What the heck is economics?

What the heck is economics? Wait, is this a philosophy post? Why are we opening up with such a question?

It turns out that the answer to this simple question determines what you will believe are insights, goals, and benefits of studying economics. However, Jacob Viner´s quip that "economics is what economists do" is not satisfying enough. We need to figure out what economics is, before we can use it to improve our lives. That is ultimately the goal. It is not just for the entertainment of a few people with fancy degrees.

The Study of Wealth

For many years, economics was consider the study of "wealth and wealth creation". Adam Smith´s monumental work has the title The Wealth of Nations. Now wealth is a noble thing to study. When given the choice between more wealth and less wealth, people choose more wealth. Studying how people and therefore nations become wealthy will greatly help improve people´s lives. If I can learn how to make people wealthy, I will gladly learn.

This framework helped improve societies and led to many insights. Adam Smith and his followers showed that wealth is not measured in amount of gold or money that sits in a vault, but goods and services that actually improve lives. Wealth and money are not the same thing. Boom, one insight from economics. A society shouldn´t increase the amount of gold, but increase the amount of goods.

The classical framework, through the work of David Ricardo, also showed the benefits of trade, a principal called comparative advantage. Even if Lebron James is a great chimney sweep (do they still exist?) it does not make sense for him to climb up the fireplace. People are better off if Lebron sticks to basketball and advertisements and he lets someone else sweep his chimney.

As useful as this is, it is terribly narrow. There is more to life than wealth. If economics is going to help us, it has to be about more than wealth. Economics is not finance, accounting, or personal investing. Econ has more to offer. Thank goodness the discipline has developed.

The Study of Decision Under Constraint

Lionel Robbins famously (well, famous for us nerdy economists, not MLK quote famous) said that "economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses." This definition has dominated the past almost 100 years within the economics profession. Its main contribution is the emphasis on scarcity. One reason that not everyone has a Bentley is because we live in a world of constraints. Economics points out the constraints in our utopias.

Ever since the debacle at Eden, people have had limitless goals they which to achieve, but only some goods to use. Yes, production allows for more means in the future to achieve future goals. However, in the production process that are still limited supplies. Even in the wealth parts of the world today (I´m talking to all my readers in the Hamptons), people live under scarcity. Scarcity, scarcity, scarcity. It defines the world on this side of the grave.

There is one major shortfall with this approach. Robbins´s framework turns every problem into a simple calculation of maximization under constraints. At least, that is how most economists have used it. If I know what a person has available to use and I know what that person´s goals are, the decision turns into a simple calculation.

There is no room for decision-making in this approach. There is no room for discovery. People are simply computers calculating pleasure and pain to maximize their utility. The great improvements made in the west over the past 300 years have not come from the reshuffling of means to meet ends. Again, Robbins helps, but he is short.

The Study of Rational Action

An outgrowth of the above approach has swept most economists since the Second World War. If we define rationality as correctly computing the above equation about pleasure and pain, economics allows for specific prediction on what people will do by assuming rationality. This approach assumes that people are smart. They do things in their own interest. Many economists have applied this idea and turned economics into the study of rational action.

This has a profound impact on our understanding of many aspects of life. Why do people go to college? It maximizes their utility. Why do people steal? It maximizes their utility. Why do people listen to Nickelback? It maximizes their utility. See, this can lead to some absurd conclusions.

However, it does help our understanding of the world. This framework allows for specific predictions of the consequences of decision, both at the personal level and the policy level. If people go to college because they expect to earn more, fewer people will go once graduate income drops. Some conclusions from this framework are obvious. Some are more profound. If criminals are crazy (as many people believe), why do we have laws? Clearly, even criminals respond to incentives.

I have found this approach extremely helpful as a guide post through life. If I know my own goals and I know the means available, this rationality approach helps show the best way to meet those goals. It encourages me to be more rational and more effectively use my means to maximize my happiness. Don´t confuse this with maximizing wealth. Unfortunately, many economists replace maximize "happiness" with maximize "wealth" as a shortcut. If we can avoid that slip-up in our daily life, we are in good shape.

Again, there is something missing. In accepting this approach, people implicitly accept that idea that people calculate like computers. This approach rules out wrong decisions. Everyone makes the choice that maximizes their utility. However, to many people, failure and bad choices seem obvious in the world around us. I rocked a mullet for a long time, good choice.

I also have made many dumb choices in my life, listening to rap music way too much. Rationality rules out innovation and creativity. It is difficult to appreciate creativity when everyone is simply calculating.

The Study of Human Action

I take a broader approach and define economics as the "study of human action." Now, this is not my original approach by any means. Ludwig von Mises wrote a book titled Human Action more than 60 years ago. It is the most satisfactory definition I have found, partly because it is the most general. Economics can help with many things, so why limited it to wealth or rationality?

While this approach is extremely broad (how can anyone study all of human action?), it does assume a few things. First, it assumes a pattern to study. If human action was chaos or people were completely irrational, no study would be necessary. Anything could happen at any time. This is a nihilist point of view, but some economists take it. Secondly, it assumes that action is the thing worth studying. Economics does not study beliefs, thoughts, or psychological processes, but concrete actions. The insights of economics are realized through people´s actions. My actions and others´ inform my understanding of the economic process. It includes looking inward at myself and why I act, but also out trying to understand how other people act.

The usefulness of these two assumptions will eventually appear. Each reader must first understand the conclusions and insights. Then, he can judge the assumptions. I would apply this same criteria to any set of assumptions. For me, these assumptions are worth it. The "human action" approach also allows me to use the above approaches. It incorporates the idea of scarcity, since all action occurs under scarcity. It also incorporates rationality, without having to accept humans as computer-like calculators of pleasure and pain. It allows economists (we are all economists) to study all of human behavior.

Of course, no approach to economics is perfect and I certainly do not understand it all. However, if it involves the actions of a person, economics can shed light on it. All we need to do is understand some basic insights and apply them.

This blog is a result of thinking about my life through the lens of economics and learning from other people. There is no sense in re-inventing the sandwich (that´s the expression, right?) when someone else already did. None of these insights are purely mine and most are not even original. However, spreading these insights is more important than claiming ownership.

If you´re eager to learn a bit about economics and improve your life in small steps, keep following.