Paul Krugman: Thinking Beyond Econ 101

What’s the Big Idea?

Can economics explain everything?

Some people have attempted to make that claim, but not Paul Krugman, who labels such a view “academic imperialism.” Krugman, who won the Novel Prize in Economic Sciences in 2008 for his contributions to New Trade Theory and New Economic Geography, points to a famous line from the great British economist Alfred Marshall, that “economics is about the ordinary business of life.”

In other words, Krugman says don’t look to economics for an explanation of the “grand passions.” A strictly economic analysis of King Lear, for instance, would certainly leave something to be desired.

What economics can help us with is understanding a series of often banal, mostly rational decisions, says Krugman, “like deciding what kind of sandwich you’re going to order. It’s about deciding where to open a business.”

Since human behavior is not always rational, and can in fact be enormously complex, Big Think asked Krugman what methods we have for understanding problems that go beyond Econ 101.

Watch the video here:

What’s the Significance?

When you look at every problem through the same lens — for instance, supply and demand — you are bound to find something in practice that doesn’t fit your theory. “There are so many places where Econ 101 doesn’t work,” Krugman says. For example, one of the major topics in Krugman’s bestseller, Conscience of a Liberal, is the way that different economists have understood wealth and income gaps in recent American history. Using the analogy of Bill Gates walking into a bar, Krugman describes how the average income in America has risen dramatically while median income has stagnated.

What’s the reason for this? One group of economists says that technology has driven demand for highly skilled workers, and those skills have dictated higher salaries. Krugman points out the flaws in this argument by comparing CEOs to schoolteachers. Both may have advanced degrees, yet schoolteachers have received modest income gains while top CEOs have realized anywhere from a fivefold to a sevenfold increase in earnings.

According to Krugman, what is as important to understand as supply and demand is the way that institutions and norms have changed, such as “the way corporate management is paid.” Even if we don’t have an “extremely rigorous way of representing them,” he says, it’s clear that changing institutions and norms “make an enormous difference.”

It is essential that we understand how to analyze problems like these because, as commentators like Krugman and others have suggested, restoring prosperity for the majority of Americans is going to be the great progressive challenge for the next generation.