The key to thinking like an economist is to ask: Is it worth it? As compared to what?

Analyzing Economic Decisions in Two Questions

Steven Horwitz is Economics Editor at Lib​er​tar​i​an​ism​.org and Distinguished Professor of Free Enterprise at Ball State University. Horwitz has written extensively on Austrian economics, Hayekian political economy, monetary theory and history, and macroeconomics.

In 1946, the economic journalist Henry Hazlitt published a book entitled Economics in One Lesson where he took the idea that the good economist sees the long‐​run, and unintended, consequences of choices and demonstrated how that principle could be applied to all kinds of particular questions in economics. With due acknowledgement to Hazlitt, I want to suggest that another way to look at economics is through two questions that capture what is distinct about the “economic way of thinking.” We might call this perspective “Economics in Two Questions.”

Good economists are constantly asking “is it worth it?” and “as compared to what?” Those two questions, which are deeply intertwined, provide the analytic framework for applying the economic way of thinking to a whole range of topics.

The “is it worth it?” question is at the heart of marginal analysis. Economists argue that when contemplating a choice, the question is, or should be, always about the benefits and costs that come with that specific choice. Imagine a student deciding whether she should spend one more hour studying for a physics test. Asking the “is it worth it?” question means asking what are the benefits of one additional hour of studying physics versus the costs of doing so. It’s not a question about the total time spent studying physics, or whether taking physics was a good idea. Those decisions have already been made. All that matters now are the benefits and costs going forward. Those are what we call the marginal benefits and costs, as they are the ones that come with the specific margin of choice faced by the actor.

As I noted earlier, whether something is worth it is closely connected to the “as compared to what?” question. We see this when we explore the nature of cost. For our physics student, the marginal cost of spending one more hour studying physics is whatever she gives up to do so. Perhaps the next best use of her hour was studying for chemistry. Perhaps it was hanging out with friends. Maybe it was folding laundry. Economists consider cost to be the next best alternative that we gave up to make the choice we made. (Technically, it’s the “expected subjective value of achieving the end associated with that choice,” but “next best alternative given up” will work for our purposes.) This is what we call “opportunity cost.”

Notice how opportunity cost is inherently comparative, and that means that our first question (“is it worth it?”) is also inherently comparative. Asking if making a specific choice is “worth it” means asking whether the net marginal benefits it delivers are greater than the next best alternative. Is studying physics for another hour “worth it?” It depends on whether the net benefits are perceived to be greater than those from any of the alternatives the chooser faces.

Key to the economic way of thinking is considering costs. All choices involve sacrificing resources from other uses. Just because something is “good” and we derive benefits from it doesn’t mean we should continue to do that thing until the gross benefits equal zero. We always have to think in terms of net benefits by considering the cost in terms of alternatives. The marginal cost might be greater than the marginal benefits, in which case it’s a bad choice.

Thinking this way is what economists mean when we say we are searching for an “optimal” solution. We want to find out where the net benefits of all choices just equal zero such that no rearrangement of resources could produce a better outcome. Even with just one choice, we are interested in the point at which the marginal benefits just equal the marginal costs.

This is why we say provocative things, such as “the optimal quantity of pollution is not zero” or “the optimal quantity of deaths or building collapses in an earthquake is not zero.” Although putting things that way might not get us invited to the best parties, there is an important truth about those statements that reflects the two questions that frame the economic way of thinking.

We could, if we put enough resources into it, perhaps reduce the level of pollution to zero or earthquake‐​proof every building to prevent all damage and death. But would it be worth it? And as compared to what? Devoting resources to pollution reduction means sacrificing other ends that we might value. The same with shoring up buildings. For example, doing the latter might indeed save lives in an earthquake, but perhaps the resources could have been better used to work on a cure for cancer or create safer cars. Those options might well save more lives than are saved on the margin by devoting additional resources to earthquake prevention. And perhaps we value the output we would have to give up by devoting resources to pollution reduction more than we value the marginal reduction in pollution. Pollution reduction has costs in terms of resources and wants sacrificed, as does preventing earthquake damage and deaths.

When economists say things like “the optimal quantity of pollution is not zero,” it has to be understood in terms of the two questions. Economists are always thinking in terms of decision‐​making on the margin and opportunity cost. “Optimal” here does not mean “ideal.” We all would prefer a world in which pollution and earthquake damages and death were all zero, if we could get there costlessly. But since all of the choices involved in attempting to achieve that end involve costs, we have to ask if it’s worth it and what the relevant comparison is.

“Optimal” means “yes, the net benefits are positive and no other alternative provides greater net benefits.” The optimal quantity of pollution is that amount at which neither less pollution nor more pollution would provide greater net benefits. The same with the optimal quantity of earthquake protection (or damage and death, to look at it from the other end). To a non‐​economist it might sound off‐​putting on the surface, but it expresses an important insight about both economics and the human condition: nothing comes without a cost.

One final point worth considering is that although economics is very good at asking these questions, economists qua economists have no special insight on what the answers are in any specific case. In order for me to even make a guess at the optimal quantity of pollution, I would need to know what every other person’s judgment of the benefits and costs of pollution (reduction) were. The subjectivity of costs and benefits prevents any one person or group of people from knowing a priori what the optimal solution is. We can say pretty confidently it’s not zero in the case of pollution because we know there are technological choices out there that could reduce pollution but that we simply find to be too expensive (“not worth it”) in terms of the marginal benefits they would provide.

One could say the same about increasing the safety of cars and the belief that the optimal number of auto deaths is not zero. The fact that we allow people to drive at 70 miles per hour is alone evidence that we don’t believe that reducing car‐​related deaths to zero is worth the cost.

The expertise of economists lies not in being able to provide definitive answers to the two questions, but in constantly asking them as a way to get citizens to engage in process of figuring out what the answers might be. Serving as a forum to help answer those questions is the role of markets in a liberal society. It is one place where we bring our subjective judgments into play and contribute to creating prices, which serve as indicators of the prospective benefits and costs of various actions. Market prices give us a way, albeit an imperfect one, of gauging whether an action is “worth it” by comparing its benefits and costs to various alternatives.

Generally speaking, most economists would love for all of these kinds of questions to be answerable through markets. Inevitably, however, some questions can’t be answered effectively in markets and we turn to either politics or community norms to resolve them. An ideal political system would be one with institutions that let us express our preferences, and have them aggregated to find a solution all would consent to, as well as the market does. Whether real‐​world political systems live up to that ideal is a question worth pondering, but at least in principle a well‐​structured and decentralized political system can serve as another forum for answering those two questions in certain situations. The same is true of small enough communities who can develop agreed‐​upon norms to solve problems that markets struggle with.

Unpacking these last couple of points would be an essay (or book) of its own. What matters is that they are all possible ways of finding consensually acceptable answers to the two questions of economics, and that they illustrate that economic expertise lies in asking the questions, not answering them. Economists are no more knowledgeable about what would make everyone happy than are the people who populate our theories and models.

Hazlitt’s “one lesson” of seeing the long‐​run consequences of our choices remains salient, but thinking about economics in two questions provides a nice window on the nature of those choices and how we reconcile the differing and conflicting answers that individuals might offer in response. Asking “is it worth it?” and “as compared to what?” is central to how the economic way of thinking helps us frame issues of social policy in a manner that enables us to discover collectively the best ways of addressing them.