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Your Economics for Dummies Questions Answered


Last week, we solicited your questions for Sean Masaki Flynn, author of Economics for Dummies.

In his answers below, Flynn addresses the economics of education, the relationship between aikido and economics, the importance of understanding opportunity costs, and how good shoes and nice teeth signal reproductive fitness. (Disclosure: Flynn himself had braces.)

While we didn’t post Flynn’s responses to “all the women who flirted with him” via this blog, he requests that they look him up via Google or Facebook.

Thanks to Flynn for all his answers and to all of you for your good questions.

Q: Aikido makes use of circular motions that are designed to use an opponent’s energy against him/herself. I see it as a step in the direction of nonlinear dynamics, versus the more linear martial arts. Since you have a unique perspective of each domain, what would you consider to be equal to aikido in the domain of economics?

A: That’s a deep question and one I definitely wouldn’t have ever pondered if you hadn’t brought it up. I think the nearest thing to aikido in economics would have to be things like confirmation bias, hyperbolic discounting, and other perceptual problems that make it difficult for people to adjust optimally to changing circumstances.

Aikido doesn’t so much use people’s energy against them as it adds something new and unexpected to a situation where they are moving — and it does so in a manner to which they are ill equipped to respond.

Good marketing guys can do this with us. We come into any situation as consumers or investors with a set of cognitive biases that make it difficult to respond optimally to a given situation if it evolves in an unexpected way. If they can manipulate the frame, we are carried along without even realizing it — until it’s too late. (Blam!)

Q: How would you summarize the “wheels of commerce” in a paragraph or two?

A: You’ve given me a killer task. But here goes: a one-paragraph abstract for Economics for Dummies.

If a society can promote a set of legal and economic institutions in which there are 1) strong property rights, and in which 2) people are prevented from coercing each other and can only engage in mutually voluntary transactions, you are likely to have the highest-possible standards of living and the most rapid growth of living standards. This optimal outcome is only possible if there is robust competition between both buyers and sellers.

Monopolies, cartels, and other forms of “imperfect competition” can screw up the whole system, as can poorly enforced or poorly defined property rights. But economists are painfully aware that this “optimal” outcome does not guarantee equality of living standards. It only guarantees two very good things: 1) that our limited supply of resources will be directed toward producing the things that people are most willing and able to pay for, and 2) that those goods and services will be produced at the lowest possible cost.

But poor people have very little ability to pay for things, so their wants will not be satisfied under a market-based economic system. This can be grossly unfair and can be rectified by some combination of private-sector charity and/or public-sector policies regarding income redistribution.

Q: What’s the economic value of good shoes and nice teeth? What’s the utility?

A: Good shoes and nice teeth are costly signals of reproductive fitness.

A signal is only credible if it is costly. A person telling you they are honest is one thing. Watching that person later stick to being honest even though it costs him his job is another thing. Such an action shows a much higher level of credibility that he will be honest in all situations.

In the same way, a person telling you that he has good genes that would produce lots of descendants is one thing, while providing you with costly evidence to that effect is much more credible. To the extent that a person has nice teeth, they either have good genes or could afford braces growing up. Both may be taken as signs indicative of being able to provide either good genes or plenty of resources to help make a lot of descendants.

And the same is true for good shoes. A person with good shoes must be both fashion conscious and able to afford good shoes. Being fashion conscious indicates a level of social skills that might help one’s descendants to survive and do well in our very social species, while the ability to afford good shoes indicates the capability of marshaling resources that could also be useful for descendants and thereby increase their evolutionary fitness.

My problem now is that none of you have actually seen my shoes. My claims about them are not costly and therefore not credible.

And, just for full disclosure, I had braces.

Q: After the federal government cleanup of our financial markets, would you be in favor of A) developing new industries and jobs with industrial policy and protective tariffs, B) encouraging growth through the private sector with tax incentives and other subsidies, or C) taking a blended approach, and why?

A: Entrepreneurs make new jobs and new industries and new products. The question from a public-policy perspective is how to best encourage them. My personal view is that the government does a really bad job choosing whom to support — either through direct subsidies, protection against foreign competition, the provision of tax incentives, or any sort of industrial policy that favors some entrepreneurs over others.

Worse yet, the possibility of successfully lobbying for subsidies, tax incentives, or protection from competitors means that it is often more profitable to direct one’s entrepreneurial efforts not toward developing new products or better methods, but rather toward figuring out better ways to game the system; better ways to lobby Congress, get increased corporate welfare, get higher tax subsidies, and so on. The very existence of A and B leads people to spend lots of energy trying to get more A and B rather than actually making better products.

So if I were in charge, there would be none of A or B. All firms would face the same tax rates, get zero corporate welfare, and be equally forced to compete with competitors domestic and foreign. This would force all entrepreneurial efforts to be directed to where they should be: the creation of new and better goods and services or the production of existing goods and services at lower costs using fewer resources.

Q: How can we demand more economics education from the public school system (the one most people go through)?

A: I went through the Los Angeles public schools, and I can tell you from firsthand experience that they are poorly managed, incredibly wasteful of money, and produce pathetic results. As a result, I would be the last one to put economic education as a top priority.

Before teaching supply and demand, we need to teach kids how to read, how to do math, how to think logically, how to use maps and graphs and charts, about history and literature and music, about our system of government, and much more about science and technology.

I do think that in a properly-run K-12 school system there would be room for a goodly amount of economics education. But first things first. The Los Angeles school district has a 50 percent drop-out rate and Johnny can’t read. Fixing those things has to be a higher priority.

Q: O.K., battle royal time. In the ring are: Steven Seagal, Jean-Claude Van Damme, Chuck Norris, Bruce Lee, William Shatner, Wesley Snipes, Jet Li, David Carradine, somebody with the last name of Gracie, Hulk Hogan, Jackie Chan, and Sean Connery (all age adjusted). Who’s comin’ outta that ring?

A: First of all, I have to engage in a little full disclosure here. I was named after Sean Connery. So a part of me wants to advocate for him.

And part of me also wants to pull for William Shatner, Mr. Priceline Negotiator.

But the best fighters on the list are Chuck Norris, Bruce Lee, and anybody with the last name of Gracie. But Bruce Lee did not engage in a lot of refereed contests, so while I suspect that he could hold his own, things really boil down to Chuck Norris and the Gracie clan.

Chuck was a superb tournament fighter with a lifetime record of 183-10-2. But that was mostly under non-contact karate rules, which is to say that I have doubts both about his ability to take a really hard shot to the head as well as his ground-fighting abilities.

So as a result, I think that I would have to give the edge to the Gracies, as they would likely be able to take Chuck to the ground and then submit him before he would have a chance to knock them out while the fight remained off the floor. Still, that would leave him with a lifetime record of 183-11-2. Not bad, man.

Q: Why is the price of everything going up, but the amount on my paycheck stays the same?

A: The underlying problem is that the money supply is increasing faster than the amount of goods and services that the economy produces. The supply of stuff to buy goes up maybe 3 percent per year due to increases in productivity and better technology.

But if the amount of money goes up faster, we get price inflation. That’s what’s been happening lately. It’s just as if at an auction they doubled the number of cars being auctioned off but the amount of money being thrown at the auction by the bidders tripled. With the amount of money going up faster than the amount of stuff being bid on, prices rise.

That’s why prices in general have been going up. But here’s the reason that your paycheck (which is the price your employer has to pay to get your labor) has not been going up as fast as the prices of the things you buy with your paycheck. Simply put, some prices change faster than others. Your labor contract is probably year-to-year. It may even be multi-year. So it is locked in for long periods of time. In the meantime, the prices of nearly all goods and services are free to be reset as often as retailers like.

Typically, retailers of most goods try to keep their prices fairly stable, since volatile prices tend to annoy customers. But with the money supply growing faster than the amount of stuff available to purchase with that money, prices tend to rise.

You can think of it starting with raw materials prices. When those rise, the cost of producing goods and services goes up. And with those costs going up, retailers raise prices in order to not lose money due to their increasing costs. Eventually, the price of labor will also go up. But with fixed-term labor contracts, that only tends to happen after a significant delay. If the inflation becomes ongoing and expected, workers will start asking for and getting automatic cost-of-living increases negotiated into their salary contracts.

That is what happened in the 1970’s when inflation got out of control. But I doubt it will happen now. Due to the credit crisis, the supply of money in the economy is likely to contract, and our recent bout of inflation is likely to subside. (Lending increases the money supply. But lending has dried up.)

Q: What aspect of economics do you think is most important for people to grasp?

A: The concept that economists call “opportunity cost” is perhaps the most important idea in economics.

Resources and time and money are limited, while our appetites are nearly infinite. As a result, we have to make choices, both as individuals and as a society, about which goods and services we would like to produce and consume. Any time we choose to do one particular thing (X), that means having to give up every other possible thing that we could have done with the time and resources devoted to doing X. Stated in economist-speak, the opportunity cost of X is giving up all the other opportunities that we might otherwise have enjoyed instead of X.

Once people start realizing that every decision has an opportunity cost, they start thinking like economists.

For example, do you want more spending on Head Start programs for preschool children? O.K., but remember that any increased spending for Head Start has an opportunity cost. Every dollar spent on Head Start means giving up a dollar of spending on feeding starving children in poor countries, efforts to decrease pollution, helping poor people get affordable housing, etc. Once a person starts thinking in terms of opportunity costs, they start making much more serious decisions about how to spend both their own money as well as taxpayer money.

Q: Steven Seagal? Really? I mean did you see Under Siege 2?

A: I did see Under Siege 2. Eric Bogosian was a great villain, Seagal kicked the tar out of evil terrorists, and a character who had only been taught a single aikido technique a single time later used it to single-handedly defeat an evil terrorist and toss her out of a helicopter to a singularly spectacular death.

That’s inspirational. That’s Seagal.

Q: Is this economy a market; or is it a meta-market, a market about markets?

A: Markets require a lot of institutional structure to make them work well. And much of that is provided by governments.

But governments do a lot more than provide for the proper functioning of markets. Another of their functions is to respond to political pressures from people who either don’t like markets or don’t like the outcomes that markets generate. And so we have a political-economical structure that promotes and restrains and supports and interferes with markets.

Political opinions vary greatly about exactly what policies should be established and executed, but if by a “meta-market” you are referring to the fact that markets only exist with the support of, an interaction with, and restraints placed on them by government, then yes, I would say we have a meta-market system.

Q: Will you write Econometrics for Dummies?

A: No. But I may write Economic Policy for Dummies. Stay tuned.

Q: Do you think some professors spend so much time doing arcane mathematics that they sometimes forget the basics of economics that you cover in your book?

Not really. Very often today’s arcane mathematics become tomorrow’s basic theory. We won’t get better unless we keep moving forward.

Q: Roughly what does one make for writing a Dummies book, and is it a more lucrative endeavor (in terms of dollars per hour) than the textbook route?

A: Author royalties are very paltry — both for textbooks and for other books. A typical royalty rate would be 6 percent or so of what the publisher can sell the book for at wholesale. That amount is typically half of the cover price. So if you see a hardcover selling for $30, the publisher probably got $15 at wholesale. So then 6 percent of that $15 would be only 90 cents. Then your literary agent will take 15 percent of that. So you are left with just 77 cents per copy.

And a book is considered a good seller if it sells 5,000 copies. Most sell far fewer. So basically, there is no money in publishing unless you can sell a lot of books.

Sadly, I am not J.K. Rowling.

Q: I read your book, and you rock! I thought you made very difficult concepts relatively easy to understand. Why don’t our politicians comprehend this information? My question: do you agree with the bailout plan?

A: You are right. I do rock. Now, as for politicians, some do understand a lot of economics while others don’t.

But I think it should be kept in mind that just because they understand good economics doesn’t mean that they will do good economics.

They are first and foremost politicians, and as such typically act in whatever ways will get them the most votes. A good example of this happened during the Nixon administration. Milton Friedman, the famous economist, personally warned Nixon that his plan to try to fight inflation by using price controls would only cause chaos and harm — especially to poor people. And Nixon acknowledged as much. But he then went ahead and ordered price controls all over the economy. Why? Because doing so increased his popularity. It allowed him to look like he was “doing something” to fight inflation without having to do anything politically costly like decreasing money-supply growth, raising taxes, or decreasing spending.

He was more than willing to engage in terrible economics because his incentives were not to engage in good economics but rather to look like he was “doing something” to help the little guy.

So perhaps the only good solution to these sorts of problems is to improve the economic literacy of the average person. That way they could distinguish between good and bad policies. If so, politicians who wanted to look like they were “doing something” would only be able to do good things.

Now, as for whether I agree or disagree with the bailout plan, I agree that we need to do something to get the credit markets going again. And I think that the current plan will likely succeed in this. And I think that something had to be done immediately.

So on the whole, I am O.K. with what got passed. Not enthused. Not convinced that it was perfect or even very good. But just happy that Congress and the administration got a good-enough solution passed and that they did so in such a timely manner.

Compared to how, for instance, Japan handled its credit crisis of the 1990’s, the current government response has been incredibly quick, mostly ideologically neutral, and practical in the sense of being willing to evolve and change as more information has come in and as we have learned from the policies we attempted in the spring and summer with regard to Bear Stearns, A.I.G., Lehman, etc.

Q: Why is economics considered more of a real science than psychology? Is it because math formulas equal validity?

A: The most important philosopher of science of the 20th century, Karl Popper, argued that economics was the only social science that had turned into a real science. To him, economics was the queen of the social sciences just as physics was the king of the physical sciences.

But why did he think this? Because economics was, to him, the only social science that engaged in systematically testing hypotheses about how the world works. Doing so is actually much easier if you engage in a lot of mathematical modeling. Why? Because in a math model it is crystal clear what your assumptions are, and also what implications follow from those assumptions.

Thus, you can say: “under assumptions X, Y, and Z, we get outcome B but not outcome A.” That sort of a very clear statement allows for experimental science.

You simply go out into the real world and find a situation where X, Y, and Z are happening and see if indeed the outcome associated with them is B rather than A. If it is, then this actual phenomenon is consistent with your hypothesis. That doesn’t mean your hypothesis is right, just that it hasn’t been overturned yet by the facts. And if people go out year after year after year constantly trying to overturn the hypothesis and they can’t, then it gains more credence. It never becomes truth; but it gains credibility and may pass into becoming referred to as a theory or even a law.

On the other hand, if you observe outcome A — the outcome that the model said wouldn’t happen — then you know the model is wrong and that you have to start over trying to find some other model of how things work.

Economics was the social science that most early on embraced math modeling and therefore was the social science that led the way in terms of making very precise, testable predictions that could be compared with the real world to see if they held up. That is why economics got the reputation of being more of a real science than psychology.

To see what I mean, think about any of the Sigmund Freud‘s writings. Is it at all clear what his assumptions are? What are his X, Y, and Z? And then, is the logic that he uses to get from his vague assumptions to his often-vague conclusions totally air tight? Not really. And then, are his predictions about human behavior in a given situation very precise? No. So, if we went out to test his “model” against what happens in an actual situation would we be able to? Not at all.

But before I get slammed by sociologists, anthropologists, psychologists, and others, let me say that much has changed. All the social sciences are now very much more mathematical and precise and thus very much more able to produce models that make precise, testable predictions. So these days, I can’t really say that economics is more of a real science than many of the others. But I would say that we were first, and that we led the way, and that that was a very good thing.

Q: Can there be a socially conscious economic model?

A: Yes. Every model that takes into account people’s preferences is socially conscious. But more specifically, you can easily build into economic models desires for collective goods like a nice environment, a more equitable income distribution, or a commitment to voting systems that lead to better outcomes for minority groups.

And economists have done this.

Let me just point you to the work of a few such researchers. I got these papers by simply searching through the EconLit database of economics papers. They give you a good idea of how seriously economists take socially conscious issues. And because they were all published in the last few months, you can see how much these issues matter to economists right now.

– “Protecting Watershed Ecosystems Through Targeted Local Land Use Policies”
– “Welfare Impacts of Alternative Public Policies for Agricultural Pollution Control in an Open Economy: A General Equilibrium Framework”
– “Does Hazardous Waste Matter? Evidence From the Housing Market and the Superfund Program”
– “What Does It Take to Achieve Equality of Opportunity in Education? An Empirical Investigation Based on Brazilian Data”
– “Are Vietnamese Farmers Concerned With Their Relative Position in Society?”
– “Roles of Income and Equality in Poverty Reduction: Recent Cross-Country Evidence”
– “Political Views and Corporate Decision Making: The Case of Corporate Social Responsibility”
– “Racial Context and Voting Over Taxes: Evidence From a Referendum in Alabama”
– “Electoral Rules and Minority Representation in U.S. Cities”
– “Protecting Minorities in Binary Elections. A Test of Storable Votes Using Field Data”