Chicago Booth Review Podcast Why Economics Is Not About Numbers

Ram Shivakumar: There's lots of little stories, and in fact, at some point you may wonder how all of these are connected. Many times they're not. They're merely illustrations of a concept, and every now and then you realize, there is something overarching around this set of ideas. So I really can't think of how you can teach economics without teaching ideas.

Hal Weitzman: Economics is all around us. At least that's what Chicago Booth's Ram Shivakumar believes. And he's on a mission to demonstrate that economics is not about numbers or theoretical models, but is at play in many everyday decisions like whether to order a pizza, where to buy it from, and what toppings to get. Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking insights in a clear and straightforward way. I'm Hal Weitzman. Today, Ram Shivakumar tells us about his distinct approach to the dismal science. If economics isn't about numbers, what is it about?

Ram Shivakumar, welcome to the Chicago Booth Review Podcast.

Ram Shivakumar: Thank you. It's a pleasure for me to be here.

Hal Weitzman: Now we're here to talk about economics. You've been teaching economics for many, how many years?

Ram Shivakumar: 23.

Hal Weitzman: Wow. And I know that your approach to economics is a little different perhaps to what people think of as standard economics. Tell me about what's different about the way you think about the topic.

Ram Shivakumar: Well, in terms of the experience of being a student in my class, I think the first thing that I suspect is different is that I cold call people. My class is really a conversation. I ask people a lot of questions. I also get a lot of questions and a lot of thoughts from students. The second thing is I tell a lot of stories, small stories and big stories. The small stories are examples, illustrations of ideas. The big stories are the things that connect the small stories into something, a set of lessons, a set of principles.

Hal Weitzman: So does that mean we all know, we all kind of know economics because seeing it all around us in every day-to-day interactions? Rather than sort of like we think of economics as being charts, graphs, numbers, theory.

Ram Shivakumar: I think actually a lot of the ideas of economics may well be understood easily, and a lot of my students will tell me, oh, that's what this is. And I think one of the things that happens is that many people who take economics see it as a course on applied mathematics, and the mathematics stops them from understanding the ideas. I think one of the things they get from my various stories and illustrations is an understanding of the ideas of economics. And then when I use very simple mathematics, simple equations, it all becomes a little clearer.

Hal Weitzman: Okay. So in order to understand economics, we should forget about mathematics.

Ram Shivakumar: I actually think you don't need a whole lot of mathematics to understand the ideas of economics. Most of my students, perhaps 99%, are never going to be professional economists. They're managers. They're entrepreneurs. And they need to know how to use the ideas of economics. And so, yes, I don't think that you need to know a whole lot of mathematics to know economics.

Hal Weitzman: Okay. So like you said, you've been teaching microeconomics here for...

Ram Shivakumar: For 23 years.

Hal Weitzman: ... 23 years. Wow.

Ram Shivakumar: Microeconomics and competitive strategy.

Hal Weitzman: So how do you think about microeconomics? What is it that you are teaching? What is it that you're trying to get across to your students?

Ram Shivakumar: I think microeconomics is actually a set of principles, not formulas, but principles that is very context-dependent. So I often tell my students that what I'm teaching them is the art and craft of economics as much as the science. When you look at the textbook, they see the science of microeconomics. When I say art, art is about ideas, art is about vision. And so the hope is that taking a course in economics and connecting with the ideas of economics helps them think more creatively in their work. The second part I'd emphasize is the craft. Craft is actually the practical aspects of executing on ideas. I don't know that I can teach the exact skills that are required to succeed in the world, but my stories illustrate the importance of the craft of economics. So art, craft, and science, truth be told, probably a lot of the first two and a lot less of the third compared to a typical economics textbook.

Hal Weitzman: Which is fascinating. Because, of course, we call economics the dismal science, and it's something where I guess within social science, economists think they're the real scientists, don't they? And they maybe think that other, the political scientists and the sociologists and whatever, are sort of chasing some of the quantitative approaches that they have. But you are saying actually it's you lead with ideas and concepts. You don't lead with numbers...

Ram Shivakumar: Yes.

Hal Weitzman: ... or measurement maybe would be a better way of putting it.

Ram Shivakumar: Yes. I think for the average person in this world, a deeper familiarity with the ideas of economics is really all that's required. If you want to go on to specialize and become an economist, yes, a deeper knowledge of the methodology is important. Yes. You are right that within the social sciences, economists might be said to have a very high opinion of themselves, okay, but I think it's-

Hal Weitzman: But just think for example, there's a Nobel Prize in economics. There is not a Nobel Prize in sociology yet.

Ram Shivakumar: Yes. But I should also add that in the last few decades, branches of economics, like the ones that I'm teaching, applied microeconomics and competitive strategy, we've learned a lot from scholarship done by people in organizational sociology and in psychology. This is the behavioral science stuff that we have spoken about offline. Yes. I think we have learned a lot from them. I'd like to think that economists are adaptive. They're learning. And we know that our science is imprecise. Economics is an art. If you think about all our discussion today about policymaking and what the Federal Reserve is going to do, it's an art. It isn't always easy to mechanically apply things. So yes-

Hal Weitzman: Right. That's right. You can't just feed the numbers into an AI algorithm or whatever and get the correct answer because there isn't necessarily a correct answer.

Ram Shivakumar: Probably not yet.

Hal Weitzman: Well, maybe that will be the answer to the whole Fed discussion, then...

Ram Shivakumar: Yes. Yes.

Hal Weitzman: ... we'll just replace it with an algorithm. So tell us about, again, back to your approach, is there one sort of ideal theme that runs through? You talked about the art and craft. Is there a one theme that's really important through as you navigate through the art and craft of economics?

Ram Shivakumar: Yes. It took me many years to understand this. As you know, we're in a business school. Almost all of our students are managers and entrepreneurs, whether in the for-profit or not-for-profit world. So my microeconomics class as well as the competitive strategy class is very much focused on what I would call management, personal management, and professional management. And so one of the themes in my econ class that I discovered, slowly, it dawned on me that what I'm really talking about is value creation, economic value creation. Microeconomics, whether it's E101 or E201 or E301, one way or the other, focuses on three variables: demand, cost, and prices. We are talking about these three variables all the time. And very simply put, if I were to give you a simple image to keep in your head, think of demand as being discreet, represented by this variable, I'll call B.

B is the buyer's maximum willingness to pay for anything. If the price goes above B, the customer does not buy. Then you have this variable, C. Let's call it the average cost of producing something. If everything is well, B is much greater than C. Indeed, every business has to create a gap between B and C. That's creation of economic value. Now, there's this third variable called P. P, if it's greater than C, means that the company is making a profit. If P is below C, the company is losing money. This P is shaped by competition, and it is shaped by bargaining or negotiation. In fact, all of microeconomics in one way or the other is about what happens to these three variables. And so this is the theme that runs through an entire economics class.

Hal Weitzman: So you've outlined B, C, and P. How does that relate to the classic kind of supply and demand then?

Ram Shivakumar: It's actually very useful to study the supply-demand model right at the beginning. And it's no accident that everyone, whether you're in high school or an advanced program, encounter it. The supply-demand model is very important because it illustrates two important concepts. One is how the price is determined. The price is determined by the balance of opposing forces, consumers who want the prices to go down and producers who want the prices to go up. Immediately, we can speak about a concept that economists have borrowed from physicists, the concept of an equilibrium, where a system is at rest. So I think this is a very important idea. Now, the way real markets work is very, very different. Markets are heterogeneous, but I show people how demand and supply works in each of these markets. Let me say that when I talk about demand and supply, I also speak about both the intellectual aspects of the model and the practical aspects.

Let me speak about the practical aspects. Every business, every manager has to understand one thing: that that demand curve for your product or service has to be created. It doesn't fall on us like manna from heaven. We have to create it. We have to persuade someone to buy our product. If we are talking about a pizza, it's a category that's well understood everywhere in the world. But if you've got a pizza, Ram's pizza, I have to convince people to come to my store. That will depend on everything from my location to my branding to the quality of my product to what anyone else is doing. So very quickly, people understand that there are a whole range of forces that are impacting demand. Then the other side, supply. If you are a pizzeria, you have to control your production. You have to procure the inputs, the raw materials, the labor, the oven. So Hal, going back to something you said, a lot of people actually know economics, but they haven't encountered it the way it is taught in the classroom. So like Moliere's character, they've been speaking prose all their life.

Hal Weitzman: Love the fact that you bought in Moliere.

Ram Shivakumar: Yes.

Hal Weitzman: But also the fact that you bought in pizza.

Ram Shivakumar: Yes.

Hal Weitzman: So anybody who's ever ordered food, who's had to decide, should we go to Ram's pizza or should we go to Domino's or whatever or have Indian food instead, has kind of made these economic calculations fed into a demand curve and everything else. Correct?

Ram Shivakumar: Exactly. And this is actually, I use the pizza example throughout the course because it's one that's easy to understand. So consumers are deciding do they want to eat pizza or Chinese or Indian food? They're also deciding which pizza to go to. That decision depends on everything from quality to price to, let's call it, convenience. So very quickly, as a business person, you understand that you may control a few things, but someone else and their decisions also impact the demand for your product. In meantime, you are busy getting prepared to supply all the pizza people want. What I have discovered in my conversations with people is that they actually practice economics. They just don't know that it's economics.

Hal Weitzman: So we're all economists.

Ram Shivakumar: You know, I'm not sure if people want to be called economists, but I would say that they understand the ideas of economics.

Hal Weitzman: If you're enjoying this podcast, there's another University of Chicago podcast network show that you should check out. It's called Entitled, and it's about human rights. Co-hosted by lawyers and law professors, Claudia Flores and Tom Ginsburg, Entitled, explores the stories around why rights matter and what's the matter with rights.

Ram Shivakumar, we talked in the first half about your different approach to economics when everybody who's ordered a pizza has, as you say, sort of been involved in economics in some sense, was practicing economics. Someone who's never taken an economics class, how is what you've described, your approach, different from what they would learn in a very traditional economics class?

Ram Shivakumar: A lot of the students who take my classes are somewhere between the age of 25 and 35. Many have never taken an econ class before. Some have, but they've taken it when they were very young, probably not taken any other courses since. So just being a little older, being a little bit more mature, having worked in the real world leaves them in a different place in terms of understanding concepts and ideas. So if you were to take my course, and I don't know if you've taken a course on economics before, I think you will find many of the things I'm talking about very familiar because they are in fact the things you and I encounter every day.

Hal Weitzman: Well, so I did take economics when I was in school, were the first times I encountered economics, and it was not as you described, it was about short run, long run, average cost curves, this kind of thing. So it was very mathematical and very conceptual and theoretical and not very practical, and certainly we didn't talk about pizza. So I'm just wondering how is this different from the way that economics is traditionally taught in the way that I learned it?

Ram Shivakumar: I think that it's unfortunate that what is often emphasized in econ courses is the methodology more than the ideas. And I think because I'm teaching in a business school where the emphasis is more on the application of the ideas, I tell lots of stories and I provide lots of examples, and then I pair it up with some concepts, some ideas that make it clear, the ideas and the theory, how they connect.

Hal Weitzman: And is economics generally well explained by economists? Are they good at explaining economics to the rest of us?

Ram Shivakumar: I suspect not. I mean, of course there are some people who are very brilliant communicators, but I think there are lots of jokes that go around that economists like to make the simple very complex. But I think the ideas of economics have been underappreciated. That's the point I want to make. They're underappreciated because people often think of economics as being complex theories of how things work. Maybe there are those theories, but let me just say that 90% of what a human being needs, I'm talking about the average person. You need just Econ 101.

Hal Weitzman: Okay. And so let's do a bit of Econ 101 because you talked about the B, C, and the P. and so let's go into the P a little bit Because I know that price elasticity is a big concept in your courses. Tell us about price elasticity and how you explain it, why it's important.

Ram Shivakumar: Well, one of the things people begin to appreciate is that not all demand curves are the same. Some demand curves are flatter. By the way, we have reference for any reader or listener, a demand curve is drawn on a P-Q axis where P is on the vertical axis Q is on the horizontal axis. So when I say the demand curve, it's a downward sloping curve, which is saying that-

Hal Weitzman: So that's price and quantities that we are [inaudible 00:17:46]

Ram Shivakumar: Prices and quantities. That is as prices go down, quantity goes up. Other things constant, and I'll explain that in a moment.

Hal Weitzman: If it's something cheaper, you want more of it.

Ram Shivakumar: That's correct. Consumers would, other things constant, buy more as prices are lower. The supply curve is upward sloping, other things constant, which means that as prices go up, producers will sell more. They have an incentive to produce more, other things constant. So one of the things that you begin to appreciate is that not all products have the same price elasticity. So you may know this story, I've spoken to you about this, the pharma bro, Martin Shkreli, some years ago brought up the rights to this drug, which this company was the only one that was producing it, and he bought it, and then he raised the price several hundred fold. I can't remember the exact numbers.

Hal Weitzman: It was like 500% or something like that.

Ram Shivakumar: Something like that. He raised the prices considerably. There were not a lot of people buying it, but the demand curve, it turns out, was what economists would call very highly inelastic. That is people needed that drug. So he was actually able to raise prices and raise revenues considerably. Let me give you another little story that's happening right now, tariffs. What tariffs do is it forces the importer of the product, the producer of the product, a foreign company, and a consumer to share in the price changes.

If a demand for something is very inelastic, it is likely that this consumer will over time have to or will have a bigger burden of this tariff increase because a tariff essentially is like a reduction in supply. Of course, the exporter, a foreign company, may decide to reduce its price and hence bear some of the burden of the tariff. So between these three players, the consumer, the importer of the product, an American company, and the exporter of the product from a foreign market, there is this burden sharing. This burden sharing depends on price elasticity, and I'm sure companies are calculating these things now to decide what their prices should be.

Hal Weitzman: Right. Okay. So you've talked about price elasticity. Talk about scaling because a few years ago you recorded a series of videos for us about scaling up an idea. Talk to us about how that scaling fits into your approach to economics.

Ram Shivakumar: Well, one of the things I speak about my class is this idea of minimum efficient scale. This is a concept. MES is what economists call it. It is the lowest volume level at which a company's average cost is approximately minimized. Let me connect this to something we often encounter on this television show, the Shark Tank. In the Shark tank, the sharks often ask the entrepreneur, how low can you get your costs? That is if he gave you capital or he acquired capital and you scaled up, how low can you get your costs, meaning average costs? Sometimes this average cost curve falls very steeply. Sometimes it doesn't fall as much. What we want to know is what is the minimum scale, minimum amount of volume at which your costs get almost as low as it gets. Now, if a company is not operating at MES, it has a severe cost disadvantage.

Imagine, for example, you are producing cars and your volume is only 10% of MES. If that average cost curve is very steep, you are likely not going to survive. So that's the reason why MES, as a concept, is really important. MES may be less important in businesses like restaurants or producing mineral water. It may be much more important when we are talking about breakfast cereal or when we are talking about even farming and agriculture. This is, I'm speaking about the United States at least. So MES is a critical concept. All those companies out there that are trying to raise money, they're trying to raise money because they recognize that the scale that is required, the minimum efficient scale has to be very big. Think of all the money that OpenAI is raising or any of the other AI companies. It's in the tens of billions of dollars because they know that's what it takes in order to hit minimum efficient scale.

Hal Weitzman: Now, when we talked about the B, C, P, and this applies to everything you've talked about. You said there's kind of a negotiation or a back and forth. There's competition, which plays into that. How do you talk about competition?

Ram Shivakumar: Well, actually, economics spends a lot of time on competition. I usually start by one extreme, perfect competition. In a model of perfect competition, there are numerous producers, numerous consumers. Every producer faces substantial competition, so they cannot undercut the other guy. The price, in other words, is determined collectively by the collective forces of supply and demand. So this is the extreme case where company really has no freedom to set a price. From there, we begin to speak about a whole range of pricing models, whether it's monopoly, which is the other extreme, the single producer that the power to set any price it wants to the price discriminating monopolist who can set prices for different groups of customers or different individuals. So this is very, very interesting for students because it bears resemblance to what they encounter as consumers. Whether you're taking an Uber or you're buying an airline ticket, there are so many applications of this. So I speak about competition throughout my course. And then of course, we end in the last few weeks with oligopoly, which allows me to speak about game theory and the like.

Hal Weitzman: Just very briefly, Ram, you talked about storytelling. Why storytelling? Obviously that sounds good to me, but as an economist, what does storytelling help you rather than just distract you?

Ram Shivakumar: I can't see how one can actually teach economics without stories. Even economists are telling themselves stories. Even if you read classic books in economics, they're storytelling, whether it's Adam Smith or John Maynard Keynes. I think these stories actually are born out of real experiences. These experiences help economists develop theories and hypotheses and ideas. And so what I said in the beginning was we tell a lot of stories. It's a bit like the Iliad or the Odyssey or the Mahabharata. There's lots of little stories, and in fact, at some point you may wonder how all of these are connected. Many times they're not. They're merely illustrations of a concept, and every now and then you realize there is something overarching around this set of ideas. So I really can't think of how you can teach economics without teaching ideas. Even a very detailed model is a story.

Hal Weitzman: So it's all stories?

Ram Shivakumar: I think so. I think it's stories reflected in the end for the professional economist in equations. It is a story. Every model is a story.

Hal Weitzman: Yeah. Okay. Well, maybe that's a good note to end on. Thank you for coming on the Chicago Booth Review Podcast, Ram Shivakumar, and telling us about the story of economics.

Ram Shivakumar: Yes. Thank you. My pleasure.

Hal Weitzman: That's it for this episode of the Chicago Booth Review Podcast, part of the University of Chicago Podcast Network. For more research, analysis, and insights, visit our website at chicagobooth.edu/review. When you're there, sign up for our weekly newsletter so you never miss the latest in business-focused academic research.

This episode was produced by Josh Stunkel. If you enjoyed it, please subscribe, and please do leave us a five-star review. Until next time, I'm Hal Weitzman. Thanks for listening.