On Economics: First Principles

An introduction to what is sometimes called ‘the dismal science’—and why actuaries should care

By Carlos Fuentes and Shiraz Jetha

Editor’s note: This is the first article in an occasional series by the authors about economics.

An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today
—Lawrence J. Peter

The authors believe that economics plays an essential role in politics, public policy, private opinion, and the actuarial profession. Considered a science by many, economics is remarkable in that it is frequently invoked to justify almost any opinions, including those that contradict each other. Its forecasting track record, poor as it is, does not seem to raise basic questions about assumptions or methodology, and neither does the lack of explanatory power of many of its theories. Timothy Geithner, president of the Federal Reserve Bank of New York (2003–2009) and secretary of the Treasury (2009–2013), writes: “One of my tasks was producing Treasury’s quarterly forecasts for the Japanese economy. This was a useful education, mostly in making me skeptical of forecasting.”[1]

Any other science that frequently fails to explain or predict would be discarded. Yet, economics, like the phoenix, comes back to life after burning itself in an endless cycle. 

How can this be? We believe the answer has to do with perceptions about the complexity of economic theories and the prevalence of vested interests. The former is rooted in the impression that economic theories are the exclusive realm of the trained professional. The public, incapable of delving into the intricacies of this science (the argument goes), should rely on the advice of experts. The latter—vested interests—explains the adulteration of cause-and-effect whereby theories aligned with personal points of view are assumed to be correct while “facts” are coerced to fit a parallel reality. 

Are the key aspects of economic theories beyond the reach of non-economists? We believe not. Most of the fundamental ideas that shape the economic discourse can be expressed in clear English. The rest requires additional effort but nothing beyond the abilities of a serious non-specialist. 

A critical consideration when embarking in a study of economics is how to approach the subject. When the goal is to understand the lay of the land—i.e., to develop a strategic view—there is no substitute in our view for a solid grasp of the salient aspects of economic history. History shows how ideas originated in specific places and times, and how they evolved. Learning about the lives of economists sheds light on the environment in which they lived, their interests, political views, even the honesty of their professed commitment to the truth. 

We will embark on a historical journey through a series of articles in which we will come across what we have found to be the most useful tools in economics, brilliant ideas, widely held misconceptions, monumental blunders,[2] controversial views,[3] and more. The goal is to develop a solid understanding at the practicing professional level of what economics is and how it can be useful in the real world. In the process we must be guarded against the natural condescension toward ideas advanced in the past to avoid the spurious belief that our modern world is the pinnacle of centuries of analytical thinking. We ought to remember that scorn for what we don’t know but we think we understand may explain to a great extent the ignorance of basic economic principles that we have seen in our experience. 

Why Should Actuaries Concern Themselves
With Economics?

In one way or another, a focal point of actuarial practice has been understanding frequency and severity. In relatively recent times actuaries have enhanced their toolkit with the addition of stress testing, stochastic simulations, and Big Data analysis. Actuaries involved in investment portfolio management, enterprise risk management, and certain other areas may have the ­opportunity—maybe the need—to make use of economics. Most of us in the United States don’t—we often defer to economists or our work is predominantly technical in nature. This is, in our view, a missed opportunity because in modern times “the long-term view,” a concept that is natural to actuaries, cannot be conceived without some solid understanding of economics and politics. 

Actuaries have the technical background to understand economics and become contributors in areas in which their presence has been discrete such as the strategic aspects of Medicaid, Medicare, and Social Security. Not only that—actuaries can become leading players in many fields that shape (or will shape) the lives of virtually everyone; think about climate change, inequality, poverty, increasing longevity, and more. 

Let’s stretch our arms and our minds with confidence remembering Frank Redington’s[4] admonition: “The actuary who is only an actuary is not an actuary.”

What Is Economics?

Political Economy or Economics is a study of mankind in the ordinary business of life
—Alfred Marshall

The most common definition of economics reads along the following lines: “the study of how societies use scarce resources to produce valuable goods and services and distribute them among different individuals,” as made famous by Messrs. Samuelson and Nordhaus.[5] The more one explores economics, the more this characterization becomes meaningful. For now, we propose to define economics as the investigation of the economy; i.e., the examination of how value is determined, the study of money, employment, exchange rates, international trade, taxes, production and allocations of goods and services, consumption, etc. The view that characterizes economics as a deductive science under which the role of the economist is to uncover “universal” laws, develop an analytical apparatus using tools borrowed from physics, make predictions and even “discoveries” that parallel those of physics such as the existences of Neptune and Pluto[6] has its place in a world of fantasy—but it is of little use to the person interested in a practical understanding of the matter. 

Equally erroneous, in our view, is the conception advanced by pop authors such as Steven Levitt and Stephen Dubner in their book Freakonomics, where economics is presented as the science that explains almost everything.[7]  Freakonomics and other pop books such as Robert Frank’s The Return of The Economic Naturalist: How Economics Helps Make Sense of Your World approach the subject via a stretched version of rational choice[8]  plus any assumption that fits the occasion. A useful concept under certain conditions, rational choice is often extrapolated to describe a fairyland.[9]  The academic view of economics as the science that explains almost everything has been characterized as follows: “Embracing one ‘new’ field after another, economics imperialism reaches its most extreme version in the form of ‘freakonomics,’ the economic theory of everything on the basis of the shallowest principles.”[10]

In academia the core economics corpus is usually split as follows:

Microeconomics. Economics of small-scale agents such as households and firms that interact in the market of consumption goods. Typical areas of study are markets; production, cost, and efficiency; price and value; supply and demand; firms; and market failures.

Macroeconomics.[11]  Economics of large-scale interactions, typically at the national and international levels. Areas of study include economic growth; production; consumption; business cycle; unemployment; inflation; international trade; monetary policy; and fiscal policy.

Until the early 20th century economics was considered, correctly in our view, a social science according to which the ultimate explanation of economic phenomena originated in human nature—a blend of the rational and the irrational. In fact, economics was known as Political Economy.[12]  Its areas of concern were not only those of microeconomics and later macroeconomics but also social justice; overpopulation; the roles of individuals, monarchs, and the estate in society; the ethics of usury; the determinants of salaries; what constitutes fair wages; ownership of capital; and more. 

Due to the complexity of economic problems it is often necessary to develop theories based on mathematical frameworks that ignore relationships among variables that are difficult to quantify or unknown; it is also required to make simplifying assumptions. This approach is reasonable if the theories are understood as approximations subject to verification and improvement. But frequently, when theories fit certain views, they are portrayed almost as logical deductions or laws of nature that are immune to the tests of common sense and reality checks. 

Consider the case of supply-side economics (also known as trickle-down economics or Reaganomics), the leading school of thought in the U.S. and the U.K. during the 1980s. After extensive modeling in 2003 the Congressional Budget Office (CBO) concluded that the revenue-generating effects of the tax cuts examined in the study would be small. Yet, the Tax Cuts and Jobs Act of 2017 was promoted under the premise that tax revenues would not decline due to increased economic activity. In fact, according to the CBO and Joint Committee on Taxation, the expected cost of the 2017 Tax Cuts and Jobs Act by 2027 is $1.8 trillion. 

Incidentally, the accuracy of forecasts on the viability of public sector programs such as Medicare and Social Security is influenced more by macro events (e.g., the introduction of tax cuts [a political event]) than by fine-tuning assumptions (e.g., mortality) or by making marginal improvements in the predictive models. This means that if the purpose, or at least one of the purposes, of forecasting is to inform, statistical models should be supplemented with tools that can incorporate a wide range of information like system dynamics and scenario analysis.[13]

An Economics Roadmap

Because your question searches for deep meaning I shall explain in simple words
—“The Divine Comedy—Inferno” Canto II,
Dante Alighieri 

Understanding the development of economics can be complicated due to the many schools that have emerged over the centuries and the voluminous amount of material they have produced, not infrequently of questionable value. For this reason, a simplified roadmap, like the one sketched below, can be quite useful in our view to establish mental order. 

An overview of the economics thinking from Ancient Greece to the Medieval Ages is informative in many ways, not least by displaying the connection between what we call now economics, social sciences, ethics, and religion, although such a connection is often ignored in the name of “objectivity.” The treatment of just price and usury, to name two of the pressing issues of the time, have influenced perceptions to our days including those on social responsibility. Indeed, perceptions play an important role in public policy discussions even if their relevance is denied by those who believe human beings behave like rational Vulcans. 

Adam Smith (1723–1790) is considered by many the father of modern economics. His most important contributions are: (i) his synthesis of the ideas espoused by mercantilists[14]  and physiocrats;[15}  (ii) the hypothesis that the wealth of any nation is determined by its national income, not by stored gold, and that income depends on labor and economic capital; furthermore, that labor could become more productive by assigning specific tasks to different groups of employees (division of labor); (iii) his belief that a laissez-faire{16}system is more productive than a regulated one if the free market operates under ideal competition conditions. By far, the last point has become the single focus of those who oppose government intervention, frequently citing Smith’s allegorical “invisible hand”[17] (forces that make the market work at optimum level) but ignoring the necessary conditions of ideal competition. Absence of such conditions explains “anomalies” such as the blatant failure of the fee-for-service reimbursement method in health care to control costs. 

Adam Smith and David Ricardo (1772–1823), along with other distinguished economists, developed the foundations of what has come to be known as the classical school, which maintains that:

  1. Economic agents act rationally in the sense that they adopt the means that allow them to maximize their utility;[18]
  2. The economy is self-regulating and, accordingly, the role of government should be limited to prevent coercion against individuals; 
  3. An unregulated economy naturally tends to its potential output (real gross domestic product [GDP][19] with fully employed resources); occasionally the economy can operate above or below its potential level, but when this happens internal forces self-adjust to bring the real GDP to its potential level;
  4. Supply creates its own demand; in other words, the economy demands all the output it produces and consequently there cannot be overproduction (Say’s Law);[20] and
  5. Subject to small and temporary variations, there cannot be unemployment because prices, wages, and interest rates are flexible.[21]

These assertions should be understood as assumptions, not as deductions drawn from first principles or facts established by empirical observation. They are the pillars of the classical and the neo-classical schools. 

Marginalism, erected on the foundations of the classical theory, arose in the 1870s as an attempt to solve the problem of value.[22] Its success, due in large part to the adoption of the concept of derivative, provided the impetus to dress up economics in the clothes of an exact science, divorcing it not only from its social science roots but also to some extent from reality, as anybody who has taken an intermediate course of microeconomics can attest. 

The classical school provided fertile grounds for the development of heterodox economics—an umbrella term that designates various schools of thought, generally those that deviate from classical and neoclassical economics, like socialism. Socialism states that the means of production, distribution, and exchange should be owned and regulated by the community and that, accordingly, private property should be abolished. Socialism is unique in the repulsion it engenders among those who regard it one of the great evils that have afflicted humanity, and the allure to those who see it is a beacon of justice erected on scientific foundations. The fact remains, however, that few of its critics or followers have taken the time browse through the table of contents of Das Kapital,[23] and perhaps an even smaller number can define the term capital as it is used in economics. 

These days the best-known heterodox school is behavioral economics, which studies the effects of psychological, cultural, and social factors on the economic decisions made by individuals and institutions. In 2002, psychologist Daniel Kahneman (1934–) was awarded the Nobel Prize in economics “for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty.” This distinction not only crowned the notable careers of Kahneman and his life-long colleague Amos Tversky (1937–1996), but also gave birth—probably unintentionally—to a new branch of economics. 

Broadly speaking, the findings of behavioral economics conflict with certain key axioms of classical and neoclassical economics, particularly rationality, as do the findings of sociology, social and cultural anthropology, political science, psychology, psychiatry, neurology,[24] and behavioral biology. Indeed, many of the insights attributed to behavioral economics belong to other fields such as psychology, sociology,[25] even marketing.[26] These disciplines are much older than behavioral economics, but except for marketing their findings have attracted little attention in the business community. (As a matter of fact, it has been argued that behavioral economics is mostly marketing.[27]

Consider the subject of frames of reference, defined as “a structure of concepts, values, customs, views, etc., by means of which an individual or group perceives or evaluates data, communicates ideas, and regulates behavior.”[28] Frames of reference have been a subject of study of sociology[29] for a long time, yet some believe that they are concepts developed by behavioral economists. 

Whereas some contributions of behavioral economics have been insightful, generally in the form of explanations of human irrationality,[30] a large number of articles center around loose descriptions of potential applications vaguely defined, “re-discoveries” branded as novel ideas,[31] and “findings” that require little more than common sense to identify them. Here are some examples: Good customer service reduces lapses; simple language lessens confusion; people are influenced by the decisions of others; people are risk-averse. 

Game theory was developed by a group of mathematicians that included John von Neumann (1903–1957) and John Nash (1928–2015). John Nash shared the 1994 Nobel Prize in economics with John Harsanyi (1920–) and Reinhard Selten (1930–) “for their pioneering analysis of equilibria in the theory of non-cooperative games.” Game theory consists of mathematical models that attempt to explain the interaction of rational decision-makers. Although no sensible person believes the assumption of rationality conforms with reality, it has some validity when applied to actors that are capable of planning strategically like large companies. Executives do not see game theory as a flawless discipline but rather as a set of tools that can provide insights under certain conditions. For a discussion of game theory and an illustration of a practical application, see “Winning or Losing the Game?” in the July/August 2016 issue of Contingencies, wherein the economic consequences of integrated (health care) delivery models are analyzed. 

Other heterodox schools are obscure and curious, such as thermoeconomics,[32] a failed attempt to adapt thermodynamics[33] to economic theory. Thermoeconomics illustrates the process under which linguistic devices are adopted to influence public perception by attempting to bestow respectability to a theory or opinion. Business schools avail themselves of similar linguistic devices when they label a course on regression analysis as “Strategic Business Decisions.” Yale’s Theodore Marmor captures the essence of linguistic abuse in health care when he states, “My fundamental contention is that the managerial discussion of modern medicine’s most prominent topics—cost, quality, access and organization—is marked by linguistic muddle and conceptual confusion. Managerial jargon—and in the United States especially, marketing hyperbole—regularly threatens to drive out clear thought or reasoned argument.”[34]

The Austrian school, a direct descendant of the classical school and marginalism, became prominent after World War II. Its most committed exponents were Ludwig von Mises and Fredrich von Hayek. According to them, any departure from classical orthodoxy is an irreversible step toward absolutism. Unemployment compensation, old-age pensions and help to the poor leads to socialism’s repression and the resulting degradation of the human spirit. The existence of monopolies—an aberration to the laissez-faire system—is largely irrelevant to justify the greater evil of government intervention, although such intervention could be necessary to restrain unions. Mises, true to the principles of the Austrian school, condemned intervention with drug trafficking as an unwarranted interference with market forces and the associated freedom of the individual. In one of those ironic twists of history, Hayek, then an unknown economist, gained notoriety not for his work, which few took seriously, but from his attacks to John Maynard Keynes[35] and his “General Theory.” Years later Hayek became famous with the reprinting in the April 1945 issue of the Reader’s Digest of his work The Road to Serfdom and subsequently, in 1974, for winning the Nobel Prize in economics—to the annoyance of Gunnar Myrdal, with whom he shared it and who considered Hayek a second-rank economist.[36] The Royal Swedish Academy of Sciences granted the award “for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena.”

The Great Depression of the 1930s caught economists off-guard. Unable to explain with any degree of plausibility its causes and uncertain about actions to restore prosperity, only a small number of economists defended capitalism while many believed that the economic crisis had established the ascendency of socialism. But in 1936, Keynes stated that whereas capitalism was imperfect and required serious amendments, it was the least flawed economic system that could be hoped for in the real world. He opposed communism and was a strong supporter of freedom, yet in some circles he has been portrayed as a proponent of unchecked government intervention and a supporter of absolutism.

Keynes discussed the causes of the Depression and offered practical solutions, in the process creating macroeconomics. Keynes rejected several assumptions from classical economics including the five noted above. In contraposition to prevalent views at the time of his writings, he postulated that the instability of the market is the consequence, to a great extent, of the ungovernable psychology of the masses,[37] and that the proximate cause of recessions (other than wars or natural disasters) is insufficient demand vis-à-vis lack of supply. He advanced other propositions and introduced a series of concepts, some of which became integral part of macroeconomics.[38] Keynes argued that in the short run[39] the best tool to fight a recession is fiscal policy—i.e., taxation and government spending. During a recession, the government should help increase demand by boosting its spending (e.g., improve infrastructure to benefit commerce, fund research, etc.) to create jobs, and/or reduce taxes to expand disposable income. Because these actions result in deficits, governments ought to do the opposite in good times to balance the budget—i.e., reduce spending and/or increase taxes. Critics immediately condemned the use of fiscal policy by focusing on the first part of Keynes’ advice (increase spending and reduce taxes during a recession) but ignoring the second (reduce spending and increase taxes during an expansion). Ironically, the historical record shows that the largest deficits in the U.S. excluding those caused by wars or financial emergencies (e.g., the Great Recession of 2007–2009) have been created by administrations that portray themselves as fiscally conservative and characterize Keynesian economics as financially irresponsible, most recently through the Economic Recovery Tax Act of 1981 and the Tax Cuts and Jobs Act of 2017.

After World War II, most industrialized countries managed their economies along Keynesian principles. The West enjoyed unparalleled prosperity until the 1973–1975 recession caused by the OPEC embargo, which ushered a period of stagflation[40] that could not be tackled with the Keynesian tools of the time. In 1979, with inflation of 20%, the Federal Reserve System (“Fed”) adopted monetarist tools in an attempt to solve the problem: It increased interest rates to reduce the money supply, which in turn choked consumption and forced businesses to stop raising prices. The medicine cured the out-of-control inflation but created the 1980–1982 recession. The result was that monetarism gained temporary prominence, especially in the Reagan and Thatcher administrations, but faded away as people questioned its ability to explain the behavior of the economy and manage it.

Monetarism, a synthesis of existing concepts undertaken by Nobel Laurate Milton Friedman (1912–2006), holds that the most important driver of economic growth is the money supply; increasing it only provides a temporary boost to economic growth and job creation. Over the long run, an expanded money supply just creates inflation. Friedman described monetarism’s main features in his 1967 address to the American Economic Association after the publication of his famous book, co-authored with his wife, Anna Schwartz, A Monetary History of the United States, 1867-1960, and predicted that given the then-current conditions of the American economy—stagflation—would occur. “The Monetary History,” as it is commonly known, states that money supply fluctuations (certainly not the psychology of the masses) are the most important cause of economic instability. This conclusion was later challenged by those who observed that if there is causation, its arrow points in the opposite direction of what Friedman postulated. The influence of monetarism, in fact if not in the public discussions, was relatively short-lived. 

Friedman rejected the use of fiscal policy to manage the economy and held that the government’s role in guiding the economy should be minimal. He opposed government management of the economy even during recessions while he defended zealously free markets. Friedman became the author of the “Shareholder Theory”—the doctrine that maintains that a company’s only social responsibility is to its shareholders.[41] His views were consistent with the belief that the market is beneficial, all-knowable, and the supreme arbiter. Friedman was an excellent writer and a skilled speaker. Many of his presentations and speeches are publicly available on YouTube, including “Milton Friedman wanted to become an actuary,” “Milton Friedman Speaks: The Economics of Medical Care,” “Milton Friedman—The Social Security Myth,” “Milton Friedman—What’s wrong with welfare? (Q&A)” and “Free to Choose Part 6: What’s Wrong With Our Schools Featuring Milton Friedman.” Incidentally, the debates on public education are useful to inform the discussion on diversity and inclusion in the actuarial profession. Some of the ideas presented in “What’s Wrong With Our Schools” are explored in the white paper “On Diversity and Inclusion,” written by one of the authors of this article and available upon request.

Finally, a few words about econometrics,[42] the branch of economics that employs statistical techniques and whose goals are to: (i) test hypotheses (e.g., whether salaries depend on race and gender), (ii) estimate parameters (e.g., the elasticity of demand of medical services), and (iii) generate forecasts (e.g., next year’s medical expenses to be covered by the Veterans Benefits Administration). Econometrics is mostly used to tackle macroeconomic problems such as labor economics and health economics. Whereas some econometric models have proved useful, others (including actuarial adaptations) have not. Robert Lucas (1937–), the 1995 Nobel laureate in economics, argued that the structural relationship observed in historical models breaks down if decision-makers adjust their preferences to reflect policy changes. The same argument, only with much greater intensity, applies to predictive models (in health care) that rely, as they must, on variables whose dependencies change over time, often in ways that cannot be estimated as it happens with the introduction of new legislation, new delivery models (e.g., integrated health care delivery models), new reimbursement models, new medical procedures, new drugs, epidemics, expanded populations covered, etc.

Backed by almost one century of research and scrutiny in its explanatory and predictive powers, econometrics is certainly an area of study relevant to health care actuaries. 

Final Remarks

Philosophers have only interpreted the world in various ways. The point, however, is to change it.
—Karl Marx

Although the most useful concepts of economics are within the reach of the non-specialist, we find their mastery is elusive for a couple of reasons. First, the landscape is crowded with theories—some of them well grounded, some of them of dubious value, many of which are inconsistent with each other. The confusion is magnified by the fact that economists, even Nobel Prize laureates,[43] disagree on the fundamentals. This state of affairs complicates the selection of learning material. Second, there are “theories” that we believe are divorced from reality but that appear legitimate because they are clothed with scientific lingo. More than a few people think that if a theory is expressed in mathematical terms it must be correct, at least to some significant degree, and that the more convoluted the mathematics, the more valuable the theory should be. Thus, one can be left with the impression that learning economics requires the kind of specialized knowledge that can only be attained by pursuing a graduate degree or by countless hours of self-study. 

Fortunately, when it comes to economics, “to substitute facts for appearances and demonstrations for impressions”[44] as actuaries have been urged to do in the name of science does not require an enormous effort. A solid grasp of the salient points of economic history, mastery of a relatively small number of concepts and tools, competence in a few theories, and common sense is what we find one needs to gain a practical knowledge of the subject. 

Carlos Fuentes, MAAA, FSA, MBA, MS, is president of Axiom Actuarial Consulting. He can be reached at carlos-fuentes@axiom-actuarial.com.

Shiraz Jetha, MAAA, FSA, CERA, works in Washington state. He can be reached at s.jethaa@gmail.com


[1] “Stress Test,” (2014), Timothy F. Geithner, p. 39.

[2] William Stanley Jevons (1835–1882) published in 1878 his “Commercial Crises and Sun-Spots,” wherein he explained that sunspots influence the business cycle. This theory has been generalized and it is not without its adherents in the 21st century.

[3] Should safety features in automobiles be regulated, or should the market decide? Do impersonal forces like the “invisible hand” know better, or is government intervention necessary? See “Milton Freedman About Cars and Child Safety,” https://www.youtube.com/watch?v=-h-8DHhrldU. 

[4] Author of “Review of the Principles of Life Office Valuations” published in the early 1950s.

[5] Economics, Paul Samuelson and William Nordhaus, 19th edition, 2009.

[6] Astronomers inferred the existence of Neptune and Pluto using Newton’s laws of gravitation. Their existence was confirmed by observation. 

[7] See Freakonomics Chapter 2 (Information Control Applied to the Ku Klux Klan and Real-Estate Agents), Chapter 4 (The Role Legalized Abortion Has Played in Reducing Crime, Contrasted with the Policies and Downfall of Romanian Dictator Nicolae Ceauşescu), Chapter 5 (The Negligible Effects of Good Parenting on Education), Chapter 6 (The Socioeconomic Patterns of Naming Children).

[8] Rational choice is the central pillar of classical and neoclassical economics. It maintains that individuals rely on rational calculations to achieve outcomes that are in line with their personal objectives. 

[9] Much can be learned from the Romanticism, an intellectual movement that rejected the precepts of order, idealization, and rationality typified by Classicism and Neoclassicism. 

[10] From Economics Imperialism to Freakonomics by Ben Fine and Demitirs Milonakis, 2009, back cover. 

[11] John Maynard Keynes created microeconomics with the publication of his epoch-making book General Theory of Employment Interest and Money (“The General Theory”) in 1936.

[12] The contemporary definition of political economy is as follows: a branch of social science that studies the relationships between individuals and society, markets and the state, using methods drawn from economics, political science, and sociology.

[13] For a description of system dynamics see “Making Sense of the Unexpected,” The Actuary, Dec 2017/Jan 2018. For a description of scenario analysis see “The Futures of the US Health Care System,” Contingencies, Mar/Apr 2016.

[14] Mercantilists were 16th- to 18th-century economists who believed that the purpose of government regulation was the accumulation of the largest possible share of wealth in the form of gold by maximizing exports and minimizing imports.

[15] Physiocrats were 18th-century French economists who believed that agriculture was the source of all wealth and that the government should not interfere with the operation of “natural” economic laws.

[16] From the French, “allow to do.” It refers to the doctrine of minimum governmental interference in the economic affairs of individuals and society.

[17] The “invisible hand” is an allegory that Smith used once in his famous work, An Inquiry into the Nature and Causes of the Wealth of Nations (Book IV, Chapter II, Paragraph IX), and three times in all his writings. 

[18] Utility is a measure of satisfaction.

[19] Gross domestic product (GDP) measures a country’s output (goods and services). Real GDP adjusts GDP for inflation.

[20] Jean-Baptiste Say (1767–1832) was a French economist and businessperson. The role of Say’s Law in the evolution of economics is frequently ignored but it can hardly be overstated. 

[21] According to the classical theory, involuntary unemployment cannot exist—anybody who looks for a job can find one within a short period of time. Those unemployed are so due to personal choice (e.g., children, homemakers, retirees). They could, if so desired, find suitable jobs. 

[22] Economic value is a measure of the benefit provided by a good or service to an economic agent. The problem of economic value was so important in economics that before the advent of macroeconomics, economic theory and value theory were sometimes used as synonyms. 

[23] Published in 1867 by the economist and philosopher Karl Marx (1818–1883), Das Kapital is one of the major works of the 19th century.

[24] Theories that explain why we think fast and slow such as the Triune Brain (to be described in a future issue) were developed by neurologists. 

[25] Consider the Asch Conformity Experiment conducted by Solomon Asch in the 1950s in which he analyses the effects of group influence on individuals. Consider also the Car Crash Experiment conducted by Elizabeth Loftus and John Palmer in 1974 in which the researchers concluded that memory can be manipulated by questioning techniques. 

[26] See the section Strategic Responses to Managing Customer Perceptions of Risk in Services Marketing (2007), p. 45 by C. Lovelock and J. Wirtz.

[27] See “Why Behavioral Economics Is Really Marketing Science,” Evonomics, August 24, 2016, by Philip Kotler. 

[28] Your Handbook for Global Leadership; Winfried H. Brunner; 2009.

[29] There are many studies on the subject. See, for example, “The Frame of Reference in Social Psychology,” The Midwest Sociologist, by Carroll D. Clark, Vol. 15, No. 1 (Winder, 1953), pp. 8-14.

[30] People tend to overvalue risk; people tend to underestimate future events and their long-term consequences, etc. But these and many other human traits have been known for millennia. See “Your Company Is Too Risk-Averse,” Harvard Business Review, by Daniel Kahneman et al, Mar-Apr 2020.

[31] See “5 Behavioral Economics Principles Marketers Can’t Afford to Ignore,” Forbes, March 2018. (https://www.forbes.com/sites/piyankajain/2018/03/01/5-behavioral-Economics-principles-for-marketeers/#3f6514c28ebc). Anybody who has taken a marketing course will recognize those principles not as cutting-edge revelations but as old marketing precepts. 

[32] Thermoeconomics is a subfield of econophysics and probably a descendant of astrology. See Practical Approach to Exergy and Thermoeconomic Analyses of Industrial Processes by Enrique Querol, Borja Gonzalez-Regueral, Jose Luis Perez-Benedito. 

[33] Thermodynamics is a branch of physics that deals with the relation between heat and other forms of energy. Rudolph Clausius and William Thompson formulated the famous Second Law in 1861. 

[34] Fads, Fallacies and Foolishness in Medical Care Management and Policy, Theodore Marmor (2008).

[35] See “Hayek on Keynes’ Ignorance of Economics,” https://www.youtube.com/watch?v=y8l47ilD0II. 

[36] See “Hayek’s ‘Rejuvenating Event,’” published in the Foundation for Economic Education, October, 9 2014, https://fee.org/articles/hayeks-rejuvenating-event/. 

[37] Keynes and others have understood the importance of psychology. Adam Smith stated in The Wealth of Nations that “human beings are selfish, egotistic, exclusively concerned with self-love and material wealth.” This opinion permeates Smith’s works, yet it is seldom acknowledged. 

[38] For instance, liquidity preference, effective demand, the consumption function, the marginal efficiency of capital. The multiplier plays a central role in Keynesian theory but the concept was developed by R. F. Kahn in his article on “The Relation of Home Investment to Unemployment” (Economic Journal, June 1931). 

[39] The short run is a period during which the quantity of at least one input is fixed. In practical terms the short run ranges from several months to several years, depending on the situation under consideration. 

[40] Slow or negative economic growth accompanied by inflation and high unemployment.

[41] In a future issue we will explore Karl Marx’s and David Ricardo’s views on wages and social responsibility.

[42] The term econometrics was coined by Ragnar Frisch (1895–1973) in his introduction to the first issue of Econometrica in 1933.

[43] The Nobel Prize is one of the most prestigious awards in the world but it does not guarantee universal acclamation, as attested by the 2016 Prize in Literature to Bob Dylan, who received it for “having created new poetic expressions within the great American song tradition.”

[44] John Ruskin, The Stones of Venice, Volume III, 1853.

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