What's Different About Economics?

"Excuse me while I have a brief Hayekian moment

Clementines. From Australia. Big juicy sweet--amazingly sweet--Australian clementines...

Isn't the world market marvelous! Nobody human knows--no machine has in its memory banks--the knowledge that an extra clementine tree should be planted in Australia in order to provide J. Bradford DeLong, a U.C. Berkeley professor, with big, sweet, juicy clementines in the northern-hemisphere summer. But the world market--our system of economic interrelationships considered as a social mechanism for guiding the production, transport, distribution, and allocation of goods and services--knows this. How wise it is! How fortunate the catallaxy! How big, juicy, and sweet the Australian clementines are!

Brad DeLong

Let's start with something simple. Consider the cup of coffee that you drink in the morning (if you don't drink coffee, then just play along). Do you know anyone involved in the process of getting you that cup of coffee?

Do you know on whose land the coffee plants grow? Do you know who planted them? Do you know who harvested the beans? Do you know who shipped the beans to a processing plant? Do you know who made any of the containers and equipment used in shipping? Do you know who worked in the processing plant? Do you know who ran the machinery that packaged the coffee? Do you know who delivered the coffee to a retail outlet? Do you remember the person who sold you the coffee--do you know that person's last name?

We live in an impersonal world. If you lived in prehistoric times, in a tribe of hunter-gatherers or a small farming village, you would know everyone involved in your life. You would not be eating things or using things touched by strangers.

Look at the clothes that you are wearing. Do you have any idea who made them? Look at the objects around the room or office or airline terminal where you might be reading this. How many strangers did it take to create those surroundings?

Some services are still personal. You know your doctor's first and last names. Of course, the specimen that you leave in the doctor's office will be analyzed by someone you do not know at all, perhaps in a lab located in a different state. And the insurance forms you fill out are going to be processed by strangers. And the pills that the doctor prescribes for you were researched, tested, manufactured, distributed, and sold in a complex process involving thousands of people unknown to you.

Economics is about the transactions that take place in this complex, impersonal world. We look at it not so much transaction-by-transaction. What we focus on is the overall outcome of the system of transactions.

What force keeps this system together? What is it that binds all of the separate activities into a coherent process that delivers coffee or clothing or medicine to people who do not know one another?

When I ask this question to people who have never taken a course in economics, often their first answer is "money." That is not a bad answer. Money certainly plays a major role in making impersonal transactions more efficient. But it is not the answer that I am looking for--not the answer that an economist would give.

For economists, the binding force is the price system. Prices are the terms of exchange between different goods and services. You do not know who sold you the coffee, but you know the price that you paid. The retailer knows the price paid to the wholesaler, who knows the price paid to the shipper and the price paid to the processor. The processor knows the price paid to the plantation operator, who knows the price paid to the harvesters and the landowners.

But who is it that sets these prices? If prices are the binding force in our impersonal web of transactions, then the person or persons who set prices must be awfully important. Who are they?

Here, the economist answers enigmatically. We say that no one sets prices. The market sets prices.

The wholesaler with bags of coffee for sale gives a price list to the retailer. But an economist would deny that the wholesaler sets the price. The wholesaler is constrained by market forces. If the wholesaler sets a price that is too high, retailers will switch to a different wholesaler. If the wholesaler sets the price too low, she will not recoup her costs of purchasing and shipping the coffee, and she will have to go out of business. Thus, although she is technically free to post any price she wants, in practice the range of prices that she can charge for her coffee in the context of the market is quite limited. Like the transactions that they serve to facilitate, prices are impersonal.

The rest of this chapter looks at differences in thinking between economists and non-economists. Many of these differences center on the price system. Economists emphasizes the benefits of the price system. When the popular instinct is to override the price system, we want to make sure that people understand the potential for adverse consequences. The sections in this chapter contrast the misconceptions of the layman with the thinking of the economist.