One of the things I have said to my economics principles students for years is that economists don’t like the letter T. It has been a good way to reinforce an important idea to students, but this year, I am planning on flip-flopping a bit (in honor of the political season) and endorsing T in appropriate circumstances.
Economists’ dislike of the letter T is obvious when we remember that in economic analysis, T often stands for taxes. Between differences in subjective values and differences in opportunity costs of production, economists recognize that voluntary exchanges create wealth and that, therefore, anything that wipes out voluntary exchanges that would otherwise have been agreed to wipes out real wealth.
Higher Costs Imposed by Governments
To illustrate, say you value a widget at $5 of other goods and services and I value it at $3 (or it costs me $3 to make it as a producer). When we exchange, it increases wealth by the difference in our values (and each of us gain some of that wealth as long as it is voluntary). However, what if there was a tax of $2.50 imposed on such transactions? That tax wedge exceeds the potential gains to our exchange (and all others where the net gains are less than $2.50), and the exchange no longer take place, wiping out the wealth that would otherwise have been created.
To the extent that regulatory burdens act like taxes, economists extend their dislike of the letter T to the letter R.
This post was published at Ludwig von Mises Institute on Sept 15, 2016.