KP

12 Foundations of Economics – Tastes, Incentives, Margins, and Science

9. Tastes and Preferences Are Subjective

  • Core idea: tastes and preferences are subjective, not objective. They exist in our heads and vary across individuals.
    • Examples: liking vanilla ice cream; how much you like it; preference comparisons (vanilla vs chocolate).
    • Contrast with objective features (e.g., height, weight): there are objective measures and standard criteria.
    • Height example: there is an objective way to measure height (e.g., with a tape measure and a common foot unit); you can test it and see what you are.
    • Tastes are in individual psyches and cannot be directly measured or judged against an objective scale.
  • Implication for economists:
    • Economists are modest and do not second-guess others’ tastes as long as those tastes do not affect others or do so in a harmful way.
    • If someone’s actions affect only the individual, there is no scientific basis to deem those tastes as right or wrong for that person.
    • As long as preferences do not affect others, there is no business of one person trying to dictate another’s taste.
  • Examples and nuances:
    • If someone smokes tobacco and derives satisfaction, an economist assumes it provides positive utility for that person, accounting for costs.
    • The analysis acknowledges costs and benefits but avoids judgment about personal taste, unless others are harmed (externalities like secondhand smoke).
    • Everyday analogies: driving a car vs. safer vehicles; the choice is about the trade-off between safety and cost, not a moral verdict on the individual.
  • Real-world illustration: tobacco vs. driving risk
    • People accept risk of driving for convenience and speed, despite higher mortality risk than flying; similarly, people accept smoking because they derive pleasure.
    • The economist’s stance: respect adult choices unless third parties are harmed; otherwise, judgments should be empirical, not moralized.
  • Key takeaway: taste and preferences are subjective and personal; economics treats them with humility and focuses on how choices affect resource use and other people when externalities exist.

10. Human Character Is Not Very Flexible

  • Core idea: changing jobs or employment type does not fundamentally transform a person’s character; what changes are incentives.
  • Supporting example: ship captains transporting prisoners; when death rates dropped, it was due to incentives, not a change in character.
  • Implication for policy and organization:
    • People in government and private sectors are of the same general type; incentives shape behavior across sectors.
    • Moving from private to public sector (or vice versa) does not rewrite a person’s core character; it alters behavior through different incentives.
  • Practical takeaway: when evaluating policies or organizational changes, focus on incentive structures and how they influence behavior rather than assuming intrinsic character changes.

11. Intentions Are Not Results

  • Core idea: what people intend to do is not the same as what actually results from their actions.
  • Pencil example (illustrative): many workers’ efforts lead to outcomes they did not intend.
  • Unintended consequences are common in an interconnected economy; some outcomes are positive (like the pencil example), others negative.
  • Detailed example: 1989 United Airlines flight crash scenario
    • Flight faced severe distress; a young child seated on a parent’s lap died during a crash that killed others who survived.
    • Flight attendants advocated for a policy mandating every passenger, including infants, to have a seat (and a car seat for infants).
    • Economists point out a counterintuitive result: if such a policy were mandated, airlines would charge for infant seats; many families would instead drive, increasing overall fatalities due to higher driving risk compared to flying.
    • The key lesson: good intentions (saving lives by ensuring every passenger has a seat) can have unintended, even harmful, consequences; policy assessments must follow the full chain of reasoning beyond act-one intentions.
  • Principle: beware of unintended consequences and trace how initial intentions interact with incentives, costs, and substitution effects across alternatives.
  • Final takeaway: in policy analysis, separate intentions from outcomes and examine the full causal chain before endorsing a policy.

12. All Decisions or Nearly All Decisions Are Made at the Margin (12.1 and beyond)

  • Core idea: most decisions are marginal—not all-or-nothing choices but trade-offs of small, incremental changes.
  • Historical note: Adam Smith (1776) opened the study of economics with Wealth of Nations; the marginal revolution occurred in the early 1870s, resolving puzzles he highlighted (e.g., why water is cheap and diamonds expensive).
  • Diamond–Water Paradox and the marginal revolution
    • Early economist intuition: water is essential for life and diamonds are mere ornaments; yet water is cheap and diamonds expensive.
    • Marginal concept: decisions are made at the margin; value is determined by the marginal unit and scarcity, not by total usefulness alone.
    • Illustration: you might own all diamonds or all water; each choice has a different marginal trade-off for the next unit rather than an all-or-nothing choice.
  • The margin in everyday choice (two illustrative scenarios)
    • Scenario 1: you choose between one useful item in your hand (diamond) or one cheap item (water); you pick the one that provides the greater marginal utility given the context.
    • Scenario 2 (paradox illustration): if someone could own all diamonds or all water, the marginal trade-off determines the choice; the key is that decisions are about incremental changes, not total possession.
  • Examples of marginal thinking in action
    • Safe driving example: you drive an older car (e.g., 2014), and you consider upgrading to a safer newer model (e.g., 2026). The added safety may not be worth the cost from your personal marginal cost–benefit perspective.
    • The cost of a slightly safer car is weighed against price, time, and other uses of resources; an extra bit of safety must justify its cost in your marginal calculus.
    • If you instead pursued a higher-end luxury model (e.g., a top-tier Mercedes), you would trade even more cost for increased safety.
  • Marginal analysis in decision making
    • The marginal framework helps explain why people don’t always maximize safety or quality at any price—they weigh additional safety against other uses of scarce resources (money, time, effort).
    • Marginal thinking underpins much of economic theory and policy design, including how to allocate resources efficiently and how incentives affect behavior.
  • Connecting to the division of labor (foreshadowed)
    • The lecturer hints that the division of labor and specialization will be explored next; margin analysis will help explain gains from specialization and productivity.
  • Summary of the margin concept
    • Most decisions are made by comparing small increments: add one more unit of a good, take one less unit, etc.
    • The idea originated from the marginal revolution in the 1870s, solving classic paradoxes like the diamond–water puzzle.
    • Real-world implications: marginal analysis explains everyday choices, policy outcomes, and the trade-offs involved in resource allocation.

Science, Economics, and the Positive/Normative Distinction

  • Economics as a science
    • Economics is a social science: a disciplined, organized search for understanding of social reality.
    • It uses positive statements (facts about how the world works) rather than normative statements (value judgments about how the world should be).
    • Positive statements are testable and verifiable (true/false) and describe causal relationships in the economy.
    • Normative statements express ethical or value judgments (e.g., what should be done) and are not claims about how the world actually operates.
  • Examples of positive vs normative statements
    • Positive: "If I let go of this marker, gravity will pull it to the ground." ext{gravity}
      ightarrow ext{downward motion}
    • Positive: other possible outcome (to the ceiling) is false in the given setup; still a positive claim if describing what would happen under the given conditions.
    • Normative: "Murder and rape are bad." This expresses value judgments and is not a verifiable natural law.
  • The role of policy in economics
    • Economic analysis can inform public policy, but values and ethical considerations influence policy choices as well.
    • The professor emphasizes that his job is to present economists’ understanding of how the economy works, not to impose ideology or change students’ policy preferences.
    • Example illustrating policy interpretation: a doctor explaining alternative treatments shows how new information can change means without changing underlying goals (saving a child); values may stay the same, but approaches can differ as knowledge improves.
  • How science handles uncertainty
    • The scientific mindset: keep an open mind, acknowledge current theories might be mistaken, and be ready to revise theories in light of new evidence.
    • In economics, predictions are not as precise as in natural sciences (e.g., astronomy) due to social complexity, but verified patterns and mechanisms still ground the science.
  • Practical implications
    • Your normative beliefs may influence how you evaluate policies, but learning economics aims to reveal how markets and incentives operate regardless of personal ideology.
    • The study encourages critical thinking about which policies improve welfare given assumptions, evidence, and trade-offs.

Four Key Logical Fallacies Often Encountered in Economics (with cautions)

  • Ad hominem fallacy
    • Definition: judging the merit of an argument based solely on the identity or character of the person making it.
    • Example: dismissing an argument for a pay raise for professors because the speaker is a professor.
    • Lesson: judge the argument itself, not the person delivering it; identity can provide bias but should not determine truth.
  • Appeal to authority (related to ad hominem)
    • Note: similar reasoning where the argument is accepted or rejected based on the authority of the person making it, rather than the argument’s logic or evidence.
    • The text treats this as closely related to ad hominem and emphasizes evaluating arguments on their merits rather than status.
  • Post hoc ergo propter hoc (post hoc) fallacy
    • Definition: concluding that because event A happened before event B, A caused B.
    • Classic example: rooster crowing precedes sunrise; the crow did not cause the sun to rise.
    • Practical caution: correlation/chronology does not imply causation; policy outcomes must be analyzed with care to establish causal mechanisms.
  • Fallacy of composition
    • Definition: assuming that what is true for a part of the whole is true for the whole.
    • Example: if standing up improves one person’s view, assuming everyone will have a better view if all stand up; in reality, the result can be worse for all.
    • Implication for policy: benefits seen for some individuals do not automatically translate into benefits for the entire country or population.
  • Naturalistic fallacy
    • Definition: concluding that because something is a certain way, it should be that way (is/ought fallacy).
    • Historical anchor: associated with discussions around slavery and moral justification; just because something exists (is) does not mean it ought to be (should).
    • Important caution: do not infer ethical prescriptions from natural states or historical prevalence.
  • Overall point
    • The course highlights these four (ad hominem, post hoc, composition, naturalistic) as frequent pitfalls in economic reasoning.
    • The instructor also notes a related but distinct concern with appeal-to-authority arguments; the core message is to evaluate arguments on their own logical and empirical merits.

Key Takeaways and Connections

  • The 12 Foundations (overview)
    • Foundations 9–12 focus on realism about human preferences, stable but incentive-sensitive behavior, the distinction between intentions and outcomes, and marginal decision-making.
    • The lecture uses vivid examples (tastes, driving safety, airline policy, pencil outcomes, diamonds vs water) to illustrate these ideas.
  • Connecting to broader themes
    • Marginal analysis underpins almost all economic decision-making and policy design.
    • Understanding the difference between positive and normative economics helps students critically evaluate policy proposals.
    • Recognizing unintended consequences is essential for robust policy analysis.
    • Being aware of common logical fallacies improves critical thinking and prevents misinterpretation of causal claims.
  • Real-world relevance
    • Many everyday decisions involve marginal choices (safety vs cost, time vs money, risk vs reward).
    • Public policy often entails trade-offs that require careful chain-of-reasoning rather than relying on good intentions alone.
    • The scientific mindset in economics emphasizes openness to revision and empirical validation of theories.

Notable Dates, Terms, and Formulas (with LaTeX)

  • Adam Smith, Wealth of Nations: published in 1776. 1776
  • Marginal revolution: early 1870s (late 19th century) – shift to marginal analysis in economics.
  • Diamond–Water paradox: classic puzzle resolved by marginal thinking (value at the margin, scarcity).
  • Positive statements: verifiable statements about how the world works (e.g., ext{If you let go, gravity pulls downward.})
  • Normative statements: value-laden judgments about how the world should be (e.g., ext{Killing is bad.})
  • Margin concept (informal formula):
    • Marginal benefit MB and marginal cost MC: if MB > MC, increase the action; if MB < MC, reduce; optimal where MB = MC.
    • This intuition underpins many decisions discussed (safety upgrades, airline-seat policies, etc.).

Connections to Previous and Future Topics

  • Builds on the idea that economic analysis requires looking beyond surface appearances (e.g., good intentions vs. outcomes).
  • Sets the stage for the division of labor and other core theories (to be covered in next sessions).
  • Encourages a disciplined approach to policy discussion: separate data-driven positive analysis from normative judgments, and always consider unintended consequences and marginal trade-offs.

Ethical, Philosophical, and Practical Implications

  • Ethical nuance: respecting individual tastes when actions do not harm others; policy should consider externalities and overall welfare rather than moralize private choices.
  • Philosophical stance: science as an ongoing, revisable pursuit of understanding, not doctrine.
  • Practical policy implication: well-intentioned policies can backfire if marginal effects and substitution effects are not carefully analyzed.

Quick Recap of Core Concepts

  • Tastes and preferences are subjective and individualized; economists avoid judging personal tastes unless they affect others.
  • Human character is shaped by incentives, not by job category; behavior changes with different incentive structures.
  • Intentions are not the same as results; unintended consequences are common in complex systems.
  • Most decisions are made at the margin; incremental changes matter more than all-or-nothing choices.
  • Economics is a science that relies on positive statements and empirical scrutiny; normative judgments accompany but are separate from the science.
  • Beware common logical fallacies (ad hominem, post hoc, composition, naturalistic); use evidence and reasoning to evaluate arguments.