“Macroeconomics and Misgivings” argues that it is a mis-conception, albeit one that is well entrenched in the mindsof both professional economists and the general public, tothink of the economy as an engine with spending as its gaspedal.
“misconception…to think of the economy as an engine with spending as its gas pedal.” This emphasizes the author’s critique of oversimplified macroeconomic models that treat the economy like a machine, ignoring complexity and human behavior.
“Finance and Fluctuations” deals with the misconceptionsabout finance that are common among economists, who oftenfail to appreciate the process of financial intermediation. Thissection looks at the special role played by financial intermedi-aries in enabling specialization. Intermediation is particularlydependent on trust, and as that trust ebbs and flows, the finan-cial sector can amplify fluctuations in the economy’s ability tocreate patterns of sustainable specialization and trade.
financial intermediaries…enable specialization” and “as that trust ebbs and flows, the financial sector can amplify fluctuations.” This shows the author’s point that finance is crucial for specialization but is sensitive to trust, which can magnify economic ups and downs.
“Specialization and Sustainability” exposes the misconcep-tion that we must undertake extraordinary efforts in order toconserve specific resources. This section explains how the pricesystem guides the economy toward sustainable use of resources.In contrast, individuals who attempt to override the pricesystem through their individual choices or by imposing gov-ernment regulations can easily miscalculate the costs of theiractions.
the pricesystem guides the economy toward sustainable use of resources” and “individuals who attempt to override the pricesystem…can easily miscalculate the costs.” This emphasizes that the author argues the price system naturally encourages sustainability, while personal or government interference can backfire.
“Machine as Metaphor” attacks the misconception held bymany economists and embodied in many textbooks that theeconomy can be analyzed like a machine. This section looksat a widely used but misguided approach to economic analysis,treating it as if it were engineering. The economic engineersare stuck in a mindset that grew out of the Second WorldWar, a conflict that was dominated by airplanes, tanks, andother machines. Their approach fails to take account of themany nonmechanistic aspects of the economy.
“attacks the misconception…that the economy can be analyzed like a machine” and “fails to take account of the many nonmechanistic aspects of the economy.” This shows the author’s critique of treating economics purely like engineering, emphasizing that human behavior and social factors make the economy more complex than a machine.
He knows that his breakfast depends upon workerson the coffee plantations of Brazil, the citrus groves ofFlorida, the sugar fields of Cuba, the wheat farms ofthe Dakotas, the dairies of New York; that it has beenassembled by ships, railroads, and trucks, has beencooked with coal from Pennsylvania in utensils madeof aluminum, china, steel, and glass.
He knows that his breakfast depends upon workers on the coffee plantations…utensils made of aluminum, china, steel, and glass.” This emphasizes the global interconnection of labor and resources—showing how everyday items rely on a complex, international network of production and trade.
How much commerce andnavigation in particular, how many ship-builders,sailors, sail-makers, rope-makers, must have beenemployed in order to bring together the differentdrugs made use of by the dyer, which often come fromthe remotest corners of the world! What a variety oflabour too is necessary in order to produce the toolsof the meanest of those workmen!
how many ship-builders, sailors, sail-makers, rope-makers, must have been employed…What a variety of labour too is necessary in order to produce the tools of the meanest of those workmen!” Note that this illustrates the vast network of specialized labor required even for basic production, showing the complexity and interdependence of economies.
The woollen coat, for example, which covers theday-labourer, as coarse and rough as it may appear,is the produce of the joint labour of a great multitudeof workmen.
the produce of the joint labour of a great multitude of workmen.” Note that even simple goods rely on the coordinated work of many people, emphasizing the importance of specialization and trade in everyday life.
The roundabout process (or high capital intensity) creates agap of time between the initial steps in the production pro-cess and the final sale of goods and services. During thattime gap, workers involved in the early stages of the pro-duction process must receive income before consumers havemade purchases. (Think of the producer of farm equipment,which must receive payment from a farmer before the farmercan use the equipment to harvest a crop.) That preconditionrequires financial intermediation. As the economy becomesmore specialized and the production becomes more round-about, the financial sector takes on more significance.
As the economy becomes more specialized and the production becomes more roundabout, the financial sector takes on more significance.” Note that higher capital intensity and longer production processes increase the need for financial systems to support early-stage workers and investments.
The steel must be transported,which may require a railroad or a ship for transportation.And so on. Most of the people whose work enables thefarmer to harvest wheat have no idea that they are partof the wheat production process. The Austrian school ofeconomics would describe this multistep production pro-cess as very roundabout.
“Most of the people whose work enables the farmer to harvest wheat have no idea that they are part of the wheat production process.” Note that complex production involves many unseen contributors, illustrating the concept of “roundabout” production in the Austrian school.
An increase in capital intensity accompanies an increasein specialization. Think of capital as tools that are usedto produce things. Farm equipment helps produce food.Manufacturing plants help build farm equipment. Steeland concrete production facilities help build manufac-turing plants. Workers with powerful tools are moreproductive. It is easier to excavate a foundation with abulldozer than with a spoon.
“Workers with powerful tools are more productive. It is easier to excavate a foundation with a bulldozer than with a spoon.” Note that more specialized work requires better tools (capital), which increases efficiency and output.
Improvements in transportation accompany specializa-tion. The farther that you can cheaply transport goods,the more specialization you will see. Before the adventof the railroad, water transport was relatively efficient,so that specialization tended to be most extensive neargood harbors and navigable rivers. Improvements intransportation have connected the world’s regions moreclosely, promoting greater specialization
Improvements in transportation have connected the world’s regions more closely, promoting greater specialization”. Note that better transport enables wider trade networks, which increases economic efficiency and interdependence.
Trade accompanies specialization. The more you spe-cialize, the more you need to trade to obtain what youwant. In a society where people specialize, you will findthem exchanging goods and services.
“The more you specialize, the more you need to trade to obtain what you want”. Note that this emphasizes the link between specialization and trade—economic interdependence grows as individuals focus on specific tasks.
If Cheryl’s bank no longer needed a mortgage paymentprocessing system, her value would be reduced. If her bankwent completely out of business, her value would be reducedmore. If the mortgage servicing industry consolidated, usingfewer systems, her value would be reduced more still. And ifcomputers suddenly became much more expensive and bankswent back to using mechanical calculators, her value wouldbe reduced still more. That last hypothetical is extreme, butthe point is that specialization is subtle, deep, and highlydependent on context.
specialization is subtle, deep, and highly dependent on context” and the examples before it. Note that this shows how the value of specialized skills depends on the broader economic and technological environment—changes in industry or technology can increase or decrease the importance of a person’s work.
The machines were made out of materials that hadto be mined and transported. That transportation requiredmany other people and machines. The transportation equip-ment itself had to be manufactured, which required miningand shipping materials to the place where the transportationequipment was manufactured
materials that had to be mined and transported” and “transportation equipment itself had to be manufactured”. Note that this emphasizes the interconnectedness of production—how even simple goods rely on a vast network of labor, materials, and technology.
Picture yourself watching news on cable television whileeating a bowl of cereal. However, instead of giving you thenews, the TV announcer asks you to consider what you wouldneed to do to make your cereal completely from scratch.You would need to grow the cereal grains yourself. If youuse tools to harvest the grain, you would have to make thosetools yourself
“what you would need to do to make your cereal completely from scratch” and “If you use tools…you would have to make those tools yourself.” Note that the passage illustrates how modern life relies on complex production processes and specialized skills, showing how dependent we are on the broader economy.
Even more strikingis the fact that almost everything you consume is somethingyou could not possibly produce. Your daily life depends on thecooperation of hundreds of millions of other people.Just as it is inconceivable that human society would haveevolved to its present state without language, it is inconceiv-able that we would have gotten to this point without special-ization and trade. Moreover, in order for society to progressfurther, patterns of specialization and trade must continue toevolve.
“almost everything you consume is something you could not possibly produce” and “human society…without specialization and trade”. Note that the author emphasizes the essential role of cooperation, trade, and specialization in supporting daily life and societal progress.
always asks, “How do you know that?” The MIT approachsuppresses that question and instead presumes that economicresearchers and policymakers are capable of obtaining knowl-edge that in reality is beyond their grasp.2 That is particu-larly the case in the field known as macroeconomics, whosepractitioners claim to know how to manage the overall levelsof output and employment in the economy.
The MIT approach suppresses that question…” and “macro-economics… claim to know how to manage the overall levels of output and employment”. Note that the author is criticizing the overconfidence of economists, especially in macroeconomics, and how MIT-style training discourages healthy skepticism about what can truly be known or controlled.
Early in 2015, I came across a volume of essays edited byE. Roy Weintraub titled MIT and the Transformation ofAmerican Economics.1 After digesting the essays, I thought tomyself, “So that’s how it all went wrong.”Let me hasten to mention that my own doctorate in eco-nomics, which I obtained in 1980, comes from MIT. Also,the writers of Weintraub’s book are generally laudatorytoward MIT and its influence.Yet I have come to believe in the wake of the MIT trans-formation, which began soon after World War II, that econo-mists have lost the art of critical thinking. The critical thinker
“I have come to believe… that economists have lost the art of critical thinking.” This emphasizes the author’s critique of modern economics, particularly how MIT’s influence after WWII shifted the field toward less critical, more formulaic thinking, signaling a departure from questioning underlying assumptions.
The Scottish writer Adam Smith is often viewed as the “father” of free-marketeconomics. (This stereotype is not quite accurate; in many ways Smith’s theories arevery different from modern-day neoclassical economics.) And his famous Wealthof Nations (published in 1776, the same year as American independence) cameto symbolize (like America itself) the dynamism and opportunity of capitalism.Smith identified the productivity gains from large-scale factory production andits more sophisticated division of labour (whereby different workers or groups ofworkers are assigned to different specialized tasks). To support this new system, headvocated deregulation of markets, the expansion of trade, and policies to protectthe profits and property rights of the early capitalists (who Smith celebrated asvirtuous innovators and accumulators). He argued that free-market forces (whichhe called the “invisible hand”) and the pursuit of self-interest would best stimulateinnovation and growth. However, his social analysis (building on the Physiocrats)was rooted more in class than in individuals: he favoured policies to undermine thevested interests of rural landlords (who he thought were unproductive) in favour ofthe more dynamic new class of capitalists.
'Smith identified the productivity gains from large-scale factory production… division of labour” and “free-market forces… and the pursuit of self-interest would best stimulate innovation and growth.” This shows how Adam Smith laid the groundwork for capitalism and the idea of the “invisible hand,” but his focus was more on class dynamics and supporting productive capitalists than purely individual self-interest.
Why? Because even the short-changed partneris still better off (by one penny) than if they had rejected the offer – and that’s allthey care about. So there is no rational reason for the offer to be rejected.In practice, of course, anyone with the gall to propose such a lopsided bargainwould face certain rejection. Experiments with real money have shown that splitsas lopsided as 75–25 are almost always rejected (even though a partner rejectingthat split forgoes a real $2.50 gain). And the most common offer proposed is a50–50 split. That won’t surprise many people – but it does, strangely, surpriseneoclassical economists! In short, the real-world behaviour of humans is notremotely consistent with the assumption of blind, individualistic greed.
“real-world behaviour of humans is not remotely consistent with the assumption of blind, individualistic greed.” This shows how experiments (like the 50–50 split being most common) challenge neoclassical economic theory, proving people value fairness and social norms over pure self-interest.
Homo sapiens have existed on this planet for approximately 100,000 years. Theyhad an economy all of that time. Humans have always had to work to meet thematerial needs of their survival (food, clothing, and shelter) – not to mention,when possible, to enjoy the “finer things” in life. Capitalism, in contrast, has existedfor around 250 years. If the entire history of Homo sapiens to date was a 24-hourday, then capitalism has existed for three-and-a-half minutes.What we call “the economy” went through many different stages en route tocapitalism. (We’ll study more of this economic history in Chapter 3.) Even today,different kinds of economies exist. Some entire countries are non-capitalist. Andwithin capitalist economies, there are important non-capitalist parts (althoughmost capitalist economies are becoming more capitalist as time goes by).I think it’s a pretty safe bet that human beings will eventually find other, betterways to organize work in the future – maybe sooner, maybe later. It’s almostinconceivable that the major features of what we call “capitalism” will exist for the
capitalism is only a very recent system compared to the long history of human economies. Note that humans have always worked to meet needs, but capitalism (about 250 years old) is just one stage among many and will likely be replaced by new ways of organizing work in the future. This helps put capitalism in perspective as temporary, not permanent.
Curiously, even though capitalism dominates the world economy, the term“capitalism” is not commonly used
Economists avoid the word capitalism
we live in a capitalist economy, and we might as wellname it.
Naming is important - understanding system we live in.
This book focuses mostly on describing one very particular kind of economy:capitalism
focus of book = capitalism
The UN defineshuman development on the basis of three key indicators: GDP per capita,life expectancy, and educational attainment.
UN’s Human Development Index (HDI) = GDP + health + education.
An “efficient” economy is one which maximizes, throughexchange, the usefulness of that initial endowment
Allocate efficiency = maximizing usefulness of existing resources through exchange, ignoring fairness or distribution.
Scarcity is a normal condition. Humans are “endowed” witharbitrary amounts of useful resources.
Neoclassical economics assumes scarcity as permanent and resources as given.
Now you can return home. Congratulations! You’ve done a lot more than just takea stroll. You’ve conducted a composite economic profile of your own community
stanford emphasizes that everyday observation gives real insight into economic life, without relying on statistics.
Has your income increased faster than the prices of the things you buy?
connects personal finances to inflation and real income.
List yourapproximate monthly income.
Budgeting shows how individuals experience the economy through income and expenses.