Economics Isn't About Emotion, or Desired Outcomes
A lot of people think just because they see prices move they know economics. They might not even know that demand curves always slope down, but they sure know econ like nothing else.
I see a lot of that-especially from math geeks and other geeks. The Chicago School of Economics is totally maligned for reasons outside of economics. People don’t like it because it doesn’t fit their view of the world or because it’s so counter-intuitive to normal linear ways of thinking. But, the beauty of the Chicago School is it relies on the individual actions of people acting in their own best interest with no central authority. In other words, freedom. But, people acting in their own self-interest is very hard to predict and the outcome can take a lot of time, not to mention wading through a lot of messiness as information changes.
It’s not that they aren’t smart or intelligent (there is a difference!), it’s that they are misinterpreting some definitions. Here are two examples. There are a lot of problems with these statements. Can you spot them if you understand efficient markets?
There are in fact, “markets in everything” even in Communist countries. Mark Perry used to run a fantastic blog at Carpe Diem and used to post evidence of markets in everything all of the time.
This thread was informative as to the misinformation regarding economics too.
President Biden @POTUSThe Inflation Reduction Act of 2022 will lower health care costs for millions of Americans. And, for the first time in a long time, make the largest corporations pay their fair share without any new taxes on people making under $400,000 a year.
Here comes the misinformation! Points for using the Milton Friedman .gif, although if Friedman were alive he would correct Mr. Smith. So would Coase, Becker, Stigler, Miller, Lucas, and all the rest.
Let’s try and unpack this nicely and succinctly, shall we?
Free and unfettered markets are the best ways to serve as guideposts to making decisions. Do I want to sell, or not? Do I want to buy, or not? Is this the best price for me to maximize my utility given all available information or should I wait? The most important thing in a marketplace is a transparent price. How do you get transparent prices?
In theory, people/businesses can enter or exit the market seamlessly and there are no constraints on buying or selling except for the personal constraints people/businesses put on themselves. Of course, in practice, this isn’t exactly true. There are costs to starting, running, and exiting a business. There are all kinds of government regulations that might get in the way. However, we can create marketplaces that exhibit most of these characteristics.
The Chicago School does assume rationality but Mr. Eich doesn’t understand the exact definition of the “rational investor”. The rational investor tries to maximize utility for themselves.
That means that one investor might value something more than another investor and is willing to pay a different price to acquire it, or on the other hand sell it. The Chicago School doesn’t imply a value judgment to that utility. It just is.
This is called “positive economic theory”. As soon as you imply values or some other sort of artificial constraint, you delve into “normative economic theory”. A good example is when someone says “it’s not fair that someone doesn’t pay enough in taxes”. What’s fair? Who is the angel that decides? Where is King Solomon when you need him? Do you think that political appointees like Brian Deese got there by merit? Was it fair? Does Chairman Xi appoint people to positions because it’s the best choice based on an objective measurement? Of course not.
Gary Becker hypothesized an immigration market. There is a supply of immigration and demand for it. That means there is a price where the two intersect. Suppose the price is $50,0000 per person to immigrate to the US. If someone other than that person pays it, do we care? Is it fair some people get their price paid while others don’t? If the person receiving the cash has to work it off for a corporation, is it slavery? If it is, how do we feel about corporations and other entities paying for people’s college degrees for them?
Some people are smarter than others and do better in the market, or life. So what? Some process information better than others and do better. So what? We are humans and there is variability. It’s the beauty of being human by the way.
Are markets manipulated? Depends on how you look at them and a lot of variables in the underlying market. If a market is highly liquid, with a large number of players in it, with a transparent price, the odds are pretty good that there isn’t a lot of manipulation. If it’s a low volume market or there are external constraints put on the market that make it tough to enter or exit, it could be manipulated. When I thought about this I immediately thought of the Nickel market and what happened this year. Certain crypto markets are not liquid despite seeming to be liquid. You find out the true liquidity when everyone wants to sell and buyers are scarce. Don’t be the last rat off the ship.
In last week’s “Better Call Saul” episode, he told the criminals he was training, “Pigs get slaughtered”. “Only take three Armani suits not the whole rack.” Markets can be the same way.
Mr. Smith goes to Economics and missed. Professors Mulligan and Cochrane tried to set him straight but they have limited time. A constraint where they can maximize their utility somewhere else other than Twitter.
I am inferring some bias in Mr. Smith’s tweets since he attacks the Chicago School as being right-wing when it’s not. It’s not any wing. Trump was no more a practitioner of the Chicago School anymore than Biden or Obama detested and didn’t practice it. The only president the US has had that approximated using the Chicago School was President Reagan and in many cases, politics got in the way of a pure application of it.
Mr. Smith is incorrect, Firms do not optimize all margins. They optimize total profit. If I have a basket of products, I might actually lose money or break even to get people in the door so I can sell them higher-margin stuff. We see this all the time but think about the gas station. They make no money on the gas and all the money on the stuff inside.
Firms do try and hit target incomes! That’s why they do a lot of research on the size and scope of the market before they try to enter. They do research on their customer acquisition costs and estimate them. If the market is big enough, they allocate resources and then price so they are competitive in that market. As long as CAC<LTV, they play in the market. If they are a monopolist, they price where marginal costs equal marginal revenue(MC=MR). Simplified, it’s the cost to produce one more of some widget.
You might not like the outcomes. But, that doesn’t mean the Chicago School of Economics doesn’t work or is discredited. In fact, based on the data we have today, the Chicago School works the best when compared to the way we currently operate things. It might be why Chicago Booth is the #1 Business school in the world according to the recent US News and World Report rankings.
The Chicago School would tell you that the bill Manchin agreed to is inflationary. The Chicago School would also tell you that the CHIP bill passed recently will do nothing to improve the supply or quality of the chips.
We sure could use a bunch of Milton Friedmans running the show today.