this issue.

So here’s a question I have been grappling with for a while: should I update my list of six principles (Incentives matter | TINSTAAFL | Trade Matters | Costs Matter | Prices Matter | Externalities Matter) to also include Time Matters? And if yes, how do I expound upon this principle?

Here’s another way of thinking about this issue – one of my objectives on this blog is to teach economics to anybody and everybody. So ask yourself this question – what do we need to do to simplify economics down to its absolute bare minimum? Will somebody who has learnt about economics by attending my classes, or reading my blog, be able to answer Navin’s question? And the short answer to this question is yes, they will. But in an incomplete fashion, because in the context of this question (and many others besides), time matters.

Time, as it turns out, really and truly matters. And for me to teach this principles, I need to try and understand it better myself.

Onwards!

Less is More

We had the honor of hosting Robert Frank for a talk at the Gokhale Institute the other day.

There’s a lot to learn from that talk (duh), but there was one particular thing he mentioned in that talk that I want to focus on today:

When it comes to teaching principles of economics, less is more.

I’m paraphrasing here, and what you’re about to read is my interpretation of his point – but when it comes to a subject like Principles of Economics, width isn’t the point, depth is.

Unfortunately, however, most students seem to emerge from introductory economics courses without having learned even the most important basic principles. According to one recent study, their ability to answer simple economic questions several months after leaving the course is not measurably different from that of people who never took a principles course.
What explains such abysmal performance? One problem is the encyclopedic range typical of introductory courses. As the Nobel laureate George J. Stigler wrote more than 40 years ago, “The brief exposure to each of a vast array of techniques and problems leaves the student no basic economic logic with which to analyze the economic questions he will face as a citizen.”

https://www.nytimes.com/2005/09/01/business/the-opportunity-cost-of-economics-education.html

Honestly, if you understand the principles of economics well enough, that alone suffices to get a grasp on how economists view most things about society. Each economist has his/her own list of what they might consider to be the principles of economics, but I’d argue that there are some that will certainly be on everybody’s list:

Incentives matter | Costs Matter | Trade matters | Externalities matter | Prices matter

As I said, some folks might include other principles, some folks might include a whole lot more, and some might provide our field with some much needed levity. It’s not so much about what makes each economists’ list and what doesn’t (although that is a topic that us economists can keep going for days on end) – but it is about two very different, and very important things:

  1. How well do you teach these principles?
  2. How much do you stress upon the application of these principles?

Learning about the principles doesn’t take all that much time, and neither does understanding them.

Applying them? Trust me, that takes a lifetime, and even us economists can trip up every now and then:

Virtually all economists consider opportunity cost a central concept. Yet a recent study by Paul J. Ferraro and Laura O. Taylor of Georgia State University suggests that most professional economists may not really understand it. At the 2005 annual meetings of the American Economic Association, the researchers asked almost 200 professional economists to answer this question:
“You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton? (a) $0, (b) $10, (c) $40, or (d) $50.”
The opportunity cost of seeing Clapton is the total value of everything you must sacrifice to attend his concert — namely, the value to you of attending the Dylan concert. That value is $10 — the difference between the $50 that seeing his concert would be worth to you and the $40 you would have to pay for a ticket. So the unambiguously correct answer to the question is $10. Yet only 21.6 percent of the professional economists surveyed chose that answer, a smaller percentage than if they had chosen randomly. (Emphasis added)

https://www.nytimes.com/2005/09/01/business/the-opportunity-cost-of-economics-education.html

It gets even worse, because as Robert Frank goes on to say in that article, students were likelier to give the correct answer if they had not taken an introductory econ course. And if that is not a damning indictment, I don’t know what is.

And so one thing that I’ve tried to change in how I teach Principles of Economics is to take things really, really slowly. Answer as many questions as possible for every nuance related to every principle, and not worry about the schedule and the teaching plan. Soak ourselves as thoroughly and as extensively as possible in each principle, ruminate about potential applications, wonder about exceptions, and then move on.

We might end up covering less, but that which we will cover, we will cover as thoroughly as possible. It is, I think, a better way to go about things. We’ll find out, at any rate 🙂

P.S.: One principle that I would want to talk about (and think about myself, to begin with!) is the principle that time matters. What is the best decision is as much a function of the choices, the trade-offs and the incentives, but each of these are subject to the time horizon that you have in mind. The decision about whether or not to have a second helping of desserts after lunch today (yumm!) is about choices, trade-offs and incentives, but it also is a function of what time horizon one has in mind:

And that principle is applicable in so many different ways! So yeah, about the list of principles of economics, my addition to the list would be “Time Matters”.