The Top Five Lessons for the Young Economist

The Mises Institute is taking back economics education. In public schools, students learn that FDR’s New Deal and World War II got the US out of the Great Depression. They learn that total government control over an economy has its downsides, but so does pure laissez-faire, so the best system is a mixed economy with government intervention. The role of the entrepreneur is minimized or even completely ignored while the role of the state is emphasized and praised.

Public education indoctrinates students so that they become unquestioning citizens who will embrace price controls, taxes, inflation, and regulations.

To fight back, we’re producing a series of short lectures corresponding to Robert P. Murphy’s excellent textbook, Lessons for the Young Economist. The text is already widely used in homeschool curricula, but we want even more students to learn Austrian economics and become equipped to think critically about socialism and interventionism. To that end, here are the five lessons from Murphy’s textbook that I think are most important.

   1. Thinking Like an Economist

A solid understanding of economics is essential for making sense of the world. Thinking like an economist means viewing the world through the lens of human action: we use scarce means to attain our desired ends. All choices involve opportunity costs because the means we use to attain one end could have been used to attain a different end. 

Henry Hazlitt and Frederic Bastiat showed that understanding this fundamental point is the key to making sense of a host of economic events and government policies. Both of them used the parable of the broken window to show that involuntary destruction, whether caused by a young hoodlum throwing a brick or a hurricane, does not “stimulate the economy” and create employment. It destroys scarce resources and redirects spending and employment. The same reasoning applies to all government policies aimed at “stimulating the economy.”

  2.  The Division of Labor and Specialization

There is a reason why Ludwig von Mises considered social cooperation in a division of labor “the greatest accomplishment of reason.” Robinson Crusoe would be able to eke out a meager existence at best. When we specialize in the tasks in which we have a comparative advantage and trade with one another, total productivity expands and standards of living can rise beyond subsistence to the levels we see and experience today.

The reason why the division of labor is so productive is because the opportunity costs (there it is again!) of production are minimized. Even if somebody has an absolute advantage in producing multiple goods, it still makes sense for that person to specialize in producing the good in which he has a relatively low opportunity cost.

   3.  Profit and Loss Accounting

The only way to rationally organize production for the benefit of consumers is with economic calculation. Entrepreneurs bid for factors of production based on their anticipation of what consumers will want in the future. Success yields profit, and waste results in losses. Profit and loss, therefore, provide an essential guide and incentive for producing what consumers want.

It’s difficult to overstate how important the mechanisms of profit and loss are for the market economy. It’s essential for students to learn what profit and loss mean so that they become immune to state propaganda and socialist envy-mongering. The economy is not zero-sum and profits are not the result of “corporate greed.” Government interventions that are aimed at reducing profits (like capital gains taxes) or mitigating losses (like bailouts and subsidies) only hamper the resource-economizing, consumer-satisfying market process.

   4.  The Failures of Socialism—Theory

Dr. Murphy covers both of the major theoretical problems with socialism: the “who will do the dirty, dangerous, and difficult jobs?” incentive problem and the economic calculation problem. While the first one is more well-known, the second is more devastating. Socialists answer the first one by claiming that with the advent of socialism, a “New Socialist Man” will emerge, with a new selfless, collectivistic human nature. Anyone and everyone will be happy to do the dirty, dangerous, and difficult jobs for the benefit of the community.

The reason the second critique is so strong is because it grants the socialists that dubious claim. Even if human nature fundamentally changes, the problem of knowing what to produce, in what quantities, using what resources remains. This problem is solved in market economies through profit and loss accounting, or economic calculation. As Ludwig von Mises famously argued,

[I]n the socialist commonwealth every economic change becomes an undertaking whose success can be neither appraised in advance nor later retrospectively determined. There is only groping in the dark. Socialism is the abolition of rational economy.

So, despite what some people say about socialism being “good in theory but terrible in practice,” socialism is theoretically bankrupt. (Students interested in the disastrous historical record of socialism will find that in Chapter 16 of Dr. Murphy’s textbook.)

   5.  Inflation

One reason inflation is confusing to both students and the general public is because its definition has shifted over the course of the 20th century. It used to refer to an increase in the amount of money, “especially by the issuing of paper money not redeemable in specie” (according to Henry Hazlitt’s copy of the American College Dictionary in 1960). Then it became synonymous with an increase in the “price level,” and nowadays people use it to refer to any increase in price. The terminological shift conflates cause and effect—people focus on the symptoms and not the underlying disease. The disease is, of course, government money creation.

But monetary expansion has many more negative consequences. New money enters the economy at a particular point, benefiting the people closest to the entry point at the expense of those further away. It enables massive amounts of government spending, discourages saving, distorts economic calculation, and destroys the culture. One of the most important consequences of monetary inflation, when the new money flows through credit markets first, is that it generates the boom-bust cycle.

Bonus Lesson: The Business Cycle

The boom-bust cycle is such an important consequence of inflation that Dr. Murphy gave it its own chapter. Ludwig von Mises first developed Austrian business cycle theory in his 1912 book, The Theory of Money and Credit. He showed that when new money is created by fractional reserve banks or the central bank, it results in artificially low interest rates. Normally, interest rates balance people’s desire to consume today versus tomorrow. When people decide to save more and delay consumption, this frees up resources for entrepreneurs to pursue new, longer lines of production.

But artificially low interest rates stimulate increased consumption and bigger production projects, even though the real resources haven’t been set aside. The economy experiences a “boom,” in which incomes increase, prices rise, businesses grow, and unemployment shrinks. But time will tell that this boom is unsustainable—it’s based on overconsumption and malinvestment. Once entrepreneurs realize their projects can’t be completed profitably (usually when interest rates rise), they liquidate their projects, unemployment rises, and the economy goes into a recession. Business cycles, therefore, are not a natural feature of the market economy, but are the result of artificial credit expansion.

Become Immune to State Propaganda

Every student should become acquainted with the fundamentals of economics, and I don’t mean the type of “economics” that is thinly veiled state propaganda. We’ve seen in these few short lessons that the market economy is a network of voluntary exchange and division of labor. It’s peaceful cooperation toward the goal of making the best use of scarce resources.

One thing the government is good at is duping people into thinking that its interventions are good for the economy, and the primary channel the government uses to spread its myths is through its grip on education. Break free with a solid economics education.

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