Economics in Two Lessons: Chapter 2

by John Q on February 27, 2018

Thanks to everyone who commented on Chapter 1 my book, Economics in Two Lessons. I’ve benefited a lot from the comments and implemented quite a few changes.

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

Moving along, here’s the draft of Chapter 2. Again, I welcome comments, criticism and encouragement.



Tabasco 02.28.18 at 12:08 am

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.


John Quiggin 02.28.18 at 12:44 am

A good point! I’ll rewrite to excuse Hazlitt but not his epigones.


bruce wilder 02.28.18 at 3:32 am

Conspiracy of the Epigones!!


Peter T 02.28.18 at 9:15 am

The examples are suitably unreal (except maybe for the jacket for tickets one, which fits with the way user-level drug deals are done). Maybe it comes under your condition A – “that everyone faces the same market-determined prices for all goods and services, including labor of any given quality, and everyone can buy or sell as much as they want to at the prevailing prices”, but there are several very real conditions which also affect money prices:

1. the distinction between essential and non-essential wants. The pauper who trades his jacket in summer for a few meals knows he or she will have to buy it back in autumn, but meals are essential now, jackets later. Those who earn more are insulated from the pressure of necessity.

2. the difference between goods which can only be bought with money and those where personal time or effort can be substituted. I’ve fixed many a car myself because – although it took me longer – it cost me less money, which is always a finite resource in its own right (for a. jobs are not always available b. there are only so many hours in a day c. some personal/family/social time is always essential and more). 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.

3. Different time pressures (tied to the essential/non-essential distinction). The farmer has to sell the crop now or watch it rot. The agro company can afford to wait. The poor person needs the loan now, or catastrophe will ensue. The usurer can wait.

Making these conditions clear would allow the use of real-world examples later on.


Collin Street 02.28.18 at 9:44 am

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 02.28.18 at 11:49 am

“in normal circumstances it’s true enough to be useful”. It’s true enough to be useful about the market part of the economy. But if you frame economics as about “choice”, then that’s a much larger domain (even in labour terms, about twice as large as the market economy – much larger again if non-labour values are taken into account). So it’s not really true enough to be useful. Money is not utility, and all attempts to come up with some standard measure of utility have failed.

Talk of choice or barter obscures the politically-negotiated division between the monetary and non-monetary spheres (is it right to sell people? sex? ancestral land? the rights to names? the labour of children?) that is at the heart of many debates.


steven t johnson 02.28.18 at 1:43 pm

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.


John Quiggin 02.28.18 at 2:43 pm

@6 I’ve added some more material along these lines in a new Section 1.3.1 of the revised Chapter 1. If you have time, perhaps you could look to see if that addresses your concerns.

Thanks to all for other comments. Keep them coming!


Robert 02.28.18 at 3:16 pm

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.


John Quiggin 02.28.18 at 4:49 pm

@9 I’m planning to talk about bounded rationality in Chapter 11, possibly including mental accounts. It’s my main field in economics, so I have to say something, but the book is already getting big.


christian h. 02.28.18 at 10:52 pm

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.


Robert 02.28.18 at 11:21 pm

In the Friday and Crusoe story, barter allows both of them to develop their skills in their particular crafts. So what they get is not due just to a more efficient allocation of resources. It is also a development of technology. You could say this explicitly. Does it go beyond the point about opportunity costs?


Peter T 02.28.18 at 11:25 pm


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.


John Quiggin 03.01.18 at 12:13 pm

@11 The sentence doesn’t mention utility. But it’s implicitly about revealed preference, which is problematic. I may tackle this when I talk abound bounded rationality

@12 I’ll see if I can work this in.

@13 That’s an important point which I should add. On your note, in the US (my target market), prime-age men average 1600 hours of paid work per year, prime-age women about 1000. I’ll include this data


Keshav 03.02.18 at 1:37 am

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.


John Quiggin 03.02.18 at 3:32 pm

@15 A good point.


philip 03.02.18 at 3:41 pm

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.


Mike Huben 03.02.18 at 4:30 pm

I’m sorry to be so slow to respond, but I found this chapter emotionally hard to read. It was just so far from what I would envision. For that reason, please forgive the bluntness of my suggestions.

The greatest fault of this chapter is that it cedes the idea of opportunity cost and TISATAAFL to markets. Opportunity costs are considered within families, within firms, and by government. Clearest example: national defense.

Another fault is a general lack of clarity of your viewpoint. Your viewpoint should constanly be reinforced. Something along the lines of “yes, markets are good, but they are grossly imperfect, cannot address many economic problems, and don’t approach their theoretic possibilities.”

Further, the concision and clarity of Hazlitt is conspicuously lacking.

Raising a number of questions at the beginning is passive. Does Hazlitt do that?

You seem to duck the issue of marginalism. Did Hazlitt too?

The strong form of Lesson 1: while no free lunches are left on the table because marginal costs=price, there have been many pre-marginal free lunches.

If economic outcomes can be improved for everyone: that happens in markets generally for all transactions up to the marginal ones. (Excepting various dubious cases) The vast, vast majority of market operations result in free lunches: libertarians are so grossly wrong here about TANSTAAFL that it is ridiculous. The question is rather when the free lunches end.

I really like the idea that you talk about economic policy in general, as opposed to state versus markets.

TANSTAAFL is really a precaution about fraud: if a free lunch is advertised, then be suspicious.

You might also point out that saloons would not combine costs of beer and lunch unless they were making more money, either by misleading customers, inducing them to spend more, or increasing volume (to offset fixed costs.) But that might distract from the point.

Your paragraph starting “The reason underlying” (and the preceding paragraph) have to be read closely to notice that they are incorrect ideas. Please be direct here!

The Hayek/Keynes example is clumsy. You seem to be dancing around without stating the idea of subjective value. A pithier example with a simple computation of greater satisfaction of values would help here.

Isn’t sale of investments, such as on a stock market exchange, an example of a zero-sum game? The seller is gambling that the investment will be worth less than the selling price and the buyer is gambling that it will be worth more. The “true price” will be what it can be sold for in the future.

The comparatice advantage section should state at the beginning that it is another example of TISATAAFL.

Why does only international trade rely on comparative advantage? Why not Robinson Crusoe and Friday?

Unfortunately, understanding comparative advantage does not happen with mere hand waving. it requires a numerical example in a table or diagram. You use 6 paragraphs to explain, when it is pretty well known that most people can’t keep six concepts in their heads at once. That may be why only economists tend to understand comparative advantage.

“We’ve seen how market prices determine…” If market prices are both cause and effect of opportunity costs, that should be stated clearly. And it only means no free lunches at the margin. You could point out that markets are a method of consuming the free lunches.

“Now let’s look at market prices.” This paragraph and the following one are meant to be comparisons of two cases. A table makes the comparisons much more comprehensible than two paragraphs of text.

The “assumptions about the way markets work” section should point out the ways these fail, and how those failures are almost always present in markets. You can point out that those failures and ways of coping with them are why economics is so complex.

“This more complicated version of the story can be formulated in mathematical terms to show that, under the stated conditions (and some additional technical requirements), a competitive equilibrium will arise in which there are no free lunches; that is, any potential benefit entails an opportunity cost that is at least as great.” This is a classic example of TLDR in one sentence. The reading level is much too high, it is passive, and requires simultaneous usage of too many concepts.

“One Lesson economists like Hazlitt implicitly assume something much stronger: that if prices reflect opportunity costs, there is no room for improvement in public policy. In particular, he assumes that any policy that benefits one group at the expense of others is undesirable. To put it more strongly, the distribution of income associated with the competitive market equilibrium we might observe if all government intervention were removed is assumed to be optimal. “
Their first (unstated) assumption is that we have the perfect competitive equilibrium needed to believe there is no room for improvement in public policy. And the leap to “distribution of income” does not make sense: do you mean “allocation of resources (including distribution of income)”?

The idea of different allocations of rights need to be introduced much earlier and more clearly (with a naturally varying example such as water rights) to show how it finds different market equilibria.


Peter T 03.03.18 at 11:03 pm

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.

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