Economics in One Page

Lunchtime Lecture, Melbourne, 28 September 2001

"What makes [economics] most fascinating is that its fundamental principles are so simple that they can be written on one page, that anyone can understand them, and yet very few do."

- Milton Friedman, quoted in "Lives of the Laureates".

THE above statement by Friedman got me thinking:  is it possible to summarise the basic principles of economics in a single page?  After all, Henry Hazlitt gave us a masterful summary of sound principles in Economics in One Lesson.  Could these concepts be reduced to a page?

Friedman himself did not attempt to make a list when he made this statement in a 1986 interview.  After completing a preliminary one-page summary of economic principles, I sent him a copy.  In his reply, he added a few of his own, but in no way endorses my attempt.

After making this list of basic principles below, I have to agree with Friedman and Hazlitt.  The principles of economics are simple:  Supply and Demand;  Opportunity Cost;  Comparative Advantage;  Profit and Loss;  Competition;  Division of Labour.  And so on.

In fact, one professor even suggested to me that economics can be reduced to one word:  "price".  Or, maybe, I suggested as an alternative, "cost".  Everything has a price, everything has a cost.

Additionally, sound economic policy is straightforward:  let the market, not the state, set wages and prices.  Keep government's hands off monetary policy.  Taxes should be minimised.  Government should do only those things private citizens can't do for themselves.  Government should live within its means.  Rules and regulations should provide a level playing field.  Tariffs and other barriers to trade should be eliminated as much as possible.  In short, government governs best which governs least.

Unfortunately, economists sometimes forget these basic principles and often get caught up in the details of esoteric model-building, high theory, academic research and mathematics.  The dismal state of the profession was expressed recently by Arjo Klamer and David Colander, who, after reviewing graduate studies at major economics departments around the US, asked "Why did we have this gut feeling that much of what went on here was a waste?" (Klamer and Colander, The Making of an Economist).

This is my attempt to summarise the basic principles of economics and sound economic policy.  (Suggested improvements are most welcome.)

ECONOMICS IN ONE PAGE

1. Self Interest:  "The desire of bettering our condition comes from us with the womb and never leaves till we go into the grave" (Adam Smith).  No-one spends someone else's money as carefully as he spends his own.

2. Economic Growth:  The key to a higher standard of living is to expand savings, capital formation, education and technology.

3. Trade:  In all voluntary exchanges, where accurate information is known, both the buyer and seller gain.  Therefore, an increase in trade between individuals, groups or nations benefits both parties.

4. Competition:  Given the universal existence of limited resources and unlimited wants, competition exists in all societies and cannot be abolished by government edict.

5. Co-operation:  Since most individuals are not self-sufficient, and almost all natural resources must be transformed in order to become usable, individuals -- labourers, landlords, capitalists and entrepreneurs -- must work together to produce valuable goods and services.

6. Division of Labour and Comparative Advantage:  Differences in talents, intelligence, knowledge and property lead to specialisation and higher productivity in some activities than in others by each individual, firm and nation.  So it is rational for a doctor not to allocate her (expensive) time to cleaning her office, even when she could do a better job than the cleaner.

7. Dispersion of Knowledge:  Information about market behaviour is so diverse and ubiquitous that it cannot be captured and calculated by a central authority.

8. Profit and Loss:  Profit and loss are market mechanisms that guide what should and should not be produced over the long run -- by showing what is valued more than the resources it consumes, and what is not.

9. Economic Incentives/Disincentives:  If you raise the cost (price) of an activity, you get less of it.  If you lower the cost (price), you get more of it.  So, raising the cost of crime will discourage criminal activity.  Generous tax credits for higher education will encourage more people to go to university.

10. Opportunity Cost:  Given the limitations of time and resources, there are always trade-offs in life.  If you want to do something, you must give up other things you may wish to do.  The price you pay to engage in one activity is equal to the cost of other activities you have forgone.

11. Price Theory:  Prices are determined by the subjective valuations of buyers (demand) and sellers (supply), not an objective cost of production.  The higher the price, the smaller quantity purchasers will be willing to buy and the larger the quantity sellers will be willing to offer for sale.

12. Causality:  For every cause there is an effect.  Actions taken by individuals, firms and governments have an impact on other actors in the economy that may be predictable, although the level of predictability depends on the complexity of the actions involved.

13. Uncertainty:  There is always a degree of risk and uncertainty about the future because people are of ten re-evaluating, learning from their mistakes and changing their minds, thus making it difficult to predict their behaviour in the future.

14. Labour Economics:  Higher wages can only be achieved in the long run by greater productivity;  that is, applying more capital investment per worker.  Chronic unemployment is caused by government fixing wage rates above equilibrium market levels.

15. Government Controls:  Price-rent-wage controls may benefit some individuals and groups, but not society as a whole.  Ultimately, they create shortages, black markets and a deterioration of quality and services.  There is no such thing as a free lunch.

16. Money:  Deliberate attempts to depreciate the nation's currency, artificially lower interest rates, and engage in "easy money" policies inevitably lead to inflation, boom-bust cycles and economic crises.  The market, not the state, should determine money and credit.

17. Public Finance:  In all public enterprises, in order to maintain a high degree of efficiency and good management, market principles should be adopted whenever possible:

1. government should try to do only what private enterprise cannot do;
2. government should live within its means;
3. cost-benefit analysis -- marginal benefits should exceed marginal costs;
4. the accountability principle -- those who benefit from a service should pay for the service.