Economics in Two Lessons: Chapter 3

by John Quiggin on March 10, 2018

Thanks to everyone who commented on Chapter 2 of my book, Economics in Two Lessons. I’ve learned a lot from the comments but haven’t yet had time to respond to them.

Now here’s the draft of Chapter 3. Again, I welcome comments, criticism and encouragement.

The book so far is available
Table of Contents
Chapter 1
draft of Chapter 2
Feel free to make further comments on these chapters if you wish.



Equalitus 03.10.18 at 7:55 am

There’s a mismatch of importance between inflation level(s) and interest rate(s).

There is no equilibrium or market equilibrium on a macro level. If there is less than 500 people in an autarky then it is equilibrium. We might say that on municipality level in Scandinavia in the 50’s and 60’s there were partial equilibrium.
Meaning that if direct democracy was implemented, how much would distribution of income&wealth change?
Other estimates for measuring level of distribution-competition are welcome. Must be empirically plausible by ultimate and original causality factors.

“The existence of a positive interest rate implies that the opportunity cost
of a given amount of consumption expenditure now is a larger amount in
the future”. — Yes but there might be demand deficit.

“The crucial factor is that in a growing economy, most people expect to
consume more in the future than at present. Conversely, we expect our
unmet needs and desires for consumption expenditure to be more
pressing now than in the future” — Yes but the empirical crucial factor is degree of growth for average or median person. Not expectations but level of growth.

There has never been any Robinson Crusoe economy because humans are group level beings. No biologist will bother wasting time on theories on human economies which are more easily falsified than creationism.

I liked the egalitarian factor by mention of Jared Diamonds short story of “The Worst Mistake in the History of Humankind”. There’s uncertainty about expansion of economic spheres without direct democracy.


Equalitus 03.10.18 at 8:43 am

The calculation problem of socialist economy is no such thing. It is a flawed strawman argument, because a functional [not necessarily high level prosperity] socialist economy must have at least 20% private sector. And then the public sector/government sector just follows the productivity and demand and prices generally, of that in the private sector.

And the socialist economy [E.g: 80% government 20% private] compares itself by productivity to other countries. And make coordination as majority profitability and national economic productivity shall be induced.


Peter T 03.10.18 at 11:20 am

re interest rates: you might find this of interest:

His thesis – that for a very long period rates were set more by custom and ease of calculation has an echo in modern drug markets, where prices vary very little, are set in round numbers and interest rates are uniform but adjusted b write-offs.

Query: is money really a store of value? Or is it not the money but the debt it enumerates, and therefore the ability to exact repayment? As many have found out, a million in the bank is cold comfort if, in times of trouble, the bank refuses to disburse it.


Peter T 03.10.18 at 11:56 am

Also, if you are going to leave the detailed critique of Hayek to Chapter 11, then it would be worth observing here that, in practice, a change in price by itself does not tell anyone enough prompt any significant decision. At best it can prompt further investigation as to the causes.


steven t johnson 03.10.18 at 12:47 pm

Jared Diamond is prone to over-excitement, and credulous about the Great God DNA. Richard G. Wilkinson’s The Poverty of Progress is a superior reference, I think. In particular, the possibility that agriculture was expanded to meet population pressure, rather than the choice of agriculture required the expansion of population, as far as I know, seems to fit the known record far better. Plant and animal domestication took so long as to suggest that agriculture was the search for additional food, which implies its massive expansion was more about relative lack of food, i.e., game and forage plants.

One unspoken assumption here is that population will increase. The notion of a natural rate of interest is dubious, even if von Mises would approve the approach. Or especially. Historically population decrease, relative or even absolute, even in modern times where it is masked by immigration or export of production, has implications for economic growth, and any purported natural rate of interest.

In a system of production for profit, the historical existence of an equity premium is not an incidental puzzle I think. It is hard to understand how anyone could think loss of equity premium is not itself an opportunity cost. Even in the mythical Eden of full employment, it’s not clear how the first lesson can be deemed to describe this ideal economic behavior. Except by prioritizing theorems over history, that is.

Beginning with the first lesson increasingly seems like the king who planned to found his dynasty, just as soon as he recovered from the removal of his cancerous testicles.


nastywoman 03.10.18 at 2:56 pm

as somebody who knows nothing about ”economics” I also have this… problem with interest rates or better said this… may I call it obsession of some economist that we need – absolutely need low interest rates… or let’s call it better ‘cheap money’ to create jobs or having a ”growing and functioning economy” – it’s like this funny believe of the ‘nasty# -(instead of ‘good’) Capitalists that only if they pay their workers the lowest (cheapest) salaries an ”economy works well”.

As real nasty Capitalist in the last years have used sooo much cheap money (low interest rates) for speculation and gambling or just in order to produce more money and so little for investing in ”human capital” -(aka ”the workers salaries”) interest rates might deserve to be mentioned last in Chapter 3 and not firstly – but as said:
What do I know?

Nothing about ”economics” just how to try being a ”good” capitalist?


Bill Murray 03.10.18 at 11:20 pm

on page 4

there may be so much grain left over that t makes sense to sow it on marginal

is missing an i in front of the single t


Anonymous Coward 03.11.18 at 10:20 am

“Conversely, if the opportunity cost of the $10 000 benefit to the high income earner is a loss to the low income earner of more than $1000, the cost exceeds the benefit.”

I’m sorry, I can’t parse that sentence to make sense, though I think I know what you mean by virtue of the previous sentence.


Paul Davis 03.11.18 at 2:08 pm

The discussion of interest rate(s) seems too disconnected from current day reality and the nature of lending and investment we are familiar with.

I like the “derivation from first principles” (i.e. wheat seed), but today, interest rates principally concern a highly liquid, highly exchangeable currency within a context where a person with a surplus of this particular form of value (a “capitalist”) has many potential choices of what to do with it, each associated with some level of risk (both actual and perceived, which may or may not be identical). To use your terminology, a capitalist expresses their risk perception via price signalling … of interest rates. The wheat seed model really only contains a “now or later” choice, whereas once currency is in play, there are many more choices, both in the present and in the future.

The interest rate available for a particular debt reflects

1) the lender’s beliefs about the risks associated with the debt much more than it represents a “now or later” choice. The lender has already made a “now or later” choice : they’re going to lend (“invest”), they’ve already stated their preference for the future.

2) the range of lending (“investment”) opportunities available now and in the future. If nobody wants to borrow money (and pay interest), then interest rates are likely to fall in order to change minds about the desirability of borrowing (and paying interest). The story will be very different if there is strong demand for capital from a variety of projects with diverse risk associated with them.

I think it would benefit this chapter if you could connect more with these aspects of current interest rate practice rather than the excessively simplified version you’re using at the moment.


bruce wilder 03.11.18 at 6:30 pm

. . . Lesson 1 in the previous chapter, like most introductory discussions of economics, deals with a timeless world of perfect certainty. Goods are exchanged once and for all. Everyone knows what they are giving up, what they are getting and the price at which the exchange can take place. Is Lesson 1 still relevant when we think about a more realistic representation of the world, where choices are made over time, and with limited information about the future?

Relevant? Are you sure you are still in Lesson 1 territory, when you introduce genuine uncertainty?

When you refer to “Lesson 1”, are you referring to Hazlitt’s One Lesson, or the dogmatic economics of market fundamentalists generally, or the conventional economics of Econ 101? Or, have you cast off on your own, and “Lesson 1” is exclusively Quiggin’s Lesson 1, with the thesis: Lesson 1 (opportunity cost is a useful way of thinking about allocative efficiency) is basically true, but (Lesson 2:) things are more complicated than that?

I am a little skeptical of utility of the “Yes (to Lesson 1), but (Lesson 2) it’s complicated” thesis as rhetoric or pedagogy, but leave that skepticism aside; what are the boundaries of Lesson 1 in your mind?

Hazlitt’s One Lesson seems to me to put forth a slight variation on loanable funds. If the general plan is to exposit Lesson 1 (with preliminary cautions attached) and circle back later with Lesson 2 complications, then I would think you should probably lay out the Loanable Funds doctrine in this Chapter 3 as a representation of Lesson 1 economics.

Laying out Loanable Funds would have the advantage that most readers would readily recognize the ideas and approach, as the basis of many common cliches of political debate. And, Loanable Funds does express the idea of opportunity costs.

But, maybe Loanable Funds doctrine is not, in your mind, an example of Lesson 1 economics. ?

I am asking, because I do feel myself a bit at sea, reading Chapter 3. You almost seem to be off on a tangent, writing about the history of debt and various concepts of interest rate. And, at the end, you briefly mention “uncertainty” again. “Uncertainty” is a boundary marker in your outline apparently, coming at the beginning and the end of this chapter. But, as a reader, I feel I need a bit more here to understand what is in and what is out. at this boundary — not theory, so much as just an author’s helpful hints for the reader drawing renewed attention to the organizational plan of the essay.

*an aside on uncertainty: I like the umbrella as an example of taking a precaution, but genuine uncertainty is not equivalent to insurable risk — that “uncertainty” is not insurable defines uncertainty is contrast to “risk”. I, personally, do not endorse the conventional distinction between “uncertainty” and “risk”, following either Keynes or Knight, and I would not recommend being dogmatic on this point.


Scott P. 03.11.18 at 7:41 pm

as somebody who knows nothing about ”economics” I also have this… problem with interest rates or better said this… may I call it obsession of some economist that we need – absolutely need low interest rates

Who are you thinking of? I can’t think of any.


nastywoman 03.11.18 at 11:49 pm

”Who are you thinking of? I can’t think of any.”

But there must (have been?) a lot of them because haven’t we had one of ”the longest Low Interest Period” and aren’t ”economists” kind of ”setting” these rates?

Or is it ”Bankers”?

It for sure wasn’t ME!


nastywoman 03.12.18 at 1:52 pm

”It for sure wasn’t ME!”

As I would grant the lowest interest rates people who need it most -(like Students who have to take out loans to get a ”good” education – just like in Germany where ”Bafög” loans carry 0 – in words ”zero percent interest”) – while I would charge ”Investors” who intent to use ”cheap money” for gambling and speculating the same interest rates as poor dude has to pay – if he has to finance his car he can’t do without – driving to work.

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