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What is economics?

Updated: Sep 19, 2020

When the graduate program director posed that basic question back in the day to our group of incoming PhD students, it almost froze us. Some of us dutifully responded with a very dry answer: the study of decisions made under scarcity. Which is totally true. You can't always get what you want, so tradeoffs always have to be made. And that can really drive the way the world works. But that definition doesn't leave you with an impression of what economists actually do. And it's rarely study stock markets.


The reality is the applications for economic thinking and tools is vast, so we do a lot of things and answer all sorts of questions. But for the audiences and clients I work with, I like to think of economics in the following ways:


The application of structural and systems thinking to problems and analytics


Nothing happens in a vacuum. Presented with a couple of data series that move up and down together, a non-initiate may be tempted to claim, "See? If we increase X, we'll get more Y." But that ignores the presence and influence of Z, never-mind all the other letters in the alphabet. And if you're changing how the system works, you better believe you're going to change the relationship between X and Y too.


Economists are very sensitive about that kind of thing. You need a structural reason that more X would lead to more Y. You base your understanding on how the system works under different assumptions about peoples' incentives and behavior, their constraints and limitations and/or your ability to capture what else might be moving the data you're looking at.


A majority of an economist's value in so many cases are the questions they'll ask to figure out the system in which your operate. How do you know what you think you know? Have you considered that related thing way over there? How do you think your product will change your customers' behavior? When we do our analytics, we're going to try and account for that.


Taking an example from my time at Zillow, when you ask me how home prices will behave during this crisis, I'm going to make you think about more than the response from buyers who lost their confidence, but the behavior of sellers and regulators and mortgage lenders. It's rare to shock just one part in the system and not see the effects reverberate throughout and bounce back to you.


The study of how market features can inhibit widespread freedom of choice from delivering the optimum result


Technically, this is a definition for the narrower discipline of welfare economics (not welfare as in the policy, but the idea of wellbeing -- consumer and producer surplus). But I bring it up as a lens for voters and policy makers. I figure you get republicans with the emphasis on freedom. With an acknowledgment that markets aren't perfect, you get your democrats.


Too often I run into proud holders of an undergraduate degree in economics who in their love of markets forget that so many of their 300 level classes were dedicated to one market failure after another: market power from a lack of competition, the presence of externalities -- those costs or benefits that flow from your decision that you didn't take into account when you made it, asymmetric information where one side eek an advantage out over another. Smart interventions can resolve market failures. Policy can be very appropriate for market health.


But it's just as often I run into folks who seem to want to force a result that's not really possible without heavy costs or unintended consequences and who equate profits with immorality. Heavy land use regulation is a perfect example. I frequently heard the phrase "we've seen that free markets can't provide affordable housing" from the same folks blocking more housing supply because the developers will make too much money.


That profit was created by the limitations on supply we put there to keep the character and housing stock of our neighborhoods the same. The profit incentivized the developer to want to change that character and supply more housing. And the more you let supply grow, the lower those profits will get as the pressure on rent comes down. The idea that by simply not allowing development, we can freeze time without consequence is an impossible fantasy. It's a system. Pull one lever and you bush four buttons you didn't intend.


Smart policy leverages the efficiency of self-adjusting market dynamics, but acknowledges the failures inherent in certain markets and the impact of the rules we impose.






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