Five economic terms we should all be using
Every year, the Edge Foundation asks a bunch of scientists one interesting question. This year’s question was “What scientific term or concept ought to be more widely known?” The hundreds of answers are varied and fascinating, but I found myself wishing that a similar survey existed for economics. There are plenty of econ terms regular people would find not only very interesting, but useful for thinking about policy. Sadly, the most commonly used econ words tend to be the ones with the vaguest meanings -- “rational,” “equilibrium” and “efficient.” Instead, here are some of my suggestions:
Everyone knows that correlation doesn’t equal causation, but somehow people seem to forget. Endogeneity is a word that can help you remember. Something is endogenous when you don’t know whether it’s a cause or an effect (or both). For example, lots of people note that people who go to college tend to make more money. But how much of this is because college boosts earning power, and how much is because smarter, harder-working, better-connected people tend to go to college in the first place? It’s endogenous. The media is full of stories about how which kind of people stay married, or what diet is associated with better health. Whenever you see these stories, you should ask “What about endogeneity?”
• Marginal versus average
Economists like to say “on the margin.” This refers to small changes instead of big overall effects. For example, people debate whether the finance industry is too large. Defenders of finance may say that the industry creates a lot of value, while detractors may say it could shrink without hurting the economy. Both could be true. Finance might create value on average, but be wasteful on the margin. Another example is the importance of effort versus natural talent. Natural talent might matter a lot on average, but a little more effort could go a long way.
• Present value and discounting
Things that we will get in the future have value today. Stocks, bonds and other financial assets are the obvious cases, but there are many more. For example, working at Alphabet Inc. (Google) might not pay more than other companies, but the knowledge, skills and resume burnishing that you get from the job could lead to higher earnings down the line. Present value means trying to figure out how much some long-term thing is worth today. To find present value, you have to use discounting, which means you have to decide how much less you value things that come far in the future. The more you want things right now, the higher your discount rate is, and the lower the present value of things like college degrees or business investments that take a long time to pay off.
• Conditional versus unconditional
On any given day, the likelihood of rain is low. But if there are dark clouds in the sky, the probability is higher. So economists say that while the unconditional probability of rain is low, it becomes conditional on seeing dark clouds -- and is much more likely. One common example of this is life expectancy. People like to point out that life expectancy in the Middle Ages was only about 35. But that includes lots of infant mortality. If you lived in the Middle Ages and you made it to adulthood, you would probably live well past 35. While conditional life expectancy has increased since then, it hasn’t gone up by nearly as much as the unconditional version -- reductions in infant mortality have been the biggest difference.
Something that’s possible for one person often isn’t possible for everyone. For example, the country can only employ so many doctors. So while it might be a good career move for a person to become a doctor, it doesn’t work for everyone. Economists say that something that works individually doesn’t work in aggregate. Another good example is debt. Individually, borrowing and spending money reduces your wealth. But in aggregate, debt doesn’t reduce the value of the whole world’s wealth, since one person’s debt is another person’s asset. When we consider our own lives, it makes sense to think from an individual perspective, but when we discuss government policy, it’s important to think in the aggregate.
So there are five econ terms I think should enter our everyday vocabulary. As long as this doesn’t happen endogenously, the marginal increase in the aggregate present discounted value of our public discourse would have a high conditional probability of being positive!
OK, so we shouldn’t use all the terms at once. But still, they might be very useful.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.