Economics by Design
by Robert A. Collinge and Ronald M. Ayers
(Upper Saddle River, N. J.: Prentice Hall, 1997), 606 pp.
General Comments: This book is an excellent teaching tool. On virtually every page, it
illustrates the economic way of thinking and trains students to look below the surface to
perceive economic effects they would otherwise miss. In helping the student to develop the
mental toolkit of the economist, Economics by Design is wonderful. Moreover, the
authors explore a wide array of topics: they show that economics is not just about
production and trade, but extends to all purposeful human action. For example, they
briefly discuss the economics of crime. The writing is engaging and clear. The only
drawback to the book is that it is aimed at advanced high school students, and even
Criterion 1: Costs and PricesHow Production is Determined
The authors begin with a masterly exposition of "the basics"scarcity,
choice, cost, the price system and the allocation of resources, and profit and loss. Their
discussion is careful and thorough. The student who learns the early chapters will have a
remarkably good grasp on the functioning of the market and the economic way of thinking.
Along the way, the authors introduce the reader to the uses of economic thinking on
issues not usually perceived as "economic." They devote several pages, for
example, to the effects of drug prohibition. They dont make a normative judgment on
whether prohibition is good or bad, but show how government policy changes prices and
incentives. The great virtue of this and many other topics they cover is that the student
learns to set aside preconceived value judgments and examine the real world trade-offs.
Attentive readers will often find themselves thinking, "I never thought of
Where many books stop with basic price theory, this ones goes further, drawing out
important implications. For example, the authors discuss how prices influence resource
conservation, and the way black markets work as "safety valves" when government
regulations have blocked the operation of the free market.
Criterion 2: Competition and Monopoly
The books treatment of competition and monopoly is very good. Monopolistic
competition is not attacked for theoretical shortcomings, but instead as a market
structure that very efficiently serves consumer desires. The allocative efficiency problem
with monopoly is explained well, as is the logic of the monopolists decision-making.
The authors also point out that successful collusion to eliminate competition in a free
market is very difficult and that monopolies are hard to sustain.
Not much space is devoted to antitrust. The student learns what the objective of
antitrust law is and that the wording of the statutes is so vague that it is often
difficult to know beforehand whether various business actions will or will not be subject
to legal attack. The book would have been stronger with a more thorough treatment of
In their "current issues" section, the authors have several pages of solid
analysis of the U. S. Postal Service and the feasibility of open competition in mail
Finally, the book gives the student an excellent discussion of mergers, leveraged
buyouts and "junk" bonds, shedding light on these much misunderstood topics.
Criterion 3: Comparative Economic Systems
Economics by Design explains the differences between free market economies and
those subject to central planning. The authors show that the choice between "the
chaos of the market" and "the rationality of central planning" (as it is so
often phrased) is a false choice. "Government planning is often disorderly and
wasteful," they write (p. 555). As an example, they cite the Nigerian
governments foolish purchase of far more cement than could be unloaded at the port,
which led to tremendous waste when the cement eventually hardened in the holds of ships.
The authors explain why it is hard to make rational decisions without a price system,
and discuss many of the undesirable consequences of command and control economic systems.
Their treatment would have been stronger, however, if they had explained the strong
tendency for planners to allocate resources abundantly toward the production of goods and
services that benefit the government and its apparatus.
Criterion 4: Income Inequality and Poverty
The issues of income inequality and poverty are dealt with rather briefly under the
chapter on "Income from Labor and Human Capital." The authors present data
showing changing shares of after-tax income earned by the various groupings between 1977
and 1992. The authors caution against leaping to the conclusion that "the richer are
getting richer and the poor are getting poorer" by pointing out that there is
considerable income mobility in the U. S. economy. "The poor" and "the
rich" are not the same people over time. They also make the important point that the
governments income distribution figures do not take account of in-kind transfers.
The book says little about the impact of welfare programs, except that they have
disincentive effects. Also, there is only a brief suggestion that some poor people are
poor because of laws and regulations that get in the way of their earning ability. The
authors should have developed this point at greater length. The discussion of the
"wage gap" for working women and critique of "comparable worth"
legislation, however, are excellent.
Criterion 5: The Role of Government
The book gives the student a good analysis of the role of government in dealing with
instances of market failure. First, regarding the problem of public goods, the authors
clearly explain the free rider problem. They also caution that just because a good has
"publicness" qualities does not mean that government should be the provider.
They write that entrepreneurs "may find ways to tie public goods to private goods
that individuals or firms are willing to buy" (p. 322). A point they omit here,
however, is that just as the market may be inefficient by under-providing the public good,
so may government be inefficient by over-providing it, or doing so at low quality.
The authors have an enlightening discussion of the problem of externalities, with a
detailed examination of the pros and cons of the various policy tools at the
governments disposal. A point they make strongly is that government regulators do
not have to bear the cost when they create rules that produce high costs with almost no
Collinge and Ayers also include an interesting discussion on "merit goods"
such as access for the handicapped. Instead of treating them as moral imperatives, they
employ sound economic thinking to show that there are trade-offs. For example, government
safety mandates may make the workplace marginally safer, but safety is not free. Workers
will find that their compensation is reduced; if given the choice, they might have
preferred somewhat higher pay to a somewhat safer work environment.
Criterion 6: Public Choice
One of the greatest virtues of this book is its full coverage of public choice theory.
Collinge and Ayers reject the naive view that government generally responds in
"the public interest." Lest the student miss the key point, it is put in bold
type: "rational ignorance means that politicians and bureaucrats can often safely
follow their own personal agendas, even when those agendas conflict with what the public
would want them to do" (p. 365). The rational ignorance of the public leads to
several political maladies the authors discuss, including the "fiscal
illusion"the tendency of voters to fix their attention on the government
spending that benefits them, while ignoring the fact that they are being taxed far more to
pay for programs, projects and services that benefit others.
Equally important to understanding economics in politics is the role of interest
groups. The authors show how the behavior of interest groups refutes the common view that
democracy leads to government actions that are in the interest of the majority of the
people. The wastefulness of the quest for government favors is brought home in the
discussion "Rent SeekingA National Pastime" (p. 367).
Finally, the authors show the student how the incentives of bureaucrats lead them to
enlarge their budgets and fend off any cuts through tactics such as "The Washington
Monument" strategy: threatening to curtail popular and even necessary public
functions in order to save the unpopular and unnecessary ones.
Criterion 7: The Role of the Entrepreneur
Collinge and Ayers nicely define entrepreneurship and explain its importance.
Entrepreneurs must take initiative and run risks if they are to succeed, and success comes
only if they produce goods or services that fill an unmet need in the market. The authors
write, "The common theme to the success stories of Americas modern
entrepreneurs is insight into what the public likes to do and how they could do it better
or more conveniently" (p. 41). This topic would have been stronger, however, with
some discussion of how taxes and regulations affect entrepreneurship.
Criterion 8: Taxation
The discussion of taxation in the book is good, as far as it goes. The authors explain
the different kinds of taxes levied and the importance of marginal tax rates. They also
cover the subject of tax incidence. The student learns why it is misleading to talk about
the employers "matching contribution" for Social Security and why the
corporate income tax ultimately is borne by individuals. They also demonstrate that taxes
alter peoples behavior.
The authors discuss several tax reform possibilities and suggest their probable
economic effects. They also provide a good analysis of "sin taxes," and the
tendency of politicians to shift the tax burden to vulnerable groups.
One thing the authors should have discussed at greater length is the overall cost of
taxation. Students need to give serious attention to the burden that taxes and the tax
system impose on the economycompliance costs, enforcement costs, and avoidance
Criterion 9: The Business Cycle
The discussion of the business cycle is one of the weaker parts of the book. They
present the Keynesian aggregate demand explanation for the business cycle, but dont
analyze it well. Neither do they clarify the conflict between Keynes and J. B. Say (and
his later defenders). The authors need to describe the debate between those economists who
believe that a market economy is inherently unstable and requires frequent government
intervention, and those who believe that a market economy is stable if left alone and
suffers from instability because of needless government intervention.
What is missing from the book is the idea advanced by the Austrians and the Monetarists
that the business cycle is not really a macroeconomic phenomenon, but a problem of many
microeconomic adjustments that must be made because of government policy. Monetarism is
only discussed in conjunction with monetary policy, not as an alternative explanation of
the business cycle; Austrian theory is not mentioned at all.
Criterion 10: Wages, Unions, and Unemployment
The authors explain wages as a market phenomenon of supply and demand. But they should
have made more clear the connection between wages and productivity.
The presentation on labor unions is too brief. The authors say it is hard to know how
much difference unionization makes in wages, but go no further than saying that the
difference is less than it appears to be if one looks only at raw wage data. The book,
unfortunately, does not go into the questions surrounding the economic impact of unions on
efficiency, productivity, prices, unemployment, and so on.
Collinge and Ayers explain the different types of unemployment and that there must
always be some unemployment in a free economy (the "natural rate"of
unemployment). They also cover how hard it is to accurately measure unemployment. They
have a competent discussion of government programs aimed at unemployment, but they need to
consider the economics of unemployment insurance.
Criterion 11: Trade and Tariffs
The books discussion of trade is very thorough, with clear explanations of the
law of comparative advantage, balance of payments, and the foreign exchange market. The
authors could have stressed more that "foreign trade" is economically no
different from any other trade between human beings.
The treatment of the various arguments in favor of tariffs is excellent. Of the
"lost jobs" argument, the authors write, "buying imported goods and
services does not imply any reduction in aggregate employment. The reason is that dollars
that are spent on products abroad bump up against the currency market and are immediately
bounced back into the U.S. economy" (p. 173). The authors dispatch the "infant
industry" argument after much analysis. They also cover the supposed harms of
"dumping" and demonstrate that policies to prevent it do much more harm to
consumers than dumping itself. They also cover "strategic trade initiatives" and
the contention that government can bring about greater national prosperity by encouraging
"the right" new industries. The authors note the "public choice"
problem: that industries chosen for assistance would most likely be chosen on the grounds
of political influence.
Finally, the book uses the case of bricks made in Mexico to show students how to
analyze hidden protectionism in seemingly innocuous government mandates.
Criterion 12: Money and Banking
Collinge and Ayers explain the function of money and how it facilitates commerce better
than barter. Money is a market phenomenon, not an invention of the state, and the authors
could have made that point more explicitly. One of the few questionable statements in the
book occurs when they say, "Paper money was more readily accepted if issued by
government" (p. 49). Evidence from our monetary history often reveals just the
opposite. Sometimes, privately issued paper notes circulated with great confidence and
sometimes government paper money, as the expression goes, was "not worth a
The books discussion of the banking system is good, with several important points
brought out besides the nuts and bolts of bank operations. For example, the student learns
about the tendency of federal deposit insurance to encourage lending institutions to make
riskier loans than they would otherwise, and how the Glass-Steagall Act restricts
competition in the financial services industry.
The role of the Federal Reserve in creating inflation is explained well, as is the
point that inflation is actually another kind of tax. The authors connect monetary policy
with interest rates and conclude, "Monetary policy cannot lower interest rates in the
long run, except through lower inflation" (p. 483). The problem of hyperinflation is
also handled well.
The authors briefly analyze the argument for reestablishing a gold standard, but
unfortunately ignore the disadvantages of having a fiat money system subject to political
manipulation by free-spending officials.