Keep Breaking Those Windows

As I prepare to speak on a Bastiat panel at the Association of Private Enterprise Educators conference next week, I am recalling the many reasons why Bastiat is one of my favorite economists. I wrote the following tribute to Bastiat earlier this semester:

One of my greatest influences is Frederic Bastiat, because his writing possesses clarity and perceptiveness that have continued to win minds for freedom since he first began writing. Though he contributed little original theory or research to the study of economics, he has been a strong voice for limited government and sound economic policy. He had a remarkable proclivity for illustrating fallacies by telling colorful tales. His wit stripped away the facades that statist positions try to hide behind, and the movement for freedom is stronger for it. Bastiat is a model of dedication to freedom in many ways.

Even though he did not develop new economic theories, he was a great communicator of the importance of property rights, individual liberty, and justice. His work illustrates that an individual does not need to be as brilliant as Alchian or Hayek to make a lasting contribution towards a freer society.

His passion for the work of liberty is a remarkable example for modern liberty-lovers. He encountered hindrance after hindrance in his political work, but by dogged determination and tireless effort, he and his colleagues were able to stop the encroachment of protective tariffs. As Bastiat wrote to an acquaintance,

“For my part, I will join the combat at whatever level I am placed, for apart from the fact that I put our noble cause a thousand times higher than our little individual ideas, I have learned from Mr. Cobden… that individual self-sacrifice is the soul and cement of any voluntary association” (The Man and The Statesman).

Edit 3/25/17: I wrote above that Bastiat did not develop new theories, but that is not true. Embarrassingly, I did not realize until a year after writing this piece that Bastiat’s “unseen” costs are the missed benefits of a choice that was not made because another choice was made instead. Sound familiar? Bastiat may have been the first to write about opportunity costs, now one of the first and most important concepts learned in economics. So I suppose my quest for a liberty hero of ordinary intellect continues.

Soapboxing On The Deplorable State of American Education…


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An “exciting” and nerdy display at my local library.

 One of the greatest challenges to liberty is the decline of personal responsibility and the accompanying desire for “protection” from harm, hunger, unemployment, and so forth. A society that fosters citizens that can take care of themselves but are also willing to help neighbors who are in need will develop the fabric of social cooperation that makes a nation stable and healthy. In this way, no one imposes on anyone else and all charity is given from genuine concern for the other’s well-being. A major contributing factor to the erosion of personal responsibility seems to be a mediocre public education system that leaves students with no conception of the importance of integrity and hard work. Alternative schools, such as private schools and homeschools are making great strides towards changing the schooling culture, but as long as the federal government has a vice grip on America’s educational system, we will continue to see lower standards. Returning America’s school systems to local control is the best way to improve the educational system and grow a generation of individuals who know what it means to be a good individual and a good neighbor. If bureaucracy is slashed, parents will have more influence and teachers will be more accountable. Continued growth of competition from private and charter schools will keep public schools accountable, but without a substantial reforms of the American public school system, we will be left with students who are not equal to the blessings of liberty and do not know its value.

A Sticky Misunderstanding

Critics of free markets often claim that one of the major shortcomings of an unrestricted market is that companies “extort” large profits, to the detriment of consumers. Underlying this claim is the assumption that companies should not be making profits; that a no profit situation would be more desirable. Perhaps the “Perfect Competition” model of a market contributes to this fallacy, because in this ideal state companies don’t make economic* profits. In this model, the price of a good equals the cost of producing the good, including opportunity cost-the profits forgone by not pursuing the next best use of resources. So a firm can make an accounting profit (bringing in more money than you pay out, and what is generally meant by the term “profits”) and still have no economic profits. The critical part of this picture is the opportunity cost, because it cannot be calculated and it is the difference between accounting and economic profits.

Labor and material costs are easy to measure, but by selling tables, a firm forfeits the chance to make dressers, or ships, or thousands of other things. How costly is that sacrifice? Only the decision maker of the firm can guess for himself what the forgone benefits could be. The extra compensation for making tables (beyond the obvious costs) is an inducement for a company to make tables instead of one of the other possibilities. If there were no profits, a company could not know how best to use their resources. These profits are signals to alert people that there is more need for one good than another. When lawn flamingos become more highly desired, the price rises. This economic profit opportunity attracts more companies to provide that good. Therefore, some compensation above cost of production is a reward for a firm “closing the gap” between what people want and what producers are making.

So here is the catch: The opportunity cost of making one thing over another can’t be calculated, and it is different for each firm. The Perfect Competition model glosses over this complexity and simply bundles a place-holding “opportunity cost” with the other costs. This model assumes no economic profitsbecause any money firms make beyond costs is reimbursement for forgone opportunities.  (This can be assumed because if there was a better use of a company’s resources, they would be pursuing that action instead.)

Non-economists can easily assume that “no economic profits”= no profits (in the general understanding of the term). Those who say that profits are higher than necessary (Occupiers, among others), don’t realize that economic profits only exist for very short periods because if the money to be made is one industry is so much higher than in another, firms will move to that industry. Prices will fall, and profits will eventually even out between industries. (In theory.) But the weird thing is, even if we accept the idea that accounting profits are not a big deal and economic profits are the real profits, we miss the point that economic profits drive innovation. Yes, it is true that businesses that make economic profits are raking in the moolah. But they earn that extra moolah by meeting the needs of customers.

*Key: Accounting profits: The money left over after all expenses are paid; general understanding of the term “profits”.

Economic profits: Accounting profits minus opportunity cost (the potential gains you give up by taking one course of action rather than another). Because we can only guess what we are giving up, and because it does not fit into a tidy equation, opportunity cost is too often ignored. *sigh* Theoretically, economic profits won’t last long, because they are a signal that it is more advantageous to make one item over another. So more companies will shift to making the higher valued item, and the price will fall until the economic profit is gone.

A special thank-you to Dr. Ivan Pongracic, Mises Chair of Hillsdale College’s Economics Department and my Industrial Organization professor, for inspiring this post and generously proofreading the draft.

In Defense of Judging a Book by Its Cover

 

There are many common adages to which economists object, but the one that really bugs me is “Don’t judge a book by its cover.” And while I understand what the phrase tries to convey, disregarding the value of quick judgements misses an essential part of human decision-making.

If we aren’t allowed to judge a book by its cover, how do we decide which to read? Given that we don’t have time to read every single book in the library, we must decide which book we will like best based on the title and the paragraph on the back. Certainly, we will make poor decisions at times. The book that looks like it could be a New York Times Bestseller could be as interesting as watching a snail race. But on the whole, we would generally pick books that we enjoy reading. In the same way, buying laundry soap would be a hassle if we had to look up all relevant scientific information regarding the efficacy and safety of the brands carried by the store before we made a decision of which to buy. It is not worth our time. Small decisions with low-stakes are best made quickly because the benefits of extra knowledge are smaller than the value of the time expended to find that information.

However, I would argue that large decisions also benefit from these judgements. In the case of meeting a new person, it only takes a few minutes to decide if you two are likely to become close friends. These judgments might lead us to occasionally miss out on good (unexpected) friendships, but we live in a world of scarce resources and we do not have the time to get to know every person before deciding if it is worth investing additional resources in a friendship.  If a person is able and willing to invest more time in making a judgement, she is more likely to make a wise decision. But we are capable of making a tolerably good (if often sub-optimal) decisions with only small amounts of information.

Agree? Disagree? I’d love to hear your thoughts.

A New Chapter

A stack of awesome books, and me.

Though there is very little I can say on this blog that hasn’t been said before much more eloquently, I aim to use this blog to explore economic ideas more deeply than I would otherwise.  As an English professor once told me, “If you haven’t tried to write it down, you haven’t thought about it.”  In the interest of writing more and thinking more deeply about a subject I am passionate about, this blog will be a record of that journey. To kick off this endeavor, I will begin with a post about one of my personal heroes and the namesake of this blog, Frederic Bastiat. Thanks for reading, and I hope the utility you derive from reading this blog exceeds the opportunity cost!