Atanu Dey On India's Development

Knowing Basic Microeconomics

February 1, 2008 by Atanu Dey

Smart people think alike. Or at least they reach similar conclusions. Take Charlie Munger and me. We reached the same conclusion about the importance of microeconomics. Seriously though, I think it is a crying shame that people in general don’t have even a nodding acquaintance with the basic principles of microeconomic theory.

Over the years I have been conducting a very unscientific survey of the level of understanding of economics by asking people opportunistically their opinion on some simple matters that involve a bit of microeconomic reasoning. The results have been disheartening. It is like asking people what is 2 plus 2 and finding that they are guessing the answer to be somewhere between 22 and 4. I think it is easy to teach people arithmetic. After all, practically every literate person is numerate enough to do sums very competently, even if they cannot quite get their heads around what exactly the normal distribution is good for. So I’m fully convinced that the average human can easily enough be taught the basic principles of micro theory and profit from that without really having to delve deep into esoterica that would gladden a PhD economist’s heart.

I think everyone deserves to know all the foundational truths about the world that have been so painstakingly discovered by some very smart people over the centuries. These are broad unifying principles, found in every major discipline, and every educated person should be totally comfortable in their understanding of them. For instance, regardless of whether you are a stock-broker or a nuclear physicist, you should know what the theory of evolution through natural selection is and how it explains the diversity of life on earth. Another example: one should know, even if one’s work is about literature and art, the atomic theory of matter and that only a hundred or so different kinds of atoms are involved in creating the universe we live in. Even more broadly, one should know what the scientific method is because we live in a world surrounded by artifacts that exist in some sense because the scientific method works.

I think that everyone should be familiar with the basics of economics because it matters in our daily existence. We all live in society and we interact with others. We in a sense create that society and how good that society ends up being depends on how we collectively understand how society functions. Our collective understanding dictates policy which in turn affects us all. Your ignorance of atomic theory does not materially affect you but ignorance of what the market is and how it works has profound consequences.

Knowing the basic elements of economics is good mental hygiene. It prevents infection by ill thought-out idea viruses and bacteria. To put it differently, it inoculates you against appearing stupid and behaving stupidly.

Enough of this. Let me just state what I consider the most important ideas we should all know related to economics. That all voluntary trade is good. It is good for both sides. That prices convey information that is otherwise either impossible or too costly to get. That incentives matter because people are motivated by self-interest. That people have differing abilities and differing preferences; which is why trade is possible. And a few other ideas that we could go into one of these days.

And lastly, it is never too late to learn a bit of economics.

[Go to Part 2 of this post.]

  • tanimadutta

    hi atanu,
    it is graet that you have written about micro economics. leave aside common people, even people from this field do not take it seriously as they say that it is static. but i always find it very exciting and the examples that one reads is mind blowing.

  • Asheesh

    Hi Atanu,

    I recently discovered your blog and have been perusing it like crazy sitting in my office.

    I couldn’t agree more with you regarding ignorance about economics. I wonder why economics is given such a step brotherly treatement compared to other subjects, when it touches upon each and every aspect of a persons day-to-day life? Most of the economics that I have learnt has been self taught out of self-interest, my teachers did a great dis-service to my classmates and me by reducing economics to a merely academic study.

    Our ideas about state of affairs in India are quite similar, I however do not have the gift of pen (should say keyboard) that you do. I hope more and more people read your blog and enlighten themselves rather being stunned into stupidity by the glittering picture painted by Indian media.

    Cheers,
    Asheesh

  • http://oshantomon.blogspot.com baransam

    I do not believe a human needs to know information which is not ‘relevant’ to his/her work or pleasure. I resonate with the famous Sherlock Holme’s statement that he will like to forget the irrelevant/unnecessary information about earth going around the sun.
    Of late, I am trying to kick this impulsive habit of knowing things which matter little to me. I am not successful yet, but I am trying.

  • http://www.neoalchemist.com neoalchemist

    Atanu, can you suggest a couple of books, which explains economics in simple terms. It will be even better if you can make a post with a list of books/topics that you wish a 10th/12th standard guy should read and understand during their holidays. Say, some sort of checklist – to prepare for their life after teens.

  • Amit

    Good points, Atanu.

    Along the same lines, all earthlings need clean air (to breathe), clean water (to drink) and nutritious food – these are all basic for survival. So it is imperative that we all learn about nature and how it works, where our food and water comes from, and what happens to soil, air and water as we thoughtlessly pollute it. It is but common sense to use the finite resources we do have judiciously (or use renewable resources), and the current economic models/theories seriously start considering and including those pesky externalities into their models, because nature doesn’t work according to those models, nor does it care for them. Unless economists are aware of another habitable planet that they can move to. ;)

    Paul Hawken has written some books on this issue, if anyone is interested.

    Your posts on solar energy and Tata Nano were right on mark.

  • http://chaitanya1.wordpress.com chaitanya

    The first person who urgently needs a lesson in econ-101 is Mr.Prakash Karat. He says he’s against raising of fuel prices. And they are against nuclear deal. I think their energy plan for India is to lick Iran and pakistan, for oil pipelines.

    Now to Amit’s point — I too am’ concerned about environment, but iam coming to realize that our economic models are not so defunct after all. There is nothing in the market system that prevents the costs of “externalities” from being incorporated into the price of the goods. Infact, economic theory says it would be a better free-market system, if ALL the costs are properly built into the price of the product. The only problem is that the costs of externalities are not AUTOMATICALLY built in. It’s the job of our *political system* to plug in those costs. In other words, its a political decision of our society, whether to plug-in the externalities into the full price. There is nothing in economic theory which prohibits that. For example, if we are concerned about climate change, just plug in the carbon tax to the price of fossil fuel. If we are concerned about an ecosystem, just prohibit any activity in that area, thus assigning an infinite cost to it. These are all political decisions.

    Because we have politicians like Karat, we are not letting the prices of goods fully reflect the full costs — the cost to environment, the cost to national energy security — of using them. Thus we are creating distorted energy usage. Ofcourse, it all comes down to the people who support such policies.

  • day_dreamer

    i second neoalchemist and join the clamour for some easy to understand books/references to understand basic economics and how it plays out in our daily life.

  • Amit

    Chaitanya, what you mention about economic models is correct, and my comment wasn’t to suggest we don’t need economic models. :)

    As for including the externalities, that would take some kind of paradigm shift (either that or our hands are forced by nature) for economists to start including them (maybe reading Tagore’s writings on nature would help?). I’m also not sure that given the global scale, just India starting to calculate the full price (as you suggest) would do the trick. Maybe it’ll happen at a future WTO meeting?

  • Amit

    I also wanted to add that some/many of the external costs are currently paid by tax-payers’ money. So while we may feel good about buying dirt cheap products, the external costs associated with them are coming out of our pocket via taxes.