Bryan Caplan  

Basic Economics Is Intuitive

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Economists often off-handedly remark that basic economics is "counterintuitive."  In one of the papers he presented at GMU, Scott Sumner has a whole appendix on "Why is economics so counterintuitive?"  Even my hands aren't clean here: In The Myth of the Rational Voter, I wrote that "...Smith's thesis [the harmony of private and public interest] was counterintuitive to his contemporaries, and remains counterintuitive today."  However, the more I think about it, the more I'm convinced that if basic economics seems counterintuitive, it's being poorly explained.  If Bastiat could make econ intuitive, so can we.

To make my prima facie case, I'm going to present a few allegedly counterintuitive economic propositions, then explain them at a 6th-grade level.

1. Counterintuitive claim: Free trade makes countries richer, even if the other countries have big advantages like cheaper labor or more advanced technology.

Intuitive version:  We'd be better off if other countries gave us stuff for free.  Isn't "really cheap" the next-best thing?

2. Counterintuitive claim: Strict labor market regulation is bad for workers.

Intuitive version: Employers don't like hiring people if it's hard to get rid of them.  Suppose you had to marry anyone you asked out on a date!

3. Counterintuitive claim: Egalitarian socialism creates poverty... even starvation.

Intuitive version: If everyone gets the same share whether or not they work, you're asking people to work for free.  People don't like working for free, especially when the work isn't very fun.  (This is my response to Sumner's Great Leap Forward Challenge: "But how do we explain to school children that millions had to starve because of a policy that encouraged people to share?")

4. Counterintuitive claim: Prices are determined by supply and demand.

Intuitive version: If the good were free, consumers would want a lot, but producers wouldn't feel like making much.  If the good cost trillions of dollars, producers would want to make a lot, but consumers wouldn't want to buy any.  In between there's got to be a price where consumers want to buy as much as producers want to make.

To deflect charges of cherry-picking, I'll open myself up to a challenge: State any proposition in basic economics in the comments, and I'll make it intuitive in a follow-up post.


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COMMENTS (55 to date)
Ted writes:

This is very good stuff. It follows the pattern of how my best economics teachers explained things. I would like to see more!

Niklas Blanchard writes:

The seeming paradox is that you can easily explain these concepts to children. I believe that Sumner even states that kids on a playground intuitively understand comparative advantage. Auction-type markets happen all the time in the lunchroom, so it's easy to get a feel for supply and demand.

It's adults, who have built up priors and biases over the years, who seem to have the problem understanding basic economic concepts.

Greg Ransom writes:

Counterintuitive Claim: interest rate manipulations can alter the time shape of production processes and the consumption plans of individuals in structurally incompatible patterns.

Evan writes:

Counterintuitive claim (falls under the strict labor market regulation claim, but even more counterintuitive):

Restricting private employers from paying employees below an arbitrary point is bad for the average worker and growth because it inhibits the number of possibly available jobs.

I have real trouble explaining that one in an intuitive manner.

Matthew Gunn writes:

Counter-intuitive claim: A steady flow of around a million immigrants per year taking jobs in the United States doesn't increase the unemployment rate of natural born Americans.

Prakhar Goel writes:

Bryan,

You are not cherry picking so much as ignoring the problem entirely. These beliefs are not held because they are right or wrong or due to some understanding. They are held because they are beneficial to organized interest groups vs. a very large disorganized majority.

#1 Free trade makes countries richer.

Yes, but it also forces a painful redistribution of jobs which job holders (in the cloth, auto, and paper industries for example) would like to dearly avoid.

#2 Strict labor regulation is bad for workers.

Correction: it is worse for new workers. The incumbents are served quite well.

#3 Egalitarian socialism creates poverty.

Once again, egalitarian socialism is to the benefit (short term at least) of the ones who are the recipients of wealth redistribution.

#4 Prices are determined by supply and demand.

Price fixing is definitely a boon to either a small set of customers or an even smaller set of sellers.

In each of these cases, the larger majority simply does not care. They have better things to do. Even if counter productive policies do get passed, the cost to each individual member of the majority is minuscule (per policy). Thus the organized minority spends significant resources on its pet policy while the majority either ignores the issue all together or, after listening to the "reasonings" of the minority, proceeds to act in a complete irrational manner (as you demonstrated in Myth of the Rational Voter). Your arguments, intuitive, correct, or not, are never given an adequate platform in the first place.

PS. If you are continuing your reading on social science, may I recommend Political Parties by Michels and Mind and Society by Pareto (assuming that you have not read them already).

Nathan writes:

Evan:

My attempt. Workers are selling their labor. A minimum wage says you can't sell an hour of labor for below a certain amount. If there were a law saying supermarkets couldn't sell bananas for less than a certain amount, you'd buy fewer bananas. A minimum wage means that employers buy fewer hours of labor, i.e., fewer jobs.

Alex writes:

Evan: If the minimum wage was a trillion dollars an hour, do you think anyone would ever get hired for anything?

Matthew Gunn writes:

Just a quick followup. I love the Milton Friedman quote, "Most economic fallacies derive from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another."

I think it takes some level of reasoning to understand dynamic effects, why some Y (eg. # of jobs) isn't fixed when you change X (eg. # of workers). The more reasoning is required, the less intuitive a claim is.

Gu Si Fang writes:

I'm in desperate need of an intuitive explanation of Gresham's law : good money drives out bad, except with legal tender laws.

Artturi Björk writes:

Counterintuitive claim:

Motives don't matter, competition does.

We are better of as consumers if selfish people compete with each other who will get to be of service to us rather than being served by altruistic person who doesn't face competition.

Nilkas Blanchard writes:

Counter-intuitive claim (paraphrased from Adam Smith):

"The ultimate goal of economic activity is not production, but consumption."

Greg Ransom writes:

Counterintuitive Claim: during a recession it is _not_ a good thing when natural disasters give the government a reason to hire people and build things to replace what has been destoyed.

greenish writes:

Counter-intuitive claim (paraphrased from Adam Smith):
"The ultimate goal of economic activity is not production, but consumption."

Are you kidding?

Which would you rather do:

1) Bake a pie, and not eat it

2) Eat a pie, and not bake it

Joe Cushing writes:

Counterintuitive Claim: Commodity speculators reduce volatility and cannot drive prices to their advantage.

Counterintuitive Claim: Eliminating jobs by increasing productivity is a good thing. Likewise, creating jobs by reducing productivity is a bad thing. --Usually the part about productivity is left out of the political discussion but I wanted to be clear where I was coming from on this.

Niklas Blanchard writes:

Are you kidding?

I don't personally find it confusing...but there are entire cottage industries that thrive off of confusing the concept...not to mention politicians who have made careers doing so.

It may have been a bad example, as Bryan dealt with free trade, but it is the first that came to mind (hat tip to Don Boudreaux).

woupiestek writes:

Regarding minimum wages: could the dead weight loss be offset by imposing a maximum wage? For example, imposing a minimum wage on nursing and a maximum wage on managing to force people (women :-b) from the former to the latter.

This is more a basic economy question than a claim.

Alan Crowe writes:

Counterintuitive Claim: The division of National Insurance Contributions into Employers Contributions and Employees Contributions is bogus.

Obviously supply and demand in the labour market are part of the story about how the incidence of taxation is divided up, but it would be nice to see a simple answer to the question: why don't the employers pass along the whole of their share of the burden in higher prices. It is not as though the customer can shop around and buy more cheaply from the firm that is evading Employers National Insurance contribution.

I want to refine my counterintuitive claim and say: The division of National Insurance Contributions into Employers Contributions and Employees Contributions doesn't even get the number of parts right. It is a three way split, paying money to the government through 1)lower wages, 2)higher prices, and 3)a lower return on your savings and investments.

Lode writes:

Counterintuitive claim: Regulation of drugs can have negative effects on our health.

Hmmmm...reading Bryan's and the other commenter's examples leads me to this conclusion:

Every claim from an economic model can be oversimplified.
DW writes:

1. coase theorem

2. paradox of thrift

Mark writes:

Self-interest: By acting in their own self-interest, individuals without intending to do so, serve the interests of others.

liberty writes:

I absolutely agree. I have long thought that these are pretty intuitive, and it is all about how it is explained. That is also one of main purposes of my book, and in general what I think Austrians do best.

"Counterintuitive Claim: interest rate manipulations can alter the time shape of production processes and the consumption plans of individuals in structurally incompatible patterns."

Intuitive version: An interest rate is what someone pays in order to borrow money to invest in something. If there are a lot of people wanting to invest, the interest rate will rise (just like any price rises when demand increases). This helps to sort the more important and efficient projects from the less important ones, which are no longer cost-effective with the higher interest rate. When government fixes the interest rate low, a bunch of projects that should be seen as too costly appear to be worthwhile (and there is a "boom"). But eventually the interest rate will have to rise again. When the interest rate rises these projects will not be affordable (and there will be a "bust.")

dullgeek writes:

Hmm... DW brings up an interesting problem with this challenge. Is the goal of the challenge to make any counterintuitive economic claim intuitive, even the ones that whole branches of economists disagree with? I am, of course, referring to the paradox of thrift, of which I'm pretty sure the austrians are not big fans.

Is it possible to make intuitive a claim over which there is vast disagreement? And if you can, can you make it intuitive without tipping your hand as to which side you fall on?

Steve Roth writes:

>3. Counterintuitive claim: Egalitarian socialism creates poverty... even starvation.

>Intuitive version: If everyone gets the same share whether or not they work, you're asking people to work for free.

Bryan, this is only intuitive because it's an inaccurate depiction of egalitarian socialism. Sweden is not the PRC; econ professors aren't mucking out stalls over there (or here, for that matter).

There's not a single thriving, prosperous country in the world that doesn't engage in a huge amount of egalitarian socialism. How can you explain that?

Why is there not a single prosperous country that operates according to the principles of libertariansism? Shouldn't one have emerged by now, and left all the others in the dust? Shouldn't there be at least one that shows at least some promise of same? There isn't.

Steve Roth writes:

But you're right that most important economic ideas can/should be explained intuitively. i.e.:

If people at the bottom of the pyramid don't have enough money to buy things and support productive enterprises, people at the top have no profitable and productive enterprises to invest in. So they manufacture gambling enterprises that endanger the whole edifice.

Eric H writes:

Counter-intuitive claim:

Interpersonal comparisons of utility are not possible.

We make them all the time:

Bill likes apples more than I do;

Jane liked Apocalypse Now more than Jeff did;

Sarah likes the guitar stylings of Rudy Van DiSarzio more than Randy likes those of Pat Metheny.

Lauren writes:

Gu Si Fang noted that Gresham's Law, particularly in the case of fiat money that has been declared legal tender, has become unintuitive.

Gresham's Law was intuitive when money was all coin--with a fixed exchange rate between bad--shaved--coins and good ones. Coin could be shaved down secretly, yet might be taken at the face value stamped on it unless it was weighed. People simply shaved down their coins, reused the shavings; and used the shaved coins--which looked fine--in shops and amongst each other. Gresham's Law was also intuitive during the years of internationally fixed exchange rates in the mid-1800s through early 1970s, when the promoters of different currencies battled politically and intermittently to have their currencies accepted at face value even when their currency values were known to have been undermined by overprinting.

The trick to understanding Gresham's Law--that bad money drives out good--is to understand that it only holds when the exchange rate between alternative monies is fixed. The bad coins were only accepted because and only as long as they were believed to trade 1-for-1 with the good ones.

If the exchange rates between several alternative currencies are flexible, there is not a big problem for people to hold and use all those several currencies simultaneously. No single money incessantly drives out the others. The currencies simply trade amongst each other at mutually-agreeable values.

Gresham's Law is less intuitive now, when for years we have been able to travel abroad and use other monies at flexible exchange rates any time we want. We no longer live in a world of fixed exchange rates. All the same, we do think before we pay about the various interest charges we might incur. Even when one legally-declared currency is required as legal tender over vast areas, the availability of other currencies or other payment options at floating exchange rates makes it less critical to use only that one legally-required currency. Sometimes black markets in other currencies even override local currency use.

A modern and intuitive discussion to Gresham's Law is available at About the Book and Author, introducing the text of William Brough's The Natural Law of Money.

The key point for Gresham's Law is that the currencies in use have to be traded at fixed exchange rates for the bad one to drive out the better ones. The minute fixed exchange rates break down, Gresham's Law breaks down. Bad money won't drive out anything but wasps if all you can do is trade it for what it's worth. It's only if it trades at a value above its worth--say, by law at its face value--that it drives out any other alternative monies.

Floccina writes:

This reminds me that I like to avoid the word "market" (unless I am talking about a grocery store). Rather than "market regulation" I would rather talk about what people are allowed to do.

IMO The language that we use has evolved to hide or soften the meaning. Nobody says that think that their neighbors should not be allowed to buy thing made by foreigners. Nobody says that think that their neighbors should not be allowed to sell their labor at below $x per hour or even that their neighbors should not be allowed to buy labor at below $x/hour.

Matt writes:

I wouldn't mind if you did a whole essay intuitively explaining interest rates and the Fed. Actually, if you could just write a children's picture book explaining the specifics of what the Fed is and what it does, I would be sooo happy. Everything about economics seems intuitive to me except when it comes to the Fed.

Yancey Ward writes:

Some "economic concepts" are counterintuitive for good reasons.

tms writes:

If the so-called multiplier is greater than 1, then why not spend a 100 trillion dollars tomorrow so we can all be rich.

Ronald Tobey writes:

Re: counterintuitive principle regarding price, supply, and demand. Supply and demand determine prices only in the emergent stage of free market formation. When operational, in a free market, price determines supply and demand.

Scott Sumner writes:

Bryan, I like those examples, and may use some in class. On further reflection I think the biggest problem isn't when there is no incentive to work, but when the incentive falls slightly due to something like a 5% increase in MTRs. I think people have trouble visualizing how those marginal changes would make people work less. We know logically that for each person there is a "straw that breaks the camel's back" but intuitively it seems like just one more straw should NEVER matter.

One other point. When I sit down with non-economists I can sometimes get them to change their minds, but I wonder if a year later they forget and revert back to "common sense."

And finally, sometimes they don't buy our simple analogies (if gifts are good, so are cheap imports) and they cling to the notion that "it's more complicated than that, jobs are at stake."

Troy Camplin writes:

I spend some part of each day explaining to people how sensible economic thinking really is. I've never understood it as counterintuitive, only poorly explained. Economics has always made perfect sense to me.

dkite writes:

Counterintuitive: Limits on foreign ownership makes a nation poorer.

This is a Canadian issue. If something of the slightest political interest is put up for sale, a hue and cry about how we are selling out rises up. If the political winds are strong enough, the sale is forbidden.

What this does is put a risk cost on any investment in Canada (what political wind will blow when?), and often limits the selling price to whatever another Canadian will offer, hence decreasing the real value of an asset.

Derek

dkite writes:

Steve Roth:

http://www.cmaj.ca/cgi/content/full/179/2/129

This is of particular interests to Canadians, where 'egalitarian socialism creates poverty... even starvation.' in our health care system. And to those who would argue, having to wait 2-3 years for a diagnostic procedure or surgery is equivalent to starvation.

Oddly enough, the socialist utopians of Sweden have figured that out.

Derek

Joe Kristan writes:

Oooh, can I play? Counterintuitive claim:

"Luring businesses to your state through targeted tax credits and subsidies is bad for the state's economy"

My answer: It's like taking your wife's purse to the bar to finance your attempts to pick up girls. The girls may let you buy them drinks, but they won't be impressed.

Dorothy writes:

Matt: the NY Fed does indeed publish comic books that [purport to] explain various financial concepts.Something there might be close to what you're looking for. See:

http://www.ny.frb.org/publications/result.cfm?comics=1

D.G. Lesvic writes:

Taking from the rich to give to the poor doesn't reduce but increases income inequality and "social injustice."

Bruce K. Britton writes:

Bryan: This is a great post, you should write the book on this.

Tim K writes:

I think if people looked at most of these economic claims from an objective standpoint they would slowly reason out the 'intuitive' conclusion. However in reality I think the biases like 'anti-foreign' and 'make-work' that you speak of Bryan are more important in their thinking.
It seems to me people think more like this:

* No labour market regulation means people will have to work for nothing and can be fired without warning

This was certainly the case with Howard's Work Choices reform in Australia and lost him the election for trying to reduce labor market regulations. I doubt most people's ability to connect the dots from less regulation to lower unemployment, especially considering their tendency to be emotionally involved. If unemployment is at 6%, then 94% of the work force think they will be made worse off by less labor market regulations - that's their intuition.

Sbr writes:

'There's not a single thriving, prosperous country in the world that doesn't engage in a huge amount of egalitarian socialism. How can you explain that?'

Garet Garrett can explain it well:

"...if Laissez Faire had not begotten the richest world that ever existed there would have been much less for the welfare state to distribute."

Intuitive version: Great sums of money attract great hordes of bandits.

Rick writes:

Counterintuitive claim: unless we stop subsidizing recycling, recycling will be bad for the environment.

Intuitive version: Recycling uses resources like energy, time and labor. If it takes more resources to recycle a can than it takes to make a new one, we shouldn't recycle. If it takes fewer resources to recycle a can, it will be profitable to do so.


And one for you (if you would):

Counterintuitive claim: Subsidizing good things is bad.

Kurbla writes:

Strangely simplistic way of thinking.

"Intuitive version: We'd be better off if other countries gave us stuff for free. Isn't "really cheap" the next-best thing?"

So, intuitively, I should allow my children to cheat instead of writing their homework, if they are certain they'll not get caught? Finally, it is free homework ...

Intuitive version: Employers don't like hiring people if it's hard to get rid of them. Suppose you had to marry anyone you asked out on a date!

Do you believe that people are more ready to marry in the societies that tolerate sex before marriage?

Intuitive version: If everyone gets the same share whether or not they work, you're asking people to work for free. People don't like working for free, especially when the work isn't very fun.

"Everyone gets the same share whether you work or not?" Doesn't look either egalitarian or socialist to me. In fact, sharing goods without work is more like capitalist thing.

chris writes:

Matt:

Highly recommended: How an Economy Grows and Why It Doesn't, by Irwin A. Schiff. (Click to download PDF.)

Tim K writes:

An article in the Economist looked at the evolution of hoarding whereby people value things more once they have them. They tested this by offering someone a mug or a chocolate bar, most took the chocolate bar. However when they were given the mug to keep, and then got someone to ask if they wanted to swap it for a chocolate bar far more declined. A similar test was performed on chimps and had the same result.
This shows how we may be inclined to value things more once we have them...such as labour market regulations, or protectionism for uncompetitive industries. So preference for the status quo is perhaps blinding their ability to think intuitively?

Patrick Barron writes:

Counter intuitive claim: Hospitals and clinics should be allowed to turn away sick patients who cannot pay.

(I believe the answer is many faceted. One, society gets fewer hospitals and clinics when they must offer services to some free of charge, just as society would get fewer grocery stores if they were required to give food to anyone who said they were hungry and could not pay. Two, total deregulation of health care and health care insurance would encourage the creation of lower cost clinics and lower cost insurance that even the poor could afford. Three, forcing hospitals and clinics to give away their services is a violation of property rights and makes slaves of health care workers. I'm sure there are more answers.)

FatTriplet3 writes:

Bryan,

I love this post and I love your simple, 6th grade explanations. They are nothing less than brilliant.

Now I get to be a party pooper. How does the fact that these concepts can be explained simply make them intuitive rather than counter-intuitive? According to The Free Dictionary, (http://bit.ly/Jw6Oo) intuition is:

1.a. The act or faculty of knowing or sensing without the use of rational processes; immediate cognition. See Synonyms at reason.
b. Knowledge gained by the use of this faculty; a perceptive insight.
2. A sense of something not evident or deducible; an impression.

Both my personal experience and my history with others confirms that much of economics is, in fact, counterintuitive. For example, people's intuition tells them that market's are Zero Sum. Its a fallacy that can be easily overcome with a simple explanation ("Last time you bought that cup of coffee you and the seller were both better off, etc")

So I remain unconvinced that you have proven your thesis.

But still, I would like you to give me your 6th grade illustration for this counter-intuitive claim:

People make decisions at the margins.

From a Big Fan,

Steve

Adam writes:

Here's a counter-intuitive economics principle I'd like explained in an intuitive manner:

Trickle down economics - one of the best ways to help those impoverished is to give more money to the rich.

Loren writes:

Here's a couple:

Counterintuitive claim: Temporary tax cuts do not stimulate the economy, but permanent tax cuts do.

Counterintuitive claim: Labor unions reduce the aggregate wages paid to non-union workers more than they increase the aggregate wages paid to union workers.

Josh writes:

Counterintuitive claim: efficient allocation of resources results in growth.

Counterintuitive claim: the economy isn't a zero-sum game. Although some people make (much) more money than others, this doesn't mean they are swallowing other people's share of the pie.

1HappyFool writes:

Steve Roth says:

Bryan, this is only intuitive because it's an inaccurate depiction of egalitarian socialism. Sweden is not the PRC;

Sweden is a member of the EU, which is perhaps the most libertarian government in existence.

There's not a single thriving, prosperous country in the world that doesn't engage in a huge amount of egalitarian socialism.

We can get all wrapped up in the definition of "country", but since European labor, capital and goods can freely flow across the borders of the member countries of the EU, they are quite analogous to the US states and make the EU quite analogous to the US federal government.

Why is there not a single prosperous country that operates according to the principles of libertariansism? Shouldn't one have emerged by now, and left all the others in the dust?

The EU emerged and, if it can avoid collapsing into collectivism or falling apart, is on course for outcompeting the US as its member countries move toward economic liberty. How do you explain that?

ArtD0dger writes:

Counterintuitive claim: Jobs, unlike goods and services, are not a scarce resource.

Intuitive version: Work all you want -- we'll make more!

slc writes:

I’m not going to present a challenge because what you have posted on your most recent intuitive blog does a good job of demonstrating your idea about counterintuitive basic economic principles. I’m a college student who just now learned and understood the basics in my Microeconomics class. I don’t know if it’s my age of learning or the atmosphere I’m in but when the basic principles were presented to me in a counterintuitive way I understood it perfectly. The Law of Demand has an inverse relationship, Price Ceiling occurs below the equilibrium price while Price Floor occurs above. Many basic ideas just appear backwards to me, but they work and occur in everyday life. Maybe to sixth graders it doesn’t make sense, but for me and my age the original writing of the principles and their explanation counterintuitivity and all worker just fine.

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