Economic Literacy: A Few Basics

Because of the financial crisis and the deepening recession, more economic literacy is being recommended once again. When I was there, the Dallas Fed had several programs to teach economics to teachers so they could teach it to their students. Teachers often asked me what were the most important economic concepts to teach students who wouldn't be taking additional courses in economics.  Here are my Top-10.

1. Adam Smith's invisible hand, which shows how individuals acting in their own self interest create a rational outcome for society. How do markets coordinate things without direction from the top? What are the roles of profits, prices and private property and competition?

 2. The broken window fallacy, which I've described here before, teaches us to compare what happens and what is seen to what doesn't happen and isn't seen. It trains students to look for opportunity costs, unintended consequences and counter factuals.

3. Opportunity cost, which trains students to include foregone opportunities as a cost of their decisions. When you come to a fork in the road, you can't take them both, as Yogi Berra advises. One cost of going one way is not getting to go the other way.

4. Decisions are made at the margin-a little more of this means a little less of that. You maximize profit when the marginal revenue from the last unit produced just matches the marginal cost of producing it. Fixed costs don't count. Once you've bought the tickets, their cost is irrelevant the next day when you're deciding wither to go to the game.

5. Don't kill the goose that lays the golden eggs.  If you have such a goose, you better take good care of it.  Goose abuse is self defeating, as in overtaxing entrepreneurs, or over-regulating the practice of medicine.

6. Incentives matter. When tax rates become too high, work and entrepreneurship aren't worth it. Frivolous lawsuits drive doctors out of state. Tax breaks on mortgage interest encourage homebuilding. Higher prices for corn will bring a bigger crop.

7. Comparative Advantage.  It's easy to see why a tropical island might export fruit to another country in exchange for machinery. That's intuitive absolute advantage. But what if one country produces everything cheaper than another? Comparative advantage favors the most-best or the least-worst.

8. The fallacy of job counting. We will always have more work to do than workers to do it. Therefore, let's not count jobs; let's make jobs count. Workers are scarce and will go where their return is highest. Politicians focus on creating jobs for their own sake. If they focus on real needs, the workers will come. The false idea that there is too little work to employ all willing workers leads to things like France's 35-hour work week.

9. Supply creates its own demand.  This is Say's Law, named for Classical economist, Jean Baptist Say. When we produce something, the wages and other income earned from that production are sufficient to purchase it. We don't have to keep expanding government employment to make up for chronic private under spending.

10. Demand creates its own supply. We might call this Keynes' Law, which is most relevant in a recession or depression when people aren't spending enough to support aggregate demand at full employment levels. The Keynesian remedy is more government spending.