Excerpts From the Book

The following excerpts highlight some of the key points covered by the book…

From the preface

After 30 years of teaching college economics, the authors are painfully aware of two points: (1) students often miss important points because they are too busy with extraneous graphs and formulas, and 2) they do not remember nearly enough of what is taught in their college economics courses. The information in this book will challenge college students to think more seriously about the really important implications of economics—knowledge that will make a difference long after one’s final exam is a faded memory.


All of economics rests on one simple principle: that incentives matter. Altering incentives, the costs and benefits of making specific decisions, alters people’s behavior. Understanding incentives is an extremely powerful tool for understanding why people do the things they do, because the impact of incentives can be seen on almost every level, from simple family decision making to securities markets and international trade.

Gains from trade

The foundation of trade is mutual gain. People agree to an exchange because they expect it to improve their well-being. The motivation for trade is summed up in the statement, “If you do something good for me, I will do something good for you.” Trade is productive because it permits each of the trading partners to get more of what he or she wants.

Profits and losses

Profit is a reward for transforming resources into something of greater value. In contrast, losses are a penalty imposed on businesses that use up resources without converting them into something more valuable. The losses indicate that the resources would have been better used producing other things.

Source of income

People earn income by helping others. People who earn large incomes do so because they provide others with lots of things that they value. If these individuals did not provide valuable goods or services, they would not be paid so generously. There is a moral here: If you want to earn a large income, you had better figure out how to help others a great deal. The converse is also true. If you are unable and unwilling to help others very much, your income will be small. This direct link between helping others and receiving income gives each of us a strong incentive to acquire skills and develop talents so we can provide others with valuable goods and services.

The invisible hand

Have you ever thought about why the supermarkets in your community have approximately the right amount of milk, bread, vegetables, and other goods – an amount large enough that the goods are nearly always available but not so large that a lot gets spoiled or wasted? How is it that refrigerators, automobiles, and CD players, produced at diverse places around the world, are available in your local market in about the quantity that consumers desire? The invisible hand of market prices provides the answer. It directs self-interested individuals into cooperative action and brings their choices into line with each other.

Why nations prosper

Capital investment and new technology clearly contribute to growth, but they do not take place in a vacuum. Countries must have certain characteristics that allow their people to interact productively with one another. Sound institutions B the legal rules and customs, both formal and informal, that guide behavior B and sound government policies are the central elements of the growth process.

Private ownership and economic progress

other business firm from raising prices, selling shoddy products, and providing lousy service? Competition provides the answer. If McDonald’s fails to provide a tasty sandwich at an attractive price delivered with a smile, people will turn to Burger King, Wendy’s, Subway, Dairy Queen, and other rivals. Competition harnesses personal self-interest and puts it to work elevating our standard of living.

The role of competition

Competition places pressure on producers to operate efficiently and cater to the preferences of customers. What keeps McDonald’s, General Motors or any other business firm from raising prices, selling shoddy products, and providing lousy service? Competition is the answer. Competition gives firms a strong incentive to develop better products and discover lower-cost methods of production.

Monetary stability

The productive contribution of money is directly related to the stability of its value. In this respect, money is to an economy what language is to communication. Without words that have clearly defined meanings to both the speaker and listener, communication is impossible. So it is with money. If money does not have a stable and predictable value, it will be difficult for borrowers and lenders to find mutually agreeable terms for a loan; saving and investing will involve additional risks; and time-dimension transactions (such as payment for a house or automobile over time) will be fraught with prices and the most value from their expenditures. Similarly, domestic producers can sell their goods and services wherever they can get the highest prices for the value they produce. As a result, consumers get more for their money, and resource owners produce more goods and services that people value. It is this expansion in production and consumption, not just jobs, that underlies higher income levels and living standards.

Trade, jobs, and income levels

Non-economists often argue that import restrictions can create jobs. When analyzing this view, it is important to keep in mind that it is production that really matters, not jobs. If jobs were the key to high incomes, we could easily create as many as we wanted. All of us could work one day digging holes and the next day filling them up. We would all be employed, but we would also be exceedingly poor because such jobs would not generate goods and services that people value.

If we are going to achieve higher living standards, we must expand the availability of goods and services that people value. Trade helps us do so. When residents are permitted to trade with whomever they want, domestic consumers can find the lowest Economics has a great deal to say about the operation of government—about how it really works, why the results will often be disappointing, and what might be done to improve its effectiveness. As it applies to government, economics replaces naive romanticism with realistic expectations. The latter may not be as much fun, but will lead to more understanding and less disappointment.

Government and economic progress

A government can promote social cooperation and enhance economic welfare primarily in two ways: (a) providing people with protection for their lives, liberties, and properties (as long as the properties and liberties were acquired without force, fraud, or theft) and (b) supplying a few select goods that have unusual characteristics that make them difficult to provide through markets.

The ordinary investor and stocks

Do not allow a lack of time and expertise to keep you out of equity investments. You do not have to do a lot of research or be a “super stock picker” in order to be highly successful as an investor. The stock market has historically yielded higher returns than other major investment categories, and index funds publications have appeared in both professional journals and popular media such as the Wall Street Journal and the New York Times. His Ph.D. in economics is from the University of Washington. A member of the Mont Pelerin Society, Gwartney was invited by Russia’s Putin administration in March 2000 to make presentations and have discussions with leading Russian economists about the future of the Russian economy. In 2004, he received the Adam Smith Award of the Association of Private Enterprise Education.

Economics and the operation of government

well-organized interest groups with favors in exchange for political support—are seriously disadvantaged. Given the current rules, politicians are led as if by an invisible hand to reflect the views of special-interest groups, even though this often leads to wasteful policies. The bottom line is clear: Representative government based solely on majority rule does not handle special interest issues well.

Voting and the political process

When voters pay in proportion to the benefits received, all voters will lose if the government action is unproductive, and all will gain if it is productive. Therefore, when the benefits and costs of voters are directly related, large majorities will oppose unproductive projects and favor productive ones.

In the age of media politics, politicians are under strong pressure to support special interests, tap them for campaign funds, and use the contributions to project a positive candidate image on television. Politicians unwilling to play this game—those unwilling to use the government treasury to provide government that acts as a neutral force, protecting property rights and enforcing contracts, can best achieve this objective.

Subsidies, transfers, and wealth creation

There are two ways individuals can acquire wealth: production and plunder. People can get ahead by producing goods or services and exchanging them for income. This method of acquiring income helps the exchanging partners and enhances the wealth of society. But sometimes the rules also allow people to get ahead by “plundering” what others have produced. This method not only fails to generate additional income—the gain of one is a loss to another—but it also consumes resources and thereby reduces the wealth of the society. Governments promote economic prosperity when they encourage productive activity and discourage plunder. A government that acts as a neutral force, protecting property rights and enforcing contracts, can best achieve this objective.

Competition and government

If the functions of the central government are strictly limited to the protection of individual rights, prohibition against restraints of trade, and the provision of national defense, then state and local governments can vary widely in the degree to which they levy taxes for the provision of government services. Just as people differ over how much they want to spend on housing or automobiles, so too will they have different views concerning expenditures on public services.

Government and Prosperity

The intellectual folly of our age is the view that democratic elections alone will establish an environment conducive to economic progress. Both history and political theory indicate that this view is false. If government is going to be a positive force for economic prosperity, the rules of the political game must be designed to bring the self-interest of voters, politicians, and bureaucrats into harmony with economic progress. This will require that the scope of government be limited and that government remain neutral among the various sub-groups of citizens.

Choosing your work activity

Finding the occupational or business activity in which you have a comparative advantage and specializing in it will help you earn more money than otherwise, regardless of how good you are in absolute terms.

Like nations, individuals will be able to achieve higher income levels when they specialize—that is, concentrate their efforts on those things that they do best. No matter how talented you are, you will be relatively more productive in some areas than others. Similarly, no matter how poor your ability to produce things, you will still have a comparative advantage in something; you will be able to compete successfully in some things and can gain by specializing in your comparative advantage.

Economics and financial planning

If you do not take charge of your finances, they will take charge of you. We are not trying to make you a Wall Street wizard or an instant millionaire. The advice presented here deals with financial basics. The search for perfection is often the enemy of positive action. Many individuals do not believe that they have either the time or the expertise to develop a really sound financial plan. As a result, they do not even apply practical and relatively simple guidelines that can help them do reasonably well and to avoid financial disaster. This section will give you such guidelines. Embrace them.

Entrepreneurship and financial success

If you want to be financially successful, you need to think entrepreneurially. Put another way, you need to focus on how you can develop and use your talents and available resources to provide others with things that they value highly. Providing others with goods and services that are highly valued compared to their cost is the key to financial success.

Don’t finance things for longer than their useful life

What happens when you borrow money to purchase vacations, clothing, or other goods that are quickly consumed or that depreciate in value? What happens when you take out a 48-month loan in order to purchase a used automobile that will be worn out in two years? The answer to both questions is the same: You will soon be making payments on things that have little or no value to you or anyone else. These payments will lead to bitterness and financial insecurity.

Use of credit cards

While credit cards are convenient to use, they are also both seductive and a costly method of borrowing. Because credit cards make it easy to run up debt, they are potentially dangerous. Some people seem unable to control the impulse to spend when there is an unused balance on their cards. If you have this problem you need to take immediate action! You need to get your hands on a pair of scissors and cut up all of your credit cards. If you do not, they will lead to financial misfortune.

Compound interest and the cost of smoking

Consider the lifetime cost of smoking. In addition to the health factor, there is a financial reason for not smoking. The price of cigarettes is around $3.75 a pack in most states, so if our teenager, call him Roger, decides against smoking he will save $1,370 a year (assuming he would have smoked a pack a day). Suppose that instead of spending this amount on something else, Roger invests it in a mutual fund that provides an annual return of 7 percent a year in real terms—that is, after accounting for inflation. ( If Roger keeps this up until he retires at age 67 he will have $597,301 from direct contributions of only $69,870. Thus, by choosing not to smoke, Roger accumulates almost $600,000 in retirement benefits—and this figure is in dollars with today’s purchasing power!

Do not put all of your eggs in one basket

The risks of stock market investments are substantially reduced if one either continually adds to or holds a diverse portfolio of stocks over a lengthy period of time, say 30 or 35 years. Even a small investor can choose this option through an equity mutual fund, a corporation that buys and holds shares of stock in many firms. When a diverse set of stocks has been held for a long time, they have yielded a high rate of return, and the variation in that return has been relatively small.