Ranjit Dighe
WEEK 3 (Sept. 13 - 17, 1999)

[Last revised on Mon., Sept. 20, at 6 pm.]

Mon., Sept. 13, 1999

Today: Critical thinking in economics; Economic institutions (begin)
I.   Pitfalls to objective reasoning
II.  How to evaluate an argument
III. A critical-thinking exercise (begin)


* bias (consider the source, context, other statements that may indicate bias)
-- One thing that may indicate bias is loaded terminology ("myths," "obscene profit rates," "our socialist president," "NATO's genocidal policy in Yugoslavia")

* (imprecision or misunderstanding of) definitions ("money," "investment")

* misstatements of fact
-- If someone doesn't have his facts straight, then his conclusions or arguments are likely to be very flawed.


* fallacy of composition: assuming that what's true for the individual (part) is also true for the group (whole)
-- (important in micro, and also when going from micro to macro)
-- Classic example: Watching a parade (or a band): If you stand up on tiptoes, you get a better view. But if everyone stands up on tiptoes, no one gets a better view.
-- Micro example: If Farmer Bob has a bumper crop, his income will rise. If all farmers have a bumper crop, prices (of crops) will plummet, and total farm income will probably fall.
-- Micro-to-macro example: If the price of a particular good goes up by 10%, producers of that good will be better off; but if the price of everything bought and sold goes up by 10%, no one will be better off.
-- Micro-to-macro example: If a family regularly spends more than it takes in, it's headed for financial ruin. Yet the government spends more than it takes in, year after year; and as long as its deficits aren't too large, it could go on doing that ~indefinitely.

confusing coincidence with causation (correlation does not imply causality)
-- Ex.: During President Clinton's time in office, the economy has had one of its longest expansions ever and unemployment has fallen by about one-third. But it would be a fallacy to conclude that Clinton must therefore be responsible for the economy's strong performance. Other factors could have been more important.
-- Closely related: the post hoc (ergo propter hoc) fallacy
---- "after this, therefore because of this"
---- Ex.: rooster causes sunrise
---- Ex.: Bush tax increase of 1990--> 1990-91 recession
---- Ex.: Prohibition in 1919 --> the Roaring Twenties

assuming your conclusion; confusing assumptions and theory with facts.
-- Does your conclusion rest on a particular premise, and how strong is that premise?
-- Remember that the economic models you learn, however compelling they may be, are just models.  Appealing to a model is not enough to validate one's argument.  Models need to be tested with real-world data.
-- Ex.: An empirical study of the effect of higher minimum wages on fast-food employment, by two Princeton economists named Card and Krueger, concluded that, contrary to the "law" of demand, higher minimum wages did not cause a reduction in employment in fast-food restaurants.  Many economists and observers reacted angrily to their findings, saying that Card and Krueger needed to go back to Econ 101, because of course a minimum wage lowers employment.  But those critics did not address the fact that the supply-and-demand model only applies to markets that are purely competitive, which the fast-food labor market almost surely is not.


First, look for obvious obstacles to objective thinking, such as bias, misstatements of fact, and those above-mentioned fallacies. Then go through the following six steps.

How to evaluate an argument:
1.  Re-state the argument
2.  Identify the assumptions (KEY STEP, and often difficult in practice)
3.  Change an assumption
4.  Argue to new conclusion
5.  * If conclusion is unchanged, go back to 3.
     * If conclusion is changed, then argument hinges on a key assumption.
6.  Verify the validity of that key assumption.

III. A CRITICAL-THINKING EXERCISE: Is Las Vegas really the best place to live in America?

[We read a recent article from The Wall Street Journal, titled "Best Place to Live?  Follow the Moving Van," about an economist's rankings of the most livable cities in America, based on moving patterns.  We split up into groups to discuss the article with an eye toward critiquing it.  I asked you to consider three questions in particular:
1.  What is Dr. Wall's (the economist's) main conclusion?
2.  What assumptions and facts does he base that conclusion on?
3.  How persuasive do you find his argument?]


Wed., Sept. 15, 1999

I.   A critical-thinking exercise (finish)
II.  Economic systems and institutions (begin)


[We reassembled into the discussion groups from last time and had a class-wide discussion of the economist's study of moving patterns.  You more or less had to be there, but the dominant opinion seemed to be that Dr. Wall's conclusion that Las Vegas is the best place to live in America because that's where the most people are moving was unconvincing.  Dr. Wall's conclusion rested on the assumption that people move to the places that they find most desirable to live in, as if they were completely free to choose where to work or where to be near their families.  Since that assumption seems highly invalid, so does Dr. Wall's conclusion.]


ECONOMIC INSTITUTION: a physical or mental structure that significantly influences economic decisions
-- Exs.: markets, corporations, banks, governments, families, cultural norms

THE ECONOMIZING PROBLEM: How does a society reconcile its limited, or scarce, resources with people's unlimited wants?

ECONOMIC SYSTEM: the set of institutions and mechanisms that a society uses to try to coordinate people's wants and needs and society's available resources; the system that decides What, How, and For Whom to produce


Fri., Sept. 17, 1999


I.  Economic systems (finish)
II. The circular-flow model

* Next Mon.: no classes - Yom Kippur
* Next Tues.: college on Monday class schedule
* I will have office hours from 3-5 Tuesday

* Quiz


Types of economic systems:

-- TRADITIONAL ECONOMY: production methods, exchange of goods, and distribution of income are all sanctioned by custom. (Examples: Primitive societies, feudalistic societies, caste-based societies.)

-- MARKET ECONOMY (laissez-faire capitalism): markets (places where buyers and sellers come together) are the key to economic organization, and the means of production (capital) are privately owned.
---- A market economy will be a decentralized system, since every good and service is distributed through a different market, and every market has many different buyers and sellers.
---- Government can still exist in a pure market economy, but its role would be extremely limited, to such things as protecting private property rights and establishing an environment conducive to the efficient operation of markets.

-- COMMAND ECONOMY (communism): public (government) ownership of virtually all means of production and property, and economic decision-making through central planning. Officially, a communist regime seeks to distribute goods and services according to people's needs (as opposed to their wants or their ability to pay). The Soviet Union's motto was once "From each according to his ability, to each according to his need."
---- Socialism is a vaguer term. It is sometimes used to mean the exact same thing as communism; sometimes people use a more limited definition, referring to extensive income redistribution through progressive taxation (rich pay higher rates) and extensive social programs for the poor, the young, the elderly, and the infirm.

-- MIXED ECONOMY: contains elements of both pure capitalism and government controls.
-- Every national economy today is in fact a mixed economy. The degree of government control varies from virtually nil (in, say, Hong Kong) to near-total (in, say, Cuba). Most countries fall well in between those two extremes.
-- U.S.: Government purchases of goods and services are about 18-20% of GDP.
-- Sweden (market socialism?): More than 90% of business activity is in private hands, but government purchases of goods and services are well over half of GDP, and tax rates are very high and progressive (rich pay higher rates), so to redistribute income from rich to poor.
-- welfare-state capitalism: capitalism with significant government regulation and a social safety net


A good way to identify the major players in our economy and how they relate to each other is through something called THE CIRCULAR-FLOW MODEL of production and income. It shows how households supply labor and savings to firms, who use that labor and invest those savings so as to produce goods and services, which they in turn sell back to those households. In other words, resources flow from households to firms in the form of labor services and savings, and they flow back from firms to households in the form of goods and services. Or we could think of income flowing from firms to households in the form of wages, interest, and dividends, and then flowing back to firms in the form of revenues for the goods they produce and sell.

[I drew the CIRCULAR-FLOW DIAGRAM on the board, starting with households and firms and then adding on: factor, product, and financial markets; government; and the "rest of the world" (international transactions).  The diagram is very similar to Figure 6-3 on page 106 of McConnell's textbook.]