What are some results in Economics that are both a consensus between most economists and far from common sense?
I would also welcome suggestions of clear definitions for what we should mean as consensus , specially considering that economics is an area with a lot of methodological divergence. Let me try first, a suggested definition for consensus in this setting would be:
the existence of a group of experts that would claim that the result is certainly true.
The principle of comparative advantage
As Paul Samuelson (1969) put it:
thousands of important and intelligent men ... have never been able to grasp the doctrine [of comparative advantage] for themselves or to believe it after it was explained to them.
Example
Imagine that an American worker who devotes all his time to soybean production can produce up to 100 tons of soybeans per year. And if he devotes all his time to steel production, he can produce up to 4 tons of steel per year.
In contrast, the corresponding figures for a Chinese worker are 30 tons of soybeans or 3 ton of steel.
Maximum possible production
American Chinese
Soybeans 100 30
Steel 4 3
A layperson could reason:
An American worker is literally more productive than a Chinese worker at everything. So why aren't we simply producing all of our own soybeans and steel?
Instead, we're doing the foolish thing of importing steel from China!
This reasoning is "common sense". It is also wrong.
Although the American worker is "better at everything" (we say he has the absolute advantage in producing both soybeans and steel), the Chinese worker has the comparative advantage (CA) in producing steel. This is because by producing 1 ton of steel, the American forgoes 25 tons of soybeans, while the Chinese forgoes only 10 tons.
And so, by the principle of CA, the American should focus on producing soybeans and the Chinese on producing steel. The two can then trade to mutual benefit.
Numerical example:
Say that without trade, the American spends a quarter of his time producing steel and the rest producing soybeans. The Chinese spends half his time on each. Hence:
1. Consumption without trade
American Chinese
Soybeans 75 15
Steel 1 1.5
But they can do better by specializing and trading. The American, whose CA is in soybean production, should specialize in soybeans. And the Chinese, whose CA is in steel production, should specialize in steel.
2. Production after specialization but before trade
American Chinese
Soybeans 100 0
Steel 0 3
The American can then trade, say, 20 tons of soybeans for 1.2 tons of steel. End result:
3. Consumption after specialization and trade
American Chinese
Soybeans 80 20
Steel 1.2 1.8
Comparing Scenarios #1 and #3, we see that with specialization and trade, both the American and Chinese workers are strictly better off. Remarkably, each gets to consume more of both soybeans and steel than they did without trade.
Thus, even though the American is "better at everything", the principle of CA offers a powerful rationale for why he should still import steel from China and be "dependent" on the Chinese worker.
Most theorems in economics would satisfy the consensus requirement. However, depending on what you consider to be common sense, different results will qualify. The following are two results that I found sufficiently hard to believe when I first encountered them.
The revenue equivalence theorem, which, according to Wikipedia, implies that
any single-item auction which unconditionally gives the item to the highest bidder is going to have the same expected revenue.
Arrow's impossibility theorem, which, according to Wikipedia, suggests that
no rank-order electoral system can be designed that always satisfies these three "fairness" criteria:
- If every voter prefers alternative X over alternative Y, then the group prefers X over Y.
- If every voter's preference between X and Y remains unchanged, then the group's preference between X and Y will also remain unchanged (even if voters' preferences between other pairs like X and Z, Y and Z, or Z and W change).
- There is no "dictator": no single voter possesses the power to always determine the group's preference.
In an open economy, the balance of payments current account equals net saving. This is often represented as:
$$S - I = X - M$$
where $S$ is saving, $I$ is investment, $X$ is exports and $M$ is imports. That is admittedly a slight over-simplification as current account includes not only exports and imports of goods and services but also other items such as income from foreign investments or employment abroad, and foreign aid. For many countries, however, the net amount of these other items is relatively small so that the balance on trade in goods and services approximates fairly closely to net saving.
This appears to diverge from common sense since, if a country has a trade deficit, most non-economists looking for explanations will consider possibilities such as:
Very rarely will a non-economist suggest that a trade deficit has anything to do with levels of saving and investment.
Note that saving and investment here include those of both the private and the government sectors. So one implication of the above is that a government deficit, unless offset by private sector net saving, will be associated with a trade deficit (just 'associated' because the direction of causation is a further question).
The Giffen Paradox - increasing prices can lead to higher demand even if the goods are considered inferior.
General consensus is increasing prices lead to less demand - if it's more expensive, people will buy less.
In some cases, increasing the price will make consumers perceive a good to be of higher quality, or more desirable, thereby increasing demand. (Example - if iPhones cost only one third of what they do, nobody would spend their money on a phone that doesn't even run Android).
However, even with inferior goods, rising prices can lead to higher demand. This paradox was first observed by Giffen in the 19th century, when rising potato prices meant poorer people weren't able to afford the occasional egg or piece of meat anymore, buying more potatoes instead.
The fact that the burden of a tax on sellers can by borne by buyers, and vice versa. More generally, the fact that true tax incidence is largely or completely unrelated to who is nominally being taxed (e.g. taxes on yacht purchases can in principle hurt the poor more than the rich, etc.).
The fact that in a perfectly competitive market with free entry and exit, all firms make zero profits in the long run (if opportunity costs are taken into account).
Coase's theorem: "if trade in an externality is possible and there are sufficiently low transaction costs, bargaining will lead to a Pareto efficient outcome regardless of the initial allocation of property". (E.g. under a cap-and-trade system for pollution permits with sufficiently low transaction costs, the final allocation of permits is independent of the initial allocation, even if some permits are sold and others are arbitrarily given away for free.)
This one's a bit more "in the weeds", but the difficulty of eliminating the marriage penalty: "it is mathematically impossible for a tax system to have all of (a) marginal tax rates that increase with income, (b) joint filing with income splitting for married couples, and (c) combined tax bills that are unaffected by two people's marital status."
Best price clauses and, to a lesser extent, price-matching guarantees have been the subject of intense regulatory activity in recent years. Here's a fact that is surprising to many, despite there being a significant consensus in the economics profession:
Best price clauses and price-matching guarantees can harm competition and consumers
A best price clause/most favored nation clause/price-parity clause requires a seller listing a price via one venue (e.g. a price comparison website) to ensure that the price listed there is no higher than that available through other similar venues. It is often imposed by venue operators to ensure their venue will attract customers. Common sense suggests that a clause requiring a vendor to be offered the lowest available price should be, at worst, neutral for consumers.
Suppose there are two venues, $A$ and $B$, that a seller can sell through. Suppose both are large suppliers of business to sellers, so simply quitting one of the venues is not a viable option.
Here's the problem: if venue $A$ charges a commission of $c_A$ to sellers who sell through its platform and venue $B$ charges commission $c_B>c_A$ then sellers will set a lower price on $A$ than on $B$ to try to steer consumers to buy through venue $A$ (where it pays lower commission). Thus, a venue can have consumers steered towards it by cutting its commission--venues compete in commission. Moreover, lower commissions (which are essentially a variable cost for the seller) are passed-through to consumers in the form of lower prices.
Now suppose there are best price clauses in effect. If $c_A<c_B$ then sellers can't steer consumers towards $A$ by setting a lower price on $A$ because $B$'s best-price clause requires the price on $B$ to be no higher than that on $A$. Thus, $A$ can no longer attract customers by cutting its commission, and so has no incentive to compete in its choice of $c$. This results in higher $c$s and higher consumer prices. This effect is theoretically robust and empirically well-validated.
A price matching guarantee is a promise from a seller to a consumer of the form "If you find the same product at a lower price elsewhere, I'll beat that better price". Common sense suggests a guarantee to beat the lowest price in the market should be good for consumers. Not necessarily so.
Here's a rough illustration of why: Suppose sellers A and B both have price-matching guarantees and consumers have a preferred seller from whom they buy by default unless the other seller offers a better deal. Normally, sellers would cut their prices to try to attract consumers from their rival. But here that doesn't work! If A cuts its price then the consumers whose default is B can just go to B and get it to match A's reduced price. But this means A has no benefit from lowering its price and will just stick with the same high price that it had all along. The price-matching guarantee has completely killed price competition!
I’m going to toss my hat into the ring with the very notion of
Who hasn’t argued with someone who “likes” A, which has an opportunity cost B, and have that person adamantly refuse to consider the loss of B as a cost for A or in any way relevant to the choice to get A? If you’ve ever tried to persist in such a situation, I’m sure you also quickly found the other person getting offended, as if you were insulting A and/or them for liking A.
A large part of the problem is, of course, the not-so-subtle verb substitution I used: the person in question here is talking about, and thinking about, “liking” A. The speaker, you or I in the hypothetical, is instead talking about the decision of whether or not to procure A. The argument is, fundamentally, that A can be good, worth “liking,” but not worth it—because of the opportunity cost B. And if anyone knows of a good way to explain that and assuage hurt emotions over feeling attacked for liking A, I’m all ears! Recognizing the problem does not itself produce a solution to it.
Anyway, unlike a lot of other issues on this page, which are important but not a daily concern, opportunity cost is, or at least could be, at the heart of just about every decision every person makes. It is relevant to all people, but a lot of people seem to not just ignore it, but to actively disdain the very concept. Therefore it seems, to me, like a strong contender here.
Price discrimination can make consumers better-off
This can happen in a variety of ways. For example, suppose that 50% of consumers are 'loyal' to firm A and 50% loyal to firm B. A consumer is willing to pay $v$ for one unit and incurs a switching cost $s\in(v/2,v)$ if they buy from a firm other than the one to which they are loyal. Consumers buy from the firm offering the highest utility, breaking indifference in favour of the firm to which they are loyal.
If firms must offer the same $p$ to all consumers then, the only pure strategy equilibrium has $p_A=p_B=v$.
If we allow firms to price discriminate by offering different prices to loyal and non-loyal consumers then $p_i=v$ is never an equilibrium and there is an equilibrium in which $p_i^{\text{loyal}}=s$, $p_i^{\text{non-loyal}}=0$.
Without price discrimination firms don't compete to attract the rival's consumers. Intuitively, it takes a price cut of at least $s$ to do so, but that means also losing $s$ units of profit from loyal consumers who also benefit from the price cut. With price discrimination, on the other hand, a firm can fight for its rival's loyal without sacrificing any profit on its own. But this goes in both firections so both firms end up having to fight for their loyals against a rival that is trying to poach them.
Another ways that price discrimination can benefit consumers is by giving a firm enough profit to make a product viable (otherwise the product wouldn't get produced at all, leaving consumers with zero surplus).
Lowering income tax rates can in some circumstances increase revenue. A simplistic view would assume higher taxes = higher revenue, but it doesn’t account for the fact that different tax rates alter behavior. It becomes obvious when you look at the extreme end — with a 100% income tax rate, nobody would bother having a job, because they don’t get to keep any of their wages. Government income from the tax would plummet.
The overall concept is described in a theory called The Laffer Curve
Let's say current engine technology allows vehicles to go one mile on a gallon of gas. Improving engine technology to achieve 10 MPG must decrease the amount of gas used, right?
Actually it depends. Increased efficiency has two effects. One effect is that per unit of distance, less gas is consumed. Another effect is that driving one unit of distance is now cheaper, increasing travel. How much travel increases depends on how much the demand curve rises moving from the old unit price to the new unit price. In fact travel can increase by a larger factor than efficiency increases, leading to more fuel consumption.
There is the monetary Impossible trinity concept in international economics:
The impossible trinity (also known as the "trilemma" ...) is which states that it is impossible to have all three of the following at the same time:
Granted there may not be much "common sense" thinking on such an esoteric concept. But the Economist magazine thinks it is pretty important according to The Economist. Also, more people are becoming aware of such things since the blockchain and cryptocurrency popularity surge in late 2017.
(Tradeable) Permits
The fact that you can correct for externalities with (tradeable/marketable) permits seems to be a consensus with economists. But considering the existing applications, the theory appears to be not common sense.
Example:
The EU/countries in the EU have implemented a Carbon Emission Trading scheme while nations within the EU continue with other regulation like promotion of solar/wind, etc. When the point of a permit trading scheme is for the market to allocate the efforts to that place where you can save CO2 most efficiently. The added regulation only distorts the permit market without actually helping to reduce the CO2 produced, as the amount of CO2 produced is set by the amount of permits issued. And by funding solar, you just make permits cheaper and increase pollution in another sector.
Another quirk is, that permits are grandfathered to companies to keep the prices down, when the gifted permits result in an opportunity cost of using them (since you could sell them at the same price), making the price rise at just the same rate as if the company had bought them. The only result of grandfathering being that it gifts money to established companies, distorting the market.
To address some further concerns in the comments:
If the amount of issued permits were to high this would still be an example of policy makers not understanding the theory of permits. The thing is, either you base your CO2 reduction policy completely on permits or not at all. If you issue too many of them, then they don't have an effect and the only reduction comes from other measures so the implementation of permits is bad. But if they are actually binding (i.e. there are less permits than people want to produce) then all the other measures have no effect as they only shuffle around where the CO2 gets produced. So the implementation of other measures is bad. In either case there seems to be a lack of understanding of how permits work.
And I also want to argue that there are not too many permits anymore, the surplus was due to the crisis in 2008. And while I would still argue that the amount issued is still too high, the price is high enough above zero, that a reduction of CO2 in one place would probably lead to an increase in a different place. But again, it does not really matter. The issue is, that they did not implement a theory in a way that it actually works properly.
It is rational to defect in the Prisoner's Dilemma
Cooperation is socially optimal in the Prisoner's Dilemma, and in this economists and non-economists typically agree. However, the rational, i.e. the individually optimal choice, is to defect. From the game-theoretic point of view this is trivial, since the payoffs of the Prisoner's Dilemma game make defection a strictly dominant strategy. But it is notoriously difficult to get non-economists to agree to this reasoning. After all, if both prisoners cooperate, this makes both of them better off compared to bilateral defection, so isn't this proof enough? Ken Binmore’s (2007) Game theory: A very brief introduction contains several different lines of reasoning people have come up with to support cooperation as the individually optimal choice; all of them flawed.
The assumption of the rationality of the agents is a consensus on neoclassical economics and other schools, that is often badly translated to real world examples by economists, due to the difficulty of measuring utility.
The dictator game translates this idea quite clearly: game theorists some economists claim humans often act “irrationally” when making offers larger than zero. Their mistake is to assume the utility outcome of the player is equal to the monetary outcome.
The "single monopoly profit theory" is often viewed as quite counter-intuitive:
Leverage of market power cannot be used to profitably foreclose a rival.
Suppose there are two products, A and B. A is monopolised and produced only by firm 1; B is supplied competitively by both firm 1 and firm 2. Common sense presents to following concern: firm 1 might try to use its market power in A to become a monopolist in B and foreclose competition from firm 2. One way to do this would be to bundle A and B1 together. Everyone who buys A would also be forced to buy B1, even if B2 were the better product. This would make it difficult or impossible for 2 to achieve any sales.
This logic is flawed, as the Chicago school pointed out. Suppose consumers will pay $v$ for A, $v$ for B1, or $v+\Delta$ for B2 (so $\Delta$ is firm 2's quality advantage). Suppose that A and B1 are bundled and that consumers buy the bundle. In a desparate attempt to win business, 2 will cut the price of B2 to zero (this is the usual Bertrand logic). Thus, consumers will buy the bundle if $$2v-p_1\geq v+\Delta\implies p_1\leq v-\Delta.$$
Thus, the best 1 can do through bundling is to earn $v-\Delta$ from each sale of A and B1. But it could do better simply by selling A at a price of $v$ and giving $B_1$ away for free. Thus, the claim that bundling/leverage of market power is a profitable way to foreclose competition turns out to be logically flawed.
Addendum: subsequent work has shown that leverage of market power is possible in various situations. But the conditions needed for it to work are more intricate than suggested by common intuition.
Nice question! I would like to add a few elusive ones that I think are important.
Natural selection does not require intelligence. It is more of a biology theory, but its economic implications are vast. Evolution of cooperation is very useful but often ignored by economists and politicians as it goes against some common sense rules.
The entire theory of probability is counter-intuitive and has plenty of traps in economics for those who use only common sense. One example is a Monty Hall paradox: once you made your decision with limited information, you will gain by changing your decision when you get more information. A common fallacy of "throwing good money after bad" stems from ignoring this principle. Literally everyone has been guilty of it.
''Diamond Paradox'' by Diamond (1971)
This is a "less-known paradox," usually put as a counter to famous Bertrand paradox. It is a starting point in the literature on informational frictions in consumer markets, and the scientists in the field agree on its significance.
Its idea is diametrically opposite to that of Bertrand. Consider the following simple example. There are $2$ firms which produce homogeneous goods at zero marginal cost and compete in prices, $p$. This simultaneously set prices. Also there is a single consumer who supplies a demand given by $1-p$. Importantly, the consumer does not observe prices set by firms and, therefore, needs to search for them sequentially, where search is costly. Suppose that cost of visiting a firm is given by $0 < c \leq \frac{1}{2}$. Then, the unique equilibrium of the market is that both firms charge monopoly price $$p^M= \frac{1}{2}.$$
This is a diametrically opposite result to that of Bertrand.
The reasoning behind the result is as follows. Suppose both firms charge $p=0$. Then, the consumer randomly visits one of the firms, say firm $i$, and buys. However, firm $i$ could have charged $c$ and made positive profits as the consumer would have bought goods anyway because she would have suffered cost $c$ had she left firm $i$ in order to buy from the rival firm. By the same argument, one can see that $p=c$ cannot be an equilibrium as now firm $i$ can charge $c+c$ and improve its profit. Continuing this way, it is easy to arrive to an equilibrium where both firms charge $p^M$. A firm does not want to charge $p^M+c$ simply because its profit is maximized at $p^M$.
Formal Analysis of the Example
Timing: First, the firms simultaneously set prices. Second, the consumer without knowing prices engage into sequential search. The first search is free and the consumer visit each firm with equal probability. The consumer can come back to the previously searched firm for free. The consumer has to observe a price of a firm to buy goods from that firm.
Beliefs: In equilibrium, the consumer has correct belief about strategies of firms. If, upon visiting a firm, she observes a price different from an equilibrium one, the consumers assumes that the rival firm has deviated to the same price too. Thus, the consumer has symmetric (out-of-equilibrium beliefs). Note: the results of the game does not change if the consumers has passive beliefs.
Strategies: Strategies of the firms are prices. As mixing is allowed, let $F(p)$ represent the probability that a firm charges a price no greater than $p$. Strategy of the consumer is whether to search for the second price, upon observing the first one. This strategy is given by a reservation price $r$, such that upon observing a price lower than $r$ she buys outright, upon observing a price greater than $r$ she searches further, and upon observing a price equal to $r$ she is indifferent between buying immediately and searching further.
Equilibrium Notion: Concept of Perfect Bayesian Equilibrium (PBE) is employed. A PBE is characterized by price distribution $F(p)$ for each firm and the consumer's reservation price strategy given by $r$ such that $(i)$ each firms chooses $F(p)$ that maximizes its profit, given the equilibrium strategy of the other firm and the consumer's optimal search strategy, and (ii) the consumer searches according to the reservation price rule $r$, given correct beliefs concerning equilibrium strategies of firms.
Theorem: For any $c>0$, there exists a PBE characterized by triple $(p^M, p^M, r)$, where $p^M$'s are charged with probability $1$ and $$r=1.$$
Proof: First, I prove that $r=1$, or that the consumer buys outright when she observes any price lower than $1$. Clearly, if she observes a price greater than $1$ she does not buy from that firm as this yields a negative payoff to the consumer. Now, suppose she observes price $p'<r$. Then, she expects the rival firm to charge $p'$ too. Thus, if she buys outright her payoff is $\int_{p'}^{1}(1-p)dp$, and if she searches she expects a payoff equal to $\int_{p'}^{1}(1-p)dp - c$. As the former is greater than the latter, she better-off when she buys immediately. This proves that $r=1$.
Next, I prove that both firms charge $p^M$. Clearly, firms never charge above $1$ as they will never sell. Then, the expected profit of a firm is $\frac{1}{2}(1-p)p$ because the consumer visits a firm half of the time. It is easy to see that the profit is maximized at $p^M$. QED.
It is impossible to beat financial markets. There is clearly a huge variation in views on how literally one can take this assertion and on how informationally efficient financial markets are, but almost all economists would agree that reading books on "the spectacular new trading system Wallstreet does not want you to know" and getting investment tips from financial analysts on TV or YouTube is a colossal waste of time.
Price control hurts consumers.
So called price gouging is a specific example. Most states even have price gouging laws, which limit how fast price for some consumer goods can increase. And it is very common to hear complains from both laymen and not-so-laymen about price surge and "speculation".
Price is an equilibrium outcome, which equalizes demand and supply. In other words, market price is a price, at which quantity supplied is exactly equal to quantity demanded. So what happens when the price is restricted below its market level? Shortage. At such price demand outstrips supply, so we see empty shelves.
There are two main negative consequences of anti-price gouging laws. First, consumer surplus decreases, since the product is consumed not by consumers, who value it the most, but by consumers, who happen to buy it when it is available.
Second, and the most important one, is that supply will not adjust to accommodate rising demand. Without price control, high prices imply increased revenue of producers, incentivizing them to ramp up production fast. So after a while supply increases and equilibrium price falls. Under price control no increase in supply is possible, since it is not profitable for producers. So the shortages will last up to the point when demand shock passes. If demand shock is permanent, then shortage will be permanent too.
The best answer to this question has to be pricing. It is agreed in economics that pricing reflects the supply and demand and it depends on these on a free market. Still, you'd often hear people how some product is too expensive because it is just some raw material plus some working hours.
Even worse, you sometimes see business owners billing their service or products by some amount of material and some hours of labour. For e.g. a carpenter who sells some closet for 1.2 cubic meter of wood at 800\$/cubic meter + 30 hours of work at 90\$ per hour, giving a grand total of nobody cares. Because if someone comes in and says I want that closet for 1 million euros and you're willing to give it for that money, that's PRECISELY what it's worth. Exactly in the same way as if someone comes in and wants to pay you 100 euros for the closet, you can't claim it's worth at least the material+labour, because nobody is willing to pay that money, so it's not worth that much, but PRECISELY 100 euros.
In a nutshell, it is a consensus in Economics that prices are driven by supply and demand on free market, but for some reason people very widely believe that it's common sense that prices are driven by production costs.