ECONOMICS OF BUSINESS DECISIONS

Term: Spring 2008

Course Title: Economics of Business Decisions

Course Number: ECP 6705-559

Meeting Times Monday & Wednesday – 3:00 – 4:15 P.M.

and Location: Final Exam: MONDAY, APRIL 28, 3:00 – 4:50.

Required Text: None – use of internet sources and lecture materials. Should you need to
review a textbook, you might try:

Zolatan J. Acs and Daniel A. Gerlowski. 1996.

Managerial
Economics and Organization. Upper
Saddle River, N.J.:
Prentice Hall.

James A. Brickley, Clifford W. Smith, Jr., and Jerold L.

Zimmerman. 2007. Managerial Economics and
Organizational Architecture. Boston, MA: McGraw-
Hill/Irwin.

Notice the commonality in the titles – an emphasis on ‘organization’ and the

‘organizational structures’ that have evolved – reflecting the current emphasis
on ‘internal structures’ necessary for ‘efficiently’ interacting in the ‘external
global environments.’ The firm’s external environment is composed of
consumers, employees/owners, competitors, suppliers, and governmental
agencies. Increasingly, this web of interconnections with the ‘external
environment’ extends explicitly through both space and time encompassing
domestic and foreign participants. It is important to acknowledge that such a
perspective involves the relaxation of the ‘normal’ assumptions postulated, but
often ignored, by ‘microeconomic’ theory, including their inclusion in
‘managerial’ or ‘business’ economics, i.e., a single product firm existing at a
point in dimensionless space at a moment in time (adjustments are instantaneous).
These factors have been long known –for example, see:

Alfred Marshall. 1920. Principles of Economics, 8th Edition.

London: Macmillan.

Marshall has written:

So far we have taken no account of the difficulties of getting exact lists of

demand prices, and interpreting them correctly. The first which we have to
 consider arises from the element of time, the source of many of the greatest
difficulties in economics.

Thus while a list of demand prices represents that changes in the price at
which a commodity can be sold, other things being equal; yet other
things seldom are equal in fact over periods of time sufficiently long for
the collection of full and trustworthy statistics….. This difficulty is
aggravated by the fact that in economics the full effects of a cause seldom
come at once, but often spread themselves out after it has ceased to exist.
(92, emphasis in the original)

Later, Marshall in addressing ‘markets’ has reported:

Again, markets vary with regard to the period of time which is allowed to
the forces demand and supply to bring themselves into equilibrium with
one another, as well as with regard to the area over which they extend.
And this element of Time requires more careful attention just now than
does that of Space. For the nature of the equilibrium itself, and that of the
causes by which it is determined, depend on the length of the period over
which the market is taken to extend. We shall find that if the period is
short, the supply is limited to the stores which happen to be at hand: if the
period is longer, the supply will be influenced, more or less, by the cost of
producing the commodity in question; and if the period is very long, this
cost will in its turn be influenced, more or less, by the cost of producing the
labour and the material things required for producing the commodity…..
those temporary equilibria of demand and supply, in which ‘supply’ means
in effect merely the stock available at the time for sale in the market; so that
it cannot be directly influenced by the cost of production. (274-5)

If you will reflect for a moment on the differentiation made in Principle of

Microeconomics between ‘a change in quantity demanded’ (or ‘supplied’) and
‘a change in demand’ (or ‘supply’), you will realize that ‘time’ is behind the
differences. Remember the diagram of a demand curve with Price on the Y-axis
and Quantity Demanded (or Supplied) per unit of time on the X-axis? Remember
the distinction made between ‘short-run’ (only one factor of production is
allowed to vary) and ‘long-run’ (all factors of production are allowed to vary)? It
should be apparent that the distinction between the ‘short-‘ and the ‘long-run’ is
based on both the production and the consumption side of the market.

So there it is, at the moment or ‘decision point’ that old ceteris paribus (‘all
other things being equal’ or ‘…held constant’), proviso is called into service,
i.e.., all changes are instantaneous! The factors most frequently mentioned as
being held constant include: income; price of other (substitute or complementary)
goods; tastes and preference; location. ‘A change in demand (or supply)’ involves
the relaxation of the ‘per unit of time’ constraint, thereby extending the time
frame (and geographic market reach) to the short-run and long run (and regional
and national/international markets).

The following source provides some useful insights which are frequently glossed-
over in most managerial and microeconomics texts::
 James V. Koch. 1976. Microeconomic Theory and Applications.
Boston: Little, Brown and Company

Perhaps, more to the point are the comments Koch makes about markets:
Our definition of a market suggests several problems. First, how much
substitutability between products must be present before the products are
considered to be in the same market? Second, what role is assumed by
such factors as geography and time? These questions arise because an
economic market is not single-dimensioned; it has three dimensions:
product, geography, and time. We will consider each of these dimensions
in turn.

From the product standpoint, substitutability is the keystone. If two

goods are close substitutes for each other, then as products, they are in
the same market. We will later indicate how cross-elasticities of supply
and demand may be used to delineate market line empirically. (18-9)

The geographic dimension of a market is usually readily apparent. Some

markets are primarily local or regional because of transport costs or
because of durability and spoilage considerations. Other markets are
national (such as national network television) because of the absence of
effective localizing barriers. Even when two products are potential
substitutes for each other, geographic distance may place them in different
markets (for example local news on radio stations in Nome, Alaska, and
Bangor, Maine).

The time dimension of an effective market is important, because the

passage of time often enables both suppliers and demanders to enter and
leave the market….In general, the greater the passage of time, the greater
the potential competition. (19)

Consideration of both time and space has been important aspects of economic
inquiry – see: the Chicago School of economics, especially: Frank Knight [1921.
Risk, Uncertainty, and Profit]; the Austrian School: especially, Ludwig von
Mises [1912. The Theory of Money and Credit] and Frederick A. Hayek [1935.
Prices and Production, 2nd Edition]; and the German Historical School: primarily
J. Heinrich von Thünen [1826. The Isolated State (Der isolirte Staat in
Beziehung auf Landwirthschaft…)]; Alfred Weber [1909. The Theory of the
Location of Industries (Über den Standort der Industrie)]; Walter Christaller
[1933. Central Place in Southern Germany (Die zentralen Orte in
Süddeutschland)]; and August Lösch [1945. The Economics of Location (an
excellent review by Stefean Valavanis is available in the American Economic
Review, 45 (4), 637-44)].

Course Prerequisites It is assumed that students enrolled in this course have already taken a two
and Description: course sequence in the Introduction to Economics (Macro- and Micro-) or
Introduction to Economic Analysis (ECO 5115) or its equivalent.
The terminology, Economics of Business Decisions, reveals that the focus is on
the processes and tools employed by consumers and producers for making good
(efficient) economic decisions. In a world of resource scarcity, efficiency
involves obtaining the most possible from a given set of resources; or,
alternatively, employing the fewest resources in obtaining a given level of output.
It is for the most part, based on the concepts that have come to be referred to as:
microeconomics – with its primary focus on individual decision makers. This
orientation involves the interactions of firms, consumers and governmental
agencies. In recent years, two additional elements have come into prominence for
the Economics of Business Decisions – (i) the organizational structures of the
business entities (firms); and (ii) the broadening of the analysis to include these
interactions at the global level (they have become international in scope).

Since the time of John Maynard Keynes, the discipline that had been known as
‘Political Economy’ [David Ricardo’s book is a perfect example: Principles of
Political Economy and Taxation, 1817, as is John Neville Keynes’ Scope and
Method of Political Economy, 1891] by the English School, was transformed
with text books differentiating between Micro- and Macro- economics. The
British economist, Alfred Marshall, treated economics as a whole in his classic
work, Principles of Economics, [8th Ed., 1920.] Contemporary economics owes
more to the so-called Continental School, which devolved from the Leon
Walrás/Vilfredo Pareto and the ‘Lausanne School,’ than it does to the English
School. More recently, the Austrian School of economics has become
increasingly popular with its ability to explain the credit-market origins and
processes of the business cycle (Ludwig von Mises) and the inherent timing
within the production process, i.e., ‘intertemporal structure of production’ (F. A.
Hayek’s decomposition the production of consumer goods into stages of
production/production time, known as the ‘Hayekian Triangle’ – see: Roger W.
Garrison. 2001. Time and Money: The Macroeconomics of Capital Structure).
An important issue is the role played by the largely implicit ‘limiting
assumptions’ of the two approaches. For example, the Continental School
approaches economics from the vantage point of ‘general equilibrium’, as
opposed to a ‘partial equilibrium’ framework.

Contrary to popular myths, Economics of Business Decisions, is NOT a watered-

down Intermediate Microeconomics Theory course. Rather, it is has a Managerial
Economics focus – underpinned by formulating a sound decision-making process.
This does not imply that ‘theory’ does not matter; it means the focus is on the
individual decision-making units – households, firms and the public sector actors,
with the firm and its interactions with both its internal and external environments.
Perhaps a single best expression of this approach may be found in Chapter 1
“Introduction: Firms and Managing Them,” of Zoltan J. Acs and Daniel A.
Gerlowski’s pioneering text: Managerial Economics and Organization. Upper
Saddle River, NJ: Prentice Hall, 1996. They have provided the following
definition:
 firm: A conscious, willful effort to organize economic activity that
consists of a collection of contracts when more than one
party is involved…. A firm is not a person or any other
living thing; it is merely a legal entity, recognized by law,
which is permitted to enter into binding contracts with
other persons and firms (2, emphasis added)

In the ‘Preface’ to James A. Brickley, Clifford W. Smith, Jr. and Jerrold L.

Zimmerman in Managerial Economics and Organizational Architecture, have
identified five factors that comprise “The Conceptual Framework” of an
‘organizational’ approach to managerial economics, an approach that focuses
‘special’ attention on “… organizational issues.” (v) They have noted that this
approach helps us understand:

▪ How the business environment (technology, regulation, and

competition in input and output markets) drives the firm’s
choice of strategy.

▪ How strategy and the business environment affect the firm’s

choice of organizational design – what we call organizational
architecture.

▪ How the firm’s organizational architecture is like DNA;

the firm’s ultimate success or failure can be traced back to
its organizational architecture, which will affect how people
in the organization will behave in terms of creating or
destroying firm value.

▪ How corporate policies such as strategy, financing, accounting,

marketing, information systems, operations, compensation, and
human resources are interrelated and thus why it is critically
important that they have coordinated.

▪ How the three key features of organizational architecture – the

assignment of decision-making authority, the reward system, and
the performance-evaluation system – can be structured to allow
managers to achieve their desired results. (v-vi, emphasis in original)

Interestingly, Acs and Gerlowski continue their analysis by explaining the terms
used in their apparently simple definition of ‘a firm’ –

It is quite important to recognize the implied functionality of firms;

they organize economic activity. For this reason, a more general
term has evolved in business for firms: organizations. (2, emphasis
in original)

…. Each of these activities is organized or arranged in a particular

way that depends on a number of forces both inside and outside the
firm.
 Traditional economic analysis focuses to a great degree on profit
maximization as the primary force driving firms in their actions. We
will adopt the much broader concept of efficiency. A particular way
of organizing economic activity is said to be efficient if it is impos-
sible, given available resources, to implement an alternative arrange-
ment under which all parties involved are at least as well off. [2,
emphasis in original]

It might be noted that the foundations of this approach were established long
ago, but ignored by most economists in a most irresponsible manner. To check
on this, read about Ronald Coase at: www.dsallasfed.org/research/ei. Pay
particular attention to his article: “The Nature of the Firm,” (Economica, 1937)
and his view that ‘activities may be accomplished ‘within’ the firm or be
‘out-sourced’, with the decision-criterion: the minimization of ‘transaction
costs.’ Coase was heavily influenced by his colleague at the University of
Chicago, Frank Knight, and his Dissertation-turned-into-a-book: Risk,
Uncertainty and Profit. In a later article “The Problem of Social Costs,” (1960.
Journal of Law and Economics), Coase more fully develops his ideas on
‘transaction costs’, calling into question the ‘conventional wisdom’ of economic
policy …. that government regulations serves to ‘correct’ market-failures and
promote economic efficiency. This silliness may be traced back to A. C. Pigou’s
notorious book: The Economics of Welfare (1920). Robert Formaini comments
on Coase, that he :

… methodologically demonstrates that regulatory interventions can

under certain conditions lead to less economically efficient outcomes
than markets alone would create. [“Ronald Coase – The Nature of Firms
and Their Costs,” Economic Insights, 8 (3); @ www.dallasfed.org/research/ei..]
A second significant contemporary economist that has contributed significantly
is James M. Buchanan, who also acknowledged the costly role ‘government
failure’ in its pretenses of correcting the alleged failures of free-markets a la A.
C. Pigou. Buchanan notes that he has been heavily influenced by Frank Knight
and Frederick Hayek. The silliness of the pretense that government can correct
market failure devolves from the conviction that ‘bureaucrats’ are superhuman
entities, capable of setting aside their own ‘self-interest’ and acting ONLY to
serve the interests of the public!, e.g., they are “… a disinterested agency that
could correct for market failures.” Unfortunately, the pretense of sainthood is
overshadowed by the existence of ‘rent-seeking’ and ‘wealth-trading’ inherent
in the legislative processes. For more on Buchanan, see: Robert Formaini.
“James M. Buchanan – The Creation of Public Choice Theory,” Economic
Insights, 8 (2); @ www.dallasfed.org/ research/ei.

A basic understanding of major precepts of both micro- and macro-economics is

assumed – the essential nature of economics as practical exercises in making
difficult decisions necessitated by explicit recognition that ALL resources (land,
labor, capital and entrepreneurial talent) are scarce. Rational decisions under
 conditions of resource scarcity require that the factors of production (or, resources
or inputs) be directed to their ‘highest and best uses.’ This has been summed-up
by James D. Gwartney and Richard L. Stroup as “There Ain’t No Such Things As
A Free Lunch,” or TANSTAAFL. Such a definition indicates that deviations
from such a pattern of resource allocation involves waste or inefficiencies – that
less is made available than would be the case.

No mode of social organization (capitalism or socialism, not even communism or

simple subsistence economies) is exempt from this so-called iron ‘law of scarcity.’
Though some decision-makers forget this, or choose to ignore it, or, arrogantly, in
their superior wisdom, presume that they are able to suspend the laws of human
nature. Such behaviors are a suspension of the ‘Baconian’ Scientific Method’ and
has been chronicled by Michael Crichton, M.D. in his disturbing speech (available
on his website – www.crichton-official.com/speeches/index.htmh): 2003. “Aliens
Cause Global Warming,” California Institute of Technology, January 17.

The ‘theories’ and ‘laws’ of economics are subject to empirical verification

through the assiduous application of the ‘Baconian’ scientific method. This
means a theory or law that fails to ‘predict’ outcomes with a high level of
precision at a high degree of accuracy must be rejected – neither science nor
economics is a democracy. When you hear “most scientists or economists agree,”
you know that, as Sherlock Holmes would, “Something is afoot.” There are no
partial truths, the theory/law is either correct or it is incorrect!

Among the issues to be investigated include such problems as (i) the nature of
organizational structures for decision making; (ii) prices and supply/demand
relationships; (iii) production theory, including cost analysis; (iv) the nature and
comparison of the relative merits (efficiency, as opposed to equity) of various market
structures); (v) the role of information, risk and uncertainty in decision making and
the need for probability models, rather than ‘deterministic’ approaches; (vi)
consideration of the distorting effects of governmental intervention into free
markets; and, finally, (vii) an evaluation of ‘time’ and the business horizon – the
short-run and the long-run.

Instructor: Louis A. Woods

Office Hours: Monday and Wednesday @ – 1:00 to 2:30; and by appointment.

Phone: [904] 620-2641

E-mail: lwoods@unf.edu

Assigned Outside The following readings constitute a portion of this courses required
Readings: readings and materials drawn from them will appear on quiz materials:

Oliver E. Williamson. 1981. “The Modern Corporation, Origins,

 Evolution, Attributes,” Journal of Economic Literature, 19
(December), 1537-65.

Ronald H. Coase. 1937. “The Nature of the Firm,” Economica, 4, 386-

405.
While not exactly a CliffNotes version, see: Robert L. Formaini
and Thomas F. Siems. Ronald Coase – The Nature of Firms and
Their Costs,” Economic Insights, 8 (3); available @:
www.dallasfed.org/research/ei/ei0303.html.

Various sets of notes will be provided to the class for students to reproduce for
their own use.

Outside Readings: In addition to the assigned reading material in the text, each student is expected to
read a total of ten (10) articles (not editorials or book reviews) from scholarly
journals over the term. Time, Businessweek, Fortune, The Wall Street Journal,
etc. are all popular periodicals and DO NOT qualify as scholarly journals. Several
examples of scholarly journals are: Journal of Business, Harvard Business
Journal, Journal of Marketing, Journal of Accountancy, Land Economics. Each
of the articles should be reviewed, summarized or outlined as a written report on
5" x 8" note-cards. Reviews must be headed with the appropriate bibliographic
heading on the top line:

Author. Year. “Title,” Journal, Vol. ?? , No. ? (Month), pages; --

for example:

Hermann Hauser. 2000. “Entrepreneurship in Europe,” Business

Strategy Review, 11, 1 (Spring), 1-9.

These reports are to be turned in on a weekly basis, beginning the week of

January 23rd.

Textbook: There is no specific textbook for use in this course. Various sets of notes
will be provided to the class for students to reproduce for their own use. There are
a number of websites and internet sources that will be cited in the class notes that
should be read. The recent re-emphasis on the notion of ‘globalization’, as seen in
the proliferation of university courses, incessant discussion by the media and the
investment and production strategies of the business community, requires the
development of the topic in this course. Perhaps the best perspective on the issue
is to be found in the book: The Commanding Heights: The Battle for the World
Economy (1998) by Daniel Yergin (global petroleum expert) and Joseph
Stanislaw.

January 7 - Orientation, housekeeping and introduction to the

three-part video set:
 January 23 The Commanding Heights: The Battle for the World Economy.
The
three segments are:

Episode 1 – ‘The Battle of Ideas’;

Episode 2 – ‘The Agony of Reform’; and

Episode 3 – ‘The New Rules of the Game’.

A summary of these ‘episodes’ is available on my

homepage. In order
to put the contemporary global economy into some
perspective, the
entire program will be viewed … the ‘storyline’ is
available online @

www.pbs.org/wgbh/commandingheights/lo/story/index/html

Should you have difficulty using this address, simply search:

‘commanding heights’ ‘PBS’ and once there click on ‘Storyline’.
In viewing this video take notes on the key ideas, individuals and
events, carefully noting their interdependencies and interactions.

Assignment: due February 3rd – develop a

flow-chart or diagram
of the key ideas, including personages, and their interconnections
developed in the last two episodes [‘The Agony of Reform’; and
‘The New Rules of the Game’] of the video.

January 21 Martin Luther King, Jr. Birthday – University

Holiday

January 23 First of the Article Reviews (note cards) is due. One will be
due each week for the next ten weeks, with the exception
of the week of Spring Break (March 13-20). The final
review will be due on April 3.

The Basic Concepts

Factors of Production – Land, Labor, Capital and
Entrepreneurship
The ‘Law of Scarcity’ and Resource Availability --
The Role of Technology, an often ignored
Factor
The Alternative ‘[Opportunity’] Cost Doctrine
 Producer Behavior – Profit Maximization via
Cost Minimization
Consumer Behavior – Maximization of Want-Satisfaction
[Utility] via the Evaluation of Alternatives

Recommended readings:

Walter E. Williams. 2002. “The Role of Profits,” @

www.townhall.com/columnists/walterwilliams/
printww20020626.shtml
__________. 2005. “The Role of Prices,” @
www.townhall.com/columnists/walterewilliams,
September 14.
__________. 2006. “Economics of Prices,” @
www.townhall.com/columnists/walterewilliams,
May 31.
D. W. MacKenzie. 2002. “The Price System as Can Owner,”
Ideas on Liberty, 52 (1), 38-40.
Sean Corrigan. 2002. “The Cone of Production,” @
www.mises.org/fullstory.asp?control=1114
William L. Anderson. 2004. “Profits do not Cause Higher Prices,”
www.mises.org/fullstory.aspx?control=1520&id=77
Thomas Sowell. 2005. “Time and Money and Housing: Part II,”
www.townhall.com/columnists/thomassowell/
printts20050901.shtma
Walter E. Williams. 2005. Gasoline Prices,”
www..townhall.com/columnists/WalterEWilliams/
2005/08/31gasoline_prices

February 6 FIRST QUIZ

February 11- The Basic Concepts

March 10 Time, Information and Decision Making --
Perfect and Imperfect Information vs.
Absolute Ignorance and Risk
Market Structures – Perfect and Imperfect
(Monopolistic) Competition & Oligopoly
and Monopoly.
Decision-Making under Conditions of Certainty –
Perfect Competition & Monopoly
Decision-Making under Conditions of Uncertainty
and Risk – Imperfect Competition and
Oligopoly
The Role of Government in Thwarting Competition

Recommended Readings:
 Alan Greenspan.1962. “Antitrust,” re-printed in Ayn Rand
(ed.), Capitalism: The Unknown Ideal, 63-71.
George Reisman. 2006. “For Society to Thrive, the Rich
Must be Left Alone,” Daily Article, Ludwig von
Mises Institute, March 2.
Howard Baetjer, Jr. 1985. “Profit-Maker – Friend or Foe?”
The Freeman, (April) @ www.fee.org/vnews.php?
nid=1496
Gerald Prante. 2007. “Summary of Latest Federal
Individual Income Tax Data,” The Tax Foundation,
Fiscal Fact No. 104 (October 5) @ www.taxfoundation.org
/publications/show/250.html. [See, especially: ‘Table 8.
Total Income Tax Share, 1980-2005 (% of federal
income
tax paid by each group)
John Chamberlain. 1981. “The Progressive Income Tax,” The
Freeman, 31 (4) @ www.fee.org/publications/the-freeman/
article.asp?aid=297.
U.S. Constitution, Amendment 5, ‘Taking Clause,’ @
www.usconstitution.net/xconst_Am5.html
Thomas Sowell. 2001. “Property Rites,” @
www.townhall.com/columnists/thomassowell/
printts20010809.shtml
__________. 2002. “An Ancient Fallacy,” @ www.townhall.com/
columnists/thomassowell/printts20020527.shtml
Walter E. Williams. 2005. “Is it Permissible?” @
www.townhall.com/columnists/walterwilliams/
printww20050921.shtml
John Stossel. 2005. “In Praise of Price Gouging,”
www.townhall.com/columnists/JohnStossel/printjr
20050907.shtml

March 11 SECOND QUIZ

March 12- The Basic Concepts

April 25 Organizational Tools – Transaction Costs and Value
Creation
Make-or-Buy Decisions – Vertical vs. Horizontal
Integration
Contracts and Incentives – Property Right, Risks and
Rents
The Modern Firm – A Work in Progress
Entrepreneurs, Technology and Change – The Legacy of
Joseph Schumpeter
Production Networks, Alternative Governance Structures
and International Differences in Organizational
 Organization

March 17 – Spring Break

March 21
Recommended Readings:

Robert L. Formaini. 2002. “Frank H. Knight – Origins of the

Chicago School of Economics,” Economic Insights, 7 (3);
@ www.dallasfed.org/research/ei/ei0203.html
Robert L. Formaini and Thomas F. Siems. 2003. “Ronald Coase –
The Nature of Firms and Their Costs,” Economic Insights,
8 (3); @ www.dallasfed.org/research/ei/ei0303.html
Robert L. Formaini. 2003. “James M. Buchanan – The
Creation of Consumers Choice,” Economic Insights, 8 (2);
@ www.dallasfed.org/research/ei/ei0302.html
W. Michael Cox. 2001. “Schumpeter – In His Own Words,”
Economic Insights, 6 (4); @ www.dallasfed.org/research/ei/
ei0302.html
Candace A. Allen. 1997. “The Entrepreneur as Hero,” Economic
Insights, 2 (1); @ www.dallasfed.org/research/ei/ei9701.html
Bob McTeer. 2000. “Growth Comes Through Change and Causes
Change,” Economic Insights 1; @
www.dallasfed.org/research/ei/ei00special.html

April 25 – Last Day of Classes

April 28 THIRD QUIZ

Final Quiz: MONDAY, APRIL 28, 3:00 – 4:50.

Short, Informative The following brief columns have been carefully selected to address key
Suggested topics that comprise the basic aspects of the Economics of
Business
Readings: Decisions. Each sheds light on contemporary issues being raised in public
discussions. Unfortunately nearly all of these discussions have created a
lot of smoke and very little light. This is true, since, as Gwartney and
Stroup have pointed out in the Introduction to their book: What Everyone
Should Know about Economics and Prosperity: “…we are a nation of
economic illiterates.” (v). In the revised edition of this book, with an
added author, Dwight Lee, Common Sense Economics: What Everyone
Should Know About Wealth and Prosperity (2005):

Our institutions are not perfect, however, and there is good reason to be
concerned by the overwhelming evidence that we are a nation of economic
illiterates. (x)

Two of my favorite and most readable and reliable economists are

 Thomas
Sowell and Walter E. Williams, so I have included a number of their most
significant brief commentaries:

William L. Anderson. 2004. “The Economics of Outsourcing,” April 21;

@ www.mises.org/fullarticle.asp?control=1488&id=68.
Doug Bandow. 2005. “Sugar Subsidies: How Sweet It Is,” February 7; @
www.townhall.com/columnists/dougbandow/printdb20050207.
shtml.
Randall G. Holcombe. 1998. “Economic Freedom and Economic
Growth,”
The Freeman: Ideas on Liberty (February); available @:
www.fee.org/vnews.php?nid=3955.
*Charles Krauthammer. 2006.“Say It With Me: Supply and Demand,”
April 28; @ www.washingtonpost.com/wp-dyn/content/article/
2006/04/27/AR2006042701693_pf.html.
John Stossel. 2005. “Half-Baked Science,” August 31; @ www.townhall.
com/columnists/JohnStossel/printjs20050831.shtml.
*Thomas Sowell. 2006. “Oily Politicians,” April 27; @
www.townhall.com
www.townhall.com/opinion/contributors/thomassowell.html.
__________. 2006. “Oily Politicians: Part II,” April 28; @
www.townhall.
com/opinions/contributors/thomassowell.html.
*__________. 2003. “Free-Lunch Medicine,” November 13; @
www.townhall.com/opinion/contributors/thomassowellprintts2003
1113.html.
*__________. 2003. “Free-Lunch Medicine, II,” November 14; @
www.townhall.com/columnists/thomassowell/printts20031114.
shtms.
*__________. 2003. “Free-Lunch Medicine, III,” November 15; @
www.townhall.col/columnists/thomassoweel/printts20031115.
shtml.
*__________. 2003. “Letters About Medical Care,” November 18; @
www.townhall.com/columnists/thomassowell/printts20031118.
shtml.
*Walter E. Williams. 2000. “Political Exploitation of Ignorance,” March
1; @ www.townhall.com/columnists/walterwilliams/ww000301.
shtml.
*__________. 2004. “Price Gouging,” March 24; @ www.townhall.com/
columnists/walterwilliams/printww20040324.shtml.
*__________. 2005. “Gasoline Prices,” August 31; @
www.townhall.com/
columnists/walterwilliams/printww20050831.shtml.
*__________. 2003. “Drug Industry Destruction,” July 30; @
www.townhall.com/columnists/walterwilliams/printww20030730.
 shtml.
*__________. 2000. “Social Security Lies,” May 14; @ www.townhall.
com/columnists/walterwillia,s/ww000525.shtml.

Additional Each student is expected to be well informed on current social and

Requirements: economic issues – both domestic and international -- by reading a reliable
newspaper or internet source, including the editorial pages (such as the
Wall Street Journal or Investor’s Business Daily; and/or by viewing a
reliable television news source (if that’s even possible) on a daily basis.

Initial
Comments: Introductory/background materials

Comments on the Baconian method, its abandonment in both the natural

and the social sciences, and intellectual honesty or opinion; fact or
fantasy; does opinion trump science? An economic answer: Confusion
over John Neville Keynes’ distinctions: ’positive economics,’ ‘normative
economics,’ and ‘economics as an art’.

In a recent Investor’s Business Daily editorial, Paul Craig Roberts

presented ‘seven big economic ideas’ and three related issues. Finally, in
an editorial written by Walter E.Williams, entitled “Economics 101’ he
identified the ‘key characteristic of economics’. In order to set the tone for
this course, I can think of no better place to begin than in Williams’
editorial, “Economics 101”:

More than anything else, economics is a way of thinking. At the

heart of economics are several simple and easily observable
characteristics of humans and the world in which we live. The first
is that people prefer more of those things that give them satisfaction
and fewer of those things that give them dissatisfaction. Second,
when the cost of something goes down, people tend to take or do
more of it, and when the cost of something increases, people tend to
take or do less of it. Finally, having more of one thing requires less
of something else. Or, as my colleague Professor Milton Friedman
puts it, “There’s no free lunch.” [“Economics 101,” available at:
www.townhall.com/columnists/walterwilliams/ww000607, all
emphasis added]

It would be wise to read Williams’ entire editorial to discover how he

applies these basic principles to ‘public policy issues’. For more about
Milton Friedman go to www.dallasfed.org and ‘click’ on ‘Publications
and Resources’ (top banner); then to ‘E’ (extreme upper right); and then
on ‘Economic Insights’. Now, page down to “Milton Friedman –
Economist as Public Intellectual,” Economic Insights, 7 (2); or you may
simply go to: www.dallasfed.org/research/ei/ei0202.

Paul Craig Roberts in his editorial has identified the seven big economic
 ideas of the 20th Century (having had the most socio-political influence).
He lists:

(i) communism (socialism);

(ii) Keynesianism and spending or demand-side economics;
(iii) Hayek’s identification of “the market system as an
information network”;
(iv) monetarism à la Friedman’s notion “demand is a
monetary phenomenon”;
(v) supply-side economics;
(vi) Coase and transaction cost analysis (“laws and property
rights” affect economic outcomes, i.e., so-
called ‘market failures’; and
(vii) Buchanan and ‘public choice’ economics (“policy-
makers use public policy to advance their own
self-interests”).

Note that there are explanatory materials devoted to Frederick Hayek,

James
M. Buchanan and Ronald Coase available on the Dallas Federal Reserve
website:

“Hayek – Social Theorist of the Century,” @

www.dallasfed.org/research/ei/ei9901;
“James M Buchanan – The Creation of Public Choice Theory,” @
www.dallasfed.org/research/ei/ei0302; and
“Ronald Coase – The Nature of Firms and Their Costs,” @
www.dallasfed.org/researh/ei/ei03.03.

Additionally, an historical evaluation and comparison of John Maynard Keynes

and Frederick Hayek and their influence of politics and economics during the 20th
and early 21st centuries may be found on the PBS website relating to one of their
programs, “The Commanding Heights,” (a nine hour special devoted to ‘the battle
of economic ideas’ during the 20th Century) especially:

‘Episode One: The Battle of Ideas’ @

www.pbs.org/wgbh/commandingheights/ lo/story/index.

The series and a companion book by the same title (1998. The Commanding
Heights: The Battle for the World Economy) was written by Daniel Yergin and
Joseph Stanislaw. Dan Yergin is one of the world’s leading experts on petroleum
and the economics of its exploitation.

Roberts begins his editorial by stating: “The two most influential – communism
and Keynesian economics – proved themselves to be false, but the shadows they
cast kept the five valid ideas in the shade.” (Emphasis added) He proceeds by
examining the ‘seven big ideas’, and concludes by observing:

Government growth is the 20th century reflected two big ideas that proved to be
wrong. If the five valid economic ideas prove to be as influential, the future will
 bring a contraction of government and an expansion of individual freedom.

Grading: Three, equally weighted quizzes will comprise 86% of the final grade. The
remaining 14% of the final grade will be determined by the outside
readings and
summaries. The following aggregate grading scale will be used:

350 to 323 (100% to 93%) ............... A

322 to 298 (92% to 86%) ................. B
297 to 270 (85% to 77%) ................. C
269 to 242 (76% to 70%) ................. D
Less than 242 (69%) ..................... F

Library Scholarly journals may be located in the periodical section of the library
Assignments: (The Third Level).

Written The individual article summaries will comprise one of the written
Communication communication requirements in this course. Please note that the cards=
Requirements: format, particularly the Bibliographic material, should conform to those
found in the Chicago Manual of Style.

Oral Class participation constitutes the demonstration of oral

Communication communication skills. At all times, class discussion and class
Requirements: participation is strongly encouraged.

Computer Use of the Internet for data searches, articles from scholarly journals
Applications: and data manipulation are encouraged. The need for students to access the
instructor=s home page to download syllabi, class materials, and project

instructions serves as an additional set of computer applications.

International Mankiw devotes several chapter to international issues. Lectures and

Coverage: handouts are used to augment the international component of this course.

Environmental Externalities/market failures, as well as government policies, are used

Issues Covered: to examine environmental issues. In addition, the regulatory response and
burden on private markets are discussed. The role of private property in a

free-market economy and its implications for economic efficiency vis-a-

vis the public provision of goods and services are examined in the so-called
>tragedy of the commons=.

Ethical Issues Ethical issues related to illegal or immoral activity within the economy
will Covered: be discussed where and as appropriate. This is particularly appropriate,
given recent scandals—Enron, Global Crossing, etc. and elected
governmental officials. Since the course addresses aggregates, aggregate
 behavior of producers, consumers, regulators will be considered.

Academic Integrity: Each student is expected to do his/her own work on assigned activities and
on all quizzes. An understanding of what constitutes plagiarism and abuse
of copyright >fair use= laws is expected of each student.

Students With Students with a disability, as defined under the Americans with
Disabilities: Disabilities Act (ADA), who may require special classroom
accommodations, should inform the instructor of any special needs during
the first week of class. Students should also contact the Office of Disabled
Services Programs (620-2769) immediately.

Gregg Mankiw has proposed the following ‘Key Element in contrast with the’ Ten Key
Concepts’ founding Gwartney, Stroup and Lee [GS&L}:

‘Ten Key Elements of Economics’

Principle #1. People Face Tradeoffs – [Incentives Matter] – The ultimate source of the need for
tradeoffs is
the ‘scarcity of (natural) resources’, sometimes this is known as the ‘Law of Scarcity’. This is
reflected in what Milton Friedman has characterized as “There ain’t no such thing as a free
lunch (TANSTAAFL).” This true since to devote scarce resources to one use, necessarily means
that there are fewer resources available to allocate to other, alternative uses. These ideas are best
seen in the ‘production possibilities curve’. This principle applies to individuals (households), as
well as to society as a whole. In making a decision whether or not to expend some portion of a
household’s (or a nation’s) scarce resources (income) [or GDP] on a particular good/service
(public policy), tradeoffs should be taken into consideration, e.g., the benefits derived and the
costs imposed by increasing taxes on households in order to provide subsidies to farmers (from
hops to tobacco, from wheat, cotton and corn to sugar and ethanol). Resource scarcities serve as
a constraint on economic production in the short-run, but over the longer run the constraint is
relaxed as prices rise. Price increases stimulate new discoveries and older, leaner sources are
made more profitable [old copper deposits and oil wells have been made more profitable by
higher prices, while small or distant, previously uneconomic deposits, are made profitable].
Additionally, as population grows the potential labor force is expanded; new technologies are
developed [olive/animal fat lamps, candles, whale oil lamps, kerosene lamps, electric lights]
encouraged by rising prices; and substitutes are found and developed [fiber glass as a substitute
for steel in auto bodies and fiber optic cable replaces copper wire in telecommunications]. This
process may be seen in Schumpeter’s ‘perennial gale of creative destruction’ driven by the
entrepreneur, his/her quest for profit by innovating. [See: W. Michael Cox. “Schumpeter – In
His Own Words,” Economic Insights, Vol. 6, No. 3; or online @
www.dallasfed.org/research/ei/ei0103]

The ‘free lunch mythology’ is clearly addressed by Walter E. Williams in an editorial he wrote
in 2001, “There’s No Free Lunch,” @ www.townhall.com/columnists/walter
williams/ww20011003. In it Williams introduces several ideas of the 19 th Century French
economist, Frédéric Bastiat (1801-1850). [See: Robert L. Formaini, “Frédéric Bastiat – World
Class Economic Educator,” Economic Insights, Vol. 3, No. 1; or online @
www.dallasfed.org/research/ei/ei9801] Williams quotes from one of Bastiat’s pamphlets, “What
is Seen and What is Not Seen,” which illuminates the issues discussed by Gwartney and Stroup
as their Principle #2: The Cost of Something Is What You [Have To] Give Up to Get It
(Emphasis added). – This principle is known as an ‘Opportunity Cost’, or, perhaps more
descriptively, an ‘Alternative Cost.’ A decision-maker (household, business man, government
bureaucrat), to avoid the waste of scarce resources, should evaluate or weigh the ‘benefits’
derived from the purchase or use of one item (a sirloin steak) in comparison with the ‘potential
benefits’ that must be foregone (Kentucky Fried Chicken – an alternative to the steak) in order
to have the sirloin steak. In this context, the value of the fried chicken (what must be given up in
order to get the sirloin steak) is known as its alternative or opportunity cost. Normally, if the
benefits derived from the steak exceed the benefits of the fried chicken (the steak’s alternative
cost), a rational consumer will purchase the steak. Another example involves a quasi-scientific
attempt to justify a ‘progressive’ tax policy (Robin Hood – take from the rich, give to the poor).
It is argued that the rich value their last dollar less (expressed as ‘marginal utility’) than the poor
value their last dollar (expressed as ‘marginal utility’), so to improve ‘social welfare’
(‘maximize society’s total utility or want satisfaction), it makes sense to transfer income from
the wealthy to the poor! The only problem is that this argument is ‘built on sand’, since it
assumes that there exists, empirically, measurable units known as ‘utils’. (This assumption is
really scientific, just like measuring the flow of electricity through a copper wire!)

Clearly, all decision-making involves a comparison of the expected benefits and the expected
costs associated with any transaction, including the use of tax revenues (more highway mileage
or more Medicaid). Reflecting on Bastiat’s example of the ‘broken window fallacy’, it is clear
that the opportunity cost associated with repairing the broken window is the foregone suit and
the income for the tailor. The production possibilities curve provides a graphic representation of
the trade-offs and their opportunity costs. One of the problems with the ‘Robin Hood tax policy’
is that it only considers that which Bastiat described as the attribute of a ‘bad economist’ – ‘that
which is seen’, totally ignoring what a ‘good economist’ must consider – ‘both that which is
seen and that which is unseen.’ Remember the quotation on page 3, above:

There is only one difference between a bad economist and a good one: The bad
economist confines himself to the visible effects, the good economist takes into
account both the effect that can be seen and those effects that must be foreseen.

Also, consider: Gwartney and Stroup’s last principle, drawn from Henry Hazlitt’s, Economics in
One Lesson -- 10. Ignoring Secondary Effects and Long-term Consequences is the Most
Common Source of Error in Economics. There Gwartney, Stroup and Lee are quoted as having
written: “Hazlitt’s one lesson was, that when analyzing an economic proposal, one:
must trace not merely the immediate results but the results in the long run, not
merely the primary consequences but the secondary consequences, and not
merely the effects on some special group but the effects on everyone.(27,
emphasis in the original)
 It would be helpful to read: Robert L. Formaini. “Henry Hazlitt – Journalist Advocate of Free
Enterprise,” Economic Insights, Vol. 6, No. 1; available @ www.dallasfed.org/research
/ei/ei0101.

Comparison of the benefits and the costs are essential if the decision maker wishes to avoid
waste (inefficient choices). This principle applies to individuals, households, larger groups, as
well as government bureaucrats. All too often, bureaucrats believe that they have superior
wisdom and, therefore have the right to impose their decisions on others. In order to accomplish
their ‘rights’ to governance, bureaucrats and bureaucracies create a justifying mythology.
Typically, this mythology is advanced and perpetuated by the self-anointed ‘intelligencia’
[интеллигéнция] … the taste makers, the cultural pace setters. For examples of the myths that
have been created, see: Walter E. Williams. 2005. “Greedy or Ignorant,” available @
www.townhall.com/columnists/walter williams/ww20050112. The myths must be scrapped
before the true relationships-- the real costs and the real benefits may be revealed.

Principle #2: The Cost of Something Is What You [Have To] Give Up to Get It (Emphasis added).
[There
Ain’t No Such Thing As A Free Lunch] – This principle is known as an ‘Opportunity Cost’, or,
perhaps more descriptively, an ‘Alternative Cost.’ A decision-maker (household, business man,
government bureaucrat), to avoid the waste of scarce resources, should evaluate or weigh the
‘benefits’ derived from the purchase or use of one item (a sirloin steak) in comparison with the
‘potential benefits’ that must be foregone (Kentucky Fried Chicken – an alternative to the steak)
in order to have the sirloin steak. In this context, the value of the fried chicken (what must be
given up in order to get the sirloin steak) is known as its alternative or opportunity cost.
Normally, if the benefits derived from the steak exceed the benefits of the fried chicken (the
steak’s alternative cost), a rational consumer will purchase the steak. Another example involves
a quasi-scientific attempt to justify a ‘progressive’ tax policy (Robin Hood – take from the rich,
give to the poor). It is argued that the rich value their last dollar less (expressed as ‘marginal
utility’) than the poor value their last dollar (expressed as ‘marginal utility’), so to improve
‘social welfare’ (‘maximize society’s total utility or want satisfaction), it makes sense to transfer
income from the wealthy to the poor! The only problem is that this argument is ‘built on sand’,
since it assumes that there exists, empirically, measurable units known as ‘utils’. (This
assumption is really scientific, just like measuring the flow of electricity through a copper wire!)

Clearly, all decision-making involves a comparison of the expected benefits and the expected
costs associated with any transaction, including the use of tax revenues (more highway mileage
or more Medicaid). Reflecting on Bastiat’s example of the ‘broken window fallacy’, it is clear
that the opportunity cost associated with repairing the broken window is the foregone suit and
the income for the tailor. The production possibilities curve provides a graphic representation of
the trade-offs and their opportunity costs. One of the problems with the ‘Robin Hood tax policy’
is that it only considers that which Bastiat described as the attribute of a ‘bad economist’ – ‘that
which is seen’, totally ignoring what a ‘good economist’ must consider – ‘both that which is
seen and that which is unseen.’

There is only one difference between a bad economist and a good one: The bad
economist confines himself to the visible effects, the good economist takes into
 account both the effect that can be seen and those effects that must be foreseen.

Also, consider: Gwartney and Stroup’s last principle, drawn from Henry Hazlitt’s, Economics in
One Lesson -- 10. Ignoring Secondary Effects and Long-term Consequences is the Most
Common Source of Error in Economics. There Gwartney, Stroup and Lee are quoted as having
written: “Hazlitt’s one lesson was, that when analyzing an economic proposal, one:
must trace not merely the immediate results but the results in the long run, not
merely the primary consequences but the secondary consequences, and not
merely the effects on some special group but the effects on everyone.(27,
emphasis in the original)

It would be helpful to read: Robert L. Formaini. “Henry Hazlitt – Journalist Advocate of Free
Enterprise,” Economic Insights, Vol. 6, No. 1; available @ www.dallasfed.org/research/
ei/ei0101.

Comparison of the benefits and the costs are essential if the decision maker wishes to avoid
waste (inefficient choices). This principle applies to individuals, households, larger groups, as
well as government bureaucrats. All too often, bureaucrats believe that they have superior
wisdom and, therefore have the right to impose their decisions on others. In order to accomplish
their ‘rights’ to governance, bureaucrats and bureaucracies create a justifying mythology.
Typically, this mythology is advanced and perpetuated by the self-anointed ‘intelligencia’
[интеллигéнция] … the taste makers, the cultural pace setter, the media elete. For examples of
the myths that have been created, see: Walter E. Williams. 2005. “Greedy or Ignorant,” available
@ www.townhall.com/columnists/ walterwilliams/ww20050112. The myths must be scrapped
before the true relationships-- the real costs and the real benefits may be revealed.

Principle #3: Rational People Think at the Margin – This represents the basis of what is known as
marginal
analysis, the weighing of the relative merits (benefits vs. costs) of the last unit(s) of a given
transaction, e.g., one more hour at a weekend party, compared with one more hour studying for
the economics test scheduled for Tuesday [benefits = momentary fun vs. cost = lower grade).
For an alternative view see Gwartney and Stroup, page 46:

If an investment program is going to enhance the wealth of a nation, the value of

the additional output derived from the investment must exceed the cost of the
investment….

If my weekly allowance is $100 and I want to buy some DVDs ($ 25 each) and go out with the
love of my life this week end. I can: (i) ignore ‘the love of my life” and buy four DVDs; (ii) buy
three DVDs and take the ‘love of my life’ out for dinner at McDonald’s; (iii) buy two DVDs
and take the ‘love of my life’ to an afternoon Matinee and dinner at Burger King; (iv) buy one
DVD and take the ‘love of my life’ to dinner at Wendy’s; (v) take the ‘love of my life’ to dinner
at Chris’ Steakhouse and walk in the moonlight along the Riverwalk. Each alternative involve a
tradeoff or the sacrifice of something desirable to the individual. The critical point is: in order to
get something of value, one must give-up, or sacrifice, something else of value.

Principle # 4: People Respond to Incentives (or Disincentives) [Emphasis added] – [Transaction Costs
Are
An Obstacle to Exchange; Reducing This Obstacle Will Help Promote Economic Progress] –
Keep in mind Gwartney Stroup and Lee’s first element of economics “Incentives Matter.” They
specifically note that incentives affect human behaviors, e.g., if you want more of a certain
behavior, provide incentives (tax breaks), but if you want less of a behavior, impose
disincentives (taxes). Please pay particular attention to the responses of buyers and sellers to the
higher gasoline prices of the 1970s (the so-called ‘energy crises’ of 1973/4). [For an analysis of
the current ‘oil crisis’, see: Thomas Sowell, “An Oil ‘Crisis?” @
www.townhall.com/columnists/thomassowell/printts 20050823; and Thomas Sowell, “An Oil
‘Crisis’? Part II, @ www.townhall.com/ columnists/thomassowell/ printts20050824.] Sowell
points to the obvious reasons for the high prices: excess demand or inadequate supply. No
mystery there. What should government’s response be? According to Sowell the best response
would be to do nothing! He notes that unfortunately there are Congressional elections coming up
in 1906 and Presidential elections in ’08. The ‘solutions’ likely to emerge are: “price controls,
arbitrary new higher gas mileage standards for vehicles, ‘alternative energy sources’”…all of
which have substantial costs, e.g., price controls = SHORTAGES; higher gas standards = higher
priced cars or lighter (unsafe vehicles); and alternative sources = more expensive energy (largely
funded through government subsidies [consider ‘ethanol’]. For more on the effects of
government subsidies, see: Alan Greenspan’s comments in his article “Antitrust,” discussed in
Principle 7, below. Alan Reynolds, in a brief article, cut to the heart of the current energy
situation [“Oil Prices: Cause and Effect,” available @ www.townhall.com/columnists/
alanreynolds20050623. He explains oil prices simply in terms of, surprise, surprise: Supply and
Demand – pointing out that only 45% of each barrel of oil is converted into gasoline! Notice that
in1997/98 the price of a barrel of oil was cut in half (a disincentive for oil exploration). Also
note that between:

…1978 and 2004 oil consumption rose 28.6 percent in the world but only 8.9 per-
cent in the United States. That difference was exemplified by a 344 percent
increase in South Korea’s oil demand.

… 60 percent of incremental oil demand [is] not coming from China and the
United States.

Especially interesting, or should I say alarming, are Reynolds’ conclusions concerning potential
proposed actions by members of Congress:

Meanwhile, some clueless senators are oddly eager to push the Chinese currency
up, which would make oil cheaper for Chinese industry and more expensive at
home. The White House seems oddly eager to enact more tax-financed subsidies
for those who buy Japanese hybrid cars, German diesels and ethanol made from
corn or sugar. It is difficult to imagine a more irrelevant ‘energy policy.’ (emphasis
added)

The only policy that might actually shrink the ‘fear premium’ in oil (estimated at
$10 to $ 20) is to use the strategic petroleum reserve strategically – to quell panic
during hurricanes, strikes, wars and the like. But the United States has instead
imported oil to add to the reserve whenever oil prices were unnaturally high (1981
to 1985 and now) and sold when the price was low (1997).

When it comes to causes and effects of high oil prices, nobody in Washington shows
 much interest in logic or facts. It might be sad if it wasn’t so pathologically pathetic.

Sowell identifies ‘organized nature cults’, read: environmental groups (a special interest group),
that impede drilling (increasing the domestic supply and lower prices). He debunks the idea that
we are running-out of petroleum (or any other minerals, for that matter) … See the bet between
Julian Simon (an economist) and Paul Ehrlich (a botanist), a paper “Julian Simon’s Bet with Paul
Ehrlich,” is available @ www.overpopulation.com/faq/People/julian_simon.html. [This particular
paper is a must read for those who have been duped into believing extreme environmental
rhetoric. After losing the bet Ehrlich reverted to his old ways “…ignoring his failed predictions in
general” and declaring that the bet “didn’t mean anything.” (Now that’s adhering to the scientific
method!)] Higher prices means that oil producers will seek out and attempt to discover and
produce more! Remember: INCENTIVES MATTER and higher prices are incentives for oil
producers.

Incentives (money, power, prestige, approval, love) normally lead to more of a given behavior,
while negative incentives (disincentives) typically discourage given behaviors. Greg Mankiw in
his Introduction to Economics textbook, rightly emphasizes the critical role that price plays in the
‘free’ market in allocating (channel or direct) resources to their ‘highest and best (most valued)
uses’. This is an issue of economic efficiency and deviations from the allocation of scarce
resources to their highest and most valued uses represent economic waste and a reduction is social
welfare. For an example, see: Thomas Sowell. 2001. “The Mail Monopoly,” available @
www.townhall. com/columnists/thomassowell/printts20010705. Sowell discusses how the Postal
Service is a protected entity and does not have to worry about competition, and therefore does not
have to cater to its customers. His point is:

When the post office’s copier takes business away from a local copier shop, it
also takes taxes away from the local government. More important, the economy’s
resources do not flow to the most efficient user but to the operation with the most
privileges.

Monopoly means inefficiency and a money-losing monopoly means even more

inefficiency.

It is rare that a change in one economic variable does not affect the behaviors of market
participants. Mankiw uses an example of an increase in the price of apples resulting in an increase
in purchases of other alternative fruit (pears) to make this point. Also, note Mankiw’s example of
seat belts….people feel safer….so they speed more, resulting in even more accidents, but fewer
deaths. More accidents are the ‘unintended consequences’ of government imposed mandatory
seat belt laws.

Principle # 5: Trade Can Make Everyone Better Off – [Increases in Real Income Are Dependent Upon
Increases in Real Output] – It makes sense to substitute the broader term, ‘exchange’ for ‘trade’
in Mankiw’s statement. Such a substitution permits a fuller understanding of the concept by
introducing the ideas of two ‘Classical economists’: Adam Smith and David Ricardo. When
considering Adam Smith’s contributions it is essential to note two major ideas: (i) the ‘division of
labor’ and (ii) the ‘invisible hand’ that is the free market. First, consider the ‘origin of the
‘division of labor’:
 This division of work is not however the effect of any human policy, but is the
necessary consequence of a natural disposition altogether particular to man, viz
[Latin, videlicet – that is to say, namely] the disposition to truck, barter, and
exchange; and as this disposition is peculiar to man, so is the consequences
of it, the division of work betwixt different persons acting in concert….Man
continually standing in need of the assistance of others, must fall upon some
means to procure their help. This he does not merely by coaxing and courting;
he does not expect it unless he can turn it to your advantage or make it appear
to be so. Mere love is not sufficient for it, till he applies in some way to your self-
love. A bargain does this in the easiest manner. When you apply to a brewer or
butcher for beer or beef, you do not explain to him your interest to allow you to
have them for a certain price. You do not address his humanity, but his selflove….
This disposition to truck, barter, and exchange does not only give occasion to the
diversity of employment, but also makes it useful. [Smith, Lectures on
Jurisprudence, 347-8, as quoted by Robert L. Formaini in “Adam Smith –
Capitalism’s Prophet,” Economic Insights, Vol. 7, No. 1; available @
www.dallasfed.org/research/ei/ei0201. Emphasis added.

Smith’s famous remark about the ‘invisible hand’ guiding the market may also be usefully
considered here:

…By pursuing his own interest he frequently promotes that of society more
effectually than when he really intends to promote it. I have never known
much good done by those who affected to trade for the public good. It is an
affectation, indeed, not very common among merchants, and very few words
need be employed in dissuading them from it. (1981. The Wealth of Nations,
I, 456, emphasis added)

For more, see: Robert L. Formaini. “Adam Smith – Capitalism’s Prophet,” Economic Insights,
Vol. 7, No. 1; available @ www.dallasfed.org/ research/ei/ei 0201. The voluntary (free)
exchange between individuals and between nations makes at least one party better off, without
making the other party any worse off, or the voluntary exchange would not take place. Ricardo
argues that individuals and nations should focus their productive efforts (land, labor, capital and
entrepreneurial talents) on doing the things they do best (in which they have a ‘comparative
advantage’.) For more, see: Robert L. Formaini. “David Ricardo – Theory of Free International
Trade,” Economic Insights, Vol. 9, No. 2; available @ www.dallasfed.org/research/ei/ei04012.
If the exchanges are truly voluntary, the mere existence of exchange indicates that the individual
parties and, by extension, society is better off. Additional insights are to be found in Dwight R.
Lee. “Economic Protectionism,” Economic Insights, Vol. 6, No. 2; @ www.
dallasfed.org/research/ei/ei04012. This paper is a must read for anyone who want to understand
the basic principles of economics and wants to be inoculated against the pathogenic views of
politicians and mainstream journalists. Perhaps one of the most telling ideas is the conflict
between production and consumption, between the interests of producers and the interests of
consumers. Lee writes:

To some degree, a strong emphasis on productions is justified….Few things are

more destructive than concentrating on grandiose redistribution [Robin Hood
economics] schemes with no thought to their negative effect on incentives to
produce [“that which is seen and that which is unseen”]. The supply-side move-
ment focuses attention on the distorting impact of high marginal tax rates have
on production decisions. Lower marginal tax rates reduce the difference between
 what consumers pay and what producers receive and make producers more respon-
sive to consumer demands.

Unfortunately, political decisions aimed at promoting production typically make

producers less responsive to consumers. Instead of seeing production as the means
of serving consumer interests, producers’ interests are treated as ends in them-
selves. The result is a reduction in the value of what is produced, which is, since
we are all consumers, a sure prescription for making most people worse off.
[emphasis added]

Principle # 6: Markets Are Usually a Good Way to Organize Economic Activity – [The Four Sources of
Income Growth Are: (a) Improvements in Worker Skills; (b) Capital Formation; (c)
Technological Advancements; and (d) Better Economic Organization] – This calls attention to
the three main ways that societies have organized themselves to produce goods and services
efficiently. First, is ‘subsistence economies’ – usually characteristic of pre-industrial societies,
where one eats what one produces and there is little division of labor, save along gender lines. In
such societies, per capita output is low as is the standards of living. The benefits and costs of
such social arrangements have been discussed in James M. Buchanan’s small book: Market as a
Guarantor of Liberty, The Shaftesbury Papers. Hants, England: Edward Elgar, 1993. The second
form is capitalism, a system in which private property, well enforced property rights and
specialization of task are well-developed. Under such a social system surplus production
accompanies the division of labor permitting a higher level of per capita output and level of
earnings, as well as a higher standard of living. [The role of specialization of task and increased
levels of worker productivity is to be seen in Adam Smith’s justifiably famous ‘pin factory’
example, according to Rima, Adam Smith:

…calculates that division of labor makes it possible for ten workers to

produce 48,000 pins per day, so that each worker produces the equivalent
of 4,800. Without division of labor, a worker might not even make one pin
in a day, and certainly not 20. (I.H. Rima. 1971. Development of Economic
Analysis. Haywood, IL: Richard D. Irwin, Inc, 68.)]

The third mode of economic organization is communism (or socialism). Under such a system
private property rights do not exist, or are strictly limited to personal effects. The factors of
production are all directly under the control of the government and are allocated to the uses
decided upon by government decision-makers (or bureaucrats), including production and
consumption. The ‘collectivization of the factors of production’ by the state eliminates the
incentives for individuals to produce and to excel.

The issue of modern capitalism and its benefits have been addressed in a series of articles
(extracted from a book, Investor’s Business Daily Guide to the Markets) published several years
ago – “The Hallmarks of Modern Capitalism,” “America, And the Entrepreneur, Ascendant,”
and “Capitalism’s ‘Miracle Period’ After WW II.”) The author(s) point out the obvious:

If capitalism has many forms, what makes the modern variety different?

For one thing, property rights are now a bedrock of our existence. In no other
system are the rights of the individual so carefully guarded.

Such a system presumes the individual will use his role as property owner to
 beneficial ends, [remember Adam Smith’s comments on ‘self-interest’ and a
‘public good’?] that in pursuing his own self-interest through profit, the
greater interest of society will be served. [emphasis added]

Contrary to what critics of capitalism say, the placement of property in private

hands requires the owner to be a good steward, not a despoiler.

It’s no coincidence, for example, that the worst ecological crisis wrought
during the industrial age came in the former nations of the East Bloc and in
the Third World, where property rights are weakest. [emphasis added]

Markets, ultimately, are a kind of democracy. One person sells, another buys
at a mutually agreed-upon price. Markets rarely discriminate – efficient markets
never do – except on price. When two parties strike a deal, it tangibly demon-
strates that both are better off, or neither would have wasted the time or effort.
[emphasis added]

Somewhat later, the author(s) add:

In today’s world, the most ‘advanced’ capitalist nations are also the wealthiest….

These countries have had the most success not only in creating wealth, but also
in getting that wealth into the most hands…. [emphasis added]

More importantly, they quote Angus Maddison’s book, Dynamic Forces in Capitalist
Development:

Since 1820, the total product of the advanced capitalist group [Britain, the
United States, Australia, Austria, Belgium, Canada, Denmark, Finland,
France, Germany, Italy, Japan, the Netherlands, Norway, Sweden and Switzer-
land] has increased 70-fold, population nearly 5-fold, and per capita product
14-fold. Annual working hours have been cut in half and life expectancy has
doubled.

These 17 decades constitute the capitalist epoch, for the pace of advance in
peacetime has virtually always been a huge multiple of that in earlier centuries….

The output of the average worker today increases more during the short span of
a career than during the entire 1,000 years of the Middle Ages.

The basic reason for this productivity miracle is investment…. [emphasis in

original]

Investments are made for improving one’s lot-in-life (betterment, self-interest) which may be
accomplished through the quest for profits. Many of those who invested in the growth of this
country (the Goulds, Vanderbilts, Rockefellers, Morgans, and Carnegies) and increased the
nation’s physical capital, infrastructure and output have been vilified as ‘Robber Barons,’
implying that they succeeded by stealing wealth, not creating it. In fact, they were responsible
for building the nation’s industrial infrastructure, partly with foreign money (investment). For an
informative perspective on this issue, see ‘The Maestro’, Alan Greenspan (1961), “Antitrust,”
paper given at the Antitrust Seminar of the National Association of Business Economics,
September [the paper has been printed in Ayn Rand’s Capitalism: The Unknown Ideal (1967),
63-71]. Greenspan’s ‘key comments’ follow:

The world of antitrust is reminiscent of Alice’s Wonderland: everything seemingly

is, yet apparently isn’t, simultaneously. It is a world in which competition is lauded
as the basic axiom and guiding principle, yet ‘too much’ competition is condemned as
‘cutthroat.’ It is a world in which actions designed to limit competition are branded as
criminal when taken by businessmen, yet praised as ‘enlightened’ when initiated by the
government. (63)

To understand these comments, it must be remembered that “All production is for consumption,”
as Ludwig von Mises was so fond of reminding us! His simple comment is a reminder that the
satisfaction of the consumer’s is THE heart of economic activity, that the consumer comes first,
not the producer – all of this was well-known to ‘classical’ and ‘neo-classical economists,’ but
was ignored in a most irresponsible way during the Keynesian era. Greenspan proceeds to assess
the origin of antitrust laws and policies:

Americans have always feared the concentration of arbitrary power in the hands of
politicians. Prior to the Civil War, few attributed such power to businessmen. It was
recognized that government officials had the legal power to compel obedience by
the use of physical force – and that the businessman had no such power. A business-
man needed customers. He had to appeal to their self interest. (Emphasis added)

This appraisal of the issue changed radiply in the immediate aftermath of the Civil
War, particularly with the coming of the railroad age. …to the farmers of the West,
the railroads seemed to hold the arbitrary power previously ascribed solely to the
government The railroads seemed unhampered by the laws of competition. They
seemed able to charge rates calculated to keep farmers in seed grain – no higher,
no lower. The farmers’ protest took the form of the National Grange movement, the
organization responsible for the passing of the Interstate Commerce Act of 1887.
(63-4)

The industrial giants, such as Rockefeller’s Standard Oil Trust, which were rising
during this period, were also alleged to be immune from competition, from the laws
of supply and demand. The public reaction against the trusts culminated in the
Sherman Antitrust Act of 1890. (64, emphasis added)

This should sound familiar – the same nonsense is heard or read daily in regard to gasoline
prices – and the pandering politicians’ demand for ‘wind-fall profits’ taxes and ‘price-controls’.
Even a simpleton can recognize that the government has a ‘monopoly’ on the use of coercion on
its citizens … no businessperson has such power to ‘force’ consumers to buy from him/her.
Greenspan continues to unravel the origins of Alice’s (or, is it really, Orwell’s) world:

It was claimed then – as it is still claimed today – that business, if left free, would
necessarily develop into an institution vested with arbitrary power. Is this assertion
valid? …. Or did the government remain the source of such power, with business
merely providing a new avenue through which it could be exercised? (64, emphasis
added)

The railroads developed in the East, prior to the Civil War, in stiff competition with
one another as well as with the older forms of transportation – barges, riverboats, and
wagons. By the 1860’s there arose a political clamor demanding that railroads move
west and tie California to the nation: national prestige was held to be at stake. But the
 traffic volume outside the of the populous East was insufficient to draw commercial
transportation westward. The potential profit did not warrant the heavy investment in
transportation facilities. In the name of ‘public policy’ it was, therefore, decided to
subsidize the railroads in their move to the West. (64, emphasis added)

This should all sound vaguely familiar, especially in connection with the issue of ‘alternative’
and ‘biofuels’ today – especially for ethanol. Adding a $ 15.00 quart of ethanol to $ 3.00 a
gallon of gasoline only makes sense when the government mandates it and provides tax
incentives (higher taxes for tax payers) to pay for it! Then too, Archer Daniels Midland (ADM)
[a company that was the subject of the largest price-fixing investigation ever, over lysine] has
the lion’s share of the market and corn farmers in the mid-West appreciate the increase in market
demand for their grain! All the while peasants in Mexico riot over higher prices for tortillas, and
Americans pay higher and higher prices for animal products, including meat, cheese, milk and
eggs!

ADM, the self-styled “Supermarket to the World” is a sponsor “The Jim Lehrer Hour” on PBS (a
government sponsored network supported by coerced taxes extracted from all citizens’ income).
There have been no specials on PBS investigating ADM, nor reporting on the economic
consequences of its past and current business practices. The following sources should be
consulted to verify my assertions:

Common Cause. 1995. “The Ethanol Switch – A Story of Corporate Welfare,”

www.ccsi.com~comcause/news/corwel.html#THE%20ETHANOL%20SWITCH.

John M. Connor of Agricultural Economics at Purdue University has written:

“Both Archer Daniels Midland structure and corporate practices favored the
implementation of the largest price-fixing conspiracy seen in modern times.” In:
Archer Daniels Midland: Price Fixer to the World. http://ideas.repec.org/p/wop

Wikipedia has the following entry on ADM and its price-fixing scheme for lysine
and citric acid under the subheading: “Critiques of ADM Practices”:

ADM is also the recipient of federal agribusiness subsidies. According to

Libertarian think tank the Cato Institute, “ADM has cost the American economy
billions of dollars since 1980 and has indirectly cost the Americans tens of billions
of dollars in higher prices and higher taxes over the same period. At least 43 percent
of ADM’s annual profits are from products heavily subsidized of protected by the
American government. Moreover, every $ 1 of profits earned (?) by ADM’s corn
sweetner operation costs consumers $ 10, and every $ 1 of profit earned (?) by its
ethanol operation costs taxpayers $30.” @ http://en.wikipedia.org/wiki/Archer_
Daniels_Midland (Emphasis added)

1996 – largest price-fixing investigation;

1999 -- three top official, including Michael Andreas, Executive Vice
President,
were sentenced to prison;
2003 –sued for patent infringements, June 09;
2005 – ADM settles class action antitrust lawsuit for $ 400 million (see:
ADM’s
2005 Annual Report (note 15, p. 52)

HOW SWEET IT IS!

Now, back to Alan Greenspan’s commentary on ‘Antitrust,’

Between 1863 and 1867, close to one hundred million acres of public lands were
granted to the railroads. Since these grants were made to individual roads, no
competing railroad could vie for traffic in the same area in the West [creation of a
monopoly]. Meanwhile, the alternative forms of competition (wagons, riverboats,
etc.) could not afford to challenge the railroads in the West. Thus, with the aid of
the federal government, a segment of the railroad industry was able to ‘break free’
from the competitive bounds which had prevailed in the East.

As might be expected, the subsidies attracted the kind of promoters who always
exist on the fringe of the business community and who are constantly seeking an
‘easy deal.’ Many of the new western railroads were shabbily built: they were not
constructed to carry traffic, but to acquire land. (64)

The western railroads were true monopolies in the textbook sense of the word. They
could and did behave with an aura of arbitrary power. But the power was not derived
from a free market. It stemmed from government subsidies and government
restrictions. (65)

When, ultimately, western traffic increased to levels which could support other profit-
making transportation carriers, the railroads’ monopolistic power was undercut….

In the meantime, however, an ominous turning point had taken place in our economic
history: the Interstate Commerce Act of 1887.

That Act was not necessitated by the ‘evils’ of the free market. Like subsequent
legislation controlling business, the Act was an attempt to remedy the economic
distortions which prior government interventions had created, but which were
blamed on the free market. (65, emphasis added)

There you have it – once the camel’s (government’s) nose is under the tent, you have a guest in
your accommodations for life. Extend the example: Social Security, CAFÉ Standards, trade
restrictions, acreage/poundage allotments – and you’ll find similar results (distortions) from
government intervention in the markets.

The second installment of the IBD’s series (“America, And The Entrepreneur, Ascendant”)
reports:

From 1890 to 1913, America’s capital stock grew at an average rate of 5.4% a
year – about 60% higher than the average for other major capitalist countries.

Relatively less was invested in the following decades….

The United States also seemed to be the home of an unusual number of

geniuses – people like Thomas Edison and Alexander Graham Bell, who
found ready markets in the U.S. for their ideas.

The vast economies of scale that America’s markets provided were not lost
on U.S. corporations

The primary reason for U.S. dominance, however, can be summed up in one,
 Ironically foreign, word: entrepreneur. Derived from the French for ‘undertake,’
it refers to the individual who drives the economy by organizing and managing
business ventures, and assumes risks for the sake of profit. [emphasis added]

Remember the first key element formulated by Gwartney and Stroup: “Incentives Matter”? Well,
profits is not a dirty word, in fact, profits provide incentives for entrepreneurs to ‘drive the
economy’ and to ‘bear risk’!

It was not a French, but an Austrian economist who first gave the entrepreneur
his due. Previous commentators on capitalism had focused on the accumulation
of capital, laissez-faire trade policies or technological change as the reasons for
capitalism’s success.

Joseph Schumpeter was different. He saw capitalism as a dynamic system beset

by periodic crises he termed ‘waves of creative destruction.’ A crisis, he believed,
led to new opportunities as much as it destroyed something old…. [emphasis
added]

The entrepreneur, he asserted, is the rarest of commodities: an able risk taker.

For a more comprehensive view of Schumpeter and his contributions to economics, see: W.
Michael Cox. Schumpeter – In His Own Words,” Economic Insights, Vol. 6, No. 3; available @
www.dallasfed.org/ research/ei/ei0103.

Principle # 7: Governments Can Sometimes [?] Improve Market Outcomes [emphasis added] –
[Income is
Compensation Derived From the Provision of Services to Others. People Earn Income by
Helping Others] – Provides economic justifications for the public provision of certain ‘essential’
goods and services (police). The primary explanation is that at times ‘markets fail’ [Adam
Smith’s ‘invisible hand’ doesn’t seem to work in certain situations] due to the nature of the
production processes (need for very large-scale production units to attain both economic and
technological efficiencies); so-called ‘externalities’ (pollution, health risks); or ‘fairness’ in the
distribution of either income or wealth (the fruits of the production process).

A good place to find some answers to the issue of so-called ‘market failure’ is in the works of
James M. Buchanan … it would be helpful to read: Robert L. Formaini. “James M. Buchanan –
The Creation of Public Choice Theory,” Economic Insights, Vol. 8, No. 2; available @
www.dallasfed. orf/research/ei/ei0302. Formaini has noted:

At first glance, public choice theory seems to be nothing more than common sense:
Governments are collections of individuals whose interaction is determined by the
same self-interest that motivates people in the private sector….

…As many economists came to doubt the efficiency of large, state-funded programs,
they saw public choice theory as a way to examine what has come to be known
as government failure. For decades following Arthur Cecil Pigou’s famous book
The Economics of Welfare, economists saw government as a disinterested agency
that could correct for market failure. Buchanan and other public choice theorists
altered the debate by proposing that government may not really correct problems
in the marketplace because of the wealth trading, or rent seeking, that occurs
 during the legislative process.

Interestingly, Pigou’s ideas figure strongly in the formulation of Ronald Coase’s ‘transaction
cost’ approach to economic analysis. [See: Robert L. Formaini and Thomas F. Siems. “Ronald
Coase – The Nature of Firms and Their Costs,” Economic Insights, Vol. 8, No. 3; available at:
www.dallasfed.org/research/ei/ei0303.html.] Coase’s arguments against the ‘Pigouvian’ position
are best developed in: Ronald H. Coase. 1960. “The Problem of Social Cost,” Journal of Law
and Economics; earlier intimations are to be found in his 1937 article, “The Nature of the Firm,”
Economica, Vol. 4 (November), 386-405.

It is well to re-consider the observations of Alan Greenspan in the paper he presented at the
National Association of Business Economists in 1961. His discussion provides insights into the
consequences of governmental policies (“things unseen” to use Bastiat’s terms). The
implications of the contrast between the entrepreneur and the bureaucrat is unnerving –
bureaucrats are portrayed in popular and most academic circles as omniscient, dedicated public
servants, while businessmen (with their own money at risk) are not only short-sighted, but
greedy (self-interested) and tend to behave illegally, if not carefully overseen by government
regulators! But, please keep James M. Buchanan’s ideas in mind: bureaucrats behave in their
own self-interest and frequently respond to the ‘rent-seeking’ behaviors of special interest (aka
‘political pressure’) groups, often placing these interests above the interests of the rest of
society. Greenspan then reviews the origins of the Interstate Commerce Act (1887) and the
Sherman Act (1890).

All of this should encourage skepticism regarding Mankiw’s idea that: Markets Are Usually a
Good Way to Organize Economic Activity [Principle # 6]. Perhaps ‘free-markets’ are a better
way of getting things done, since they harness, explicitly and legally, individual self-interest in
serving the needs and wants of others through the provision of positive incentives (rents, wages
and salaries, interest and dividends, AND profits.

For a brief comparison of the issue of provision of goods and services by the ‘free market’ and
by the ‘government,’ see: Hugh Macaulay. 1999. “Can Government Deliver the Goods?” The
Freeman: Ideas in Liberty (January); available @: www.fee.org/vnews.php?nid=4220.

Principle # 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services
– [Profits Direct Businesses Toward Activities That Increase Wealth] – Identifies the nexus
between/among ‘production,’ ‘wealth creation,’ and a region’s ‘standard of living.’ Perhaps one
of the most illuminating sources for a deeper understanding of these issues, particularly in Africa
and South Asia, as well as other regions of developed countries, may be found in the writings of
Sir Peter Bauer (1915-2002), especially a brief article in a hard to find German economics
journal: “The Vicious Circle of Poverty.” Much of the material from the article may be found in
chapters with the same title in several of his books. On his death in 2002, Thomas Sowell wrote
a tribute to Bauer, it is worth a quick read, just to discover his key ideas
[www.townhall.com/columnists/thomassowell/20020510] Other tributes to Sir Peter are: Paul
Craig Roberts, “Peter Bauer: A Dissenter on Development,” www.vdare.com/roberts/bauer;
Peter Brimelow, “In Memoriam: Peter, Lord Bauer,” www.dare.com/pb/bauer_memorium; and
Razeen Sally, “Aid, Trade, Development: The Bauer Legacy,”
www.lse.ac.uk/collections/globalDimensions/ research/aid....

Several of Sowell’s comments regarding Sir Peter Bauer and these issue are:

The dominant orthodoxy in developmental economics was that Third World

countries were trapped in a vicious cycle of poverty that could be broken only
by massive foreign aid from the more prosperous industrial nations of the
world… [emphasis added]

Peter Bauer never bought any part of this vision. He had too much respect for
people in the Third World, where he had lived for years, to think of them as
helpless. ‘Before 1886,’ he pointed out, ‘there was not one cocoa tree in British
West Africa. By the 1930s there were millions of acres under cocoa there, all
owned and operated by Africans.’

Developmental economics’ hostility to the market and ‘contempt for ordinary

people’ were to Bauer ‘only two sides of the same coin.’ [emphasis added]

If poverty was a trap from which there was no escape, Bauer declared, we would
all still be living in the Stone Age, since all countries were once as poor as Third
World nations are today.

Peter Bauer considered it arbitrary and self-serving to call international transfers

of money [wealth] to Third World governments ‘foreign aid.’ Whether it was aid
or a hindrance was an empirical question. Sometimes it could turn out to be simply
‘transferring money from poor people in rich countries to rich people in poor countries.’
[emphasis added]

Bauer likewise rejected ‘overpopulation’ as a cause of Third World poverty, even

though that was also one of the key dogmas of developmental economics. [emphasis
added]

Finally,

The later research of Hernando de Soto, published in his book ‘The Mystery
of Capital,’ added still more evidence that supported Peter Bauer’s thesis that
Third World people were capable of creating wealth, even if their governments
followed economically counterproductive policies that held them back.

For decades on end, Peter Bauer stood virtually alone in opposing the prevailing
dogmas of developmental economics.

Perhaps a most telling observation about Sir Peter Bauer has been made by Paul Craig Roberts.
He has written:
One of the chilling facts about the 20 th century West is how poorly champions
of individual liberty have fared in free societies. They seldom receive state
honors. Rarely are they celebrated in academia or the media.

One of the 20th century’s great economists, Ludwig von Mises, a refugee from
Hitler, could not get a university appointment in America. Mises said that
government was the problem, not the solution, and outraged progressives, who
were committed to the welfare state, ostracized him. F.A. Hayek was disparaged
for many years for his warnings against big government, as was Milton
 Friedman.

There have been no prizes for those whose work advanced liberty. Neither are
there Ford, Rockefeller, or Carnegie Foundation grants nor Mac Arthur
Foundation ‘genius’ grants. Progressive prejudice has been such that no one
who advances liberty could possibly be seen as a genius. The liberal-socialist
establishment has worked to shut such people up.

For decades Lord Bauer stood alone in opposition to the view that only planning
and foreign aid could produce economic development in poor third world
countries.

He watched marketing boards destroy a flourishing peasant agriculture keyed to

exports, forcing the peasants back into subsistence farming….

Bauer’s dissent on development was based on his realization of the importance of

traders in moving an economy from subsistence to exchange. This critical activity
of traders was curtailed by the regulations imposed by development planning.

Ironically, according to Bauer’s research:

With planning and aid came poverty and war. Foreign aid, Bauer noted, made
control of the government a life-and-death matter, causing genocidal warfare
between tribes…. [emphasis added]

Even more telling are the observations of Peter Brimelow:

…, Bauer had two problems as an economist. Firstly, in the mysterious

way that these things happen, he chose to get interested in free market
economics at a time when it was utterly and completely out of fashion –
…portrait of Cambridge (U.K.) in the early 1950s, with economics
discourse controlled by the self-styled ‘secret seminar’ orchestrated by
left-wing Keynesians led by Richard Kahn and Joan Robinson….

Bauer’s second problem – in some ways even more serious, it may have
cost him the Nobel Prize – was that he preferred words to numbers and
arguments to equations….

Most economists since Adam Smith and David Ricardo have understood the connection between
production, exchange, wealth creation and rising standards of living (individual and national) are
attained by serving the needs of others, while pursuing your own self-interest. Please remember
Adam Smith’s comment on the pursuit of self-interest:

By pursuing his own interest he frequently promotes that of the society

more effectually than when he really intends to promote it. I have never
known much good done by those who affected to trade for the public
good……

Few have put it better, none more succinctly.

Principle # 9: Prices Rise When the Government Prints Too Much Money – [The ‘Invisible Hand’
Principle -- Market Prices Bring Personal Self-Interest and General Welfare Into
Harmony] – Such actions by thegovernment are meant to have a(n) ameliorative effect(s)
 on certain economic variables, but all too often, there are ‘unintended consequences’
(read ‘inflation’). Inflation has been described as ‘Too many dollars chasing to few
goods,” resulting rising price levels. To understand one of the effects of ‘too much
money’, ‘inflation’, and ‘contemporary issues’, see: Walter E. Williams. 2005. “Gasoline
Prices,” @ www.townhall.com/columnists/ walter williams/ww20050831. Most
economists recognize the harmful effects of inflation, many recall the ‘good-ol’-days’ of
the late 1970’s (President Jimmy Carter) and the days of the first Reagan administration
when inflation rates were high …. To verify this statement, go to:

www.bls.gov
↓
in the left hand corner, click on:
“Inflation $ Consumer Spending”
↓
CPI and Inflation Calculator
↓
“Tables Created by BLS”
↓
[First Table]
“Table Containing History of CPI”

In this table, look at the last column on the right, per cent change year on year and read down to
the period 1970 to 1990. Note that in 1971 the annual CPI rate (inflation rate) was 3.3%. After
1973 [the first, so-called ‘energy crisis’ began in October of that year], the rate rose to 12.3% in
1974 and remained higher than the average for the previous decade. The second, so-called
‘energy crisis’ began in 1979 [remember the seizure of the U.S. Embassy in Tehran and Iranian
Hostage Crisis under Jimmie Carter, which lasted for 444 days? (November 4, 1979 – January
20, 1981)] when the CPI reached 13.3% and in 1980 was still high at 12.5%, only falling to
8.9% in 1981. (Could it have been the election of Ronald Reagan as President that ‘encouraged’
the Iranians to free the hostages ONLY a few minutes BEFORE he was sworn in as President?)
It then fell to 3.8% in 1982, and has continued to be low to the present day.

Despite the acknowledgement by Milton Friedman, that “always and everywhere,” ‘inflation is a
monetary phenomenon,’ myths about inflation abound. In an essay, “Ten Great Economic
Myths,” in Murry N. Rotherbard’s book, Making Economic Myths,” Auburn, AL: Ludwig von
Mises Institute, 1995, 18-29. Rothbard’s first myth is:

Myth 1: Deficits are the cause of inflation; deficits have nothing to do with inflation.

In recent decades we always have had federal deficits. The invariable response
of the party out of power, whichever it may be, is to denounce those deficits as
being the cause of perpetual inflation. And the invariable response of whatever
party is in power has been to claim that deficits have nothing to do with inflation.
Both opposing statements are myths.

Deficits mean that the federal government is spending more than it is taking in in
taxes. Those deficits can be financed in two ways. If they are financed by selling
Treasury bonds to the public, then the deficits are not inflationary. No new money
is created; people and institutions simply draw down their bank deposits to pay for
the bonds, and the Treasury spends that money. Money has simply been transferred
 from the public to the Treasury, and then the money is spent on other members of
the public.

On the other hand, the deficit may be financed by selling bonds to the banking
system If that occurs, the banks create new money by creating new bank deposits
and using them to buy the bonds. The new money, in the form of bank deposits,
is then spent by the Treasury , and thereby enters permanently into the spending
stream of the economy raising prices and causing inflation. By a complex process
the Federal Reserve enables the banks to create the new money by generating bank
reserves….In short, the government and the banking system it controls in effect
‘print’ new money to pay for the federal deficit. (19, emphasis in the original)

Thus, deficits are inflationary to the extent that they are financed by the banking
system; they are not inflationary to the extent they are underwritten by the public.

General price changes are determined by two factors: the supply of, and the demand
for, money. (19-20)

Some economists have argued that ‘inflation’ is a form of ‘tax’ on peoples’ wealth (savings and
investments), eroding the value of their assets over time. This is a cruel joke to play on people
‘saving for their retirement’. A wonderful example of this view may be found in a brief article
by Llewelln H. Rockwell, Jr., 2005. “Bush’s Ten Worst Economic Errors,” The Free Market,
Vol. 23, No. 6 (June), 3-6. In this article, Rockwell considers the single worst economic mistake
that President Bush has made to date, has been his appointment of Ben S. Bernanke as the head
of the Council of Economic Advisors (notice that Bernake is now the Head of the Federal
Reserve), replacing Greg Mankiw. Rockwell wrote:

Number One: The Appointment of Ben S. Bernanke, formerly of the Fed, to be

chairman of the Council of Economic Advisors. Please listen to his words from
a speech given in the context of trying to settle down people’s fears of the
economic future.

‘The US government has a technology, called a printing press (or, today its
electronic equivalent), that allows it to produce as many US dollars as it wishes
at essentially no cost. By increasing the number of US dollars in circulation, or
even by credibly threatening to do so, the US government can also reduce the
value of goods and services, which is equivalent to raising the prices in dollars
of those goods and services. We conclude that, under a paper-money system, a
determined government can always generate higher spending and hence positive
inflation.”

Having caught his breathe, Rockwell continues, sarcastically:

Well, these comments certainly do calm fears that deflation is in our future. But
what he seems incredibly sanguine about is the effects of inflation. Already,
inflation amounts to a daily robbery of the American consumer. Even in these
supposedly low inflation times, price indexes have doubled since 1980. What
this means is that one dollar in 1980 purchases only 50 cents worth of goods and
services today. There are no long lines at gas stations and we aren’t panicked for
our future, but we are still being robbed, only more slowly and more subtly than
in the past.

The Bernanke appointment is … the most egregious decision that the Bush adminis-
 tration has made.

An inflationist Keynesian and an aggressive advocate of printing-press economics,

Bernanke is the sort of crank who becomes famous in history for having destroyed
whole countries. He is utterly and completely dedicated to the idea that paper money
will save the world, with no downside. I shudder for our future if he becomes head of
the Fed. Yet this appointment is probably a pathway to Greenspan’s job, as it was for
Greenspan himself. (6, emphasis in the original)

Principle # 10: Society Faces a Short-Run Tradeoff between Inflation and Unemployment –
[Too
Often Long-Term Consequences or Secondary Effects of an Action are Ignored] -- It’s
important to note upfront that government has a monopoly on ‘money creation’, but has
no power to create jobs, that is a function of the ‘private sector’. While some economists
believe in this relationship, known as the so-called ‘Phillips curve,’ many economists
have called it into question. Murray Rothbard, for example, considers it to be one of the
“Ten Great Economic Myths,” having written:

Myth 6: There is a tradeoff between unemployment and inflation.

Every time someone calls for the government to abandon its inflationary policies,
establishment economists and politicians warn that the result can only be severe
unemployment. We are trapped, therefore, into playing off inflation against high
unemployment, and become persuaded that we must therefore accept some of both.

The doctrine is the fallback position for Keynesians. Originally, the Keynesians
promised us that by manipulating and fine-tuning deficits and government spending,
they could and would bring us permanent prosperity and full employment
without inflation. Then, when inflation became chronic and ever-greater, they
changed their tune to warn of the alleged tradeoff, so as to weaken any possible
pressure upon the government to stop its inflationary creation of new money. (24)

The tradeoff doctrine is based on the alleged ‘Phillips curve,’ a curve invented
many years ago by the British economist A.W. Phillips. Phillips correlated [In
statistics it has been long know that correlation is not causation.] wage
rate increases with unemployment, and claimed that the two move inversely: the
higher the increases in wage rates, the lower the unemployment. On its face, this
is a peculiar doctrine, since it flies in the face of logical, commonsense theory.
Theory tells us that the higher the wage rates, the greater the unemployment,
and vice versa. If everyone went to their employer tomorrow and insisted on
double or triple the wage rate, many of us would be promptly out of a job.
Yet this bizarre finding was accepted as gospel by the Keynesian economic
establishment. (24-5, emphasis in original, material in brackets added)

By now, it should be clear that this statistical finding violates the facts as well
as logical theory. For during the 1959s, inflation was only about one to two
percent per year, and unemployment hovered around three or four percent, whereas
later unemployment ranged between eight and 11%, and inflation between five and
13%. In the last two or three decades, in short, both inflation and unemployment
have increased sharply and severely. If anything, we have had a reverse Phillips
curve. There has been anything but an inflation-unemployment tradeoff.

But ideologues seldom give way to the facts, even as they continuously claim to
‘test’ their theories by Facts. To save the concept, they have simply concluded
 that the Phillips curve still remains as an inflation-unemployment tradeoff, except
that the curve has unaccountably ‘shifted’ to a new set of alleged tradeoffs. On
this sort of mind-set, of course, no one could ever refute any theory.
In fact, current inflation, even if it reduces unemployment in the short-run by
inducing prices to spurt ahead of wage rates (thereby reducing real wage rates),
will only create more unemployment in the long run. Eventually, wage rates catch
up with inflation, and inflation brings recession and unemployment inevitably in
its wake. After more than two decades of inflation, we are now living in that
“long run.”

There are several major points to consider in Murray Rothbard’s discussion of the Keynesian
adherence to the so-called Phillips curve: (i) an unwillingness on the part of Phillips curve
advocates to adhere to the standards of the Baconian Scientific Method [subject their theory to
the rigors of empirical testing]; and (ii) once the theory has been demonstrated to be defective to
reject it and seek a new theory. [Remember the points made by Michael Crichton in his Michelin
Speech, “Aliens Cause Global Warming”?]

The French economist, Frédéric Bastiat, wrote as a precaution:

There is only one difference between a bad economist and a good one: The bad
economist confines himself to the visible effects, the good economist takes into
account both the effect that can be seen and those effects that must be foreseen.

Walter Williams uses the writings of Bastiat to refute the silly notions regarding the potential
economic outcomes (benefits) of 9/11 – job creation associated with public and private
expenditures ‘rebuilding’ the damage. He employs Bastiat’s well-known, but often forgotten,
idea of the ‘broken window fallacy’ [a child throws a rock through a shopkeepers window,
which then has to be replaced, creating work and income for the glazer (that which is seen)]. But
this is not the whole of it, since it fails to take into account what the shopkeeper might have done
with this money, it alternative use (that which is unseen), say the purchase of a new jacket.]
There is in fact a reorientation of spending and income earning away from the tailor and to the
glazer. Williams concludes: “Property destruction always lowers the wealth of a nation.”

For other examples of the ‘free lunch’ mythology (ignoring the ‘Law of Scarcity), the
significance of government intervention (“I’m from the government and I’m here to help you”)
and their applications to contemporary issues, see the following:

Thomas Sowell. 2001. “Electricity Shocks California,” @ www.townhall. com/

columnists/thomassowell/printts20010111.

Thomas Sowell. 2001. “Property Rites,” @ www.townhall.com/columnists/

thomassowell/prints20010809.

Thomas Sowell. 2002. “An Ancient Fallacy,” @ www.townhall.com/columnists/

thomassowell/printts20020527.

Walter E. Williams. 2004. “Minimum Gasoline Prices,” @ www.townhall.com/

columnists/walterwilliams/printww20040331.
Sowell, in “Electricity Shocks in California,” points out the role of government, through the use
of price controls, in creating shortages and then seeking to shift the blame onto the private
sector. Notice what Sowell writes,

In the never-never land of California ideology, it is considered terrible if the public

should have to pay the full cost of what it wants.

In California, prices higher than you like are attributed to ‘greed’ or ‘price gouging’
and the answer is either more government regulation or having the government take
over the utility company completely and run it….

But just as there is no free lunch, there is no free electricity. And the idea that the
government can run businesses at lower costs flies in the face of worldwide evidence
that whatever enterprise politicians and bureaucrats run has higher costs.

Far from lowering the cost of producing electricity, government at all levels has for
many years and in many ways been needlessly increasing that cost. (emphasis added)

He concludes with:

But if we are too squeamish to build a dam and inconvenience some fish or reptiles,
too aesthetically delicate to permit drilling for oil out in the boondocks and too
paranoid to allow nuclear power plants to be built, then we should not be surprised
if there is not enough electricity to supply our homes and support a growing economy.

Mankiw in his ‘Introductory’ text, provides an interesting example of a social tradeoff that needs
careful consideration: a tradeoff between efficiency and equity. Notice Mankiw’s definition of
terms: efficiency – the property of getting the most it can from its scarce resources;” and,
“equity – the property of distributing economic property fairly among members of society.”
Please note the inherent disconnect between the two terms: ‘efficiency’ is a ‘technological
concept’, while, ‘equity’ refers to some ‘moral standard’. ‘Efficiency’ may be measured as an
increase in some quantitative variable (output, costs, price) which serve to raise social welfare
(product), while ‘equity’ is a qualitative term, (defined as “something that is fair or just”), a term
that has as many meanings as there are people observing a process – what’s fair to me, may be
unfair to others (reducing their well-being). Perhaps, as important in understanding these
distinctions, is the decomposition of economics and economic analysis first made by John
Neville Keynes, father of John Maynard Keynes, in his book, The Nature and Scope of Political
Economy. Keynes argued that an individual’s approach to economic analysis may take one of
three approaches: (i) positive analysis; (ii) normative analysis; or (iii) the art of practicing
economic analysis. Positive economics involves the study of economic phenomena as they are
(an empirical approach), while normative economics considers economic phenomena as they
ought to be (implying some ethical judgment, without specifically identifying whose ethical
values are being used as the standard). Further clarification may be found differentiating the
tasks of the economist as: (i) ‘scientist’ (implying positive analysis); and (ii) ‘policy formulator’
or political adviser (employing normative judgments).

The issue of economist as ‘scientist’ necessitates consideration of the Baconian ‘Scientific

Method’ and its application to the advancement of knowledge. For an example of the misuse and
abuse of the ‘Scientific Method’ in an attempt to advance a particular political viewpoint, see:
Michael Crichton, “Caltech Michelin Lecture,” January 11, 2003; available at: www.crichton-
official.com/ speeches/index. All of the other papers on the website are worth reading.
Deliberate misuse of the scientific method is a form of intellectual dishonesty and fraud and is
often employed to advance or justify normative goals.