Four Vital Economic Principles

Simple things everyone should understand, but far too many don't

Earlier this month, I explained how too much focus on economics and the pursuit of prosperity in policy, rather than worrying about first principles which lie upstream of the monetary issues, is a distraction that fails to achieve desired results. Having said that, some understanding of the basics of economics is useful more often than you’d expect, particularly given how little of it most people ever get taught. Here’s my take on the four most important principles in economics.

Supply & demand

When the supply of something goes up, the price will come down, and vice versa. Demand is the opposite: when the demand for something goes up, the price will go up, or if demand is reduced, you can expect prices to fall.

There’s a lot of complicated math going into calculating what the expected price will be if supply or demand change in certain ways. That stuff’s for professional economists. But understanding the basic principle of things moving up and down? That’s for everyone.

If you understand supply and demand, you can understand why subsidies for something expensive always tend to make it even more expensive: providing access to new buyers who formerly couldn’t afford it before is exactly equivalent to an increase in demand. You’ll understand why increasing the minimum wage is so counterproductive: when the demand for wages goes up, employers are able to purchase less labor from workers, leading to both layoffs and price increases, driving up the costs for the people who just got raises, and also for everyone else who didn’t just get a raise, so everyone ends up worse off. You’ll understand how turning degrees into employment credentials screwed up the entire higher education system. And so on.

Monopoly and monopsony economics

Free market principles work exceptionally well at describing the workings of a free market. But when conditions of freedom do not exist in the marketplace, those principles break down.

If I want a burger and there are ten different burger joints in town, I’m in a pretty good position. I can see what the different restaurants offer and pick which combination of food and price I like best. And they know that, so they compete with one another to beat each other’s quality and/or price. But if there’s only one, my choices are sharply limited. I can either buy the burger they sell, at the price they charge, or go without. And since they know they’re my only choice, they have no real reason to do any better, so they’ll inevitably end up selling overpriced garbage.

If it’s just something as trivial as a burger joint, you might wonder, with some justification, what the big deal is. But make the stakes a little higher, it becomes a very big deal indeed. What if there’s only one gas station? (If you’ve ever taken a long road trip, you’ve probably seen those stations out in the middle of nowhere, with no stops for 50 miles, that charge half a dollar more than the going rate. Because what are you gonna do if you don’t have another 50 miles’ worth in the tank?) What if there’s only one school you can send your kids to? (And now you understand why school choice laws end up making the quality of education in public schools go up, not down.)

Now here’s an interesting twist on it. What if there are multiple sellers, but only one buyer, or a very small number of very large buyers? If you run a business, and your entire business is dependent on revenue from one buyer? Then we run into monopoly’s less well-known cousin, monopsony. It’s a different type of distortion of the free market. Remember Jafar’s version of the Golden Rule: whoever has the gold makes the rules. In monopsony, instead of the public being at the mercy of the seller, the sellers are at the mercy of the buyer.

You don’t see monopsony very often, outside of industries whose whole reason for existing is to be government contractors, but one significant exception is in health care. When insurers, not customers, pay all the bills, it gives them a horrendous amount of leverage over the hospitals and clinics; by deciding what will be paid for and what won’t, they can literally choose who lives and who dies. The last time I was at a clinic, they gave me a substantial discount when I offered to pay out-of-pocket; I assume this behavior is to incentivize people to give them a bit of wiggle room and help lessen the insurers’ tyranny over their operations.

Amortization

Quick question: if Andrew wears $30 shoes, and Ben wears $180 shoes, whose footwear is more expensive?

Obvious (but wrong) answer: Ben’s. Just look at the prices.

Correct answer: Don’t just look at the prices. Also look at how long they last.

If they both last the same amount of time, Ben’s are clearly more expensive; just look at the prices. If Andrew’s cheap shoes will wear out in 6 months, and Ben’s will last for 3 years, then over the course of Ben’s 3 years, Andrew’s going through 6 pairs of $30 shoes, for a total of $180, so the total cost is the same. But if Ben’s shoes last longer than 6x as long as Andrew’s, he’s saving money overall. (And he’s also got the benefit of wearing nicer shoes!)

Thinking about the cost of goods as a function of price over time, rather than simply as price alone, is known as amortization, and most people either never encounter the term or never think about it outside of the context of business expenses. (Or, occasionally, the amortization schedule on a large loan.) In business, the way it’s formulated is a little bit different; amortization (or depreciation, which is basically the same thing with some subtle differences) is a term typically used for talking about assets losing value over time, whereas you don’t tend to think of a pair of shoes as “an asset” with a price tag, something that you might resell to someone else someday. But the basic idea, that the cost of something is not just its dollar amount but should be looked at as its price spread out over its lifetime, is the same.

Now, please don’t go splurging on unnecessary luxury items and say “Bob Frank said I’d save money by buying expensive things.” You’re not saving any money if you buy something unnecessarily. But if you are already going to buy something anyway, take the expected lifetime into account and see if paying extra for something high-quality won’t save you some money in the long run.

Unintended consequences

I’ve mentioned moral hazard before, the observation that when a person or group is insulated from the direct consequences of their actions, their risk-taking behavior gets worse because they won’t end up paying for it if something goes wrong. This is just one of many principles that economists group under the category of “unintended consequences.” Here are just a few of the more common problems people run into by not thinking things through long-term:

• The Cobra Effect: Paying a bounty for solving a problem leads to creating more problems to be solved, making the overall problem worse.

• The Jevons Paradox: Making something scarce easier to access leads to more people using it, making the scarcity even worse. (Jevons’ original work involved efficiency of resource use, but the same principle applies in plenty of other places.)

• The Streisand Effect: Trying to make people stop talking about something draws further attention to it, making the problem even worse.

All of these problems are things that could have been prevented if the people in charge had not stopped thinking after “A leads to B,” but had then asked the question “what does B lead to?” Unfortunately, we are explicitly taught not to think that way. They call it the “slippery slope fallacy,” the idea that predicting long-term problems is an invalid form of reasoning. (Interestingly enough, this only seems to apply to predicting long-term problems. One of the things I remember clearly from high school was a unit on logical fallacies, and how strange it felt to me that they said, in so many words, that predicting “A leads to B, and B leads to C, which is bad” was a slippery slope fallacy and you shouldn’t do it, but predicting “A leads to B, and B leads to C, which is good” is perfectly valid and just fine for you to claim without running afoul of any logical fallacies!)

The reality is, thinking beyond a single degree of cause and effect is one of the highest forms of human reasoning. All too often, the slope does turn out to be slippery indeed, and learning to tell when this will be can save you a lot of trouble down the road! Almost makes you wonder why Leftist-dominated institutions of learning explicitly teach you not to think that way, doesn’t it?