What is the Biggest Fallacy in Economics?

Consider 'biggest' to mean a combination of widespread belief and extent of error.

Nomination :

That two goods exchanged have been agreed by the exchanging parties to have equal economic values.

Corollary: If one of the goods is money, then the economic value of the other can be represented by its money price in the exchange.

Any other nominations?

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The labor theory of value.

The labor theory of value.

That the Fed prevents

That the Fed prevents inflation, or that health care should be [a] free for all.

That supply and demand are

That supply and demand are scalars.

the one fixed pie wiew of

the one fixed pie wiew of wealth! I'd say this one tops them. Its got a lot of tow in colleges and universities where our brightest young minds are bieng edu....er brainwashed

that gold no longer serves a

that gold no longer serves a function in economic life. boy is that one gonna turn out to be UGLY WRONG.

Don, What is your standard

Don,

What is your standard for "biggest fallacy"? Your nomination and corollary, while certainly valid - do they have far-reaching policy implications? It seems like something more fundamental like the fixed-sum wealth view mentioned above should be "biggest" because of how it influences laws.

Brandon, That supply and

Brandon,

That supply and demand are scalars.

You originally said that they were flat, meaning, I assume, independent of price.

I'm not sure what you mean by scalars, presumably not vectors. Demand can have different components, but all of the components can be added directly to produce a total demand without a requirement for a projection.

Regards, Don

Jonathan, What is your

Jonathan,

What is your standard for “biggest fallacy"? Your nomination and corollary, while certainly valid - do they have far-reaching policy implications? It seems like something more fundamental like the fixed-sum wealth view mentioned above should be “biggest” because of how it influences laws.

I don't know the true extent of either fallacy. I'm pretty sure that my nomination lies at the foundation of Behavioral Economics and may undermine most or all of its conclusions. I suspect that other areas of economics may well be affected as well. I wouldn't have thought that a fixed-sum wealth fallacy was itself necessarily widespread, as opposed to a closely related fallacy that someone that gets better off does so at your expense.

Regards, Don

A monopolist has no

A monopolist has no effective limit on the prices that he can charge.

Regards, Don

That there is more than one

That there is more than one type of economy (capitalist, socialist, etc.) and that the members of a society can make a choice as to what type of economy they want to have. [without suffering any negative consequences from that choice - ed Don]

That costs don't

That costs don't sink.

Regards, Don

Don: I didn't think anyone

Don:
I didn't think anyone saw that, since I edited it immediately afterwards.

For all practical purposes, they mean the same thing, but I thought "supply and demand are scalars" sounded better than "supply and demand curves are flat," because most people don't even seem to realize that they're functions.

This fallacy manifests itself in numerous ways: Support for price controls and minimum wages, the belief that illegal immigrants do jobs that Americans aren't willing to do, the belief that taxes won't effect economic activity, and that welfare doesn't encourage irresponsible behavior, and so forth.

Brandon, OK, that makes

Brandon,

OK, that makes sense.

I didn’t think anyone saw that, since I edited it immediately afterwards.

The email of comments to the author of the blog only contains the original version, never the edited version.

Regards, Don

tim of the idea that those

tim of the idea that those who believe that one gets better off only at anothers expense are implicitly assuming a fixed pie (sum). I would say that this belief is just a part of an overall fixed sum idea of economics.

The belief that the

The belief that the appropriate behavioral assumptions about free actors are inappropriate to make about people in government. The popular corrolary to this fallacy is the belief that people in government really will provide public goods rather than free ride.

Don, maybe my microeconomics

Don, maybe my microeconomics is a little rusty, but I thought most economists taught/believed that when two goods are exchanged all that is clear is that both parties expected to be better off.

Only in the limiting case of perfect competition and general equilibrium could one conclude as a matter of logic that at the margin the economic value of goods is exactly the market price. Outside the limiting case, for example in any empirical work, using the money price as an estimate of economic value is often better than nothing, but the analyst should exercise some caution in interpreting results.

What about the Coaseian

What about the Coaseian argument that "Businesses are set up like command economies" which implies that command economies are not the bane to freedom that liberals suggest they are?

I've heard that one thrown about in some discussions before.

1. That prices have a moral

1. That prices have a moral component. (Although this fallacy may be a result of the zero-sum view of wealth.)

2. That wealth can be increased through aggressive violence (i.e., that aggressive violence is anything other than negative-sum).

3. That anything in economics can be understood on the time scale of a single transaction (i.e., that economic decisions and behavior somehow don't have (a) historical precursors and (b) future consequences). See Hazlitt's Economics in One Lesson.

How about that the balanced

How about that the balanced budget multiplier is something other than one.

That prices are given as

That prices are given as inputs to market activity -- rather than a byproduct of it -- and as such can be fiddled with.

That "basket of goods" price

That "basket of goods" price indices such as the CPI are in way an accurate measure of true inflation.

That saying "X is the

That saying "X is the ethical course of action" (X being price controls, whatever), will somehow overcome the negative economic effects that X will have.

That consumers are, on

That consumers are, on balance, rational

That free lunches exist.

That free lunches exist.

What about the Coaseian

What about the Coaseian argument that “Businesses are set up like command economies”

Is there a fallacy in this part?

which implies that command economies are not the bane to freedom that liberals suggest they are?

I'm not seeing how the first implies the second.

The two country Ricardian

The two country Ricardian model as an example of the global effects of free trade.

Free trade can hurt a country in the long run if they are developing the other country's capital structure at the expense of their own and lose their competitive advantage.
Very simplified example: We had advanced technology we sold to the world. Europe would give us a lot of cheese and wine for the products of this technology. We outsourced that to China and we are temporarily better off. China then starts selling it to Europe instead of us and we are worse off, since Europe won't give us as much cheese and wine for our technology. The world is definitely better off, but not necessarily the US.

Other countries becoming more free also "hurts" the countries who were free beforehand. If every country was as economically liberal, Hong Hong's economy would not be as prosperous.

I am not quite sure about this, but I'd like to throw this out there to a group of Austrian influenced classical liberals and see what they think. I don't think that government regulation could solve this, and I think that the damage is only done in the medium term. In the short term there are lower prices and higher profits, in the long term there is more compound growth that has huge effects... but perhaps in the medium term the competitive advantage that allowed the existence of a middle class is destroyed.

I think his point is the

I think his point is the proponents of the argument use the successful "command-based" business as support for a state-planned economy. The flaw is Coase was wrong.

BTW, I was replying to

BTW, I was replying to David.

Jeff's post reminds me of

Jeff's post reminds me of probably the most common and destructive fallacy of economics: "we".

I'm surprised no one else

I'm surprised no one else has said it, but the broken window fallacy is still pretty prevalent and damaging. I don't know how many times in the run up to the war in Iraq I argued with people who believed that World War II brought us out of the Depression.

How is a business like a

How is a business like a command-based economy?

The people that comprise a company have the choice of accepting the terms of employment or finding a better alternative, and free to choose the time-scale on which such a decision is made. Actors in a command economy have no such choices.

In order to obtain the highest degree of productivity, a company will (to the extent necessary) align an employee's compensation with his performance. Doing so is relatively difficult, and the companies that do so more successfully obtain more valuable services with less risk. A command economy has no reason to connect performance with compensation.

And the ability to engage in economic calculation?

If a business is set up like a command economy, then every single contract is a form of "command economy." By aggreeing to perform certain actions for mutual, reciprocal benefit, the parties to a contract bind one another to do specific things. This is no more a form of "command" than any other form of cooperation.

Damn, John, you beat me by

Damn, John, you beat me by about 1 minute. Absolutely the Broken Window Fallacy. Because people believe that you can "create" jobs by destroying things or building public works, their whole view of how economics (and the world) work is completely skewed. Someone mentioned Hazlitt up in the comments somewhere, and Economics in one lesson is pretty much 25+ chapters about different facets of the BWF and why it's a steaming pile of poo.

Jeff, there are so many

Jeff, there are so many assumptions and vaguaries in your question, I find it hard to know how to begin to respond.

My first reaction is this: to the extent that there is a "harm" ocurring during this "middle term" time period you mention, what you call "hurting" is actually the economic basis for adaptation and innovation.

As an initial matter, I do not see how anyone could classify being out-competed in a market as the seller of a good constitutes as being "hurt." It simply means that buyers have better alternatives than dealing with you. When one no longer produces goods that best meet the buyers' most urgent needs at the best price, that is a signal to change what you produce and/or the way you produce it. By using some form of governmentally-imposed (i.e., violent) trade restriction to prevent this from happening, you also necessarily remove the economic reason to adapt. The result is stagnation and economic decline.

That wars help the

That wars help the economy.

That hurricanes help the economy.

That digging holes in the ground helps the economy.

That armageddon, nuclear holocaust, or giant plague-worms from outer space help the economy.

That increasing the supply

That increasing the supply of money can create wealth.

That the existence of the

That the existence of the Social Security "Trust Fund" is of any benefit whatever in making future Social Security payments.

Regards, Don

Okay, since the FOMC isn't

Okay, since the FOMC isn't interesting enough to spend too much time on I'll try to clarify:

I don't really identify with the US or the middle class of the US as "we", and I agree that it was bad terminology. I don't think it a bad thing that free trade is allowing the overall economic pie to grow while perhaps it shrinks for some of the US middle class (Look at where real wages have gone). I do think that capital development from free trade is something that's vastly overlooked in conventional trade theory. It should also be noted that a country trading with most of the world could be a net loser in the long run from the rest of the world turning more to free trade. They also don't necessarily benefit when a country that resembles their production capabilities starts to engage in free trade. A corollary to that is causing a trading partner to change to more resemble the original country's production capabilities isn't necessarily good for the country either.

The reason I think this involved a fallacy worth mentioning is that it seems like libertarians have a knee-jerk reaction to deny/ignore most of the above only because this line of thought sounds like it implies statist action is necessary/beneficial (I don't believe it does, show me the policy that you think would help given the above and I'll tell you why it won't work).

Here's a big libertarian economic fallacy: Government policy has never helped the economy. (Of course, the belief that we can really measure this could be another fallacy itself.)

A stopped clock is right 2 times a day... though perhaps the government is more rightly labelled a stopped calendar...

Here's a fallacy to go with

Here's a fallacy to go with Jeff's: Government policy that does help the economy has no opportunity cost.

a country trading with most

a country trading with most of the world could be a net loser in the long run from the rest of the world turning more to free trade. They also don’t necessarily benefit when a country that resembles their production capabilities starts to engage in free trade. ... Here’s a big libertarian economic fallacy: Government policy has never helped the economy.

Actually, I would call that a big Straw Man.

From the narrow, limited, selfish perspective of one market competitor who faces new competition, yes, the arrival of another competitor is bad news. That's the impetus behind the drive for protectionism in the first place.

Many of these governmental restrictions on free trade do have an economic benefit. Of course they do. That's what protectionism is: using governmental force to obtain a special benefit at the general expense. It is no different than when a goverment grants a company a monopoly -- the benefits accrue to the monopolist, at the expense of everyone else.

But, as Hazlitt pointed out, anti-free-market actions only yield benefits if you (a) consider its effect on a limited group of people, and (b) over a short span of time.

By expanding one's scope to include more people over a longer period of time, it becomes clear that all such interferences with free trade cause harm.

These arguments against free trade have been addressed by at least one prominent free-market libertarian. And refuted.

Digging holes in the ground

Digging holes in the ground can help the economy.

That the uncritical mixing

That the uncritical mixing of the apples of business operations with the oranges of ownership structure, as with stock and option expensing, somehow magically result in more accurate and transparent financial reports.

Regards, Don

David, Digging holes in the

David,

Digging holes in the ground can help the economy.

What have you got against undertakers?

Regards, Don

As for a fallacy, perhaps

As for a fallacy, perhaps the notion that (when developing policy) government agents can be ascribed altruistic and self-denying characteristics when they are rational, self-interested actors like the rest of us.

Don, I don't know anything

Don, I don't know anything about html but the "can" should be italicized. I was replying to Jacob, who was obviously referring to public works projects.

I was giving the undertakers their due =)

That the overall standard of

That the overall standard of living can be increased by any means that does not eventually result in an increase in the supply and variety of consumer goods and services.

Regards, Don

David, Put around what

David,

Put around what you want to italicize.

That reducing unit cost of

That reducing unit cost of input, particularly labor, benefits a company, regardless of the affect on the volume and quality of output.

Perhaps not the "biggest" fallacy but a prevalent one indeed.

To me, the biggest fallacy

To me, the biggest fallacy is that inflation can be measured. The next biggest fallacy is that government welfare programs help the poor. Following that one is the fallacy that government spending expands the economy.

The biggest "fallacy" in

The biggest "fallacy" in economics is not the fault of economists at all but in the minds of those people who forget the very first principle.

Whenever a fundamental economic principle is espoused, it is always (should always be) preceded by the qualification -

ALL OTHER THINGS BEING EQUAL (the Pari Passu qualification)...

In other words, if we were to debate supply and demand as an example then leaving this principle out of the premises means that any number and manner of side issues and red herrings can be introduced to cloud the matter.

By reducing the question to its simplest form ("all other things being equal", or for the pedants "we are talking about this relationship in total isolation from any other influence") then Economics 101 theories can be made to make total sense.

NOW, try applying those theories to the real world...

Why do they not seem to work? Because we have taken them outside of the pari passu principle!

Why do they not seem to

Why do they not seem to work?

They seem to work fine to me. What examples did you have in mind?