Economics in Two Lessons: Chapter 2

You criticise Hazlitt for “not bothering to spell out” the “stringent conditions”, under which in an ideal competitive equlibrium, market prices equal opportunity costs. This is unfair. Hazlitt published his book in 1946, but the stringent conditions were first proven by Arrow and Debreu in the 1950s.

Conspiracy of the Epigones!!

The core thought is that prices are about money, but choice is about many things, most of which are not about money and cannot be valued in it.

The basic economic framing is that anything can be valued and that any values can be compared and ordered: this means that all things can be equated with some sums of money of “equivalent” value. Like all economic models, it reveals some truths and conceals others; it’s not entirely true — as I used to say, it’s easier to get some things done with a slab [of beer: 24 cans] than with the price of a slab — but in normal circumstances it’s true enough to be useful.

Peter T @4 made a good start at unraveling the analysis, and the followup @6 went deeper, I think.

“The key idea may therefore be restated in terms of the broader point that it is opportunity cost, rather than just monetary cost, that matters when making economic decisions.” This assumes that economic decisions are consumer choices, where the capitalist seeking greater profit is the same thing as the head of household budgeting the family income. It seems to me that capital investment choices, in which opportunity costs are foregone profits, are the ones that matter most, leaving the relevance of this moot.

“That is, just as the opportunity costs of our choices are determined by market prices, those market prices are determined by our choices.” I suggest that it might be more useful to think that the division of labor in society, rather than consumer sovereignty, is more important. That seeing economics as how consumers determine prices by their rational analysis of opportunity costs, which inputs changes that somehow revise prices to reflect these opportunity costs, provided there are certain ideal conditions met, such as full employment, fundamentally concedes the game to Hazlitt. If Hazlitt rules are correct, then any given level of unemployment can be defined as natural, and the debate ends.

As I see it, the chapter implicitly says this, contradicting its express words.

A. Market-determined prices are the only prices which allow consumers to make fair exchanges that satisfy their opportunity costs. All restrictions on the availability of goods and services limits choice directly, and all interference with prices limits the ability of consumers.

B. All consumers are equally unable to know all prices and all outcomes of choices, which is sufficient for the theory. Though it is physically impossible for them to have equal knowledge, the input from those who do know more should be more influential precisely because they do know more. One cannot pretend a limitation due to the limitations of human cognition and the complexity of nature are market failures, because wanting something different is crying for magic.

C. Price determination by individual actors destroys the equivalence of prices and opportunity costs throughout the system, which is precisely why government interference with the economy is intrinsically wrong. As James Buchanan taught us, the government is just another economic actor, making choices to its benefit. And it is the only agent with the real power to determine prices for a prolonged period of time, because only government can enforce monopoly. The higher prices imposed by a private agency will provide an opportunity for profit by other private agencies, breaking the monopoly.

D. Everyone makes the best possible choices given their preferences. That some people make wiser choices than others is inevitable, impossible for mere social arrangements to prevent. That some therefore receive greater benefit is just, beneficial to society at large.

E. Sellers bear the full opportunity cost of producing the good, and buyers receive the full benefit of consuming it, no more and no less. The obvious solution is to assign property rights so that the market can equilibrate prices and opportunity costs. The implicit acceptance of Hazlitt’s one lesson conceded that only markets do this. The caveat that it is only true sometimes is irrelevant. (This is by the way a problem closely related to pricing for joint production, which so far as I know still lacks a general solution.)

Obviously these are not conclusions the OP concedes.

Adam Smith on the division of labor is seen as optional. It seems to me that if Adam Smith demonstrated anything, it is that division of labor in a society permitted greater production of goods. That the true wealth of nations lay in a functional production system, rather than in money, not even bullion rather than financial instruments. That economics is not about how consumers can make best choices for their consumption, which is home economics, but how the society can best arrange a division of labor to satisfy human wants. Hazlitt and the OP share common ground in seeing economics as home economics writ large.

My opinion only, to be sure.

I cannot read the chapter from this computer.

You could reference last year’s nobel winner Richard Thaler somewhere. He’s known, for among other things, demonstrating that people don’t treat everything as commensurate and evaluated in terms of money. In their minds, people keep track of separate funds for their utility bill, rent, food, etc. They might simultaneously have a savings account and a credit card bill, at a higher interest rate, that they do not pay off each month.

So, empirically, the concept of opportunity costs does not apply universally.

in section 2.2, you write:

“So, the fact that trade takes place is sufficient to conclude that both parties are better off, relative to the alternative of not trading.”

This is an instance of an issue with neoclassical economics (I’m probably misusing the term – I mean a theory of economics that admits no notion of value beyond price) that I find frustrating – its mathematical formulation assumes a utility function with particular properties, but as expressed in this sentence utility is defined in circular fashion as market participants’ choices.

@10

re Chapter 1: It’s a start. Would it be worth noting that households and the internal operations of governments and corporations run on different principles to those of market exchange? Households are ideally communistic (from each according to their ability, to each according to their needs), and internally organisations run on command or hierarchy, not exchange. Economics does not have much to say about either (unless you take Becker seriously).

Note: Participation rate for women in Australia is 60%, for men 70%. Not a large enough difference to say that “most market work is done by men”, and it highlights the double burden.

You say it’s provable that “under the stated conditions (and some additional technical requirements), a competitive equilibrium will arise in which there are no free lunches”. I don’t think you said anything incorrect, but it seems misleading to say that economists have proved conditions under which an equilibrium “will arise”. They have proved conditions under which a competitive equilibrium *exists* – there’s some set of prices such that, if everyone chose optimally under the belief that they can transact as much as they want at these prices, they would actually be able to carry out all their desired transactions. That doesn’t give us any reason to believe this happy state of affairs will come to pass, even if everyone is hyper-rational, there are no externalities, etc.

Since one of the assumptions you list is that (A) everyone can transact as much as they want at the prevailing prices, I guess it is formally correct that under this assumption (and the others), an equilibrium will arise. But although (A) sounds like a description of the environment (which we might judge more or less realistic), it’s not – it’s is an assumption on outcomes, not on primitives. I worry that this way of presenting things suggests that *if* the Econ 101 view of the world was correct (hyper-rationality, no externalities), then a Pareto optimal outcome would arise. Then in order to argue that the world isn’t Pareto optimal, we’d need to argue that there are ‘imperfections’ relative to Econ 101. This cedes too much ground to Hazlitt and his epigones. There certainly are imperfections – but even if there weren’t, there wouldn’t be any reason to predict that a Pareto optimal outcome would arise.

Here are a couple of typos I saw and some thoughts I had reading the sections before but never got round to typing out. First the typos: on page 10 you have an opening quotation mark around perfectly but no closing quotation mark and on page.11 you have ‘. . . economics in its present firm.’ Where I think firm should be form.

Now for the wider points. In the introduction your first question is ‘But why respond to a 70-year old book when new books on economics are published every day?’ and you answer it with ‘It turns out that Economics in One Lesson has been in print continuously since its first publication and has now sold more than a million copies. Readers have embraced the message that all economic problems have a simple answer, and one that matches their own preconceptions.’

Okay but is 1 million copies a lot for that time period and is still widely read? How influential is it really? Is it on many reading lists for economics courses? Is it referenced much by economists, policy makers, pundits etc.? Or is it more that many economists, policy makers. Pundits etc. continue to make the same mistake that Hazlitt did? I think it is the last question that is the important one and you do go on to talk about unemployment and the problems of market failure that Hazlitt and many contemporary economists don’t address. I think a bit of expansion here would be good just to show what kind of policies are being recommended and implemented without sufficient regard for lesson 2 and what it might look like if other policies were considered. You also go on to discuss income distribution and property rights and how what Hazlitt assumes to be natural isn’t. It might be worthwhile to make it explicit that many people still consider the consider system of property rights and income distribution to be natural and to give examples of why it isn’t and the effects this has. I know this will be covered by the sections on lesson 2 but reading the first two chapters I do keep thinking okay Hazlitt was wrong but why does this matter, having some more clear examples in the introduction might help keep this in mind before getting to lesson 2.

In the optional bit of chapter 1 you write ‘In a traditional society, most economic decisions are made on the basis of custom, or of fixed obligations (what Marx and Engels called ‘motley feudal ties’). The central idea of tradition is to do whatever has been done before. In a modern society, we are faced with new choices all the time, regarding how to spend our household income, how to manage the business of production and how to determine public policy.’ I think this has been expanded on from the first draft but I’m not sure what you are trying to argue here. That in pre-modern society people did not face lots of choice so opportunity-cost was not a significant issue? This does not seem right to me, pre-modern societies still had market transactions and people had agency and choice which would incur opportunity costs but the market did have a different role (I’m thinking Polanyi). Also tradition, ties, and reciprocity still have a big influence on choices in modern society. I know you know more than me about this stuff it just strikes me as an odd paragraph.

In fact I think that is something you could mention in chapter 2; if your friend or relative is short of money at the end of the month you might stand them a free lunch and if your positions were reversed in the future you might hope shoe or he would do the same for you. Or if your friend wants your jacket to go out that evening you might lend it out and trust you will get it back in the future. Your friend might feel an obligation to sell you the baseball tickets at face value rather than for a mark-up on the secondary market.

I’ll come back to a point I made briefly @6.

“Price” is the amount of money two people are willing to exchange something for. As such, it supposes that the thing has monetary value. Remove the thing from the market and there is no price – just a cost (both monetary and non-monetary). There is no agreement. So one cannot usually talk of the price of, say, children other than in a metaphorical sense. A great deal of public policy is concerned with the boundary between the market and the non-market, between what can be priced and what can only be costed (note that in monetary terms this will always be comparing an exact and concrete negative against a nebulous and uncertain positive).

This distinction is becoming acute for us all in environmental issues, as it was in social issues in the 19th and 20th centuries. Then it was child labour, the balance between paid work, leisure and retirement, slavery, household work and so on. Now it’s about the withdrawal of large parts of the earth system from the monetary sphere (marine reserves, forests, controls on pollution or agricultural practices). That this is contentious is not because we cannot weigh costs and benefits, but because that withdrawal directly threatens the social order.