The Top Three Economic Concepts

Greg Mankiw points to what he thinks are the top three concepts for all students to take away from an economics course.

1. Comparative advantage and the gains from trade.

2. Supply, demand, and the efficiency of market equilibrium.

3. Market failure, such as externalities, and the role for government.

The lesson is that we can all gain from economic interdependence and that markets are a good, but not always perfect, way to coordinate people in an interdependent world.

I have to agree with this list, still Craig Newmark’s list is also pretty good.

1. People tend to respond to incentives.

2. Scarcity, and its important corollary, opportunity cost.

3. Markets tend to be low cost allocators of goods and services.

I think many people in policy debates fail to appreciate the importance of incentives. And scarcity and opportunity cost are extremely important. The idea of opportunity cost is what lies at the heart of the notion of “there ain’t no such thing as a free lunch.” One can quibble with number three since Mankiw’s number three can invalidate Newmark’s number three. Generally speaking firms seek to maximize profits, and that implicit means that firms also minimize costs at the profit maximizing level of output. However, if there are externalities then the costs may not be fully born by the firm and it may over-produce the good in question.

If I had to put together a list like this, I’d sort of cheat and list,

    1. Comparative advantage, gains from trade.
    2. Incentives and opportunity costs.
    3. Markets are generally efficient at allocating resources, but can be distorted by unaccounted for externalities or government regulation

Yeah, I know that is technically 4, but market failures are an important exception to the efficiency of markets.

Update: I’ve changed number 3 to match yetanotherjohn’s suggestion in comments. It returns the list to having only 3 concepts, but also includes how markets can fail and that government can also be a source of market inefficiency.

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Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. yetanotherjohn says:

    How about for 3:

    Markets are generally efficient at allocating resources, but can be distorted by unaccounted for externalities or government regulation

    And by the way, I don’t think there is any magic in limiting it to 3 items. Now top ten lists, that’s different.

  2. Steve Verdon says:

    YAJ,

    Nice, I’ll change it.

  3. William d'Inger says:

    Basically I agree, but there is one broad economic concept that the public seems to miss. It’s not that I remember it from my business classes, it’s more like something that has slowly seeped into my mind over my many decades since graduation.

    Economic systems are similar to ice in that if you try to bend a rod of ice quickly, it will shatter. On the other hand, as glaciers show, ice can bend and flow around almost any obstacle when given sufficient time.

    The quick-fix public (and especially the politicians who pander to that crowd) tend to do more harm than necessary. I think the bend but don’t break concept needs to be driven home to those who want to change the world before sundown.

    Hopefully, this isn’t too far off subject.