Economics as the study of people investigates how people succeed, what makes us happy,
how we interact, and how we have become so much more prosperous than was ever thought possible. Understanding economics allows you to make better personal and professional decisions. Key insights:
Free markets are self-managing through individual consumer demand and producer supply decisions – a process coined the invisible hand
Incentive structures – hidden and visible – are hugely important in determining market behavior
Stocks are ownership stakes in companies; bonds represent money lent for interest. Both are important in free markets, but bond ratings are extremely important to Governments
Opportunity cost is the cost of the next best decision not taken – the dinner not consumed if the decision is to see a movie
Capitalism is where the means of production (producers of products & services) are owned by private citizens
Communism is where the means of production is owned (or largely controlled) by Government
Capitalist markets can go through booms and busts for a variety of different reasons
Creative destruction is a feature of capitalist markets where innovative products displace old ones
Behavioral economics recognizes that people use logic and emotion when making decisions
Game theory studies how human strategies interact with each other – the Prisoner’s Dilemma is one famous example.
Full title: 50 Economics Ideas You Really Need to Know, by Edmund Conway.
Length: 208 pages, or 6 hours and 44 mins on Audible
Introduction to 50 Economics Ideas
Whilst a short book, 50 Economics Ideas is jam packed with information. This summary is a little longer than others, and in an effort to be concise uses fewer quotes from the author. Notwithstanding, I’ve chosen 13 concepts from the 50 in the book to expand upon in the sections below.
Key insight 1: Supply, demand, and the invisible hand
Economics is the social science that studies how people interact with things of value; in particular, the production, distribution, and consumption of goods and services. At the heart of economics – and thus the heart of how people interact – is the law of supply and demand. Understanding how these two forces interact will help you understand why diamonds are more expensive than water, why NBA players earn more than WNBA players, and why the price of flowers rises then falls through February 14th.
Supply. Suppose you live in a small community with just two households, and you are the one with an orange tree. Suppose it yields 100 oranges per year – more than you can eat – and you’re willing to sell excess oranges to your neighbors. This makes you a ‘producer’ of oranges which you ‘supply’ to the ‘market.’ It follows then that your neighbors are the ‘customers’ who ‘demand’ the oranges. Now suppose you’re flexible on how many oranges you sell depending on the price. At a low price you might sell 20 of your oranges, but if the price was high enough you might sell them all. This introduces the concept of a ‘supply schedule’ (see table below).
Demand. Now suppose you are neighbor who wants to buy oranges. At a low enough price you could make it a staple part of your diet and eat 100 per year. If the price was too high, you might eat them as a treat and have a few per month. We could quantify these preferences through a ‘demand schedule’ as shown below.
Demand and supply. If you combine the demand and supply schedules into a graph, you can see the overlap crossover occurs at a price of $3/orange where 60 oranges will be supplied to the neighbor.
If the supplier set the price at $1, the neighbor would buy all 100 oranges, and the supplier would be disappointed to have sold them so cheaply. Conversely, setting the price at $5/orange would result in only 20 oranges sold, and the supplier having excess oranges. The ‘market equilibrium’ price here is $3.
Inelastic demand or supply. Supposed instead of oranges you are buying gasoline for your car; mainly to get to work and back, but also for other uses. If the price is set high you might reduce car use in some areas, but you’ll still need gas to get to work. The demand curve here is said to be ‘inelastic’, which means you don’t reduce consumption much as price increases. Essential goods and services like food staples and utilities mostly fall into this category.
Now consider Saudi Arabia and their production of oil which is refined into gasoline. They have developed the oil fields, made the refineries, bought the oil tankers to transport the oil/gas around the world. Their whole system is designed to work at a certain volume level. Almost irrespective of the price, Saudi Arabia wants to run your system near 100% of capacity. The supply curve for oil is said to be ‘inelastic.’
Elastic demand or supply. Now suppose you are buying clothes. If the price is right – i.e. low enough – you might buy what you need plus a few extras currently in fashion. If the price is too high, you are happy to make do with previous purchases and wait for lower prices. As a result the demand curve is said to be ‘elastic’, which means small changes in price can lead to big changes in quantity purchase.
Suppose now you own a factor that makes clothing products. If the price is right – i.e. high enough – you can focus production on this seasons hot item. If the price is low, you can switch production to other clothing lines, or even to other cloth products like sheets. As a clothing producer, you have an ‘elastic’ supply schedule.
The invisible hand – balancing supply and demand. Economists like to draw lots of graphs like the one above which show what happens to equilibrium price and volume when consumer preferences change. A good example of changing demand is flowers before or after Valentine’s Day. Flowers selling for $30 on Feb 13th can be bought for $10 on Feb 15th. Buyers and sellers adjust to constantly changing demand and supply curves as if by magic – the so called ‘invisible hand.’
No government action is needed to regulate the flowers market over Valentine’s Day, nor the chocolate egg market across Easter, nor the children’s gifts market across Christmas. Consumers preferences change for different reasons, and suppliers adjust price and volume to achieve a ‘market clearing’ price where all supply is sold. A self-managing, self-correcting system of production and consumption. Magic.
The invisible hand – societal good out of individual self-interest. Adam Smith in The Wealth of Nations first coined the phrase ‘the invisible hand’ to describe who people acting in their own self-interest can produce societal benefits. Take the orange grower above; their desire to make money selling oranges meant oranges were available for consumers to purchase. The same goes for oil and clothes producers above; and indeed all products. And in competition between providers means that goods continue to get better, faster, and cheaper – all without any direct intervention by governments or consumers (other than buying the best products). From Adam Smith:
“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”
“Every individual... neither intends to promote the public interest, nor knows how much he is promoting it... he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”
Key insight 2: Societal incentives and Austrian individualism
Societal incentives. An incentive is anything that motivates a person to do something. The baker does not sell you bread because you are hungry, but because he is paid to do so. The beautician provides her services with a smile because she is seeking to be paid not just once, but several times through repeat custom. There are also non-financial incentives. Have you taken extra care to dress up for a date or job interview? Have you turned down an over-time shift to attend a party? Have you put your rubbish in a public bin to avoid being shamed by those around you for littering?
Businesses are very clever with hidden incentives. Google search and Facebook are free because it provides these companies with individualized consumer choice information that they can sell for literally billions. Walmart and Costco have loyalty systems to provide them consumer choice information to help them optimize their supply chains. An internal (or intrinsic) incentive comes from within. Donating to charity or volunteering your time provides personal fulfillment and satisfaction. When Adam Smith noted in 1759 that people ‘want to be loved, and to be lovely’ – he was talking about intrinsic motivation.
Governments achieve policy outcomes through incentive structures. Take personal income tax rates – what level should they be set at? Government’s need taxation revenue to pay for infrastructure, national Defense, etc – so the tax rate should be high. But would you work if you had to pay 80% of your income in tax? Of course not. By setting the tax rate, governments directly impact our incentives to work and earn, and their ability to raise revenue. By setting investment depreciation rates, and intellectual property laws, governments directly impact businesses willingness to invest in research and productive capacity. By establishing a regime of crimes and punishments – financial penalties and/or jail time – governments directly impact our willingness to engage in illegal behavior. This apples to everything from speeding, illegal parking, theft, assault, and so on.
Take car insurance as a detailed example. People are incentivized to take out insurance to avoid the full cost of a replacement car in an accident. Insurance companies incentivize people to drive safely by increasing premiums for bad drivers. But governments need to establish laws to incentivize people to tell the truth about their driving history (it’s a crime to lie); and also to incentivize insurance companies to pay out on legal claims. The incentive structure is far more pronounced in modern society that seems so at first glance.
And incentive structures need to evolve with technology (banning mobile phones when driving), and the economy (lower tax rates to stimulate work, spending, and investment). You can think of the whole enterprise of government as being about managing the minimum set of societal incentives to achieve a health, safe, caring, and wealthy society over time. And the task is made more complex by the fact that economists – let alone the public – don’t often agree on the correct incentives are to improve a particular situation. This sounds like a wicked problem to me; perhaps politicians aren’t over-paid after all?
Austrian individualism. Conway notes that mainstream economics is very much an assumption-based, top-down subject analyzing whole nations, or at least large sectors of the economy. Economy wide data such as Gross Domestic Product (the output of a nation), or inflation (increase in the nominal price level) are produced. However, an obscure group of economists from Austria (Carl Menger, Ludwig von Mises, Friedrich Hayek) focused on the individual. From Conway:
“The Austrian School instead emphasizes that individual decision-making should be at the forefront [of economic thinking]. After all, only individuals can act; countries, companies, and institutions do not have minds of their own – they are a collective entity, but one that comprises many different individuals.
Economic phenomena – a country’s wealth or levels of inequality for instance – are a product of choices made by thousands of individuals, rather than a consequence of the concerted policies of politicians or big business. The consequence is that there may not be any way of, for instance, reducing inequality to a certain level, since it is not the product of human design but a manifestation of human action.”
One of the key insights from the Austrian School was that individuals are endowed with different gifts and respond differently to the same set of incentives. This turns out to create a huge problem for governments setting policy – should they focus on equality of opportunity (having uniform rules for all), or equality of outcome (ensuring everyone gets the same income)? More from Conway:
“The generalization trap as … Friedrich Hayek observed, is that everyone is different, and as such – although they might be treated in precisely the same way – the way they react to that treatment may differ greatly. The only way to ensure they are equal, he maintained, ‘would be to treat them differently. Equality before the law and material equality are therefore not only different but are in conflict with each other; and we can achieve either one or the other, but not both at the same time.’
Consider a classroom with two students who are provided the same instruction. One student studies hard, gets a good education, and goes on to get a high paying job. The second student does no study, plays computer games, and gets a low paying job. The end result is high income inequality between the two students. Is taxing the high-income student to pay for the low-income student to achieve equal outcomes the right answer? Some might say it is, but would any future students study hard just to be taxed? The last word on individualism is from Friedrich Hayek:
“A society that does not recognize that each individual has values of his own which he is entitled to follow can have no respect for the dignity of the individual and cannot really know freedom.”
Key insight 3: Stocks and bonds
Bonds and the bond market. The first bonds date from the 12th Century Venice, when the city-state's government began issuing war-bonds known as prestiti, perpetuities paying a fixed rate of 5%. These were initially regarded with suspicion but the ability to buy and sell them became regarded as valuable. Modern bond markets, markets for government or company debt, are far less well known than stock markets but are far more influential. So what is a bond? It is simply a loan from investors to a government or company that pays a certain yield every year for a fixed number of years before the return of the original capital.
Since bond investors don’t receive any capital growth (see stock market below), they are considered far more risk averse in ensuring the folks they lend to will pay them back. The interest rate charged reflects the risk of loan default (i.e. not getting paid back); with higher interest rates being charged to riskier debtors. In 2019 the US Government debt was $22.8 trillion dollars, with interest paid to cover that debt of $375 billion. Thus the interest rate for this debt was 1.6%. A bond market worried about not seeing that $22.8T repaid might increase the interest rate to say 1.5%. This would increase the annual interest bill by an additional $679 billion, equal to the entire US Defense budget. Needless to say, Governments want to keep bond markets happy by instituting sound economic policies that convince bond holders they’ll be repaid.
Bond ratings are how bond markets assess the riskiness of a particular bond, and they correlate directly with the interest charged. Bond ratings start a AAA for the best bond, before going through AA+, AA, AA-, A+, A, A-, BBB+, BBB, and BBB- to round out so-called investment grade bonds. These are the bonds your pension fund owns. Non-investment grade bonds (speculative bonds) go from BB+, BB, BB-, B+, B, B-, CCC, CC, C, and finally D. It’s a crazy system. Why not just number riskiness from 1 to 20? So why can’t Government just borrow money to spend on your favorite goodies (i.e. free education, free healthcare)? Answer: the bond market.
Stocks and the stock market. The first major corporation was the British East India Company formed in 1600, followed by the Dutch East India Company in 1602. What set these initial companies apart from bonds were three things:
Equity raising. Money was raised through individual shareholders providing capital in return for a fixed amount of ownership in the company. Contributing $1,000 to total capital raising of $100,000 would give the investor a 1% ownership in the company. This stake entitled the owner to a 1% share of profits issued as dividends.
Limited liability for loss. The extent of an investor’s liability for any loss was the value of the shares themselves. In this example, his initial $1,000 investment.
Transferable ownership. Shares could be bought or sold on stock ‘exchanges’ and still retain all the ownership privileges (a share of profits), and protections (limited liability).
Not all companies are traded on public exchanges. Many private companies are owned by family members or small groups of people. When a company goes from being privately held, to publicly owned, it has an Initial Public Offering (IPO) in which the first investors by shares. These can subsequently be traded on public exchanges.
Valuing stocks. Most would be aware that the stock market can be quite volatile with large price gains and falls possible. Why is this so? What follows is a simplified explanation using discounted cash flow (DCF) to give readers an insight into why stocks are so volatile. In the three examples below we value the same company assuming annual profits/dividend grow at 6%, 8%, and 10%. We do this by calculating and summing up what the dividend would be worth each year for 40 years. Note we ‘discount’ the value of future income by 5% as we value current money more than future money. So how much is the company worth? To save space I haven’t shown lines for years 11 to 39.
The company’s value is either $4,368, or $6,547, or $10,168; depending on whether you think profit growth will be 6%, 8%, or 10% over the next 40 years. If you thought the market was pricing in 6% and it should be 10%, you would buy the stock at $4,368 and wait for it to rise to $10,168; an increase of 133%. A nice gain. However, if you bought it when profit growth was at 10%, and then it slowed to 6%, you’d stand to lose 57% on your investment when it fell in price from $10,168 to $4,368.
Welcome to the stock market where the tinniest assumptions make all the difference. Fortunately, you can buy an index fund and just own the entire market and hope that the economy continues to grow and companies prosper.
Other insights from 50 Ideas You Really Need to Know - Economics
4. Opportunity cost. No matter how wealthy or famous you only have 24 hours in the day. Any choice to do one thing, means not doing something else. This is opportunity cost. The opportunity cost of going to the pub is not studying for your exams. The opportunity cost of a big night out is not saving $100 towards your house deposit. From Conway: “By knowing precisely what you are receiving and what you are missing out on, you ought to be able to make better-informed, more rational decisions.” One way to think about opportunity cost in spending decisions is to consider the ‘value-for-money’ received. What you get for what you pay; compared to alternatives. Increasingly in the busy world it’s necessary to consider ‘value-for-time’ in the same way.
5. Capitalism. Capitalism is a where the means of production are owned by citizens and not the state; thus it associated with the free market (and the invisible hand). From Conway, “In practice, what we call capitalist economies these days … are better described as ‘mixed economies’, which combine the free market with government intervention.” The debate in capitalist societies on the level of government involvement, and how to mitigate that capitalism does result in some extreme winners and losers.
6. Communism. Karl Marx – the founder of communism – believed societies had transitioned from feudal states, through mercantilism, to capitalism; and would in the future move to a utopian communist system. In the early days of the industrial revolution in Europe where landlords and factory bosses owned most everything this may have seemed a reasonable idea. Then several things happened. First, universal voting made governments more accountable to the people. Second, capitalism brought about a huge increase in wealth and prosperity powered by science. And third, communism failed miserably where ever it was tried with literally millions dying in the process. What folks think of as European socialist countries like Sweden are actually capitalist economies with very high tax rates funding a large welfare state.
7. Boom and bust. Recessions and depressions result when the economy contracts (production, consumption, and employment fall). Capitalist economies tend to boom and bust cycles for different reasons. The 2000 recession was brought about by a business investment slump after year 2000. The 2008 recession followed collapsing home prices which resulted in consumers stopping spending. Consumers either borrowing and spending; or saving and repaying debts, can drive booms and busts. The 1990s boom was from new technology (internet). The automobile, aviation, electricity, assembly line production, etc powered previous economic upswings. The economic drivers today are artificial intelligence, big-data, genetics, grid electrification, and block-chain technology. There will be future recessions, but they are the price we pay for amazing technological and economic growth.
8. Creative destruction. Joseph Schumpeter was a famous Austrian economist who believe creative destruction was an essential part of capitalism. From Schumpeter, “The process of industrial mutation … incessantly revolutionizes the economic structure from within, … destroying the old one,… creating a new one.” In boom times inefficient business can make money and keep operating; however in recessions these firms go bankrupt. Whilst this is painful in the short term, it frees up entrepreneurial spirit, labor, and capital to move to new dynamic businesses. And it is these new businesses – think Tesla, SpaceX, Netflix – that drive future economic growth. It is a model for ‘economic survival of the fittest’.
9. Behavioral economics. Neoclassical economists assumed people always acted rationally – so called Homo Economics. However, psychologists Amos Tversky and Daniel Kahneman blew this myth apart with a range of experiments which founded behavioral economics. Their research showed people often do what is ‘right’ rather than what is profitable, can distinguish between decisions involving money or no money, and worry about losing say $100 around 2.5x more than gaining the same $100. And much more besides. We are not rational.
10. Game theory. From Conway, “Game theory is the science behind human strategy. It is the study of how humans attempt to second-guess each other’s actions, and what the ultimate consequences will be.” Game theory is used in politics, finance, commerce, product pricing, negotiations, and war decision making. The prisoners’ dilemma is one famous example of game theory where the police incentivize criminals to tell-tale on their criminal partners in return for lower sentences.
Why you should read this book if you’re under 30
Economics principles govern society and human interactions in far more ways than you realize. Trying to understand or make your way in society without understanding economic principles is like playing professional poker with real money without knowing the rules. You might get lucky occasionally, but over the long term you’ll definitely get played. Use economic knowledge to improve your personal, financial, and work-place decisions. Use economic knowledge to understand how and why the world around you works from weekend markets, to politics, to the economy and global progress, and significant world events like international trade deals.
Relationship to other Eruditeable books
#2 – Factfulness. Understanding economics will help you understand some of the factors that have driven the dramatic improvement in the human condition over the last 200 years as described in this book.
#8 – A Little History of Philosophy. Some of the economists covered in 50 Economics Ideas are discussed in more detail in this book.
#11 – Don’t Burn this Book. This book covers different economic and political approaches to society and the different cultural and prosperity outcomes they yield. An understanding of economics will add value to your understanding of politics as covered in this book.
#12 – Loserthink. As well as teaching you how to think generally, this book recommends you think like an economist in certain situations. By reading 50 Economics Ideas you’ll be well prepared to do just that.
#16 – The Personal MBA. This book has some overlap with the content discussed in 50 Economic Ideas in relation to personal decisions, leadership, and consumer and market behavior.
#18 – Sapiens. This book chronicles the path of human history, which since Adam Smith’s book The Wealth of Nations has been heavily influenced by economic concepts. Reading 50 Economic Ideas will enrich the reading of this book and your understanding of our history.
About the author
Ed Conway is the Economics Editor of Sky News, the 24-hour television news service operated by Sky Group. Conway received his MA at Oxford, and Master Public Administration at Harvard University. He is a former correspondent for the Daily Mail newspaper and the Economics Editor of the Daily Telegraph and the Sunday Telegraph newspapers.
In August 2011, Conway joined Sky News as economics editor and covered topics including financial market crisis Great Recession and euro crisis. He is also known for his numerous stories including a G20 summit, Greek default and its rescue fund. Among his many interviewees are the managing director of the International Monetary Fund, Christine Lagarde, the Chancellor of the Exchequer, Philip Hammond, and the Bank of England Governor Mark Carney.