We’ll get back on the regular Monday-Wednesday schedule next week.

Ask someone whether they would like more money and you will get a look. Obviously they would. So it sounds strange to hear economists talk about the “demand for money” as if it were an open question. It is an open question, just not the one you would think. Nobody is asking whether you want to be wealthy. They are asking what form you want your wealth to take, and how much of it you want sitting around in spendable form.

That distinction turns out to be the hinge the entire Federal Reserve swings on. So it is worth a minute.

Say you come into $2,000. You can leave it in checking, where you can spend it this afternoon, or you can move it somewhere that pays you: a CD, a Treasury, a savings account with a real yield. Money that pays you cannot be spent at the hardware store on Saturday without some hassle first. So the choice comes down to what you are giving up by keeping it spendable.

And that depends entirely on what the other option pays. If a one-year CD pays half a percent, keeping your $2,000 liquid costs you ten dollars a year. Most people happily pay ten dollars for the convenience. If the CD pays six percent, the same convenience now costs $120, and suddenly the trip to the bank is worth making.

There is the whole idea. The interest rate is the price of keeping money in your pocket. When that price is high, people economize on pocket money and move it into things that earn. When it is low, they do not bother. High rates, less cash floating around. Low rates, more.

The Fed controls that vertical line. If they shift it to the right, the interest rate will fall. If they shift it to the left, the interest rate will rise.

Note for my monetary friends: yes, I know. You don’t have to get at me about it.

How the Fed moves the line

Your bank does not keep your deposits in a drawer with your name on it. It lends most of them out and keeps a fraction on hand. That is fractional reserve banking, and it is why the bank pays you interest instead of charging you for a safe deposit box.

It also means that if every depositor turned up on the same morning wanting cash, the bank could not pay. One bank in that spot can usually borrow from others. If every bank is in that spot at once, there is nobody left to borrow from, and you have a banking panic. Preventing exactly that is why Congress created the Fed in 1913, built out of twelve regional Reserve Banks, to act as the lender of last resort: the one institution that can always lend when no one else will.

That same plumbing gives the Fed three ways to change how many dollars are circulating.

The reserve requirement is the minimum share of deposits a bank must keep rather than lend. Raise it and banks lend less, shrinking the money supply; lower it and they lend more. This is the tool every textbook opens with, so it is worth knowing that the Fed set it to zero in 2020 and has left it there, which means the real work now runs through the other two, plus the interest the Fed pays banks on the reserves they hold.

The discount rate is what the Fed charges banks to borrow from it directly. Cheaper borrowing, more lending, more money. Costlier borrowing, less.

Open market operations are the workhorse. To put more dollars in circulation, the Fed buys bonds from banks and pays with newly created money. To pull dollars out, it sells bonds. This is, quite literally, how new money enters the economy.

Three tools, one purpose: sliding that vertical line left or right.

Lower rates and Aggregate Demand

Say the Fed buys bonds. The money supply line slides right and crosses money demand at a lower interest rate. Two things follow, and they land on two different groups.

Households spend more. Back to your $2,000. At six percent you had it locked in a CD; at half a percent you pull it back out, because the reward for tying it up no longer covers the inconvenience. Multiply that across millions of households and consumption rises.

Businesses invest more. A contractor is eyeing a $400,000 excavator that would earn him about $30,000 a year. At nine percent, financing it costs $36,000 a year and the deal is dead on arrival. At five percent, it costs $20,000 and he buys the machine. Nothing about the excavator changed. Nothing about the demand for his services changed. The cost of money changed, and that alone moved a $400,000 decision.

Consumption and investment are two of the four pieces of Aggregate Demand (the other two, government spending and net exports, are their own posts). Push both up and AD shifts right. That is expansionary monetary policy.

Run the reel backward for the other direction. The Fed sells bonds, the money supply shrinks, the rate rises, households park money instead of spending it, the contractor walks away from the excavator, and AD shifts left. Contractionary policy.

Now look hard at Figure 2, because this is the part that gets waved past. When AD shifts right along an upward-sloping supply curve, you get more output and a higher price level. The output is the point of the exercise. The higher prices come along whether you wanted them or not.

Stretch the horizon and it gets sharper. Short-run supply slopes up because input prices, wages included, are locked in by contracts. Contracts expire. When they are renegotiated at the new, higher price level, short-run supply shifts back, and the economy settles at roughly the output it started from, now with permanently higher prices. In the short run, cheap money buys output. Given enough time, it buys prices. Readers who sat through the inflation post will recognize the wage-lag mechanism doing its work here.

The dual mandate, and why it fights itself

Congress handed the Fed two headline jobs: keep prices stable and keep employment high. (The Federal Reserve Act actually lists three, tacking on moderate long-term interest rates, but the first two are what everyone means by “the dual mandate.”)

Both are perfectly reasonable things to want. The trouble is that the Fed has one lever, and the two jobs pull it opposite ways.

Unemployment too high? Expansionary policy. More money, lower rates, more spending, more hiring. Glance back at Figure 2 and watch the price level climb as you do it. Inflation too high? Contractionary policy. Less money, higher rates, cooler prices. But now the contractor skips the excavator, the dealer skips the hire, and the crew that would have run the machine stays home.

This is the short-run Phillips curve, after the economist who first put the pattern on paper: lower unemployment tends to arrive with higher inflation, and lower inflation with higher unemployment. The Fed is a doctor with one drug that lowers your fever and raises your blood pressure. Full dose breaks the fever and spikes the pressure. Skip it and the fever runs. There is a defensible amount to give, and it depends entirely on which one is likelier to kill you first.

Two honest qualifications, because this is a trade-off and not an iron law.

First, the goals sometimes agree. When Aggregate Demand falls on its own, in an ordinary demand-driven recession, output and prices drop together, and expansionary policy nudges both back where they belong. For a stretch the Fed gets to help everyone at once. The conflict bites when the economy is already near capacity, or when the shock comes from the supply side. An oil shock raises prices and cuts output at the same time, and no setting on the dial fixes both.

Second, the trade-off is temporary. Friedman and Phelps argued in the late 1960s that once people come to expect inflation, they bake it into wages and contracts, and the menu vanishes. You are left with the inflation and the unemployment together, which is more or less the story the 1970s told. In the long run the Phillips curve is vertical. So the Fed is not choosing between inflation and unemployment in general. It is choosing between them right now, on a menu that gets rewritten the moment people figure out what the Fed is up to.

That is the sense in which “achieve both at once” is a promise the arithmetic will not keep.

How the Fed is supposed to steer

Here is the job as drawn up on the board.

The economy slips into recession. AD has fallen left, output sits below what the economy could produce, people are out of work. The Fed sees it, buys bonds, rates fall, spending and investment recover, AD swings back right, and the downturn ends sooner and shallower than it would have.

Or the economy runs hot. AD has pushed past what the economy can sustain. Plants run extra shifts, employers bid against each other for workers, prices climb. The Fed sells bonds, rates rise, the boom cools, and inflation never gets rolling.

Smooth the cycle. Shorten the busts, shave the booms, hold the economy near its sustainable output. That is aggregate demand management, and as ideas go it is a genuinely appealing one.

Why it is harder than the board makes it look

Read that description again and notice the tense. To prevent a boom or a bust, the Fed has to move before it arrives. By the time a recession is plainly underway, the damage is already done. Which means the whole enterprise rests on forecasting, and forecasting runs headlong into three delays.

The first is the knowledge lag. What is actually happening right now? Nobody knows. GDP is hard to measure, and the BEA puts out an advance estimate about a month after a quarter closes, then revises it, then revises it again, then revises it once more in the annual reconciliation. Those revisions are not always small, and they have on occasion flipped a quarter from growth to contraction long after the fact. Averages and first drafts both hide things.

The second is the solution lag. Once you have decided what is wrong, you still have to settle on the fix. Which tool, how much? Committees deliberate, and deliberating eats months.

The third is the implementation lag. Whatever the Fed decides takes time to bite. New money has to be lent, then spent, then spent again by whoever got it. Estimates of how long monetary policy takes to work through the economy vary, but they are counted in quarters, not weeks.

Stack the three and the shape of the problem is this. You are shooting at a target you cannot see directly. A spotter tells you where he thinks it is. Your shot takes a year to land. And a while after you fire, the spotter calls back to say the target was never quite where he told you it was.

None of that means monetary policy does nothing. It means the Fed works with worse information and slower tools than the tidy diagrams let on, and that a move which would have been right in March can be doing active harm by the time it lands in December.

Where this goes next

So there is the machinery. The Fed moves the money supply, the money supply moves the interest rate, the interest rate moves consumption and investment, and those move Aggregate Demand. Push right to fight unemployment, left to fight inflation, and try not to overshoot either way while working from data that shows up late and tools that act slow.

Which leaves two questions, and they are the ones actually worth arguing about. First, incentives: does the Fed aim at the right targets? An institution run by people has to be judged by what those people are rewarded and punished for, and a central banker’s rewards are not obviously lined up with yours. Second, information: even granting perfect intentions, can anyone hit a target under these conditions, or does the attempt to smooth the cycle sometimes add a wobble of its own?

Reasonable economists disagree on both. That is a topic for another day, and the subject of part two.

Dear Editor:

Mohamed El-Erian celebrates “economic statecraft” as a bold new system of operations for the global economy. He also lets the end result slip: “already stressed low-income households will face some higher prices.”

Strip away the talk of resilience and reciprocity and the new doctrine amounts to little more than “trickle-up economics.” The people who write the rules and lobby for the tariffs are large, wealthy, and politically well-connected. The people who pay for them shop at the dollar store and worry about getting to work.

Every protected industry, every “just-in-case” supply chain, every subsidized plant sends a bill. That bill won’t be paid by people in the board rooms and consultancy offices El-Erian’s Wharton students will one day staff. It lands on the single mother buying groceries and the retiree stretching a fixed income.

Washington has rediscovered an old trick. Promise security, deliver higher prices, and count on voters not noticing who cashed the check. Adam Smith understood this 250 years ago and we should, too.

David Hebert
American Institute for Economic Research

Alright, so last week we talked about booms. Basically, a boom a period where an economy is producing more than it can in a “sustainable” way. By “sustainable,” I don’t mean what the environmental people mean (though that may be a part of it), I mean more along the lines of “given how many workers there are, how much capital there actually is, and the state of technology, we are producing beyond our Long Run capability as indicated by the Long Run Aggregate Supply.”

This naturally leads to a question of “well what’s a bust, then?” And at some level, the question is pretty easy: it’s the exact opposite of a boom: the economy is producing less than its long run potential.

In a bust, the Short Run Equilibrium (where the SRAS and AD curves cross) is to the left of the Long Run Aggregate Supply curve. It’s useful to point out here, which I probably should have done last week, that the economy is always wherever these two lines (SRAS and AD) cross. Sometimes, those lines cross at a point on the Long Run Aggregate Supply, in which case we are in neither a boom nor a bust. But most of the time, we’re in one or the other.

When the economy is in a bust, we can infer a few things. First, unemployment will almost certainly be rising because firms are producing less output than they would otherwise be producing. Why do firms lay off workers in a bust? Well, it’s pretty hard to lay off capital equipment and recover much of anything. But if you lay off workers, you save money on your wage bill!

Second, we can infer something about what’s likely to happen to prices: most of them are going to start coming down (or, more accurately: rising more slowly). Remember what we said about “sticky prices” last week: the idea that some prices, such as wages and raw material prices, are slower to change than others, such as the price of final goods like gasoline. In a bust, we can see by looking over at the Y-axis, that the overall price level has fallen. This typically means that prices for consumer goods are falling (or not rising as quickly). While politicians typically say that they want prices to come down, most are pretty reluctant to see that actually happen.

So here’s the question we need to ask: if we’re in a bust, how do we get out of it? There are two pathways:

Boost Aggregate Demand

The first way we’ll go over is probably the most straight-forward: all we need to do is boost aggregate demand. Here, we can use the tremendous purchasing power of the US government to act as a “buyer” in some sense and have them spend tremendous amounts of money, so much so that they actually lead to an increase in the overall Aggregate Demand of the US. This isn’t hard to imagine. Washington DC has a budget of about $7 trillion while the US economy’s total GDP is $30 trillion. In other words, federal spending alone is about 23% of GDP. So yea… they can move the Aggregate Demand curve (and next week’s post will be about how).

Graphically, this would shift the AD line to the right and the economy would move from Point 1 (where there was a bust) to Point 2 where the bust is abated:

This sounds pretty straight-forward and, at least conceptually, it is. We’ll talk more about some complications on this next week. But for now, from a conceptual point of view, this isn’t hard to grasp or otherwise understand.

The Automatic Adjustment Mechanism

But if you stop and think about it, boosting Aggregate Demand isn’t the only way to get out of the bust (where the Short Run Equilibrium is left of LRAS). We could also move the SRAS curve to the right.

But how do we do that?

And herein lies the interesting insight. We do that… by doing nothing. Remember, some prices adjust more quickly than others. But if all prices adjusted the same amount, well there’s really be no difference in hardly anything. As a thought experiment: what if I waved a magic wand and doubled all the money in your bank account, wallet, salary, retirement accounts… etc? That would sound awesome! But what if waving that magic wand also doubled all the prices at all the stores, too? You have twice as many dollars but everything costs twice as many dollars. So are you wealthier than you were before? In terms of dollars (what economists call “nominal”), yes! But in terms of what you can do with those dollars (what economists call “real”), not at all. Importantly, though, you’re not poorer in real terms, either. Everything is exactly the same; it’s just that everything costs twice as many dollars but you also have twice as many dollars.

During a bust, final goods prices have fallen while other prices, such as wages, raw material prices, rent, etc. are all still locked in at their previously higher price. But as those contracts come up for renewal, they can be renegotiated downward. And as those prices fall, the cost of production falls back in line and the SRAS curve will shift to the right.

Through this, we get out of the bust and back to the Long Run Aggregate Supply curve and everything is hunky doory.

And this, too, isn’t difficult to understand. Prices adjust, markets clear, and we get out of a bust. Problem solved, no government required. Libertarians, eat your heart out.

But what’s the problem with this? Notice that it requires that workers accept lower wages (or, again, more accurately: smaller raises than they might have been used to). Explaining to people “hey, it’s alright that you make fewer dollars because the price of everything else went up more slowly, too!” doesn’t tend to cut it. People tend to have an emotional connection to their the number of dollars on their paycheck and how that number changes over time. If people expect it to go up by X% in a given year and instead get some number less than that, even if it all works out the same or even better in real terms, people still tend to get upset. I saw research at some point, but can’t seem to find it now, suggesting that people would rather get a 5% raise while prices rise 4% than get a 3% raise while prices stay the same. In the latter case, they’re actually wealthier in real terms, even though they got a smaller nominal raise. To an economist, this is intriguing. But to a person, this… kind of makes sense. We tie a lot of our self-identity (rightly or wrongly) to how many dollars we make. We want that number to go up fast because that means we’re worth more! Sort of.

Conceptually

Setting all that aside, we’re now faced with a question: if we find ourselves in a bust, should we try to get out of it by boosting Aggregate Demand or should we just let SRAS shift to the right and call it good?

One consideration (besides the psychological considerations above) is “how quickly will these two get us out of the bust?” If boosting AD will get us out of it by the end of the week but waiting for SRAS to shift will take a year, a pretty compelling case can be made for boosting AD as the appropriate means. Likewise, if SRAS is shifting quickly and everyone’s cool with it, then maybe we want to just let that happen instead.

There are other considerations to keep in mind, too. But those will have to wait for next week.

Inflation

• We’re back in an era of rising inflation, sort of.

  • Here’s the BLS’s report from last month, the next report is due out on July 14

  • I’ll just point to one important chart here:

    

• Now before we go off to the races, keep in mind that there’s an on-again-off-again… situation in the Middle East that is heavily influencing energy prices and, by extension, everything else.

  • The index for energy rose 3.9% in just May while the index for all items less food and energy (since those are volatile) rose by only 0.2%. And no, those are not annualized figures.

    • This tells us that the primary driver of inflation right now is energy prices and, from other sources, we can infer that most of this is due to the ongoing situation in the Middle East.

    • It feels a lot like “inflation” sure, and it is, sort of, but it’s not the kind of inflation that the Fed will probably care too, too much about.

• On top of all of this, Kevin Warsh is now on the job! What is he going to do?

Unemployment

• We also had the monthly Employment Situation report come out on 7/2.

• The headline that people are pointing to is the +57,000 nonfarm payroll employment number.

  • Estimates were that this number would be closer to +120,000, so that it came in so much lower was a surprise and not necessarily a good one.

  • There were also downward revisions to the previous few months’ employment numbers. April was revised downward by 31,000 (now at +148,000) and May was revised downward by 43,000 (now at +129,000)

• Still, the three month rolling average for the overall job market is +100,000 and this is… fine. It’s not great, it’s not bad, it’s just… fine.

• What is important, though, is to look at trends within sectors.

  • Here’s the crazy thing: over 100% of job growth since Trump took office has come from healthcare and social assistance. Every other sector has combined to actually lose jobs.

Side Notes on Unemployment and Unemployment Insurance

• I had a couple of Substack posts on here that are relevant to this discussion.

• In case you didn’t know, I started a weekly series on here where I use Claude (and I want to continue being very upfront about that) to turn my lecture notes from when I was a professor into Substack posts. Each week, there’s one post on “the lesson” and a second on “an application.” It’s been super fun and if you haven’t already, you should check them out!

• Here are the two that are relevant for this discussion:

  • What is Unemployment?

  • Application post

Tariffs, Tariffs, Tariffs

• I had a number of pieces come out recently on tariffs.

  • Detroit News, 6/17

  • RealClearMarkets, 7/1

  • Wall Street Journal, 7/6

  • And I have two that have been accepted, one which will be out on Monday, 7/13 at RealClearMarkets again and another that’s coming out in The Hill… at some point.

• Look, I’ve been beating this drum for two years now: tariffs are bad policy, full stop.

• But what’s incredibly frustrating, and what the Trump Administration seems determined to demonstrate, is that tariff uncertainty is even worse.

  • Businesses can adjust to any trade policy if it’s set in stone and predictable for a long enough time. But how are you supposed to make long term plans when tariff rates, exemptions, product classifications, etc. keep changing?

  • Worse, the legal justification keeps shifting, meaning that businesses don’t even know what grounds the tariffs are coming from and what sorts of rules exist around them.

  • And now, with the White House reporting that they have no intention of renewing the USMCA (or CUSMA, depending on where you live), they have just triggered a massive new wave of uncertainty regarding trade relations between two of our closest trading partners.

• In case you forgot, this is the same USMCA that in 2020, President Trump hailed as “the largest, most significant, modern, and balanced trade agreement in history” and that “all of our countries will benefit greatly” from this Agreement.

• The same USMCA that Trump called “the largest, fairest, most balanced, and modern trade agreement ever achieved… a colossal victory for our farmers, ranchers, energy workers, factory workers, and American workers in all 50 states.”

Every college student knows the feeling. You pull an all-nighter before the final, chug a Red Bull at 3 a.m., and for a few glorious hours you are a machine. You could do this forever, you tell yourself. But you can’t. Nobody can. Try to run on all-nighters and energy drinks all semester and your body will hand you the invoice, with interest.

Economies work the same way. They can run hot for a while, producing and hiring and building at a pace that feels like it could last forever. It can’t. And once you understand why, you understand the business cycle. You also understand why the people who light the fuse are rarely the ones who get blamed for the explosion.

To see it clearly, we need only three lines on a graph. Do not let the jargon scare you. Each one is a plain idea dressed up in a lab coat.

Three curves, one economy

The first is Aggregate Demand, or AD. It answers a simple question: at any given price level, how much stuff does everybody in the country want to buy? Households, businesses, government, and foreign customers all rolled into one line. Like an ordinary demand curve, it slopes down. When the overall price level is lower, people want to buy more of what America makes.

The second is Short-Run Aggregate Supply, or SRAS. This is how much businesses are willing to produce right now, given their costs. It slopes up. Here is the key: in the short run, a lot of prices are locked in by contracts. Your wage, the office lease, the two-year supply deal with a parts vendor. When the prices of finished goods rise but your wage is stuck, your boss suddenly finds that you are a bargain. So he asks you to work more, cranks up production, and output rises.

The third is Long-Run Aggregate Supply, or LRAS. This one stands straight up and down. It marks “potential,” the normal amount an economy can crank out when nobody is fooled and every contract has caught up to reality. There are only so many workers, so many machines, so many hours in the day. In the long run, the price level has nothing to do with how much we can actually produce.

When all three lines cross at the same spot, the economy is humming along at full employment. No boom, no bust. Just the steady, sustainable pace.

Where booms come from

So what knocks the economy off that quiet perch? Plenty of things can. A tax cut, a war, a burst of business optimism. But the most common troublemaker, and the one worth watching, comes from the market for loanable funds. That is the fancy name for the place where borrowing and lending get sorted out, and the price that clears it is the interest rate.

Left alone, the interest rate does an honest job. It matches savers who are willing to wait with borrowers who want money now. That price carries real information. It tells businesses how patient people actually are, and therefore which projects are worth starting.

Now suppose someone leans on that price and holds it artificially low. In the United States, that someone is the Federal Reserve. When the Fed pushes the interest rate below the rate that savers and borrowers would have settled on themselves, borrowing looks cheap and saving looks pointless. Money that would have sat in the bank goes chasing houses, cars, and stock. Aggregate Demand increases to the right as people take out loans and spend the money (I mean… who takes out a loan just to sit on the money and do literally nothing with it?).

The early 2000s ran this exact playbook. After the dot-com bust and the shock of September 11, the Fed cut its target interest rate from around 6.5 percent in 2000 all the way down to 1 percent, where it sat from June 2003 to June 2004 (Federal Reserve). Money was about as cheap as it had ever been. And Americans did exactly what you would expect. They borrowed.

The boom that feels too good to be true

When cheap money shoves AD to the right, the economy does not just move to a new happy resting place. It overshoots. The new short-run equilibrium lands to the right of potential, past that straight-up-and-down LRAS line. Output climbs above its sustainable level. Unemployment falls below what is normal. Profits look spectacular.

This is the all-nighter. For a while it feels wonderful, and it feels permanent. In the mid-2000s, the party had a name: housing. Average home prices in the United States more than doubled between 1998 and 2006, the sharpest run-up on record, with the wildest gains of 15 to 17 percent a year coming in 2004 and 2005 (Federal Reserve). Builders built. Buyers bought homes they planned to flip. Wall Street packaged the mortgages and sold them around the world. Everybody was working, everybody was borrowing, and everybody assumed the music would keep playing.

But output above potential is a body running on Red Bull. The extra production comes from straining resources harder than they can be strained for long. Workers whose wages are locked in below the new cost of living eventually notice. Contracts expire. Overtime wears thin. The all-nighter cannot become a lifestyle.

What cannot be sustained will not be sustained

Every boom built on cheap money carries the seed of its own bust, because the boom rested on prices that were lying. When reality catches up, the correction is not gentle.

Sometimes the trigger is the central bank itself, hitting the brakes. The Fed raised its target rate from 1 percent back up to 5.25 percent by June 2006. Suddenly those adjustable-rate mortgages that looked so affordable reset to numbers families could not pay. Defaults climbed, the mortgage-backed securities that banks were holding turned toxic, and lenders got scared. Credit, which had been sloshing everywhere, froze solid.

Here, one could argue that what the Fed was trying to accomplish was shifting Aggregate Demand back to the left. If they do it perfectly and at the perfect time, then everything goes right back to where it was before, the boom is over, and there’s no bust.

This is the thrust of “Aggregate Demand Management.” Basically, through policy (which we’ll cover more extensively next week), the government (through the Fed but also through taxing/spending policy) can balance the overall economy. If it’s in a boom, then we just need to shift Aggregate Demand to the left. If it’s in a bust, then we just need to shift Aggregate Demand to the right.

The automatic adjustment mechanism

Here is the part politicians hate, because it is slow and it cannot be rushed with a speech. The economy does eventually heal itself, but it heals the hard way. Those locked-in prices that caused all the trouble, wages and rents and salaries, finally start to adjust. As they fall back into line with reality, it gets cheaper to hire and to produce. As the cost of labor and raw materials comes up for renegotiation and adjustment, the Short Run Aggregate Supply curve moves. If those prices are increasing, then SRAS will shift to the left. If those prices are decreasing, then SRAS will shift to the right.

In the case of a boom, the SRAS will shift to the left as wages and raw material prices rise, which means the economy will move from 1 to 2 to 3:

Notice what happens in the short-run: when the Fed lowers interest rates, AD shifts to the right. This increased spending leads to increased economic output and to increased hiring to create that output. The reason for this is actually kind of simple: some prices in an economy are quicker to adjust than others. You’ve probably noticed that gas prices fluctuate pretty much daily. But the wage of the clerk at the gas station does not. His wage is set by a contract and lasts a lot longer.

So now, I’ll give you the single most confusing sentence in all of macroeconomics:

Think of the long run as this hypothetical period of time where all prices are able to adjust. The price for things that you and I purchase as consumers can change pretty quickly. Those happen in the short run. But things like our salaries or the monthly cost of your cell phone bill all change much, much less frequently. I’m lucky enough to get an annual performance review every January. During this magical window of time, I find out if I’m getting a raise that year and by how much. For the rest of the year, my wage is set.

This is the basic idea behind “sticky price theory.” The fact that some prices adjust quickly while others adjust more slowly is a hugely important insight. And, as it turns out, it can absolutely affect things in the broader economy.

I’ve simplified things a lot by saying that some prices are fixed by “contracts.” The reality is that prices can be slow to adjust for a whole bunch of reasons, including the cost of changing the prices themselves.

An admission

Now look, this is one basic story of how a boom can occur and what could happen as a result of the Fed’s actions. The truth is that there is a lot more that goes on the background than I’ve presented here. Anyone who tells you that this is all cut and dry is clearly selling you a load of, well, you get the idea.

This is also why economists disagree sometimes (ok, often). We’re not really disagreeing about economics per se, we’re disagreeing about 1) what’s going on in the background?, 2) how big of a deal those things are compared to one another?, 3) how much is expected versus unexpected by people in and around an economy?, 4) just how sticky are prices, are some prices stickier than others and if so, which ones?, and a whole bunch of other things.

There’s going to be a part two for this post next week because the truth is that I’ve barely scratched the surface of what can be illustrated with just these three curves.

But in the meantime, I want you to sit and think about something. With just these three lines on one graph, you can already start to see how a whole bunch of stuff is suddenly a lot clearer. Despite what people say about economics being “fake” or the models being “too simplistic,” this is actually pretty amazing.

This is why I love economics. If you do it right, everyone says “yea, that’s obvious, Dave!” But doing it right is difficult and requires a lot of practice. Doing it wrong? Well, that’s easy and in today’s day and age, it can even get you elected to office!

That is not a thought experiment. It happened to a midwife named Epiphania Mudehwe in Mutare, Zimbabwe, in the winter of 2008. Her notes devalued while she was in line at the supermarket, and she was unable to buy any groceries. The money could not even cover her bus fare, so she walked three hours home. Prices around her were changing by the hour.

Last week I wrote about how the damage inflation does depends on whether you see it coming. Zimbabwe is what happens at the far end of that spectrum, when the surprise never stops, the price level runs faster than any human being can react, and money itself stops working. It is worth looking at closely, because it is the clearest modern demonstration of a simple truth: a currency is not a law of nature. It is a promise. And promises can be broken.

The breadbasket that broke

Zimbabwe was not always a cautionary tale. For much of the twentieth century it was known as the breadbasket of southern Africa. Its farms produced surplus maize, tobacco, wheat, and beef, its mines yielded gold and platinum, and at independence in 1980 its currency traded at roughly one to one with the US dollar.

For its first decade, the money behaved. Inflation averaged around 10 percent in the 1980s and ran somewhere between 20 and 30 percent through the mid-1990s. High by American standards, but a functioning currency. People saved in it. People priced things in it. People trusted it.

Then the trust started to go. Annual inflation, which had been around 55 percent in 2000, climbed to 132 percent in 2001, then to 599 percent in 2003, then to 1,281 percent in 2006. By March 2007 it had reached 2,200 percent. Each step felt manageable from the one before it. That is how these things go. Nobody wakes up to a thousand percent inflation. You back into it, one seemingly survivable jump at a time.

I’ll save the full question of why this happened for another post, because the mechanics deserve their own treatment. The short version is the oldest story in monetary economics: a government that needed to spend more than it could tax or borrow, and a central bank willing to print the difference. The printing press is the most tempting tax of all, because no legislator has to vote for it and no taxpayer gets a bill in the mail. The bill arrives anyway. It just arrives at the cash register.

The number that breaks your brain

Here is where it gets hard to write about honestly, because the figures stop meaning anything.

There is a technical definition of hyperinflation, and we owe it to an economist named Phillip Cagan, who in 1956 drew the line at 50 percent per month. Compounded, that means prices more than double every two months. By that standard, there have been roughly 57 hyperinflations in recorded history. Zimbabwe’s stands very near the top.

The trouble with documenting it is that the government stopped keeping score. On July 13, 2007, the Zimbabwean government said it had temporarily stopped publishing official inflation figures, a move observers read as an attempt to draw attention away from runaway inflation. You cannot see what the central bank refuses to measure. The charitable interpretation is that printing those numbers became effectively meaningless.

Two economists found a clever way around the blackout. Steve Hanke of Johns Hopkins and the Cato Institute, working with Alex Kwok, used a workaround that deserves a moment of appreciation (read their study here and a four year retrospective here). One company, the insurance firm Old Mutual, was listed on both the London Stock Exchange and the Zimbabwe Stock Exchange, and each share represented the same claim on the same company regardless of where it traded. Compare the two prices and you can back out what the Zimbabwe dollar was really worth against hard currency on any given day, no matter what the government claimed. From the gap, they reconstructed a daily price index.

What they found: Zimbabwe’s inflation peaked at a monthly rate of 79.6 billion percent in mid-November 2008. At that peak, prices were doubling roughly every 24.7 hours.

Read that again, because the brain slides right off it. Not 79.6 billion percent per year. Per month. Prices doubling about every day. The only hyperinflation worse in all of recorded history was Hungary in 1946, where prices doubled roughly every 15 hours.

What a number like that does to people

Statistics this large stop registering as real. So forget the statistics for a minute and picture the day-to-day, because that is where hyperinflation actually lives.

Your wages are a melting ice cube. Workers who got paid at 9 in the morning rushed to spend the money by noon, because waiting until the afternoon meant a measurable loss in what it would buy. Hold cash for an afternoon and you have lost part of it. Hold it overnight and you may have lost most of it. The rational move is to convert every dollar into something, anything, with real value the instant it touches your hand. A bag of cornmeal holds its worth. A paper note does not.

This is the behavior economists dryly file under “shoe-leather costs,” the wear and tear of running to the bank and the store more often as money loses value. In Zimbabwe the metaphor became literal. People genuinely wore through their shoes shuttling between shops, trying to outrun the next price change. Multiply one person’s frantic afternoon by an entire nation and you have an economy that has rerouted enormous amounts of human effort into the single unproductive task of spending money before it dies. Every hour spent sprinting to the store is an hour not spent making anything. The country was working furiously and producing less and less.

The stores gave up too. Shops changed prices multiple times a day, and some stopped displaying prices altogether, simply telling customers the current figure at the register. A price tag is a promise about tomorrow, and no merchant could make that promise anymore.

Even the machines surrendered. People could not withdraw money from ATMs because the machines could not handle values in the billions and trillions, returning a “data overflow error” instead. By the time the ATMs were reprogrammed to allow withdrawals of 100 billion dollars a day, that sum would not buy a loaf of bread. When you write a check, you had to make it out for twice the cash price of the item, just to cover how much the currency would lose before the check cleared.

The hundred-trillion-dollar joke

Faced with prices that doubled daily, the government did the only thing the printing press knows how to do. It added zeros.

Zimbabwe redenominated its currency three times, in 2006, 2008, and 2009, chopping zeros off the bills each time, with denominations climbing all the way to a 100 trillion dollar banknote. None of it worked, because none of it touched the reason the zeros kept coming back. Each reset rebased the unit of account and bought a few months of convenience before the zeros returned.

The crowning artifact of the whole catastrophe was that 100 trillion dollar note. Issued in January 2009, the 100,000,000,000,000 dollar bill was the largest-denomination banknote ever legally issued by any government. And here is the detail that says everything: at the moment it was issued, it could not buy a loaf of bread.

There is a grim comedy to the afterlife of that note. The Zimbabwe dollar it represented became worthless as money and then, years later, valuable as a novelty. By June 2015 the 100 trillion dollar note had a face value of about 40 US cents, yet collectors were paying far more than that for it. The bill is worth more as a curiosity on a shelf than it ever was as the currency of a nation. You can buy one online today for around thirty dollars, real dollars, which is to say one printed note of a dead currency now trades for roughly seventy-five times the entire face value it once carried. Money that could not buy bread can now buy a steak dinner, as long as you sell it as a souvenir rather than spend it as cash.

How it ended

Here is the part worth sitting with, because it cuts against the instinct that only a government can fix a problem a government created.

Zimbabwe’s hyperinflation did not end because the central bank finally found the right policy. It ended because ordinary people stopped using the currency. At the peak, people simply refused to use the Zimbabwe dollar, and the hyperinflation came to an abrupt halt. Merchants started demanding US dollars and South African rand. Shoppers obliged, because they had no choice. Foreign currency was effectively legalized as a de facto currency in September 2008, formally acknowledging a dollarization that was already happening in every shop in the country.

Hanke, who watched it up close, calls this spontaneous dollarization. Good money drove out bad, and the government’s hands were tied. The people abandoned the dollar before the state was willing to admit it was dead. Official use of the Zimbabwe dollar was abandoned on April 12, 2009, but by then the public had already moved on. The currency did not so much get retired as get fired by the people who were supposed to use it.

A sobering footnote: the lesson did not stick. Since 2009 Zimbabwe has tried at least six times to reintroduce a national currency, most recently a gold-backed unit called the ZiG launched in 2024. Each attempt has run into the same obstacle, which is that trust, once burned, is extraordinarily hard to rebuild. A government can print money in an afternoon. It cannot print confidence.

The lesson worth keeping

It is tempting to file Zimbabwe under “faraway disaster, couldn’t happen here,” and the magnitudes here are so extreme that the comparison to a 4 percent American CPI reading feels almost insulting. The distance is real. American institutions are sturdier, the Federal Reserve is independent in ways Zimbabwe’s central bank was not, and the dollar is the currency the rest of the world flees toward in a crisis, not away from.

But the mechanism is not exotic, and that is the point. Every hyperinflation in history runs on the same engine: a government spending more than it can raise honestly, and a central bank covering the gap with new money. The difference between Harare in 2008 and a stable economy is one of degree and restraint, not of kind. The printing press works the same everywhere. What varies is whether the people running it can stop.

Money holds its value only as long as people believe it will. That belief is the most valuable and most fragile asset any economy has. Zimbabwe spent a decade discovering how quickly it burns, and more than fifteen years, so far, discovering how slowly it returns.

Are you better off or worse off?

This isn’t a trick question. You’re worse off, and it isn’t close. Your paycheck now buys half of what it used to. You feel poorer because you are poorer.

Now hold that feeling, because it explains more about the economy in 2026 than most of what you’ll read in the financial press. The reason inflation hurts is not really the rising prices. It’s the part you didn’t see coming.

Where we are right now

Let’s start with the numbers, because they’re back in the headlines and worth getting right.

In May 2026, the Consumer Price Index rose 4.2 percent over the previous twelve months. That’s the Bureau of Labor Statistics’ broadest measure of what urban consumers pay for a basket of everyday goods and services, and 4.2 percent is the highest annual reading in about three years. On a monthly basis, prices rose 0.5 percent in May after climbing 0.6 percent in April.

Most of the recent jump traces back to energy. The energy index rose 3.9 percent in a single month and accounted for more than sixty percent of May’s total increase. Strip out food and energy, and “core” inflation looks tamer: up 0.2 percent for the month and 2.9 percent over the year.

That gap between the headline number and the core number is your first hint that “inflation” is not one thing. Different prices move for different reasons, and the average hides as much as it reveals. But the deeper distinction, the one that actually determines who wins and who loses, is whether the inflation was expected.

The two kinds of inflation

Economists split inflation into two flavors, and the difference between them is the whole ballgame.

• Unanticipated inflation is the surprise kind. Prices jump and nobody saw it coming. This is the doubling-overnight scenario from the top of this post.

• Anticipated inflation is the kind everyone sees on the horizon. You know prices are going up, your employer knows, your landlord knows, your bank knows. Everybody plans around it.

These two produce wildly different outcomes, and untangling them tells you why the same 4 percent can feel like a mugging in one decade and a rounding error in another.

When inflation catches you by surprise

Go back to the overnight doubling. You, the worker, are clearly worse off. But notice that the money didn’t vanish. Somebody is on the other side of that trade.

Think about your employer. The price of whatever your company sells just doubled, but the wage your employer pays you didn’t. From the boss’s point of view, you just went on sale. You produce the same goods that now sell for twice as much, and you cost exactly what you did last week. In real terms, you became cheaper to employ overnight.

This is the quiet engine inside surprise inflation. When prices leap ahead of wages, employers find labor a bargain, they hire and produce more, and measured GDP tends to rise for a while. It looks like a boom. For the people whose paychecks are lagging behind the cost of living, it does not feel like one.

Run the movie backward and the same logic holds. Suppose prices were cut in half overnight while wages stayed put. As a shopper, you’d be thrilled. As a worker, you’d be in trouble, because now you cost your employer twice as much in real terms relative to what the company can charge. Surprise deflation makes workers expensive, hiring slows, and output tends to fall. Consumers feel rich right up until the layoffs start.

The pattern underneath all of this is redistribution. Unanticipated inflation quietly moves wealth from people whose incomes are fixed or slow to adjust toward people on the other side of those contracts. Workers with sticky wages lose, employers gain. Lenders who are owed fixed dollars lose, borrowers who repay in those cheaper dollars win. Nobody voted for this transfer. It just happens, in the dark, while the official story is that the economy is growing.

Now, the honest caveat. Wages do not stay frozen forever. This is the part the overnight-doubling story leaves out. Workers notice when their paychecks stop covering the bills, they negotiate, they switch jobs, they demand raises, and over time wages climb to catch up with prices. The “labor is cheap” effect is a feature of the short run, when wages are sticky and contracts haven’t reset. The longer inflation runs, the more fully wages adjust and the more that early advantage to employers fades. The surprise is temporary. Which brings us to what happens when the surprise wears off entirely.

When everybody sees it coming

Here’s the trick. People are not potted plants. Once inflation becomes expected, everyone starts acting on the expectation, and that changes everything.

Suppose you knew with certainty that prices would double next month. What would you do today? You’d buy now, before the price tags change. You might even buy extra, figuring you can resell later. Everybody else reasons the same way, so demand floods forward in time.

And the sellers? They’re not potted plants either. If a store owner knows his costs and his competitors’ prices are about to double, he raises his prices today. Why wait? The expectation of higher prices tomorrow becomes higher prices right now.

Workers play too. Once everyone expects 5 percent inflation, workers ask for raises of at least 5 percent just to stay even, employers grant them because they expect to charge more, lenders bake the expected inflation into interest rates, and landlords write it into the lease. The whole economy adjusts in advance.

When inflation is fully anticipated, that redistribution from the surprise version largely disappears. Wages, prices, interest rates, and contracts all move together. Nobody gets fooled because nobody is surprised.

So does anticipated inflation cost us nothing? Not quite. Even expected inflation burns real resources. Stores reprice constantly, the famous “menu costs” of reprinting every tag and catalog. People waste time and effort managing cash they’re trying not to hold, since money is losing value just sitting in a wallet. Everybody runs in place to avoid a tax nobody can opt out of. The effort spent dodging inflation is effort not spent producing anything. The faster prices rise, the more of the economy’s energy gets diverted into this useless scramble.

What it adds up to

Strip away the jargon and the lesson is simple. The damage inflation does depends almost entirely on whether people see it coming.

The surprise kind redistributes wealth in the shadows, rewarding some and punishing others according to who happened to be locked into yesterday’s prices, while the official numbers may flash green. The expected kind spares us most of that injustice but still taxes us all through the wasted effort of staying one step ahead. And when expectations spiral out of control, the running never stops, and an economy can quite literally exhaust itself sprinting to the store.

So the next time a politician points to a inflation number and tells you it’s modest, or a pundit waves off 4.2 percent as nothing to worry about, ask the question the headline can’t answer: did we see it coming? Because the cruelest tax has always been the one nobody warned you about.

How much you saw coming, of course, is a topic for another day. And why governments so often let it happen anyway? That one’s coming soon. I promise.

Here’s the question that earned three economists a Nobel Prize: does that check help you find a job faster, or does it quietly encourage you to look a little longer?

The honest answer is “yes.” Both happen at once, and which one wins is the whole ballgame. Let me explain.

A program that grew up in a hurry

When the financial crisis hit, Congress did what Congress usually does in a downturn. In June 2008, President Bush signed the Emergency Unemployment Compensation program into law, tacking extra weeks of federally funded benefits onto the 26 weeks states normally provide. As the recession deepened, the program was extended and expanded again and again under President Obama, climbing in tiers until, at the peak, a laid-off worker in a hard-hit state could collect benefits for up to 99 weeks. That’s nearly two years. The maximum 99-week window was available from December 2009 through August 2012, and the whole apparatus finally expired at the end of 2013.

This was not some fringe experiment. Since 2008, almost 24 million workers received extended benefits, and the program kept millions of people out of poverty. Those are real families, real groceries, real rent paid. Any honest accounting starts there.

But economists noticed something else happening at the same time. The average length of unemployment stretched out dramatically. When the emergency program began in 2008, the typical spell of unemployment ran about 17 weeks. By late 2013, it had ballooned to over 36 weeks. Some of that was simply a brutal job market. But not all of it, and to see why, you need to meet the economists who explained the rest.

The Nobel that formalized common sense

In 2010, the prize went to Peter Diamond of MIT, Dale Mortensen of Northwestern, and Christopher Pissarides of the London School of Economics, “for their analysis of markets with search frictions.” The committee had a sense of humor about the timing, handing out a prize for the study of unemployment in the teeth of the worst unemployment crisis in a generation.

Their insight sounds obvious once you hear it, which is the mark of a good one. In the real world, a worker and a job don’t find each other instantly. Searching takes time and effort. A perfectly good welder and a factory that needs a welder can sit on opposite sides of town for months, each looking, neither connecting. The economists called this “search friction,” and it explains a puzzle that had nagged the profession for decades: how can you have millions of people looking for work at the very same moment that employers have job openings they can’t fill?

The answer is that matching is hard. And once you accept that searching takes time, a second question follows naturally: what determines how long someone searches?

The two costs that govern a job search

Picture a job search as a tug-of-war between two costs.

On one side is the cost of staying unemployed. No paycheck, savings draining, the daily sting of the bills. The heavier this cost, the harder and faster you’ll hunt, and the more willing you’ll be to take a decent offer rather than hold out for a perfect one.

On the other side is the cost of finding a job. The hours spent scrolling listings, tailoring resumes, driving to interviews in your one clean suit. Worth remembering: the employer faces these costs too. Every hour spent interviewing candidates is an hour not spent running the business, which is why firms try to keep their candidate pools small and their searches short.

Now watch what unemployment benefits do to that tug-of-war. A check that arrives whether or not you’re working lightens the cost of staying unemployed. The rope slackens on that side. And when one side of a tug-of-war eases up, the rope moves. With less financial pressure pushing you toward the first available job, you can afford to search longer. This isn’t a moral failing or a character flaw. It’s arithmetic. Lower the cost of any activity and people will do more of it. Lower the cost of searching and people search longer.

That is the predictable, and predicted, effect of stretching benefits to 99 weeks. The longer the benefits last, the longer the average search can run. No economist worth the title was surprised.

Here’s where it gets interesting

If the story stopped there, it would be a tidy little parable about government meddling, and you could close the tab. But the same Peter Diamond who helped win that Nobel Prize argued something that complicates the picture, and he argued it well enough that it deserves a fair hearing.

A longer search is not automatically a wasted one.

Think about what the heavy cost of unemployment actually pressures people to do. It pressures them to grab the first thing available. Sometimes that’s fine. But sometimes the skilled machinist, desperate after his savings run dry, takes a job stocking shelves, abandoning the trade he spent fifteen years mastering. He’s employed, the statistics look better, and the economy has just shoved a craftsman into a job that wastes most of what he knows.

And here’s the part the statistics hide. Three months later he’s miserable, he quits, and he starts the whole search over again. Now count it up honestly. That “quick” match didn’t end his job search. It just interrupted it. He’s had two short spells of unemployment instead of one longer one, and odds are the two short ones add up to more total time out of work than if he’d held out for the right job the first time.

This is worth sitting with, because it’s the kind of thing a single statistic will lie to you about. Picture two welders. The first takes a five-month search and lands a welding job he keeps. The second grabs a shelf-stocking job after two months, white-knuckles it, quits, and spends four more months finding welding work, for six months of searching split across two spells. Glance at a month-to-month chart and the second welder looks like the success story. He got off the unemployment rolls fast. He was a triumph of labor-market efficiency right up until he wasn’t. But he actually spent more of his life out of his trade than the welder who took the “long” search and got it right the first time. The headline number rewarded the churn and punished the patience. It measured speed when what mattered was whether the match stuck.

Diamond’s point was that giving a worker enough breathing room to find a job that actually fits his skills can be good for him and good for the economy that needs those skills put to use. A welder welding is worth more to all of us than a welder stocking shelves. Under this view, some unemployment insurance doesn’t just cushion hardship, it can grease the gears of good matching, which is the very thing the search-friction theory says we should care about. And sometimes the patient search that looks slower on the chart is the faster road to a job that lasts.

So we have two true things sitting in tension. Benefits lengthen searches. And longer searches sometimes produce better matches. The benefit that lets a laid-off engineer hold out for engineering work is the same benefit that lets someone else settle comfortably onto the couch. The program cannot tell the two apart. It pays them both.

So who’s right?

This is the part where you might expect me to tell you. I’m not going to, because the honest answer is that it depends on magnitudes that reasonable people read differently.

If the matching benefit is large and the couch effect is small, generous benefits look like a wise investment in getting people into the right jobs. If the couch effect dominates, long benefits mostly subsidize longer idleness, at real cost to taxpayers and to the workers themselves, since skills rust and employers grow wary of long gaps on a resume. The empirical literature exists, it’s voluminous, and it does not speak with one voice. Anyone who tells you the question is settled is selling something.

What the search-friction framework gives us is not the answer but the right questions, the ones a thoughtful citizen should ask of any benefit program. How long should the help last? Long enough to prevent fire-sale job matches and real hardship, but not so long that it underwrites indefinite searching. Where exactly is that line? That’s a judgment call about how much we value insurance against bad outcomes versus how much we worry about dulling the incentive to work. Your answer will depend on your values, your read of the evidence, and frankly your assumptions about your fellow citizens.

That’s not a dodge. It’s the actual shape of the problem. Beware anyone who pretends a genuine trade-off is a free lunch, in either direction. The folks who insist benefits are pure compassion with no incentive cost are kidding themselves. So are the folks who insist benefits are pure sloth with no matching value. The economics says both effects are real. The size of each is where the honest argument lives, and that argument is yours to have.

So the next time a politician promises to extend benefits, or another promises to cut them, you’ll know the question to ask. Not “does this help people?” or “does this make them lazy?” but “which effect is bigger here, and how do we know?” That question won’t win you any applause at a rally. It just happens to be the right one.

The editorial board writes powerfully about the open-ended nature of exemptions to the newly-proposed Section 301 tariffs (“Trump’s Latest Big Tax Increase,” Review & Outlook, June 9, 2026). The problem with exemptions isn’t the race to get them, but who gets to win that race.

A discretionary exemption process is a prize and the firms that are most likely to claim that prize are the ones who have a “campaign checkbook,” sure, but also the lawyers and lobbyists. A Fortune 100 company can have its Washington office secure a meeting with a cabinet secretary. A small manufacturer in Grand Rapids, scrambling to make payroll, has to fill out a form online and hope a junior staffer passes it up the chain.

As a result, the tariff lands hardest on the firm that can least afford it and the relief flows to the firm that needs it least. This isn’t competition. It’s cronyism and an exemption process this arbitrary all but guarantees exactly this outcome.

This is how arbitrary power always works. It doesn’t level the playing field, it tips it toward whoever has the referee’s phone number.

Pretty ironic for a president who promised over a decade ago that he would “drain the swamp.”

David Hebert
American Inst. for Economic Research
Grand Rapids, MI

Now imagine I told you that the rate can fall for the worst possible reason: people giving up.

I want to walk you through one of the most quoted, least understood numbers in American public life. By the end, you won’t need me to tell you what to think about it. You’ll just see what it actually measures, what it quietly leaves out, and why that gap matters.

Three buckets, not two

Most people assume the working-age world splits cleanly into “has a job” and “doesn’t.” Reality has a third bucket, and it’s where all the mischief lives.

The government sorts adults into three groups. The employed worked last week. The unemployed didn’t work, but actively looked for a job. And then there’s everyone not in the labor force, the folks who didn’t work and didn’t look. Stay-at-home parents, retirees, full-time students, and, crucially, the discouraged worker who wanted a job, struck out for months, and finally stopped trying.

Here’s the part that trips up nearly everyone. The labor force is only the first two buckets added together: the employed plus the unemployed. The third bucket sits outside it entirely.

And the famous unemployment rate? It’s just the unemployed divided by the labor force. Look hard at that formula and notice who’s missing. The discouraged worker isn’t in the numerator. He isn’t in the denominator. He has vanished from the arithmetic altogether.

So ask yourself the question I used to put to my students: what happens to the measured unemployment rate when an unemployed person gets discouraged and quits looking? He exits the labor force. The number of unemployed shrinks. The rate goes down. Nothing about his life improved. He just stopped counting.

A story from the hearing room

I worked for the Joint Economic Committee for a stretch, and one 2010 hearing burned itself into my memory.

A member of Congress was celebrating a drop in the unemployment rate, crediting the policies that had supposedly produced it. The trouble was that the number of discouraged workers had jumped sharply, and that exodus was a big part of why the measured rate had fallen. We had come prepared. We had the data, and we laid it out plainly, in front of the director of the Bureau of Labor Statistics himself: the rate had dropped in part because people had given up, not because they’d found work.

That’s the whole lesson in one room. The same number that one person waves as a triumph can describe a labor market quietly bleeding hope. The statistic answers a narrow question accurately. The trouble is that people ask it a much broader one.

What the headline rate doesn’t tell you

The unemployment rate is a snapshot, and snapshots are silent on a lot. It doesn’t tell you how many people gave up. It doesn’t tell you how hard the people still looking are actually trying. It doesn’t tell you about the accountant driving for a rideshare app because he can’t find accounting work, the underemployed who’d take full-time hours tomorrow if anyone offered. It doesn’t tell you about job growth, and it doesn’t break things out by age, sex, race, or education, all of which can matter enormously.

This doesn’t make the number useless. It makes it a single gauge on a very complicated dashboard. Looking at it is fine. Treating it as the only gauge is where people go wrong.

And before anyone accuses the BLS of cooking the books, understand that the exclusions are mostly sensible. We don't count full-time students who aren't working or job-hunting, and thank goodness, or the rate would look absurd. We don't count active-duty military, who sit outside the civilian count entirely. And we don't count grandpa, who retired and earned every minute of his fishing. None of these folks are working, and none are looking, which is exactly why they land outside the labor force rather than inside the unemployed column. Leaving these folks out is the right call. You just have to know what the definition is before you celebrate or mourn the number it produces.

Where today’s numbers stand

As of the May 2026 jobs report, here’s the lay of the land. The headline unemployment rate held at 4.3 percent, where it has stayed in a narrow band between 4.3 and 4.5 percent since July 2025. Employers added 172,000 jobs, well above the roughly 80,000 most forecasters expected. On its face, a steady, healthy market.

But run your eyes down the dashboard. The labor force participation rate, the share of adults working or looking, sat at 61.8 percent, essentially flat over the past year. The broader U-6 measure, which folds in discouraged workers and people stuck in part-time jobs who want full-time, stood at 8.1 percent, nearly double the headline figure. And the long-term unemployed, those out of work 27 weeks or more, numbered about 2.0 million, up by 524,000 over the year and now 27.5 percent of all unemployed people.

So which is it, strong market or soft one? Both readings are defensible, which is exactly the point. The headline says “fine.” The deeper gauges say “fine, but more people are stuck for longer, and the searches are getting harder.” No single number carries all of that at once, which is why it pays to read the whole dashboard rather than the top line.

The flavors of unemployment

Not all unemployment is the same beast, and lumping it together is how bad policy gets made. Economists carve it into three main types.

Frictional unemployment is the short-term gap while you’re between jobs, and it’s mostly healthy. When my dad lost his job, he spent eight months finding the right next one. He was “unemployed” that whole time, but a chunk of those months was spent searching for a good match rather than grabbing the first thing available. That search has value, for the worker and the employer, who’s also hunting for the right person. A world with zero frictional unemployment would be a world where everyone takes the first job offered, good fit or not. That would be a more desperate economy, not a healthier one.

Some of this is just the calendar. I used to wash boats in northern Michigan. My winter job prospects in that line of work were, let’s say, frozen. The folks grooming ski hills have the opposite problem come July. Call it seasonal unemployment, a tidy subspecies of friction.

Structural unemployment is nastier and more durable. It comes from a lasting mismatch between the skills workers have and the skills employers need. When auto plants moved to automated welding, skilled spot-welders found their specialty suddenly surplus. When studios shifted to computer animation, hand-drawn animators discovered their craft had been quietly priced out.

This is the churn Joseph Schumpeter called creative destruction back in 1942. The relentless drive to cut costs, the self-checkout lane, the automated phone tree, the drive-through cashier sitting three states away, destroys particular jobs. It also frees up labor and capital to do new things, which creates jobs that didn’t exist before. The destruction is visible and local and gets the headlines. The creation is diffuse and gradual and rarely does. Both are real, and you can’t have one without the other.

Cyclical unemployment rides the business cycle. When the economy slumps, firms shed workers. Automakers laid off heavily in the 2007 to 2009 downturn, then rehired as conditions improved. This is the type stimulus policy usually targets, and it’s worth keeping mentally separate from the other two, because a structural problem doesn’t yield to a cyclical cure.

So what is “full employment”?

Here’s a riddle. If frictional and structural unemployment never fully disappear, can we ever hit zero percent? No. There’s always somebody between jobs or retraining for a shifted market.

Economists call the floor we can realistically reach the natural rate of unemployment, or, in one of the great oxymorons of the discipline, the full-employment rate of unemployment. There’s healthy disagreement about the exact figure, but it’s generally pegged a few points up from zero. Zero isn’t the goal, and chasing it would do more harm than good.

Why some people stay unemployed longer

Now put on the dismal-scientist hat, because here’s where it gets genuinely interesting. Why are some spells of unemployment short and others grindingly long?

Boil it down to two forces: the cost of finding a job and the cost of not having one.

Finding work is itself costly. It eats time, the hours spent scrolling listings and tailoring resumes. It costs money, the travel, the interview clothes, the printing. And it costs the employer too. Every hour spent interviewing you is an hour that interviewer isn’t doing their actual job, which is why companies work hard to keep their candidate pools small. When a university recruited me, they flew me in, put me up for two nights, fed me, and ran me past a parade of administrators. The out-of-pocket tab ran a couple thousand dollars. The time cost was bigger still. Hiring is expensive on both sides of the table, and that expense lengthens searches.

Then there’s the cost of not working, which mostly means: no paycheck. The higher that cost bites, the harder and faster you’ll hunt for a job, and the likelier you’ll take a decent offer rather than holding out. Lower that cost, and some people will, reasonably, search a little longer.

This isn’t a moral judgment. It’s just incentives. Raise the pain of joblessness and searches shorten. Cushion it and searches lengthen. Both effects are real, and which one dominates is an empirical question, not a slogan.

The unemployment insurance trade-off

This is where unemployment insurance earns its place in the conversation, and where the everyman test really pays off, because the logic is simpler than the politics.

UI pays you something to live on while you’re between jobs. Ask the public-choice question: how does that change behavior? It lowers the cost of staying unemployed. That’s arithmetic, not an accusation. A program designed to soften the blow of job loss, by design, also reduces the urgency to take the next available job.

And here’s the honest part. That can be a feature rather than a bug. Consider: how many currently unemployed people could land a job at a big-box store or a fast-food counter by the end of the week? Probably a lot of them. Does that mean a laid-off welder or software engineer should grab that job immediately? Not obviously. A bit of breathing room to find a match that uses their skills can be good for them and good for the economy that needs those skills deployed well. The same cushion that lets one person hold out for the right fit also lets another spend nine months on the couch with the dog and the hiking trails. The policy can’t tell those two apart. It funds them both.

So the trade-off is real and it cuts both ways. Make benefits too thin and you force skilled people into mismatched jobs, wasting talent and ginning up more structural churn down the road. Make them too generous or too long and you extend some spells past what’s healthy for the worker or the budget. There’s no setting that’s purely good. There’s only a balance, and reasonable people put the dial in different places.

It’s worth saying plainly: most economists do not favor abolishing unemployment insurance. But “keep it” and “it changes incentives” are both true at once, and any honest case has to hold both.

The hard question underneath

Richard Wagner in To Promote the General Welfare framed the dilemma about as well as anyone has. The whole challenge of public assistance, he wrote, is how to treat the genuinely unfortunate humanely without extending that same provision to those who are merely improvident, foolish, lazy, or cunning.

That’s the knot. Help the people who truly need help. Don’t build a machine that quietly rewards people for gaming it. No program ever drawn up has perfectly threaded that needle, because the genuinely-down-on-their-luck and the comfortably-coasting often look identical on a benefits form.

I’m not going to tell you where the dial belongs and no economist actually can. That’s a values question dressed up in economics and your values are your own. What I can tell you is this: the next time you hear a number cheered or mourned on the evening news, go look at the rest of the dashboard. The headline rate was never built to answer the questions we keep asking it.

But peek inside the budgets. The first family spends most of its income on groceries, clothes, the mortgage, a dinner out now and then. The ordinary business of living well. The second family spends almost nothing on itself. It plows nearly half its income into building a third garage, a fourth garage, a spec house down the street it isn’t sure it can sell, and a workshop full of machines running at half capacity. Both families “earn” the same amount. You would not say they are living the same life, and you would not bet on their futures the same way.

This is the trouble with Gross Domestic Product. It’s a sum. And a sum, by its nature, throws away the very thing you most want to know: what’s in it.

One Number, Four Ingredients

Recall how GDP is built. The expenditure formula adds up four things:

Y = C + I + G + (EX − IM)

Consumption, investment, government spending, and net exports. Every dollar of output lands in one of those buckets. When the headline crosses the news ticker, GDP grew at such-and-such a rate, all four buckets have already been melted down into a single figure.

That melting-down is convenient. It’s also where the information goes to die. Two economies can post the same growth rate, even the same size, while being built as differently as our two families. The only way to see it is to pry the number back apart and look at the pieces. So let’s do that, with the two biggest economies on earth.

America: An Economy That Spends on Itself

Here’s how American GDP breaks down, using the Bureau of Economic Analysis’s standard expenditure shares for recent years.

Consumption is about 68 percent of the whole. More than two-thirds of everything America produces is bought by households for their own use: food, cars, rent, haircuts, streaming subscriptions, knee surgeries. Business investment runs around 17 to 18 percent. Government purchases, the productive kind, roads, courts, aircraft carriers, not the transfer payments, come in around 17 to 18 percent as well. And net exports are negative, around minus 3 percent, because America buys more goods from abroad than it sells.

Step back and the shape is unmistakable. The American economy is built around the American consumer. It is, at its core, a machine for letting ordinary people buy the things they want. You can think that’s glorious or thin, but that’s what the composition says: this is an economy that spends on itself, on its own people’s daily lives.

China: An Economy That Builds

Now China, using its National Bureau of Statistics figures, on the same expenditure basis.

Household consumption is about 40 percent of GDP. Investment, gross capital formation, factories, rail, apartment towers, industrial machinery, is also about 40 percent. Government consumption adds roughly 17 percent, and net exports run a positive 3 percent or so, since China sells the world more than it buys.

Put those side by side and the contrast jumps off the page. In America, households consume about 68 cents of every dollar. In China, households consume about 40 cents. The gap that opens up in China gets poured, in almost equal measure, into investment. China invests roughly 40 percent of everything it produces, a rate nearly double America’s and one of the highest sustained levels any large economy has ever recorded.

(A quick honesty note, because the numbers get slippery here. You’ll sometimes see China’s consumption quoted at around 56 percent. That figure folds in government consumption on top of household spending. The apples-to-apples comparison, household to household, is roughly 40 percent in China against roughly 68 percent in America. Comparing China’s combined 56 against America’s household-only 68 would be cheating, so we won’t.)

Same Growth, Different Animal

Here’s what makes this more than a curiosity. Both economies grow at respectable rates. China has been posting numbers around 5 percent, America around 2. If you ranked them by the headline figure alone, you’d file them under the same heading: “large economy, growing.” The sum tells you they’re cousins.

The composition tells you they’re different species.

The American number swells when families buy more, take more vacations, eat out more, get the knee replaced. Growth, in the American configuration, is downstream of ordinary people getting what they want. The Chinese number swells when the state and state-directed firms build more, another high-speed rail line, another industrial park, another tower. Growth, in the Chinese configuration, is downstream of construction and capacity, much of it directed from above rather than pulled forward by what households actually want to buy.

Neither composition is automatically “better,” and I want to be careful here, because it’s easy to wave the American flag and call it a day. Investment is not a vice. A country that consumes every dollar it earns and builds nothing is eating its seed corn, and decades of heavy Chinese investment did build genuinely productive things and lifted hundreds of millions out of poverty. Apply the public-choice lens, though, and the question isn’t how much gets invested but who decides. Investment chosen by people risking their own money, answerable to whether buyers actually show up, tends to find its way to good uses. Investment directed by officials chasing growth targets, spending other people’s money with their eye on a promotion, faces no such discipline.

And here the composition starts to whisper something the headline number shouts down. When you build apartments nobody moves into and rail lines that will never cover their cost, the spending still counts. Every yuan of it lands in that 40 percent investment slice and pushes GDP up, exactly the way our second family’s fourth garage made its budget look busy. The sum can’t tell the difference between investment that pays off and investment that just keeps cranes busy. It adds up dollars. It cannot audit them.

You don’t have to take this as theory. China’s property sector has been contracting for years now, apartment prices in some major cities have fallen sharply from their peaks, and the consumption side has stayed stubbornly weak as households, watching their main asset lose value, hold tighter to their wallets. That’s what it looks like when a big chunk of the investment slice turns out to have been building things people didn’t need. The bill comes due, but it comes due quietly, years after the GDP figures already banked the credit.

Why the Composition Is the Story

This is the payoff, and it generalizes well past China. Whenever someone hands you a single economic number, ask what got summed to make it. The headline is an average, an aggregate, a melting-pot, and every one of those operations is a machine for hiding variation. A country can grow because its people are getting richer or because its government is pouring concrete. Same growth rate, opposite stories.

It cuts the other way too, lest this turn into a lecture aimed only at Beijing. America’s heavy consumption share has its own questions hiding inside it. How much of that spending is financed by debt? How much of the investment slice is genuinely productive versus propping up asset prices? The composition doesn’t answer those either. But at least, by breaking the number apart, you know which questions to ask. The aggregate lets you ask none of them. It just nods and says “growth.”

Recall the two families. Same income, utterly different lives, and the only way you’d ever know was to open the budgets. GDP is the household income line for a whole country. Useful, real, worth knowing. But if you stop reading there, you’ve learned the one fact that conceals all the others.

The number is a door, not a destination. The story is always one level down, in the composition, where the sum can’t reach.

As a reminder: these are written with Claude’s Opus 4.8 on medium. I’m not at all impressed with Claude’s ability to generate accurate images and spent the bulk of my copy-editing time fixing issues there (they weren’t stylistic fixes, either).

Imagine you’re standing in a grocery store holding a loaf of bread that costs a dollar. Simple enough. But that one dollar is hiding a small miracle. Before that bread reached your hands, a farmer grew wheat and sold it for thirty cents. A miller ground it into flour and sold that for sixty-five cents. A baker turned the flour into a loaf and sold it for ninety cents. The grocer put it on a shelf and charged you a dollar. Four people, four transactions, one loaf.

Now here’s a question that trips up almost everyone: when economists add up everything the country produced this year, how much did that loaf contribute? Thirty plus sixty-five plus ninety plus a dollar? That’s $2.85. Or just the dollar you paid?

The answer is one dollar. And understanding why it’s one dollar is the key to understanding the single most cited, most misused, and most misunderstood number in all of public life: Gross Domestic Product.

What GDP Actually Measures

GDP is the dollar value of all the final goods and services a country produces in a year. Three words in that sentence are doing all the work, so let’s take them one at a time.

Dollar value. We don’t count carrots and cars and haircuts in their own units, because you can’t add a carrot to a haircut. So we convert everything into the one thing they have in common: a price. Everything becomes dollars, and then we add the dollars.

Final goods. This is the bread lesson. We count the loaf, not the wheat and the flour and the dough, because the value of all those intermediate steps is already baked into the price of the loaf. The farmer’s thirty cents didn’t vanish. It’s sitting right there inside your dollar. Count the wheat separately and you’ve counted it twice, once as wheat and again as bread. Economists call the alternative “value added,” and it’s a neat trick: add up only what each stage contributes (thirty cents, then thirty-five, then twenty-five, then ten) and you get exactly one dollar again. Two roads, same destination.

Produced this year. GDP only counts new production. If you buy a brand-new textbook, you’ve added to this year’s GDP. If you buy it used, you haven’t, because that book was already counted the year it was made. Reselling existing stuff just moves it around. It doesn’t create anything new.

The cleanest way to think about the whole thing is this: GDP is total income. Every dollar you spend on a final good becomes income for somebody. Your dollar for bread becomes income for the grocer, the baker, the miller, and the farmer. Spending and earning are the same river viewed from opposite banks.

The Famous Equation, and the Trap Hiding Inside It

Every economics student learns to write GDP as an equation:

Y = C + I + G + NX

Gross domestic product (Y) equals Consumption plus Investment plus Government spending plus Net Exports. Spelled out a bit more, that last term is exports minus imports, so:

Y = C + I + G + (EX − IM)

Consumption is what households buy, from groceries to furniture. Investment is what businesses buy expecting it to pay off later, like factories and equipment and the houses we build. Government spending is the productive stuff government buys, roads and schools and aircraft carriers (note that Social Security checks don’t count here, because they’re not buying production, just moving money from one pocket to another). And net exports are what we sell abroad minus what we buy from abroad.

Now I want to show you a trap. It’s a trap that snares not just freshmen but senators, presidents, and a distressing number of people who should know better.

Here’s the setup as it appears in every textbook. Suppose consumption is 2,000, investment is 1,000, government spending is 3,000, exports are 4,000, and imports are 2,000. Add it up: 2,000 + 1,000 + 3,000 + (4,000 − 2,000) = 8,000. Fine.

Now suppose some official decides the economy “should” be at 9,000 instead of 8,000. What’s the move? The textbook answer, the one I’ll bet you can see coming, is: just increase G by 1,000. Government spends another thousand, GDP clicks up to nine thousand, everybody claps.

Stop right there. That answer treats the GDP equation like the dashboard of a car, as if “G” were an accelerator you could press to make the whole economy go faster. It is not. The equation is an accounting identity. It is a way of categorizing spending that has already happened, not a set of levers that cause spending to happen. Confusing the two is like believing you can get richer by rewriting your checkbook.

Where does the extra thousand dollars the government spends actually come from? It gets taxed away from C and I, or borrowed from the pool of savings that funds I, or printed, which raises prices and quietly shrinks the real value of everything else in the equation. The accounting identity always balances, by construction. That’s what makes it an identity. But the identity tells you nothing about whether anyone is better off. It’s a snapshot, not an engine.

Hold that thought, because it’s about to crack open one of the most overheated debates in American politics.

Why the Trade Deficit Is an Accounting Result, Not an Economic Wound

Look again at the equation, specifically at that minus sign in front of imports. Y = C + I + G + (EX − IM).

Politicians love to point at the trade deficit, the gap where imports exceed exports, and treat that minus sign as proof that imports are subtracting from American prosperity. Every foreign-made good, the story goes, is a dollar drained out of GDP, a point scored for the other team. Run a trade deficit and you’re “losing.”

But ask yourself a question the equation practically begs you to ask. When you buy a television assembled in Vietnam, which letter did that purchase land in first?

It landed in C. You’re a consumer; you consumed. The full price of that television got added into consumption the moment you bought it. When a business buys an imported machine, it lands in I. When the government buys imported steel for a bridge, it lands in G. Every imported good gets counted as a plus the instant an American buys it, because GDP is measuring spending, and you really did spend.

So why the minus sign? Because GDP is supposed to measure what America produced, and that Vietnamese television wasn’t produced here. Having added its full price into C, we now have to take it back out, or we’d be crediting American production with goods made on the other side of the planet. The “− IM” term isn’t a penalty. It’s a correction. It’s bookkeeping cleaning up after itself, removing from the total exactly what it never should have included as domestic production in the first place.

Sit with what that means. Imports get added in and then subtracted back out. The minus sign doesn’t make you poorer. It cancels an entry that was only there to be canceled. The trade deficit isn’t a hole in the economy that imports dug. It’s the residue of an accounting convention, the footprint left when we add up spending one way and then net out the part that happened abroad.

This is why the framing of “winning” and “losing” at trade is, at the level of the arithmetic itself, a category error. The trade balance is a line in a ledger, not a scoreboard. When you bought that television, you didn’t lose. You handed over some dollars and walked out with a television you wanted more than the dollars, and the fellow in Vietnam wanted the dollars more than the television. Two people, both better off, the same double thank-you that powers every voluntary trade ever made. The accounting identity records the dollars. It cannot see the gratitude, and it certainly cannot see who “won.”

None of this settles every trade question. There are serious arguments about strategic industries, about national security, about trading partners who don’t play by the same rules. Those are real debates worth having. But they have to be argued on their own terms, honestly, as the genuine tradeoffs they are. You cannot import the conclusion “we are losing” straight out of a minus sign that was only ever there to keep the books from double-counting. The arithmetic doesn’t carry that freight. Anyone who tells you it does is selling something, and it isn’t economics.

All the Things GDP Cannot See

If GDP can’t tell you who won at trade, it’s worth asking what else it can’t tell you. The honest answer is: quite a lot.

GDP misses anything that doesn’t pass through a market. For most of American history, an enormous amount of valuable work, raising children, cooking, keeping a home, happened inside families and never registered as a dollar of GDP. Hire a nanny and a cleaning service to do the identical work and suddenly it counts. The work didn’t change. Only the paperwork did. A good chunk of measured economic growth over recent decades is partly an accounting artifact of household work moving into the formal market.

GDP can’t see the underground economy either, the cash jobs, the off-the-books hustle, the outright illegal trade. In countries with corrupt governments or weak property rights, where declaring your income invites a tax collector or a thief (sometimes the same person), enormous swaths of real economic life simply go dark. The official figures make these places look poorer than they are.

GDP doesn’t count leisure, though an afternoon spent recharging is hardly worthless. It doesn’t subtract for pollution; a factory that fouls a river adds to GDP while making the country arguably poorer. It doesn’t net out the costs of crime; a wave of burglaries that has everyone buying alarm systems and hiring guards shows up as growth. And it struggles badly with new technology. Would you trade your smartphone for a hundred cell phones from 1985? Of course not. But GDP, looking only at prices, has a hard time capturing the fact that the thing in your pocket is a miracle the richest man on earth couldn’t have bought forty years ago.

Most fundamentally, GDP measures the size of the economic pie. It says nothing about how that pie is sliced, or whether the slicing is fair. That’s not a flaw to be fixed. It’s just a reminder that GDP was built to answer one question, and we keep demanding it answer questions it was never designed to touch.

The Number and Its Limits

GDP is one of the great inventions of twentieth-century economics. It lets us take something as sprawling and chaotic as a national economy and hold it in a single figure. That’s genuinely useful, and when the Bureau of Economic Analysis reports that real GDP grew at an annual rate of 1.6 percent in the first quarter of 2026, that number means something.

But the danger was never that GDP tells us too little. It’s that we ask it to tell us too much. We treat an accounting identity as a control panel and conclude we can spend our way to prosperity. We stare at a minus sign meant to prevent double-counting and convince ourselves we’re losing a war. We watch the headline number tick up and forget to ask what prices did, or what the number can’t see, or who got which slice.

GDP is a remarkable measuring stick. The trouble starts the moment we mistake the stick for the thing it measures. Numbers don’t think. That part is still our job.

I had intended to pre-write several articles and just schedule them to go out but then life got in the way.

Instead, I'll leave you with these:

And the theme song for our adventure:

https://youtu.be/BLONWy46gIE?is=s7YawNhtgPwtJoES

Imagine you run a McDonald’s franchise in Sacramento. On April 1, 2024, the State of California informed you that the people taking orders and dropping fries now had to be paid at least $20 an hour, up from $16. That is a 25 percent jump in the price of your most basic input, handed to you in a single day, not phased in over years. You did not get a vote. You got a notice.

Now ask yourself the only question that matters when a price goes up: what do I do differently tomorrow?

That question, and the millions of quiet answers to it, is the whole story of California’s fast-food minimum wage. And it is a far more interesting story than either side of the shouting match wants to admit.

What a Price Actually Is

A wage is a price. It is the price of an hour of someone’s labor. And the first thing we learn in any honest economics class is that prices are not arbitrary insults handed down by greedy corporations. They are information. A price tells you how scarce something is relative to how badly people want it, and it tells you, the moment it changes, to adjust your plans.

So when California quadruple-stamped a $4 increase onto the price of fast-food labor, it sent a loud, unmistakable signal to every franchise owner in the state: labor is now more expensive, find substitutes. And here is the uncomfortable part for everyone involved. They did exactly that. Not because they are villains. Because that is what the price told them to do.

The Substitutes Were Already Waiting

If you have walked into a fast-food restaurant lately, you have met the substitute. It is a glowing touchscreen kiosk that takes your order without complaint, without a break, and without a paycheck.

Here is the crucial thing the kiosk teaches us, and it comes from the economist Jacob Vigdor, who studied Seattle’s minimum-wage experiment. Once a company develops the technology to replace a worker in one expensive city, rolling it out everywhere else is nearly free. The kiosk that gets engineered for San Francisco does not stay in San Francisco. It comes to Alabama too, where there is no high minimum wage at all, simply because it now exists.

A higher minimum wage, in other words, does not just change the math in California. It pays for the research and development of the very machines that will replace entry-level workers everywhere. As my colleague Art Carden likes to put it, a fast-food “worker” in a high-wage city is increasingly just an ordering kiosk. The minimum wage did not protect that job. It funded the thing that ate it.

Now, the Honest Part

Here is where most articles on this topic, on both sides, start cheating. So let me not.

The data on California’s law is genuinely contested, and you should be suspicious of anyone who tells you otherwise. One camp, centered at UC Berkeley, studied the law and found that workers got an 18 percent raise, that menu prices rose only about 3.7 percent (call it fifteen cents on a four-dollar burger), and that employment did not measurably fall. A Harvard and UC San Francisco team found something similar: real raises, no detectable hit to staffing. If you support the law, those are your studies, and they are not nothing.

The other camp, including economists Jeffrey Clemens and Jonathan Meer, ran the numbers using the Bureau of Labor Statistics’ Quarterly Census of Employment and Wages and reached a darker conclusion: California’s fast-food sector shed roughly 18,000 jobs it otherwise would have kept, around 3 percent of the workforce. A separate analysis of theirs pinned menu-price increases at 3.3 to 3.6 percent.

So who is right? Honestly, the dust has not settled, and I am not going to insult you by pretending it has. The employment number is the single hardest thing in all of economics to measure cleanly, because you are trying to count jobs that didn’t happen, the hire that was never made, the shift that was quietly cut. You cannot photograph an absence.

But Does It Matter Who’s Right?

But notice something. You do not actually need the 18,000 number to make the point that matters.

Look back at the friendly studies, the ones the law’s supporters cite. Even they find that prices went up. Even the on-the-ground reporting from places like UC Santa Cruz finds hours getting trimmed, overtime disappearing, benefit thresholds quietly moving out of reach, and automation accelerating. One coastal Burger King operator’s locations reportedly cut shift work by more than 21 percent in the first year.

This is the part you cannot deny, no matter which employment study you trust. When you raise the price of something, people use less of it, or they find a substitute, or they pass the cost on. A franchise owner facing a 25 percent labor-cost increase has exactly three moves: raise prices, cut hours, or automate. The California data shows all three happening at once, because of course it does. That is not ideology. That is arithmetic.

The wage floor did not repeal the law of demand. It just decided who would absorb the cost: the customer at the register, the teenager whose shift got cut, or the worker whose job became a touchscreen.

Who Pays, Who Benefits

This is where it pays to ask the public-choice questions: who gains, who loses, and who has the incentive to keep the whole thing going?

The winners are real and worth naming honestly. A worker who keeps her job and gets a genuine 18 percent raise is better off, full stop. That is not a rounding error in someone’s life.

But the losers are real too, and they are quieter, because they are mostly invisible. They are the workers who never got hired because the kiosk got installed instead. They are the teenager with no experience and no references who is now too expensive to take a chance on, exactly the person an entry-level job is supposed to exist for. And here is the genuinely uncomfortable history: the earliest American champions of the minimum wage, a century ago, wanted it to work this way. They understood perfectly well that a wage floor prices the least-skilled out of the labor market. They considered that a feature. Today’s advocates have far kinder intentions. The economic mechanism does not care about intentions.

There is one more beneficiary that often goes unacknowledged: the company that makes the kiosks. Every time a city raises the cost of labor, it hands a gift to the firms that sell labor’s replacements. The software developer and the kiosk manufacturer never show up to the rally. They just cash the check.

The Point Is Not “Don’t”

Let me be clear about what this column is and is not arguing.

Whether California should have raised the wage is an ethical and political question, and you are entirely free to look at the trade-off, real raises for many, lost opportunities for some, higher prices for all, and decide the bargain is worth it. Reasonable people do. I am not here to make that decision for you.

What I am here to insist on is that there is a trade-off, and that anyone who tells you there isn’t, that you can raise the price of labor by 25 percent overnight and conjure something from nothing, is selling you a free lunch. There are no free lunches. There is only the question of who picks up the check, and whether you were honest enough to look around the table before the bill arrived.

The kiosk, it turns out, already knew the answer.

What do you do? You use less plastic. You hunt for substitutes. You stop wasting it. You don’t need to know why the price went up. Maybe a hurricane wrecked a chemical plant in Texas. Maybe scientists discovered plastic is miraculously useful for medical devices and demand exploded. You don’t know, and here’s the remarkable part: you don’t need to know. The price told you everything you needed to do.

That little number did a job that no committee, no central planner, and no team of experts could ever do. And it did it without a single meeting.

The Mystery of the Mundane

Start with something humbler than plastic. Start with a pencil.

Nobody on Earth knows how to make a pencil. That sounds absurd, but it’s true. The wood comes from a cedar tree in the Pacific Northwest, felled with a saw made of steel, which came from iron ore mined somewhere else, smelted using coke from coal dug up by people who’ve never met the lumberjack. The graphite comes from Sri Lanka. The eraser involves rapeseed oil from Indonesia and a chemical reaction nobody at the pencil factory could explain. The yellow paint, the brass ferrule, the glue.

Thousands of people on six continents, most of whom will never meet, none of whom set out to make your pencil, somehow cooperate to put a perfectly good one in your hand for a quarter. No one is in charge. No “Pencil Czar” coordinates the lumberjack and the graphite miner and the paint chemist.

So how does it happen?

You’re Not a Jack of All Trades, and Thank Goodness

You don’t make your own shirt. You probably couldn’t if you tried. You don’t grow your own food, refine your own gasoline, or assemble your own phone. Instead, you do one or two things reasonably well, and you trade for everything else.

This is specialization, and it’s the reason a modern person of modest means lives better than a king did three centuries ago. By focusing on what we each do best and trading for the rest, all of us end up with more stuff, better stuff, and cheaper stuff than we could ever produce alone.

But trade needs prices. And prices need a market.

What Is a Market, Anyway?

Here’s a trick question: what is “the market”? Is it a place? A building? The New York Stock Exchange?

None of those. The market, the way economists talk about it, is a process. It’s the ongoing dance of plan coordination between buyers who want things and sellers who have them. It has no address. It’s happening right now, everywhere, all the time.

And it runs on two simple tendencies.

The first is demand: the lower the price, the more people buy. That’s the demand curve, and it slopes down.

The second is supply: the higher the price, the more people are willing to produce and sell. That’s the supply curve, and it slopes up, because making one more of anything costs more than the last (you use up the easy resources first).

Put them on the same chart and they cross at exactly one point. Say it with me: demand slopes down, supply slopes up, and X marks the spot.

Why the Market Doesn’t Need a Boss

Nobody actually knows what these curves look like. Do you know your own demand curve for apples? Of course not. All we know is the general shape. So how does the market find that magic crossing point?

Suppose a price starts out too high. Sellers eagerly pile up goods, but buyers shrug and walk away. Now there’s a glut: more stuff for sale than anyone wants to buy. Do we send men with guns to force people to buy the extra inventory? No. The sellers, stuck with unsold goods, quietly cut prices until the shelves clear.

Now suppose the price starts out too low. Buyers swarm, shelves empty, and there’s not nearly enough to go around. Do we point a gun at producers and order them to make more? No. The shortage itself bids the price up, which convinces sellers to make more but also buyers to buy less.

In both cases the market self-corrects. Not because anyone commanded it, but because buyers compete against other buyers for scarce goods, and sellers compete against other sellers for your scarce dollars. That two-sided competition is how markets work.

Prices Are Information in Disguise

Back to our plastic. Say the only use for it today is making soda bottles. Then a researcher discovers plastic is invaluable for medical equipment. What should happen?

We’d want Coca-Cola to use less plastic so more is freed up for hospitals. We’d want plastic manufacturers to make more of it. Ideally, both at once.

How do we pull this off? Do we convene a Global Plastic Summit and hand out marching orders to every bottler and manufacturer on the planet?

We don’t have to. The surge in medical demand pushes the price of plastic up. Coca-Cola, seeing its costs rise, economizes, maybe switches to aluminum or glass, without ever learning why plastic got expensive. The manufacturers, seeing higher prices, crank out more. Everyone adjusts, nobody coordinates, and the plastic flows to where it’s needed most.

This is the quiet genius of prices. They compress an unfathomable amount of information, every shortage, discovery, disaster, and change of heart on Earth, into a single number you can act on. A rising price says “use less, this is getting scarce.” A falling price says “go ahead, there’s plenty.” You don’t need the backstory. You just need the number.

So What Happens When We Fight the Price?

Here’s where it gets interesting, and where good intentions start running into hard arithmetic.

If prices are just messengers carrying information, what happens when we shoot the messenger? When a law declares that a price may not rise or fall to its natural level?

We call these laws price controls. A price ceiling forbids a price from going above a set level (think rent control). A price floor forbids it from dropping below one (think minimum wage). And whenever the law forces a price away from where buyers and sellers would have settled, something has to give. The information gets scrambled, and people respond to the scrambled signal in ways nobody intended.

Rent Control: Fewer Apartments, Worse Apartments

Who wouldn’t want cheaper rent? Imagine a law capping rent at a fraction of the going rate. Tenants cheer.

Now think like a landlord. When the law slashes what you can charge, what do you do with that spare bedroom you used to rent out? Maybe you turn it into a home office instead. That’s one less room on the market. Why pour money into fresh paint and a new water heater when there’s a line of desperate renters who’ll take the place no matter what shape it’s in? So maintenance slides.

The result of capping rent isn’t cheap apartments for everyone. It’s fewer apartments, in worse condition, with would-be renters left out in the cold. During New York’s rent-control era, people resorted to scanning the obituaries to find a newly vacated apartment, racing to call before anyone else. Imagine fielding calls from strangers angling to rent your relative’s place before the funeral. The price was held down, but the desperation just popped up somewhere else.

Minimum Wage: A Surplus of Workers

Now the floor. What is unemployment, really? It’s a surplus of labor, more people wanting to sell their work than buyers willing to hire at that price. And what creates a surplus? A price held above where the market would clear.

When the law sets a wage above what a worker’s labor can currently produce, the most vulnerable workers, the youngest, the least experienced, the ones still building skills, lose their best bargaining chip: the ability to say “I’ll work for less to get my foot in the door.” They’re not priced into a better job. They’re priced out of any job.

Here’s the part that matters: whether these laws are good or bad is an ethical question, and that’s genuinely up to you to decide. But whether they cause these effects is not up for debate. “Rent control reduces the supply of housing” and “minimum wage laws cause some unemployment” are statements about cause and effect, as solid as 2 + 2 = 4. You can favor the policy anyway, for reasons you find compelling. You just can’t pretend the arithmetic isn’t there.

When the Cure Breeds the Disease

Let me close with my favorite example, because it shows how far this logic reaches once you start looking, and because it actually happened.

Imagine you’re a French colonial official in Hanoi in 1902. Your administration has just built a gleaming modern sewer system, the pride of the “civilizing mission.” Unfortunately, it turns out a sewer is a five-star resort for rats: warm, wet, food everywhere, and not a predator in sight. The new system handed the city’s rodents a golden age, and worse, these were plague-carrying rats. You have a public health crisis on your hands.

So you reach for an obvious fix: a bounty. Pay locals a reward for every rat they kill. To keep it manageable, you don’t make people haul in whole rats, just the tails as proof. Bring in a tail, collect your penny. Simple, humane, results-oriented. Soon thousands of tails are pouring in every day, and you pat yourself on the back for a job well done.

Now run it through the same machinery we’ve used all along. You’ve just put a price on rat tails, and a price calls forth supply. At first that means hunting the rats you wanted gone. But the people of Hanoi do the arithmetic you didn’t. Soon, rats start turning up alive in the streets with no tails. Why kill the rat? A live, tailless rat goes right back to breeding more rats, which means more tails to harvest later. Then it gets worse: on the outskirts of the city, enterprising farmers simply start breeding rats to farm the bounty.

You set out to shrink the rat population. You built it a subsidy. The French were left furious that they’d been outsmarted, spending a fortune only to increase the number of rats in Hanoi.

This isn’t a fable I’m dressing up for effect. The historian Michael G. Vann dug the episode out of the colonial archives and published it as “Of Rats, Rice, and Race: The Great Hanoi Rat Massacre,” in French Colonial History in 2003, and later as a full graphic history with Oxford University Press. Economists now cite it constantly, because it’s the cleanest illustration imaginable of an incentive doing exactly what you told it to do rather than what you meant it to do.

This is the deepest lesson in economics, and the most uncomfortable. Intentions are not results. The official wanted fewer rats. He got a rat industry. He wasn’t a fool or a villain; he simply forgot to ask what the people on the other end of his policy would do once he changed their incentives.

That’s the whole game. The people who pushed rent control and minimum wages weren’t villains either. Most of them wanted exactly what you and I want: cheaper housing, higher pay for the struggling. Nobody in the room is rooting for more homelessness or more unemployment.

But good intentions don’t suspend the laws of economics any more than they suspend the law of gravity. If you want to actually help, and not merely feel as though you’ve helped, you have to ask the unglamorous economist’s question every single time: and then what happens?

Because somewhere out there, a price is about to deliver your message. The only question is whether you’ll like what it says back.

Quick housekeeping: since these posts are picking up subscribers, I feel the need to remind everyone that these are written using AI (Claude Opus 4.8 in this case, which is a bit like using a blowtorch to light a cigar) after which I then go through, double check all the numbers (it got the demand and supply curves completely wrong initially in the previous post DESPITE the notes it was working from repeatedly saying “demand slopes down, supply slopes up!”), and do some copy-editing. I have never and I will never copy and paste the raw, Claude output without doing these things first.

Remember the “or” goods? When one option gets too expensive, people switch to the next best thing. Now ask yourself what “expensive” really means. It isn’t just the price tag. For something illegal, the cost includes the risk of getting caught and the penalty if caught. That risk attaches to getting the drug and holding it and moving it, not to how potent it is once you have it.

So put yourself in a smuggler’s shoes. You can move a truckload of low-potency product or a briefcase of high-potency product, and you face roughly the same prison sentence either way. Which do you choose? The briefcase, every time. More value, less bulk, same risk. Prohibition doesn’t just push people toward illegal markets. It pushes those markets toward the strongest possible version of whatever’s banned.

Economists call this the iron law of prohibition, a phrase popularized by economist Mark Thornton: the more intense the enforcement, the more potent the product becomes. It’s why Prohibition in the 1920s gave us bathtub gin and hard liquor instead of beer. Nobody was bootlegging something as bulky and weak as beer when the same risk could move whiskey. The booze got stronger because it was banned.

And it didn’t stop with alcohol. The economist Audrey Redford, now at Hampden-Sydney College, has spent her career tracing exactly how this plays out in modern drug markets, and her work is the best place to send anyone who wants the rigorous version of this argument. In “This Is Your Entrepreneurial Alertness on Drugs” she shows how prohibition turns drug suppliers into entrepreneurs whose main innovation is evading the law. She has a great term for it: “malnovation,” innovation aimed not at serving customers better but at staying one step ahead of regulators. The whole legal structure, as she points out, defines banned drugs by a minimum potency while putting no ceiling on the maximum. Read that twice. The law itself quietly rewards making the product stronger.

The result is a grim march up the potency ladder. Crack down on prescription painkillers like OxyContin and the people who were using them don’t simply vanish. They reach for the closest available “or” good. That turned out to be heroin, and then heroin laced with fentanyl, a substance so concentrated that a dose the size of a few grains of salt can kill. We squeezed one end of the balloon and it bulged out somewhere far deadlier.

Redford and Benjamin Powell make the historical case in “Dynamics of Intervention in the War on Drugs: The Build-Up to the Harrison Act of 1914” (The Independent Review, 2016), tracing how each intervention created the problems that “justified” the next one. It’s a ratchet. Each crackdown produces an ugly consequence, which becomes the argument for a further crackdown, which produces a worse consequence still.

Now, here’s where I have to do my job and stay honest with you. None of this tells you what we should do. You might look at the potency ladder and conclude prohibition or the “war on drugs” are counterproductive. You might instead decide the harms of legal access would be worse and the iron law is a price worth paying and that we need to more to stop drugs and help people get off of them. These are normative questions, they are absolutely important, and they’re also incredibly difficult. What the economics tells you, the positive part, is simply this: when you ban something, you don’t get to choose the form it comes back in. The market chooses because the market reflects all of our wants without discriminating what’s good for us and what’s bad for us. And in the case of drugs, it tends to choose whatever packs the most value into the least detectable package. Anyone who promises a crackdown with no substitution effect is selling you something, and it isn’t economics.

That’s the whole lesson of the “or” goods, pushed to its sharpest point. Change the cost of one option and people don’t stop wanting the thing. They just find the next door. Sometimes that next door leads somewhere far more dangerous than where they started.

Hold that thought. By the end of this post you’ll know the answer, and you’ll know it because of two of the most powerful ideas in all of economics: demand and supply. They sound boring. They are not. They explain why diamonds cost more than water, why your favorite restaurant raises prices when its rent goes up, and why nobody did anything useful with the steam engine for about 1,600 years.

Let’s start at the beginning.

Substitutes and Complements: The Things Around the Thing

Economics has a simple way to sort the goods in your life. Some things are “or” goods:

• If you’re hungry, you could eat pizza or a salad.

• If you’re looking for a date night activity, you could go to the movies or go play putt putt.

• If you’re looking for a place to live, you could rent or you could buy a house.

You pick one when the other gets too expensive. Those are substitutes.

Other things are “and” goods:

• Hot dogs and buns.

• A mouse and a keyboard.

• Dinner and a baby-sitter (if you have kids).

You tend to buy them together, and when the price of either one rises, you end up buying less of both. Those are complements.

One word, “or” versus “and,” and you’ve already got a working map of how prices ripple through your shopping cart.

Why does this matter? Because the price of one good never stays contained. It reaches into everything connected to it, boosting the “or” goods and dragging down the “and” goods. Keep that in mind as we build out the rest of the picture.

The Puzzle That Stumped Economists for 250 Years

Here’s a question that made some very smart people look very silly for a very long time.

Which is more valuable, water or diamonds?

If I offered you a gallon of water or a gallon of diamonds (that’s about 29 pounds of diamonds), which would you grab? The diamonds, obviously. But that’s strange, isn’t it? Water keeps you alive. Diamonds just sit there and sparkle. The thing that’s essential is nearly free, and the thing that’s useless for survival costs a fortune.

This was called the water-diamond paradox, and it genuinely puzzled economists for centuries. Everybody knew it was true. Nobody could explain why.

The answer arrived in the 1860s and 1870s, worked out independently by William Stanley Jevons, Léon Walras, and above all Carl Menger, the founder of the Austrian school, who nailed it most cleanly. Their insight has a clunky name, “marginal analysis,” but a simple idea behind it.

“Marginal” just means the next one. Not all the water in the world versus all the diamonds in the world. Just the next gallon of each.

And there’s the trick. Water is everywhere, so the next gallon is worth almost nothing to you. You can get it from the tap. Diamonds are rare, so the next one is worth a great deal. Think about how easy it is to go fetch a gallon of water versus a gallon of diamonds.

So we have to separate two things people constantly mix up:

• Use value: what the thing does for you. Water keeps you alive; diamonds look pretty.

• Exchange value: what you can get for it in trade. Here diamonds win in a landslide.

The paradox dissolves the moment you stop thinking in terms of “all or nothing” and start thinking at the margin.

This isn’t just a parlor trick about jewelry, by the way. It’s how to think about your whole life. Your textbook might frame it as “studying for an exam versus keeping a friend,” as if you had to choose one or the other. But you don’t. Real decisions are almost never all-or-nothing. You don’t choose between all studying and all friendship. You choose how to spend the next hour. Anyone who tells you that you must sacrifice the entire friendship to pass the test isn’t much of a friend, and isn’t much of an economist either.

This is why I get twitchy whenever a politician starts talking about “needs.” Framing things as “needs” pushes you straight into all-or-nothing thinking. People do have needs. But in a world of scarcity, there are always trade-offs at the margin, and pretending otherwise is how bad policy gets sold.

The Demand Curve, Demystified

Once you accept scarcity, demand falls right out of it. Demand simply relates how much of something people want to the sacrifice they have to make to get it. In plain English: it relates the price to how much you buy.

Would you buy more of something when the price is low, or when it’s high? Low, of course. Draw that on a graph with price going up the side and quantity going across the bottom, and you get a line that slopes downward. Higher price, less bought. Lower price, more bought.

Now, one distinction that trips up nearly everyone, and it’s worth getting right:

• Demand is the whole line, the entire relationship between every possible price and how much you’d buy at each.

• Quantity demanded is a single point on that line, the specific amount you’d buy at one specific price.

Keep those straight and you’ll already understand price better than most people who write about it for a living.

This gives us the Law of Demand: hold everything else constant, raise the price, and the quantity demanded falls. Lower the price, and quantity demanded rises. That’s it. It’s why you stock up when something is on sale.

Here’s the part people get backwards constantly: a sale does not “increase demand.” The whole line didn’t move. You just slid down to a different point on the same line. The price dropped, so the quantity demanded went up. Saying “the lower price increased demand” is like saying stepping on the scale made you heavier. Worth being precise about, because once the line itself starts moving, you’ll want to know the difference.

Why does the line slope down in the first place? Diminishing marginal utility, that same idea from the water and diamonds. The first slice of pizza is glorious. The fourth is fine. The seventh you’re forcing down out of spite. Each additional unit is worth less to you, so you’ll only buy more if the price drops to match.

When the Whole Line Moves

The demand curve itself can shift. When it slides right, people want more at every price. When it slides left, they want less at every price. Here’s what that looks like:

Notice the difference from a sale. A sale keeps you on the same line and slides you down it. A shift picks up the entire line and moves it. Six things move it:

1. The number of buyers. More people who want the product means more sold at every price. The line shifts right. Fewer buyers, it shifts left. Simple as that.

2. Tastes and preferences. You just decide you like something more or less. Imagine you woke up tomorrow and your favorite food made you gag. You’d buy a lot less of it at any price. Or someone learns how animals are treated before slaughter and swears off meat for good. Their demand curve for steak collapses leftward, no price change required.

3. The price of a substitute. Here’s where the neighbors come in. Go-karting, mini golf, and the movies all make decent dates. If go-karts and mini golf get expensive, the movies start looking better, and demand for movie tickets shifts right. (Though notice: with date night getting pricier overall, you’ll probably go on fewer dates altogether. Can you see why?)

4. The price of a complement. Drop the price of one thing and you’ll want more of its partner. Cheaper kegs mean more demand for red Solo cups. Cheaper printers mean more demand for ink. The two travel together.

5. The expected future price. If you think the price is about to jump, you buy more today. This is perfectly ordinary. You stock up before a storm. You buy the car before the tariff hits. You fill the tank when you hear gas is going up next week. Expectations move the line right now, before the future even arrives.

6. Income. This one splits in two. A normal good is something you buy more of as you get richer: restaurant meals, vacations, new cars. An inferior good is something you buy less of as you get richer. The classic example is boxed mac and cheese. Broke college students eat a mountain of it, and there’s nothing wrong with that, it’s a sensible response to a thin budget. But once the paychecks get bigger, most people trade up. They don’t quit mac and cheese forever, they just eat less of it. New cars instead of used. Craft beer instead of whatever’s cheapest. Same person, different income, different choices.

Put it all together and you reach a slightly dizzying conclusion: the demand for anything depends on the demand for everything else. The price of kegs touches the market for cups. Your raise touches the market for mac and cheese. It’s all connected. Which is exactly why economists lean on the phrase ceteris paribus, Latin for “all other things held constant.” We freeze the rest of the world so we can study one thing at a time. We know the world doesn’t actually hold still. We’re just not magicians.

Now, the Other Half: Supply

Demand is about the people who want the stuff. Supply is about the people who make it. And supply runs on an idea you already know in your bones: opportunity cost.

Of course factories buy raw materials. No surprise there. But here’s the part that’s easy to miss. The factory has to convince the seller of those materials to sell to them rather than to anyone else on Earth. Why does that matter?

Because resources have opportunity costs too. When you use a chunk of titanium to make a golf club, that same titanium can’t become an airplane part. So when a business buys materials, it’s effectively making a bold claim: “I can turn this titanium into something more valuable than anyone else on the planet can, which is why I’m willing to outbid them all for it.”

And here’s the beautiful part. The only way that business survives is if it’s right. If it can’t actually produce something more valuable than its competitors with those materials, it loses money, it fails, and it stops gobbling up resources that someone else could use better. Profit and loss aren’t just scoreboards. They’re a sorting mechanism that pulls resources toward whoever uses them best and yanks them away from whoever doesn’t. Isn’t that something?

This is where the difference between accounting profit and economic profit earns its keep:

• Accounting profit is just dollars in minus dollars out. Revenue minus expenses.

• Economic profit is accounting profit minus opportunity cost, what you gave up to do this instead of the next best thing.

Suppose I have two job offers. A professorship that pays $200,000, or a job at McDonald’s that pays $35,000.

Taking the McDonald’s job isn’t “free.” It costs me the $200,000 professorship I turned down, which is why its economic profit is deeply negative. The accountant says I made $35,000. The economist says I lit $165,000 on fire. Both are right. They’re just answering different questions, and the economist’s question is usually the one that matters for decisions.

Why the Supply Curve Slopes Up

The supply curve slopes upward, the mirror image of demand, and it captures increasing marginal cost.

Picture yourself stranded on an island, Tom Hanks in Cast Away, spending all day catching fish. Now you want some coconuts. Which fishing spot do you abandon first, your best or your worst? The worst, naturally. And which coconut tree do you climb first? The best one. Want more coconuts? Now you give up your second-best fishing spot for your second-best coconut tree. And the third. And the fourth.

Every step, you sacrifice more fish to get fewer coconuts. That’s increasing marginal cost, and it’s exactly why the supply curve rises. The more you produce, the more valuable the alternatives you have to give up.

You feel this in your own life. How much harder will you work for $1,000 than for $1? To pull more hours out of you, I have to pay enough to outweigh whatever you’d give up. Lay out a typical day, sleep, gym, friends, TV, video games, eating, reading, and rank it by what you’d hate to lose. Ask you to work two hours and you’ll skip the gym, the thing you value least. Cheap. Ask for eight hours and now I’m taking your reading, your games, time with friends. That hurts, so I’d better pay a lot more. The supply curve is that rising price you demand as I ask you to give up more and more valuable pieces of your day.

And once again, mind the distinction:

• Supply is the whole line, the producer’s willingness to produce across all prices.

• Quantity supplied is the single amount actually produced at one given price.

What Makes the Supply Line Move

Just like demand, the whole supply curve can shift. Right means more produced at every price; left means less:

Four big movers push it one way or the other:

1. The price of resources. If steel gets more expensive, Ford’s willingness to crank out cars drops. Supply shifts left. Cheaper inputs shift it right.

2. Technology. When Eli Whitney’s cotton gin made it dramatically easier to process cotton, the supply of cotton products exploded rightward. Most technology shocks push this way, and here’s a humbling thought about how fragile that progress is. Hero of Alexandria built a working steam device, the aeolipile, back in the first century AD. And then nothing. For roughly 1,600 years it sat there as a toy and a temple parlor trick until Thomas Savery built a practical steam pump in 1698, and then Newcomen and Watt turned it into the engine of the Industrial Revolution. The idea was right there the whole time. Sometimes the bottleneck isn’t the invention. It’s everything around it.

3. Nature and political disruption. A hurricane wrecks the local supply curve, shifting it hard left. So do “political storms.” When a brutal dictator seizes power, people are understandably afraid to show up to work, and supply shifts left. Elect leaders who get the incentives right and you can shift it the other way. What exactly those good policies are is a longer argument for another day.

4. Taxes. And here I want to be careful, because this is a positive statement about how the world works, not a normative one about what we should do. Raise the cost of producing something, through a tax, and businesses produce less of it. Supply shifts left. Lower that cost and they produce more. Supply shifts right. That’s just the mechanics.

Now, please don’t go charging out of here yelling “the economist said cut all business taxes!” Because I didn’t. Tax dollars fund roads, courts, defense, and plenty else, and whether and how much to tax is a genuine normative debate worth having. All I’m telling you is what the supply curve does when you pull the tax lever. What you should do with that lever is up to you and the ballot box. My job is to make sure that when you step into that voting booth, you at least know which way the lever moves things. That’s education. The rest is your call.

So, BOGO or 50% Off?

Back to the grocery store. Why “Buy One, Get One Free” instead of “50% off,” when the math is identical?

Because demand slopes down.

Say each can of soup sits on the shelf for $1.50. To you, the first can is worth $2, but the second is only worth 50 cents, because of diminishing marginal utility. That second can just isn’t worth as much to you as the first.

Run the 50% off deal and each can costs you 75 cents. You happily buy the first can (worth $2 to you, a steal at 75 cents). But the second? It’s only worth 50 cents to you, and they want 75 cents for it. No sale. You walk out with one can, the store collects 75 cents, and it just gave away margin on the can you would’ve paid full price for anyway.

Now run BOGO. You pay $1.50 and walk out with two cans. The first was worth $2 to you, so you’re thrilled. The second was only worth 50 cents, but hey, it was “free,” so why not. The store collects $1.50 instead of 75 cents and moves twice the inventory.

Same math on the sign. Wildly different outcome at the register. The store isn’t being sneaky, it’s reading your demand curve and pricing the second can, the one you value less, at the only price you’d ever pay for it: zero. Everybody walks away happy, which is sort of the whole magic of trade.

The Big Idea

Strip away the jargon and here’s what demand and supply really teach you. Value isn’t fixed and it isn’t found in the thing itself. It lives at the margin, in the next unit, in the next hour, in the next trade. Water versus diamonds, your job versus the one you turned down, the first can of soup versus the second, it’s all the same lesson. There’s no “all or nothing.” There’s only “what’s the next step worth, and what does it cost?”

Get comfortable thinking that way and the world stops looking like a series of moral absolutes and starts looking like what it is: a vast web of people making trade-offs, bidding for resources, and signaling to one another through prices what they value and what they don’t. No one’s in charge of it. And it works remarkably well anyway.

That’s not a reason to cheer for any particular policy. It’s a reason to understand the machine before you start yanking its levers.

Dear Editor,

Mr. Holder is exactly correct that the redistricting chaos has gone on long enough (“This Redistricting Chaos Must End,” Opinion, 5/18/26). Unfortunately, his proposed solutions have all been tried before and have failed before. As long as people are born, die, and move around, the problems will not go away as long as we continue to use geography for our basis of representation. But in the age of computers, there is no reason to suspect that geography is the best way to group people.

An alternative means would be alphabetically by surname. One Representative could serve, for example, the Andersons, Baileys, and Changs of a state while another serves the Joneses through the Murphys. Each state could set their own cutoffs. Alternatively, we could allocate representation by birthday. The math all works the same, but politics would be transformed.

Pork barrel spending, a favorite among elected officials, runs on geography. A Congressperson can deliver a bridge or an Air Force base to a district, but not to surnames. A diffuse constituency, scattered across every town and county in the state, is a constituency that is hard to bribe with targeted spending.

The problem Mr. Holder identifies isn’t who draws the lines. It’s that we’re still drawing lines on maps to begin with.

David Hebert
Director, Economics & Economic Policy
American Institute for Economic Research

Ok, I’ll admit that the representation-by-surname example is a bit absurd. BUT, the underlying point that there’s no reason to automatically assume that geography has to be the answer to issues of representation.

If we’re going to continue drawing lines on maps, we’re going to continue having problems of gerrymandering. It is an unavoidable problem with this kind of system because you have to define what “better” and “worse” mean in the context of the decision. If you are a Republican, for example, the redistricting efforts going on in certain states would make those districts better for you. If you’re a Democrat, then those efforts will make those districts worse for you. If you think proportionate representation by race/gender/socioeconomic class/whatever is an ideal to strive for, then those districts may or may not lead to better districts for you.

Before we draw lines, we need to figure out what goal it is that we’re trying to accomplish with those lines, acknowledge it, and then go about determining where to draw the lines with that goal in mind. Instead, what we’re doing is exactly what we’ve done every time this comes up: argue about the lines and the goals at the same time. And as we’ve seen, that only produces problems.

For this week, I chose to expand upon that lesson and apply it to tariffs. You might not hear the thank-you from overseas and they might see how thankful you are when your item arrives, but those thank-yous are still very real. But the President decided that they weren’t and that we need to do something about them.

Imagine you walk into a store, hand over $40 for a shirt, and both you and the cashier say thank you. Now imagine a third person — someone who had nothing to do with the transaction — walks over, pockets $8, and tells you that you should be grateful he let the deal happen at all.

That’s a tariff.

When an American retailer imports a shirt from Vietnam, something important happens: both parties gain. The Vietnamese manufacturer gets dollars it prefers over the shirt. The American importer gets a shirt it can sell for more than it paid. Consumers get a shirt at a price they prefer over keeping their money.

Everybody said thank you. Everybody walked away better off.

This isn’t ideology. It’s logic. Voluntary exchange, by definition, leaves both parties better off — otherwise one of them wouldn’t do it. The double thank-you isn’t a pleasantry. It’s evidence that value was created, not merely transferred.

A tariff inserts a government between those two thank-yous and says: one of them doesn’t count.

Here’s the part that gets glossed over in the political debate: somebody pays the tariff, and it isn’t the foreign country.

When the U.S. government slaps a 25% tariff on imported goods, it doesn’t send an invoice to Hanoi or Beijing. It sends the bill to the American importer — the company buying the goods. That company then does what every business does with higher costs: it passes them along. To retailers. Who pass them along to you.

The foreign producer may lose some business, yes. But the primary, immediate, most direct effect of a tariff is a tax on American consumers and businesses.

This isn’t a controversial empirical claim. It’s close to consensus among economists across the political spectrum. The arguments for tariffs — protecting domestic industries, national security, reciprocity — are normative arguments about whether that tax is worth paying for other reasons. Those are fair debates to have. But the debate should be honest about who’s writing the check.

The Public Choice Question Nobody Asks

Here’s where it gets interesting. Apply a simple question to any tariff: who benefits, and who pays?

The benefits are concentrated. A tariff on steel helps American steel producers — a specific, identifiable, well-organized group with lobbyists, PACs, and senators on speed dial. The costs are dispersed. Every American who buys a car, a refrigerator, a can of soup, or a building pays a little more. But “a little more” spread across 330 million people doesn’t organize well. It doesn’t hire lobbyists. It doesn’t write campaign checks.

So the political incentive is almost always to expand tariffs, regardless of the economic cost. The winners show up. The losers don’t know they lost.

This is why economists across the ideological spectrum have been skeptical of tariffs for about 250 years — not because they’re naive about geopolitics, but because they understand whose interests tend to drive the policy.

The Honest Version of the Pro-Tariff Argument

To be fair — and economics demands fairness — there are serious arguments for strategic tariffs. National security considerations around semiconductors, pharmaceuticals, and defense manufacturing are real. The argument that trading with a non-market economy that subsidizes its exports distorts competition is not frivolous.

Now, I happen to believe that national security concerns still do not necessarily justify tariffs (for that, you need a monopoly trading partner with a very real chance of becoming hostile), but that’s arguably the most serious argument for tariffs in today’s day and age.

That’s a coherent position. The honest version of it, though, admits the cost. “We are choosing to pay higher prices in order to achieve other goals.” That’s a legitimate policy choice. What’s not legitimate is pretending the tariff is free, or that the foreign country is paying it, or that it’s purely punishing bad actors overseas.

Every tariff is a tax on the American who buys the imported good. The question is whether what we get in return is worth it.

The Takeaway

Trade isn’t complicated. Two people swap things they value less for things they value more. They both say thank you. Multiply that by a billion transactions a day and you get the modern economy.

Tariffs don’t undo bad deals. They interrupt good ones. They tax the thank-you.

Whether that’s worth doing is fundamentally a normative question. Reasonable people can absolutely disagree on this.

But before you decide it’s worth it, we need to lay out the positive facts of the matter. Americans, not foreign firms/countries, are paying the tariffs. They do not seem to have done much of anything to actually cause China any problems they weren’t already experiencing.

Positive analysis should help inform your normative judgements. But we need to understand the positive analysis first and right now, it’s not clear that we do.

President Trump wants to suspend the federal gas tax in an effort to give Americans relief at the pump. It sounds appealing, but it isn’t good policy.

The federal gas tax is set at 18.4 cents per gallon. If suspended, gas prices would certainly fall, but not by much. A typical driver filling a 15-gallon tank once per week would save about $8 per month. If we suspended it today through election day, drivers would save almost enough to afford one movie ticket to see Dune III.

The cost to the country, however, would be enormous. The federal gas tax raises $2.4 billion per month in revenue, which goes straight into the Highway Trust Fund and pays for road construction and maintenance across the country. Suspending it now through election day would reduce that fund by about $15 billion.

This is what makes the gas tax worth defending, even for fiscal hawks and libertarians. Unlike most taxes, it actually follows sound economic logic. The person who drives more, pays more in taxes. The trucker hauling heavy freight, whose rig damages roads far more than a family sedan, pays more. The charge from the gas tax follows the use, almost automatically. Economists call this the benefit principle: the people who use a service are the ones who finance it. The gas tax is one of the few places in the entire federal tax code where that principle actually holds.

Suspending it doesn’t make gas cheaper in any meaningful sense, especially when gas prices are already up almost 50% since the Iran conflict began. All it would accomplish is draining a fund specifically designed to keep American roads drivable, pushing that cost onto state budgets or deferring maintenance and costing American taxpayers even more down the road.

The only real solution to high gas prices is the one staring everyone in the face: end the conflict disrupting global oil supplies. A gas tax holiday is a bumper sticker masquerading as policy and undermines one of the few taxes in the federal code that makes sense. Drivers would end up with the same high prices at the pump, $15 billion less in the Highway Trust Fund, and worse roads to show for it. Some relief.

David Hebert is the Director of Economics & Economic Freedom at the American Institute for Economic Research

There are a few important caveats to this that should be mentioned. First, what the federal government does with the money is a completely separate issue from how the government collects the money. I’m defending the latter, but the former is clearly rife with the problems of overspending in certain areas, underspending in others, etc. that plague so many bureaucratically made decisions. If you want evidence of this, look at Detroit in the 1950s and the construction of I-75 and I-375, which were placed in such a way as to displace “undesirable” (read: African American) households and businesses. This is most certainly NOT what I am defending when I defend the gas tax.

Second, vehicles are getting better and better fuel economy as measured in “miles per gallon.” This is especially true of electric vehicles. One of my favorite exam questions I would ask (as an extra credit question) was “how many miles per gallon does a Tesla get? Explain your answer.”

Most students left the answer blank, I think because they were done with my exam at that point and the ridiculous questions I would ask. Some students put “infinity, because it doesn’t use any gas to make itself go,” which I’ll admit was the answer I was sort of looking for. But one kid answered “zero, because if I put gasoline in the engine of a Tesla, it would (probably) explode.” He got full credit and a lovely note for thinking outside the box (I also knew the kid and knew that he knew his stuff).

Returning to gas taxes… if vehicles are getting better and better mileage, then the revenue from the gas tax will go down relative to the number of vehicle-miles driven. This doesn’t bode well for financing the maintenance of roads through this means. For this reason, there are advocates for a mileage fee rather than a gas tax. At that point, though, they’re really talking about toll roads, which are fantastic, and perhaps we could have a discussion about full on road privatization.

But that’s a topic for another day.