The Crisis in Economic Understanding
Economists Should Recognize the Role of Opportunity Cost in Their Careers
Note: I have not been as active on Substack as I had intended. I got an infection after a biopsy that was done last Wednesday and found myself at full strength only today.
If you want to know more about my medical adventure, read “Competition Works, Even in Health Care,” EconLog, August 17, 2024. If you want to know the outcome of the test—it’s almost entirely good news—read “News on My Health,” EconLog, August 20, 2024.
Now to today’s topic, which I’ve been noodling for a couple of weeks.
In the last month, two important articles, one a blog post and the other a Wall Street Journal op/ed, have made the case that economists are losing touch with the power of economics to explain phenomena.
The first is by Alex Salter of Texas Tech University. It’s here and I commented on it here. Salter makes the case that economics, taught well, can give important insights into everyday phenomena. Here’s a key paragraph from Salter:
Economics education has major problems. Doctoral programs are churning out applied mathematicians and statisticians with little to no knowledge of price theory. At the undergraduate level, social control (“market failure!”) and activism (“inequality!”) have replaced careful reasoning about markets and politics. Very few programs instill in students an appreciation for the power and universality of the economic way of thinking.
The second is by Steven E. Landsburg of the University of Rochester. It’s titled “What Aspiring Economists Aren’t Being Taught,” Wall Street Journal, August 2, 2024. It’s gated but Donald Boudreaux published a large portion of it here. Here’s part of what Boudreaux quotes:
Here’s an economics brain teaser: Apples are provided by a competitive industry. Pears are provided by a monopolist. Coincidentally, they sell at the same price. You’re hungry and would be equally happy with an apple or a pear. If you care about conserving societal resources, which should you buy?
Most of my sophomore-level economics students can solve this problem, which I posed on an exam. Almost nobody else can. I’ve tried it out on a lot of smart lawyers, accountants, entrepreneurs and scientists. Neither can the latest version of ChatGPT.
First I’ll tell you the answer; then I’ll tell you the moral. In a competitive industry, prices are a pretty good indicator of resource costs. Under a monopoly, prices usually reflect a substantial markup. So a $1 apple sold by a competitor probably requires almost a dollar’s worth of resources to produce. A $1 pear sold by a monopolist is more likely to require, say, 80 cents worth of resources. To minimize resource consumption, you should buy the pear.
I think it’s not too melodramatic to say that economics is in a crisis. As Landsburg notes, even many Ph.D. students are no longer taking price theory.
And it shows, not just in younger economists but even in economists well over age 50, who are not using it even though they were taught it. Maybe they’re not using it because they perceive that it’s not welcomed. (I’m not sure about this last statement.)
Exhibit A for the older economists is the reaction of James Poterba, an economics professor at MIT, and Claudia Goldin, an economics professor at Harvard University and the most recent winner of the Nobel Prize in economics, to a fascinating story told by the late economist Anita Summers, mother of Larry Summers and sister of Kenneth Arrow.
I wrote about the story here. The gist of my point is in the title of my blog post. Here was a very talented and smart female economist who, in the late 1940s or early 1950s, was strongly discriminated against. But when the discriminator, the head honcho of Standard Oil, figured out that Summers had the answer to a very important question and could back it up, he quit discriminating.
After writing that blog post, I started thinking about it more. And I realized that neither Poterba nor Goldin explicitly made the point that an economist studying and applying price theory should have made: that the profit motive gave the CEO of Standard Oil a strong incentive not to discriminate on grounds of gender and so he didn’t.
Poterba, who is 65 or 66, didn’t earn his Ph.D. at the University of Chicago. So he didn’t get the “Chicago Price Theory” treatment. But Claudia Goldin, who is 78, earned both her Master’s and her Ph.D. at the University of Chicago. Moreover, she studied under Gary Becker, the economist who drove home, in his Ph.D. dissertation and subsequent book The Economics of Discrimination, the fact that relatively free markets make discriminators pay a price for discriminating.
There it was in the Summers interview, staring them in the face, and they didn’t mention it. Of course, it could be that both Poterba and Goldin understood this and didn’t bother saying. But I have my doubts.
One of the things we still learn and teach in economics is the concept of opportunity cost. When we choose A and could have had B but can’t have them both, we give up B. Unfortunately, even though we teach it, many economists have not integrated that understanding into their choices about what to teach in graduate school.
And the opportunity cost can be very high. Here’s what Mark Koyama, an economics professor at George Mason University, wrote on his July 29 Substack post titled “The Divine Economy:”
I first encountered Seabright’s work when reading his brilliant 2004 book The Company of Strangers, as a graduate student. At the time when my mind was absorbed solving differential equations and Hamiltonians, The Company of Strangers provided a welcome break: a wide-ranging, perspective on the division of labor and the market economy.
Koyama got lucky. It was a welcome break. Many Ph.D. students, though, didn't take such a break and got wrapped up in differential equations and other math. And it shows in their lack of understanding of both price theory and the wider economy.
Great stories. I've always been amazed by the Kenneth Arrow / Larry Summers / Paul Samuelson family connections. Kind of the Royal Family of economics. (Aren't there one or two more economics notables on the family tree?)