Month: January 2009

I’ve picked up another book. It’s called “Predictably Irrational.” The author uses examples from experimental economics to teach us how we differ from how some economic models might suggest or assume we act. So far, there have been some interesting results, his discussion about the concept of “free” in particular is thought provoking.

One chapter is entitled “The fallacy of supply and demand.” Naturally, this caught my eye. He uses some experiments to show how ideas of what things are worth initially can be more or less arbitrarily set by advertising or other clever sales techniques. Ok, so far so good. The results are pretty convincing, but he doesn’t stop there. He then extrapolates these results into the idea that people’s thoughts on value are easily manipulated and therefore we can’t rely on markets and free markets ideas in general to bring about equitable trades since everyone is under the sway of the advertisers.

He’s way off. He left out a very important aspect of supply and demand, perhaps the most important one out there… competition. I am fully willing to believe that when confronted with a new thing, we don’t have a good idea of what it should cost or what value that thing has to us. His experiments show that that concept of value is easily skewed by all sorts of things. But a rational person doesn’t usually buy the first thing he sees, he checks around for prices. It is competition that tells us what we can expect to pay for something. Once we know that, we can figure out how we value that thing.

It isn’t clear to me what supply and demand even means without taking competition into account. So his chapter certainly doesn’t show any “fallacy” with that concept. Rational people check prices, who knew?

I received the Bastiat collection the other day (published by Mises.org) and as expected, I am totally blown away by it. He proves that you can get the essence of economics without having to be a mathematician or spend an eternity in college studying it. This is his introduction to the first essay in the book, the famous, “That which is seen, and that which is not seen.”

“In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.

The same thing, of course, is true of health and morals. Often, the sweeter the first fruit of a habit, the more bitter are its later fruits: for example, debauchery, sloth, prodigality. When a man is impressed by the effect that is seen and has not yet learned to discern the effects that are not seen, he indulges in deplorable habits, not only through natural inclination, but deliberately.

This explains man’s necessarily painful evolution. Ignorance surrounds him at his cradle; therefore, he regulates his acts according to their first consequences, the only ones that, in his infancy, he can see. It is only after a long time that he learns to take account of the others. Two very different masters teach him this lesson: experience and foresight. Experience teaches efficaciously but brutally. It instructs us in all the effects of an act by making us feel them, and we cannot fail to learn eventually, from having been burned ourselves, that fire burns. I should prefer, in so far as possible, to replace this rude teacher with one more gentle: foresight. For that reason I shall investigate the consequences of several economic phenomena, contrasting those that are seen with those that are not seen.”

That is the essence of economics. Much of what he has to say is relevent to the current machinations of Washington DC. Pretty good for someone that was writing in the early 1800’s!