Saul Levmore: Let’s play a game of free association. I say “economics,” you say whatever comes to mind. Economics—money. Economics—Wall Street, housing bubble, prices, incentives. Ohh, if you said incentives, that’s pretty sophisticated.
I think it’s easy to see why economics is relevant. Economics is everywhere. Economics is why buildings go up; economics is why cookies cost $3.00. Economics is about getting the seat you want on the plane. Economics is, yeah, it’s about making money, but it’s about human behavior in general. Economics is to the real world around you as meteorology is to the weather, it’s interpreting all the phenomena and figuring out if there’s anything we can do about that. How could that not be relevant to every one of us?
That’s a lot of what we’re going to talk about today. Economics is, formally at least, the study of the allocation of scarce resources. You don’t have enough of something, a lot of people want it, who gets it, how do they get it, what do they give for it, how do you get people to make more of the thing. All of that is economics. I’ll say it again; economics is about the allocation of scarce resources.
Economics is also about puzzles. Economics likes to assume, just to make its job easier, that people are rational. You know, what is a rational person? The rational man is the guy who sees that the price of wheat rises; he gets up earlier in the morning and grows more wheat on his farm. Economics is the guy who buys more of something when the price drops. That’s the rational man.
The rational man loves to download stuff from iTunes when iTunes price goes down, but the rational man also creates more music in his garage and sells it when he gets paid more by people who download it from iTunes. One guy wants the price low; one guy wants the price high. They’re using incentives to communicate with one another.
So economics is about exchanges, economics is about prices, therefore it’s about money and it’s about incentives. Once you have those four things down, you’re beginning to put the package together. I said that economics was about puzzles. Economics is also about puzzles.
And these puzzles are even deep mysteries, have a lot to do with how economics got started in the first place. Kings would be really confused about some things. They would issue new coins, the coins would go out into the realm and the coins would disappear. Where were these coins going?
Peter the Great, I just read the other day, beheaded some 1,000 people for hoarding coins. And he could never figure out why when he issued silver coins, people would hide them or bury them in the fields. Why didn’t they want to use these coins? What was so great about holding them? Well, that’s the mystery that economics was out to solve. Peter the Great hired advisors and he wanted to figure these things out.
How come countries traded some things and not others? England and Portugal were sending wine and cheese back and forth, but some things never seemed to travel. Why was that? Well out of these puzzles came the study of economics. And the people who advised these Kings can be thought of as the first economists. And economists have continued to like puzzles ever since. Think about sovereigns in our own time. Think about something the government does and wonder why the government does it.
So a fire breaks out. You can imagine one world where ten competing fire departments, you’d look them up on the internet and you’d say, “Oh, how much to put out my fire?” And people would race around for prices to put out fires. That’s not the way it works. Instead, the government is in charge of firefighting. Economists are very interested in that, you know, why is the government in charge of firefighting and not growing wheat? Why doesn’t competition make firefighting work better or do governments somehow compete to see who’s better at putting out fires? Of course, there is a little bit of competition there because if the government does a bad job putting out fires or plowing the streets in the wintertime, then voters will throw them out of office and bring in new politicians. Still, that’s not exactly using prices, that’s using votes rather than prices. And our job today is to understand the use of prices. Two of the things we are going to focus on today are prices and the form of competition. And let me say a little bit about them before we get there.
Prices and competition or its opposite, monopolies, are two central tools in the study of economics. Prices are these things that tell people how much something costs, how much they have to sacrifice to buy it, how important it is to make more of the thing. We’re going to see a lot of prices today. By form of competition, I mean, the people who make these things, are they competing with other firms to make it or are they the only one out there making it.