LESSON 1 Thinking Like an Economist

In this lesson you will learn:

• What it means to “think like an economist.”
• The types of questions that economics can help explain.
• Why it is important for everyone to understand basic economics.

Thinking Like an Economist

This book is a manual for a new way of looking at the world. After you master the lessons contained within these pages, you will be able to understand events in ways that your untrained peers will miss. You will notice patterns that they will overlook. The ability to think like an economist is a crucial component of your education. Only with sound economic thinking will you be able to make sense of how the world works. To make responsible decisions regarding grand political ideas as well as your occupation and mundane household finances, you must first decide to learn basic economics.

Creative and careful thinkers throughout human history have developed various disciplines for studying the world. Each discipline (or subject) offers its own perspective as history unfolds before us. For a complete education, the student must become acquainted with some of the most important findings in each field. Economics has proven itself to be worthy of universal study. A well-rounded young adult will have studied not only algebra, Dante, and photosynthesis, but will also be able to explain why prices rise.

Every subject you study will contain a mixture of knowledge that is deemed important for its own sake, as well as practical applications that may prove useful in your daily life. For example, every student should have a basic understanding of astronomy, since it illustrates the grandeur of the universe; but basic astronomy can also come in handy when guiding a wayward yachtsman who has lost sight of land. For a different example, consider mathematics. The study of advanced calculus is rewarding for its sheer elegance (though some students might consider the reward inadequate for the effort required!). But everyone needs to know basic arithmetic in order to function in society.

We will see the same pattern holds in the subject of economics. It is, in a word, simply fascinating to learn that there are underlying principles or “laws” that explain the operation of any economy, whether in ancient Rome, the Soviet Union, or a county fair in Boise, Idaho. Yet economics also has much to offer in practical guidance of your daily life. Knowledge of economics, by itself, will not make you rich, but it’s a good bet that ignoring the lessons of this book will keep you poor.

Economists look at the world in a unique way. Picture the crowds waiting to ride a popular amusement park roller coaster. A biologist surveying the scene might notice that people begin sweating as they approach their turn to get onto the ride. A physicist might notice that the first hill has to be the tallest. A sociologist might notice that the riders are arranged in groups of the same ethnicity. And an economist might notice that the first and last cars have much longer lines than the others, probably because people don’t like waiting but they also prefer riding in the very front or the very rear.

The economic perspective is not useful in every situation. On the soccer field or at the prom, the lessons in this book will not prove as relevant. But in your life you will encounter many situations of critical importance when your decisions will need to be informed by sound economics. It is not necessary for everyone to become an economist. It is important for everyone to learn how to think like an economist.

Is Economics a Science?

In this book, we adopt the view that economics constitutes an independent science, just as surely as chemistry and biology are distinct fields of study As we go through the lessons in this book, we will do so scientifically, meaning that we will use an objective set of “tools” for our analysis, that do not rely on particular ethical or cultural assumptions. The principles or laws of economics are the same, whether the economist is a Republican or a communist, and whether he lives in New Zealand or Somalia.

Warning! When we say economics is a science, we do not mean that we conduct experiments to test economic laws, the way a nuclear physicist studies the results of smashing atoms in a particle accelerator. There are important differences between a social science such as economics, versus a natural science such as physics. We will explain this in more detail in Lesson 2, but for now we simply want to caution you that basic economic principles can be discovered through mental reasoning. It wouldn’t make sense to go out and “test” the laws of economics, just as it doesn’t make sense to use a ruler to go out and “test” the various proofs that you might learn in a geometry class. The upshot of all this is that the lessons in this book will stand the test of time—there is no danger that a new experimental finding will overturn them tomorrow. In practice, professional economists make all sorts of conjectures, many of which turn out to be wrong. But the core body of economic theory—the types of laws and concepts contained in this book—is not testable; it’s simply a way of viewing the world.

Despite the possible confusion of economic science with a natural science, nonetheless we use the term science because it’s important to stress that there really are objective laws of economics. When politicians ignore the teachings of economics, their programs run into disaster—imagine the chaos if NASA ignored the laws of physics!

The Scope and Boundaries of Economic Science

It’s a common misconception for people to think, “Economics is the study of money.” Yes, economics obviously has a lot to say about money, and in fact one of the basic purposes of economics is to explain the different prices—which are quoted in units of money—of various goods and services being sold in the market place.

Contrary to this popular misconception, economics is broader than the mere study of money. In its widest scope, economics can be defined as the study of exchanges. This would include all of the exchanges in a normal market setting, where the seller hands over a physical object or provides a service, and in return the buyer hands over the appropriate amount of money. But economics also studies cases of barter, where the traders exchange goods or services directly with each other, without using money at all.

Pushing it to the extreme, economics even has a lot to say about cases where a single, isolated person takes actions to improve his or her situation. This is often called “Crusoe economics,” after the fictional character Robinson Crusoe who was shipwrecked on an (apparently) deserted island. We will study Crusoe economics in Lesson 4. It will be clear that even an isolated person behaves “economically” because he takes what nature has given him and exchanges the status quo for an environment that he hopes will be more pleasant.

The common theme running throughout all of the examples of exchanges is the concept of scarcity. Scarcity can be succinctly explained by the observation that there are limited resources and unlimited desires. Even Bill Gates faces tradeoffs; he cannot literally do whatever he wants. If he takes his wife out to a fancy restaurant, he has reduced his options (ever so slightly) and has diminished his ability to buy other things in the future. We can describe the situation by saying, “Bill Gates needs to economize on his resources, because they are finite.”

It is the universal fact of scarcity that gives rise to what people have termed the “economic problem”: As a society, how should we decide which goods and services to produce, with the limited resources at our disposal? In Lesson 5, we will see how the institution of private property solves this problem. But it is scarcity that causes the problem in the first place.

Warning! Economics does not study a hypothetical “economic man,” who cares only about acquiring material possessions or earning money. This is another common misunderstanding of what economics is all about. Unfortunately, there is some truth to this stereotype because many economists actually do build models of the economy that are filled with fictitious people who are very selfish and will only act altruistically if they are forced to do so. But in this book, you will not be learning any theories of that flavor. Instead, the lessons in this book do not depend on people being penny-pinchers; the laws we will develop in these pages apply to Mother Teresa as much as they apply to Donald Trump.

Economic science, as taught in this book, does not tell workers that they should take whatever job pays the most money, nor does it tell business owners that they must consider only financial issues when running their operations. These points will be made clearer during the subsequent lessons themselves, but we must stress up front that there is no “economic man” in the following pages; we are always discussing the principles that explain the choices of real people in the face of scarcity. The principles involve the fact that people have desires in the face of limited resources, but the principles are broad enough to cover people with any desires.

The Economics of Real People

Economics deals with the real actions of real men. Its [laws] refer neither to ideal nor to perfect men, neither to the phantom of a fabulous economic man (homo oeconomicus) nor to the statistical notion of an average man Man with all his weaknesses and limitations, every man as he lives and acts, is the subject matter of [economics].

—Ludwig von Mises, Human Action (Auburn, Ala.: Ludwig von Mises Institute, 1998), pp. 646–47

Economics studies and tries to explain how people make exchanges. A shipwrecked sailor wants to “exchange” some sticks and two rocks for a crackling fire, while a missionary wants to “exchange” his leisure time for a grueling trip to a remote jungle where the residents have never seen a Bible. A complete theory of exchanges must cover these types of cases too, not just the more familiar example of a broker exchanging 100 stock shares for $2,000.

Why Study Economics?

One reason to study economics is that it’s simply interesting. When you stop and think about what happens every day in a modern economy it should take your breath away. Consider the bustling metropolis of Manhattan: Millions of people work on this tiny island that is less than 23 square miles in land area. Obviously there is not enough food produced on the island itself, to feed these hordes. At first some readers may not understand this claim—some of the finest restaurants in the world are in Manhattan! But these exquisite restaurants rely on vendors to give them the raw materials to produce their very expensive dishes. If invading Martians placed an impenetrable plastic bubble around Manhattan (with small holes in the plastic to allow for ventilation), within two months hundreds of thousands of New Yorkers would be dead from starvation.

Yet in the real world—where no Martian bubble obstructs trade—farm produce, refined gasoline, and other items are shipped into Manhattan on a daily basis, allowing the inhabitants to not only eke out a bare survival, but actually to thrive. The workers on the tiny island of Manhattan transform the materials at their disposal into some of the most highly valued goods and services on the planet—think of the expensive jewelry, clothing, financial services, legal work, and Broadway performances “produced” in Manhattan. When you consider the incredible complexity of these processes, it is a wonder that its operation is normally so flawless that we take it for granted. The lessons in this book will shed some light on how the market economy achieves such feats, day in and day out.

Another reason to study economics is that it will help you make decisions in your personal and professional life. Of course, the lessons in this book will not by themselves make you rich. Rather, they will give you a framework to help analyze your plans so that you are more likely to achieve your objectives. For an analogy, studying geometry alone will not allow you to become a professional engineer, designing four-lane bridges. But nobody would want to drive on a bridge designed by someone who is ignorant of geometry.

Beyond its intrinsic beauty and practical applications to your own life, economics is a crucial topic because we live in a society plagued by an activist government. Unlike other scientific disciplines, the basic truths of economics must be taught to enough people in order to preserve society itself. It really doesn’t matter if the man on the street thinks quantum mechanics is a hoax; the physicists can go on with their research without the approval of the average Joe. But if most people believe that minimum wage laws help the poor, or that low interest rates cure a recession, then the trained economists are helpless to avert the damage that these policies will inflict on society.

For this reason, it is the young adult’s duty to learn basic economics. The lessons in this book will show you how.

Lesson Recap...

• This book will teach you to think like an economist. Different subjects (chemistry, biology, etc.) offer different perspectives on the world. Some perspectives are more useful in certain situations than others. Economics is a distinct field, or science, and it has important insights on how the social world works.
• Economics is the study of exchanges. In a modern economy, the most familiar exchanges involve money, but economic principles apply to any type of exchange.
• Every citizen should understand basic economics because of the danger of destructive government policies that ignore the lessons in this book.

NEW TERMS

Barter: A situation where people exchange goods and services directly, rather than using money in an intermediary transaction.

Scarcity: The condition of desires exceeding the available resources to satisfy them. Scarcity is a universal fact requiring people to make exchanges.

Tradeoffs: The unfortunate fact (caused by scarcity) that making one choice means that other choices become unavailable.

STUDY QUESTIONS

1. Can economics make you rich?
2. Is economics a science? Why or why not?
3. Does scarcity affect everyone?
4. Do the laws of economics still work inside a maximum security prison?
5. *Isn’t it just as important for the average person to understand particle physics, since much of the funding for this research comes from government grants?

*Difficult material.

**More challenging material.