Economic Way of Thinking - Chapter 1

• Lots of people find economic problems baffling because they don't understand how economy works.

  • We don't notice how our system works because we are used to it, so we take it for granted.

Recognizing order

• Example: rush hour is chaos but it works.

The importance of social cooperation

• Hobbes believed that if people could be induced to not attack each other, then cooperation would emerge because people are committed to self-preservation.

  • We depend on organizations that encourage cooperation.

  • The life Hobbes knew was simpler, more bound by custom and tradition, so he didn't understand the importance of his question.

• Adam Smith did not agree with thinkers of his age that said that only the careful planning of political rulers could prevent society from crumbling.

  • He believed that society functioned well on its own.

  • “Wealth is created via labor, and self-interest spurs people to use their resources to earn money”

An apparatus of the mind: the skill of the economist

• The Economic Way of Thinking is an approach, a technique of thinking about the complex world around us.

  • “All social phenomena emerge from the actions and interactions of individuals who are choosing in response to expected additional benefits and costs to themselves.”

  • It displays three aspects: one focusing on actions, the second on interactions, and the third on consequences.

• Economize: to use resources in a way that extracts from them the most of whatever the economizer wants. Continually comparing expected additional benefits and costs.

  • Scarcity: making a sacrifice to get more of what you want.

  • We deal with scarcity by economizing.

  • Each does what they think is best for themselves, and end up contributing to the bigger flow of things.

• This leads to the idea of unintended consequences.

  • “How can such an orderly pattern of events emerge, not on purpose, but as a by-product of people pursuing their own separate interests?”

• Specialization: the division of labor, according to Smith.

  • A necessary condition for the increases in production that have expanded the wealth of nations in recent centuries.

  • Specialization in the absence of coordination is the road to chaos.

  • In the modern society, people's economizing actions occur in the context of extreme specialization.

• Interactions: exchange

Cooperation through mutual adjustment

• Commercial society: when the division of labor has been once thoroughly established.

  • A man's wants produce surplus which can be exchanged for other goods.

• Individuals choose their actions on the basis of the net advantages they expect.

  • When the ratio of expected benefit to expected cost increases, people do more of it.

  • Why does it happen? “a process of continuing mutual adjustment to the changing net advantages that their actions generate.”

Signals

• People need information to successfully accommodate and adjust to others.

• Market-formed prices communicate useful information to participants in the economy.

  • Prices help us know what to produce, to clarify options to consumers, etc.

Rules of the game

• Economic systems are shaped by the “rules of the game”.

  • Rules affect incentives, so everyone must know roughly what they are, and they must be reasonable and stable.

    • When they are not, the game breaks down.

• Property rights form a large and important part of the rules governing most of the social interactions in which people regularly engage.

  • A market-exchange economy is based on private property rights.

  • Private property rights help clarify our options and opportunities.

  • Private property rights can be voluntarily traded for similar rights to other goods and services.

  • In socialist economies, private property rights are different from social property rights.

    • This creates confusion.

  • Clear property rights spark efforts to discover new resources, to innovate.

The biases of economic theory

1. Is this perspective biased? No because it makes emphasis on choice.

• Society by itself never makes choices and decisions. Only individuals can do that.

  • Individuals are the fundamental units of analysis.

  • Individuals choose after weighing benefits and costs.

2. Economic thinking is criticized by the emphasis on the economizing process, it assumes that people are calculating.

   • No. Economic thinking analyzes the way that humans naturally act.

3. Is criticized because it contains a pro-market bias.

• Can't we call “biases” conclusions?

The skills of the economist

• We can observe facts, but it takes a theory to explain the causes.

  • It takes a theory about cause and effect to weed out the irrelevant facts from the relevant ones.

• The economic way of thinking has to be supplemented with information from other areas of knowledge.