Value Judgements

Everything has an ideology. Or rather, ideologies come out in most of the things that we do in this life. Nothing bothers me more than when people claim that economics is objective, that once you create an economic model you have created some divine and authoritative account of it. Models are no more authoritative than a poem. They are just poems that people tend to believe, and listen to.

Deciders, All of Us
Being an economist means making a lot of choices that your readers never see. This is why there is that quote about "liars, damned liars, and statisticians". Let me give you a couple of examples. For any model to work you have to make assumptions; assumptions are based on your point of view, which is based on your set of preferences, your worldview, your upbringing, on and on. The problem is that economics has gotten very rigid in what assumptions are made. For instance, we always assume that people act rationally. People might not act rationally. Period. We also might assume a certain set of preferences onto people, like a preference for labor over home production -- or home production over labor depending on the gender of the person. Heck, some of the Becker's theories in A Treatise on Family are premised on the idea that there are biological differences between the sexes that predisposes woment to have a comparative advantage at housework. Think about that for a second. You can't include everything in a model, it cannot recreate real life in equation form. That means making decisions about what to include and what to assume away.

Assume that the credit market works, poor people should be able to pay for education by borrowing money and therefore pull themselves up by the bootstraps. Can we assume that? Does that make sense given what I know about the world? No, would things work more smoothly if the credit market did work, yes. But it shouldn't be assumed a priori like that. It's irresponsible. Decisions we make matter, they hide or expose people's lives.

Choosing Costs, Choosing Benefits
Along with these decisions of modeling, we also have to make decisions about what costs and benefits to include in our calculations. Let's think about a basic problem -- how many gallons of GOOK Factory A should produce. I'll give you the answer first, and then explain it a bit: Factory A should produce where marginal benefit equals marginal cost.

1. GOOK is good for the residents of East Gookville who buy it, they use it for a lot of things -- it might even cure cancer. There are benefits to the production of gook for the people who buy it. We will call these benefits to people who buy GOOK marginal private benefit or MPB ( for now, don't worry about why it's marginal, or ask me in the comments and I'll write another post with graphics to explain).
2. GOOK costs money to make, Factory A has to pay residents of East Gookville for their labor, and there are the raw materials that go into GOOK. We will call this the marginal private cost (MPC) of GOOK.

So we should produce X number of GOOK when

(Equation 1) MPB(x)=MPC(x)

Incidentally, the price of GOOK will be equal to MPB or MPC at this point.

Got it?

Good, now, let me complicate things. This is the private equilibrium point, all the private costs and benefits are taken into account.

The production of GOOK produces this nasty smoke and gross slime that pours out of the factory and into East Gookville. It smells bad, it makes kids sick. It's Erin Brockovitch territory. There are two ways to think about this smoke and slime. It is either a increase in the cost, or a decrease in the benefit. It really doesn't matter which way you think about. I'll go with the cost model here. Normally, in the market, the slime and smoke would not enter into the equation, neither Factory A nor the people who buy GOOK have to pay to help clean up East Gookville. It is an externality -- a cost or benefit not borne by any of the agents managing a transaction. They are maybe my favorite thing you would learn about in the first semester of microeconomics.

So imagine that we added in the Social Cost (SC) or the slime and smoke (if you want to think of it as the Slime Cost, I'll support you).

(Equation 2) MPB(x)=MPC(x) + SC(x)

This will increase the price, right? Because this number will be bigger than the number in Equation 1. And an increase in price means fewer units of GOOK are sold, which means that the benefits of GOOK to the community of East Gookville offset the costs. Now, we are producing a socially optimal amount of GOOK.

Here is the trick -- which costs do you include. If you think that there are social costs or benefits to an action that has a market (or one that doesn't have a market) they need to be taken into account if we want to reach a social optimum, and as the person writing the equations I get to decide what to include, and how to quantify the benefits.

Warning: Once you start doing this, and applying it to your everyday life, you can rationalize *anything*. I should have this piece of cake, because it will make me happy, and my happiness will confer a social benefit on all the people I smile at in the train. You see what I mean, tricky business, and economists rarely talk about the decisions they are making behind the scenes and the implications that they have. A continuation including my "most quoted quote" will follow sometime before bed.