As promised in Chapter 1, this first part of the book contains chapters outlining how economic ideas have directly made money for firms, by enhancing revenues, cutting costs, facilitating innovation, or some combination of all three. In some cases, the entrepreneurs or businesses that implemented these ideas were acutely aware of them and their origins, and so the line between idea and outcome is easy to grasp. In other cases, businesses used an economic idea without knowing it, and economists later validated it, theorized about it, or quantified its impact. In a few cases, economists and businesses pursued their ideas in parallel, each seemingly unaware of the ideas or efforts of the other, though I suspect this may change over time (maybe some from each camp will read this book and make this prediction come true). All routes to business success are broadly consistent with the overall thesis of this book and with the quote from Keynes about the power of defunct (and not-so-defunct) economists and their ideas.
Chapter 3 begins with a discussion of how economic ideas have influenced how firms set prices. To be sure, in highly competitive markets, firms are price-takers: They take what the market dictates. But in a surprising number of situations, markets take a while to settle down and, especially in new markets or circumstances, economists have offered useful advice about how those markets should be created and prices set.
Chapter 4 turns to the other side of the coin: minimizing costs. Here, too, business can figure out how to cut costs to the bone without the help of an economist. But in many kinds of businesses where things must be moved around (like planes or trucks) or supplies, materials, and inventory must be managed, minimizing costs becomes a lot more difficult to do without the aid of some formal techniques. Indeed, an entire field of study, known as operations research, grew out of the work of mathematical economists. You’ll meet the founders and the work they spawned in this chapter.
Chapter 5 addresses a seemingly technical subject, empirical economics, which leads in surprising directions. Economists test their propositions through the use of increasingly sophisticated statistical techniques, so in one sense economics is part applied statistics, part theory. After providing a brief history of how the uses of these techniques in the business world has changed over time, I introduce a surprise: the extension of similar techniques into sports. That’s right, sports. With the publication of Moneyball, the same kinds of techniques economists have long used to test their hypotheses and to generate forecasts of economic variables have been applied by a new generation of quants to the performance of certain athletes and teams, and thus indirectly to the financial performance of their owners. In “Beyond Moneyball” I only scratch the surface in discussing how what started as a hobby in the garage of baseball guru Bill James has now spread to multiple sports, while creating a new academic specialty to boot (couldn’t resist the pun).
Chapter 6 discusses the one exceptional pattern in this part, the parallel interests in experimentation in the worlds of economics and business. Of the two fields, experiments are newer and more unconventional among economists, who traditionally either theorized about the working of the economy or its constituent components (in increasingly sophisticated mathematical terms), or used the statistical techniques profiled in Chapter 5 to test their theories. It is hard to stop the real world, apply a treatment to one population, and compare what happens to a control group, as medical researchers commonly do. Nonetheless, you will learn in Chapter 6 that this is changing, and there is growing interest in and work among economists in using human subjects (students and businesspeople) to test theories. As for business, experiments have long had a place in this world: What else, after all, do most entrepreneurs and many established firms do except constantly experiment until they get things right so that people or other firms want to buy what they have to sell? With the rise of the Internet, running experiments has become far less costly, and the testing of the look and feel and the specific content of websites, among other things, has become routine.
Chapter 7 addresses a topic you won’t find (at least yet) in many textbooks: the economics of matchmaking. This is a relatively new branch of the field, and it addresses markets where non-price attributes are even more important than prices for allocating resources. Think about the job market, or the dating market, and you get the idea. The chapter outlines how economists have made important contributions to our understanding of these markets, and growing matchmaking businesses, facilitated by the Internet, have listened to them. I loved (again pun intended) working on this chapter and hope you have as much fun reading it.
In Chapter 8 I finally get around to the topic with which I opened the book, the world of finance and how it has been affected by the ideas of the economists (or financial economists, as they may prefer to call themselves). I know in the wake of the financial crisis the temptation of some (maybe many) readers is to ask: What good have economists been for finance; aren’t they partially to blame for the crisis? I will address that issue in the policy part of the book in Chapter 12. Chapter 8, however, outlines for you a number of important positive contributions of economists and their ideas to finance that have led to new financial products (think indexed mutual funds and exchange traded funds) or that have greatly facilitated the pricing of other products (think options, which have been a mixed blessing). For those inclined to think better of economists, the positive tone of Chapter 8 will not be a surprise: If economists can’t help those in the financial world, which is all about money, then how can they possibly be of use to firms in other industries? It turns out, if you are persuaded by Chapter 8, that economists needn’t worry about the answer to that question.
Before beginning the chapters in this part, some readers may be tempted to ask a different, but important question: If the economic ideas surveyed in this book are so good and valuable, why are economists even necessary to think them up? One answer, which economists trained in the University of Chicago’s Department of Economics would give, is that ordinary people are smart enough to figure out by themselves the good ideas they need to make money and they don’t need to consult economists to help them to do it. Firms and their customers know what’s in their best interest or act as if they know. That’s a good answer for a lot of ideas, but I also believe an incomplete one.
Not everyone who has no economic training, or who hasn’t read or hired someone with this background, came to every idea laid out in this part on their own, nor could they be expected to. That would be like saying that ordinary people, without training in science, could be expected to come up with all of the discoveries that scientists in all kinds of disciplines have made over the centuries. To believe this to be true reminds me of the old joke about what an economist, presumably one trained in free market economics at Chicago, said when he or she was told there was a $20 bill on the sidewalk: “No, that can’t be, because if it was there it already would have been picked up.”
But we all know there are plenty of $20 bills, some even larger than that, that are left on sidewalks all the time, just as there are ideas remaining to be discovered, or at least widely implemented, in both the physical and social sciences (and many economists think they are leaders of the pack among social scientists). You will find some of those ideas in the remaining chapters of this book, beginning with the chapters in this part.