No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter One: Introduction to Economics 28 A final fallacy to mention here is the broken window fallacy , brilliantly elaborated by the economist Frederic Bastiat and later by Henry Hazlitt. This fallacy is seen in almost every newspaper after an economic disaster. Let’s say a hurricane hits Florida, causing billions of dollars in damages. A common headline will say that the rebuilding of the Florida infrastructure will cause gross domestic product ( GDP) to rise as spending accelerates. This is seen as somehow mitigating the damage of the hurricane in that “at least the economy will be stimulated.” The fallacy here is that the money used to rebuild came from somewhere. Had the hurricane not hit, that money would have been spent in some other way, adding to the total goods or services or capital equipment rather than simply replacing what was there before. The spending after a hurricane is almost a total loss, despite what you read in the newspaper. John Stossel’s Broken Window Fallacy MICRO & MACRO ECONOMICS You may have heard of two kinds of economics: microeconomics and macroeconomics . Microeconomics looks at individual choices and incentives, while macroeconomics looks at economy as a whole. Rather than look at individual market supply and demand curves, macroeconomics aggregates (adds up) individual markets into one economy. This book is primarily microeconomic in nature, for a very important reason. All economics is microeconomic at its root. Microeconomics looks at people and how they make their choices. There are macroeconomic (or economy-wide) effects, but there are only microeconomic choices. In my view, the economic profession took a serious detour in the 1930s with John Maynard Keynes’ General Theory , which focused on insufficient effective (aggregate) demand as the source of economic problems. This began the profession’s focus on aggregate demand and aggregate supply analysis, as if these are two knobs that can be pulled by policymakers. Given the introductory nature of this book, it’s doubtful you have heard of aggregate demand and aggregate supply—we’re going to keep it that way for now, since that analytical technique is particularly unfruitful for understanding the real economy. Even macroeconomic policy choices (such as the interest rates set by central bankers) operate through the choices of individual decision makers; we will therefore focus on individual choice. We will, however, highlight how individual choices can have macroeconomic effects where appropriate. broken window fallacy: An error in reasoning that assumes because a harm will be repaired, and the repair stimulates the economy, the harm is beneficial to the economy; the error is in the failure to identify how the resources would have been used alternatively gross domestic product: a commonly used measure of national or overall economic output macroeconomics: The study of the economy as a whole, where all individuals’ and firms’ decisions are aggregated as if the economy can be analyzed as a single entity microeconomics: the study of how individuals and firms make choices to allocate resources