Thinking Like Economists

Phillip TussingEconomics Instructor

Houston Commuity College

Exercises Based on Ideas of Actual Economists

• Adam Smith & Abraham Maslow: Needs

• Joseph Schumpeter & Erik Brynjolfsson, Creative Destruction

• Thorstein Veblen & Alfred Marshall, Conspicuous Consumption

• Arthur Pigou, Pigovian Tax

• Thomas Piketty, Wealth Inequality

• Thomas Hobbes & John Locke, Private Property

1. Adam Smith, 1723-1790

Self-interest

• "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages." -The Wealth of Nations, 1776, Book I, Ch ii, para. 2, lines 26-27

Mutual Benefit

• “…man has almost constant occasion for the help of his brethren…. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them.” (WN I.ii.2:26)

What is the Benefit?

• Abraham Maslow (1908-1970), a psychologist, in 1943 developed a “Hierarchy of Needs” which suggest the actual psychological needs people have, some of which may be advanced through economic transactions.

Exercise

• 1. Randomly assign two equal sets of roles or pass out two sets of cards, "buyer" and "seller". On each of these cards will be one of these products: "education", "medical care", "food". The seller’s price of each will be randomly assigned as min of $15, $20 or $25. Buyer’s max price randomly given as $20, 25 or $30.

• 2. Students will be randomly assigned max resources of $40, $55 and $70.

• 3. Set the students loose to talk and negotiate with one another. The object of the game is to be able to buy with one's resources all three products. A secondary goal will be to be able to buy those products at less than their resources, and have some "savings".

2. Joseph Schumpeter, 1883-1950

Creative Destruction – the result of Innovation & Globalization

• “The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory… incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.” –Capitalism, Socialism and Democracy (1943), p. 83

Destruction of Capitalism

• “… the capitalist process in much the same way in which it destroyed the institutional framework of feudal society also undermines its own.” –CSD, p. 139

Luddites

• People who destroyed power looms and spinners that were taking jobs away from weavers in Britain in the early 19th century. This is the classic conservative reaction to social & economic innovation.

Technology & Unemployment

• “The most productive firms reinvented and reorganized decision rights, incentives systems, information flows, hiring systems, and other aspects of organizational capital to get the most from the technology. This, in turn, required radically different and, generally, higher skill levels in the workforce.” 

• Erik Brynjolfsson, Race Against The Machine: How the Digital Revolution is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy

Are You Obsolete?

• A report was published by by the UK's University of Oxford Martin School's Programme by Frey & Osborne on the Impacts of Future Technology, dated September 17, 2013, listing 702 jobs according to the likelihood that they will be made obsolete by technology in the near future.

• Exercise: Pass out the list to students. Ask them which career on the list they hope to pursue. Does its likelihood of being replaced by computer technology make your student desire that career more, or less?

Income Disparity, Intellectual Property & Information Tech

• “The evidence that the current [patent] system encourages companies to invest in research in a way that leads to innovation, increased productivity and general prosperity is surprisingly weak. A growing amount of research … suggests that, with a few exceptions such as medicines, society as a whole might even be better off with no patents than with the mess that is today’s system.” –The Economist, 8 Aug 2015

• “In fact, the ratio of CEO pay to average worker pay has increased from 70 in 1990 to 300 in 2005 [331 in 2015], and much of this growth is linked to the greater use of IT,” ― Erik Brynjolfsson, Race Against The Machine: How the Digital Revolution is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy

Q: Is someone who uses someone else’s invention a Pirate or an Entrepreneur?

Examples of progress bypassing property rights:

• 1. Steam engine: invented by Thomas Newcomen 1712; improved & sold by James Watt 1781.

• 2. In the early 1800s, land for railroads was taken from farmers & ranchers in the US by “eminent domain”

• 3. Computer Graphic Display: invented by Xerox PARC; adapted by Steve Jobs to the Macintosh 1979.

• 4. 1980s-90s: China grabs land from farmers, takes foreign technology to jump-start its export businesses.

Corporate Perspective

3. Conspicuous Consumption & Inferior Goods

Thorstein Veblen, 1857-1929 Alfred Marshall, 1842-1924

Conspicuous Consumption

• " …the means of showing pecuniary strength, and so of gaining or retaining a good name, are leisure and a conspicuous consumption of goods.” –The Theory of the Leisure Class (1899)

Conspicuous Consumption?• -emerald-encrusted

golden throne • -chair• -La-Z-Boy recliner• -bicycle• -Kia car• -Mercedes Benz SUV• -Toyota Prius hybrid• -Ford F-350 Super-Duty

truck• -Jeep Rubicon Unlimited• -wedding dress

• -tuxedo• -suit• -shirt & pants• -sack for wearing• -tent• -shack• -5-room house• -35-room house• -rowboat• -sailboat• -35-foot yacht

Inferior Goods

• "Inferior goods" were …introduced by Alfred Marshall (1842-1924), …. Inferior goods are differentiated from normal goods by the fact that as income rises, quantity demanded of these goods falls.

What is Inferior?

• Which of the above list of goods is “inferior”?

• What is the relationship of normal and inferior goods to various income levels?

• To what extent is the definition of “inferior good” related to social norms?

Inferior Goods & Income Levels

• Is a bicycle a normal or inferior good?

• -in China in 1975• -in China in 2015• What happened

between those dates in China?

4. Arthur Cecil Pigou

Pigouvian Tax

• “It might happen… that costs [of production or consumption] are thrown upon other people not directly concerned…. All such effects must be included—some of them will be positive, others negative." The Economics of Welfare, Pt 2, Ch 2, para. 3, p. 115

• To deal with over-production, Pigou proposes a tax on the producer. This could equalize marginal private cost and marginal social cost, reducing the quantity produced, moving the economy back to equilibrium.

Costs & Benefits of Pigouvian Tax

• Point: A Pigouvian tax is intended to benefit society and internalize the externality, but the people who benefit are one group, whereas there the group who are harmed is different. This means there is still a deadweight loss to a Pigouvian tax (or subsidy), even though there is also a benefit.

Discussion: Pigouvian Tax

• 1. How beneficial is a gasoline tax levied to reduce the pollution caused by the burning of gasoline?

• 2. How beneficial is the tax if the revenue is used (as it is at the Federal level) to fix roads, making them easier to use?

• 3. How beneficial would the tax be if the revenue were used to subsidize hybrid cars? Does this have anything to do with how the electricity the cars use is generated?

Pigouvian Taxes & Energy

• How beneficial would the tax be if the electricity used by those hybrid cars were generated by coal? by wind? natural gas? Solar? Nuclear fission? Hydrogen? Nuclear fusion?

5. Thomas Piketty

Piketty Proposes

• The French economist Tomas Piketty's book Capital in the Twentieth Century (2014) documents in depth the increasing inequality of wealth between rich and everyone since the 1970s, in contrast to decreasing inequality in the period 1900-1970. Piketty argues that this is because the after-tax return on capital investment is normally higher than the long-term economic growth rate, which

he expresses as "r>g". He supposes that the disruptions of WW's I & II plus the Great Depression destroyed previously accumulated fortunes, but that new ones have been built since then, and that to prevent this growing inequality from continuing some form of global wealth tax is needed.

Is Piketty Right?

• Piketty's historical data has not been seriously questioned, but a number of economists have criticized his analysis and his proposed remedy. For example, one young economist, Matthew Rognlie, has produced data which suggests that much of the increased capital is actually in the form of housing, and that returns to productive capital have decreased, in line with standard economic analysis. Still, we have a problem of increasing inequality on such a scale that it raises the issue of inequality of access to good educational opportunities, medical care and jobs, all of which are drags on economic growth. What, if anything, should be done?

Exercise

• Set up 3 or 4 groups of students with different positions on how to address rising inequality. Assign the exercise in one class period, allow some time to gather information and develop arguments, speak briefly with each group in a subsequent class period, then present a small debate, with 5 minutes to present each group's proposal and arguments, three minutes each for criticism of other proposals, then three minutes each for rebuttal, and the class votes on which group "won" the debate.

Positions

• 1. The default position: laissez faire; leave the government out of the economy; interference would reduce the capacity of the economy to be productive.

• 2. Piketty's proposal: a wealth tax, either a yearly tax of some percent on increase in wealth, or an estate tax.

• 3. Bill Gates' proposal, which is a progressive tax on consumption and an equal reduction in income taxes.

Georgism

• 4. Another possibility: all tax revenue from land, based on the ideas of Henry George (1839-1897). Some modern Georgists advocate a property tax.

Thomas Hobbes, 1588-1679 John Locke, 1632-1704

Sovereign & Property

• “Propriety [ownership of property] belongeth in all kinds of Common-wealth to the Soveraign Power.

• “the Propriety which a subject hath in his lands, consisteth in a right to exclude all other subjects from the use of them; and not to exclude their Soveraign…. The Soveraign… is understood to do nothing but in order to the common Peace and Security.” Hobbes, Leviathan, Pt II, Ch xxiv, para 5 & 7

• “The safety of the People, requireth further, from him, or them that have the Soveraign Power, that Justice be equally administred to all degrees of People; that is, that as well the rich, and mighty, as poor and obscure persons, may be righted of the injuries done them… For in this consisteth Equity; to which, as being a Precept of the Law of Nature, a Soveraign is as much subject, as any of the meanest of his People.” Leviathan, Pt II, Ch xxx, para 15

State of Nature to Commonwealth

Labor Theory of Property

• “…every man has a “property” in his own “person”…. Whatsoever, then, he removes out of the state that Nature hath provided and left it in, he hath mixed his labour with it… and thereby makes it his property.” – Locke, 2nd Treatise of Gov’t, para. 26

• “God, the Lord and Father of all, has given no one of his children such a property … but that he has given his needy brother a right to the surplusage of his goods; so that it cannot justly be denied him, when his pressing wants call for it: and therefore no man could ever have a just power over the life of another by right of property in land or possessions...” – Locke, 1st Treatise of Gov’t, para. 42

Discuss

Hobbes• There is no ownership

in the chaotic State of Nature ‒ it can only occur in a Commonwealth ‒ and so all ownership is conferred by the sovereign.

• But, even the sovereign must be just in distributing ownership over property & helping the helpless poor.

Locke

• All ownership over property comes from labor a person puts into producing something, which occurs regardless of what government’s laws say. So you may rebel against those laws if they violate property rights.

• But you still have an obligation to help the helpless poor.

Questions

• Locke was important in providing principles underlying the Declaration of Independence & the US Constitution.

• Hobbes’ argument is often used to defend the right of the government to distribute property according to fairness.

• Both think protection of the “helpless poor” is necessary.

• Take half the class and divide them into two parts; one group presents Hobbes’ point of view; the other Locke’s

• The rest of the class act as judges and decide who wins – and “why?” (this is the most important part)

• Who are the helpless poor? Should we always protect them? Why or why not?

Discussion can Lead to Greater Understanding