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What is Economics? Why Study It?

Tags Calculation and KnowledgePhilosophy and Methodology

06/18/2002Gene Callahan

[Excerpt from Chapter 1 of Economics for Real People, available through Mises.org and Amazon.com.]

[Economics] is universally valid and absolutely and plainly human. —Ludwig von Mises, Human Action

When we first approach a science we want to know, "What does it study?" Another way of approaching the same issue is to ask, "What basic assumptions does it bring to its examination of the world?" As a first step in tackling a new subject, you usually try to gain an idea of what it is all about. Before buying a book on biology, you determine that you will be reading about living organisms. At the beginning of a chemistry course, you learn that you can expect to study the ways in which matter combines in different forms.

Many people feel that they are generally familiar with economics. However, if you ask around, you will find that people have difficulty in defining the subject. "It's the study of money," some might tell you. "It has to do with business, profit and loss, and so forth," someone else asserts. "No, it's about how society chooses to distribute wealth," another person argues. "Wrong! It's the search for mathematical patterns that describe the movement of prices," a fourth insists. Professor Israel Kirzner points out, in The Economic Point of View, that even among professional economists, there are "a series of formulations of the economic point of view that are astounding in their variety."

The primary reason for this confusion is that economics is the youngest of the sciences known to man. Certainly there has been a proliferation of new branches of existing sciences in the several centuries since economics came to be recognized as a distinct subject. But molecular biology, for example, is a division of biology, not a brand-new science.

Economics, however, is different. The existence of a distinct science of economics can be traced back to the discovery that there is a predictable regularity to the interaction of people in society, and that this regularity emerged without being planned by anyone.

The inkling of such regularity, standing apart from both the mechanical regularity of the physical universe and the conscious plans of any specific individual, was the first emergence of the idea of spontaneous order into the Western scientific consciousness. Before the emergence of economics as a science, it was simply assumed that if we found order in things, then those things must have been put in order by someone—God in the case of physical laws, and specific humans in the case of man-made objects and institutions.

Earlier political philosophers proposed various schemes for organizing human society. If the plan did not work out, the plan's creator generally assumed that the rulers or the citizens had not been virtuous enough to execute his plan. It didn’t occur to him that his plan contradicted universal rules of human action and could not succeed no matter how virtuous the participants were.

The increase in human freedom that began in Europe during the Middle Ages and culminated in the Industrial Revolution exposed a tremendous gap in the existing scheme of knowledge. Increasingly, Western European society was not being explicitly ordered by the command of a ruler. One by one, restrictions on production were falling. No longer was the entry into trades strictly controlled by a guild. Yet somehow there seemed to be about the right number of carpenters, blacksmiths, masons, and so on. No longer was a royal license necessary to enter into some line of manufacturing. And yet, although anyone could open a brewery, the world was not flooded with beer. Once again, the amount made seemed just about right. Even without anyone creating a master plan for a city’s imports, the mix of goods that showed up at the city gates seemed roughly correct. In the nineteenth century, French economist Frédéric Bastiat remarked on the wonder of that phenomenon by exclaiming, "Paris gets fed!" Economics did not create that regularity, nor is it faced with the task of proving that it exists—we see it in front of us every day. Economics, rather, must explain how it comes about.

Many scholars contributed to the dawning realization that economics was a new way of looking at society. The origins of economic science stretch back earlier than is frequently thought, certainly back to at least the fifteenth century, when work done by the Late Scholastics at the University of Salamanca in Spain later prompted Joseph Schumpeter to dub them the first economists.

Adam Smith may not have been the first economist, as he is sometimes called. But more than any other social philosopher he popularized the notion that human beings, left free to pursue their own goals, would give rise to a social order that none of them had consciously planned. As Smith famously put it in The Wealth of Nations, free man acts as if "led by an invisible hand to promote an end which was no part of his intention."

The Austrian economist Ludwig von Mises said in his magnum opus, Human Action, that this discovery left people filled with

stupefaction that there is another aspect from which human action might be viewed than that of good and bad, of fair and unfair, of just and unjust. In the course of social events there prevails a regularity of phenomena to which man must adjust his actions if he wishes to succeed.

Mises described the initial difficulties in determining the nature of economics:

In the new science everything seemed to be problematic. It was a stranger in the traditional system of knowledge; people were perplexed and did not know how to classify it and to assign it its proper place. But on the other hand they were convinced that the inclusion of economics in the catalogue of knowledge did not require a rearrangement or expansion of the total scheme. They considered their catalogue system complete. If economics did not fit into it, the fault could only rest with the unsatisfactory treatment that the economists applied to their problems. (Human Action)

For many, the feeling of stupefaction was soon replaced by one of frustration. They had ideas for reforming society, and now they discovered that the emerging science of economics stood in their way. Economics advised these reformers that some plans for social organization would fail regardless of how well they were carried out, because the plans violated basic laws of human interaction.

Stopped in their tracks by the achievements of the early economists, some of these reformers, such as Karl Marx, attempted to invalidate the entire subject. Economists, Marx contended, were simply describing society as they found it under the domination of the capitalists. There are no economic truths that apply to all men in all times and places; most specifically, the laws formulated by the classical school, by writers such as Smith, Thomas Malthus, and David Ricardo, will not apply to those living in the future socialist utopia. In fact, said the Marxists, these thinkers were merely apologists for the exploitation of the masses by the wealthy few. The classical economists were, to phrase it in the style of the Chinese Marxists, running dog lackeys of the imperialist warmonger pigs.

The extent to which Marx and like-minded thinkers succeeded in their goal of undermining the foundations of economics reflected the fragility of those foundations. The classical economists had discovered many economic truths, but they were plagued by certain inconsistencies in their own theories, such as their inability to construct a coherent theory of value. (We will address this specific difficulty in more detail later.)

It was Mises, building on the work of earlier Austrian economists such as Carl Menger, who finally reconstructed economics "upon the solid foundation of a general theory of human action."

For some purposes it might be important to differentiate between the general science of human action, which Mises called praxeology, and economics as the branch of that science that deals with exchange. However, since the term praxeology has not gained widespread use, and a sharp delineation of economics from the rest of praxeology is unimportant in an introductory book, I will use economics as the name for the entire science of human action. Mises himself often uses it in this manner: "Economics . . . is the theory of all human action, the general science of the immutable categories of action and of their operation under all thinkable special conditions under which man acts" (Human Action).

What does Mises mean by "human action"? Let him tell us:

Human action is purposeful behavior. Or we may say: Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego’s meaningful response to stimuli and to the conditions of its environment, is a person’s conscious adjustment to the state of the universe that determines his life. (Human Action)

In a similar vein, the British philosopher Michael Oakeshott described human action as the attempt to replace what is with what ought to be, in the eyes of the person acting.

The wellspring of human action is dissatisfaction, or, if you want to see the glass as half full, the idea that life might be better than it is at present. "What is" is judged to be deficient in some way. If we are completely satisfied with the way things are at this moment, we have no motivation to act—any action could only make matters worse! But as soon as we perceive something in our world that we judge to be less than satisfactory, the possibility of acting in order to remedy this situation arises.

For example, you lie on a hammock, perfectly happy with the world, letting everything pass you by. But your idle is disturbed by a buzzing sound. It occurs to you that you would certainly feel more relaxed if this sound stopped, in other words, you can envision circumstances that you feel ought to be. You are experiencing the first component of human action, dissatisfaction.

However, in order to act, dissatisfaction is not enough. First of all, you must understand the cause of the uneasiness. Well, the noise, of course. But we cannot simply wish noises away. We must discover what is causing the noise. In order to act, we must understand that each cause is the effect of some other cause. We must be able to follow a chain of cause and effect until we reach a place where we feel our intervention, our action, will break the chain and eliminate our dissatisfaction. We must see a plan for moving from what is to what ought to be.

If the buzzing is from an airplane passing overhead, you will not act. (Unless your house has an anti-aircraft gun installed, there is nothing that you’ll be able to do about the plane.) You must believe that your action can cause an effect in your world. In order to act, it’s not necessary that you are correct in your belief! Ancient man often believed that performing certain rites could improve his environment, perhaps bringing rain during a drought or causing the herds he hunted to increase. As far as I know, those approaches did not work. But the belief that they would was enough to lead people to act on them.

So you look around to find the cause of the noise and see a mosquito. Perhaps you can do something about the buzzing—you can swat the little bugger. You are contemplating an end, that of being rid of the mosquito. You see that achieving the end will bring you a benefit—the noise will be gone, and you can rest undisturbed.

So, you could get up and kill the mosquito. But you had come outside with another end in mind—just loafing around on the hammock. You are now grappling with another component of human action—you have to make a choice. Being rid of the mosquito would be grand, sure—but you’ll have to get up. And that’s a bummer. The benefit you expect to receive from being rid of the mosquito comes at the cost of getting up. If the benefit from your action exceeds your cost, you will profit from the action.

Although we often use profit to refer to monetary gain, it also has a wider sense, as in, "How does it profit a man to gain the world but lose his soul?" We perform all of our actions, whether buying a stock or retreating to a mountain to meditate, with an eye to profiting in this psychic sense. As the above quotation indicates, if we choose to lead a pious life in poverty, it is because we expect the end result to benefit us more than the cost of surrendering the pursuit of worldly goods: we expect to profit from the choice.

Choices involve considering the means necessary to achieve our ends. I wouldn’t mind being the strongest man in the world. But if I contemplate pursuing this end, I must also think about what I would have to do to achieve it. I would need to have access to strength-training equipment, to buy nutritional supplements, and I would have to spend many hours each day in training. In our world, everything we desire does not appear simply by wishing for it. Many things that we want, even things that we need to stay alive, can be had only after an expenditure of time and effort. Strength-training equipment does not simply fall from the sky. (Thank God!) And if I’m spending several hours a day weight lifting, I can’t spend those hours writing a book, or playing with my kids.

For mortal man, time is the ultimate scarce item. Even for Bill Gates, time is in short supply. Although he can afford to charter private jets to both Aruba and Tahiti on the same morning, he still can’t fly to both places simultaneously! To be human is to know that our days on Earth are numbered, and that we must choose how to use them. Because we live in a world of scarcity, the use of means to pursue an end involves costs. To me, the cost of spending my time weight training is determined by how much I value the other ways I could spend that time.

For economics, the value of the particular ends we might choose is subjective. No one else can tell me whether an hour spent weight lifting is more or less valuable to me than one spent writing. Nor is there any possible way to objectively measure the difference in my valuation of these activities. No one has invented a "value-ometer." Expressions such as "That dinner was twice as good as last night’s" are simply figures of speech. They don’t imply an actual ability to measure satisfaction. As Murray Rothbard pointed out, the way to verify this is to ask, "Twice as much of what?" We don’t even have a unit by which we might measure satisfaction.

The subjective nature of value was one of Carl Menger’s major insights. For the classical economists, value was a paradox. They attempted to base their theory of value on the labor involved in producing a good or the usefulness of the good, by some objective measure. But consider such a simple case as finding a diamond lying on the ground during a stroll. No labor was required to produce the diamond, nor is it more useful, at least to directly maintaining life, than a cup of water. And yet a diamond is generally considered much more valuable than a cup of water. Menger cut this Gordian knot by basing his theory of value on just that fact—things are valuable because acting humans consider them to be so.

Economics does not attempt to decide whether our choice of ends to pursue is wise. It does not tell us that we are wrong if we value a certain amount of leisure more than some amount of money. It does not view humans as being only worried about monetary gain. There is nothing "noneconomical" about someone giving away a fortune, or turning down a high-paying job to become a monk.

The question of whether or not there are objective values does not concern economics. Again, that should not be taken to mean that Austrian economics is hostile to any religion or system of ethics. I personally know of Austrian economists who are Catholics, atheists, Orthodox Jews, Buddhists, Objectivists, Protestants, and agnostics, and, if I only knew more economists, I’m sure I could mention Muslims, Hindus, and so on. Economics should, quite properly, leave comparing values to ethics, religion, and philosophy. Economics is not a theory of everything, but simply a theory of the consequences of choice. In studying economics, we take human ends as an ultimate given. People, somehow, do choose ends and do act to pursue them. The goal of our science is to explore the implications of these facts.

Mises said in the introduction to Human Action:

Choosing determines all human decisions. In making his choice man chooses not only between various material things and services. All human values are offered for option. All ends and all means, both material and ideal issues, the sublime and the base, the noble and the ignoble, are ranged in a single row and subjected to a decision which picks out one thing and sets aside another. Nothing that men aim at or want to avoid remains outside of this arrangement into a unique scale of gradation and preference. The modern theory of value widens the scientific horizon and enlarges the field of economic studies.

Why Should We Study Economics?

Once we have an idea what our subject is, the next question is whether it is worth studying. Given that you are reading this essay, you must have some notion that it could be useful. But if you don’t intend to become a professor of economics, what can you gain from learning about it?

One of the benefits of studying economics is a deeper understanding of our own situation as acting humans. For instance, people often fail to properly account for the cost of their choices. Once we understand that our costs are measured in terms of our foregone alternatives, we might have a very different view of some common choices.

Let's look at a mundane example. We all know someone who has spent a great deal of time on some home improvement project. Perhaps this person undertook the project for sheer enjoyment. Economics will not attempt to recommend something else that would have been more enjoyable—it is not a self-improvement guide!

But often, the "do-it-yourselfer" will say that he is doing the work to "save money." "Look," he’ll tell you, "it would have cost me $5,000 to get my roof done professionally. I managed to do it for only $1,000 in materials." An economist is able to point out that his calculation is faulty, and that he may have acted contrary to his own purpose. He has not taken into account the cost of his foregone opportunities. If the job took him 100 hours, and he could have put this time in at work and earned an additional $8,000, he has actually suffered a large monetary loss by doing the job himself. This example turns on dollars and cents, but in other cases, it is psychic costs that we fail to account for properly. When a philanderer cheats on his wife, we may wonder if he has fully considered the costs involved. Perhaps he has, in which case economics can turn the problem over to ethics and religion. But all too often, people take account of the immediately visible profit from an action and fail to account for the less visible, more distant costs. Bastiat referred to this as the problem of what is seen and what is not seen. He felt that it was an important task of economics to teach us "not to judge things solely by what is seen, but rather by what is not seen."

Another benefit of an understanding of economics is that it is crucial to evaluating questions of public policy. Should we raise the minimum wage, leave it alone, or even eliminate it? Can we lift our standard of living by protecting domestic industries? What would be the result of privatizing Social Security? These are all economic questions.

Some people feel that these questions should be answered on a "practical," case-by-case basis. They claim to disdain the use of theory in resolving them. The English economist John Maynard Keynes saw the error in such thinking:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist. (The General Theory of Employment, Interest, and Money)


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