The Economic Conversation is a long and sometimes complex book. You can hardly be expected to understand everything in it. If you're the average student you will forget a great deal of it after the final exam. But whatever you do, remember the following lessons. They will help you to make sense of the economy, economics, economists, and, who knows, maybe even your life.
Economics is difficult to put into a single definition. Because economics is a versatile discipline that can be applied to so many different topics, and because the make-up of personalities, socio-economic positions, and rhetorical methods of economists and economic commentators is so radically heterogeneous, "economics as such" is hard to define. In truth, economics has many definitions to represent the many ways that people enter into and try to stay inside the economic conversation. Think of choices in the face of scarcity and competition, of markets and their allocative functions, of the interaction between market and non-market institutions and their impact on distribution, of money and its effects on production and consumption, and you're in the general territory, from Smith to Friedman and from Marx to Samuelson (see Preface to Students).
Economics is an ongoing argument intended to grasp-or change-reality. Do not expect from economics and economists to get ready-made answers to your economic problems and those of the world. The complexity of economies makes the task of economics as a science especially difficult. When a geologist on the hill makes a guess about the future history of a stone, the stone, having patiently listened to the good geologist, does not run to tell his wife this hill's about to fall, so pack up some salt and let's get the heck outta here. But a human might. Human subjects listen to economic theories and predictions and change their behavior accordingly, sometimes enough to reverse the force and direction of a prediction! The best economists understand this rhetorical point-the one about the interaction between speech, audience, and action-and work it into their way of presenting their arguments. Still, there is disagreement. To some, former Fed Chairman Alan Greenspan was a master rhetorician of the economy. To others, he was merely lucky, something like the Peter Sellers character in the old film Being There. Adjusting expectations is just one reason that economics is an ongoing argument, and a complex one, too. Think of available theories as possible arguments to make in a specific context: use the theory of public goods to argue in favor of, say, a pollution tax or right-to-pollute auction market; use the Keynesian multiplier-accelerator model to bring optimism and confidence to your civic leaders contemplating a big investment, and so on. As is common to any lively discipline, arguments are met by counter-arguments; the result is an ongoing discussion in which you have the opportunity to contribute if you wish and if you make an effort to know how to argue in economic terms.
Economic thinking thrives on basic accounting. Economics begins with basic accounting. The balance sheet and income statements give a complete picture of the constraints under which people make economic choices. They tell you to differentiate stocks (as recorded in the balance sheet) and flows (as recorded in the income statement). (Remember the bathtub analogy?) For example, when you decide to go out for dinner, you will weigh the cost (the flow out), against your earnings (the flows in). In addition you will have to consider the consequences for your balance sheet. Do you have enough cash (an asset)? Can your put the amount on your credit card or is your debt already too high, given your other constraints and wants (liability)?
Opportunity costs are often important, even critical. We urge you to internalize this one without becoming neurotic or Scrooge-like. Recall the definition: opportunity cost is the value of the second best alternative, the thing you (or society) chose not to do. If you are like the poet Robert Frost then two roads diverged in a yellow wood and you took the one less traveled by. The opportunity cost of your decision was the other road, the one most traveled by. (In the poem you only had two roads to choose from.) But what if in your life there are three roads? four? n + 1 roads? Opportunity cost compels you to account for the full costs of every economic decision, whether you take it or not. The cost of reading this book is not only its price but also the benefits that you forsake by reading it instead of some other book. (Of course, the benefits of reading our book are maximal and unique!)
Investment and consumption are related but different activities. Consumption is an expenditure on anything that gets used up within a year. In the income account it shows as a flow out (money down the drain). Investment is an expenditure on anything that will last for a long time. In the accounts it shows up as an addition to assets. Because of the time factor, you expect the theory of investment to be different from the theory of consumption. The cost of 'consuming' an asset is depreciation or capital consumption allowance; this is an expense on the income statement.
If you remember only one picture from this book, make it the circular flow. Everything, as Bob Marley sings in a song, "goes around and comes around." What shows up as production on one side of the economy also shows up as income on the other side. Expenditure equals income. Gross Domestic Product equals total national income (ignoring a few technical adjustments). What goes around comes around, as shown by the circular flow.
Economics involves contrasting views. The economy is complex and economics is an evolving discipline. It should come as no surprise, therefore, that there is a wide range of viewpoints on any particular topic among economists. To keep matters simple, we focused throughout the text on two major viewpoints, namely the Keynesian and free-market (with variants: libertarian, classical, new classical, and monetarist) viewpoints. But we also highlighted other alternative perspectives, many of which fall nowadays under the rubric of "heterodox economics."
McCloskey: Yeah, as a free-marketeer I tend to believe that markets adjust quickly to whatever shock they experience and that government intervention usually makes things worse. Regardless, freedom is better than the lack of it.
Klamer: As a Keynesian I believe that markets work sometimes but not all the time; when they don't work the government can be well-advised to intervene. The challenge, then, is to get a good and effective government. I'd prefer, for example, a health care system run with people who have the common good in mind rather than their private gain.
Ziliak: And as a left-libertarian working toward the Beloved Community, I believe that freedom to achieve is different from freedom to be left alone, and that government-despite its historical complicity in furthering racism, sexism, Ponzi speculation, and other kinds of social damage-is still a site for enabling the freedoms to achieve. I agree for example with Justice Thurgood Marshall at his death: America still needs affirmative action. But I also agree with the French philosopher Proudhon: government can be stupid and evil. And with Stanley Fish: "principles can get you into trouble." Still, "intervene" is not the right word for all of government, and it's odd that Keynesians have accepted this right-wing term: are the Bill of Rights and the Rights of Man "interventions," possibly optional because "not worth the cost"?
McCloskey: Let freedom ring, constrained by ethics and rights, I say.
Ziliak: Yes: both kinds of freedom!
Choosing follows the rule of rational life. It's not unreasonable to assume that people in general are reasonable and therefore do what is best. In economics we take this insight a step further. In the free market analysis we presumed preferences to be given-they are what they are-and concentrated our attention on the implications of the constraints, that is, on the costs of alternatives and on the available means of satisfying them. (See Chapter 2.) But one must be careful to distinguish tastes from values, as we did, else economic policy can justify anything, including financial fraud, Holocaust, and slavery as just a "taste" to be efficiently satisfied. The idea that tastes are "given" is a simplifying assumption for model-manipulation and should not be thought of as dogma or truth.
Demand and supply is a price-guided process of coordination among buyers and sellers. Each market has a demand side (the buyers) and a supply side (the sellers). Price is the mediator between both. An increase in price will virtually lead to less quantity demanded and more quantity supplied - ceteris paribus (all other things remaining constant). In perfectly competitive markets price changes settle down quickly in new equilibrium (Chapters 3 and 8).
Markets can be imperfect. Price can exceed marginal cost. Firms can be price makers. Vertical monopolies, an extreme case, can bring social harm, for example through rent-seeking with politicians and through poor treatment of labor by management.
Freedom to be is better than the lack of it. Still, freedom to produce, consume, exchange, and redistribute goods and services, without government harassment or bureaucratic entanglements, tends to be better for individuals and societies than is the gross lack of such freedom.
Aggregate demand and aggregate supply. When thinking about the macroeconomy, keep apart the demand-side and supply-side factors. A change in money supply or consumption affects aggregate demand first; a change in technology affects aggregate supply first. (Chapters 22, 26, and 27.)
Keynesian economics is demand-side economics. The Keynesian perspective presumes that the prime movers of the economy are demand-side factors, such as investment, government spending and consumption. (Remember: Expenditures equal C + I + G + Net Exports.) A decline in investment can bring the economy (GDP) down. An increase in government spending can bring it back up (by a larger amount because of the income multiplier). (Chapters 23 and 24)
New classical economics is supply-side economics. The new classical and monetarist perspectives make you think of changes in aggregate supply whenever there is a change in aggregate demand. Their reason is "adjusting expectations": workers learn to expect change, which in turn causes, through exit, loyalty, voice, or some combination, their wages to change (Chapter 27). The new classical and monetarist conclusion: whatever happens, the economy will move by means of changes in aggregate supply to its "natural" level of output and unemployment. Keynesians do not disagree with the outcome; they insist, however, that the adjustment can take a long time (years) during which the government can effectively intervene.
International thinking is important. The American economy, no matter how big, is subject to what happens in the rest of the world. Smaller countries, such as Holland and Jamaica, are keenly aware of the international economy in which they live. Rising interest rates in Germany matter, as does a decline in the Japanese economy and a rise in the Chinese. (Think of the effects on aggregate demand and aggregate supply.)
Paul: How about the disagreements? My problem is that I do not know what to make of it since economists seem to disagree so much.
Bayla: Just think that markets work and you'll do fine.
Ziliak: Hah! Good one, Bayla. Have I told you the one about the girl who got everything she ever wanted? She lived happily ever after.
Maria: If you think that markets always work you may not have read the book that well after all, at least not the part that Klamer and Ziliak have written.
Bayla: I thought that they all wrote the book together. At any rate, you must be referring to their dialogues. I confess that I cared most for what McCloskey had to say.
Maria: Hey, guess what? We disagree once again!
Ziliak: Joking aside, the disagreements in economics are no more frequent or heated than they are in other disciplines-evolutionary biology, Shakespeare studies, labor history, string theory, literary criticism. These are rife with conflict, the healthy conflict you'd expect in a science concerned with understanding and persuasion more than a search for universal consensus, whatever that is.
Klamer: Absolutely. This is I think an important point, one that tends to get missed by the many thousands of business majors we economists teach. Scientists and literary critics are not phased by the disagreements. But of late business schools have portrayed business as a kind of homogeneous knowledge, leading some students to feel uncomfortable with argument.
McCloskey: Another reason to teach courses in "the rhetoric of economics," as the three of us do.
In view of the complexity of the subject matter, that is the economy with all those people in all those markets with all those transactions, the fact that economists disagree on some issues should come as no surprise. We could have suppressed those disagreements, including the ones between the three of us, but then we would have misled you.
If after reading the book you found yourself sympathizing with McCloskey and Bayla then you are some sort of classical, neoclassical, or libertarian economist; if instead you sympathized with Paul, you are a moderate Republican or Democrat who believes that Keynesian policies are sometimes necessary to stimulate sluggish economy. Readers agreeing with Klamer and Maria are definitely Old School Keynesians, while those who sympathize with Ziliak and Rodney fit into some other "school" of thought: if your sympathies lean toward the flourishing of liberty, dignity, and racial and social justice, you may be like Ziliak a "left-libertarian;" if it leans toward command and control policies such as the nationalization of industries and government control of labor markets, then you are probably, like Rodney, a socialist.