What the heck is economics?

I visited eight sections of introductory economics this fall here at St. Ben’s and St. John’s. My mission: to recruit economics majors and minors. I need to do this because students have no idea what economics is or why they might want to major in the subject.

The same holds true for the general public. When I tell someone that I’m an economist, they likely say: “Oh, I took economics in college. It was so boring and it was just a bunch of equations. I didn’t get anything out of it.”

Sadly, research reveals that the last statement is true: Students who take introductory economics courses cannot answer basic economic questions any better other students.

I want to change that for you.

Definitions of economics
Here are two definitions of economics offered by leading economics textbooks:

“Economics is the study of how people make choices under conditions of scarcity and of the results of those choices for society.”  (From Robert Frank and Ben Bernanke, “Principles of Economics.”)

What kinds of choices? What do we mean by scarcity? This definition doesn’t seem very promising. (Ironically, I contributed to this textbook.) Let’s try another:

“Economics is a way of thinking. It entails accurately describing economic events, such as the Great Depression, explaining why such events occur, predicting under what circumstances such events might take place in the future, and recommending appropriate courses of action.” (From John Taylor, “Principles of Economics.”)

A little better. But what is this way of thinking?

Five aphorisms
Victor Fuchs, an economist at Stanford University, wrote a wonderful book entitled “How We Live: An Economic Perspective on Americans from Birth to Death” (1983).  He described the economic way of thinking through five aphorisms. I find this to be the best way to understand the way economists think and how economics is applied to the world.

• There is no free lunch. Yes, you’ve heard this one before, but think about it again. It says that every action you might take involves a cost. Suppose, for instance, that we are considering a tax cut. This policy has a cost: the government will not earn as much revenue as it otherwise would have, meaning that government must spend less or borrow more. (No, such tax cuts do not pay for themselves, but that’s another column.)  Economics starts from the premise that we must set out what these alternatives are if we are to make sound choices.

• There is more than one way to skin a cat. (Note to my fellow cat lovers: this saying refers to catfish.) There is rarely only one way to accomplish a goal, and this maxim emphasizes this fact. For instance, we might be considering a tax cut because we want to promote faster economic growth. There are many alternative policies that can do this: increased public spending on infrastructure, changes in the regulatory environment, improvements in education are just three. This is why economists are famous for saying, “On the one hand this, on the other hand that.” Our discipline is founded on the idea that there is rarely a single, optimal way to do something. And, we don’t ignore these alternatives just because they might be politically unpalatable.

• Nature doesnt make leaps. This phrase, in Latin, is the epigram for one of the first best-selling economics textbooks: “Principles of Economics” (1890), by Alfred Marshall. (Ever notice that economists have trouble coming up with a clever new title for their books about the principles of economics?)  Economists continue to embrace this notion because we have tools to find alternatives and calculate the costs of those alternatives, but these tools are not effective at measuring the effects of large, disruptive actions. For instance, economists cannot answer questions such as, “What would be the effects of eliminating taxes?” We can answer questions like, “What if taxes rates were reduced by 5 percent?” This frustrates many policy makers who prefer to ignore our economic advice.

• There can be too much of a good thing. One of my favorites, this adage asserts that we must compare the benefits of an action with the costs. It may have made sense to reduce tax rates in the 1980s since top tax rates were 70 percent. However, when tax rates on capital gains are 15 percent, the extra benefit of further reduction might be considerably smaller than the cost of further reduction (e.g. more borrowing).

• Time is money. This motto has two meanings for economists. First, it reminds us that we need to be careful to take the time value of money into consideration when we calculate costs and benefits. The ability to earn interest means that a dollar today is not worth the same as a dollar in one year. Second, it emphasizes that time is itself a resource that needs to be included in our reckoning of costs and benefits. 

Starting a conversation
The shortest definition of economics I know of is this: “People respond to incentives. The rest is commentary.” Economics builds on this premise to understand the world around us. I hope to use this column to help you understand economics, the economy and the economist’s approach to the world.

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Comments (24)

  1. Submitted by David Greene on 10/26/2011 - 09:00 am.

    Economics is the means we use to ignore justice.

    It may be harsh, but it’s true. We like to talk about economic numbers, what percentage this, what inflation that. But in doing so we tend to ignore the actual effects on human beings. So a tax cut might sound great, even given the reduced public revenue. What we often don’t do is consider what the consequences of that reduced revenue are.

    For every decisions, we also need to boil away the technocratic mumbo-jumbo (and I say that as a highly technical engineer) and get to the core of what our decisions mean for people, not profits.

  2. Submitted by Neal Rovick on 10/26/2011 - 09:45 am.

    My impression of the current state of economics sees it as a field removed from science. Sure there are lots of equations and graphs and lots of scholarly papers based on moving apparent correlation into “laws”, but there are fundamental disagreements as to cause and effect, re the current Keynesian debate. How can something so fundamental and critical remain open to wide debate?

    However, the biggest flaw that I see with economics as a predictive and steering tool is that it is so new a field (post-WW2). The assumptions of “ever-upward” that were so apparent in the post WW2 era when we were the only surviving industrialized nation that had instituted many new processes and procedures during the war, are no longer so easily made when the rest of the world has the same information and tools. It’s the flaw of assuming that trend lines must continue. It is assumed that the gyroscope of the economy will always return to trend, despite several millennia of example of economies that have wobbled off course permanently.

    This failure to recognize that the fate of the US economy is largely determined by the rest of the world now and the idea that, if left alone, the US economy would wobble back onto trend growth through sheer inertia (because it “always” has been that way) has resulted in decades of ignoring the fact that the world has changed and the old ways are not so sustainable. This has resulted in a possibly fatal delay. Indeed, today, the main Republican fall-back position on the economy is that it will get better on it’s own (thank God it didn’t happen on Obama’s watch!!).

    The most laughable recent economic assumption that was burst was the ‘efficient market’ hypothesis. Risk was hedged away, right? Well, what has happened in the last few years–who hasn’t been hurt? We have the ludicrous example of bond assemblers selling bonds they know that are going to fail, yet the very same crooked bond-sellers hold the stock and bonds of the bond-buyers–in effect the bond-sellers will end up feeling the losses of the bond-buyers. We have the example of Germany where Germans are pushing for no bailout of Greece because they don’t want to pay for the problems of others, when in reality, the default of Greece will result in the bankruptcy of German banks, German people, and possibly Germany as a country.

    I would think that the most helpful field of investigation in modern economics would be the study of the functioning of massively interconnected systems and developing methods of measuring and controlling off-balance risks to the system. Because the old gyroscopes won’t work forever.

  3. Submitted by Paul Udstrand on 10/26/2011 - 10:02 am.

    I think economist are so bored with economics they desperately want to pretend they’re doing something else, anything else. None of the definitions you offered describe economics. One kind of describes social psychology, and the other describe what historians do.

    Economics is the study of the exploitation, distribution, and movement of resources, capital, and wealth within human societies. It can get rather complex but basically that’s it.

    There are obviously psychological, political, and sociological components, but those are best left to the disciplines that study them.

    The difficulty economists have in identifying their own field explains a lot, and it tells you that the field has largely devolved into competing ideologies rather than disciplined reason and observation. Bernake’s definition is based on Randian “objetivism”. Taylor is creating narratives which are inherently ideological.

    I’m sorry but the five “principles” outlined here are mostly mundane observations pretending to be intellectual lynchpins. It has been humorous and alarming over the last decade as economists (perhaps bored economists) have attempted to deploy their “methods” in other fields and areas of human activity and behavior. And of course these attempts have yielded even less results than such methods have yield in actual economics. So have an article by an economist who promises to define economics, and fails.

    There’s only one important question right now in economics: “why did the vast majority of economists fail to anticipate the Great Recession”? Clearly the answer is that economists were too busy doing everything BUT economics. The economists that did anticipate the recession and bubbles were studying the exploitation, distribution, and movement of resources, capital, and wealth within human societies. Economists pretending to be psychologists, sociologists, mathematicians, historians, and philosophers, have nearly collapsed our economies.

  4. Submitted by James Hamilton on 10/26/2011 - 11:27 am.

    @1: As with any tool, economics can be used as a weapon. But we do little to help individuals when we make economic choices that undermine our own social goals. Properly used, i.e., as described above, economics is an important part of any discussion of serving human needs.

    Once we have agreed on a goal, our focus should be on how to accomplish that goal most effectively and economically. One can argue, for example, that limited mortgage interest deductions on primary residences have spurred responsible home ownership, with all its attendant benefits to a community, while deductible mortgages on recreational properties together with cheap and plentiful credit distorted real estate values and exposed millions to chaos in the event of a sharp downturn in the economy.

    Ignoring short and long term economic risks in pursuit of various goals, by public and private agencies and indiviudals, is one of the things that brought us to where we are today. We need to have a resonably reliable view of the costs of any undertaking before beginning.

  5. Submitted by Mike Gordon on 10/26/2011 - 11:29 am.

    Economics is a religion. Growth is god and will provide.

  6. Submitted by Michael Kuhne on 10/26/2011 - 12:02 pm.

    Wow. I was actually pretty excited about this new column – until I read the comments.

    Actually, I’m still excited. We need a columnist to serve as a public intellectual forwarding a discussion about economics. People can fulminate in response, but that’s part of the debate.

    I am not an economist, but I have an advanced degree. I read Michael Lewis’ The Big Short, and although it was well written, I did feel lost in many of the sections where economics vocabulary and theory dominated. I admit it: I need to become more economics literate. I am hoping this ongoing column can be a part of that evolution.

    I look forward to the next column.

  7. Submitted by Greg Kapphahn on 10/26/2011 - 12:22 pm.

    I have a few thoughts. First of all, economics, as it’s most often practiced, is based on a set of underlying assumptions, assumptions which, far too often, are not made clear, but which have a very determinative effect on the conclusions reached by those studying any particular economic issue.

    In recent history, two sets of assumptions have been most common: socialism and capitalism. Most American economists, rather than taking a broadly-based approach to the study of economic issues, reject the socialist approach to economics out of hand and thus only consider approaches based on capitalist theory. Thus they are severely biased before they even begin.

    Second, as is so often the case with humans, the ultimate aims of a society act to flavor economic study so thoroughly that economic study is pursued, not as an objective science but only as a way to produce the invisible, unspoken, and often unconscious aims of those doing the study and analysis (or of those paying for it).

    It seems to me that we have two competing visions of the purpose of American society which have shaped our economy and our well being Post WWII.

    From the end of WWII up until the advent of Ronnie Raygun, the chief societal aim of America seems to have been to produce the greatest possible well being for the greatest possible number of its citizens.

    There was tremendous societal, legal, and economic pressure against those things which worked to the detriment of average citizens.

    Beginning with Ronnie Raygun and continuing from that time, the chief societal aim of America seems to have gone in a very different direction, that of creating maximum value for owners and/or shareholders of business concerns (and the upper management class that might or might not be responsible for said value increases).

    There has been tremendous societal, legal, and economic pressure against those things which worked to the detriment of owners and CEOs of the largest business and financial enterprises (with detriment to average citizens simply being zeroed out as a factor in all economic equations).

    Because economics is not a pure science, but is always done for particular purposes and, therefore, aimed in particular directions, economists have all too willingly warped their work around those societal assumptions.

    As we see from the extreme increases of income in our nation’s highest echelons of economic elites, the assumptions which were sold to the general public beginning with Ronnie Raygun, that “a rising tide [for the already fabulously wealthy would] lift all boats,” have largely accomplished exactly what they were meant to accomplish.

    We are, in 2011, exactly where those who designed and supported those policies hope and dreamed we would be. Vast numbers of economists believe we are exactly where we should be because they agree with those assumptions without ever revealing that it is exactly such assumptions which underlie their approaches to economics – that our nation functions far better with a very small number of fabulously wealthy people and a large number of increasingly desperate and impoverished people).

    Until we begin to recognize the underlying assumptions being used by each and every economist who suggests “solutions” to our nation’s “problems,” we will have NO idea where their solutions are designed to lead us.

    Without their revealing their underlying assumptions, NO economist can be trusted to suggest ANYTHING that will take us anywhere we want to go.

    Finally, economics as its currently practiced, has no appreciation for the way human societies operate according to chaos theory. Despite tremendous pressure in the direction of change, not much happens for a very long time. Then a “tipping point” is reached and great deal happens all at once. Most economists seem to ignore that reality and thus miss things such as massive financial crises which arise,…

    when the creeping suspicion on the part of the executives of financial institutions that those to whom they are selling derivatives and credit default swaps might be starting to realize that they’re lying through their teeth about the value of those things,…

    suddenly becomes the reality that EVERYONE ELSE is lying just as much as they are and NOTHING in which they’ve all invested their own (and a lot of other people’s) resources can be depended upon to be worth anything.

    Chaos theory helps us to understand how human nature makes us prone to such debacles, but, since economists ignore it, and ignore the frailties of human nature (sorry, but we are NOT rational actors), they miss the inevitability of such crises when there are no controls to prevent them.

  8. Submitted by Dennis Tester on 10/26/2011 - 12:43 pm.

    “The shortest definition of economics I know of is this: “People respond to incentives. The rest is commentary.”

    That definition only applies to capitalism. The study of free market economics is an examination of purchasing and investment incentives of people who are free to make choices in the marketplace. In a free society, tax cuts can *increase* economic activity which in turn *increases* revenue to the government. When Ronald Reagan cut the marginal tax rates in 1981, tax receipts increased from $599 billion in 1981 to $1.032 trillion in 1990, an increase of 72%.

    But the definition also explains the failure of Marxism, because when Igor realized he would get the same pay as Ivan regardless of job performance, the quality of output leveled out to the lowest common denominator. This phenomenon illustrated how Uncle Karl failed to recognize the affects of incentive and reward on human behavior.

    Most economics taught in academia focuses on government actions and inactions instead of the real world, which are the actions of the consumer.

    The role of government in a free society is to simply establish an environment where goods and services are traded with minimal interference from outside forces that place undue burden on the transaction. Caveat emptor.

    Because when governments attempt to control the economy for the good of the people they end up controlling the people for the good of the economy.

  9. Submitted by Greg Kapphahn on 10/26/2011 - 01:03 pm.

    Some of us (especially economists) fail to realize that there are MANY incentives at work in our everyday lives and only a very few of them have to do with economic compensation.

  10. Submitted by Paul Udstrand on 10/26/2011 - 01:32 pm.

    I think one of the difficulties economists have is they seem to be confused about whether or not they’re studying natural phenomena or human created phenomena. They have a tendency to pretend they’re discovering natural laws when in fact economies are not natural phenomena, they are created with specific objectives in mind. There are organizing principles, but those are the products of choices not discovery. You don’t have to organize an economy around investors or profits, we’ve chosen to do so. Nor are economies the product of evolution, they are more accurately described as being the product of ideology.

    The dirty little secret about all those fancy equations is they don’t actually do anything useful.

  11. Submitted by Dan Kaufman on 10/26/2011 - 01:47 pm.

    My views has always been that no one really understands economics. Therefore, if I don’t take a course in it, I still know as much as anyone else. This column seems to agree with this premise.

    Somewhat surprisingly, if with my lack of “formal training” in economics, I have been paying more attention to economics recently. Books like “Freakeconomics” have help better explain economics in interesting and understandable ways.

  12. Submitted by Neal Rovick on 10/26/2011 - 01:48 pm.

    Mr Tester brings up some data from Reagan administration and inadvertently steps into the swamp of tricky numbers.

    If you go on nominal tax receipts, yup, they increased 72% from ’81-’90. Wow, over 7% a year!!

    BUT, if you go by inflation adjusted numbers, based on 2005 adjusted numbers, the increase in that period is only 20%. 2% a year, not such a big wow. In fact, pretty anemic.

    By the way, what also happened in that time period? The deficit in 1981 was 11.6% of the budget. The deficit in 1990 was 17.6% of the budget.

    How that for a different take on the same numbers? Does that convince anyone that tax cuts increase revenue? In fact, didn’t the revenue fall even further behind outlays?

    A tricky swamp indeed.


  13. Submitted by John Edwards on 10/26/2011 - 02:01 pm.

    The scariest part of part of Mr. Johnston’s column was his phrase “the government will not EARN as much revenue as it otherwise would have . . .” Government does not earn or create wealth. It can only extract it from the private sector. I am sure, however, that he does not allow his obvious left-wing bias to infiltrate his classroom teaching or color his MPR commentary.

  14. Submitted by Dennis Tester on 10/26/2011 - 02:09 pm.

    “You don’t have to organize an economy around investors or profits, we’ve chosen to do so.”

    No we haven’t, Paul. The real power of free markets isn’t the profit motive, it’s consumer choice. We have organized our economy around giving the consumer the most choices possible and the competition for the consumer’s dollar has led to constant innovation, lower prices and higher quality.

    Those who produce the greatest innovation, the lowest prices and/or the highest quality reap the most reward (profits).

    The only ideology involved is practiced by those who fear and resent this arrangement.

  15. Submitted by Dennis Tester on 10/26/2011 - 02:11 pm.

    Reagan’s problem was that although the tax receipts doubled, the democrat congress spent it all and more.

  16. Submitted by David Greene on 10/26/2011 - 02:30 pm.

    Good discussion here.

    @Greg (#7)

    > Despite tremendous pressure in the direction of
    > change, not much happens for a very long time.
    > Then a “tipping point” is reached and great deal
    > happens all at once. Most economists seem to
    > ignore that reality and thus miss things such as
    > massive financial crises which arise

    This gets right to one of the five aphorisms in the article: Nature Doesn’t Make Leaps. Perhaps Nature doesn’t, but people certainly do.

    This gets us to:

    @Paul (#10)

    > They have a tendency to pretend they’re
    > discovering natural laws when in fact economies
    > are not natural phenomena, they are created with
    > specific objectives in mind.

    This, I believe, is the central failure of economics. Economics, at least as presented to the “common man” is founded in a set of principles where are, if not completely unjustified, are certainly shaky.

    1. People are rational actors

    Uh yeah, right.

    2. Information is free and widely available

    Actually, we make most of our choices with very
    little information and that information is
    withheld deliberately.

    3. All incentives can be expressed in terms of

    Not hardly. Many people make seemingly
    irrational choices from an economist’s point of
    view but are perfectly rational for that person
    in his or her situation.

    4. All costs can be expressed in terms of money

    Even the economists admit this is untrue.
    “Externalities” is the trapdoor used to get
    them out of uncomfortable situations. But
    those externalities represent some of the
    highest costs we bear today.

    5. The Market is an invisible hand

    Actually, this one is really “The Market is
    God.” because it is omnipresent and
    omnipotent. This is really the corollary of
    1-4 and is just as false.

    Economists operate in a fictional world of perfect actors, perfect information and sterile policies, where equations guide decisions about who gets health care.

    It reminds me of the old physics joke about measuring various properties of a cow. “First, assume a spherical cow…”

  17. Submitted by Lars Negstad on 10/26/2011 - 02:46 pm.

    Wow, what a robust discussion.

    Nothing like money and religion to stir up some controversy. Speaking of which:

    I think one of the more dangerous notions is that economics is a science. It is not. It is an ideology, or set of ideologies, that as others have more eloquently stated, seeks to mask its ideological basis and offer itself up as a science.

  18. Submitted by Lance Groth on 10/26/2011 - 03:43 pm.

    I am not an economist and don’t pretend to be one. I never even took an econ course. However I’ll try to pay attention to this column and hopefully learn something.

    Regarding Mr. Tester’s comment on the Reagan tax cut, he seems to have omitted (inadvertently, I am sure) that Reagan raised taxes in 7 out of his 8 years as president, for a total of 11 tax increases. And, as governor, instituted the largest tax increase in California history (up to that time). He also doubled spending. Reagan was never shy about raising taxes or increasing spending.

    Conservatives seem to have a blind spot when talking about Reagan. If you’re going to talk about tax cuts and revenue increases, it only seems fair to present a complete picture of what actually happened. Biased input results in biased output – you know – GIGO.

    Now on with economics…

  19. Submitted by Alec Timmerman on 10/26/2011 - 05:44 pm.

    Dear Dennis,

    Tax receipts increased 99.6% in the 1980’s

    tax receipts increased 504% in the ’40’s
    tax receipts increased 134% in the 50’s
    tax receipts increased 108% in the ’60’s
    tax receipts increased 168% in the ’70’s
    tax receipts increased 96% in the ’90’s

    Top marginal tax rate between 1940 and 1970? About 70%.

    Reagan’s tax cut produced lower than average growth for the decade of the ’80’s.

    Your stat sounds fabulous, until you stack it up to all of the other decades before it.

  20. Submitted by Alec Timmerman on 10/26/2011 - 05:48 pm.

    One last thing. Part of those tax receipt increases were due to Reagan raising FICA taxes. The FICA taxes are factored into the “doubling” myth.

    So Dennis is arguing that a tax cut raised revenue with the help of a tax hike. misdirection.

  21. Submitted by Bernice Vetsch on 10/26/2011 - 06:05 pm.

    1) I believe economics began as a branch of philosophy, if I’m remembering correctly. Modern economists still seem to begin with a view of human nature that shapes their thought.

    2) Tester et al., please see the October 17 Bloomberg article “Candidates channeling Reagan don’t talk about his tax increases,” in which Bruce Bartlett told writer Andrew Zajac that, “Except for the ’81 tax cut, he [Reagan] raisaed taxes nearly every year he was in office, 11 times in all.”

  22. Submitted by Jerry Von Korff on 10/27/2011 - 07:32 am.

    Economics is a discipline designed to shed light through acquisition and analysis of data on what the how, why, and for whom of the production of goods and services, and the distribution of wealth. Like all disciplines, it can become the servant of a variety of value systems.

    Much of what passes for economics in the media is really the use of the tools of economics to advocate for particular policy choice or particular economic system. The economist becomes a lawyer or lobbyist for an interest group proposing changes in our political economy that benefits that group. Or, the economist seeks to hitch his or her rising star to the cause of a political party or candidate in hopes of procuring a position of power in Washington.

    We could use a healthy dialog on what the discipline of economics teaches. Under what circumstances does government spending or tax cuts stimulate employment? What is the effect of the minimum wage (or 40 hour week) on employment and incomes? What is the impact of current free trade policy on total wealth, on wages, and on distribution of wealth? Have tax cuts for the wealthy created jobs? These are all questions that benefit from careful statistical analysis of economic data as well as deep thoughtful analysis utilizing the framework provided by the discipline of economics.

  23. Submitted by Dennis Tester on 10/27/2011 - 08:06 am.

    Well Alec, then by your measure you should have been a big fan of Reagan’s, right?

    This much is not debatable: When Reagan took office, inflation was at 13%, the prime lending rate was 20%, the top marginal tax rate was 70%, and the federal budget deficit was about $80 billion. He cut the top marginal tax rate from 70% to 38%.

    When he left office, the economy was expanding for a seventh consecutive year.

  24. Submitted by Paul Udstrand on 10/28/2011 - 07:51 am.

    //Much of what passes for economics in the media is really the use of the tools of economics to advocate for particular policy choice or particular economic system.

    Actually I would amend that slightly. I would say the economics advocates for a particular constituency. The Chicago Free Market brand Tester is fond of advocates for the wealthy, the Keynesian brand advocates more the middle class, Marxism of course advocates for labor, etc. It goes back to my comment about economies being created not discovered, the argument is really about what kind of economy we want to create.

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