Naked Economics, Wheelan, Charles [open ebook .txt] 📗

economics, Wheelan shows that they can be reduced to plain English. He boils economics down to its essentials. He demonstrates that the term “lucid economist” is not an oxymoron.

In these pages, we see how many of the criticisms of economists are undeserved. Economic analysis is a hard and complex subject—in many cases far more complex than analysis in the physical sciences. Physics can elegantly explain simple contained systems such as the planets revolving around the sun or electrons in orbit around an atom. But even the physical sciences have difficulty understanding phenomena in nature. Weather forecasting is a case in point. Despite complex satellite observations and intricate weather forecasting models, meteorologists often cannot improve on very naive forecasting models such as “The weather tomorrow will be exactly like it is today.” To be sure, the inertia model misses all the turning points but retains an excellent overall record. And when forecasters are asked to make longer-run projections on such subjects as global warming, their range of forecasts makes economic forecasts appear precise by comparison.

Economics is more difficult than the physical sciences because we cannot usually run controlled laboratory experiments and because people do not always behave predictably. A whole new branch of behavioral economics has attracted considerable attention by combining the insights of psychologists and economists, but we still are unable to predict individual behavior with any precision. But that we are far from understanding everything does not mean that we understand nothing. We do know that individual behavior is strongly influenced by incentives. We do know that there are many logical regularities, and we have enjoyed a steady accumulation of knowledge. We do know that every sale involves a purchase and that obvious opportunities for profit are rarely overlooked—the basic idea behind the theory that our securities markets are remarkably efficient.

And as inexact as economic science may be, it has a direct impact on our lives and it has a critical role to play in government policymaking. Economists influence all branches of government. The tasks of promoting economic growth and high employment while avoiding inflation have long been recognized as the domain of government economists. Remember Bill Clinton’s most successful campaign slogan during the 1992 election? “It’s the economy, stupid!” Promoting competition and restraining monopolies (Justice Department), limiting pollution (Environmental Protection Agency), and providing medical care (Health and Human Services) are examples of major activities within different cabinet departments that have crucially important economic components. Indeed, it is hard to think of any political decisions, be they on social, tax and expenditure, international, agricultural, or national security issues, that do not have economic consequences. And however skeptical politicians may be about the ability of economists to solve these problems, the economists’ advice is not ignored. Indeed, as John Maynard Keynes once wrote, “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”

The influence of economists is also increasingly pervasive in the business and financial communities. Peter Lynch, the former manager of Fidelity’s Magellan mutual fund, once opined that if you spent fourteen minutes talking to an economist you would have wasted twelve minutes. Perhaps it is ironic that the investment performance of professional mutual fund managers is now regularly evaluated based on techniques developed by financial economists. Moreover, economists influence countless other business decisions. They project product demand for companies as diverse as General Motors and Procter & Gamble. They are employed in large numbers by consulting firms engaged in business tasks from strategic planning to inventory control. They help investment firms fashion portfolios of securities by analyzing the trade-offs between expected return and risk. They advise chief financial officers of corporations on dividend policy and on the effect of debt on the price of the firm’s common stock. In our financial markets, option traders on the floors of the major options exchanges carry hand-held computers programmed with an economic model to tell them the prices at which they should trade put and call options. The fact is that economic analysis is incredibly useful for investors and producers as well as for government policymakers.

Ordinary consumers will also find that economics can illuminate many perplexing everyday issues. Why is it so hard for individuals to buy health insurance? Why do we stop at McDonald’s along a highway even though many other establishments may make better hamburgers? Why do so many people apply to “prestige” colleges even though many other institutions offer just as good an education at far lower prices? Have you ever wondered what such common terms as “adverse selection,” “public goods,” and “the prisoner’s dilemma” have to do with everyday life? These are among the subjects treated in this delightful book.

It’s often said that if you ask ten economists the same question you will get ten different answers. But I’ll wager that if you asked ten economists why there is a shortage of cabs and apartments in New York City, all ten would tell you that limitations on the number of taxi medallions and rent control are what restrict the supply of these goods and services. There are certainly many areas where economists are in virtual unanimous agreement. Economists overwhelmingly agree that free international trade can improve the standard of living of the trading countries and that tariffs and import quotas reduce general welfare. Economists generally agree that rent controls reduce the volume and quality of housing. Economists were virtually unanimous in their forecast that the horrific tragedy of September 11, 2001, would lead to a contraction of economic activity. My own experience in government suggests that there is far less difference in the views of economists (be they conservative Republicans or liberal Democrats) than there is between economists and those who come from different disciplines. Economists of contrasting political views agree among themselves on most issues. A bipartisan majority of economists is quite likely