Economics 101

by | Apr 2, 1997

Many people think economics is about businesses and financial institutions but economics is much broader than that. Economic theory makes a valuable contribution whenever there are costs and benefits of any human action. Take dating. Suppose you see a fat, old, ugly, cigar-smoking man dating a beautiful young lady. What prediction would you make about […]

Many people think economics is about businesses and financial institutions but economics is much broader than that. Economic theory makes a valuable contribution whenever there are costs and benefits of any human action.

Take dating. Suppose you see a fat, old, ugly, cigar-smoking man dating a beautiful young lady. What prediction would you make about that man’s income? I’d guess that you’d say it’s pretty high. Why? Essentially what the man tells the beautiful young lady is, “Look, I can’t compete for your hand on the basis of a guy like Williams; so I’m going to offset my disadvantages by offering you greater splendor.”

That’s what economists call a “compensating difference.” Suppose do-gooders come along and claim that it is unfair for beautiful young ladies to charge fat, old, ugly, cigar-smoking men higher prices than handsome men. They get a law passed forbidding beautiful young ladies from demanding more from fat, old ugly cigar-smoking men than handsome men. What then happens to the probability of fat, old, ugly cigar-smoking men of dating beautiful young ladies? If you said zilch, go to the head of the class. Such a law would deny them their most effective means of competing with handsome men, namely offering a higher price.

The same principle applies to any less-preferred person or good. Most people prefer filet mignon to chuck steak. The reason chuck steak sells is because it offers a “compensating difference”, it sells for a lower price. If we made a law saying that chuck steak had to be sold for the same price as filet mignon, chuck steak wouldn’t sell. It couldn’t offset its perceived quality differences by offering a lower price.

I do speaking engagements for which I am paid. So does Nobel Laureate Milton Friedman for handsome fees as high as $30,000 which I don’t get. In the interest of fairness, suppose a law is passed saying that people had to pay me the same as they paid Friedman, what do you think would happen to the probability of my being hired. Right. It’s just like the fat, old, ugly cigar-smoking man; it would go to zilch. The reason I have speaking engagements is because I am free to say, “I’m not as good as Friedman, but I’m not as expensive either.”

What about the minimum wage? That’s a law that says no matter whom you hire, you must pay them a minimum of $5.15 an hour. That produces effects not dissimilar from any of the above examples. A person perceived to be worth only $3, in terms of productive output, just won’t be hired though he would be hired if it were legal for him to offer a compensating difference as I do when competing with Friedman. Thus, one of the effects of the minimum wage, though not its intention, is to reduce employment opportunities for low skilled people.

The lesson here is that economic theory, like any other good theory such as Galileo law of falling objects is perfectly general. Some people may object saying, “Williams, we’re dealing with humans not inanimate objects!” No problem. The law of gravity says that the independent influence of gravity is to cause a falling body to accelerate at 32 feet per second per second. It matters none whether that falling object is a brick or a human. It’s the same with economic theory whether we’re talking about fat, old ugly cigar-smoking men, chuck steak, speaking honoraria or a low skilled worker. When prices are controlled, the less-preferred are always handicapped.

Walter E. Williams is a professor of economics at George Mason University. In 1980, he joined the faculty of George Mason University in Fairfax, Va., and is currently the John M. Olin Distinguished Professor of Economics. He is also the author of Race and Economics: How Much Can Be Blamed on Discrimination? and Up from the Projects: An Autobiography. Williams participates in many debates and conferences, is a frequent public speaker and often gives testimony before both houses of Congress. This editorial was made available through Creator's Syndicate.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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