More Basics of Economics with Paul Samuelson

Paul Solman: On Tuesday, we posted the first transcript from a series of interviews I’ve done with Paul Samuelson over the years. This installment picks up where the last left off, explaining the most basic ideas of economics — scarcity, trade-offs and opportunity cost — as only Paul Samuelson could. In today’s excerpt, Samuelson finishes up on opportunity cost and cost-benefit analysis (the heart of economic thinking) and also covers both diminishing and increasing returns to scale.

Any economics teacher should read these transcripts, which I’ve tidied up for use in the classroom. If you know economics teachers, please alert them. And if you simply want to understand the fundamentals of economics yourself — simply, without a number in sight — read on. Paul Samuelson was a marvel of clarity. The more I read these over, the more I realize the fact. Read the transcript:

SOLMAN: One of the things economists do, when making decisions about trade-offs, is to put a monetary value on things most of us don’t normally price. Is that at all useful, or is that a waste of time?

SAMUELSON: Actually, in my advanced high falutin’ frontier economics, I often work with what I define as money metric utility, and I ask people: ‘Do you really want that? What are you willing to pay for that?’ There was the famous oil spill on the West Coast. A number of the economists here at MIT were hired on both sides of the litigation to try to put a money cost of how much money they would be willing to forego to have the clean water in the British Columbia bays, and that’s some measure of the damage done. Now, you can’t put a dollar value, a franc value, on many of the finest things in life, but where the calculus of economics can apply, it can be very useful.

SOLMAN: So, for example, there was this famous case in the late ’70s of the Ford Pinto, and it turned out that National Highway Traffic Safety Administration had a little calculation, that Ford Motor Co. adopted for where to put its gas tanks, and in there was the value of a human life.

SAMUELSON: Yeah.

SOLMAN: And many people said, this is preposterous, this is an outrage. Was it an outrage?

SAMUELSON: Well, it could have been. There were private airplanes known to have a defect in them, but they were not called back from the market because they figured, we’ll just pay damages, in court, in one case out of 100 that’s going to result from this. Now, I don’t think you can leave that to private interests of corporate managers.

SOLMAN: No, surely not, but don’t we have to, in calculations, even put a value on human life?

SAMUELSON: Yes.

SOLMAN: Money metric.

SAMUELSON: Yes, we do, and, for example, the Hudson River, which flows through heavily populated areas, is quite polluted, and good environmental calculation will say it’s worth devoting our scarce resources to make it better. But if somebody said, it’s got to be a 99.99 percent pure, you couldn’t do that for all the national income of the country. Those last little impurities are extremely costly, so there has to be a cost benefit calculation made, not by people in the industry, not by the greatest enthusiasts about environment, but in a democracy — rule of reason — by a jury of human beings.

SOLMAN: Do you do that in your own life? Do you say to me, how much is it worth for me to go to that concert, say, or to not read the newspaper this morning?

SAMUELSON: Yes, yes. For example, before we had children, we went often to the movies. When it turned out you had to have a babysitter, you had to make elaborate preparations, so going to what was then a $5 movie was actually a $45 cost. That didn’t mean we gave up movies, but we went once every ten days [LAUGHTER] to a movie and not once every three days. So of course I’m making that calculation, and so does the professor of French down the hall here. It isn’t just that economists do that. That’s the human condition.

SOLMAN: And do you put a price on things that are less obvious than that? Do you put a price on, for example, having kids initially? I mean, did you think about it that way?

SAMUELSON: When I was a kid, I reckoned things in Hershey bars. Is this worth three Hershey bars to me? Then I grew up and I began to reckon things in martinis [LAUGHTER], but I was reckoning it in terms of the price of a martini. And now I reckon it in terms of the annual cost of comfortable living that is compatible with my means, as best I can foresee them for the rest of my life.

SOLMAN: So what was something that was worth three Hershey bars, when you were a kid?

SAMUELSON: Well, sometimes two Baby Ruths [LAUGHTER].

SOLMAN: No, but an activity.

SAMUELSON: Actually, going to the movies. I could to the movies on Saturday for ten cents, but I didn’t go on Wednesday evening. When I reckoned it up with Hershey bars, it came a time when I changed that decision. But I had to have some notion of what I was using up, the money I was using up was really the foregone opportunities, and that’s where we came in in this discussion [which began in the post on Tuesday, Dec. 15.

SAMUELSON: The Malthusian Theory, that mankind, for biological and sociological reasons, is so fertile, so fecund, that if you started out with the new continent and plenty of land for everybody, in several generations we would multiply our numbers. And a ten-fold increase in density of population, in an agricultural community, will not leave intact the amount of harvest per person. The law of diminishing returns will apply. Now I don’t agree with his 18th century view that you can’t do anything about it, but it’s the most dramatic example, and it’s economics I’m talking about. Charles Darwin got his theory, his notion of natural selection, evolution, and so did its independent discoverer, Alfred Wallace, from reading Malthus. They realized there was a struggle for existence, a potential scarcity down the road if, in an unbridled way, all the rabbits were allowed to reproduce, all the humans were allowed to reproduce, and stuff like that.

SOLMAN: What’s a more mundane example?

SAMUELSON: Well, adding salt to the soup. The first amount, people will go to war for, they’ll die for. You go beyond a certain point, and you’ve got arteriosclerosis and stroke [LAUGHTER] down the road. Everything in moderation, because you don’t have a continuation at constant returns to scale in life.

Diminishing returns has its opposite. You can’t build an atomic bomb with a little pinch of uranium. You have to develop a critical mass. An example I give of the opposite of diminishing returns is that in the Queen’s Navy, you were allowed a grog of rum a day, but you couldn’t save it up. You had to drink it in the presence of the bosun’s mate, because you wanted to save it up to get a good drunk. That’s increasing returns. And most things, at a very small scale, are subject to increasing returns. But beyond a certain point, they turn the other way, and diminishing returns is a very important part of life.

SOLMAN: And in your own life, diminishing returns?

SAMUELSON: Well, I’m working on a hard research problem. I work harder and harder at it. It actually becomes self-destructive. It would be better to have a fresh mind, work for three hours on it, put it away, let your fresh mind unconsciously be turning it over. The mathematician who says, ‘I can’t afford to take time to take a vacation’ is foolish.

SOLMAN: Because there are diminishing returns to the extra hours of effort.

SAMUELSON: Right.