The debt ceiling fiasco is over, and with it, the costly Inflation Reduction Act, or as I like to call it, the Inflation Recession Act, was unfortunately left mostly intact. Congress’s lackluster attempt to curb spending will matter even less considering this, as new calculations show. The time is ripe for a reassessment and elimination of at least the ill-advised tax credits contained within the IRA before irreversible damage is inflicted on our already suffering economy.  Last year, the Congressional Budget Office (CBO) estimated that the IRA would cost $391 billion from 2022 to 2031. But with updated data and Treasury rules, new cost estimates show it to be three times higher at $1.2 trillion.  During my recent testimony before the U.S. House Ways and Means Committee, I noted the need for a re-estimate of the IRA’s cost for tax credits that subsidize manufactured battery cells and modules for electric vehicles (EV). The CBO’s estimate of these tax credits was $30.6 billion, but new calculations have it at nearly $200 billion–or nearly seven times higher. Battery cells can receive a $35 tax credit for every kWh of energy the battery produces, while battery modules can receive $10 per kWh, or “$45 for a battery module that does not use battery cells.”  The CBO’s assessment was conducted prior to the Treasury’s release of draft guidance in March that relaxes mineral sourcing standards to produce EV batteries. And since the IRA passed, there’s more evidence that incentives matter as EV manufacturers substantially increase production to get the tax credits well above CBO’s estimates.  Look no further than Tesla for a real-time example of how these tax credits will cost us.  Maker of the most-sold EVs in America, Tesla moved its battery production from Germany to Texas after the tax credits were announced. And its Model Y emerged as the best-selling EV in the U.S. last year, with a total of 234,834 units sold. Its battery starts at 75-kWh, so for those sales, Tesla could have received more than $616 million in tax credits had the tax credits been in place. For 2023, Tesla expects to manufacture 2 million EVs, resulting in possibly $5 billion in annual tax credits for batteries.  Meanwhile, Ford, which had the second-highest EV sales last year, plans to triple production for its F-150 Lightning, targeting 150,000 units by the end of 2023. The battery size for this model starts at 98-kWh, and assuming Ford meets its goal, that would cost taxpayers $514 million in tax credits. If Tesla and Ford can collectively receive at least $1 billion in tax credits in 2023, it’s easy to see how the CBO’s estimate over the next decade for all EV batteries is too low.  This difference between the estimates and the growth of the EV market is concerning in this post-pandemic economy, verging on a recession where more than 60% of Americans are estimated to be living paycheck to paycheck. More government spending, like what’s allotted in the IRA, and more debt, like what’s allowed under the debt ceiling deal, is the last thing America needs.  As government spending increases, so do taxes, leading to less work, lower productivity and growth, and, subsequently, less tax revenue. These measures contribute to even higher budget deficits that stifle economic growth, increase poverty, and exacerbate multi-decade high inflation.  While the IRA’s green energy initiatives, massive tax hikes, and excessive spending should have been enough reason to reject it initially, Democrats forced it through based on CBO’s massive underestimates of tax credits and other initiatives. Now, taxpayers will suffer the aftermath of this expensive legislation, which is why these costs should be reevaluated and ultimately eliminated before this weak economy is made worse for struggling Americans.  For a better path forward, we need more pro-growth policies and less government spending, not bad debt deals and corporate welfare to large businesses on the backs of taxpayers.    Vance Ginn, Ph.D., is founder and president of Ginn Economic Consulting, LLC, senior fellow at Americans for Tax Reform, and chief economist or senior fellow at multiple think tanks across the country. He previously served as the associate director for economic policy of the White House’s Office of Management and Budget, 2019-20. Follow him on Twitter @VanceGinn. (0 COMMENTS)

  Thirty days have passed since my Wall Street Journal obit of Bob Lucas was published, so I can reproduce it below. Robert E. Lucas Jr. Brought Rationality to Macroeconomics A Nobel laureate and a giant in the field dies at 85. By David R. Henderson May 15, 2023 at 6:01 pm ET (May 16 print edition) Keynesianism had taken some lumps by the early 1970s, but it was still the dominant school in macroeconomics. Then Robert E. Lucas Jr. came along. The longtime University of Chicago economist died Monday at 85. In a famous 1972 article, Lucas made a crucial observation. He noted that virtually every macroeconomic model erroneously assumed, implicitly or explicitly, that government officials who made economic policy could essentially fool people into making irrational decisions. Microeconomics assumed people were rational. Why shouldn’t macroeconomics make the same assumption? For this and other insights he was awarded the 1995 Nobel Prize in Economics. Over time, Lucas argued, people would start to understand the model that policy makers used for the economy. That meant, for example, that if the Federal Reserve increased the growth rate of the money supply to get a temporary reduction in unemployment, the policy would work only if the actual growth rate was bigger than what people expected. Lucas extended this thinking in a 1976 article that came to be called “the Lucas critique” of macro models. He argued that because these models were from periods when people had one set of expectations, the models would be useless for later periods when expectations had changed. While this might sound disheartening for policy makers, there was a silver lining. It meant, as Lucas’s colleague Thomas Sargent pointed out, that if a government could credibly commit to cutting inflation, it could do so without a large increase in unemployment. Why? Because people would quickly adjust their expectations to match the promised lower inflation rate. To be sure, the key is government credibility, often in short supply. Lucas also did work in the 1980s that broke down the barrier between development economics, which focused on poor countries, and the study of economic growth. He thought that the same tools, such as tax policy, used to achieve economic growth in rich countries could be used to generate growth in poor countries. One of his most quoted statements comes from his 1988 paper “On the Mechanics of Economic Development.” After asking what the Indian government could do to get growth like that of less-poor Indonesia or Egypt, Lucas wrote that “the consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else.” Lucas was willing to change his mind when the evidence demanded it. In the early 1960s, he thought that taxing capital gains like ordinary income was “the single most desirable change in the U.S. tax structure.” By 1990 he had concluded that “neither capital gains nor any of the income from capital should be taxed at all.” He estimated that cutting the tax rate to zero would increase the capital stock by about 35%. The Nobel committee called Bob Lucas “the economist whose work has had the greatest impact on the development of macroeconomics and macroeconometrics since 1970.” That’s putting it mildly. He will be missed. Mr. Henderson is a research fellow with Stanford University’s Hoover Institution and editor of the Concise Encyclopedia of Economics. There were many stories I couldn’t fit within my word limit. Here is one of my favorites: Bob Barro, now at Harvard, was a colleague of Bob Lucas at the University of Chicago at a time when smoking was allowed pretty much everywhere. Bob Barro hated cigarette smoke; Bob Lucas was almost a chain smoker. But Barro highly valued conversations with Lucas. How highly? Barro had a sign on his door that stated, “No smoking, except for Bob Lucas.” (0 COMMENTS)

Kevin Kelly is an author, photographer, and visionary with a keen interest in technology and futurism. In addition to his own books, Kelly is a founding editor and ongoing contributor for Wired Magazine. On his website, Kelly says, “I write in order to think.” On this episode of EconTalk, Russ Roberts welcomes Kevin Kelly for a compelling conversation on advice and technology. Kelly introduces his new book Excellent Advice for Living. The two discuss useful mantras in their lives and why mantras work, along with the future of technology and our relationship to it. Roberts and Kelly speak to people’s reluctance to accept advice or have their mind changed. Why is it hard to listen to advice? What is the best way to reach young people with good advice?   1- Kelly and Roberts agree that discomfort is a good thing and that it is an agent for becoming a better person. How do you feel about discomfort? Are you able to consistently get outside of your comfort zone even when it means there will be an adjustment period? To what extent is the experience outside of a normal routine important for realizing new talents and interests?   2- Roberts and Kelly argue that maxims and mantras can help to build consistent, good habits which can protect a person from making mistakes. Kelly offers a powerful maxim with which a person should remember to consult a third thing when considering two sides. How can thinking about a gray area, or a third side, help to illuminate an answer to a problem? Are people willing to consider a third side? In terms of a unique business plan in a competitive field, can you think of an individual or a company who utilized a third side of a black and white case to get ahead of competitors?   3- Kelly finds power in having control over his time as opposed to money. What is the advantage of caring more for time than money? How can planning in terms of life experiences and goals be more fulfilling than only planning for a career based on its monetary value? What might you give up when you choose to live this way? As Kelly himself says, you can never do things if you don’t give some things up…   4- Kelly and Roberts are skeptical of the technology panic cycle in which people are concerned about technology taking over humans. Today, we see different people have contrasting relationships with technology, where some let it harmfully dominate their daily lives while others utilize it in a productive manner. What type of person is vulnerable to the power of technology? Will we always have the power that Roberts and Kelly allude to in shutting down technology if it becomes dangerously invasive?   5- Roberts disagrees with the utopian argument that AI will come to develop a mind of its own. Instead, he and Kelly recognize the value of having something that ‘thinks’ differently than us as humans, and that we should be more thoughtful consumers in utilizing AI. What do you think about the trajectory of AI technology? Is there going to be exponential growth in AI which results in a problematic entity? To what extent do you agree with Kelly that there should be people working on how to “unplug” AI, just as there are people working to prevent asteroid strikes? (And is this a good metaphor???)   Brennan Beausir is a student at Wabash College studying Philosophy, Politics, and Economics and is a 2023 Summer Scholar at Liberty Fund. (0 COMMENTS)

Here’s Encyclopedia Britannica: laissez-faire, (French: “allow to do”) policy of minimum governmental interference in the economic affairs of individuals and society. The origin of the term is uncertain, but folklore suggests that it is derived from the answer Jean-Baptiste Colbert, comptroller general of finance under King Louis XIV of France, received when he asked industrialists what the government could do to help business: “Leave us alone.” Here’s today’s Bloomberg: Senior Chinese officials are soliciting advice from business leaders and economists on how to revitalize the economy in a flurry of meetings attendees have characterized as unusually urgent in their tone. Top officials have held at least six consultations in recent weeks with the executives, according to people present who requested anonymity when discussing sensitive issues. Leaders pressed those assembled for ideas on ways to stimulate the economy, restore confidence in the private sector and revive the real estate industry, the people said. In response, the business leaders and economists called on the government to make urgent policy revisions and adopt a more market-oriented, rather than planning-led, approach to growth, they said. And here’s a famous French proverb: plus ça change, plus c’est la même chose (0 COMMENTS)

  One of the best features of the 2017 Tax Cuts and Jobs Act was the introduction of “expensing” for capital investments. Translation: Corporations that made capital investments could deduct (i.e., expense) those costs from taxable income in the year they made those expenditures. The only condition for expensing was that the asset had to have a “life” of 20 years or less and had to be purchased after September 27, 2017, but before January 1, 2023. Unfortunately, starting this year, the 2017 law also phases out the ability to expense. The phaseout will be complete on January 1, 2027.  As expensing phases out, the effective tax rate on capital will rise substantially. That, in turn, will lead to less investment. With less investment, the capital stock won’t grow as quickly as it would have. That means that worker productivity won’t grow as much, which means that real wages won’t grow as much. These are the opening two paragraphs of my short article “The U.S. Tax Rate on Capital is Rising,” TaxBytes, Institute for Policy Innovation, June 14, 2023. Read the whole thing, which is not long. Thanks to Adam N. Michel of the Cato Institute for explaining something in a Canadian study that he referenced. (0 COMMENTS)

It’s been observed many times that there is a fundamental divide in how people view the idea of fairness, with one side viewing fairness as being process oriented, while the other views fairness as being outcome oriented. In the process view, as long as everyone plays by the same rules, things are fair, and the results will also be fair because they came about as the result of a fair process. In the other view, fairness means having an equal likelihood of success, and if everyone playing by the same rules produces unequal results, then this is an unfair process, and the rules should be altered to produce a fair outcome. In the process view, a boxing match between me and the current world champion where both fighters observed all the rules and were officiated by an unbiased referee, would be a fair fight despite the fact that it would almost certainly end in a first-round knockout. (Fortunately for the champ, I’m content with my current arrangements so his title is safe.) On the outcome view, since both fighters don’t enter the ring with the same likelihood of success, it’s not a fair fight. At the limit, on the outcome view, a fair system would be one that advantages some fighters and handicaps others to the point where every fight always goes the distance and ends in a draw. More recently, this general divide has shifted into discussions about “equality” and “equity.” As this description advocating the equity approach puts it, “Equality means each individual or group of people is given the same resources or opportunities. Equity recognizes that each person has different circumstances and allocates the exact resources and opportunities needed to reach an equal outcome.” Here we see a similar divide in thinking – one side thinks that as long as the process is fair, so are the outcomes, while the other thinks that if the outcomes are unfair (according to how closely it matches pre-selected results), so is the process. I lean much more in favor of the process side of this debate than the outcome side. Part of that is practical. The fundamental idea of the outcomes side is that “we” (read: political elites) should decide in advance what the outcomes are “supposed” to be, and “we” (political elites, again) have both the knowledge and ability to effectively design rules favoring some groups at the expense of others in a way that will reliably produce a predetermined outcome. I don’t believe technocrats have either the knowledge or ability to carry out such a task, and I think political elites wielding the power to treat people unequally in the service of creating a desired outcome is a terrible idea, because [gestures broadly at all of human history]. But these are simply practical concerns. A more fundamental objection I have is the idea that correct results are something that exist in advance of the process creating them. This kind of objection was recently brought to the forefront of my mind by a recent Twitter thread from Daron Acemoglu, suggesting that perhaps we are on the verge of having the kind of supercomputing power available to us to solve the kind of knowledge problems that concerned F. A. Hayek. Acemoglu fundamentally misunderstood the problem Hayek was describing. It’s not the case that economic information just exists “out there,” exogenously, and that if only we had enough computing power it could be used efficiently. Economic information doesn’t exist independently of the economic system – markets do not merely aggregate economic information; they generate the information itself. Economic information does not exist prior to, and independently of, the market process, it is continuously created in the ever-ongoing market process. Acemoglu spoke as if the information simply exists as given, and we need only to input this pre-existing information to a system with sufficient computing power to solve the problem of economic calculation. He missed Hayek’s point completely. This is analogous to what I find fundamentally wrong with the outcome view. It, too, treats the idea that “correct outcomes” are something that have their own exogenous existence, independently of what people are doing to generate those outcomes, and therefore the goal is to design a system that creates these pre-existing “correct” outcomes. But I’ve never been able to make sense of that view. The grade a student should receive for an assignment isn’t something that simply exists out there in the ether, waiting for the correct grading process to uncover – the grade they should receive is something that is created, in the process of completing that assignment and the end result produced from that process. Likewise, the “correct” outcome of a sports competition doesn’t exist prior to the competition itself – it is generated as a result of engaging in that competition. And similarly, the outcome one “should” receive in an economic system doesn’t exist prior to that person’s productive engagement in that system – it emerges from how much that person produces that is valued by other people. For example, it’s not the case that a priori, Steve Jobs somehow “deserved” to make lots of money and the market correctly uncovered that pre-existing information. Instead, the market process made Steve Jobs a lot of money because by engaging in that process, Jobs produced a lot of things other people valued. Prior to engaging in that process, there was no answer to the question of how much Steve Jobs “should” make, and any theory that treats those answers as having a given, independent existence makes the same mistake Acemoglu made about Hayek. (0 COMMENTS)

Many pundits view financial crises as exogenous shocks that impact the business cycle.  I’ve argued that most financial crises are actually endogenous, caused by the business cycle.  There is very little evidence that financial crises have much effect on output, except when bank failures lead to currency hoarding that a central bank cannot fully accommodate due to a gold price peg.  The banking crisis of the 1930s was a result of a depression that began in 1929, and the post-Lehman crisis of late 2008 was the result of a recession that began in December 2007. Steven Kelly has a tweet pointing out that the recent banking problems in the US occurred on the West Coast, which is the worst performing region of the country (suffering from tech layoffs.) Sudden bank runs are too often characterized as spontaneous fits of irrational panic. But what we see is that they’re very much tied to the business cycle. In 2023, West Coast bank runs have followed a West Coast business cycle that has very much turned: When the banking problems developed back in March, the press was full of stories that the long awaited recession (which was already expected due to the Fed’s 2022 “tight money” policy) would now begin.  After all, the recession of 2008 seemed to get much worse immediately after Lehman failed.  (Actually, it got much worse before Lehman, but due to data lags this was not known until a few months later.) Three months later we are still waiting for the recession. People continue to make bad predictions because they have the wrong model.  High interest rates do not indicate tight money.  Financial turmoil is mostly the effect of a weak economy, not the cause. Eventually, the US will experience a recession.  But as long as the Fed continues to try to prevent recessions, the exact timing of recessions will be largely unforecastable. (0 COMMENTS)

Contrary to what economists believe, there are no scarce resources. The public debt is a “social convention” as are government deficits. The physical world, however, is not infinite, and constitutes the sine qua non condition of mankind’s existence. There is one scarce resource: the earth. Preserving mankind from climate change is thus the supreme goal, to which all necessary resources must be sacrificed. Such are the essential arguments of Le Monde columnist Stéphane Foucart (see “La dette, une simple convention sociale, est perçue comme plus dangereuse que la détérioration irréversible des conditions de vie sur Terre” [“Debt, a Mere Social Convention, Is Seen as More Dangerous than the Irreversible Deterioration of the Conditions of Life on Earth”], Le Monde, June 3, 2023). It does not help the author to invoke John Kenneth Galbraith, a now forgotten dirigiste economist from around the roaring 1960s. Much is missing in the journalist’s reasoning. A condition for the survival of mankind, otherwise than in small numbers in caves or in hunter-gatherer tribes, is that individuals cooperate efficiently. Consent is an essential component of the economic concept of efficiency. In market exchange and other voluntary relations, consent is easy to reach: he who doesn’t want to participate in an exchange just has to decline. Political relations are different, and there is no justification for part of mankind to impose on the rest its predictions or fears. Environmental models just provide that: predictions—as shown by the old Malthusian fears and the 1970’s scares that did not materialize. In a liberal perspective, any collective action must be founded on some sort of presumptive unanimity, and there can be unanimity only on general rules, not on ad hoc acts of regimentation. Think of one implication of rejecting this liberal principle. The supreme goal to be imposed, by believers on non-believers, would be the salvation of immortal souls created in the image of God. Infinite bliss for eternity has an infinite value for even only one individual, not to speak of as large a number of individuals who can fit in uteruses. Even the disbelievers will he happy, during all eternity, to have been forced to obey God. Except for those who have infinite faith in the environmentalists’ predictions (the new religion), trade-offs still have to be made. For example, is it the current environmentalists through their taxes (and other forms of conscription), or their children by reimbursing the public debt, who will have to pay to save the earth? Something else is also missing: understanding what “the finitude of the physical world” can actually mean. There is just so much land to grow food, yet 1.5% of the American labor force produce today much more food for much more people than did about 84% of workers at the beginning of the 19th century. Physical resources are certainly finite: there is just so much land, steel, and aluminum right now to build apartment blocks or wind turbines. But one resource is potentially quasi-infinite: human ingenuity, inventiveness, and entrepreneurship. As Julian Simon argued, man is the ultimate resources, and “man” means the several individuals rather than bureaucratic structures and state coercion (see Simon’s The Ultimate Resource, 1981). This is why the earth barely fed 220 million of inhabitants, nearly all poor, in year zero of our era, and we are now 7.9 billion, of which a large proportion are well fed and comparatively rich. On dangerous environmental scares, allow me to quote a recent Regulation article of mine: Since the 1970s, environmentalists have been recycling Thomas Malthus’s arguments to claim that population stagnation or decline would be good because it would prevent or reverse environmental catastrophes. In his 1968 book The Population Bomb, Stanford biologist Paul Ehrlich warned that an exploding world population was hitting resource constraints and that, within a decade, food and water scarcity would result in a billion or more people starving to death. Governments, he opined, should work toward an optimal world population of 1.5 billion, a goal corresponding to 57 percent less than the actual population in 1968 and 81 percent less than today’s 7.9 billion. In 1965, the New Republic announced that the “world population has passed food supply,” and that world hunger would be “the single most important fact in the final third of the 20th Century.” The “freedom to breed is intolerable,” ecologist Garrett Hardin pontificated. The “carrying capacity” of the planet is a fallacy or a hoax. In his book Capitalism, Alone (2019), Branko Milanovic gives many illustrations of the fallacy over the past two centuries. One of them involved British economist Stanley Jevons (1835-1882), who reasoned that the price of paper would soon explode given the diminishing number of trees. He hoarded paper in such quantities that, 50 years after his death, his children had not used up all his stock. Milanovic adds (p. 200-201): We are no smarter than Jevons. We, too, cannot imagine what might replace fuel oil or magnesium or iron ore. But we should be able to understand the process whereby substitutions come about and to reason by analogy. Resources, including those diverted by political authorities through deficits (or inflation), are real resources, not “social conventions.” They are no more social conventions than finite physical or human resources that serve to satisfy virtually infinite human desires. Considered together, resources are limited, but substitutable and augmentable. The ones that become relatively scarcer are economized as their prices increase, and other resources, including human ingenuity, are substituted for the scarcer ones. If, and only if, institutions favorable to individual liberty and prosperity are maintained or improved, we can expect that (except perhaps for catastrophes such as asteroid hits or nuclear war) human ingenuity will continue, with limited resources, to produce more and more income and wealth, which means increased possibilities of consumption or leisure as each individual chooses; and, if need be, more resources to address, or adapt to, climate modifications. All that does not necessarily mean that nothing should be (prudently) done now, but it does mean abandonning a mushy view of society and the economy. (0 COMMENTS)

I’m going through old copies of the Journal of Law and Economics, the first journal to which I subscribed, before sending them off to a young woman who is majoring in economics and thinking about going into a graduate program. I came across an article by my UCLA industrial organization professor, Sam Peltzman. I took his two-quarter IO sequence in my first year at UCLA, which was his last year before he moved to the University of Chicago. The article I came across is his “The Gains and Losses from Industrial Concentration,” JLE, October 1977. I had marked it up a a good bit. In this article Peltzman asks the question “[I]f [industry] concentration and profitability are indeed related, what market process produces the relationship?” That’s a pretty important question. He then states: The traditional answer has been that high concentration facilitates collusion and super marginal-cost pricing, for which some profitability measure is a proxy. Unfortunately, this answer does not logically follow from the usual evidence, so its acceptance by economists and practitioners of antitrust policy is little more than an act of faith. After going through the data, he does a nice back-of-the-envelope calculation showing that breaking up concentrated industries would hurt the firms, by raising costs, and consumers, by raising prices. He writes: To get at the magnitude of the risks facing an anticoncentration policy, we can focus on industries which have a four-firm concentration ratio greater than .5. The average concentration ratio in this sector is around .7, and the typical member spent something over 70 cents per dollar of output for payroll and raw materials. Now imagine that through a divestiture action the concentration ratio for such an industry is reduced to .5. Given our empirical results, this action could raise unit costs on the order of 20 percent, which in turn would raise price by 10 to 15 percent. Assuming unit elastic demand, the lower figure would impose a cost on consumers of around 9.6 cents per dollar’s worth of output, of which 9.1 cents would be a transfer to producers. Resource costs would increase by around 12.7 cents per dollar of output, so producers would lose 3.6 cents per dollar, and the total loss would be just over 13 cents. [DRH explanation of the math: producers gain 9.1 cents per dollar and lose 12.7 cents per dollar, leaving a net loss of 12.6 minus 9.1, or 3.6 cents per dollar. Consumers would lose 9.6 cents per dollar and so the overall loss is 9.6 cents plus 3.6 cents, which is 13.2 cents.] Since this concentrated sector currently accounts for around one-fourth or 250 billion dollars of manufacturing sales, any extensive deconcentration program would risk imposing losses which are many times greater than the typical estimates of the benefits such a policy might have been thought to produce. Sam was always so good at these back of the envelope calculations. I remember being in Washington briefly in the summer of 1974 and finding out about a conference at the American Enterprise Institute at which Sam spoke. He presented a similar kind of calculation on an issue involving the pharmaceutical market. An economist from, I think, the Labor Department named Alex Maurizi was the discussant. In his discussion, he challenged some of Sam’s numbers. But I pointed out, in Q&A, that Maurizi’s alternative numbers would make Sam’s point all the stronger. This back-of-the-envelope style was one of the best things I learned from Sam.   (0 COMMENTS)

The most powerful weapon in an economist’s arsenal is the law of demand. When the price (or opportunity cost) of something increases, people will purchase, consume, or choose it less often. The law of demand is a common backbone for many arguments. If the spine breaks the body falls. Naturally, those who want to undermine economic arguments will attack the law of demand directly. Typically the law of demand is derived from simple indifference curve analysis that relies on the idea that individuals maximize with respect to constraints. The simple retort that individuals don’t actually maximize would, if true, cut the heel of the indifference curve defense of the law of demand. Regardless of whether or not the retort is true, whenever it’s brought up the resultant conversation is often hopelessly pedantic and includes a lot of talking past each other. Gary Becker defended the law of demand and avoided the pedantic conversation by dropping the maximization assumption. In fact, he drops the whole utility function. The law of demand can be derived from the nature of: Assume that our individual chooses a bundle (x,y) at random within the above constraint (conjure a familiar triangle in your mind). As each component varies, the slope and intercept of the triangle will shift. As the triangle changes shape the probability that some given bundle is chosen will also change. A mathematically stronger version of this argument exists if we assume that they consume their entire income (a small amount of rationality in choice required). In a very clever way, Gary Becker has rescued the law of demand, or at least a version of it sufficient to retaining most arguments made by most economists. There still remains a problem. Becker’s defense only functions in environments where the parameter shift directly changes the choice set. It is not generalizable to all situations where we argue that some behavior declines when an associated cost increases. Consider the following game. A mugger accosts a pedestrian who has five dollars in his wallet. The pedestrian has the choice to open his wallet willingly or to keep walking. Subsequently, after the mugger observes the pedestrian’s choice, he may either shoot or not shoot the pedestrian. If he shoots he always gets the cash, but he would prefer to not shoot as it includes the risk of him being put away for a much longer time. Typically the Subgame Perfect Nash equilibrium is as shown below. The pedestrian always opens his wallet based on the idea of backwards induction. He anticipates that the mugger will never shoot if he’s already received the money, and that the mugger is willing to shoot to get the money, despite the extra risk. Thus, he always opens his wallet, and the mugger never shoots. If we take the mugger’s behavior as given in each contingency, the anticipation of mugging acts similarly to a constraint on the pedestrian. Formally, however, the pedestrian is not constrained by the mugger. He is only constrained by his strategy set {Open Wallet, Keep Walking}. If we wanted to make Becker’s defense here we might say that the Pedestrian chooses a mixed strategy between his two options. The presence or absence of a mugger would not deter his behavior whatsoever. To the extent that the actions of the mugger serve can be properly analogized to a budget constraint, they must be considered a cognized budget constraint. Becker’s defense only works for forms of constraint that directly impact the choice set. The law of demand applied generally is that when the opportunity cost of something rises, people do less of it (and vice-versa). Kirzner (1962) argued in response to Becker that for a market equilibrium to hold all agents could not be price-takers, at least some must be acting purposefully. Economists who focus on non-market decision-making might find Kirzner’s point moot outside the market context, where all they are concerned with is shifting opportunity costs often couched in the market term “relative prices”.  If we hope to expand the use of economic theory in arenas beyond markets (as Becker did), we must bring in more tools than just the budget constraint.   Thanks to Henry Thompson for sarcastic yet useful comments.   References: Becker, G. S. (1962). IRRATIONAL BEHAVIOR AND ECONOMIC THEORY. The Journal of Political Economy, 70(1). Kirzner, I. M. (1962). RATIONAL ACTION AND ECONOMIC THEORY. Journal of Political Economy, LXX, 380–385.   Marcus Shera is a Hayek Fellow with the Mercatus Center at George Mason University in his fourth year where he studies Economic History and Smithian Political Economy. He also writes at theeconplayground.com. (0 COMMENTS)