Friday, April 29, 2005

Freakonomics

Steve Levitt appeared on The Daily Show with Jon Stewart on Comedy Central last evening to discuss his new book, Freakonomics (buy website), written with Stephen Dubner (who profiled Levitt a couple of years ago in The New York Times).

Steve is the next generation of the "Chicago School" of economics, in which the basic price theory of economics is inserted into every social environment imaginable. The original generation--Friedman, Becker, and Stigler--focused on what are by now traditional areas like education, the family, and the law. But I'd wager that even the founders of the School would have to admit that Steve's ability to see the economics in unusual situations is without equal, past or present. The next generation also comes armed with modern computing power and thus a much greater ability to analyze data in support of their claims. I will soon get my copy of Freakonomics and enjoy my chance to read it.

What does it mean to "see the economics" in a given situation? Economics consists of exactly two ideas: optimization and equilibrium. Optimization is the process by which all economic agents--households, workers, firms, governments--achieve their objectives subject to constraints on their resources. It leads to the familiar condition that an activity is undertaken until its marginal reward equals its marginal cost. Equilibrium is the process by which the competing efforts to optimize by these agents form a stable arrangement. An equilibrium is defined by relative prices, and those prices typically form the basis of either the marginal reward or the marginal cost in the individual agents' optimization processes. So "seeing the economics" means figuring out what is driving the optimization and equilibrium in a given context. As I often tell my students, if you cannot see the optimization and the equilibrium in what I am saying, then I am not talking about economics.

Here are the book's chapters, from the Freakonomics website, showing where the authors are looking for optimization and equilibrium:

On The Daily Show, Jon Stewart thought Chapter 4, in which the book supports a hypothesis that the reduction in crime in the late 1990s was attributable to fewer "unwanted" children in the wake of Roe v. Wade entering their prime criminal years, was the most interesting. He then asked Steve how he "controlled" for other factors that might affect the crime rate, like the number of police. Steve then tried to give an answer based on multiple regression (which he did in an excerpt from the book, shown here). That's got to be a first for late night television.

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1 comment:

exdartmouthstudent said...

Economics consists of exactly two ideas: optimization and equilibrium.

Not exactly. Your school of economics consists of exactly two ideas.

Other schools consist of exactly one idea, and derive all other ideas from that first idea of humans acting (see mises.org).

Optimization is superficially a part of the Austrian school (humans act to increase their well-being, remove uneasiness, or optimize, depending on your semantics). However, each man's notion of optimization is subjective and personal and can be neither quantified nor aggregated.


Your focus on equilibrium is misplaced, but more importantly your grouping of government under "economic agents" is...um...misleading at best, and downright damaging at worst. The idea that a government has "resources" of its own to optimize was aptly destroyed by von Mises:

At the bottom of the interventionist argument there is always the idea that the government or the State is an entity outside and above the social process of production, that it owns something which is not derived from taxing its subjects, and that it can spend this mythical something for definite purposes. This is the Santa Claus fable raised by Lord Keynes to the dignity of an economic doctrine and enthusiastically endorsed by all those who expect personal advantage from government spending.