Wednesday, June 13, 2012

Naked Economics (Summary) by Charles Wheelan

*This was one of four papers I wrote for my final exam in Current Economic Issues (ECON 404) last October. Please read and give feedback and/or constructive criticism! I also highly recommend both this book and its author!*

Economics is often a subject, like calculus, that most individuals tend to avoid in school. Conversely, it is actually one of the most practical subjects with many real life applications. It is primarily misunderstood due to the large amount of technical definitions and complex theories found in textbooks. Charles Wheelan’s purpose for this book is to explain some key economic concepts so that smart people, who may not have ever taken an economics class, will understand them in a way that is simple, practical and intriguing. He achieves his purpose by expressing four straightforward yet dynamic points in this book. One, every person in the world is driven by different incentives that produce utility; two, human behavior must be taken into account when studying economics; three, each good or service not only has a price tag, but it also has implied social impact; and lastly, economics doesn’t have all of the answers, but rather it simply offers a framework as to how one should approach current economic issues.

First of all, every person makes decisions based on some kind of incentive; however, the definition of that incentive varies on an individual basis. In the United States, we can compete freely as no one tells us how many purple dresses can be sold at the Gap or how many hours one can work during the week. The most important assumption in economics is that individuals act in such a way as to make themselves as well off as possible. It’s not to say that all people act selfishly, but simply that each person has their own unique preferences. Wheelan discusses the black rhino and how its horn is a fever reliever and powerful aphrodisiac which makes it more valuable than the rhino itself. A single rhino horn can be sold for $30,000 on the black market. For this reason, the black rhino was hunted and is quickly becoming extinct. That is also an example of how incentives are not always good and in this particular case, has a negative effect on the animal kingdom.

Similarly, when you are paid solely on commission, you work harder. If the price of gas rises, you drive less. Self-interest makes things work more smoothly in the world today. Incentives matter and can be related to productivity contrary to the belief free market economists held in the past. If you do not reward good behavior and punish bad behavior, it can have damaging effects to a country's productivity, production and economy as a whole. Wheelen points this out by using the former Soviet Union as an example. However, incentives are not perfectly aligned to one’s own needs. For example, if your house sells for higher than the asking price, your agent makes a higher commission. While this does not benefit you in any direct way per se, you did benefit from the agent’s services and the process went more quickly compared to selling it on your own, thus maximizing your utility.

Secondly, economics cannot be studied without studying consumer behavior which explain things about markets that figures, graphs and theories cannot. We can’t always predict how a person will act or react to certain outcomes. Capitalism can be brutal and along with it there are winners and losers. On another note, the same can be applied to human capital. Human capital comes in terms of skills, talents, education and experience. A symptom of being poor is not being able to find a good job, but more so the cause is lack of human capital. It is true that Americans are better off today as a whole than we were at any point in history. Not every Americans is rich, but the standard of living is much higher than it was even twenty years ago. Bill Gates is richer than the average American because his abilities are scarce; while, for example, the ability to flip burgers is very common. Brad Pitt is in the movie industry rather than the insurance industry because he goes where he can get paid the most. In addition, there is no one else in the world who can do what he can do and that is: open movies at the box office. In the same way, the economics of information is also a very powerful tool. McDonald’s didn’t make a better hamburger; it just merely advertised quality, predictability and satisfaction in all of its products. Having invested heavily in advertising and slogans, an American can even walk into a McDonald’s in a town they have never been in and still know what to expect. That is the beauty of utilizing market power in America.

Thirdly, the price of an item not only has a numeric cost, but more importantly it has an implied social cost that also leaves a mark on the world. There are many things Americans enjoy for free that are provided by the government called “public goods.” Basic research, law enforcement and parks and open spaces are considered public goods. If any of these items were privatized, hardly anyone would pay to for these services, especially law enforcement. This notion is mainly based on if your neighbor is 'paying for it, you will still have some protection too'. However, many goods are private yet don’t reflect the true cost. The underlying argument for this is that for every action or decision there is an implied social impact that many consumers do not take into consideration. For example, the cost of driving and maintaining a car is relatively low when you have a well paying job. On the contrary, drivers do not pay for the physical damages a car leaves on the environment such as pollution, wear and tear on the roads—which can be much more costly. Also you physically can be forced into situations that affect your short or long term health such as standing next to a smoker or losing sleep because your neighbor is playing loud music all night.

And finally, while one cannot find the all answers to each of life’s dilemmas through economics; nevertheless, it still provides a framework that can be used to figure out how to solve said dilemmas. Politics will always remain hard to figure out, but the organization of political groups may be able to be explained. While politicians want to make decisions that will generate more benefits than expenses for a nation, they are persuaded by opting for the greater good and personal endorsements. Re-election is often a driving factor as to why politicians do not act as rationally as a consumer would. Also, the process will always favor smaller organized groups at the expense of larger scattered groups. Another issue is measuring the overall performance of a country. Figures such as GDP, unemployment and budget deficits/surpluses contribute greatly to it. Figures such as demographics and family size are also important. America is getting older and our workforce, mainly consisting of Baby Boomers (those born between 1941 and 1964), is starting to shrink. In order to compensate for the eventual reduction in workers, younger Americans need to start having or thinking about having more children. If not, our productivity and size of the workforce will decrease requiring us to make some unwanted lifestyle changes.

Having a basis of both macro and micro-economic concepts through Wheelan’s book, readers are able to look objectively at the role of the Federal Reserve and learn more about factors affecting monetary policies. Trade and globalization are both good things that have provided a better vehicle to exchange goods and services than ever before. On the other hand, buying cheaper goods always comes at a greater cost. They may be cheap for the consumer but the laborer sowing hems on T-shirts in Vietnam is being paid an extremely low wage and forced to work in intense conditions. Wheelan argues, though, that from a Western perspective that job seems absurd and unsafe, but to the woman in Vietnam that her job allows her to put food on the table and a roof over her children’s heads. The principles of trade and development economics can also be applied to why some countries are better off while others are worse off. Utilization of natural resources is a big but not definite role in determining wealthy and poor countries. Examples of this are Africa and Latin America, two continents that have not allocated their natural resources well. Another major factor is the importance of decision-making—regardless if they are made on a national or personal level. The decisions consumers and leaders make on a daily basis have lasting consequences for everyone in both the short and long term.

In conclusion, Wheelan shows that economics can actually be a fun and interesting topic with many real life applications. Studying economics and human behavior go hand in hand as he demonstrates with examples in real life, consumer behavior, the government and in the financial sectors. There are many factors theorists and consumers who do not consider when discussing free markets but are crucial when applied to the real world. Social factors, incentives and applications of economic concepts also weigh heavily on the success of markets. Wheelan brings not only a well-rounded approach but one that is clear and simple for the everyday reader to understand.

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