On What Econ 101 Actually Is (And Says)

There has been much recent discussion within the econo-blogosphere about the usefulness (or lack thereof) of “Econ 101.” This discussion seems to have started with Noah Smith’s Bloomberg column, in which he suggests that most of what you learn in Econ 101 is wrong. Mark Thoma then took this a bit further and argued that the problem with Econ 101 is ideological. In particular, Thoma argues that Econ 101 has a conservative bias. Both of these arguments rely on either a mischaracterization of Econ 101 or a really poor teaching of the subject.

Noah Smith’s dislike of Econ 101 seems to come from the discussion of the minimum wage. His basic argument is that Econ 101 says that the minimum wage increases unemployment. However, he argues that

That’s theory. Reality, it turns out, is very different. In the last two decades, empirical economists have looked at a large number of minimum wage hikes, and concluded that in most cases, the immediate effect on employment is very small.

This is a bizarre argument in a number of respects. First, Noah seems to move the goal posts. The theory is wrong because the magnitude of these effects are small? The prediction is about direction, not magnitude. Second, David Neumark and William Wascher’s survey of the literature suggests that there are indeed disemployment effects associated with the minimum wage and that these results are strongest when researchers have examined low-skilled workers.

Forgetting the evidence, let’s suppose that Noah’s assertion that the discussion of the minimum wage in Econ 101 is empirically invalid is correct. Even in this case, the idea that Econ 101 is fundamentally flawed is without basis. When I teach students about price controls, I am careful to note the difference between positive and normative statements. For example, many students tend to see price controls as a “bad” thing. When I teach students about price controls, however, I am quick to point out that saying something is “bad” is a normative statement. In other words, “bad” implies that things should be different. What “should be” is normative. The only positive (“what is”) statement that we can make about price controls is that they reduce efficiency. Whether or not this is a good or a bad thing depends on factors that are beyond an Econ 101 course — and I provide some examples of these factors.

Further, by emphasizing the effects on efficiency and the difference between positive and normative statements, this gives students a more complete picture of both the effects of price controls as well as why they might exist. In fact, it is precisely this lesson about efficiency and allocation that is an essential part of what students should learn in Econ 101.

For example, it is common for economists to discuss rent control when they discuss price ceilings. When societies put a binding maximum price on rent, this creates excess demand. However, one would not test whether this is a useful description of reality by examining the effects of rent control on homelessness. On the contrary, economists emphasize that in the absence of the price mechanism, other allocation mechanisms must substitute for price. Non-price rationing comes in a variety of forms: quality reduction, nepotism, discrimination, etc.

Similar arguments can be made for the minimum wage. For example, the basic point is that the minimum wage creates a scenario in which the quantity demanded for labor is less than the quantity supplied of labor. The ultimate outcome could come in a variety of forms. This could lead to a standard account of higher unemployment. Alternatively, this could simply cause a reduction in hours worked. Finally, in the case in which the firm faces some constraint (at least in the short to medium term), there is another way that firms can adjust. Standard Econ 101, for example, suggests that the nominal wage should equal the marginal revenue product of the worker. If the nominal wage is forced higher, there are two ways to increase the marginal revenue product — reduce labor or increase the price of the product.

The value of Econ 101 is the very process of thinking through these possible effects. What effect we actually observe is an empirical question, but it is of secondary importance to teaching students how to logically think through these sorts of examples.

Noah’s view of Econ 101, however, seems to come from his belief that economists want Econ 101 to be as simple as possible. And his argument is that this is misguided because simple often dispenses with the important. Mark Thoma, on the other hand, makes the argument that Econ 101 has a conservative bias:

The conservative bias in economics begins with the baseline theoretical model, what is often called “Economics 101.” This model of perfect competition describes a world that agrees with Republican ideology. In this model, there is no role for government intervention in the economy beyond setting the institutional structure for free markets to operate. There is nothing government can do to improve the ability of market to provide the goods and services people desire at the lowest possible price, or to help markets respond to shocks.

I think that this is both wrong about Econ 101 and it is also a strange view of conservatism.

First, I am not a conservative. However, it seems to me that many conservatives like government intervention. A number of conservatives think that child tax credits are a good idea and that marriage should be encouraged through subsidization. For these sorts of things to be justified on economic grounds requires that they believe that children and marriage generate positive externalities for society. While it is true that Republicans have been particularly obstructionist, Republican does not equal conservative. In addition, obstructionism might not have as much to do with economic beliefs as it does with political motivations about who gets the credit, the lobbying of special interest groups, the desire to imperil the image of the competing party, etc. — regardless of the rhetoric.

Which brings me to my second point. If you are a student who only learned the perfectly competitive model in Econ 101, then you should politely ask for a refund. Econ 101 routinely includes the discussion of externalities, public goods, monopoly, oligopoly, etc. All of these topics address issues that the competitive market model is ill-equipped to explain. And it is hard to argue that any of these topics have any sort of ideological bias.

5 responses to “On What Econ 101 Actually Is (And Says)

  1. Paul Davidson

    the question of what happens to aggregate employment when you lower the average money wage(or raise to the $15 minimum wage) can not be answered by using the usual Marshall marginal value productivity type demand for labor downward sloping curve.n.
    For as Keynes writes about transferring this microlabor demand analysis to the macro labor demand analysis is that the argument is that Marshallian micro-demand functions “can only be constructed on some fixed assumption as to the nature of the demand and supply schedules of other industries and as to the amount of the aggregate effective demand. It is invalid, therefore, to transfer the argument to industry as a whole unless we also transfer our assumption that the aggregate effective demand is fixed. Yet this assumption reduces the argument to an ignoratio elenchi” [Keynes, 136, p. 259]

    Keynes was writing about whether the demand for labor curve can be aggregate of Marshallian micro demand for labor functions .Accordingly the question becomes when the minimum wage goes to $i5 this will increase production costs at every level of employment thereby shifting upward the aggregate supply curve in money terms.
    Simultaneously the aggregate money wage income at every level of employment will increase, thereby increasing money spending on consumption out of wages at every level of income, thereby shifting upward the aggregate demand curve in money terms [ignoring
    effects on exports vs. imports and any change in Investment spending].

    Now unless you are using my textbook POST KEYNESIAN MACROECNOMIC THEORY, this analysis will ever be taught in Econ 101 or eve any advanced course in macroeconomics!

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  3. Excellent blog post. I’m pretty sure Noah has never even taught 101. He has way more to gain by becoming the “face” of the 101 revolution but bears almost no cost if the outcome of his ideas are disastrous for students.

  4. Surely Ecom101 should be dealing with more basic matters in economics, of which the minimum wage is not! It must include the necessary and sufficient axioms and assumptions for explaining micro/macro-economics and this could rightly include some of the material in my recent book on the theory, Consequential Macroeconomics. Write to me for an e-copy (for free) chesterdh@hotmail.com.

  5. Nice start to answering Smith and Thoma. I have taught Econ 101 for over 5 years and used several texts. I think it’s too socialist. But for the most part, it teaches too must trivia.

    The most important issue economics should respond to is the hockey stick effect of per capita GDP as described by Deirdre McCloskey and others which shows that standards of living were flat from 10000 BC to 1800 AD. Then with the industrial revolution standards of living took off and multiplied 30 fold since. Then we need to explain why and how it happened.

    Econ 101 needs to get rid of perfect competition. It’s the stupidest thing anyone ever dreamed up!

    As for min wage, all econ texts say that a min wage causes unemployment only if it is higher than the market wage for entry level jobs. All the research and data shows is that the min wage has rarely been above the market wage. That “economists” like Smith and Thoma don’t get that is very sad and speaks to the deteriorated state of the profession.

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