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Book - Price Theory Price Theory
An Intermediate Text
by David D. Friedman

Forward reprinted by permission of David D. Friedman
©1986, 1990 David D. Friedman


Modern economics is above all a way of thinking about social behavior. When a person decides to engage in any activity, the economist instinctively looks for benefits to that person that exceed his costs; conversely, if he decides not to engage in an activity, the economist looks for costs that exceed the benefits. Moreover, if two persons voluntarily engage in a transaction or trade, the economist looks for gains to both participants, not gains to one and losses to the other.

Recent decades have seen growing confidence that this economic way of thinking provides important insights into human behavior under quite different economic systems and institutions. It has been used to help understand primitive societies studied by anthropologists as well as advanced economies of the modern day; capitalist countries like the United States as well as transactions in organized markets, like the stock market; decisions to engage in crime as well as decisions to study economics; and decisions by college graduates with high IQ’s as well as decisions by illiterates with low IQ’s.

Although the range of behavior analyzed with the economic way of thinking has been greatly extended during the past several decades, textbooks on economic principals generally have taken a much narrower view of the scope of economics. This is not surprising since recent developments in a scientific field usually do not find their way into textbooks for many years. Fortunately, several economics texts in recent years have begun to take a broader view, and this text by David Friedman does so in the most thoroughgoing and satisfactory manner of any that I have seen. Every chapter shows evidence of a skilled and imaginative economist applying his tools to the world around him. Perhaps I can whet the reader’s appetite for the book with a few examples culled from different chapters.

Travelers have long recognized that homes in cities like Chicago, even though Los Angeles has a milder winter climate than Chicago does. Chapter 21 explains this by showing why indoor temperature can be raised more cheaply in Chicago than in Los Angeles, notwithstanding the lower outdoor temperatures in Chicago. The reason is that home owners in Chicago invest in much better insulation, more powerful and more efficient heating units, and so forth. Given these investments, it is cheaper to raise indoor temperatures there than in Los Angeles.

Plea bargaining occurs when prosecutors agree to lighter sentences in return for guilty pleas by defendants. Plea bargaining has been frequently criticized for permitting guilty criminals to escape with excessively light sentences, but Friedman shows in Chapter 19 that the system of plea bargaining indirectly may raise the punishments to defendants who bargain! Plea bargaining avoids costly trials for some defendants and thereby enables prosecutors to spend more of their limited budgets on trials of defendants without plea bargains. By spending more on each trial, the prosecutor raises the likelihood of getting a conviction with a stiffer sentence.

The crucial point is that these stiffer sentences also raise the sentences of defendants who plea bargain. Prosecutors can now refuse to plea bargain unless a defendant accepts a relatively stiff sentence because defendants who refuse to bargain can expect a stiffer sentence. This is a good example of the so-called “Prisoner’s Dilemma,” or of the conflict between individual and group incentives. By bargaining alone, defendants are forced to accept less favorable terms than they could extract by bargaining together.
Since radio and television programs are costly to produce but are “free” to viewers, each station must find indirect ways to cover the cost of producing programs. The most common way is to advertise products of companies that pay for commercials. A less common way, mainly used by “educational” radio and television, is to ask viewers for contributions. However, efforts to raise contributions encounter the same conflict between individual and group incentives found in plea bargaining. Viewers could get better programming by contributing together, but each one separately has an incentive to view without contributing.

Religious programming can provide proper incentives by claiming that contributions to support a religion or preacher improve the standing of the contributor with his God. Therefore, each viewer cannot free-ride by shifting the burden of support to others because he then fails in his duty to God, who is aware of the behavior of everyone. Friedman advances this argument to explain why religious preaching on radio appears to be more common than religious preaching through written media.

As a final example, consider tariffs, quotas, and other protection against imports. Almost 200 years ago, Alexander Hamilton argued that “infant” industries in the United States should be protected by tariffs so that the growth of these industries would not be stifled by competition from imports. Yet the evidence is clear that import protection is mainly given not to growing infant industries but to what Friedman calls “senile” industries, like steel and shoes (see Chapter 18). He shows how competition for political influence among special interest groups provides political support for tariffs and other restrictions that mainly benefit old declining industries. This is an excellent example of how the economic way of thinking is used to explain political behavior.

Economic theory is a powerful engine that permits a more rapid and deeper application of the economic way of thinking to behavior. Concepts like utility, cost, production functions, investment, equilibrium, and strategic behavior are useful in building this engine. Since the economic way of thinking is quite foreign to ordinary ways of thinking about behavior, command of economic theory requires dedication and systematic study to master its logic and structure. These are developed in the first 15 chapters of this text, although applications are also liberally sprinkled throughout these chapters. Friedman relies on geometry and is sufficiently rigorous and also considers various weaknesses as well as strengths of economic theory.

I highly recommend this text to students and others with curiosity about our economic and social world. David Friedman obviously enjoys his work, for his enthusiasm is manifest on practically every page. You may find his enthusiasm contagious and also have fun as you use your new way of thinking to understand, and perhaps improve, the world around you.

Gary S. Becker
University Professor of Economics and Sociology
University of Chicago