Recent Read: “What are economists for?”

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I came across an interesting post on LSE’s Business Review blog on what economists actually do. It’s a good intro for non-economists. Some highlights:

One short answer is that economics is the social science focusing on people’s material well-being, the ‘business side’ of life. How do people earn a living? What do they buy with the money they earn? What spurs the overall economy to grow?

While a starting point, the domain of economics has continued to expand, blurring any distinctions between it and other social sciences. For example, crime was once exclusively a matter for sociologists and corruption for political scientists. But economists realised that these social problems might respond to economic incentives, and left untreated could destroy a productive economy. In this way, the issues have become part of mainstream economics.

One might think nothing could be further from the ‘business side’ of life than art, but even this has become the subject of economists’ study. In 2015, Picasso’s painting Women of Algiersbroke the record for the highest price paid at an art auction. While economists may have few insights about the quality of the brushstrokes, they have deeper insights about the outcome of the auction, held at the international auction house, Christie’s.

Bidding was intense. The opening price was $100 million. Bidders drove the price up to $180 million, its sale price, in ten minutes. Though they were allowed to bid in $1 million increments, at several points in the auction bidders jumped over the previous offer by $10 million.

To many people, this jump-bidding strategy is puzzling. It wastes the chance of winning the painting for less if the other bidders would have dropped out before the price rose the full $10 million. Some economists suggest that jump bidding may be a strategic attempt to scare off other bidders. They reason that rivals may consider it foolhardy to stay in an auction with someone who values the item so highly that he or she would be willing to waste money to prove it (Avery 1998).

Jump bidding is not the only interesting feature of this auction. Why did Christie’s pick $100 million for the opening price instead of $80 million or $120 million? Why not have each bidder submit a single, secret bid instead of ascending series of open outcries?

How is value determined? Scholars puzzled over this for a long time. Why are diamonds, mere decorations, so prized, while water, essential for human life, flows freely from public fountains? In the Middle Ages, philosophers advanced the just-price theory. This argues that value is an inherent property of an object. On this view, diamonds are expensive because of their inherent quality, and water is not. But this theory is unsatisfactory. It does not explain where this inherent value comes from, nor is it consistent with price variation across cultures and time. Karl Marx contributed the labour theory of value, arguing that the value of an object is the effort workers put into its production. The labour theory has its own drawbacks, leading to the awkward conclusion that an hour-long tooth extraction would be sixty times more valuable than one that had taken a minute.

One of the great advances of modern empirical economic research is causal identification—uncovering true causal relationships rather than overinterpreting apparent correlations as causation. Uncovering causal relationships is difficult in economics. Opportunities to run experiments are limited by the expense and ethics involved in controlled interventions in markets (although these opportunities are growing, owing to an explosion of interest in laboratory and field experiments).

Economists have to devise clever ways to establish causation in nonexperimental data. Pick one of your favourites. A microeconomist might choose Dale and Krueger’s (2002) study of whether a more prestigious college causes higher earnings after graduation, explaining the problem that positive correlation may be wholly due to the higher ability of students admitted to better colleges. A macroeconomist might pick Romer’s (1992) study of whether fiscal or monetary policy deserved more credit for the US recovery from the Great Depression. The problem: a bad economy can feed back to make beneficial policies look damaging.

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