Atanu Dey On India's Development

Knowing Basic Microeconomics — Part 2

This is a follow up to the previous post on Knowing Basic Microeconomics where I had claimed that micro theory is essentially codified common sense and that it is never too late to learn a bit of microeconomics. Many people have written to me (and some commented on the post) that they would like references to some work that makes micro theory accessible to the lay person.

I am not familiar with what is available and therefore I am not qualified to answer that question. I have read a few non-academic books on economics but they are the type that attempt to address the concerns that are usually macro in nature. I find macroeconomics only mildly interesting. But macro stuff (dare I call it nonsense?) is what you normally read in the popular press — stuff about the business cycles, interest rates, unemployment, inflation, etc. Pundits on TV and newspapers are always going on about GDP growth rates and how the developing economies are doing and what will happen in the year 2030 or some such remote date. I find it uninteresting because most of those stories are “just so” stories and everyone has his favorite.

What happens at the macro level is clearly dependent on what goes on in the micro level and that is where the more interesting concepts lie, in my opinion. Let me try an analogy. Epidemiology, the study of disease in large populations, cannot be divorced from an understanding of the germ theory of disease, and the causes and nature of health and sickness in individuals. You could spend the whole day reading about the statistical prevalence of, say, AIDS around the world but you will never know what needs to be done about the problem until you appreciate how a virus is involved and how it affects the human immune system. So also, simply being told about the movements of the macroeconomic variables is basically a lot of useless information unless you have some understanding of how they are the result of underlying micro variables.

Microeconomics is interesting because it helps one in making sense of what is going on around oneself. The world becomes a lot less mysterious and a lot more interesting when you not only know what happened but also know why it possibly happened. It is not that if you know the principles, you can predict everything and therefore it becomes boring. Surprises and twists in the tale do happen even when you are quite familiar with the personalities of the principal actors in a soap opera. If you did not know the characters, you would really not even care about what happens to them, anyway.

OK, enough of this. Let’s talk about learning micro. There must be great sources out there and one of these days I should really get off my butt and do a bit of research so that I can meaningfully answer the question of which sources to read. I have been writing about micro on this blog in fits and starts. There are lots of posts categorized as “Economics” and they present a somewhat coherent picture. As they are blog posts, they are neither self-contained nor complete. Still, if you were to read the entire lot, it would eventually make some sense. Gaps and dangling references can be dealt with separately later.

For starters, I would recommend these posts:

A set of useful tools.

I believe there is a small set of very powerful tools, or mental models, that can help us comprehend the dynamic world we live in. It is surprising that such a complex and complicated world is amenable to comprehension using only a small set of tools. But it is indeed true. The tools that I refer to are immensely powerful and flexible. That these tools exist is a powerful testimony to the ingenuity of humans. Seemingly innocuous and simple ideas have profound implications.

Take, for instance, the universal tool called arithmetic. Simple enough that even a five-year old can be taught to use it with ease. But profoundly powerful in the hands of a person who is trying to make sense of a world enormously complicated but often enough yields to a bit of arithmetic. Not using this tool is dangerous. Those who refuse to do arithmetic are doomed to speak nonsense. Not just speak nonsense, but wreak havoc by implementing policies that are patently harmful.

Reasoning economically.

Studying people exercising choice is what makes economics a study of behavior. Behavior – both human and non-human – has to do with rewards and punishments, gains and losses, in other words incentives. To some, the broadest generalizations that a study of economics leads to are, first, incentives matter, and second, markets work. The rest of economics is an elaboration and detailed arguments about those two generalizations. Recalls to mind what Ernest Rutherford had said about physics: “All science is either physics or stamp collecting.” That is, physics is central and the other bits of science are just a collection of facts that are peripheral and mere detail that one should not be overly concerned with.

How to study economics.

The point is that reading textbooks teaches you vocabulary. Vocabulary — precise meanings of words — is important because otherwise you cannot reason in the discipline. After you have learnt the vocabulary, you can read and comprehend sentences and paragraphs and thus follow an argument and figure out whether that argument makes sense or not. And more importantly, if you have the vocabulary, you will be able to figure out things for yourself and not just that, you will be able to express your point of view precisely for others to follow.

The Tathagata’s Sermon on Economics. That’s a light-hearted look at the big picture. Won’t quote from that piece because it has to be read in its entirety.

I will have to put some effort and collect all the bits that are scattered around on this blog and put it within the covers of a book one of these days. I will have to make sure that the bits fits properly without too many gaps and that they are properly cross-linked so that the pieces add up to a somewhat complete picture.

Let me end this one on a personal note. I came late to the study of economics. I only studied engineering (undergrad) and computer science (post grad) in India, and did not have the slightest inkling about economics. My study of economics was primarily motivated by the question “why is India poor?” I got around to asking that question only when I had been working in the Silicon Valley (at HP in product marketing, if you care). As I am the least disciplined person you are ever likely to meet, I could not study economics on my own. So I ended up doing my doctoral work in economics. That external discipline got me to where I think I understand the basics to some degree. Fortunately, I learned quite a bit of economics at the Cloyne Court in Berkeley, not just at school. I did eventually answer that question of why India is poor to my satisfaction. Which is what this blog is all about.

More to come.

  • joebob

    Let me offer an interesting way to frame micro vs macro economics.

    Draw a complete path or circle around wat you want to consider and then do a balance sheet about what and how much and what type of money transferes across the line or boundry.

    For simplicity, the area outside the circle can be viewed in a simle fashion and often the small amount that comes in and goes out can be viewed as a sort of sink or source and one does not have to keep track of the small effect the exchange has on the overall system except for the rules of exchange. In this form, money inside of the path can be viewed as being distroyed or created at the border. for example, if I do work and get money from outside the border, I can assume that the same amount will come in each time I dod the same work and this amount does not change the source’s ability to pay me. By the same token any money that leaves the inside can be seen as a loss if it does not bring in something of use. In this way, lost efforts or broken items that must be replaced can be seen as the distruction of the money and money waisted.

    The is different for money that stays inside the border where it simply moves from on place or set of hands and anothers and if the money is accumulated, inside the circle we can see this and take action.

    Where this is important is when we look at the governements budget and wars and other expenses. We are often told that the governement waistes money or looses it which is factually and realistically wrong. What has happened is that the money is transfered from one set of hands to anothers. NO ONE IS BURNING THE MONEY, what is happening is that the money is making someone happy and someone sad or hurt.

    We must look at the exchange in full. For the U.S. the money spent on a stupid war is often seen as a loss or waisted resource, and it is for thse who dont view the full picture. When the full picture is taken in what has happened is the money went from the hands that might have used it for something productive as they see it – into the hands of those who will do something differnet with it – like buy power and influence and politicians who then spread that money to others. No money is distroyed or lost – the moeny has simple done other things that might solidify the power of a certain group more then if they did not get the money. Money is transfered not distroyed.

    I have a model for understanding economies that is very good. I saw it first in a 2002 American Scientist piece and from that one small model one can get an idea about how various wealth distributions happens and how those distributions can be limited or controlled and what happens when they run open loop.

    here is the link:
    http://www.americanscientist.org/template/AssetDetail/assetid/14769

    America Scientist
    September-October 2002

    Volume: 90 Number: 5 Page: 400
    DOI: 10.1511/2002.5.400

    COMPUTING SCIENCE
    Other Formats: Postscript Postscript (gzipped) PDF
    Follow the Money
    Brian Hayes

    He did another piece or two related to roads and traffic and choices that was illumnating also but I don’t have that link at hand. One can do a search and discover that and other links.

    Whats fascinating about “Follow the Money” is the explaination of how fraud can stabalize a system from the collapse of singulatirites that can happen. I don’t like fraud as a solution but his description of how it stablizes a system gives an understanding why it evolves when other more fair controls to wealth accumulation are not inplace.

    As an engineer, one of the concepts important in understanding a system with feedback is the concept of phase or time delay. Somthing that can provide some stabalization of it feed backs fast might produce distructive results if the time delay or phase is shifted.

    too late here to say much more – joe m.