Why is economics so counterintuitive? (Part 1)

[I should first explain the “part 1.”  The hope is that you will read this before the political art post which follows.  They are separate issues, but the second is easier to understand if you read this first.  Mankiw visitors:  I do off-topic posts every Sunday, early next week I’ll do a monetary post that gives you an idea of my views on the crisis.]

Last Sunday I discussed the counter-intuitive nature of “the economic way of thinking,” which I termed (perhaps incorrectly) the ‘economistic worldview.’  Here I’d like to speculate on why so many economic principles violate common sense.

It is easy to find numerous examples of where common sense views differ from the economistic perspective.  Some of these do not even involve empirical judgments, but rather seem to merely reflect logical errors.  For instance, in Pop Internationalism Krugman pointed out that people often worry about a net loss of jobs both from U.S. investment flowing overseas, and from Americans buying foreign goods, even though (as a matter of accounting) both the current and capital accounts cannot be in deficit at the same time.  (A U.S. trade deficit can only be financed by a capital account surplus.)

Krugman also claimed that many prominent pundits don’t really understand the logic behind comparative advantage.  This is especially perplexing because two children playing in a sandbox understand that when trading toys the point is to give away as little as possible and get back as much as you can.  I don’t have much to add to what others have said about this, I presume it is because the costs of trade are more visible than the benefits.

I often find news articles, even in respected publications, which confuse the most basic principles of supply and demand.  Thus in a recent LA Times piece entitled “Americans may be losing faith in free markets” Peter Gosselin (2008) argued that:

Most mainstream economists assert that these [gasoline price] increases are simply the logical outcome of booming global demand meeting limited global supply.  But the price run-ups seem out of whack with demand, which has increased only about 1% worldwide.

Actually, a small rise in “demand” (i.e. consumption) is exactly what one would expect if rapidly rising demand was pushing up against a highly inelastic supply.

And this sort of misuse of supply and demand occurs almost every day in major media outlets.  I think the problem is that people want to reason from a price change; “the price went up therefore,” or “the interest rate rose therefore,” or “the exchange rate appreciated therefore.”  But in fact, there is no “therefore,” no implications that flow from price changes.  The impact of higher prices depends entirely on whether it was caused by a shift in supply or demand, the impact of higher interest rates on investment depends entirely on whether it was caused by a shift in the supply or demand for loanable funds, and the impact of exchange rate appreciation on exports depends entirely on whether it results from a change in export supply or import demand.  Even many economists (including me) occasionally forget this.

If I ask students (or adult non-economists) how a firm would respond to a rise in its costs, they almost always say that firms will pass on the higher costs to consumers.  But they are much less likely to say that firms would pass on lower costs in the form of lower prices.  This sort of reasoning makes little sense to economists, as the profit function is symmetrical.  I assume that the average person’s reasoning goes as follows:

1.    Companies are greedy.
2.    It would be altruistic for the company to absorb higher costs without a price increase.
3.    It would be altruistic for the company to pass on lower costs to consumers.
4.    Therefore, companies don’t absorb higher costs and don’t pass on lower costs.

The flaw in this reasoning is point #3, although it would seem that a greedy company would not want to pass on lower costs in the form of lower prices, in fact that is exactly what a greedy company would want to do.  (I.e., if moving from cost situation A to B causes companies to raise prices from X to Y, then logically moving from cost situation B to A should cause companies to want to reduce prices from Y to X.)  Why don’t people see this as obvious?  Perhaps reasoning about causality somehow gets entangled with moral reasoning.

An experimental philosopher named Joshua Knobe reported some interesting findings in an interview on Bloggingheads.tv.  (I believe this example is mentioned in his new book, Experimental Philosophy, but I am not sure.  (And, no, the title is not an oxymoron.))  Knobe said that two groups of people were given two slightly different stories, and then asked a question.  The first group heard a story where an engineer went to the CEO of a company with a project that he said would dramatically boost profits.  But there was one drawback; it would seriously harm the environment.  The CEO said “I don’t care about the environment, I only care about profits.  Do the project.”  For the second group, everything in the story was exactly the same except that project was said to actually help the environment.  Again the CEO said “I don’t care about the environment, I only care about profits.  Do the project.”  In both cases the listener was asked whether the CEO intentionally hurt (or helped) the environment.  Most people in the first group said the CEO did intentionally hurt the environment, but most in the second group said that he did not intentionally help the environment.

As with the case of greedy companies passing on higher prices, the two situations in Knobe’s experiment are symmetrical.  Knobe was not able to ascertain the cause of the peculiar asymmetry in responses.  But it struck me as interesting that in both this example and the previous cost/price example the public seemed to adopt such a highly skeptical view of the motives of big corporations that they were led to an irrational asymmetry in their worldview.

Economic philosophers have also addressed this problem.  Wilkerson (2005) noted that human brains evolved under conditions far different from the modern economy:

because of the social nature of hunting and gathering, the fact that food spoiled quickly, and the utter lack of privacy, the benefits of individual success in hunting and foraging could not be easily internalized by the individual, and were expected to be shared.  The EEA [i.e. Stone Age] was for the most part a zero-sum world, where increases in total wealth through invention, investment, and extended economic exchange were totally unknown.  More for you was less for me.  Therefore, if anyone managed to acquire a great deal more than anyone else, that was pretty good evidence that theirs was a stash of ill-gotten gains . . . Our zero-sum mentality makes it hard for us to understand how trade and investment can increase the total amount of wealth.  We are thus ill-equipped to easily understand our own economic system.

Confusion about whether firms pass on costs in the form of higher prices, leads to another common misconception; that the debate over regulation is primarily a question of who gains and who loses.  Certainly that is how it portrayed in the media (consumer interests vs. business interests.)  In fact that is almost never the key issue—it is generally one group of consumers pitted against another, often with consumers as a group being hurt by regulations designed to help them (as the costs are passed on by companies in the form of higher prices, and absent externalities, if consumers valued the mandate at more than the cost of production, companies would already be providing it.)

In addition to logical errors, much common sense reasoning reflects serious underestimates of the relevant elasticities.  After my previous post on economistic reasoning, I received several challenges to my defense of speculation, price gouging, etc.  I think I also would have received challenges to my views on elasticities, if the readers had understood just how counter-intuitive they were.

Don’t many economics textbooks use examples of the demand for drugs when they want to illustrate a perfectly inelastic demand curve?  I use these examples when I want to illustrate elastic, or unit elastic demand.  A few years ago I read that a highly effective medication for AIDS was being taken by only about 10% of all HIV positive patients worldwide.  Why?  It is too expensive.  This is a surprising example of just how elastic is the demand for life-saving drugs.  Or take the example of highly addictive drugs.  I find many students assume the demand would be perfectly inelastic.  But if the addict was so addicted that he spent his entire income on the drug, the demand would actually be unit elastic.

I knew a heavy smoker who used to argue that high taxes would stop people from smoking, as cigarettes were very addictive.  Later I learned that his wife had stopped smoking after their getting married, on grounds that the family couldn’t afford two smokers.  That’s when it hit me that introspection is a horrible way of thinking about elasticities.  I don’t pay much attention to prices when I go grocery shopping, so if I used introspection I would assume that people aren’t very responsive to food price changes.  My students often write short essays on a market they choose, and almost invariably they say “my product has an inelastic demand, because there aren’t any good substitutes.”  And they often say this when there are good substitutes.

Why is this important?  Because it affects even professional economists.  Although the more fervent supply-siders sometimes overstate their case, the responsiveness of output to marginal tax rates is probably much greater than most economists suspect.  Why do I say this?  After all, aren’t economists’ views shaped by scientific research, not introspection?  Unfortunately, the data can never resolve an issue this complex, with lags that may last for many decades (think about how a high MTR makes college students less likely to go to school for 12 years in order to become a brain surgeon.)  Because the data are so indeterminate, researchers ultimately go with their priors (Robert Barro in one direction, Austan Goolsbee another.)

To summarize, we have logical errors, reasoning about morality entangled with moral reasoning, invisible effects being ignored, the assumption of zero sum games, the extremely confusing identification problem, and faulty estimates of elasticities based on introspection.  This is just off the top of my head, and I presume Bryan Caplan’s book has a much more complete analysis.


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35 Responses to “Why is economics so counterintuitive? (Part 1)”

  1. Gravatar of TGGP TGGP
    22. March 2009 at 17:18

    Wilkinson is wrong about the lack of extended trade. Archaeologists have found evidence that hunter-gatherers traded things over some surprisingly long distances. We really do have a propensity to truck and barter! In the hunter-gatherer days there probably weren’t professional middlemen though, hence the near-universal animus for middlemen minorities which Thomas Sowell discusses in Are Jews Generic? (which I host here).

  2. Gravatar of Jeffrey Yasskin Jeffrey Yasskin
    22. March 2009 at 17:53

    Regarding how a firm passes changes in its costs on to its customers, I think you have to look at the mechanisms, not just the economic abstraction. That is, given a rise in costs, what causes the firm to raise its prices, and conversely, given a reduction in costs, what causes the firm to lower its prices?

    Assuming the market is at equilibrium, meaning no firm has more profits than it needs to continue existing, given increased costs, if a firm were to keep its original prices permanently it would go out of business. Let’s also assume that the increase in costs is approximately equal among all firms in the same market. This sets up the iterated prisoner’s dilemma with the twist that as long as firms don’t cooperate, they’re knowingly approaching death. There’s a time limit on defection, but no time limit on cooperation. Since firms know that the pressure on each of them is similar, I think they’re likely to cooperate quickly by raising prices.

    On the other hand, say costs fall across the industry. We know the long term behavior is for prices to fall too (the firms will eventually defect), but how does that happen? The firms know they can individually survive indefinitely with artificially high prices. The only things that push prices down are individual defections to steal market share and new firms entering the business. Individual defections are unlikely since they know their price decreases will be quickly met by competitors’ price decreases, which just makes things worse for all the firms involved, rather than shifting market share. And new firms take time to enter the business. So we should expect cost decreases to only slowly cause price decreases.

    I don’t know to what extent this actually happens, but if lags are significantly longer for price decreases than price increases, that could completely explain the public assumption. People forget causes if they occur too long before their effect, regardless of any moral reasoning.

    Part of your argument seems to be based on the claim that greedy firms want to lower their prices in response to cost decreases. I was taught that nobody, firms nor individuals, “want” to lower their prices; they are forced to do so by the market. That also partly explains your claim from http://blogsandwikis.bentley.edu/themoneyillusion/?p=592 that “the distribution of nominal wage changes shows a sharp discontinuity at 0%”.

    I suppose this only holds in inelastic industries, where out-of-equilibriumly-high prices actually produce higher profits for producers. If consumers assume less elasticity in their preferred industries than there actually is, that could also explain the answer.

  3. Gravatar of libfree libfree
    22. March 2009 at 18:08

    Wilkerson might be wrong about stone age tribes, but stone age to present is still a small subset of what makes us human. Looking back far enough would result in an animal world without real “trade”. In that world, the more fruit I eat off the tree, the less you have. These behaviors, over tens of thousands of generations are still with us today.

  4. Gravatar of Jon Jon
    22. March 2009 at 19:10

    “foreign goods, even though (as a matter of accounting) both the current and capital accounts cannot be in deficit at the same time. (A U.S. trade deficit can only be financed by a capital account surplus.)”

    Except there is a net outflow of actual currency. The last careful analysis of this that I know is a 1996 FR study*, concluding that seventy percent of USD currency is held abroad.

    I know of two quick and dirty proxies for estimating outflows. The first is volume of 100-dollar bills. Based on domestic surveys, we know that most 100-dollar bills print go abroad. So the relative growth of 100s versus other denominations estimates the transfer of currency abroad**. The second method is based on the M1/M0 ratio. Both give the same general amounts.

    * http://www.federalreserve.gov/paymentsystems/coin/1096lead.pdf

    **http://www.federalreserve.gov/paymentsystems/coin/gifjpg/value.jpg

  5. Gravatar of Patrick C Patrick C
    23. March 2009 at 00:06

    Firms only pass savings on to consumers in competitive markets. Perhaps people have the view they have because they are used to firms that frequently use collusion, coercion, and branding to control prices.

    If we’re not talking about competitive markets, but markets where there are hew enough firms that game theoretic considerations come into play, then the behavior of firms cannot be modeled with the profit function alone.

    On elasticity. Are you saying that there is no such thing as a perfectly inelastic good? I was under the impression that elasticity of demand was about how much someone would be *willing* to pay, but not a statement about their personal budgets. If you include budget, there is always a maximum price at which a consumer will cease to make a purchase. So the only way to look at elasticity in such a context is to look at it in terms of an isobudget curve.

    Or perhaps your point is that elasticity is only a property of curves? Please tell me what, if any, good is inelastic, in your conception.

  6. Gravatar of Por que é necessário ensinar economia? « De Gustibus Non Est Disputandum Por que é necessário ensinar economia? « De Gustibus Non Est Disputandum
    23. March 2009 at 00:27

    […] metodologia da ciência, pensamento econômico, psicologia evolutiva trackback Trechos de um bom texto de Sumner: It is easy to find numerous examples of where common sense views differ from the economistic […]

  7. Gravatar of Phil P Phil P
    23. March 2009 at 06:49

    Scott, I think it’s just a matter of education. Not everyone studies economics in school (I never did, I only became interested in it later). I think the theory of supply and demand is very intuitive once you’ve been taught it. Physical science is the same thing. What’s intuitive about the idea that planets revolve around the sun because of gravity, or for that matter, that they revolve around the sun rather than vice versa? But once you’ve been taught it it seems common sense.

  8. Gravatar of Paul Johnson Paul Johnson
    23. March 2009 at 10:22

    I’d like to suggest that the propensity to truck and barter is not the same as understanding comparative advantage. Kids will trade for what they don’t have, but not for what their playmates can produce (?) more efficiently.

  9. Gravatar of Randy Randy
    23. March 2009 at 12:56

    Scott, I think on this post you may prescribe more irrationality than is present, though people cannot use economics language and constructs to explain what may be their reasonable thought process. For example, unlike most economic models we really don’t operate in a world of perfect competition, by which I mean price equals marginal cost and there are decreasing returns. Most business people’s lives are devoted to destroying perfect competition and developing an environment of monopolistic competition by which I mean pricing higher than marginal cost and increasing returns. And, in fact, in many industries they are able to do this even if just for a finite period. That is what branding and a lot of other business tasks are about. Thus, in your price example, if you told an economist that the firm had a monopoly or at least was a monopolistic competitor they too might respond in a similar manner. On the environment question, hurting the environment is clearly a cost that the perpetrator is not incorporating into the cost of production but passing on to society at large, e.g. its a negative externality. Some economists might call this a market failure but I prefer to think of it as an example of an incomplete market. In your reverse case you note the presence of a positive externality but you don’t say whether or not the firm feels it is being compensated for that and in fact implies that it is indifferent, in which case it is completely correct to say that they cared only about the profit. I agree that economic thought is not always intuitive but there are complex economic arguments that may be in sync with people’s intuition when dealing with monopolists, example one, and incomplete markets, example two.

  10. Gravatar of Josh U Josh U
    23. March 2009 at 13:52

    I have never seen your website until today, very interesting. Hat tip to Greg Mankiw who linked to here.

    You take a very strong shot at Peter Gosselin (no R, you misspelled his name) in this post. I superficially agreed with your point, and intrigued by the whole thing, decided to go read his article.

    I come back now to let you know that I think this article and this quote perhaps do not support your argument to the degree that another quote may have. First, when reading the quote in context, its easy to determine that the author was interested more by the size of the price response to the uptick in demand, rather than being fundamentally unaware of elasticity. In fact, you could read his quote to mean that the price response showed a somewhat stunning elasticity if the only market participants were purchases and users of gasoline.

    Second, you leave out his next sentence:
    “The mismatch has fueled suspicion among many Americans and their political leaders that the third financial bubble of the decade — after tech stocks and housing — is underway, this time in energy.” The author has been proven correct, since the price of oil is less than half of what it was when he wrote this article.

    Thats not to say that his larger point about people souring on the free market is valid, but I think he’s probably worthy of more credit when it comes to the quoted material.

  11. Gravatar of ssumner ssumner
    23. March 2009 at 17:23

    TGGP, Good point. I recall reading that Neanderthals were less likely to trade than Cro-magnon tribes. Is that right?

    Jeffry, Nice try, but I can’t buy your argument for several reasons. The strongest is that it doesn’t apply at all to monopolies, but I find that people have exactly the same misconception about monopolies as oligopolies. So the unfortunate truth is that people simply use bad logic. In addition, I don’t see any theoretical reason (or empirical evidence) to support your hypothesis, which is that when costs rise oligopolies suddenly behave like competitive industries, and yet when prices fall they behave like cartels. What if costs zig zagged up and down? By your theory prices would rachet upward. But that makes no sense. It would require greater and greater collusion over time. I am not saying that such a thing never happened for one minute in all human history, but to view that hypothesis as the norm is simply nonsensical.

    libfree, Whether Wilkinson is completely right or not, it is an interesting theory. BTW, a new book claims that significant evolution has occurred in the last 10,000 years (although most of their examples are disease resistance, diet adaptation, etc.)

    Jon, I did my dissertation on cash hoarding, and I don’t agree with the Fed study. I think most cash is in the U.S. (and being hoarded.) In addition, while technically correct about the accounts, you could consider cash like an interest free loan to the U.S. government (especially now that T-bills are also near zero percent.) In that case the equality would still hold. And currency flows are tiny compared to the current and capital accounts.

    Patrick, Regarding your first point, see my previous response to Jeffrey. I suppose demand could be perfectly inelastic over a very tiny range, but even that would be rare. I use ordinary demand curves, which is what the public uses when they say cigarette taxes don’t have much impact on consumption. They have that view despite the fact that higher cigarette prices lower the smoker’s real income. Most people don’t even know about the other kinds of demand curves. But I would add that I also think income compensated demand curves are generally far more elastic than most people think.

    PhilP, Thanks, I’ll change the spelling. If supply and demand is so intuitive, why do so few understand it? Even in upper level classes I find students almost always want to “reason from a price change” which means they don’t understand S&D. They say things like “gas prices are rising so you’d expect people to cut back on gas consumption.”

    Paul, Yeah, maybe that was a bad example. If experienced pundits have trouble with the intuition of comparative advantage, it can’t be that obvious. I should delete that phrase if I ever try to do anything with this material.

    Randy, I agree about monopolistic competition, but that issue never came up in my essay. The price/cost example also works for monopoly–see my answer to Jeffrey. I’m not sure you really understand the environmental example. It is completely symmetrical. There are absolutely no possible real world considerations that could explain this asymmetry, unless the term “intentional” means something very different from what most people assume. And in fact that’s actually a very possible explanation. When you hear a child say “he did that on purpose” do you know whether “that” is good or bad? I do, I have never heard it used for something good.

    Josh U, I am afraid I can’t agree with you. He clearly does not understand supply and demand. I can see no possible interpretation of that sentence that would “rescue” him. A huge price increase is exactly what one would expect if supply was inelastic. But he uses this example to criticize the economists explanation for what happened–which is precisely that supply is inelastic. If he has some other criticism in mind, he should say so. To be honest, I see this sort of misunderstanding of supply and demand everyday in the media. How often do you see phrases like “consumers continued to buy more despite the price increase.” That’s nonsensical–why should a price increase cause consumers to buy less!!! Regarding the rest of the article, that was not my concern. I did not provide an overall evaluation of the article. But since you claimed he was proven correct, let me strongly disagree. I don’t think you’d find many serious economists who think the oil price increase was a “bubble” which I presume you assume means driven by speculation. There is simply no good evidence for that. Instead, the increase was driven by a boom in the world economy, and the sharp drop was caused by the sharp decline in the world economy. The exact same thing happened in most other commodities–were these bubbles too?

  12. Gravatar of Randy Randy
    23. March 2009 at 18:20

    Scott, my point, even though you don’t make it in your post, is that most “average” individuals concept of a business is that of a monopolistic competitor, since that is what they are exposed to for the most part in real life. Hence, their interpretation of the agent’s motive may be completely appropriate given that they rarely experience a firm in a truly competitive market in their real life, even though they cannot express it in those terms. In the environmental example maybe we are talking about the same thing but I think there is an asymmetry with respect to intention as most people use the term. To intentionally damage the environment without incorporating the costs into one’s own production function is equivalent to saying I don’t care about the environment. To intentionally help the environment without concern for compensation is basically the same thing as saying I don’t care about the environment. If I help the the environment I could reasonably expect to be compensated in my pricing structure; if I don’t that means at a minimum that I am indifferent about the environment since I don’t care if I am charged with damaging it so long as I don’t get economically charged and I don’t care if I help it to the degree that I don’t expect to get paid for providing the positive externality. There may be a sense in which we could argue about “intention”, but clearly the CEO has demonstrated indifference, which most people in common language would interpret in the same way as intentionally damaging and not intentionally damaging in my opinion. I think you would have to be trained in economic logic and problem definition to come up with a different analysis. Linguistics is complicated and what is one person’s intention is another person’s indifference. And remember, most people don’t know what an indifference curve is. BTW, I really like your blog and find the level of interaction you provide terrific and I thank you for it.

  13. Gravatar of Jon Jon
    23. March 2009 at 18:35

    “Jon, I did my dissertation on cash hoarding, and I don’t agree with the Fed study.”

    Interesting, I’d like to hear your critique of the Fed study.
    Still, if the balance is large, you have to look at that in terms of the QE by the Fed which goes from large to huge. Don’t you need a firm idea on that question to know what magnitude of QE is reasonable?

  14. Gravatar of Al Al
    23. March 2009 at 18:38

    i think it is Keynesian economics that is unintuitive. Once I started reading about the Austrian school, everything made sense.

    Al

  15. Gravatar of TGGP TGGP
    23. March 2009 at 20:14

    The book Sumner is referring to is The 10,000 Year Explosion. It is about how the huge increase in population and agricultural civilization accelerated evolution. One of the things they believe changed is our brains.

  16. Gravatar of Sören Höglund Sören Höglund
    24. March 2009 at 03:41

    The problem with the “intentionally harming” vs “intentionally helping” example is one of asymmetric use of language. “Intentionally” is simply used interchangeably with “knowingly” when it comes to harmful acts in common vernacular.

    Which makes sense, really. It doesn’t matter whether you’re hurting the community because it benefits you, or because you like to see the community suffer. It’s still very much in the community’s interest to punish you severely and make sure it doesn’t happen again. On the other side of the spectrum, it’s also in its interest to promote the behaviour of individuals who put the tribe’s interest first over those whose interests merely aligned.

    It might be sloppy and imprecise use of language, but it’s not really an irrational reaction.

  17. Gravatar of ssumner ssumner
    24. March 2009 at 06:06

    Randy, Thanks for the compliment. I wasn’t clear when I said I agreed about monopolistic competition (MC). I meant that most people do think of this as the typical firm. But the MC profit functions is just as symmetrical as is the profit function of the purely competitive firm or the pure monopoly. There is no question that people’s reasoning is irrational. When I explain this to people there is an “aha” moment. So I am confident about my view.

    The environmental case is interesting. If I follow your analysis I think you are saying that the asymmetry in the word ‘intention’ may reflect some unstated connotations the word has. Possibly, but see my reply to Soren below.

    Jon, I believe the Fed argued that any money not accounted for in the U.S., was being hoarded overseas. I believe it is mostly hoarded within the U.S. I recently saw a picture on the internet of a room full of $100 bill found in Texas. Drug money. If most currency is hoarded (and it is) that makes QE much, much easier to accomplish.

    Al. I would put it this way. Most people think like Keynesians (tax cuts boost demand not AS, the Fed controls interest rates, not the money supply.) You have “uncommonly good” sense due to your reading. It seems reasonable after you understand it, but common sense isn’t always enough, you need to study economics, as you have done.

    TGGP, Thanks for the book title. I forgot to mention that your middleman example was very appropriate. The fact that this group has often been despised throughout history, speaks volumes about cultural attitudes. I should probably say that book you refer to has a very controversial and non-PC view on Jewish success, it links it to genetics.

    BTW, Some might view this as anti-intellectual, but I stay away form genetic explanations of culture. No matter how what one intends, they will tend to be viewed as very insulting. I am not telling anyone else how to behave, just giving my own views, which reflect my personality.

    Soren, I think your analysis is plausible, but you still might want to take a look at Knobe’s research. I heard him last year on bloggingheads.tv, but I presume it is also in his new book. The most surprising thing about the “intention” experiment, is that he tried every explanation he or anyone else could think of, and they all failed. Thus some thought it was related to good v. bad outcomes. But he found other stories where the asymmetry in peoples’ interpretation was exactly reversed. It was one of the most perplexing things have ever heard.

  18. Gravatar of Sören Höglund Sören Höglund
    24. March 2009 at 10:40

    I’d have to take a closer look at the research to formulate a more definite opinion, yeah. You could imagine other “bad outcome” situations where people would make distinctions between motivations, but I suspect those would be more personalizable situations, like a boss delighting in punishing his people compared to someone who does it in order to accomplish something. “Environmental damage” is so abstract that it’s very hard to imagine why it would be a goal rather than a byproduct.

    But this is idle speculation and I should stop until I educate myself.

  19. Gravatar of Jon Jon
    24. March 2009 at 18:55

    “I believe the Fed argued that any money not accounted for in the U.S., was being hoarded overseas. I believe it is mostly hoarded within the U.S. I recently saw a picture on the internet of a room full of $100 bill found in Texas. Drug money. If most currency is hoarded (and it is) that makes QE much, much easier to accomplish.”

    Yes, but what’s your evidence? An equally one-off counter is that 90% of 100 dollar bills are disbursed by the Fed in NY state–by offices that happen to service bank ‘branches’ which handle transferring dollar currency overseas.

    Obviously hoarded dollars makes QE easier because the actual ‘domestic’ circulation is so small, but surely it also heightens the risk that 1.2 trillion is much too much.

  20. Gravatar of TheMoneyIllusion » Why is economics so counterintuitive? (Part 1) | CurrencyAids.Com TheMoneyIllusion » Why is economics so counterintuitive? (Part 1) | CurrencyAids.Com
    25. March 2009 at 04:45

    […] Go here to see the original: TheMoneyIllusion » Why is economics so counterintuitive? (Part 1) […]

  21. Gravatar of curious curious
    26. March 2009 at 00:39

    “Later I learned that his wife had stopped smoking after their getting married, on grounds that the family couldn’t afford two smokers.”

    Larry Summers has suggested something similar at the international level stating it is better to put polluting factories in the third world where people die sooner than in the developed world – that we cannot afford the health costs. Cap and trade makes sense in this regard.

    http://www.whirledbank.org/ourwords/summers.html
    DATE: December 12, 1991
    TO: Distribution
    FR: Lawrence H. Summers
    Subject: GEP

    ‘Dirty’ Industries: Just between you and me, shouldn’t the World Bank be encouraging MORE migration of the dirty industries to the LDCs [Less Developed Countries]? I can think of three reasons:

    (continues)

  22. Gravatar of ssumner ssumner
    26. March 2009 at 05:15

    Jon, You may be right. It’s been years since I researched this question. At the time, I notice that the U.S. C/GDP ratio wasn’t all that high. It was lower than some developed economies, albeit modestly higher than Canada, which might be the most similar. But I found it implausible that many Canadian bills were being hoarded overseas. I’ve have never heard of that phenomenon. But if not many Canadian bills are outside Canada, and if most American currency was held overseas, shouldn’t the C/GDP ratio in the U.S. be more than twice the Canadian ratio?

    But again, I haven’t looked at this recently, and your NY Fed data is certainly interesting. I have an open mind on this issue.

    I also agree that it would make it easier to overshoot toward high inflation. However, I am not worried about that happening in the U.S. I am worried about undershooting.

    Curious: I am curious about how your point relates to estimating elasticities?

  23. Gravatar of Mark Mark
    26. March 2009 at 08:18

    For a good review of The 10,000 Year Explosion by a guy who’s very knowledgeable, see here. Hawks regularly discusses this and similar issues on his site.

  24. Gravatar of Jon Jon
    29. March 2009 at 18:45

    “But if not many Canadian bills are outside Canada, and if most American currency was held overseas, shouldn’t the C/GDP ratio in the U.S. be more than twice the Canadian ratio?”

    I’ve been pondering this question. I made a (very) brief attempt to find timeseries data at the bank-of-canada website, but alas gave-up. I’m more interested in the M1/M0 ratio than the velocity. I think the reserve-ratio complicates the velocity question too much. After all, GDP is sensitive to currency+credit, not just base money.

    I’d like to see the Canadian equivalent of this:
    http://research.stlouisfed.org/fred2/series/MULT

  25. Gravatar of ssumner ssumner
    30. March 2009 at 13:07

    Jon, The U.S ratio was higher in 2002. I believe the C/GDP ratio was just over 6% in the U.S., and just under 4% in Canada. My hunch is that foreign holdings are somewhere between 25% and 50% of the total.
    I just don’t trust any of the aggregates anymore. They are all distorted by the financial crisis. My view of monetary aggregates is the same as my view of interest rate targeting–very useful, except when you really need it.

  26. Gravatar of Jon Jon
    30. March 2009 at 17:40

    Hmm. Well fair enough, M1 is distorted at the moment, but for this question we can look at “normal” periods. I’d still like to see the historic M1/M0 ratio for Canada.

  27. Gravatar of Murph Murph
    1. April 2009 at 05:23

    Good, concise, even-handed summary – thanks !

  28. Gravatar of Liberals Are Cavemen | KyleSmithOnline.com Liberals Are Cavemen | KyleSmithOnline.com
    1. April 2009 at 18:34

    […] very interesting blog by an economics professor named Scott Sumner relays this point about why people (liberal people, by […]

  29. Gravatar of Kaleberg Kaleberg
    5. April 2009 at 18:37

    I never found economics counterintuitive. I always found it to be silly. Then again, I never managed to grasp the why of phenomenology. It’s not as if there is any correlation between economic theory and real world economies. I think astrologers did a better job in that they, at least, affirmed that the sun would follow a fixed course in the zodiac.

    Economics studies the allocation of resources in the fulfillment of human needs, but it ignores the all present issues of power, collective will, society, security and social structure. This blindness tends to give economics a rather hollow feel, like hermeneutics and other forms of literary criticism which ignore the real bases of literature.

    As for Jews and middlemen, it started with the hatred of Jews because they killed Jesus H. Christ the son of god, and also god himself, and some other weird stuff like that. Around the time of the Crusades, the original millennium, western Europe whipped itself into a bit of a frenzy and Jews were barred from a broad variety of occupations in many countries. That meant no more Jewish farmers, smiths, drapers or what have you. The remaining career options were more limited, and the more lucrative ones involved being a middleman. While everyone may hate a middleman, witness the current anger at Federal Reserve credit resellers, Jews were hated quite some time before they became associated with that role.

  30. Gravatar of ssumner ssumner
    8. April 2009 at 16:34

    Kaleberg. People who claim economics cannot explain anything often look in the wrong places. They think economists should be able to make unconditional forecasts, like when the next recession or bull market will occur. But economics cannot do that, indeed if we could it would actually disprove economic theory. But economics, or more particularly free market economics, has a lot to say about why S. Korea is richer than N. Korea, in other words it has lots to say about the most important issue facing the world today–abject poverty.

  31. Gravatar of caddy caddy
    26. August 2010 at 05:59

    To intentionally help the environment without concern for compensation is basically the same thing as saying I don’t care about the environment. If I help the the environment I could reasonably expect to be compensated in my pricing structure; if I don’t that means at a minimum that I am indifferent about the environment since I don’t care if I am charged with damaging it so long as I don’t get economically charged and I don’t care if I help it to the degree that I don’t expect to get paid for providing the positive externality.

  32. Gravatar of marisa marisa
    16. July 2011 at 22:35

    Wilkinson is wrong about the lack of extended trade. Archaeologists have found evidence that hunter-gatherers traded things over some surprisingly long distances. We really do have a propensity to truck and barter! In the hunter-gatherer days there probably weren’t professional middlemen though, hence the near-universal animus for middlemen minorities which Thomas Sowell discusses in Are Jews Generic?

  33. Gravatar of Kane Kane
    23. August 2011 at 19:58

    Marisa is not wrong about the lack of extended trade. There is evidence hunters and gathers traded things over extended distances.
    They just need to look harder

  34. Gravatar of TheMoneyIllusion » Some thoughts on saving, debt, deficits, etc. TheMoneyIllusion » Some thoughts on saving, debt, deficits, etc.
    23. December 2011 at 12:21

    […] in a context saturated with notions of “good” and bad.”  A few years ago I discussed a study by Joshua Knobe: An experimental philosopher named Joshua Knobe reported some interesting findings in an interview […]

  35. Gravatar of TheMoneyIllusion » Positive or normative? TheMoneyIllusion » Positive or normative?
    3. March 2012 at 06:30

    […] a strictly logical perspective there is no necessary value implication.  A while back I discussed a wonderful example by the experimental philosopher Joshua Knobe, who pointed out that (in experiments) whether a person thinks of an action by a corporate CEO as […]

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