Economics for the Citizen

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Part
1

Last fall semester,
I didn’t teach for the first time in 37 years. No, I haven’t
retired. It was my semester-off reward for two terms as department
chairman at George Mason University. A break is well deserved after
a chairmanship – a job not unlike that of herding cats.

During fall
semesters, I typically teach our first-year Ph.D. microeconomics-theory
course. Out of a love for teaching, I’ve decided to not completely
take off but deliver a few lectures on basic economic principles
to my readership. We’ll name the series “Economics for
the Citizen.”

The first lesson
in economic theory is that we live in a world of scarcity. Scarcity
is a situation whereby human wants exceed the means to satisfy those
wants. Human wants are assumed to be limitless, or at least they
don’t frequently reveal their bounds. People always want more
of something, be it more cars, more food, more love, more happiness,
more peace, more health care, more clean air, or more charity. Our
ability and resources to satisfy all those wants are indeed limited.
There’s only a finite amount of land, iron, workers, and years
in a lifetime.

Scarcity produces
several economic problems: What’s to be produced, who’s
going to get it, how’s it to be produced, and when is it to
be produced? For example, many Americans, and foreigners too, would
love to have a home or vacation home along the thousand miles of
California, Oregon, and Washington coastline. Shipping companies
would like to use some of it as ports. The U.S. Defense Department
would like to use it for military installations. There’s simply
not enough coastline to meet all the competing wants and uses. That
means there’s conflict over coastline ownership and its uses.

There are several
methods of conflict resolution. First, there’s the market mechanism
– let the highest bidder be the one who owns and decides how
the land will be used. Then there’s government fiat, where
the government dictates who gets to use the land for what purpose.
Gifts might be the way whereby an owner arbitrarily chooses a recipient.
Finally, violence is a way to resolve the question of who has the
use rights to the coastline – let people get weapons and physically
fight it out.

At this juncture,
some might piously say, “Violence is no way to resolve conflict!”
The heck it isn’t. The decision of who had the right to use
most of the Earth’s surface was settled through violence (wars).
Who has the right to the income I earn is partially settled through
threats of violence. In fact, violence is such an effective means
of resolving conflict that most governments want a monopoly on its
use.

Part 2

Which is the
best method to resolve conflict issues surrounding the questions
of what’s to be produced, how and when it’s produced,
and who’s going to get it? Is it the market mechanism, government
fiat, gifts, or violence? Before you attempt an answer – which
I’ll give in the next lecture – be advised that it’s
a trick question that easily traps many of my teeny-bopper sophomore
students and even a few graduate students.

I personally
believe that economics is fun and valuable. People who say they
found it a nightmare in college just didn’t have a good teacher-professor.
I became a good teacher-professor as a result of tenacious mentors
during my graduate study at UCLA. Professor Armen Alchian, a very
distinguished economist, used to give me a hard time in class. But
one day, we were having a friendly chat during our department’s
weekly faculty/graduate-student coffee hour, and he said, “Williams,
the true test of whether someone understands his subject is whether
he can explain it to someone who doesn’t know a darn thing
about it.” That’s a challenge I love: making economics
fun and understandable.

Which is the
best method of resolving conflict over what’s produced, how
and when it’s produced, and who’s going to get it? Among
the methods for doing so were the market mechanism, government fiat,
gifts, or violence. The answer is that economic theory can’t
answer normative questions.

Normative questions
deal with what is better or worse. No theory can answer normative
questions. Try asking a physics teacher which is the better or worse
state: a solid, gas, liquid, or plasma state. He’ll probably
look at you as if you’re crazy. On the other hand, if you ask
your physics teacher which is the cheapest state for pounding a
nail into a board, he’d probably answer that the solid state
is. It’s the same with economic theory, as opposed to economists.
That is, if you asked most economists which method of conflict resolution
produces the greater overall wealth, they’d probably answer
that the market mechanism does.

The bottom
line is that economic theory is objective or non-normative and doesn’t
make value judgments. Economic-policy questions are normative or
subjective and do make value judgments – questions such as:
Should we fight unemployment or inflation, should we spend more
money on education, and should the capital gains tax be 15 percent
or 20 percent? It’s in the area of value judgments where there’s
so much disagreement among economists.

Keeping the
distinction between nonnormative and normative in mind is very important,
so let me elaborate a bit. Take the statement: The dimensions of
this room are 30 feet by 40 feet. That’s an objective statement.
Why? If there’s any disagreement, there are facts to which
we can appeal to settle the disagreement, namely getting out a measuring
instrument. Contrast that statement with: The dimensions of this
room should be 20 feet by 80 feet. Another person disagrees, saying
it should be 50 feet by 50 feet. There are no facts to resolve such
disagreement. Similarly, there are no facts to which we can appeal
to resolve a disagreement over whether the capital gains tax should
be 15 percent or 20 percent, or whether it’s more important
to fight inflation or unemployment.

The importance
of knowing whether a statement is nonnormative or normative is that,
in the former, there are facts to settle any dispute, but in the
latter, there are none. It’s just a matter of opinion, and
one person’s opinion is just as good as another. A good clue
to telling whether a statement is normative is whether it contains
the words “should” and “ought.”

At the beginning
of each semester, I tell students that my economic theory course
will deal with positive, nonnormative economic theory. I also tell
them that if they hear me making a normative statement without first
saying, “In my opinion,” they are to raise their hands
and say, “Professor Williams, we didn’t take this class
to be indoctrinated with your personal opinions passed off as economic
theory; that’s academic dishonesty.” I also tell them
that as soon as they hear me say, “In my opinion,” they
can stop taking notes because my opinion is irrelevant to the subject
of the class – economic theory.

Another part
of this particular lecture to my students is that by no means do
I suggest that they purge their vocabulary of normative or subjective
statements. Such statements are useful tools for tricking people
into doing what you want them to do. You tell your father that you
need a cell phone and he should buy you one. There’s no evidence
whatsoever that you need a cell phone. After all, George Washington
managed to lead our nation to defeat Great Britain, the mightiest
nation on Earth at the time, without owning a cell phone.

Our next discussion
will be a bit more interesting. We’ll talk about what kinds
of behavior can be called economic behavior.

Part 3

There are four
classes of behavior that can be called economic behavior. They are:
production, consumption, exchange, and specialization. The discussion
of specialization will be left to the next article.

Production
is any behavior that creates utility, that is, raises the want-satisfying
capacity of something. When a mill smelts iron ore, it raises the
want-satisfying capacity of the material by changing its form. The
metal’s want-satisfying capacity is raised further when it’s
made into steel and the steel into rails, girders, and the like.
Production also includes changing the spatial characteristics of
a good. Navel oranges have no want-satisfying capacity for Philadelphians
if the oranges are in California.

The person
sometimes called the middleman or wholesaler changes the spatial
characteristics of the oranges by moving them from California to
Philadelphia, thereby raising their want-satisfying capacity to
Philadelphians.

Consumption
is easy. Consumption is simply the reduction of the want-satisfying
capacity of something. When I eat a hamburger, I reduce its want-satisfying
capacity. When I drive my car, I reduce its capacity to satisfy
wants. By the way, if production is greater than consumption, the
result is called saving. If it’s the opposite, we call it dis-saving.

Exchange is
a bit more complicated; misunderstanding it leads to considerable
confusion and mischief. The essence of exchange is the transfer
of title. Here’s the essence of what happens when I buy a gallon
of milk from my grocer. I tell him that I hold title to these three
dollars and he holds title to the gallon of milk. Then, I offer:
If you transfer your title to that gallon of milk, I will transfer
title to these three dollars.

Whenever there’s
voluntary exchange, the only clear conclusion that a third party
can make is that both parties, in their opinion, perceived themselves
as better off as a result of the exchange; otherwise, they wouldn’t
have exchanged. I was free to keep my three dollars, and the grocer
was free to keep his milk. If you think it’s obvious that both
parties benefit from voluntary exchange, then how come we hear pronouncements
about worker exploitation?

Say you offer
me a wage of $2 an hour. I’m free to either accept or reject
your offer. So what can be concluded if I’m seen working for
you at $2 an hour? One clear conclusion is that I must have seen
myself as being better off taking your offer than my next best alternative.
All other alternatives were less valuable, or else why would I have
accepted the $2 offer? How appropriate is it to say that you’re
exploiting me when you’ve given me my best offer? Rather than
using the term “exploitation,” you might say you wish
I had more desirable alternatives.

While people
might characterize $2 an hour as exploitation, they wouldn’t
say the same about $50 an hour. Therefore, for the most part, when
people use the term “exploitation” in reference to voluntary
exchange, they simply disagree with the price. If we equate price
disagreement with exploitation, then exploitation is everywhere.
For example, I not only disagree with my salary, I also disagree
with the prices of Gulfstream private jets.

By no means
do I suggest that you purge your vocabulary of the term “exploitation.”
It’s an emotionally valuable term to use to trick others, but
in the process of tricking others, one need not trick himself. I’m
reminded of charges of exploitation Mrs. Williams used to make early
on in our 44-year marriage. She’d charge, “Walter, you’re
using me!” I’d respond by saying, “Honey, sure, I’m
using you. If I had no use for you, I wouldn’t have married
you in the first place.” How many of us would marry a person
for whom we had no use? As a matter of fact, the problem of the
lonely hearts among us is that they can’t find someone to use
them.

Part 4

In the last
lecture, we discussed three of four kinds of behavior that can be
called economic behavior: production, consumption, and exchange.
We’ll turn our attention to the fourth – specialization.

Specialization
is said to occur when people produce more of a commodity than they
consume or plan to consume. Specialization can occur on an individual,
regional, or national basis. Here are examples of each. Detroit
assembly-line workers produce more crankshafts than they consume
or plan to consume. Californian citrus growers produce more navel
oranges than they consume or plan to consume. Brazilian coffee growers
produce more coffee than they consume or plan to consume.

There are two
requirements for specialization. There must be an unequal endowment
of resources and trade opportunities. The unequal endowment part
means that an individual has the skills or a region or nation has
the kind of resource endowment of land, labor, capital, and entrepreneurial
talent whereby it can produce certain things more cheaply than another
individual, region, or nation.

For example,
while it’s possible to grow wheat and corn in Japan, it would
be an expensive proposition. Why? Because crops like wheat and corn
use a lot of land, and Japan is relatively land poor, and its land
is expensive. By contrast, the United States is land rich; hence,
grain production is relatively cheap. Therefore, it makes sense
for the United States to take advantage of what it can do more cheaply
– specialize in grain production – and for Japan to specialize
in what it might produce more cheaply – say, camera lenses.

In order for
specialization to occur, there must be trade opportunities. It wouldn’t
make sense for U.S. farmers to produce more grain than they consume
or plan to consume if they couldn’t trade it. Neither would
it make sense for Japanese producers to produce more camera lenses
than they consume or plan to consume. That’s why trade opportunities
are necessary in order for people to take advantage of specialization.

Imagine that
the Japanese government imposed trade restrictions on U.S. grain
imports. Japanese farmers could charge monopoly prices and enjoy
higher income, and Japanese consumers would pay higher prices. Would
you deem it an intelligent response for the U.S. government to retaliate
against Japan’s trade restrictions by imposing trade restrictions
on Japanese camera lenses, thus allowing American lens producers
to charge monopoly prices and American consumers to suffer higher
prices? Put another way, is it a smart response for the U.S. government
to harm American consumers because Japan harmed its consumers?

Specialization
and trade make people dependent upon one another for their everyday
wants. How many of us make our own eyeglasses, cars, houses, clothing,
and food? We get all those goods by specializing in what we do well,
getting paid, and trading with others for what they do well. Through
specialization and trade – we might call it “outsourcing”
– we enjoy goods as if we actually produced them. By the way,
those who call for independence individually, regionally, or nationally
are asking us to be poorer. It makes no difference whether they’re
calling for energy independence, clothing independence, or coffee
independence.

Let’s
look at just a few misleading statements about international trade.
The United States trades with Japan. Does anyone really think that
it is the members of the U.S. Congress who trade with their counterparts
in the Japanese Diet? It’s really individual Americans trading
with individual Japanese through intermediaries.

What about
fair trade? If you purchase a Japanese-made camera lens on mutually
agreeable terms, you’d probably conclude that it was a fair
trade, or else you would have kept your money. An American camera-lens
producer might call it unfair because he couldn’t sell you
his lens at a higher price. Economic theory can’t answer a
subjective question like whether it would be fairer if you had to
pay a higher price; it can say that a higher price would result
in your having fewer dollars for other things.

The next article
will focus on one of the most important economic concepts –
costs.

Part 5

Someone might
have made you a gift of this publication. Does that mean reading
this article is free? The answer is a big fat no. If you weren’t
reading the article, you might have watched television, talked to
your wife, or worked on your homework. The cost of having or doing
something is what had to be sacrificed. While reading this article
might have a zero price, it most assuredly doesn’t have a zero
cost.

To reinforce
the idea that price is not the full measure of cost, imagine that
you live in St. Louis, Mo. The barber who cuts your hair charges
$20. Suppose I told you that a barber in Charleston, S.C., would
charge you $5 for an identical haircut. Would you consider the Charleston
haircut cheaper? While it has a lower price, it has a much greater
cost. You’d have to sacrifice much more in terms of time, travel,
and other expenses in order to get the Charleston haircut.

People often
erroneously think of costs as only material things, but that which
is sacrificed when a particular choice is made can include clean
air, leisure, morality, tranquility, domestic bliss, safety, or
any other thing of value. For example, a possible cost of a night
out with the boys might be the sacrifice of domestic bliss.

Costs affect
our choices in many ways, and for the purposes of this discussion,
we’re going to assume that all of the costs associated with
a given choice are borne by the chooser.

Just about
the most important generalization that we can make about human behavior
is that the higher the cost of a particular choice, the less of
it will be chosen, and the lower the cost, the more of it will be
chosen. This generalization underlies the law of demand. For simplicity,
let’s assume price measures cost while we hold everything else
influencing choice constant.

The law of
demand can be expressed several ways: The lower the price of something,
the more will be taken, and the opposite is true for the higher
price. We can also say there exists a price whereby one can be induced
to take more or less of something. Finally, there’s an inverse
(reverse) relationship between the price of a good and the quantity
demanded.

Why do people
behave this way? The answer, in a word or two, is that people try
to be as happy as they can. For example, if, when the price of oil
rises, people simply ignored the price increase, they’d have
less to spend on other things and be less happy. If they sought
substitutes for the higher-priced oil, they’d have more money
left over, and they’d be happier. That’s why higher oil
prices give people incentive to purchase more insulation, buy better
windows, wear sweaters, and maybe move to a warmer climate. These
choices, and many more, are substitutes for heating oil, allowing
you to use less oil.

When people
say a certain amount of one thing or another is an absolute must,
that’s like saying the law of demand doesn’t exist and
there are no substitutes. That’s untrue – consider a diabetic.
Can he do without 50 units of insulin a day? The law of demand says
that at some price, say at $1,000 a unit, he can. There’s always
at least one substitute for any good, and that’s doing without
the good altogether. In the diabetic’s case, no insulin.

While not having
insulin has unpleasant consequences, it’s a likely substitute
at $1,000 a unit. You say, “Williams, that kind of economic
analysis is cruel!” It’s no crueler than the law of gravity
that predicts that if you jump off a skyscraper you’re going
to die. Both outcomes are unattractive, but it’s reality. Indeed,
tragically, millions of our fellow men around the globe are forced
to endure the unpleasant substitute for insulin.

In the next
discussion, we’ll explore some interesting features of cost,
choice, and the law of demand.

Part 6

My last article
introduced the law of demand, which states that, holding everything
else constant, the lower the price of something, the more people
will take of it; and the higher the price, less will be taken. But
there’s a bit of complexity we must add. It’s crucial
to recognize that it’s relative prices that determine choices,
not absolute prices.

Relative price
is one price in terms of another price. Here’s an example;
actually, it’s a trick I pull on freshman students. I say,
“Suppose your company offered to double your salary if you’d
relocate to its Fairbanks, Alaska, office. Would you consider it
a good deal and accept the offer?” Some students thoughtlessly
answer yes. Then I ask, “What if upon arrival you find out
that rents are more than double what you’re paying now and
the prices of food, clothing, gasoline, and other items are three
and four times more expensive?” The end result is that, while
your absolute salary has doubled, your salary, relative to other
prices, has fallen.

A bit trickier
example of how it’s relative prices, not absolute prices, that
influence behavior comes with the observation that married couples
with young children who can’t be left alone tend to choose
more expensive dates than married couples without children. The
couple’s income and tastes have little to do with their decision;
it’s relative prices. Keeping the numbers small, say an expensive
date, dinner and concert, has a $50 price tag and a cheap date,
a movie, $20. The choice of the $50 dinner-and-concert date requires
that the married couple without children sacrifice two and a half
movies that they could have otherwise enjoyed.

The married
couple with children must pay a babysitter $10 whether they go on
the expensive or cheap date. With the cost of the babysitter figured
in, the dinner and concert will cost them $60 and the movie $30.
In choosing the dinner-and-concert date, they sacrifice only two
movies. The dinner-and-concert date is relatively cheaper for the
married couple with children, since they sacrifice only two movies
compared to the married couple without children’s two and a
half. Since it’s cheaper, we can expect to observe married
couples with children to take more expensive dates when they go
out. It doesn’t take economic analysis to come up with this.
A husband might suggest, “Honey, let’s hire a babysitter
and take in a movie.” The wife replies, “That doesn’t
make sense. Since we have to pay $10 for a babysitter whether we
go on a cheap or expensive date, why not get our money’s worth
and take in a dinner and concert?”

How about another
example of relative prices? Suppose today’s coffee price is
$1 a pound, and you typically purchase two pounds per week. You
hear news that a freeze in Brazil destroyed much of its coffee crop
and coffee prices are expected to rise. What would you do, and why?
I’m guessing you’d make larger coffee purchases now, but
why? The average person would answer, to save money. That’s
an OK answer, but it doesn’t tell the whole story. Once again,
it’s the law of demand working. If coffee prices are expected
to rise next week, that means coffee prices this week have fallen
relative to those next week, and the law of demand says that when
a price of a good falls, people will take a larger quantity. It
works in reverse as well. If coffee prices are expected to fall
next week, you’d buy less coffee this week. Why? Coffee prices
have risen this week relative to next week.

You might be
tempted to ho-hum this coffee analysis as oversimplification, but
it is the basic principle underlying the complexities of futures
markets such as the Chicago Mercantile Exchange, where people, as
speculators, become rich, sometimes poorer, guessing about the future
prices of commodities.

Part 7

There’s
a reggae song that advises, “If you want to be happy for the
rest of your life, never make a pretty woman your wife.” Mechanics
have been accused of charging women higher prices for emergency
road repairs. Airlines charge business travelers higher prices than
tourists. Car-rental companies and hotels often charge cheaper rates
on weekends. Transportation companies often give senior citizen
and student discounts. Prostitutes charge servicemen higher prices
than their indigenous clientele. Gasoline stations on interstate
highways charge higher prices than those off the interstate. What
are we to make of all of this discrimination? Should somebody notify
the U.S. attorney general?

The fact that
sellers charge people different prices for what often appear to
be similar products is related to a concept known as elasticity
of demand, but we won’t get bogged down with economic jargon.
Think about substitutes. Take the reggae song’s advice about
not taking a pretty woman as a wife. Pretty women are desired and
sought after by many men. An attractive woman has many substitutes
for you, and as such, she can place many demands on you. A homely
woman has far fewer substitutes for you and cannot easily replace
you. Hence, she might be nicer to you, making what economists call
“compensating differences.”

It’s all
a matter of substitutes for the good or service in question. Business
travelers have less flexibility in their air-travel choices than
tourists. Women generally see themselves as having fewer alternatives
for emergency auto repairs. A man might have more knowledge about
making the repair or be more willing to risk hitchhiking or walking.
A prostitute might see a sailor on shore leave as having fewer substitutes
for her services than the area’s residents. Motorists traveling
from city to city are less likely to have information about cheaper
choices than local residents.

Politicians
seem to ignore the fact that when the price of something changes
people respond by seeking cheaper substitutes. New York City raised
cigarette taxes, thereby making a pack of cigarettes $7. What happened?
A flourishing cigarette black market emerged.

In 1990, when
Congress imposed a luxury tax on yachts, private airplanes, and
expensive automobiles, Sen. Ted Kennedy and then-Senate Majority
Leader George Mitchell crowed publicly about how the rich would
finally be paying their fair share of taxes. But yacht retailers
reported a 77 percent drop in sales, and boat builders laid off
an estimated 25,000 workers. What happened? Kennedy and Mitchell
simply assumed that the rich would behave the same way after the
imposition of the luxury tax as they did before and the only difference
would be more money in the government’s coffers. They had a
zero-elasticity vision of the world, namely that people do not respond
to price changes. People always respond, and the only debatable
issue is how much and over what period.

This elasticity
concept is not restricted to what are generally seen as economic
matters; it applies to virtually all human behavior. When a parent
asks his child, “How many privileges must I take from you to
get you to behave?” that’s really an elasticity question.
In other words, how high must the punishment price be for the misbehavior
in order to get the child to take less of it? It’s easy to
see how elasticity applies to law enforcement as well. What must
be done to the certainty of prosecution and punishment to get criminals
to commit less crime?

My next article
will focus on property rights, a noneconomic concept that has a
heavy impact on economics.

Part 8

Economic theory
is broadly applicable. However, a society’s property-rights
structure influences how the theory will manifest itself. It’s
the same with the theory of gravity. While it, too, is broadly applicable,
attaching a parachute to a falling object affects how the law of
gravity manifests itself. The parachute doesn’t nullify the
law of gravity. Likewise, the property-rights structure doesn’t
nullify the laws of demand and supply.

Property rights
refer to who has exclusive authority to determine how a resource
is used. Property rights are said to be communal when government
owns and determines the use of a resource. Property rights are private
when it’s an individual who owns and has the exclusive right
to determine the non-prohibited uses of a resource and receive the
benefit therefrom. Additionally, private-property rights confer
upon the owner the right to keep, acquire, and sell the property
to others on mutually agreeable terms.

Property rights
might be well defined or ill defined. They might be cheaply enforceable
or costly to enforce. These and other factors play a significant
role in the outcomes we observe. Let’s look at a few of them.

A homeowner
has a greater stake in the house’s future value than a renter.
Even though he won’t be around 50 or 100 years from now, the
house’s future housing services figure into its current selling
price. Thus, homeowners tend to have a greater concern for the care
and maintenance of a house than a renter. One of the ways homeowners
get renters to share some of the interests of owners is to require
security deposits.

Here’s
a property-rights test question. Which economic entity is more likely
to pay greater attention to wishes of its clientele and seek the
most efficient methods of production? Is it an entity whose decision-makers
are allowed to keep for themselves the monetary gain from pleasing
clientele and seeking efficient production methods, or is it entities
whose decision-makers have no claim on those monetary rewards? If
you said it is the former, a for-profit entity, go to the head of
the class.

While there
are systemic differences between for-profit and non-profit entities,
decision-makers in both try to maximize returns. A decision-maker
for a non-profit will more likely seek in-kind gains such as plush
carpets, leisurely work hours, long vacations, and clientele favoritism.
Why? Unlike his for-profit counterpart, he doesn’t have property
rights to take his gains. Also, since he can’t capture for
himself the gains and doesn’t himself suffer the losses, there’s
reduced pressure to please clientele and seek least-cost production
methods.

You say, “Professor
Williams, for-profit entities sometimes have plush carpets, have
juicy expense accounts, and behave in ways not unlike non-profits.”
You’re right, and again, it’s a property-rights issue.
Taxes change the property-rights structure of earnings. If there’s
a tax on profits, then taking profits in a money form becomes more
costly. It becomes relatively less costly to take some of the gains
in non-money forms.

It’s not
just businessmen who behave this way. Say you’re on a business
trip. Under which scenario would you more likely stay at a $50-a-night
hotel and eat at Burger King? The first is where your employer gives
you $1,000 and tells you to keep what’s left over. The second
is where he tells you to turn in an itemized list of your expenses
and he’ll reimburse you. In the first case, you capture for
yourself the gains from finding the cheapest way of conducting the
trip, and in the second, you don’t.

These examples
are merely the tip of the effect that property-rights structure
has on resource allocation. It’s one of the most important
topics in the relatively new discipline of law and economics.

Part 9

We’re
all grossly ignorant about most things that we use and encounter
in our daily lives, but each of us is knowledgeable about tiny,
relatively inconsequential things. For example, a baker might be
the best baker in town, but he’s grossly ignorant about virtually
all the inputs that allow him to be the best baker. What is he likely
to know about what goes into the processing of the natural gas that
fuels his oven? For that matter, what does he know about oven manufacture?
Then, there are all the ingredients he uses – flour, sugar,
yeast, vanilla, and milk. Is he likely to know how to grow wheat
and sugar and how to protect the crop from diseases and pests? What
is he likely to know about vanilla extraction and yeast production?
Just as important is the question of how all the people who produce
and deliver all these items know what he needs and when he needs
them. There are literally millions of people cooperating with one
another to ensure that the baker has all the necessary inputs.

It’s the
miracle of the market and prices that gets the job done so efficiently.
What’s called the market is simply a collection of millions
upon millions of independent decision-makers not only in America
but around the world. Who or what coordinates the activities of
all these people? Rest assured it’s not a bakery czar.

There are a
number of ways to allocate goods and services. They include: first-come-first-served,
gifts, violence, dictatorship, or lotteries. When the price mechanism
performs the allocation function, we realize efficiency gains absent
in other methods. The price mechanism serves as a signaling function.
Prices rise and fall, reflecting scarcities and surpluses. When
prices rise as a result of higher demand, this acts as a signal
to suppliers to expand output. They do so because whenever the price
exceeds the costs of production, they stand to gain. They ship the
goods to those with the highest willingness to pay.

Let’s
look at just one of the baker’s needs – flour. How does
the wheat farmer know whether there’s a surge in demand for
bakery products? The short answer is that he doesn’t. All he
knows is that millers are willing to pay higher wheat prices, so
he’s willing to put more land under cultivation or reduce his
wheat inventory. In other words, prices serve the crucial role of
conveying information. Moreover, prices minimize the amount of information
that any particular player involved in the process of getting flour
to the baker needs in order to cooperate.

What if politicians
thought that flour prices were too high and enacted flour price
controls in the wake of a surge in demand for bakery products? Would
wheat farmers put more land under cultivation? Would millers work
overtime to produce more flour? The answer is a big fat no because
what would be in it for them? The result would be flour shortages,
but the story doesn’t stop there because mankind is ingenious
about getting around government interference. If there were flour
price controls, we’d see black markets emerging – people
buying and selling flour at illegal prices. That’s always one
effect of price controls. Another would be the corruption of public
officials who know about the illegal activity but for a price look
the other way.

In 302, the
Roman emperor Diocletian commanded, “There should be cheapness,”
declaring, “Unprincipled greed appears wherever our armies
… march…. Our law shall fix a measure and a limit to this greed.”
The predictable result of Diocletian’s food price controls
was black markets, hunger, and food confiscation by his soldiers.
Despite the disastrous history of price controls, politicians never
manage to resist tampering with prices – that’s not a
flattering observation of their learning abilities.

Part 10

In 10 short
articles, there’s no way to even scratch the surface of economic
knowledge. I’ll simply end the series with a discussion of
a few popular sentiments that have high emotional worth but make
little economic sense. I use some of these sentiments as a teaching
device in my undergraduate classes.

Here’s
one that has considerable popular appeal: “It’s wrong
to profit from the misfortune of others.” I ask my students
whether they’d support a law against doing so. But I caution
them with some examples. An orthopedist profits from your misfortune
of having broken your leg skiing. When there’s news of a pending
ice storm, I doubt whether it saddens the hearts of those in the
collision repair business. I also tell my students that I profit
from their misfortune – their ignorance of economic theory.

Then there’s
the claim that this or that price is unreasonable. I used to have
conversations about this claim with Mrs. Williams early on in our
44-year marriage. She’d return from shopping complaining that
stores were charging unreasonable prices. Having aired her complaints,
she’d ask me to go out and unload a car trunk loaded with groceries
and other items. Having completed the chore, I’d resume our
conversation, saying, “Honey, I thought you said the prices
were unreasonable. Are you an unreasonable person? Only an unreasonable
person would pay unreasonable prices.”

The long and
short of it is that the conversation never went over well, and we
both ceased discussions of reasonable or unreasonable prices. The
point is that whatever price a transaction is transacted at represents
a meeting of the minds of both buyer and seller. Both viewed themselves
as being better off than the next alternative – not making
the transaction. That’s not to say that the seller wouldn’t
have found a higher price more pleasing or the buyer wouldn’t
have been pleased with a lower price.

How about your
parents’ admonition that “Whatever’s worth doing
is worth doing as well as possible”? That’s not a wise
admonition. I tell my students, often to their amazement, that it
might not be worth it to try to get the best grade possible in economics.
Let’s look at it. Say they have biology, physics, English,
and economics classes. They work their butts off in economics, earning
an A, but spending so much time studying economics takes time away
from other classes – and they wind up earning an F in biology,
a C in physics, and a D in English. That makes for a semester grade
point average of 1.75. They’d be better off, in terms of grade
point average, if they spent less time studying economics, maybe
earning a C, and allocating more time to biology and English and
thereby earning a C grade in all their subjects. They’d have
a higher grade point average (2.0) and wouldn’t be on academic
probation.

Another example:
You ask your wife to have the house as neat and clean as possible
when you return from work. You return, and the house is immaculate.
You compliment her, saying, “That’s a great job, honey.
What’s for dinner, and where are the kids?” She responds,
“I don’t know where the kids are, and there’s no
dinner prepared, but the house is immaculate.” Just as getting
the best economics grade possible is nonoptimal, so is doing the
best job possible cleaning the house.

Then, there’s
“You can never be too safe.” Yes, you can. How many of
us bother to inspect the hydraulic brake lines in our cars before
we start the engine and head off to work? Doing so would be safer
than simply assuming that the lines were intact and driving off.
After all, prior to launching a space vehicle, the people at NASA
make no similar assumptions. They go through a countdown of all
systems, taking nothing for granted. Erring on the side of overcaution
is costly, and so is erring on the side of under-caution, though
for a given choice, one might be costlier than the other.

April
11, 2006

Walter
E. Williams is the John M. Olin distinguished professor of economics
at George Mason University, and a nationally syndicated columnist.
These articles originally appeared in Freedom
Daily
.

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