The economics book big ideas simply explained

LONDON, NEW YORK, MELBOURNE, MUNICH, AND DELHI DK LONDON DK DELHI First American Edition, 2012 PROJECT ART EDITORS Anna Hall, Duncan Turner SENIOR ART EDITOR Ivy Roy SENIOR EDITORS Janet Mohun, Rebecca Warren ART EDITOR Arijit Ganguly Published in the United States by DK Publishing 375 Hudson Street New York, New York 10014 EDITOR Lizzie Munsey ASSISTANT ART EDITORS Sanjay Chauhan, Kanika Mittal US EDITOR Kate Johnsen CONSULTANT ART DIRECTOR Shefali Upadhyay MANAGING ART EDITOR Michelle Baxter SENIOR EDITOR Anita Kakar MANAGING EDITOR Camilla Hallinan EDITORS Rupa Rao, Priyaneet Singh PUBLISHER Sarah Larter DEPUTY MANAGING EDITOR Alka Thakur ART DIRECTOR Philip Ormerod EDITORIAL MANAGER Rohan Sinha Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwise), without the prior written permission of both the copyright owner and the above publisher of this book ASSOCIATE PUBLISHING DIRECTOR Liz Wheeler DTP MANAGER Balwant Singh Published in Great Britain by Dorling Kindersley Limited PUBLISHING DIRECTOR Jonathan Metcalf DTP DESIGNERS Vishal Bhatia, Bimlesh Tiwary A catalog record for this book is available from the Library of Congress Copyright © 2012 Dorling Kindersley Limited All rights reserved ISBN: 978-0-7566-9827-0 ILLUSTRATIONS James Graham produced for DK by PICTURE RESEARCH Louise Thomas TALLTREE LTD PRODUCTION EDITOR Ben Marcus MANAGING EDITOR David John PRODUCTION CONTROLLER Sophie Argyris COMMISSIONING EDITOR Sarah Tomley SENIOR DESIGNER Ben Ruocco original styling by STUDIO8 DESIGN 07 08 09 10 11 10 001 - 186345 - Sep/2012 SENIOR EDITORS Rob Colson, Deirdre Headon DK books are available at special discounts when purchased in bulk for sales promotions, premiums, fund-raising, or educational use For details, contact: DK Publishing Special Markets, 375 Hudson Street, New York, New York 10014 or SpecialSales@dk.com Printed and bound in China by Leo Paper Products Ltd Discover more at www.dk.com CONTRIBUTORS NIALL KISHTAINY, CONSULTANT EDITOR JAMES MEADWAY Niall Kishtainy teaches at the London School of Economics and specializes in economic history and development He has worked for the World Bank and the United Nations Economic Commission for Africa Economist James Meadway works at the New Economics Foundation, an independent British think tank He has also worked as a policy adviser for the UK Treasury GEORGE ABBOT CHRISTOPHER WALLACE George Abbot is an economist who worked in 2012 on Barack Obama’s presidential reelection campaign He previously worked with Compass, the influential UK think tank, on strategic documents such as Plan B: A New Economy for a New Society Christopher Wallace is Head of Economics at the UK’s prestigious Colchester Royal Grammar School He has been teaching economics for more than 25 years JOHN FARNDON MARCUS WEEKS John Farndon is the author of many books on contemporary issues and the history of ideas, including overviews of the booming economies of China and India Marcus Weeks studied philosophy and worked as a teacher before embarking on a career as an author He has contributed to many books on the arts and popular sciences FRANK KENNEDY Frank Kennedy worked for over 25 years in investment banking in the City of London as a top-ranked investment analyst and as a managing director in capital markets, where he led a European team advising financial institutions He studied economic history at the London School of Economics CONTENTS 10 INTRODUCTION LET THE TRADING BEGIN 400 BCE–1770 CE 20 Property should be private Property rights 22 What is a just price? Markets and morality 24 You don’t need to barter when you have coins The function of money 26 THE AGE OF REASON 1770–1820 52 Man is a cold, rational calculator Economic man 54 The invisible hand of the market brings order Free market economics 62 The last worker adds less to output than the first Diminishing returns 63 Why diamonds cost more than water? The paradox of value 64 Make taxes fair and efficient The tax burden Make money from money Financial services 30 Money causes inflation The quantity theory of money 34 Protect us from foreign goods Protectionism and trade 36 The economy can be counted Measuring wealth 66 Divide up pin production, and you get more pins The division of labor 68 Population growth keeps us poor Demographics and economics 70 Meetings of merchants end in conspiracies to raise prices Cartels and collusion 38 Let firms be traded Public companies 39 Wealth comes from the land Agriculture in the economy 74 Supply creates its own demand Gluts in markets 40 Money and goods flow between producers and consumers The circular flow of the economy 76 Borrow now, tax later Borrowing and debt 78 The economy is a yo-yo Boom and bust 80 Trade is beneficial for all Comparative advantage 46 Private individuals never pay for street lights Provision of public goods and services WAR AND DEPRESSIONS INDUSTRIAL AND ECONOMIC REVOULTIONS 1929–1945 1820–1929 90 92 98 How much should I produce, given the competition? Effects of limited competition Phone calls cost more without competition Monopolies Crowds breed collective insanity Economic bubbles 100 Let the ruling classes tremble at a communist revolution Marxist economics 106 The value of a product comes from the effort needed to make it The labor theory of value 154 Unemployment is not a choice Depressions and unemployment 126 Companies are price others avoid it Risk and uncertainty 130 Make one person better off 164 Government spending without hurting the others Efficiency and fairness and demand Supply and demand the lower the cost Economies of scale chocolate less than the first Utility and satisfaction movies is the fun you’d have had at an ice rink Opportunity cost 134 Workers must improve their lot together Collective bargaining be noticed Conspicuous consumption External costs in culture Economics and tradition 168 Managers go for perks, not their company’s profits Corporate governance 170 The economy is a predictable machine Testing economic theories 171 Economics is the science of scarce resources Definitions of economics 172 We wish to preserve a free society Economic liberalism 138 Protestantism has made us rich Religion and the economy 116 When the price goes up, some people buy more Spending paradoxes 166 Economies are embedded 133 The cost of going to the 137 Make the polluter pay 114 You enjoy the last boosts the economy by more than what is spent The Keynesian multiplier 132 The bigger the factory, 136 People consume to 108 Prices come from supply 162 Some people love risk, takers not price makers The competitive market 140 The poor are unlucky, 178 Industrialization creates sustained growth The emergence of modern economies not bad The poverty problem 180 Different prices to different 118 A system of free markets is stable Economic equilibrium 124 If you get a pay raise, buy caviar not bread Elasticity of demand 142 Socialism is the abolition of rational economy Central planning 148 Capitalism destroys the old and creates the new Creative destruction people Price discrimination POST-WAR ECONOMICS CONTEMPORARY ECONOMICS 186 In the wake of war 262 It is possible to invest 1945–1970 1970–PRESENT and depression, nations must cooperate International trade and Bretton Woods without risk Financial engineering 266 People are not 220 Policies to correct markets 188 All poor countries need is a big push Development economics can make things worse The theory of the second best 270 Tax cuts can increase 222 Make markets fair 194 People are influenced by irrelevant alternatives Irrational decision making 196 Governments should nothing but control the money supply Monetarist policy 202 The more people at work, the higher their bills Inflation and unemployment 204 People smooth consumption over their life spans Saving to spend 206 Institutions matter Institutions in economics 208 People will avoid work if they can Market information and incentives The social market economy efficiency require many assumptions Markets and social outcomes will be rich Economic growth theories 226 Globalization is not inevitable Market integration 232 Socialism leads to empty shops Shortages in planned economies 234 What does the other man think I am going to do? Game theory 242 Rich countries impoverish the poor Dependency theory 244 You can’t fool the people Rational expectations about probability when they choose Paradoxes in decision making 250 Similar economies can 214 There is no perfect voting system Social choice theory benefit from a single currency Exchange rates and currencies 216 The aim is to maximize happiness, not income The economics of happiness the tax take Taxation and economic incentives 224 Over time, all countries 248 People don’t care 210 Theories about market 100 percent rational Behavioral economics 256 Famine can happen in good harvests Entitlement theory 272 Prices tell you everything Efficient markets 273 Over time, even the selfish cooperate with others Competition and cooperation 274 Most cars traded will be lemons Market uncertainty 276 The government’s promises are incredible Independent central banks ... incorporated ideas from disciplines such as psychology and sociology into their theories, as well as new advances in mathematics and physics, such as game theory and chaos theory These theorists... price is simply the price the buyer freely agrees to pay, given honest information The vendor is not obliged to make the buyer aware of facts that might lower the price in the future, such as the. .. theories 170 The economics of happiness 216–19 ■ Gender and economics 310–11 measure.” This approach helped form the basis of the discipline that would become known as economics In his 1690 book