Mankiw’s Ten Principles of Economics 1: People Face Trade-offs

The introduction to this series is here.

The first of the Ten Principles of Economics laid down by N. Gregory Mankiw is “People Face Trade-Offs”. Principles of Macroeconomics, 6th Ed. 2012, p. 4. In language more suited to a high school textbook than a best-selling college textbook, he provides several examples. If you study economics for five hours, then you can’t spend that time studying something useful, like welding or English Literature. If parents have a certain amount of money, every dollar they spend on rent can’t be saved, or used to buy food. Then, as if society were a person, and faced trade-offs in exactly the same way (government is just like a household) he gives two macro examples. First:

The more a society spends on national defense (guns) to protect its shores from foreign aggressors, the less it can spend on consumer goods (butter) to raise the standard of living at home.

There is also a trade-off between a clean environment and a high level of income. If companies have to pay for environmental contamination, they make smaller profits, pay lower wages, or raise prices or some combination. This is the last example:

Another trade-off society faces is between efficiency and equality. Efficiency means that society is getting the maximum benefits from its scarce resources. Equality means that those benefits are distributed uniformly among society’s members. Emphasis in original.

Mankiw explains this by saying that government policies that help those in need, like unemployment insurance or welfare reduce efficiency, because, and I quote because otherwise you’ll think I’m being snarky:

When the government redistributes income from the rich to the poor, it reduces the reward for working hard; as a result, people work less and produce fewer goods and services. In other words, when the government tries to cut the economic pie into more equal slices, the pie gets smaller.

The statement that individuals face trade-offs in consumption of goods and services as well as every other human activity is vacuously true. We get one life, and at any point in time can only do one thing. If we do one thing we cannot do another. So what’s the point of this principle? I think it’s not the principle itself, but the examples. Each supports the principles of neoliberalism, as described by Philip Mirowski in this article.

Mankiw’s first two examples are folksy and disarming. Let’s try a similar version:

Angela has a problem: should she summer with her mom on Martha’s Vineyard, or should she summer with her dad on their ranch in Montana? Jane has a problem: should she pay her utility bill, or should she buy the drugs she needs to control her Parkinson’s Disease? Since these are two individuals, you can see that the problems they face are identical. Both will suffer if they make the wrong decision, and both will suffer anyway because of the knowledge they could have chosen otherwise. The rich and the poor are just the same: people struggling with trade-offs. Or, from Mirowski on neoliberalism: [9] Thou Shalt Know That Inequality Is Natural.

Things get more complicated at the macro level. The third example, guns or butter, is as abstract as the first two are concrete. Mankiw makes it seem that “defense” is a consumer good, like Hummel Figurines or orange marmalade. The government just goes down to the defense store and buys as much as it wants. He doesn’t talk about how those decisions get made at the social level, and doesn’t talk about who gets the benefits of those guns and who pays the costs of the foregone butter, or whether there are better ways to keep aggressors away than bombing their countries. He turns the example into a concrete fact, with no context. The choices made in the US and other countries about how much “defense” to “buy” would make a really interesting case study in macroeconomic behavior, and just defining terms would be really helpful to public discourse. That’s certainly not the point of the Mankiw textbook.

One of the goals of neoliberalism, Mirowski’s Number 5, is to change the idea of democracy from one of participation by citizens in determination of social policy to one of consuming state services, like defense. Guns v. butter shows how that notion gets into people’s heads. Given the level of corruption in the system, in the broad sense of Zephyr Teachout in her excellent book, Corruption in America, it’s also an example of crony capitalism, part of Number 8. There’s a lot more to unpack in the guns and butter example, but let’s move on.

The environmental example is fascinating. From the very beginning of this country, companies polluted lakes, rivers and the air, to keep costs low and prices down. No one did anything. Then when citizens started complaining about their ability to breathe the air and drink the water, and the rich people and their corporations act all outraged, like they have a right to pollute. Mankiw ignores this history, and ignores the obvious fact that dumping pollutants everywhere hurts everyone in general, and some people dramatically; and profits only a few. Again, the entire issue of pollution and environmental destruction would make fascinating case studies in economics. Mankiw’s discussion supports Mirowski number 10: Thou Shalt Not Blame Monopolies and Corporations.

Finally, there is the trade-off between equality and efficiency. Mankiw’s explanation about the negative effects of a progressive income tax on economic efficiency is flatly wrong. For my explanation, see this and this and this. For a short view, does Mankiw think the economy in the 50s was less efficient strictly because of high income and estate taxes on the rich? I’d love to see a paper showing how that happened. Piketty and Saez suggest a top tax rate of 80%. Here’s a short article explaining their thinking, and here’s an impenetrable paper that lies below it.

I assume Mankiw was referencing Arthur Okun’s 1975 book Equality and Efficiency: The Big Trade-Off. Okun postulated that there was a trade-off between equality and economic efficiency from his armchair, and he discusses the implications for policy in this excellent piece. By 1995, it was clear that the facts did not support his speculation. This paper is a review of literature and discussion of exactly how wrong Okun was: Lars Osburg, The Equity/Efficiency Trade-off in Retrospect. Subsequent work has made this even more clear. Mankiw ignores all the evidence and new theory to the contrary, choosing to continue to support an unmeasured armchair theory Mirowski number 9: Thou Shalt know that Inequality is Natural.

The point of this discussion is that textbooks have an outsized influence on people, particularly on non-specialists. They may not recall the argument, but they will recall the examples and the general approach, especially when those are common in discourse, and not contravened by other authorities. I know this from my own college education. It has taken years for me to shed the parts that don’t conform to the reality of life as I have lived it and seen it.

Notre Dame undergrad (math); JD, Indiana University at Bloomington; 1st Lieutenant, US Army.; private practice in corporate and securities law; Assistant AG in Tennessee for consumer protection and securities; Blue Sky Securities Commissioner, Tennessee; private practice, bankruptcy and corporate law.

I have had a lifelong interest in economics. For most of my career, that interest was practical, focused on the problems in front of me. Lately I have been more interested in economics as a theory, especially its impact on the lives of people like those I met in my bankruptcy practice, and on the politics of money in the US. I also enjoy reading philosophers, starting in college and steadily expanding my reading ever since. I wrote at FireDogLake for a number of years.

Generally, I think the problem facing the US is the dominance of neoliberal discourse. I think it clouds the vision, and limits the kinds of problems that can be identified and solved. For example, the existence and danger of climate change can easily be identified in a scientific discussion. However, the problem does not fit the neoliberal discourse because science insists that the pursuit of individual and corporate self-interest will lead to devastation. In neoliberal discourse, the pursuit of self-interest always leads to Eden.

The neoliberal project has two prongs. One is the police function of crushing dissent and alternative views. The police function is provided by government agencies and private and institutional actors. The counterpart is the economic system , which is operated by government and by private and institutional actors. Some of these actors operate in both spheres. I focus on the second prong.

20 replies
  1. Alan says:

    Mankiw quoted by Ed: “Another trade-off society faces is between efficiency and equality. Efficiency means that society is getting the maximum benefits from its scarce resources.”
    *
    For a rather different take on supposed efficiency and equality trade-off see Why Profit Maximization Is Absurd. (The link goes to a section of an interesting site that is developing a critique of neoclassical economics based on the writings of Smith and Hume.)

  2. TarheelDem says:

    Let’s look at the telescope the other way around. The earth has a finite amount of materials of certain kinds. The stored energy in earth’s materials and the influx of energy from the universe is finite. The life of each laborer is finite. So are the life of each plant or animal. There are in fact natural limits and limits placed on the carrying capacity of the global ecological system. One wonders why the miraculous economic system is not presenting the tradeoffs associated with those limits in a way that allows sound ecological-economic decisions.

    Money is limited by the matter and energy required to make the tokens that represent it. It is finite, but the symbolic capacity of money, especially in digital form is immensely huge.

    Putting things back in order is a continuing cost of being in the natural world. The tradeoff between novelty and maintenance is always present.

    I’ve probably left out some of the real limits.

    What is striking about Makiw’s argument is those are fundamentally contrived examples whose purpose seems to set up the argument that markets are the most efficient way to allocate goods under conditions of tradeoff. That is, scarce goods or limited goods.

    One of the things that is still troubling about economic theory (among the many) is the failure to have a way of incorporating the two realities that are front and center in the economy: technology and information.

    Making choices or tradeoffs central to economics seems to be a matter of academic imperialism, trying to extend the jobs of economists into other areas of the social sciences and especially into law and politics. That seems to me to be the core of the neoliberal project–creating a frame of neoliberalism that will permeate law, politics, and business and provide intellectual control (i.e. the ability to run experiments on entire populations disguised as policy recommendations) and job security for the young neoliberal economists going through the institutions.

    In this respect, you are correct. Textbooks are not technical; they are propaganda.

    • thatvisionthing says:

      There are in fact natural limits and limits placed on the carrying capacity of the global ecological system. One wonders why the miraculous economic system is not presenting the tradeoffs associated with those limits in a way that allows sound ecological-economic decisions.

      I have seen this question asked in a Randy Wray MMT post on Naked Capitalism last year. Ed’s July 2 Revolutionary Changes post linked to a different RW/MMT/NC post that had over 300 comments on it. I felt such a pang when I saw Hugh was one of the first commenters, haven’t seen him for awhile. Anyway, the post I’m referring to, Debt-Free Money, had over 500 comments, none of which Wray fielded on NC, though he did go through them and pick some out to take over to his own blog to laugh at. Meanwhile on NC, disagreements and heat and people (Wray: “trolls”) (me: “Hugh”) got banned. Because that’s how MMT rolls. But here’s the question and here’s the answer:

      http://www.economonitor.com/lrwray/2014/07/04/battling-the-master-baiters-in-the-trenches-for-mmt-troll-friday/

      JZ July 2, 2014 at 9:05 am. Lol. Wake me when MMT demonstrates how to print oil.

      (Randy Wray:) (Done, dude. My new 3-D printer.)

  3. thatvisionthing says:

    Macro econ 101: At least, I’m trying to remember, I think it was macro econ 101 that I … I guess I had a teaching moment that I still keep thinking about. First, realize I have not got that mathematical brain. Also not good with heavy textbooks. Was probably in the wrong place. But, fulfilling a requirement. So like at the first lecture class in that bowl room with 150+ students, we’ve had an assignment to read, I was kind of not getting something basic, and I raised my hand and as part of my question I said or asked: I don’t even know where money comes from. Like tell me that first thing. And the teacher made fun of me. And I dropped the class. And that was the sum of my college econ education. Skip to 2008. Ah, you know, that was a good question.

  4. jonf says:

    Guns and butter. I recall arguing about it during Viet Nam. It is simply silly. If you really need the guns that is what you buy. But on that account it does not mean other goods and services are lost. And of itself it carries no lesson or moral.
    .
    Unemployment and poverty are macro consequences of capitalism as practiced under our neo liberal banner. It says nothing at all about who works the hardest. And payments to the unemployed reflects that fact. Some people get wealthy often owing merely to luck and nothing at all related to working hard.
    .
    So trade offs are as you say : vacuous. And some, maybe most, have nothing at all to do with real economic choices.

  5. bloopie2 says:

    My takeaway from your post is that, in real life, things are so much more complicated than a simple equation can comprehend. I think that’s true. But when I follow that line of reasoning further, I end up at a point where no assumption or set of rules can describe what’s happening. I feel that “What’s the point of any of this?” Truly, if all the economists and wannabes would shut up, what would we lose? Doesn’t the “economy” go on by itself? Shouldn’t we (including the politicians who try to put ideas into action) just ignore all of them and just go on without lives? Would it make any difference?

    • Ed Walker says:

      Well, I think there is a lot to be said for thinking about how the economy works. One way to do that is with an ideological bias masquerading as a textbook. Another way would be a case examination, for example, how does our society actually make decisions about specific economic allocations like guns and butter or who gets what kind of health care. In the second case, the answer “markets” gets you an F.

  6. wallace says:

    quote” Truly, if all the economists and wannabes would shut up, what would we lose?”

    note.. file this under

    Great Moments in Cognition

  7. orionATL says:

    mankiw does not have a particularly good reputation among macroeconomists of high intellectual caliber. he seems, however, to be well appreciated among those who procure his intellectual services.

    as for the hobson’s choice of guns or bread, one argument used to be that war and war materials are inflationary because non-productive. but that seems only to be the case in good economic times. the u.s has been at war for 15 years with little effect on prices. perhaps we can say now that severe recessions are good for war.

    in any event, warring has two consequences on labor and consumption – it takes men and women out of the productive labor market and it kills, or renders less well-off, potential consumers.

    as for mankiw’s alleged efficiency vs equality hobson’s choice, that is an example of the blatant nonsense for which mankiw’s services are procurred by those favoring the favoring of the very well-to-do.

    in the first place, “equality” in common economic use does not mean literal, strict equality, e.g., in the economic world not everyone has to have the identical income. in the second place “efficiency” is a code word for “market efficiency” which is a) a grotesque fiction about economic efficiency in reality (and one which demands in-equality in order for “market efgiciency” to work at all) and b) a moral, political, and intellectual open sesame for predacious individuals operating in a market.

  8. thatvisionthing says:

    textbooks, Stephanie Kelton interviewing fellow UMKC econ prof Fred Lee last year:

    http://stephaniekelton.libsyn.com/fred-lee-talks-about-his-contributions-to-heterodox-economics

    Stephanie Kelton: Years ago I remember you gave a talk and we had a conference here at UMKC, and I think we were over in the Lindehall Library and we had a huge room full of people and you got up and you grabbed some microeconomics textbooks and you opened a window and you threw them out the window. I remember that, and it was shocking to people in the room because you were essentially saying everything contained within these, right, within the bounds of these pages should just be thrown out completely. So where do you start?

    Fred Lee: Start throwing out, you pick the book up and throw it in the trashcan.

  9. pdaly says:

    I like your example, Ed, of Angela’s dilemma (should she summer with mom on Martha’s Vineyard, or summer with dad in Montana?) vs. Jane’s (should she pay her utility bill or purchase her medications to control her Parkinson’s Disease).
    .
    The false equivalency to their situations is clear to people with limited incomes. I wonder whether a wealthy person like Angela would see it the same way.
    .
    When it comes to tradeoffs for the rich, it seems “time” rather than “money” is their scarce resource. The rich girl Angela could afford to do BOTH–visit mother on Martha’s Vineyard AND visit father on his Montana ranch. She would just have to figure out the social opportunity costs of being in one place over the other and time her visits right.
    .
    And perhaps rich Angela assumes that the Janes of this world could SIMILARLY do “both” (pay the rent and pay for meds) if only the Janes were not ..I don’t know.. ‘lazy’, ‘spending money on unnecessary things’ or ‘expecting handouts’?
    .

    • Ed Walker says:

      That’s a nice analysis of this example. I intended it to point to the role of utilitarian thinking in neoliberalism, but your discussion shows us how a person might react to their own situation by assuming that everyone could do what they do, and blaming those who don’t do well for failing. People don’t like to assume that their personal success or even their personal status is due to anything other than their personal merit. It’s almost like people internalize the tenets of utilitarianism to justify their good fortune.

  10. thatvisionthing says:

    “People face tradeoffs” — stay in the box and look in the mirrors, or step outside

    https://www.youtube.com/watch?v=bkZyUeZ5jSs

    Jaron Lanier: There’s a whole world, I mean there’s worlds within worlds within reality outside of the digital sphere. You know, back in the old days when we were doing the early experiments with virtual reality, one of the things we always did is we took a flower and we left it outside so when somebody would come out of virtual reality they could look at the flower. Because when you’re in virtual reality for a long time and then you look at a flower, you’ve never seen a flower like that. Suddenly you see it as this thing so filled with detail and so filled with just mystery and it just glows. I’ve always kind of found that to be the best use of the digital world, not to treat it as a channel to reality, not to treat it as a way to organize reality, but to treat it as a contrast to reality. Because then it helps us notice just how absolutely astonishing this world we’re in is. You know, it’s astonishing.

  11. thatvisionthing says:

    people face tradeoffs

    Why do you seek gold when our land has such lovely flowers?
    – Last words of Peru’s Inca ruler, Atahualpa, before being strangled by Francisco Pizarro’s men

    from Guiding Stars, a sampler of quilters’ favorite quotations

  12. ess emm says:

    Nice article. Obviously Mirowski is on to the game the neo-liberal A-holes are playing. We small-d democrats need to develop a political program that is a real alternative to neo-liberalism rather than just the same neo-liberal program that unfolds a little slower, or is slightly gentler.

  13. Alan says:

    I think one of the key points to keep in mind as we slog through Mankiw’s ten principles is one made by Mirowski in the paper you quote:

    Along the way they have lightly sloughed off many prior classical liberal doctrines…without coming clean on their reversals.

    *
    This also connects up with the earlier discussion of paradigms. Neoclassical economists and neoliberals represent modern economics as if there is an economic paradigm that started with Adam Smith. But Samuelson, Friedman, Hayek, Mankiw and many others have all systematically misrepresented the history of economics to make this appear to be the case. They aren’t extended and elaborating Smith as much of what Smith wrote is in at odds with their own economic theories. What Mankiw claims Adam Smith claimed, for example, is complete crap. This is not a matter of the finer points being open to interpretation. You’d have to be an illiterate to read Wealth and believe Mankiw’s claims about Smith. At least one critic has stated that Mankiw’s use of Smith in his ten principles “borders on academic malpractice”.

    • Ed Walker says:

      It’s infuriating that economists act like there is an actual paradigm in economics, one with sufficient power and consensus to justify teaching it to non-specialists who will use it in their daily lives, and specifically in the formation of their political/economic views and their political stances. It means that even people whose views are progressive are amenable to the bullshit suggestions of the Third Way dems and the centrists who claims that the answer has to involve markets and not governments.
      *
      It’s a struggle just to get people to think about economics as a social justice issue, rather than an technical problem best left to experts.

    • thatvisionthing says:

      I’m looking for trees in economics. Not board feet, trees. Living, breathing trees holding their ground. Do they exist, and under what theory? How do they figure? I searched “tree” in Steve Keen’s 518-page PDF and got two hits, one in the bibliography, references to J.D. Robertson’s (1930) Trees of the Forest, Economics Journal 44 (can’t find–help anyone?), and this anecdote on p. 181:

      Have you heard the joke about the chemist, the physicist and the economist who get wrecked on a desert isle, with a huge supply of canned baked beans as their only food? The chemist says that he can start a fire using the neighboring palm trees, and calculate the temperature at which a can will explode. The physicist says that she can work out the trajectory of each of the baked beans, so that they can be collected and eaten. The economist says, ‘Hang on, guys, you’re doing it the hard way. Let’s assume we have a can opener.’2

      (wondering, was that a coconut palm?)

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