Preface xiii

1 Introduction 1

1.1 What This Book Provides 1

1.2 Looking around Corners 4

1.3 Ideological Stance 5

1.4 Economics Embedded in Philosophy and Sociology 7

1.5 My Own Biases 8

1.6 What Is to Come? 9

Part I the Subject of Economics 13

2 What Economists Do 15

2.1 What Economics Encompasses 15

2.2 How Economists Work 18

2.3 Some Characteristics of Economics 32

Appendix 2.1: Unrealistic Assumptions Can a Good Theory Make 37

Appendix 2.2: Is the Stock Market Efficient? 39

3 How Well Do They Do It? 43

3.1 Forecasting 43

3.2 Choosing the Right Policies: The Problem of Value Judgments 47

3.3 Implementing Economic Policies 51

3.4 Biases 52

3.5 Disagreement among Economists 57

Appendix 3.1: A Survey of American Academic Economists’ Opinions 60

Part II Some Infrastructure 63

4 Beguiling Words 65

4.1 Some Widely Used Terms and Phrases 66

4.2 Some Terms and Phrases Relating to Economics and Politics 71

5 Important Economic Ideas: Often Misunderstood 84

5.1 Levels versus Rates of Change 84

5.2 Stocks versus Flows 86

5.3 Real versus Nominal 90

5.4 Future versus Current Dollars 91

5.5 The Price Level versus Relative Prices 97

5.6 Stable Prices versus Low Prices 98

5.7 Gross versus Net and Single versus Double Counting 98

5.8 Opportunity Costs versus Monetary Costs 99

5.9 Cost–Benefit Analysis 102

5.10 Wage Rates versus Labor Costs 104

5.11 Capital Goods versus Human Capital 105

5.12 Marginal versus Average Utility 106

5.13 Marginal versus Average Costs 107

5.14 Big Business versus Market Power 108

5.15 Pro-market versus Pro-business 109

6.16 “Should” and “Can” versus “Will” 109

5.17 Comparative versus Absolute Advantage 110

Part III Economic Theory and Policy 113

6 The Crown Jewel of Economics: The Price Mechanism 115

6.1 An Overview of the Price Mechanism 115

6.2 Equilibrium 118

6.3 Shortages 120

6.4 A Digression: The Equilibrium of the Firm 121

6.5 What Happens in the Absence of a Price Mechanism? 122

6.6 The Dark Side of the Price Mechanism 126

6.7 The Upshot 144

Appendix 6.1: More on Supply and Demand 147

7 Risk Taking and Incentives 156

7.1 Risk Bearing and Entrepreneurship 156

7.2 Incentives 159

8 Looking around Corners 175

8.1 Do Easier Bankruptcy Laws Help the Poor? 177

8.2 Should Artists Receive a Share of the Capital Gain When Their Work Is Resold? 179

8.3 Do We Want Fewer People Exploiting the Poor? 181

8.4 Cut the Gas Tax to Slow the Rise of Soaring Gas Prices? 183

8.5 A Costless Way to Alleviate Destitution in Third World Countries? 185

8.6 Ban or Fine All Speculators? 187

8.7 Is Limiting Tobacco Advertising an Effective Policy? 191

8.8 Would Importing Pharmaceuticals from Canada Substantially Lower Drug Prices? 192

8.9 An Efficient and Humane Way to Reduce Cocaine Production? 193

8.10 Protecting Lives by Requiring Use of Seatbelts? 195

8.11 Do You Really Want Your Bid to Win? 196

8.12 Is Fast Chinese Economic Growth Bad for the United States? 197

8.13 In Emergencies Should Prices Ration Supply, Thus Letting the Rich Outbid the Poor? 201

8.14 Is Gaining from Someone’s Misfortune a Moral Wrong? 202

8.15 Should Those Close at Hand Have a Special Responsibility to Alleviate Misery? 204

8.16 Seven Short Ones 205

8.17 On the Other Hand 208

9 Natural Resources and Environmental Economics 210

9.1 Running Out of Privately Owned Natural Resources 210

9.2 The Tragedy of the Commons 215

9.3 Pollution Permits and Taxes on Pollutants 217

9.4 Tail-pipe Pollution 222

9.5 Protecting Endangered Species 223

Part IV Looking at Data 225

10 Empirical Economics 227

10.1 Role of Empirical Work in Economics 227

10.2 Types of Empirical Evidence 228

10.3 What to Watch Out for in Statistics: Some General Problems 230

Appendix 10.1: Survey Data 242

Appendix 10.2: Measuring GDP, Savings Rates, Price Indexes, Employment, and Poverty 244

11 Some Simple (?) Ways of Presenting Data: Percentages, Figures, and Graphs 252

11.1 Percentages 252

11.2 Figures and Graphs 255

12 Samples and Their Problems 260

12.1 Selecting a Representative Sample 260

12.2 Watching for Inappropriate Samples 261

12.3 The Regression Fallacy: Building a Bias into the Sample 262

12.4 Sample Size and Coincidence 264

12.5 Sampling Error, Confidence Intervals, and Significance 265

12.6 Some Warnings about Significance Tests 268

Appendix 12.1: The Normal Distribution 269

13 Regressions: The Workhorse of Empirical Economics 272

13.1 The Regression Coefficient 273

13.2 How Well Does the Regression Fit the Data? 275

13.3 What Should You Look at in a Regression? 277

13.4 A Summing Up 279

13.5 Looking the Workhorse in the Mouth 279

13.6 In Conclusion 290

14 The Workhorse in Action: Some Examples of Empirical Economics 292

14.1 Consumption and Saving 293

14.2 Should You Choose a Large Mutual Fund? 300

14.3 The Slave Trade and African Economic Development 303

14.4 The Effect of Tax Changes on Real GDP 306

Epilogue 311

Index 315