I just finished Bryan Caplan's The Myth of the Rational Voter. It was excellent, and I will review it when I get around to it. It uses the abysmal understanding of economics of the average American -- even on a non-quantitative, intuitive level -- to illustrate why voters choose bad policies. Anyway, the side issue of the poor economics understanding still exists, so I thought I would post these two economics lessons that I stumbled on the last couple days.

Lesson #1 is a video of Milton Friedman explaining the myriad things that go into the making of the common #2 pencil.

The explanation is based on the essay I, Pencil by Leonard Read where he explains in even greater detail the things that have to happen for a pencil to be created.

The point is that no one individual knows all the details of the pencils construction, particularly the details how much of what materials are necessary at what times. This information is possessed only in aggregate. Further the only effective means of exchange of this information is through the price system.

Don't believe me? Well, let us assume that there is a single individual who does understand the process of pencil manufacture in all its details. This overlord is placed in control of the manufacture of pencils in a country to make sure that there are always enough. Now imagine that some event -- such as the SATs -- comes along that increases the demand for pencils say 20% in a given month.

In order for the overlord to do his job he must communicate this 20% increase in demand for pencils to all levels of production, not just the manufacturer of pencils who assembles all the parts. Metal miners must be told to get more aluminum ore; smelters and foundries must be told to change that ore into sheet metal. More rubber trees must be grown and turned into erasers. More wood must be harvested as well as graphite. (I actually don't know how they make graphite.) All of these processes require tools and manpower, all of which may have to be acquired in greater amounts. Further, changes in shipping must be taken into account.

Considering the sheer volume of messages that must be sent, it is not surprising that an overlord system is not an effective system for regulating production of pencils or any other product. Instead, we use the price system. When the pencil demand increases, the manufacturer buys more raw materials, uses more shipping, and purchases more tools. This increase in demand raises the price, causing the market to be more attractive for these goods. The greater attractiveness attracts more people to provide these goods, either the existing producers or new ones.

Prices provide information content.

I recommend reading the essay. It is really good. (Hat-tip: Cafe Hayek)

Lesson #2 is from Megan McArdle. I just love this quote:

Repeat after me: a community gets wealthier by making itself more productive. It does not get wealthier by making sure that more of what it consumes is produced locally.

Matt Yglesias and I cannot enrich the Atlantic community by giving up blogging in favor of hand crafting cunning little decorative objets out of gingham and rickrack and selling them to our officemates. Though Matt is a hell of a fine seamstress, and I myself am widely sought after for my exquisite color sense, we can produce our new line of country-inspired home collectibles only if we write less. Though it is true we would have created two jobs right here in the Watergate, not to mention a large number of ribbon-encrusted dust collectors, we would have lost two associate editor jobs. And people are willing to give us a lot more for our writing than for Matt's new line of Little House on the Prairie themed crocheted beer cozies .

Similarly, a bike path is good for the economy to the extent that it makes people more productive. It is not good for the economy because it produces local jobs maintaining the bike path, selling bicycles, or repairing the inevitable physical consequences of bicycle-car collisions.

For more information, read the essay That Which is Seen, and That Which is Not Seen by Frederic Bastiat, particularly the parable of the broken window. Moving production around does not actually increase it. It amazes me how often people forget that in economic debates.