Thursday, June 11, 2009

The supply of pie

Some ideas stand out for being easy to understand, easy to put into few words, and incredibly useful for people who are trying to explain how the world works to other people who lack common sense. (Greg Mankiw organized his best-selling Principles of Economics around ten such ideas, which are humorously described here.)

I suspect that the biggest success story in the spread of such ideas is supply-and-demand. It's hard to know how many people really get it, but almost everyone is as least vaguely understands that the price of gas has something to do with how much gas there is to go 'round.

Here is the next up-and-coming crucial economics concept for the voting public: The-size-of-the-pie-and-how-you-cut-it-up. The supply of pie vs how you cut it is an abbreviation for a pie-adigm with several key points:
  • One way to measure the success of an economy is to look at the "size of the pie." To do this, you might look at the GDP, or some other measure of everyone's total earnings.
  • A very different way to measure the success of an economy is to look at how "fair" things are; how is the pie being cut up? How rich are the rich and how poor are the poor, not in absolute terms, but by comparison to each other?
  • Many controversial economic policies are policies that either increase the "size of the pie" at the expense of "fairness" or increase "fairness" while decreasing the "size of the pie."
One pie-controversial policy question concerns international free trade. Economists widely agree that removing international trade restrictions usually increases the size of each nation's pie, but that free trade often increases income inequality.

Another pie-controversial issue is redistributive taxation. When we pay taxes which are spent on medicare, social security, and welfare programs, we are increasing equality. But economists widely agree that such taxes (at least at high levels) substantially reduce size of the national pie. The famous diagram illustrating this is the Laffer curve (made fun of here).

Once you are good at identifying the pie size-vs-distribution trade-off inherent in policy questions, you can understand the motivation behind brilliant paired policy proposals such as this one: Allow free trade and raise redistributive taxes at the same time, just enough to correct for the inequality introduced by trade, but not enough to eliminate the increase in the size of the pie that came from free trade.

The supply and distribution of pie is at the heart of the clash between conservatives and liberals over economic policy. Conservatives tend to focus on the size of the pie. The pie grows with lower taxes, freer trade, fewer regulations in general. Liberals tend to focus on how the pie is cut, making sure that everyone gets a fair share. Socialist libertarians care about everyone getting a fair share, but are very careful about how to go about achieving this so not to hurt the overall size of the pie any more than absolutely necessary.

2 Comments:

Blogger Mama JJ said...

Darn. I thought you were going to talk about REAL pie!

11:18 AM  
Anonymous Anonymous said...

Don't we all want a piece of pie by and by?
kbs

6:58 PM  

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