The economics major is in dire straits. Across the nation, econ curricula aren’t instilling an appreciation for, or even a familiarity with, the economic way of thinking. Theory classes limit the power of economic analysis by reducing markets to sterile exercises in “perfect competition,” or else subordinating social science to social control by obsessing over “market failures.” Empirical classes equip students with sophisticated statistical tools but at the cost of reducing applied economics to data-mongering.
The unfortunate result is that econ majors are almost always half-educated and quarter-lettered. They can memorize models and run regressions. They will confidently make pronouncements about the necessity of corrective taxes and regulations to promote economic efficiency. But they’re unable to explain why popcorn costs so much at the movies, how we know high oil prices aren’t the result of price-gouging, or—most worrying of all—what makes some countries rich and others poor. The situation is grim.
Econ majors are almost always half-educated and quarter-lettered.Yet it’s not hopeless. All the materials that professors need to train economists well are already available. There are many ways to restructure curricula to produce competent economic reasoners. All of them require wide reading and deep thinking. Students whose attention spans run out at 280 characters have no place in an economics program.
Whatever the texts and series of classes, a serious economics program should graduate only those students who demonstrate proficiency in each of the following areas:
The nature and scope of economics. Economics is defined not by what behaviors it studies but how it studies those behaviors. The economic way of thinking begins with purposiveness: All action is an attempt to improve self-perceived wellbeing. Furthermore, to act means to choose, which means tradeoffs are unavoidable. Purposiveness is essentially related to economization. Rationality and scarcity are flip sides of the same coin. Anything we apply this paradigm to becomes economics.
Economic modeling. Learning economics requires thinking in models. Models are deliberate simplifications of reality designed to isolate a few key variables (market prices, rates of production, profits, etc.) so we can explore the causal relationships among them. While the content of models should vary depending on the scenario, they should not contradict the basic tenets of rational choice. We’re no longer doing economics if they do.
Students should learn to work with a few workhorse models in economics, especially supply and demand, price-taking firms (not perfect competition), and price-searching firms (not monopoly). Economics curricula already include these models. The problem is that students do not learn how to apply them effectively. For example, almost every economics major could use the price-searcher model to make predictions about market power and the economic losses associated with “underproducing” and “overcharging.” But very few would see that their argument implies these firms aren’t making enough money. Businesses have many pricing, marketing, and contracting strategies to capture additional gains from trade, thereby creating more value for consumers.
Scarcity and competition. Resources are scarce whenever there is an opportunity cost associated with their use. Always and everywhere, we must decide how to allocate limited means among competing ends. Choosing one pattern of resource use necessarily means forgoing others. Cost and choice always go together.
Scarcity necessitates competition, yet not all forms of competition are created equal. War, pillage, and plunder are the most common forms of competition in human history. These rationing mechanisms create widespread misery and poverty (except among the winners). In contrast, market competition under the rule of law is comparatively recent and rare. This rationing mechanism creates widespread contentment and wealth (even for the losers). One of the most important tasks of economics is to discover which forms of competition are compatible with social flourishing and which aren’t.
The tasks of the economic system. The ubiquity of scarcity means every economic system—capitalist, communist, or anything in between—must determine:
- What gets produced?
- How does it get produced?
- Who gets the resulting product?
Market economies primarily rely on the price system to answer these questions. “A price is a signal wrapped in an incentive,” Alex Tabarrok and Tyler Cowen astutely note. Prices convey information about the value of resources in various lines of production. And prices give both buyers and sellers a reason to act on that information.
One of the most important tasks of economics is to discover which forms of competition are compatible with social flourishing.Suppose I own a contracting business that specializes in backyard pools. Households’ willingness to pay for my services determines the volume of resources I’m willing to devote to installing pools. If changing weather patterns cause permanently cooler summers for the foreseeable future, my sales will suffer—unless I lower the price of my services enough to make them worthwhile.
Furthermore, how I install the pool depends on input prices. How many compact backhoes and mini excavators do I use? How many men with shovels? The answer depends on the rental prices of capital and labor. Changes in their relative cost will affect my behavior in predictable ways. When wages rise relative to the interest rate, you’d expect me to pick a more capital-intensive production process.
Building the pool earns my business income. Some of that income goes to paying workers. Some goes to paying whomever owns the capital equipment. Some goes to whomever supplied the concrete. How much I pay depends on their prices, which are the costs I bear to bid their services away from someone else. My residual income (what’s left over after paying all my costs) is my profit. Hence prices determine the distribution of income among laborers, capitalists, and entrepreneurs, too.
Property rights. Markets depend on property rights. When property rights are insecure, production and exchange are sporadic and rare. Strong property rights, in contrast, make specialization and trade widespread. Prices are most effective at communicating knowledge and aligning incentives when the legal system is free and fair.
When we trade with each other, we’re exchanging property rights. Purchasing an apple means purchasing the legal right to dispose of the apple as I see fit, given civil law and criminal statutes. In the case of fresh produce, the difference between physical resources and title to those resources is usually irrelevant. But for cars, houses, pork belly futures, or shares of corporate stock, the legal claim can often be more important than physical possession. (In fact, for the final two items on that list, the most profitable actions might never require taking actual possession.)
Property rights force us to confront the costs and benefits of our choices. Who do you expect would take better care of a car: a renter or an owner? Renters have the right to use the car, but only temporarily. The condition of the car becomes someone else’s problem after the contract expires. But an owner knows extreme speeding or off-roading today could result in a lower sale price for the car tomorrow. In addition to the use value, the owner takes into account the car’s capitalized value, dependent on its future stream of services. The reason you have to sign pages and pages of agreements whenever you rent a car is because the rental company understands these incentives. They’re trying to get you to behave as if you’re an owner for the duration of the rental.
Comparative institutions and the “Invisible Hand”
Property rights are an important example of what economists call an institution: a human-devised (but not necessarily human-designed) constraint that makes our behavior predictable, or else intelligible, by subjecting it to a rule. All activity, commercial and non-commercial, is governed by institutions. One of the most important tasks of economics is to study why institutions form, how they work, and what behaviors they promote.
We need a concerted effort to put the economic way of thinking back into the econ major.The market process is a devised-not-designed system, which encompasses many formal and informal institutions. Markets channel self-interest and harness dispersed knowledge to produce widespread material prosperity. Nobody acting within the market intends this. Households want to consume as much as they can as cheaply as they can; businesses want to produce as much as they can as cheaply as they can. Guided by the price system, the complex and often contradictory plans of demanders and suppliers reconcile on terms acceptable to all. This is the famous “Invisible Hand conjecture,” postulated by Adam Smith in 1776: “Every individual … neither intends to promote the public interest, nor knows how much he is promoting it … he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”
Much of the accumulated wisdom of economics simply isn’t present in today’s undergrad courses. We need a concerted effort to put the economic way of thinking back into the econ major. Renovating the major’s core, meaning introductory and intermediate microeconomics, is the most important task. Strengthening macroeconomics and advanced specialty courses (such as econometrics or public economics) is worthwhile, too, but is not the priority. If we don’t start fixing things now, it won’t be long before economics deserves its low reputation as the “dismal science”—and it will be our own fault.
Alexander William Salter is the Georgie G. Snyder Associate Professor of Economics in the Rawls College of Business at Texas Tech University and the Comparative Economics Research Fellow at TTU’s Free Market Institute. He also holds fellowships with the Independent Institute and the American Institute for Economic Research. The views in this column are solely his own.