WEBVTT NOTE How Do People Make Economic Decisions? 1 00:00:00.000 --> 00:00:30.000 What I want to talk about today are a few of the most basic principles of economics and what I want to get across with this talk is a description of what we call like the economic point of view which is a way of looking at things and understanding how economic principles play a role in shaping the world we live in and I hope I'll be able to explain these ideas in very simple terms and then show you how you can use even very simple concepts to think about much bigger and more complicated problems in the real world. So just to start I should say something about 2 00:00:30.000 --> 00:00:33.840 about why the economic point of view is important at all. 3 00:00:33.840 --> 00:00:38.680 One of the most important ideas spread by Ludwig von Mises and others was the notion 4 00:00:38.680 --> 00:00:42.120 that ideas are what shaped the course of history. 5 00:00:42.120 --> 00:00:46.760 Even the most powerful nations in the world ultimately rest on the ideas held by the people 6 00:00:46.760 --> 00:00:47.860 in them. 7 00:00:47.860 --> 00:00:53.520 So all it takes to change things is to change the ideas people have about the world. 8 00:00:53.520 --> 00:00:58.060 And so economics, which is a part of every bit of our everyday lives, is absolutely vital 9 00:00:58.060 --> 00:01:03.220 for people to understand in order for them to be able to hold informed opinions about 10 00:01:03.220 --> 00:01:05.780 human society and the way it works. 11 00:01:05.780 --> 00:01:12.660 And one way economics helps us to change these ideas is that it gives us a very specific 12 00:01:12.660 --> 00:01:17.620 scientific way to look at certain questions and answer certain problems. 13 00:01:17.620 --> 00:01:22.340 So what I mean is if we think about discussions of economic policy that we usually hear on 14 00:01:22.340 --> 00:01:26.940 the TV and in the news and so on, a lot of time, a lot of the time when we argue about 15 00:01:26.940 --> 00:01:56.940 about these things. Reporters and analysts focus on questions like what rights does the government have to make me do this or that or they say things like my individual rights come before those of society or something along those lines and these ideas are important but with economics we can actually avoid some of these very difficult problems just by pointing to the results of our logic and saying well look it doesn't really matter what we think should be the case, should be the goal that we're aiming for. 16 00:01:56.940 --> 00:02:04.940 The policy that we're discussing can't possibly produce the results that you want it to. 17 00:02:04.940 --> 00:02:11.940 So, for example, in the recent healthcare debate, a lot of the focus was on issues like, is it constitutional and things? 18 00:02:11.940 --> 00:02:20.940 And as important as those questions are, economists ask questions like, what are the necessary results of this policy? 19 00:02:20.940 --> 00:02:25.740 okay so with that in mind we can start with the basics with maybe the broadest 20 00:02:25.740 --> 00:02:30.900 of all economic questions which is why do people do what they do what motivates 21 00:02:30.900 --> 00:02:34.980 people and this is obviously a very important question in economics but the 22 00:02:34.980 --> 00:02:39.220 answer is very simple people do things which they believe will make them happy 23 00:02:39.220 --> 00:02:44.220 individuals are always choosing to do whatever it is that they believe will 24 00:02:44.220 --> 00:02:49.380 increase their welfare and this idea of welfare of human happiness is an umbrella 25 00:02:49.380 --> 00:02:55.380 which actually covers everything that people are capable of valuing from very 26 00:02:55.380 --> 00:03:02.220 simple things like providing for your own immediate physical needs but also 27 00:03:02.220 --> 00:03:06.180 this also includes broader activities things that we would consider selfless 28 00:03:06.180 --> 00:03:14.540 as opposed to selfish things like giving to charity and things like this and this 29 00:03:14.540 --> 00:03:18.180 is a big difference actually in the way that Austrian economists see the world 30 00:03:18.180 --> 00:03:34.180 as opposed to most economists because most economists tend to assume that people only value things for their own uses for very narrow selfish purposes and that they only value a very small number of easily definable things like their money income. 31 00:03:34.180 --> 00:03:43.180 So it's very, most economics is actually quite unrealistic in this sense, whereas the Austrians I think tend to get it right because they understand that people can actually pursue anything they want. 32 00:03:43.180 --> 00:03:49.020 So, Washington Economics is capable of explaining all the choices that human beings make as 33 00:03:49.020 --> 00:03:50.580 opposed to just a very few. 34 00:03:50.580 --> 00:03:54.940 Okay, so there's this whole range of things which motivate people and economists call these 35 00:03:54.940 --> 00:03:55.940 motives incentives. 36 00:03:55.940 --> 00:03:59.500 This is one of the big concepts in economics. 37 00:03:59.500 --> 00:04:05.100 Some of you may have heard of or actually read the famous book by Stephen Leavitt and 38 00:04:05.100 --> 00:04:09.500 Stephen Dubner called Freakonomics, which is very popular these days, which basically 39 00:04:09.500 --> 00:04:13.120 argues that everything in economics is an incentive problem. 40 00:04:13.120 --> 00:04:19.120 And they ask all kinds of very strange questions like, what do sumo wrestlers and high school teachers have in common? 41 00:04:19.120 --> 00:04:26.120 Or why is it that the vast majority of all drug dealers still live with their moms? 42 00:04:26.120 --> 00:04:35.120 And the answer, by the way, is that sumo wrestlers and high school teachers both have a very high incentive to cheat, and in fact do cheat. 43 00:04:35.120 --> 00:04:42.120 And most drug dealers live with their moms because the vast majority of drug dealers make less than the minimum wage. 44 00:04:42.120 --> 00:04:52.120 But anyway, the point is that with this kind of reasoning, you can answer all kinds of very strange questions just with a little bit of economic thinking. 45 00:04:52.120 --> 00:05:01.120 By the way, I would actually hesitate to recommend that book for economics or any of the many books like it because I think there are some problems with it that I'll just mention in a few minutes. 46 00:05:01.120 --> 00:05:09.120 But in any case, these economists spun a really elaborate explanation for these strange little problems out of this very simple concept of incentives. 47 00:05:09.120 --> 00:05:15.120 And incentives are basically just a fancy way of saying that people do things that they believe will make them happier. 48 00:05:15.120 --> 00:05:22.120 So we realize that individuals pursue happiness by themselves, but then the next question is, 49 00:05:22.120 --> 00:05:27.120 what if, in order to make myself better off, I need the help of someone else? 50 00:05:27.120 --> 00:05:33.120 How can people be induced to behave in a certain way which benefits me? 51 00:05:33.120 --> 00:05:37.120 And again, the answer is simple. You have to provide them with a benefit. 52 00:05:37.120 --> 00:05:42.840 you have to provide them with an incentive so for example I don't want to 53 00:05:42.840 --> 00:05:50.280 work I would rather watch my Jersey Shore marathon in my underwear so someone 54 00:05:50.280 --> 00:05:54.440 else offers to pay me to work and that payment is my incentive it's a reason 55 00:05:54.440 --> 00:05:59.480 that I for me to do something it's a benefit that I gain and of course the 56 00:05:59.480 --> 00:06:03.280 cost of choosing to work is that I miss out on the delightfully tasteless 57 00:06:03.280 --> 00:06:19.280 Incentives are simple, but they get a bit more complicated when we look at society and many individuals and see that all of society is essentially a network of incentives provided by people to get other people to do things that they maybe normally wouldn't do. 58 00:06:19.280 --> 00:06:27.280 But the key to understanding this is that in doing this, in doing things for other people, we actually make each other better off. 59 00:06:27.280 --> 00:06:37.280 And I think a little bit later, Dr. Thornton is going to talk about social cooperation in the division of labor and how this increases welfare, so I'm not going to step on his toes too much. 60 00:06:37.280 --> 00:06:46.280 But I will just point out that the market is this amazing method of coordinating different people's incentives, coordinating the different things that people want. 61 00:06:46.280 --> 00:06:51.280 And it works without having to organize it from the top down by force. 62 00:06:51.280 --> 00:06:53.320 by Force. 63 00:06:53.320 --> 00:06:59.920 And once we understand this, it becomes very important also to understand what people want 64 00:06:59.920 --> 00:07:04.800 to do and try and look at the economy and see if it's organized in a way that allows 65 00:07:04.800 --> 00:07:09.440 for that to happen, that allows for people to achieve their goals. 66 00:07:09.440 --> 00:07:15.960 And especially we have to look at how society is organized because it turns out that government 67 00:07:15.960 --> 00:07:20.640 tends to create disharmony through various artificial restrictions which create perverse 68 00:07:20.640 --> 00:07:45.640 The best way to think about this is to just take the idea of how a free market works and what kind of incentives it provides and compare that to economic systems which aren't completely free, to see the contrast. 69 00:07:45.640 --> 00:07:51.640 And when we compare free and regulated economies, we of course, we always have to remember that even free markets aren't perfect. 70 00:07:51.640 --> 00:07:55.640 Sometimes the market does generate strange incentives for people. 71 00:07:55.640 --> 00:08:03.640 But the point is that these problems tend to be minimal if people are free to choose whether or not to interact with each other, to make contracts with each other. 72 00:08:03.640 --> 00:08:07.640 And if people are free to change the arrangements they have if they don't work. 73 00:08:07.640 --> 00:08:14.640 But it probably won't come as a surprise to you that the most serious problems appear when government intervenes in the economy. 74 00:08:14.640 --> 00:08:23.120 So you can think about incentive problems by comparing which kind of behavior is desired 75 00:08:23.120 --> 00:08:26.600 and which kind of behavior is actually rewarded. 76 00:08:26.600 --> 00:08:29.360 Now if they're the same, then there's no problem. 77 00:08:29.360 --> 00:08:34.140 But when you reward behavior that you don't want, you simply encourage it. 78 00:08:34.140 --> 00:08:38.560 So to take a recent example, there was this fuss a few weeks ago about the budget and 79 00:08:38.560 --> 00:08:42.720 the concern that the government would shut down if they didn't reach an agreement on 80 00:08:42.720 --> 00:08:44.480 spending. 81 00:08:44.480 --> 00:08:48.080 So fortunately they did reach an agreement and the world did not end as of course it 82 00:08:48.080 --> 00:08:51.560 would have if the government had been around for a few days. 83 00:08:51.560 --> 00:08:57.120 But the principle behind determining the budget is a classic example of terrible incentives. 84 00:08:57.120 --> 00:09:03.700 And the reason is that next year's budget is essentially based on this year's expenses. 85 00:09:03.700 --> 00:09:08.300 So the idea is that if the government spends its budget this year, next year it gets at 86 00:09:08.300 --> 00:09:14.280 least that amount plus new funding, funding for new projects that they have. 87 00:09:14.280 --> 00:09:19.000 And so, of course, this is a famous case of bad incentives because the policy rewards 88 00:09:19.000 --> 00:09:27.480 spending and at the same time people are just left having to hope that next year, simply 89 00:09:27.480 --> 00:09:33.360 out of their good nature, the spenders, the politicians will just decide not to spend 90 00:09:33.360 --> 00:09:34.360 as much. 91 00:09:34.360 --> 00:09:40.920 But, of course, the whole policy rewards spending because they get more money depending on how 92 00:09:40.920 --> 00:09:42.760 much they spend this year, right? 93 00:09:42.760 --> 00:09:49.760 Okay, so how do you solve problems of conflicting incentives when you end up rewarding behavior that you don't want? 94 00:09:49.760 --> 00:09:54.760 The easiest answer is that you can form more explicit contracts. 95 00:09:54.760 --> 00:09:57.760 You can carefully define what's expected of everybody. 96 00:09:57.760 --> 00:10:01.760 And this way people can choose the arrangement which serves them best, 97 00:10:01.760 --> 00:10:06.760 and over time they can try to invent new ways to solve any new problems which come up. 98 00:10:06.760 --> 00:10:09.760 And immediately you can see why this might pose a problem for government, 99 00:10:09.760 --> 00:10:11.760 The Government is a very important part of the process. 100 00:10:11.760 --> 00:10:14.760 The contract that people have with government is really just an idea. 101 00:10:14.760 --> 00:10:16.760 It's not really defined. 102 00:10:16.760 --> 00:10:20.760 And in any case, it's very difficult to change from the outside. 103 00:10:20.760 --> 00:10:23.760 But from the inside, governments can change the contract 104 00:10:23.760 --> 00:10:26.760 without requiring much consent of the people on the outside. 105 00:10:26.760 --> 00:10:29.760 So governments can very easily be insulated 106 00:10:29.760 --> 00:10:32.760 from demands of people outside government. 107 00:10:32.760 --> 00:10:35.760 The taxpayers can't just draw up a new agreement, 108 00:10:35.760 --> 00:10:38.760 they can't just make a new contract if they think that the current one is bad. 109 00:10:38.760 --> 00:10:43.160 They can't sort of take their business elsewhere as they would in the marketplace. 110 00:10:43.160 --> 00:10:50.760 And so these incentive problems persist because there is no real contract between, say, people and government. 111 00:10:50.760 --> 00:10:59.760 So another way to improve incentives is to enforce property rights, one of the more fundamental concepts, again, in economics. 112 00:10:59.760 --> 00:11:04.160 And a really good way to look at this is to look at environmental problems. 113 00:11:04.160 --> 00:11:11.160 A very common claim made against free markets is that they result in all kinds of environmental destruction. 114 00:11:11.160 --> 00:11:19.160 But environmental problems are actually just a good example of incentive problems that are caused by government interventions in the economy. 115 00:11:19.160 --> 00:11:28.160 If you look at the historical record and even today, you see environmental disasters most often in places where there are no property rights 116 00:11:28.160 --> 00:11:33.160 or where the government has granted privileges to people to exploit natural resources. 117 00:11:33.160 --> 00:11:43.160 So the key point is that if you have to decide how to use your own resources, you make a much more careful use of them than when someone gives you their resources. 118 00:11:43.160 --> 00:11:48.160 So a little example and I'll explain how it figures into the bigger picture. 119 00:11:48.160 --> 00:11:59.160 Just imagine if I say to you that I'll give you $100 and you can spend it however you want, but in 20 minutes you have to give me back whatever is left over that you haven't already spent. 120 00:11:59.160 --> 00:12:03.160 So what do you do? Well, you go out and spend it as fast as possible, right? 121 00:12:03.160 --> 00:12:07.160 Because in 20 minutes, you lose the money whether you've bought anything or not. 122 00:12:07.160 --> 00:12:12.160 And this is basically, this is the principle in resource economics. 123 00:12:12.160 --> 00:12:14.160 This is the bad incentive that exists. 124 00:12:14.160 --> 00:12:19.160 Because what happens is, you have, for example, governments who either, 125 00:12:19.160 --> 00:12:25.160 through using the land themselves or leasing it out to various corporations 126 00:12:25.160 --> 00:12:40.440 In that situation, you have governments who own the forests and they lease them out to 127 00:12:40.440 --> 00:12:43.480 timber companies for a certain period of years. 128 00:12:43.480 --> 00:12:49.040 But because the timber companies don't own the forest and they only have access to the 129 00:12:49.040 --> 00:12:54.200 resources for a limited time, their incentive is to just take everything they can as fast 130 00:12:54.200 --> 00:13:01.200 The American Buffalo, which was endangered for a very long time, was hunted almost to extinction because nobody owned the animal. 131 00:13:01.200 --> 00:13:08.200 This is the result of completely deforesting various forest areas, and this happens both in the US and in places like the Amazon. 132 00:13:08.200 --> 00:13:14.200 There are many other famous historical cases of this sort of thing as well. 133 00:13:14.200 --> 00:13:21.200 The American Buffalo, which was endangered for a very long time, was hunted almost to extinction because nobody owned the animal. 134 00:13:21.200 --> 00:13:26.640 and almost to extinction because nobody owned the animals or the land they lived on. 135 00:13:26.640 --> 00:13:31.560 Nobody had an incentive to make sure that the population was kept high. 136 00:13:31.560 --> 00:13:35.880 This is one of the most famous problems in resource economics, it's called the tragedy 137 00:13:35.880 --> 00:13:38.880 of the commons. 138 00:13:38.880 --> 00:13:43.320 And the idea is that when many people own a resource or when nobody owns a resource, 139 00:13:43.320 --> 00:13:48.760 when government owns a resource, nobody really has an incentive to keep the value of the 140 00:13:48.760 --> 00:13:54.120 Research High, because nobody is really bearing the cost of using the resource, if that makes 141 00:13:54.120 --> 00:13:56.600 any sense. 142 00:13:56.600 --> 00:14:02.640 And in general, the great solution to this is to transfer ownership from a situation 143 00:14:02.640 --> 00:14:08.680 of no ownership or government ownership to private hands, because in that case, the property 144 00:14:08.680 --> 00:14:15.840 belongs to individuals, and they have the maximum incentive to keep its value high. 145 00:14:15.840 --> 00:14:20.520 And you avoid all these sorts of environmental problems. 146 00:14:20.520 --> 00:14:28.520 And just to show you how powerful this idea of individual property rights and contracts 147 00:14:28.520 --> 00:14:34.200 can be, even in cases where property rights aren't clear or where there's community 148 00:14:34.200 --> 00:14:38.320 ownership, so you have many people making a claim to the same resources, it's still 149 00:14:38.320 --> 00:14:45.280 the case that free systems develop better solutions than the ones created by governments. 150 00:14:45.280 --> 00:14:49.800 Nobel Prize winner in economics of a couple of years ago, Eleanor Ostrom, has spent a 151 00:14:49.800 --> 00:14:54.880 lot of her career explaining how it is that communities develop methods of dealing with 152 00:14:54.880 --> 00:15:00.560 resource problems and environmental destruction, and how people naturally evolve solutions 153 00:15:00.560 --> 00:15:04.080 to these problems, usually without the help of government. 154 00:15:04.080 --> 00:15:09.440 In fact, it's even been suggested that in the case of very large scale problems that 155 00:15:09.440 --> 00:15:13.360 we hear a lot about, such as climate change, there may be ways in which the free market 156 00:15:13.360 --> 00:15:23.360 can provide answers as to how to encourage good behavior by people to solve these problems without actually having any recourse to government. 157 00:15:23.360 --> 00:15:28.360 Okay, so that's incentives. 158 00:15:28.360 --> 00:15:36.360 And talking about how incentives and how they work and don't work leads to another huge idea in economics, the idea of unintended consequences. 159 00:15:36.360 --> 00:15:38.360 Again, the idea is all in the name. 160 00:15:38.360 --> 00:15:44.520 Sometimes we do things as individuals or as a society which have results that no one intended. 161 00:15:44.520 --> 00:15:46.880 Unintended consequences can be good or bad. 162 00:15:46.880 --> 00:15:51.640 Good unintended consequences would be things like the emergence of markets. 163 00:15:51.640 --> 00:15:56.760 For the most part, people don't get together and simply say, let's start a highly specialized 164 00:15:56.760 --> 00:15:58.960 and developed economy together. 165 00:15:58.960 --> 00:16:03.000 Things start out much smaller than that, with individuals trading with each other to make 166 00:16:03.000 --> 00:16:07.500 themselves better off and at the same time making others better off, and this snowballs 167 00:16:07.500 --> 00:16:29.500 or money is another good example. Individuals start by finding commodities, which are valued by many people, and they use these commodities just as tools to exchange with other people, not necessarily to be used on their own. 168 00:16:29.500 --> 00:16:34.300 and people do this because it makes them better off but before long there's a 169 00:16:34.300 --> 00:16:38.620 medium of exchange money which is used by many people which has emerged 170 00:16:38.620 --> 00:16:42.860 spontaneously and which helps everyone so these are good unintended 171 00:16:42.860 --> 00:16:46.420 consequences consequences that help people achieve a greater degree of 172 00:16:46.420 --> 00:16:50.780 welfare and which can't be imitated or artificially created by governments as 173 00:16:50.780 --> 00:16:56.100 mr. French was pointing out but there are also many bad unintended consequences 174 00:16:56.100 --> 00:17:00.380 and these are often the results of government interventions and the major 175 00:17:00.380 --> 00:17:03.720 way in which government creates unintended consequences is through 176 00:17:03.720 --> 00:17:07.860 playing around with prices. The most common examples are things like the 177 00:17:07.860 --> 00:17:12.260 minimum wage. When people argue that we should raise the minimum wage they 178 00:17:12.260 --> 00:17:16.300 usually claim that it's to help certain people, those who have low incomes, who 179 00:17:16.300 --> 00:17:20.360 are relatively uneducated, who have trouble making a living and so on. But 180 00:17:20.360 --> 00:17:24.780 economics shows us that the minimum wage is actually cause unemployment among 181 00:17:24.780 --> 00:17:29.420 helping these very people and also helps to cause various types of discrimination against 182 00:17:29.420 --> 00:17:33.980 those groups and essentially all government programs follow this pattern. 183 00:17:33.980 --> 00:17:36.700 They actually hurt the people that they're designed to help. 184 00:17:36.700 --> 00:17:41.660 This is a point that Mises made many times that even from the perspective of the people 185 00:17:41.660 --> 00:17:46.300 who are in favor of the interventions, those interventions are still failure. 186 00:17:46.300 --> 00:17:51.820 So these are sorts of unintended consequences and another really good example of unintended 187 00:17:51.820 --> 00:17:55.600 Consequences comes from environmental regulation again. 188 00:17:55.600 --> 00:18:00.640 Ever since the Endangered Species Act was passed, it has made things very difficult 189 00:18:00.640 --> 00:18:06.160 for anybody who owns land on which an endangered species happens to live, because if it's 190 00:18:06.160 --> 00:18:10.420 established that an endangered species lives on your property, you can't do anything to 191 00:18:10.420 --> 00:18:15.560 disturb the habitat of the animals, you're prohibited from building or really doing anything 192 00:18:15.560 --> 00:18:21.220 near the habitat, and in some cases your land can actually be effectively seized from you. 193 00:18:21.220 --> 00:18:26.500 So the rules can be very extreme. Sometimes even if you have just a couple of endangered 194 00:18:26.500 --> 00:18:31.380 birds, it can mean that you can't use any of your land at all because anything could 195 00:18:31.380 --> 00:18:37.060 be construed as destroying the habitat. So this is a real problem for landowners and 196 00:18:37.060 --> 00:18:43.820 a response to this regulation by landowners is that sometimes when they find endangered 197 00:18:43.820 --> 00:18:48.020 animals on their land, instead of reporting to the habitat to the Environmental Protection 198 00:18:48.020 --> 00:18:55.020 Agency. So their land can simply become regulated or confiscated. They just kill the animals 199 00:18:55.020 --> 00:18:59.460 to avoid their trouble. And there's a name for this practice, it's called shoot, shovel 200 00:18:59.460 --> 00:19:05.000 and shut up. And the idea is that you don't want your land taken away from you. So if 201 00:19:05.000 --> 00:19:09.260 you happen to stumble across the habitat of endangered animals on your land, you're not 202 00:19:09.260 --> 00:19:13.620 going to tell anybody about it. Why would you? You just kill them, put them in a hole 203 00:19:13.620 --> 00:19:24.620 So it's obvious when you think about it that a landowner who has a significant investment in his property isn't just going to give it up. 204 00:19:24.620 --> 00:19:35.620 This is another example of how the economic way of thinking, just thinking a little bit about incentives, helps us understand problems which people tend to completely miss. 205 00:19:35.620 --> 00:19:40.620 Without thinking about incentives, it's very easy to get caught in the trap of thinking, 206 00:19:40.620 --> 00:19:48.620 well, the best way to preserve endangered species must be to simply make a law that punishes people for hurting them. 207 00:19:48.620 --> 00:19:58.620 But of course, no, that's not the case because the unintended consequence is that the law makes it in the interest of owners to kill the endangered species instead of the other way around. 208 00:19:58.620 --> 00:20:05.620 Okay, so incentives and unintended consequences lead to the next problem I'll talk about, 209 00:20:05.620 --> 00:20:10.300 the most famous kind of incentive problem, which is called moral hazard. Of these problems 210 00:20:10.300 --> 00:20:15.340 I'm speaking about, this is one which you would probably not hear about in most standard 211 00:20:15.340 --> 00:20:19.620 introductory lectures to economics, but that's exactly why I'm including it in the basic 212 00:20:19.620 --> 00:20:24.100 principles. One of my teachers in graduate school used to say that moral hazard is actually 213 00:20:24.100 --> 00:20:28.740 the most important problem in economics and that's actually pretty close to the truth 214 00:20:28.740 --> 00:20:32.900 because we can see this principle absolutely everywhere we look and that's why it's important 215 00:20:32.900 --> 00:20:36.620 to learn even at the introductory level. 216 00:20:36.620 --> 00:20:40.760 And with moral hazard, the principle is also pretty easy to understand. 217 00:20:40.760 --> 00:20:45.560 Moral hazard is basically the notion that when you can push the cost of your own behavior 218 00:20:45.560 --> 00:20:50.580 onto other people without them really being able to do anything about it, this changes 219 00:20:50.580 --> 00:20:51.580 your behavior. 220 00:20:51.580 --> 00:20:58.580 By the way, moral hazard is actually a bad name for this problem because it's not a moral problem, it's an economic one, but that's a side point. 221 00:20:58.580 --> 00:21:06.580 So moral hazards do exist in the free market, but the most significant cases, again, happen because of government intervention. 222 00:21:06.580 --> 00:21:16.580 And so one way to think about moral hazard is to ask how your behavior would change if you could make other people responsible for your actions. 223 00:21:16.580 --> 00:21:20.580 Economists usually talk about this problem in terms of insurance. 224 00:21:20.580 --> 00:21:24.580 You buy health insurance to help you in case you have some kind of accident, right? 225 00:21:24.580 --> 00:21:28.580 But the problem is, you have some control over how risky your behavior is. 226 00:21:28.580 --> 00:21:32.580 You can control how healthy you are to some extent. 227 00:21:32.580 --> 00:21:36.580 So, if you have health insurance, maybe because 228 00:21:36.580 --> 00:21:40.580 you know that you won't have to pay if you get hurt, you start doing riskier things 229 00:21:40.580 --> 00:21:44.580 than you normally would. Maybe you take up chainsaw juggling or bullet catching 230 00:21:44.580 --> 00:21:49.500 Catching or something. Or maybe, and this is much more realistic, you have car 231 00:21:49.500 --> 00:21:52.980 insurance and because of that you start driving a little bit more carelessly 232 00:21:52.980 --> 00:21:56.220 than you normally would because if you get in an accident you're not the one 233 00:21:56.220 --> 00:22:00.820 who's going to pay the bill. With a cost reduced it becomes that much easier not 234 00:22:00.820 --> 00:22:04.900 to pay attention. This sort of thing actually does happen. 235 00:22:04.900 --> 00:22:09.980 There's a very famous study by an economist named Sam Peltzman who showed 236 00:22:09.980 --> 00:22:15.980 The theory showed that laws which require you to wear your seatbelt actually cause traffic accidents. 237 00:22:15.980 --> 00:22:17.980 So why would this happen? 238 00:22:17.980 --> 00:22:20.980 Well, it's because when you wear your seatbelt, you feel safer. 239 00:22:20.980 --> 00:22:23.980 And because you feel safer, you take more risks. 240 00:22:23.980 --> 00:22:26.980 And taking more risks causes more accidents. 241 00:22:26.980 --> 00:22:31.980 So this is one example where a government intervention, in this case designed to make people safer 242 00:22:31.980 --> 00:22:37.980 by making you wear your seatbelt, actually makes driving more dangerous. 243 00:22:37.980 --> 00:23:07.980 and I'm not claiming by the way that you make a conscious decision to do these things in the sense that you think well today I'm just going to be really reckless I'm just going to go crazy on the road and I don't care what happens it's more that there are subtle changes in your environment and in the arrangement of your incentives certain types of behavior carry higher rewards or lower costs than the otherwise would because of regulations like this and this results in you making different decisions so you can use the idea of incentives and more hazard to understand all kinds of decisions 244 00:23:07.980 --> 00:23:26.980 In the recent financial crisis, we had a round of bailouts where failed firms were saved by the government, and a major concern of economists was that this was a moral hazard situation. 245 00:23:26.980 --> 00:23:35.980 The problem is that if we just rescue a firm every time it fails, the behavior of the firm starts to change because they're not bearing the cost of their behavior. 246 00:23:35.980 --> 00:23:36.980 here. 247 00:23:36.980 --> 00:23:41.260 They start to invest in riskier forms of business because they assume that they won't be responsible 248 00:23:41.260 --> 00:23:42.860 if they fail. 249 00:23:42.860 --> 00:23:46.360 The cost gets pushed onto the taxpayers instead. 250 00:23:46.360 --> 00:23:50.060 So by bailing firms out, you just encourage reckless decisions and you promote the same 251 00:23:50.060 --> 00:23:54.140 sort of problems which got the firms into trouble in the first place. 252 00:23:54.140 --> 00:23:57.740 And actually, the US experience is not the most extreme one. 253 00:23:57.740 --> 00:24:02.620 Two of my economist colleagues have a new book out called Deep Freeze, which is about 254 00:24:02.620 --> 00:24:32.620 Iceland's economic collapse in the past few years, which was probably maybe the worst in the world in this most recent great recession and what they point out is how Icelandic banks had an explicit guarantee from the Icelandic central bank that they would be bailed out in the event that their business went sour and this had a really obvious result because banks were explicitly told that they were too big to fail 255 00:24:32.620 --> 00:24:37.620 They completely ignored all reasonable guidelines for keeping themselves solvent. 256 00:24:37.620 --> 00:24:42.620 And eventually when the banks failed, the central bank of Iceland couldn't handle the strain and then the whole system collapsed. 257 00:24:42.620 --> 00:24:51.620 But this is a very important real-world example of how this very simple idea of moral hazard can have really revolutionary consequences. 258 00:24:51.620 --> 00:24:56.620 I don't actually have a copy of this book with me, but I think it's for sale downstairs in the bookstore. 259 00:24:56.620 --> 00:25:00.620 And if you're interested in these ideas, then I recommend the book to you. It's a little more advanced. 260 00:25:00.620 --> 00:25:11.620 But it has a lot of interesting material to help you understand how all these economic problems tie together in the big picture, especially in terms of government meddling and monetary policy. 261 00:25:11.620 --> 00:25:18.620 The book's also written by one of my Ph.D. advisors, so I have to say nice things about it, whether I want to or not. 262 00:25:18.620 --> 00:25:24.620 So thinking about incentives can be a very useful way to think about how people behave in the world. 263 00:25:24.620 --> 00:25:29.620 But now, after talking about how important incentives and incentive problems are for a minute, 264 00:25:29.620 --> 00:25:34.620 I'm going to confuse you for a second by talking about why incentives aren't important. 265 00:25:34.620 --> 00:25:42.620 And what I mean is, as I mentioned before, some economists think that all of economics is just trying to arrange people's incentives. 266 00:25:42.620 --> 00:25:49.620 But that isn't everything. And this is one place where Austrians tend to do better than most other economists. 267 00:25:49.620 --> 00:25:59.620 So as an example, Austrians are very interested in discovering economic laws, certain relationships which are true in all times and in all places. 268 00:25:59.620 --> 00:26:06.620 And these laws are more fundamental than people's incentives because they exist no matter what the arrangement of incentives is. 269 00:26:06.620 --> 00:26:11.620 So a famous example is Mises' argument against socialism. 270 00:26:11.620 --> 00:26:17.620 Usually when economists talk about socialism, they talk as if socialism were just a problem of incentives. 271 00:26:17.620 --> 00:26:23.620 that is, how do we motivate people to do the right things, to produce the right things 272 00:26:23.620 --> 00:26:27.620 when government is controlling all the production in society. 273 00:26:27.620 --> 00:26:31.620 But what Mises showed was that the problem of socialism was much deeper than that. 274 00:26:31.620 --> 00:26:37.620 He argued that no matter what the incentives for people are, no matter how well you try and organize a society, 275 00:26:37.620 --> 00:26:42.620 a socialist economy can't work because it doesn't have a functioning price system, 276 00:26:42.620 --> 00:26:46.620 because it doesn't have a system of private property exchange. 277 00:26:46.620 --> 00:26:50.140 That criticism of socialism, it's a little bit complicated, but the punchline is that 278 00:26:50.140 --> 00:26:52.660 it doesn't matter how you try to motivate people. 279 00:26:52.660 --> 00:26:59.060 Without private property, you have no way to rationally organize a society. 280 00:26:59.060 --> 00:27:04.020 So the last sort of unifying theme I want to mention is the idea of choice. 281 00:27:04.020 --> 00:27:07.480 If there's one core principle of economics, it would be choice. 282 00:27:07.480 --> 00:27:11.500 Essentially everything economics teaches is related in one way or another to human beings 283 00:27:11.500 --> 00:27:16.540 is choosing between alternative possibilities and economic science is basically teasing 284 00:27:16.540 --> 00:27:21.680 out those many implications of human choice and probably the most important implication 285 00:27:21.680 --> 00:27:28.100 of choice is cost. Choice implies something which is not chosen. We can't do everything 286 00:27:28.100 --> 00:27:33.340 we want. So every time we make a choice, we have to choose to give up something else. 287 00:27:33.340 --> 00:27:40.340 So for example, for you guys to be here today, you had to give up something else. Justin 288 00:27:41.500 --> 00:27:52.500 And we call this thing that we give up an opportunity cost, because we're giving up the opportunity to do something else. 289 00:27:52.500 --> 00:27:57.500 And this is really important because it means that every human action has a cost. 290 00:27:57.500 --> 00:28:02.500 There is no such thing as a free lunch. No matter what you do, you're always paying for it in some way, 291 00:28:02.500 --> 00:28:06.500 whether in terms of your time or your money or what have you. There's always something given up. 292 00:28:06.500 --> 00:28:12.500 And this was one of the points that Henry Hazlitt makes in his famous book, Economics and One Lesson, 293 00:28:12.500 --> 00:28:18.500 which is a great introduction to how to think about economic policy and all its hidden costs. 294 00:28:18.500 --> 00:28:25.500 That book is all about understanding how, for everything we see being done, there's always something which remains unseen, 295 00:28:25.500 --> 00:28:27.500 something we've given up. 296 00:28:27.500 --> 00:28:34.500 The one lesson of economic policy that Hazlitt talked about is that we can't just look at the results of a policy 297 00:28:34.500 --> 00:28:39.140 for a few people or for a short time, we have to look at how our policy affects all people 298 00:28:39.140 --> 00:28:46.620 and at all times, and this means looking at examining those things that we had to give 299 00:28:46.620 --> 00:28:47.620 up. 300 00:28:47.620 --> 00:28:56.820 So, to take one example, it has pointed out that it's very easy to look at the results 301 00:28:56.820 --> 00:29:01.500 of certain, say, government interventions and see results which look as if they're very 302 00:29:01.500 --> 00:29:03.260 beneficial to society. 303 00:29:03.260 --> 00:29:08.260 You can actually see and interact with and use say like a new community center in your 304 00:29:08.260 --> 00:29:10.020 neighborhood for example. 305 00:29:10.020 --> 00:29:14.480 But what you don't see is what could have been done with the resources used to build 306 00:29:14.480 --> 00:29:18.020 that center if they had been left to the free market. 307 00:29:18.020 --> 00:29:21.680 You don't see what you could have had otherwise. 308 00:29:21.680 --> 00:29:27.500 So maybe in that case you could have had your new 50 foot solid gold statue of Justin Bieber 309 00:29:27.500 --> 00:29:29.140 instead of the community center. 310 00:29:29.140 --> 00:29:38.140 You can see that this is kind of a theme to my understanding of pop culture, that's the only name I know, even though you guys are probably way too old for that. 311 00:29:38.140 --> 00:29:49.140 In fact, actually, the example is probably really bad, because if you guys don't like Justin Bieber, then you're going to be begging for government intervention, and I've just totally undermined the free market. 312 00:29:49.140 --> 00:29:58.140 But anyway, Justin would want you to know that in order to get the new public roads or public buildings or what have you, we have to give up something else. 313 00:29:58.140 --> 00:30:02.660 and we have to think about these trade-offs that we make whenever we make our policy decisions. 314 00:30:02.660 --> 00:30:07.020 So at the introductory level I recommend the Haslet book, Economics in One Lesson, 315 00:30:07.020 --> 00:30:09.820 and also a few years ago the Mises Institute 316 00:30:09.820 --> 00:30:13.540 recorded a series of conversations with Austrian economists about different 317 00:30:13.540 --> 00:30:14.820 aspects of the book 318 00:30:14.820 --> 00:30:18.820 and why it's continuing relevance for us today 319 00:30:18.820 --> 00:30:23.980 and I recommend those interviews to you as well. 320 00:30:23.980 --> 00:30:26.900 So, well, I think I'm out of time so with that I'll...