Principles of Economics

Principles of Economics
by Karl Case and Ray Fair
(Upper Saddle River, N. J.: Prentice Hall, 1996), fourth edition, 1014 pp.

Rating: C+

General Comments: This is a densely-packed textbook. Wasted space is at a minimum and the authors’ discussions are often very extensive. It does a good job of developing the student’s ability to employ economic thinking, but is not always well balanced on disputed policy issues. Case and Fair lean heavily toward the mathematical approach, and the book is mainly a college text and should only be used with advanced high school students.

Criterion 1: Costs and Prices—How Production is Determined

The authors begin with a broad definition of economics, then devote several pages to the question, Why study economics? They provide persuasive answers, developed at length. They also include a section on the scope of economics, making the point that economics encompasses not just business and consumer behavior, but virtually all human decision-making.

The book gets the student off to a good start in understanding the essentials of economic thinking—scarcity, cost, specialization and exchange, the production possibilities curve, and so on. It does a good job explaining market dynamics and the importance of the price system in allocating resources for satisfying consumer wants. The vital point that free markets allocate resources efficiently without any central direction (the "invisible hand") is driven home—so is the role of profits and losses.

The book has many good "Issues and Controversies" boxes to put "real life" emphasis on theory. The box on ticket scalping (p. 111) makes the point that underpricing leads to shortages and that the actions of ticket scalpers actually have beneficial economic consequences. That analysis helps show the student that with economic thinking, you will often see much more than first meets the eye.

Criterion 2: Competition and Monopoly

The authors provide a sound, analytical look at the various market structures from perfect competition to monopoly. They include several pages on the debate over the efficiency of monopolistic competition (pp. 353-56) in which they give "both sides." But they omit one of the strongest arguments for adopting a laissez-faire approach: the high cost of government regulation itself.

Regarding monopolies, the authors note how government barriers to entry often encourage monopolies. They then say that governments often create monopolies where morally questionable activities such as drinking and gambling are involved so that they can tax them. They pose this strange, uneconomic question: "How can anyone criticize the state-licensed, implicit taxation of drinking and gambling?" (p. 325). They seem to imply that "sin taxes" can’t be criticized, but they certainly have been. Rather than exploring the question further, the authors leave the reader dangling.

The book has a lengthy discussion of antitrust laws, but it omits a vital argument in the case against antitrust laws—that they often do more to protect competitors than to protection competition, an observation made by many scholars. Also, antitrust officials have their own incentives that don’t necessarily coincide with the "public interest."

Criterion 3: Comparative Economic Systems

Case and Fair seem unequivocal on the inefficiency of centrally-planned economic systems, writing, "It is an understatement to say that the planned economies of Eastern Europe and the former Soviet Union . . . have completely collapsed" (p. 41). However, in the later chapter on comparative systems, they cite dubious statistics purporting to show a very fast rate of economic growth in the Soviet Union. It would have been more instructive to explore the realities of life for ordinary Soviet citizens: long lines, shortages, poor quality goods. Even better would have been an analysis of the inherent problems of planning an economy without a price system and profits. The book lacks a theoretical discussion of the well-known difficulties of central planning.

The book also devotes much more space to discredited Marxian theory than it does to the arguments of the classical economists. Students might conclude that there is something to be said for the Marxian idea that labor is exploited by capitalists because it (and other tenets of Marxist thought) is not held up to scrutiny.

The book gives no analysis of the economic implications of the welfare states of Europe. Also, the discussion of the Japanese economy is marred by its enthusiasm for MITI, which many economists believe has done the Japanese more harm than good, citing the recent collapse of the Japanese economy and that of other Asian nations which practiced MITI-style "industrial policy." In any case, the authors need to address the central question: Can government planners produce better results than investors and managers operating in the market?

Criterion 4: The Distribution of Income and Poverty

Case and Fair make several excellent points about income disparities. First, they note that "Income and wealth are imperfect measures of well-being. Someone with a profound love of the outdoors may choose to work in a national park for a low wage rather than to work for a consulting firm in a big city for a high wage" (p. 436). That is an important point. People often assume that low income means unhappiness, which is not necessarily true. Second, they point out that exchange among individuals will certainly create inequalities in wealth, but since voluntary transactions leave both parties better off, there is no reason to condemn differences in wealth when they arise from free exchange and the natural differences between individuals’ talents, savings rates, investment inclinations, and willingness to work.

However, when the authors analyze the distribution of income, they ignore the high degree of income mobility in the U. S., or that the "rich" and the "poor" are not the same people over time. Furthermore, the book quotes socialist Michael Harrington, who engages in tired bromides of class warfare, blames capitalism for poverty and calls for a government "war on poverty." The authors could have subjected Harrington’s rhetoric to some economic analysis, but decline to do so. Indeed, the section favoring income redistribution receives about three times as much space as any opposing view. Since the discussion centers on such non-economic matters as utilitarian justice and social contract theory, it teaches little about economic thinking.

Case and Fair also include a short presentation of the "comparable worth" controversy, but fail to give the student much insight into the economic problems and unintended consequences that would arise from having government officials decide what compensation must be paid for jobs.

Finally, the book’s treatment of the various redistribution programs is mostly descriptive, with little or no economic analysis. Of Social Security, for example, the authors write, "Currently, the system is collecting more than it is paying out, and the excess is accumulating in the trust funds. This is necessary to keep the system solvent" (p. 452). This is extremely misleading—all that is "accumulating" in the trust funds is debt in the form of federal bonds. Many scholars have concluded that it is impossible to keep such a system "solvent." In any case, the student is not informed that Social Security is headed for bankruptcy early in the 21st Century without either massive tax hikes, massive cuts in the level of benefits, or some form of privatization.

Criterion 5: The Role of Government

Case and Fair begin their chapter on the role of government with the problem of externalities, and observe correctly that negative externalities are not exclusive to free market economies. They write, "Many were shocked at the disastrous condition of the environment in virtually all of Eastern Europe" (p. 403). That is a good point, but the authors need to make the connection between the absence of private property and pollution.

The problem of providing public goods is explained clearly and the authors note that it may be more efficient for government to pay private enterprises to produce public goods, a possibility that is frequently overlooked. Unfortunately, the authors push the student toward the belief that there are many public goods. For example, the book devotes four paragraphs to the dubious argument that income redistribution is a public good. This has been contested by many economists, but the authors never give any counter-argument.

Another area the authors discuss is imperfect information. They give a good explanation of the problems of adverse selection and moral hazard, and make the point that the market often finds solutions to problems of asymmetrical information. But the book fails to point out that government action can also make things worse.

Criterion 6: Public Choice

The book has a good section on public choice, or "social choice" as the authors prefer to call it. They devote nearly a page to the voting paradox, but barely explore the problem of rational voter ignorance. The authors do recognize that public officials have their own personal incentives, writing, "To understand the way government functions, we need to look less at the preferences of individual members of society and more at the incentive structures that exist around public officials" (p. 428).

The ensuing discussion of government inefficiency is good. The authors note that government officials have an incentive to provide visible benefits, while hiding the costs or spreading them widely. More concrete discussion of actual cases, however, would have made this section more beneficial to the student.

Case and Fair introduce the concept of "rent-seeking." They state that, "Some have argued that favorable legislation is, in effect, for sale in the marketplace" (p. 429). This idea is good as far as it goes, but the authors don’t explain why interest groups are often able to buy the favorable laws they want.

Criterion 7: The Role of the Entrepreneur

Entrepreneurship is almost ignored in the book. It is defined and briefly discussed on p. 73, but hardly ever comes up again. There are no features on successful entrepreneurs and no discussion on the link between risk and reward. The authors do ask whether there is an entrepreneurial spirit in the formerly communist nations in Eastern Europe, but do not consider how it is stifled by onerous taxes and regulations—in Eastern Europe or anywhere else.

Criterion 8: Taxation

The book’s chapter on taxation devotes several pages to the different kinds of taxes, their classification, and the normative issues of tax equity and "the best" tax base. After that, they come to the analytical issue of tax incidence and they correctly conclude that, with regard to payroll taxes, "Most of the payroll tax in the United States is probably borne by workers"(p. 474). This is a sound conclusion. The authors also consider the incidence of the corporate income tax and write, "Because it is levied on an institution, the corporate profit tax is indirect, and therefore it is always shifted. . . . It is difficult to argue that a tax is a good tax if we can’t be sure who ultimately winds up paying it" (p. 476). Students benefit from this kind of analysis.

Where the book is weak is on the costs of tax enforcement, compliance, and the opportunity costs of transferring resources from the private sector to the government. Contemplating those points is part of good economic thinking.

Criterion 9: The Business Cycle

Students looking for an explanation of what causes business cycles will find this book frustrating. Whereas many texts present the main contending theories in one section, this one scatters them in different places. Moreover, it never gets to the crucial question: Is the market inherently unstable, prone to recurring cycles that only government action can deal with, or is the market stable if left alone, and only thrown into cycles because of poor government policy? They omit the big debate over Say’s Law, even though it is an important topic in the economics profession.

Students learn the controversial Keynesian aggregate demand-aggregate supply model, along with the Keynesian policy prescriptions. However, little critical analysis follows. The authors do discuss the shape of the aggregate supply curve in a number of places in the text and in ways that raise questions about Keynesian assumptions, but much more could have been done to inform the student of recent critiques of Keynes. For decades, some economists have been asking whether "the multiplier" really multiplies at all and whether government spending ever really "stimulates" the economy, but the student is given the Keynesian approach almost straight up as if it were gospel.

In discussing Monetarism, the authors fail to point out what many economists believe, namely, that bad monetary policy during the 1920s was a cause of the Depression. They also fail to describe the history of the Depression to show the many policy errors (huge tax increases, increases in tariffs, attempts to keep wages and prices from falling, among others) that deepened and prolonged it. Students never read arguments against government activism.

Case and Fair include a discussion of the Marxist theory of the business cycle, but say nothing about the Austrian theory.

Criterion 10: Wages, Unions, and Unemployment

The authors provide a good analysis of what determines wages in the market; unfortunately they do not make explicit the link between productivity and compensation.

On the policy issues relating to labor markets, the book tends to be one-sided. The occupational segregation hypothesis is presented as the explanation for the lower average earnings of women, but there is much debate over this question. Many prominent economists argue that rational decisions married women make with regard to family responsibilities better explain lower average earnings for women. Nonetheless, the authors write, "Those in positions of power (often white men) have both the incentive and the ability to maintain discriminatory practices over long periods of time" (p. 503). This idea has also been subjected to considerable attack by economists who argue that irrational discrimination tends to be rare because it is harmful to people and institutions that practice it. The student, however, is given the impression that it is a settled question.

The minimum wage dispute is marred by the uncritical acceptance of recent studies purporting to show that increasing the minimum wage has "virtually no effect at all on unemployment." The Card/Krueger studies cited by the authors support no such broad conclusion, and many economists have criticized them as methodologically unsound.

The book has several pages on the history of labor unions, including their decline, which the authors suggest is mainly a result of increasing competition. The authors understand that unions operate as monopolies of labor, although they fail to make the point that those who organize and run unions are just as self-interested as are business monopolists. They tell the student that unions can cause higher unemployment and reduce productive efficiency.

The authors’ discussion of the causes of unemployment is good, but they do not go into an analysis of the true economic effects of various government programs to deal with unemployment.

Criterion 11: Trade and Tariffs

Case and Fair capably explain the reasons for trade and how it follows the law of comparative advantage. Their only shortcoming is that they fall into the common pattern of discussing international trade in nationalistic terms. Students should understand that nations do not specialize and trade, people do.

The authors clearly explain the effects of tariffs and quotas. Unfortunately, the presentation too often looks to government programs to solve problems. Why not leave the investment decisions to entrepreneurs, who stand to lose their own money if they are wrong? Students should think about this key point. There is little evidence to suggest that politicians spending other people’s money are smarter at picking winners and losers than are private entrepreneurs.

Finally, the authors endorse too readily the argument that "dumping" and other "unfair trade practices" must be met with government policies. Many economists believe predatory pricing is an overblown worry, both domestically and internationally, and that if we establish laws against it, many domestic producers will try to use those laws to stifle competitors. Unfortunately, the student is not encouraged to think about such unintended consequences of laws.

Criterion 12: Money and Banking

The book capably shows the functions of money, but it fails to connect its origins to the marketplace. Little is said about the advantages and disadvantages of commodity money versus fiat money. There is a brief discussion of the gold standard in an appendix, but it understates the benefits of the gold standard (that it facilitated international trade and imposed monetary discipline on governments) and overstates its problems.

The historical development of banking is covered well, as is modern banking and regulation. However, there is a serious omission: Very little is said about federal deposit insurance, so important in the savings and loan crisis.

The Federal Reserve System is given almost no historical treatment. Why was it begun? How well has it done its job? The authors avoid these questions and concentrate instead on the functions of the Fed, which are clearly explained. What the student needs here is at least a hint of skepticism. Some economists, for example, have argued strongly that a governmental agency should not be a "lender of last resort." But Case and Fair make it sound as if it were incontestably good that the Fed can bail out troubled banks. The fact that the U.S. has suffered a Great Depression, at least nine recessions and a vastly depreciated currency since the Fed was created should at least raise a question.

On the subject of inflation, the authors may confuse the student. At one point, they present the very dubious idea of "cost-push" inflation; later they state the sound and proven principle that sustained inflation is a purely monetary phenomenon.