Naked Economics: Undressing the Dismal Science (Fully Revised and Updated)

One crucial role for government in a market economy is dealing with externalities—those cases in which individuals or firms engage in private behavior that has broader social consequences.

(Progressive taxes, such as the income tax, fall more heavily on the rich than the poor.)

Taxes that fall more heavily on the poor than the rich, so-called regressive taxes, often offend our sense of justice.

This phenomenon, whereby taxes make individuals worse off without making anyone else better off, is referred to as “deadweight loss.”

For example, both a gasoline tax and an income tax generate revenue. Yet they create profoundly different incentives. The income tax will discourage some people from working, which is a bad thing. The gasoline tax will discourage some people from driving, which can be a good thing. Indeed, “green taxes” collect revenue by taxing activities that are

Good policy uses incentives to channel behavior toward some desired outcome. Bad policy either ignores incentives, or fails to anticipate how rational individuals might change their behavior to avoid being penalized.

Kahneman and others have advanced the concept of “bounded rationality,” which suggests that most of us make decisions using intuition or rules of thumb, kind of like looking at the sky to determine if it will rain, rather than spending hours poring over weather forecasts.

The field of behavioral economics has evolved as a marriage between psychology and economics that offers sophisticated insight into how humans really make decisions.

Nike pays a typical worker in one of its Vietnamese factories roughly $600 a year. That is a pathetic amount of money. It also happens to be twice an average Vietnamese worker’s annual income.11 Indeed, sweatshops played an important role in the development of countries like South Korea and Taiwan,