The Answer Is Transaction Costs

• Adam Smith's Wealth of Nations: Introduction and Book I

  Send us a textAdam Smith's "The Wealth of Nations" developed from decades of lectures on jurisprudence, examining how market exchange creates prosperity through division of labor and specialized skills.• Two core observations drive Smith's thinking: humans seek approval from others and have a propensity to "truck, barter and exchange"• Exchange is Smith's key concept—not just for goods but for ideas, sentiments and social coordination• Division of labor dramatically increases productivity through specialization, increased dexterity, and tool development• Smith's famous pin factory example shows how 18 specialized workers produce thousands of times more than individuals working separately• The extent of the market limits division of labor—larger markets allow greater specialization• Smith argues that differences between philosophers and street porters arise from "habit, custom, and education" not innate capacity• While profit is legitimate, Smith criticizes how powerful interests manipulate government to restrict competition• Justice (respecting person, property, and promises) forms the essential foundation for any functioning commercial society• Smith's work intended as a handbook for lawmakers, not ideological advocacy• The Wealth of Nations represents applied moral philosophy addressing how societies become prosperousJoin us next time when we'll examine Book Two of Smith's masterpiece.If you have questions or comments, or want to suggest a future topic, email the show at [email protected] ! You can follow Mike Munger on Twitter at @mungowitz

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• Second Place Is The First Loser: Strategy Over Speed

  Send us a textThe ancient tradition of Il Palio in Siena showcases a complex system of strategic corruption, neighborhood rivalries, and high-stakes horse racing that has endured for centuries. This 90-second race around Siena's central piazza involves extensive bribery, intense negotiations, and centuries-old vendettas that make speed secondary to political maneuvering.• Horse assignments determined by lottery prevent wealthy neighborhoods from buying fastest horses but create opportunities for strategic corruption• Jockeys accept bribes up to €80,000 to impede rivals or assist allies, with reputation determining future employment• The "rincorsa" (starter horse) wields extraordinary power in determining when the race begins• Enforcement of bribe agreements relies on reputation, trust, and fear rather than formal contracts• Coming in second place is considered worse than finishing last, leading to public ridicule that can last generations• Neighborhood identities and rivalries date back to medieval times, with memories of betrayals lasting decadesBook o'da'week:  Okay, it's a film.  But it's great!Book o da week:  Il Palio documentary, 2015. Cosimo Spender, director and writer. https://www.imdb.com/title/tt3669520/ If you enjoy learning about the economics of unusual institutions, join us next week for the third installment of our Adam Smith podcast series with Adam Smith Works.If you have questions or comments, or want to suggest a future topic, email the show at [email protected] ! You can follow Mike Munger on Twitter at @mungowitz

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• When Bats Attack: Understanding Insurance

  Send us a textMike Munger explores insurance economics through the lens of transaction costs and risk management, culminating in an amusing case study about "bat-in-mouth disease."Insurance transfers risk from individuals to larger pools, reducing the expected variance of outcomesThe fair price of insurance equals expected value (probability × potential loss) plus transaction costsInformation asymmetry, subjective risk valuation, and strategic behavior complicate insurance marketsInsurance faces two major challenges: adverse selection (who buys insurance) and moral hazard (behavior changes after getting insurance)Deductibles and co-pays help align incentives between insurers and insuredInsurance history dates back 5,000 years to ancient China, Mesopotamia, Greece, and RomeThe "bat-in-mouth disease" case study shows what happens when someone tries to purchase insurance after an incidentTransaction costs explain why dogs sometimes stop climbing stairs and why freezing credit cards--ie, transaction costs--might prevent impulse spending. The piano player in a brothel story, and its history.The book o'da'month is Daniel Flynn, The Man Who Invented Conservatism. Bat in mouth story:  https://www.nbcnews.com/news/us-news/bat-flies-womans-mouth-arizona-costing-nearly-21000-medical-bills-rcna222463Some background on insurance:Kenneth Arrow on the Uncertainty & Welfare Economics of Medical CareAnja Shortland on Kidnap: Inside the Ransom Business"Piano player in a brothel" story origins:https://www.goodreads.com/quotes/93559-my-choice-early-in-life-was-either-to-be-ahttps://barrypopik.com/blog/dont_tell_my_mother_im_a_banker_she_thinks_i_play_piano_in_a_whorehouse Daniel Flynn book:  The Man Who Invented ConservatismIf you have questions or comments, or want to suggest a future topic, email the show at [email protected] ! You can follow Mike Munger on Twitter at @mungowitz

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• Adam Smith's Wealth of Nations: Episode #2--The "Model"

  Send us a textTransaction costs provide the key to understanding Adam Smith's complete philosophical system and how his two great works form an integrated whole. • Smith's two essential claims: humans desire to learn proper behavior and have an innate propensity to truck, barter, and exchange• Sympathy in Smith's view means synchronizing feelings with others—not perfect emotional matching but sufficient "concords" for social harmony• Three core principles guide proper behavior: justice (respecting others' person, property, and promises), beneficence (proper use of what's ours), and prudence (sacrificing present comfort for future well-being)• Self-command turns virtuous intentions into actual proper behavior• Four sources of moral judgment: motive, reaction, convention, and consequence• As societies scale up, we move from moral community (acting from love) to moral order (following rules from their utility)• Smith's "Chinese earthquake" example anticipates the modern trolley problem by revealing how moral agency affects our decisions• The "man of system" tries to impose ideal plans without regard for human nature or gradual change• Smith's egalitarian views positioned economics against slavery and hierarchical social structuresAlso posted, with resources for teaching and learning, at Adam Smith Works, thanks to Amy Willis. If you have questions or comments, or want to suggest a future topic, email the show at [email protected] ! You can follow Mike Munger on Twitter at @mungowitz

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• Adam Smith's Wealth of Nations: Episode 1 (Background)

  Send us a text(N.B.:  This episode is cross-posted at our partner site, Adam Smith Works. There are lots of resources and background material there, if you want to delve deeper)The Scottish Enlightenment emerged as a remarkable intellectual movement that shaped modern economics, philosophy, and social science, with Adam Smith at its center developing a dual theory of human nature through his two masterworks.• Scottish Presbyterian education fostered literacy and critical inquiry despite doctrinal rigidity• The 1707 Act of Union created unique conditions where Scots pursued intellectual achievement rather than political power• Scottish universities thrived through student-funded education while Oxford professors "gave up even the pretense of teaching"• Thinkers like David Hume, Francis Hutchison, and Thomas Reid established key intellectual foundations• Smith's concept of sympathy involves synchronizing sentiments with others, not just feeling pity• Justice protects "person, property and promise" as the foundation of social order• Beneficence is "the ornament" of society while justice is essential to its existence• Smith was strongly anti-slavery, describing enslaved Africans as "nations of heroes" superior to their captors• The Theory of Moral Sentiments and Wealth of Nations form a unified system, not contradictory works• Commercial society requires both moral foundations and economic understanding to function properlyFor the complete series on Adam Smith's Wealth of Nations and additional resources, you can also visit Liberty Fund's Adam Smith Works website.  For the material on this episode, go here. APPENDIX:To reduce transaction costs, here is substantial amount, probably more than you want, of primary and secondary material on Smith and WoN.  Enjoy!Primary Smith Sources From Liberty Fund 1.      The Theory of Moral Sentiments (1759/1790). Edited by D. D. Raphael & A. L. Macfie (Indianapolis: Liberty Fund, 1982) https://oll.libertyfund.org/titles/theory-of-moral-sentiments-and-essays-on-philosophical-subjects  2.      An Inquiry into the Nature and Causes of the Wealth of Nations (1776). Edited by Edwin Cannan (Indianapolis: Liberty Fund, original editions 1904, in two vols.): https://oll.libertyfund.org/titles/smith-an-inquiry-into-the-nature-and-causes-of-the-wealth-of-nations-cannan-ed-in-2-vols  3.      Lectures on Astronomy (c. 1748).  Essays on Philosophical Subjects (1795), which contains Smith’s “History of Astronomy”—based on his lectures.  https://oll.libertyfund.org/titles/theory-of-moral-sentiments-and-essays-on-philosophical-subjects  General Resources 1.      Aristotle. (n.d.). Nicomachean ethics. (Jowett translation) If you have questions or comments, or want to suggest a future topic, email the show at [email protected] ! You can follow Mike Munger on Twitter at @mungowitz

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