 Welcome everybody. In this lecture, we're going to walk through the types of implications we can derive from basic economic insights. Specifically, we're going to see the types of things we can learn about reality just from thinking through the implications of the fact that people act, meaning they behave purposefully, that they have conscious goals they're trying to achieve. As we'll see, there's a lot of things we can learn about that situation just by thinking through it. Let me start though by giving a review of what we covered in the last lecture. There we talked about the fact that there's a difference between the natural sciences and the social sciences and that the methods that are appropriate in each can be different. And so it's true, we want to be able to say that economics is a science. It's an objective field that gives us results that we can be confident about. And the results in economics, what you can call economic principles or economic laws, those things are valid whether or not the person hearing them likes them. So just as the laws of physics are what they are and if the people in government don't like it and say, no, no, we want to be able to send a ship into space that goes faster than the speed of light and how much money do we need to throw at that. Just tell us what we need to do and that's what we're going to do and get it done. Because we have the political will, gosh darn it. And the physicists can say, no, I don't care how much money you throw at it. I don't care how much political willpower you put into it. The laws of physics say you can't accelerate a rocket ship faster than the speed of light. By the same token, the sorts of things we're going to learn as we go through my book, Lessons for the Young Economist, which is the textbook for this course, those things are objective economic laws or principles. And it's not based on my personal political whims or preferences. Those are objective principles. And if people in government or supporters of certain government measures don't like those results, well, too bad. They can't overturn objective reality. However, having said that, even though we're acknowledging economics is a science and that you can come up with conclusions in economics that aren't based just on your prior political prejudices or feelings about the way you think things ought to go, even so, that doesn't mean that the way we develop economic principles or laws is the same technique that we use in physics to come up with laws of physics. So in the natural sciences, again loosely speaking here, I'm just going to boil it down very simply, what they do is they come up with guesses at the underlying laws governing the behavior of the matter and energy that they're observing. And ultimately, the way physicists think they've hit upon a good description of nature is if they can explain observations in that way. And in particular, if they can predict beforehand what an experiment is going to reveal or what an observation is going to be, like if it's an astronomy or something, and they're going to say, you know what, we think that tomorrow at such and such time, at any point of telescope, at this part in the sky, we're going to see the comet. And then, if lo and behold, that happens, comes to pass as they predicted, they're going to say, see, we have a good understanding of the laws governing the behavior of objects in the solar system. So a lot of people mistakenly think that that approach is what we ought to be doing in economics and that the way we develop laws or principles in economics is to come up with guesses or hypotheses, if you want to use a fancier term, that yield certain testable implications, that the hypothesis says you're going to see results that look like such and such, and then we go and test it and see, okay, the conditions that this thing said need to be true are going to be true next Thursday, and then this hypothesis said under those circumstances you should see these results, you should see prices behaving a certain way, you should see certain things happen in the grocery store, you should see something happen with the reported profits of these certain firms, whatever it is, and then you go and look and see, was the hypothesis confirmed or rejected? And there's a whole discussion we can have about that type of enterprise, but the point is that's what people think is going on, or that's what a lot of people think we should be doing in economics in order to make it truly scientific and objective, because again, that's clearly the kind of thing that happens in the natural sciences or what's often called the hard sciences, and so people think that's what we ought to be doing in economics. And what we went over last lecture is to say that, no, that's actually not what we should be doing in economics, at least if we're talking about basic economic principles or economic laws. And I gave an example that if you open up any introductory microeconomics textbook, if you're taking a standard course in college, the introductory economics class, or even if you go into Barnes & Noble and grab some of the sort of pop econ books off the shelf that are written by professional economists for the layperson to try to get the person to be interested in economics and say, hey, economics is fun. Let's learn about the way an economist looks at the world. And I said one of the things you will often see in books like that that are trying to explain economics to the complete novice is they'll open up with things along the lines of, hey, this is how you think like an economist. These are some principles that the economist uses when he or she is looking at the world. These are sort of the tools that an economist has to help understand reality. So just like the physicist approaches the world armed with knowledge of the laws of physics, by the same token the economist approaches the world and analyzes things from the perspective of these principles or laws of economics. And it's often described as the economic way of thinking or thinking like an economist. So last lecture we talked about one of those principles is something like people respond to incentives that they'll phrase it in that way or something along those lines. And they'll say that's the kind of thing that the economist knows is true and the economist uses to help make sense of things whereas somebody else might not think along those lines. And so the economist has an insight into a situation because the economist knows people respond to incentives and armed with that knowledge about reality and how people are I the economist have something useful to contribute to this discussion that the mathematician might not or that the physicist might overlook. The physicist and the chemist and the mathematician they all have certain things they might want to say and contribute to some issue based on their knowledge and expertise from their own fields but the economist comes to this scene and has a certain perspective and one of the things the economist has that other people might not is this knowledge that people respond to incentives. I know that because I'm an economist. So my question is how does the economist know that that's true? What reason does the economist have for thinking that people respond to incentives? And I argued that really it's not an empirical question. It's not that the economist grabbed thousands of people and ran an experiment to see do they respond to incentives or not and let me remind you of the example I used. I said suppose I grabbed somebody and I said hey I'm going to give you this $100 bill if you chop off your left arm what do you say? And the person says no thanks I'm not going to do that. Did I just show that this is one instance where a person did not respond to incentives? Well I offered him $100 to chop his left arm off and he didn't do it. So would I say well that's one strike against my hypothesis that people respond to incentives but let me go get a broader sample and let me see if I can find 70% of the people I asked to chop their left arm off well then I can say as a general rule most people respond to incentives but you know there's 30% of them. No you see what I'm saying that's not at all how the economist would handle that situation. The economist would not blink an eye at that. He would say correctly and reasonably that oh no no no this guy responds to incentives it's just the $100 was not incentive enough to get him to chop his arm off. Okay does everyone see how that works? And so my point is there that's how the economist would deal with that and so clearly when the economist walks around the world looking at situations thinking okay the way I'm gonna make sense of what I see here is to always keep in mind that people respond to incentives because that's the way economists think about things that that's actually that principle that the economist is carrying around in his or her toolbox is not something that has been empirically tested and that's why it's in the toolbox because hey we've vetted this thing and lo and behold it stood the test of time. That in various experiments and observations and so on we feel pretty confident in our statement that people respond to and say that's not the kind of knowledge that it is. It's just a decision that you make as the social scientists and particulars and economists to say the economic way of thinking looks at reality like this. One of the things we do is we try to make sense of everything by believing that people respond to incentives and you couldn't falsify that principle. The way that a physicist might be very sure that no sorry Mr. President I don't care how much money you give the NASA budget we can't make a spaceship that goes faster than light. Well it could happen they could see a comet or something that gets faster and faster and it seems to be going faster than the speed of light and then they would say huh maybe we were wrong that's that's interesting. So ultimately what we think of as the laws of physics could be overturned tomorrow in light of new observations whereas what we're going to be learning in this course is the principles or laws of economics are not like that. Okay so now that I've sort of gotten you to see the type of thing that we're going to be studying in this course and that's fleshed out through the entire book Lessons for the Economist let me just deal with one obvious objection to that. A lot of people when they hear someone like me explaining this is what we're going to be doing when we go over basic economic principles they're going to recoil in horror and say what are you talking about that's very unscientific that seems very dogmatic it sounds like you're saying you already know the way everything's got to turn out the answers are already in your head and you don't care what the evidence says and isn't that that's almost medieval or something that seems like you're doing theology it doesn't seem like you're doing science. And we talked about last class that the reason people think that is that their model for what science is is something like physics or chemistry where yes in physics or chemistry if you had the kind of procedure we just talked about that we use in economics you would be horrified and you would say no that's just not a good way to do physics or chemistry but I pointed out think of a different analogy where the type of procedure I'm outlining here makes perfect sense and that's geometry so in geometry what do you do? You start out with definitions or they could call them axioms and then you go through you start with these primitive things because okay that's fine I'm okay with those definitions and axioms and then you just step by step work through what's called a proof and you end up with a theorem at the end of that thing and you know that that conclusion is true it has to be true so long as you didn't make a mistake starting from the axioms and going step by step down and reaching the conclusion it's a logical deductive process so it's deduction not induction if you're familiar with those terms so the specific example I gave was the Pythagorean theorem because that's probably the most famous theorem that many of you if you ever took geometry you would at least know what that was where you have a right triangle with the sides labeled A, B and C where C is the hypotenuse and if it is a right triangle and it satisfies the other assumptions or conditions of what's called Euclidean geometry well then you can prove it has to be the case that A squared plus B squared equals C squared and then I walked you through a way you might go about proving that it's certainly not that you go out and measure a bunch of triangles in the real world and then see how often does the Pythagorean theorem turn out correct or is it close enough to seeming correct that we just say that it's because our ruler was a little bit off or we didn't quite measure it right but yeah it looks like it's true it's close enough our observations that's not at all the way you try to establish the Pythagorean theorem you prove it by doing something like drawing lines to make squares connected to each of the legs of the triangle and then you can kind of move the squares around and show look at for any right triangle that you draw for me I can always construct these three squares such that the area of the square connected to the A side and the area of the square connected to the B side you add those together and that equals the area of the square connected to the C side hence A squared plus B squared equals C squared and since I just proved that for an arbitrary triangle where we didn't plug in specific numbers I just proved it for any right triangle because we can always take a right triangle and write A, B and C and I just showed you it has to be the case that I can always build these squares and move them around blah blah blah I just did it in general so for any triangle you give me as long as it really is a right triangle according to what's called Euclidean geometry the answer has to be true and I can go to sleep tonight and I'm not going to worry that tomorrow I'm going to wake up and someone's going to on a piece of paper draw and demonstrate to me that oh no see you made a mistake I just came up with a right triangle for which this is not true I don't have to worry about it the way technically physicists could be proven wrong tomorrow that what they thought were the laws of physics might turn out not to be the laws of physics so that's the way we do things in math and that's a general principle that's not just in geometry in general in math when you prove something in math that's what you're doing you're walking through a deductive process such that as long as you didn't make a mistake in any of the steps and the mistakes should be or sorry the steps should be things that you can just verify in terms of it being self-evident that yeah can I go from step four to step five and the person reading the proof can say yeah that's obvious that you have to be able to do that otherwise reality doesn't make any sense to me that's the way my mind works that you can make that jump so as long as you've done that correctly then the answer you end up with has to be true so long as the initial conditions were true the initial assumptions or axioms and if somebody said some critic said oh my gosh you mathematicians that's just so unscientific all you're doing is coming to the table with your preconceived notions about what a squared and b squared and c squared have to be and then you're just picking your definitions to get that at the end because that's what you wanted to be like in the beginning and so you're just arguing in a big circle and just spitting out results that you already knew in the beginning because you assumed them right that's the kind of thing that someone might say to the economist who heard me explain the kind of economics we're going to go over in this class right so I'm hoping you see how silly that would be to say it to somebody teaching geometry to say oh no no you're not making it scientific I want you to teach your geometry by having your students go out and empirically observe the world and that's the way you teach geometry don't just do it with these so-called proofs where all you're doing is plugging in your initial assumptions and then transforming them and ending up with just a rearrangement of what you already assumed see that would be a crazy objection to the enterprise of geometry and a mathematician would rightly say okay what you're talking about your objection is relevant for the hard natural sciences like physics and chemistry and astronomy but uh-uh that's not the way we do things in geometry because math is a different type of knowledge from what the natural scientists are exploring and the methods that are appropriate in advancing knowledge in mathematics are different from the methods that are appropriate to advancing knowledge in physics or chemistry or astronomy and so don't wag your finger at me what we're doing here in math makes sense because of the nature of what math is so by the same token I'm saying the type of thing that we're trying to teach you in this course the type of economic principles or laws by their nature they're a kind of knowledge it's something that mathematicians don't know historians don't know biologists don't know, chemists don't know the stuff we're gonna learn in this course is a new type of knowledge it's a distinct branch of human inquiry it's called economics but I'm saying the way we discover these principles is by thinking through the implications of the idea or the axiom the starting point that hey I think there are thinking beings out there who are trying to achieve goals and they have reason and they're trying to change the course of reality by their choices just our decision to see that in the world then kicks in a bunch of implications just like our decision to say I'm gonna define this thing and call it a triangle I'm gonna define what a right angle is so on and so forth once you decide to do that then the Pythagorean theorem sort of spits out of that that it's a necessary implication of your decision to choose those initial definitions and so on so that's what we're doing in this course and I just wanna make sure you understand that because it's important to know that economics is a science but the kind of principles or foundational laws we're going over here you discover by just thinking through the implications of your initial decision to interpret reality as there are conscious beings out there who are trying to achieve purposes or goals so that's what we're gonna go over in today's lecture I'm just gonna give you some examples of what you can learn just by following this technique