Learning Economics with Paul Krugman

IT arrived today, and I set about reading it on my way home from work on the train. I quite like public transport because of this reason – plenty of book time.

Krugman’s book is obviously a beginners Economics textbook, but as a beginner I suppose it suits me fairly well and despite what Giles says I think it will set me up well for my Masters.

Like most economic textbooks it normally retails for some astronomical number slightly above my daily wage, but luckily I was able to get hold of a copy for £22 or so second hand and I thought this was a good price for an Economics textbook.

I say I’m a beginner, but I’m aware of all the basics assumptions and the larger themes of Economics.  To be honest, I have allowed a lot of the minutiae of Economics to pass me by, because shifts in the demand curve are not as exciting as looking at gales of creative destruction, and my time is precious.

Krugman opens his book with a chapter on the common ground economists share, things which Giles, Tim, Krugman and Sumner all agree on, despite their differences elsewhere.

There are four principles underlying how individuals make decisions and five principles on how these decisions interact.

The four principles dictating how individuals make decisions are below.

  1. Resources are scarce.
  2. The real cost of something is what you give up to get it.
  3. “How much” is a decision at the margin.
  4. People usually exploit opportunities to make themselves better off.

My more astute reader (yes, sadly singular) will have realised that I’ve covered all four of these in my preamble.

  1. Resources are scarce, and that is why Krugman’s book can be sold for $141.
  2. The “real cost” referred to is the opportunity cost of doing something. By taking public transport instead of driving I am not just saving the money by not running a car but I am also gaining the time to read, something I enjoy but which is incompatible with driving. Something similar is discussed very briefly here.
  3. The decision at the margin involves decisions which are not either or but “how much.” My decision to buy Krugman’s books was made at the margin, $141 was too rich for my blood but £22 was just right.
  4. I took advantage of an opportunity to buy a book cheaply because I think I will not only enjoy learning from it but that I will improve my prospects come October.

There are also five principles for understanding the interaction of individuals’ actions.

  1. There are gains from Trade.
  2. Markets move towards Equilibrium.
  3. Resources should be used as efficiently as possible to achieve society’s goals.
  4. Markets usually lead to efficiency.
  5. When markets don’t achieve efficiency, government intervention can improve society’s welfare.

    These should be fairly uncontroversial, although from where (and when) I’m sitting that “usually” in point 4 is doing a lot of work.

    It should be fairly clear that there are gains from trade, because trade allow specialisation and that people who trade voluntarily are doing so because they see something they want more than something they have.

    Specialisation is best and most famously illustrated by Adam Smith and pin manufacture.

    One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them. I have seen a small manufactory of this kind where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day…

    [However: For a discussion on how trade can lead to underdevelopment please see this post here on Joseph von Thunen which was written a little while ago while arguing with Thomas Byrne.]

    The other four points also discuss the operation of a market economy.

    The equilibria discussed above is illustrated by Krugman with a supermarket checkout. Many lanes are congested but no lane is more congested than any other; it is in equilibrium. To ease the crowding a new till is opened which is subsequently flooded with people attempting to avoid queueing. Once people have shifted about any subsequent lane swapping becomes unnecessary and a new equilibria is reached.

    Resources should be used as efficiently as possible to achieve society’s goals. That is resources should be used to maximise the opportunities to make people better off without making anyone else worse off. This stands in contrast to more egalitarian uses of resources which may be less efficient but may be “fairer.” (A definition of “fair” is something I will not attempt – I’ll leave that to Paul.)

    Markets usually lead to efficiency is another of the main arguments in favour of Capitalism over other arguments. As Tim Worstall reiterates (and reiterates and reiterates and…), despite the inequality capitalism brings, it also makes us rich because it allocates resources efficiently.

    Markets fail. They usually do so when actions have i) side effects, for example carbon emissions, ii) when once party prevents mutually beneficial trade occurring in an attempt to capture  a greater share of resources for themselves and iii) when the good, for example roads, are not suited for efficient management by the market.

    Although nothing controversial that is a lot of food for thought.

    It is easy to declare that homo economus or rational man does not exist and dismiss the above, because its true man is not as rational as assumed. But very often those that do dismiss don’t have a better model to offer. Homo mostly economus seems like a fairly good starting point for analysis and a great place to start a text book.

    I will be reading further and sharing what I learn on this blog through the next few months (its a big book) and I hope you can all contribute thoughts, supplement and critiques as and when you feel like it.