Economics 101, Good or Bad?

By James Kwak

Over at the Washington Post, Michael Strain of the American Enterprise Institute is upset that people are picking on Economics 101. He singles out Paul Krugman and Noah Smith in particular for claiming that “the pages of economics 101 textbooks are filled with errors, trivia and ‘useless fables.'” Instead, Strain insists, “an economics 101 textbook is a treasure.” He continues by discussing some of the key insights that you can gain from the basic models presented in an introductory economics class.

Except, for the most part, Strain is rebutting an argument that no one is making. He is right to say that Economics 101 provides many valuable lessons—the competitive market model, opportunity cost, diminishing marginal returns, comparative advantage, the labor-leisure tradeoff, etc. But no one denies the analytical power of those abstract concepts.

Krugman’s argument was that for some policy issues, the lessons of Economics 101 are just not that important: correct sign but small magnitude, you might say. One of his examples was international trade; his point was that even if free trade is better than protectionism, the welfare gains from reductions in tariffs are relatively small, especially in a world where most trade is mostly free already, and especially when compared to the gains from other factors such as technological innovation.

Smith did say that most of what’s in an introductory textbook is “probably wrong,” but if you read his article it’s clear that he meant “probably wrong [if you expect it to accurately describe the real world].” Smith’s example is the minimum wage; his point is that while the supply-and-demand model predicts that a higher minimum wage will increase unemployment, empirical research shows that real labor markets often do not behave that way. The Economics 101 model is wrong as a description of reality; that doesn’t mean that it isn’t an important source of insight. Here’s how Smith puts it:

That doesn’t mean the theory is wrong, of course. It probably only describes a small piece of what is really going on in the labor market. In reality, employment probably depends on a lot more than just today’s wage level — it depends on predictions of future wages, on long-standing employment relationships and on a host of other things too complicated to fit into the tidy little world of Econ 101.

I think “small” might be an overstatement—statutory wage levels are probably a big factor in the low-skilled labor market—but otherwise Smith’s point should be uncontroversial. A friend and labor economist said to me that when thinking about the impact of a minimum wage, the natural starting point is the supply-and-demand diagram, because it’s so powerful—but you don’t stop there. The model is incomplete, like all models, and if you don’t realize that you will make mistakes.

Professional economists know all this, and hence many think that models need to be balanced by empirical research, even in first-year classes. Strain doesn’t buy this because “economists’ empirical studies don’t agree on many important policy issues.” I don’t understand this argument. The minimum wage may or may not increase unemployment, depending on a host of other factors. The fact that economists don’t agree reflects the messiness of the world. That’s a feature, not a bug.

People like Krugman and Smith (and me) aren’t saying that Economics 101 is useless; we all think that it teaches some incredibly useful analytical tools. The problem is that many people believe (or act as if they believe) that those models are a complete description of reality from which you can draw policy conclusions. As Smith says, “If economics majors leave their classes thinking that the theories they learned are mostly correct, they will make bad decisions in both business and politics.” In the first (1948) edition of his famous textbook, Paul Samuelson lamented that the simple model of the competitive market—you know, the one that says that markets maximize social welfare—is “all that some of our leading citizens remember, 30 years later, of their college course in economics.”

In the past forty years, simplistic applications of Economics 101 concepts, stripped of nuance or empirical verification, have swept the policy field in areas from labor markets to taxes to health care. They now constitute virtually the whole of the establishment Republican Party’s economic policy, as represented by Paul Ryan (who talks exactly like someone with an exaggerated faith in a handful of Economics 101 snippets). The problem isn’t Economics 101—it’s the transformation of Economics 101 into an ideology that, like most ideologies, claims the status of objective truth.

8 responses to “Economics 101, Good or Bad?

  1. And may a black cat knock on the door and give you a hug, rather dubious at this point.

  2. traderbill

    If only the GOP hadn’t refused to index the minimum wage, we wouldn’t be having this discussion now. Overlooked is how much employers have made by underpaying employees. For some reason, at the other end of the spectrum though, outlandish bonuses for CEO’s and senior management which has now extended to board members, never comes into play.

  3. I think you’re avoiding responsibility. You can’t teach people lies and expect them to eventually learn the truth. Econ 101 should clearly involve zero curves and more practical knowledge. “Some College” is bigger than many ethnic groups on polls.

  4. Back in 1917, during the Russian Revolution, the leadership there needed to send a mole over to the western world, they wanted someone to figure out what the hell was going on over there. They had personally sent over enough gold to fill a freight train a mile long, and baited it with a small portion guarded by Mark Twain. But once he passed, instead of using it to further strengthen the dollar in the form of the gold standard, the Federal Reserve was created to leverage the holdings in the name of the public demanding for a more convenient form of currency, paper money. Once on the wrong track, that gold was then covered up and the study of human behavior began in earnest. Over the next century the study continued and approaching the 100 anniversary of this event, the results are finally done and the report is to be sent back from whence it came. It basically states that the western world has fast tracked insanity, in the forms of institutions, education, commerce, judicial, gvt, and yes, economics, just to name the few.
    Now the point of no return has long since been breached and the bad behavior set in stone, a solution does exist, yet only known to a couple people with Russian ties naturally, now those people are going to be just fine once the solution is applied, the rest of you I’m not so sure about. Be mindful that behind every peacemaker, there is a gun, a gallows, and a jail. So enjoy your remaining days, or not, makes no difference to me, all that is left to pay are the consequences, that’s it, for time waits for no one and there is no place to hide once you’ve drifted so far off course without even being conscious of it.

  5. Your last sentence is very important for everyone (especially students) to grok. Just like science has morphed in some (usually leftist) circles into a “scientism” (“if it doesn’t reduce to science/physics it is fake” or “everything will necessarily be reduced to science/physics eventually”), a similar academic and/or rightist conversion of economics to an “economism” has also occurred in some circles (bubbles). It really is the old adages, combined, “To a (college) man with a little knowledge of a hammer, everything looks like a nail, and that’s (intellectually) dangerous.”

  6. I believe that the fundamentals of ECO 101 hold true for the most part. The problem is that the “invisible hand”, as the force maintaining market equilibrium, does not exist when the markets are manipulated by entities in an effort to control markets.This holds true in a globalized market as well.

  7. So Bill, if the invisible hand did exist__, it would now have to be considered a FRAUD of unimaginable proportions, right? Because either the not so invisible hand would be the most affluent person around, or the most affluent people around would have to reduce their financial holdings to match the not so invisible hand. Financial control of markets and manipulation of not so invisible hands equals FRAUD.
    Like I said, only the consequences are left to be payed once you are PAYED to not know something, which is how the Feds(the she devil and satan) are controlling mkts these days, it’s all cards they have left to play, and it’s hideous I might add.
    If the free mkts don’t exist for some reason, it’s because they have been tax into extinction by the oligarch’s.

    Now if I misinterpreted your statement, it’s because of “those peoples”(the she devil and satan in particular) greed, arrogance and hypocrisy, which is something we already knew.

  8. Since Trump has been trumping the same message since 1980, maybe your Dad’s Econ 101 (Trump’s) is not the same as today’s “artificial intelligence” algorithm-driven, dark pool derivatives, no double entry bookkeeping, giant IRS squid suck out taxing people for NOT buying a for-profit health insurance policy Econ 101…?

    The TRUTH with all its intertwined beauty and goodness is the absolutism of the math:

    More misery for others = More $$$$ for ME ME ME