Economic Brain Teasers
Economic brain teasers can be helpful to understand economic relationships. Using them for ‘gotcha’ type answers, however, is extremely unhelpful.
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The Wall Street Journal published an opinion piece on August 2, 2024, “What Aspiring Economists Aren’t Being Taught” by economics professor Steven Landsburg. In it, Landsburg argues via a brain teaser, that many people have a severe lack of economic understanding. The problem with that conclusion is that the brainteaser proves that is not the case.
The Brain Teaser
Here’s the brain teaser presented by Landsburg:
Apples are provided by a competitive industry. Pears are provided by a monopolist. Coincidentally, they sell at the same price. You’re hungry and would be equally happy with an apple or a pear. If you care about conserving societal resources, which should you buy?
As stated by Landsburg, almost no one can answer this brain teaser. But he believes it is because people do not understand economics. I (and at least a few other economists) argue that it has nothing to do with understanding economics, but with making assumptions.
Landsburg’s ‘Solution’
The answer presented by Landsburg is that ‘if you care about societal resources, you should purchase the pear’. That answer is based on the economic reasoning described below.
In a competitive market, the price of a good equals its marginal cost of production. The reason for this is the following: suppose an additional apple costs $1 to produce. This $1 cost is the marginal cost of producing an apple. The marginal cost captures things such as the additional cost of labor, transport and anything else needed to get that 1 extra apple.
Now, if you were to charge $1.10 for the apple, a new business would open up next to you, selling for $1.09. The new business would capture the entire market and make a profit on each apple. You would be out of business. Thus, you would lower the price as well. This goes on until we hit the $1 price. No new business will enter as there are no profits to be made. Thus, the price = marginal cost.
On the other hand, if you’re a monopolist, you don’t have to worry about a new business opening up. Thus, you would select an optimal price that maximizes your profits, which would be greater than marginal cost. In the Landsburg example, since the price of an apple and pear are both $1 (assuming for simplicity), the marginal cost of the apple seller in the perfectly competitive market is $1 and the marginal cost of the monopolist pear seller is less than $1 (Landsburg uses $0.80).
A lower marginal cost “implies” that fewer resources are used to make the item. Thus, fewer resources are used to make the pear, than the apple. So if you want to ‘conserve societal resources’ as in the Landsburg brain teaser, you should buy the pear.
Issues with the Brain Teaser
The problem with the brain teaser is that it makes several very strong assumptions, which it does not specify. This is a common theme we’ve discussed at Nominal News, of how economists and non-economists talk past each other – economics requires many implicit and explicit assumptions to derive a result.
The ‘trick’ assumption in this brain teaser is around ‘conserving societal resources’. Landsburg interprets it to mean minimizing consumed resources (for example, the amount of energy, water and labor hours needed). With that definition in mind, Landsburg makes the first strong assumption – marginal cost of production equals the amount of resources consumed. Why is this assumption flawed?
Let’s use an example by economist Ben Golub. Suppose the apples and pears are used further by an apple tart seller to make apple tarts and a pear tart seller to make pear tarts. Let’s slightly reverse the situation – suppose the apple tart seller is a monopoly, while the pear tart seller is in a competitive market, and both charge the same price for the tart, $2. By Landsburg’s logic, if you want to minimize consumed resources, you should purchase the apple tart from the monopolist.
The apple tart seller has a marginal cost of $1.90 (recall that the price must be greater than marginal cost since it is a monopoly), $1 of labor and $0.90 worth of apples. The total amount of resources used to make the apple tart is also $1.90 since to make $0.90 of apples, the apple seller needed to spend $0.90 (recall that that the apple seller was originally a competitive market, and thus the price of apples reflected the resources needed to make them).
On the other hand, suppose the pear tart seller, who is in a competitive industry, has a marginal cost of $2, of which $1 is labor and $1 is the cost to purchase pear from the pear seller. But now, the total resources consumed in the production of this pear tart is actually $1.80. That is because to make the $1 of pears, the monopolist pear seller only used $0.80 of resources. Thus, the pear tart seller uses fewer resources than the apple tart seller, so we should buy the pear tart in the perfectly competitive market!
This is where the brain teaser ‘logic’ fails. The key assumption that marginal cost equals the number of resources used is a very strong one. In the pear tart producer example, the $1 marginal cost of the pear tart producer did not reflect true resource usage, since the monopolist pear provider was charging a mark-up. There is no reason to assume that in the original Landsburg example, the marginal cost of production of pears is reflective of resource usage.
The assumption that the marginal cost accurately reflects used resources is critical to the Landsburg result. This assumption should be made clear when giving such ‘brain teasers’, but then the answer to the brain teaser would be ‘obvious’.1
Teaching Economics Better
The reason this opinion piece jumped out to me was due to Landsburg's claim that this brain teaser shows us that many economists and non-economists are poorly trained and have limited understanding. As stated by Ben Golub, this is a poor way of teaching economics and bringing in more people into the field (which is what I hope to do with Nominal News).
By obfuscation, this brain teaser is bad. Brain teasers have their place to understand relationships, but in economics, there are a lot of moving parts when considering the real world. One way to improve Landsburg’s question, would be to ask instead under what assumptions and scenarios would it be ‘better’ to buy the monopoly produced pear. Although this is a more involved question, it would entail thinking about wider issues such as whether marginal cost is reflective of resources used and, more broadly, what is happening in the entire production chain. That, I believe, is more conducive to learning about economics.
Unlike the Landburg example, where we were only exposed to one particular idea, thinking through the various assumptions and mechanisms needed to get to the Landsburg result allows us to understand social interactions better. Fundamentally, that is the aim of economics – to discover and understand social and economic relationships.
Interesting Reads from the Week
Note: My thoughts on the recently announced proposal of offering $25,000 down payment assistance for first time buyers. Based on our previous discussion here, demand-side subsidies might not work too well. Research has shown that in the education sector, educational tax credits resulted in private colleges significantly increasing tuition.
Article: Behavioral Economist
discusses how our feeling of happiness is often influenced by the social circles we are in. As elaborated by the author: “Whenever we feel that “we could” reach a higher social circle, we feel motivated to try, even though it may lead to lower satisfaction when we end up a smaller fish in a bigger pond. This is because our hedonic system is not designed to make us happy, but to push us to achieve our highest potential.- talks about the shortfall in funding for US schools. The US school funding approach via property taxes is also somewhat globally unique – “The US is one of only three OECD nations that does not provide more resources to disadvantaged schools (the other two are Turkey and Israel). This is because the other largest share of funding for public schools comes from property taxes – wealthy communities, with higher property values, tend to have better schools because they get more funding.”
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Very helpful. I'm working on developing a new test of broad-based economic thinking now, so I'll keep this post in mind and avoid gotchas.
And why use perfectly competitive markets, which don’t exist, as part of an explanation? Just another reason that non-economists conclude that economists are somewhat bonkers.