Introduction to Economics

Posted: April 15, 2012 in Economics, Freedom
Tags: , , , , , , ,

economy

If you are new to the subject, this article will be for you. You will find no complicated formulas or theories here, just a few basic concepts. There will be some in depth explanations and examples through the embedded links for those who want to pursue the concepts further.

What is Economics?

Contrary to popular belief, you need no understanding of math to understand economics; logic and reason on the other hand can be of vital importance.

Economics is about choices. It is looking at the choices of what you or someone else does with your time and money. It also involves who is best to make these choices. It is about how people act and interact, which leads to how wealth is created and maintained. It is about incentives.

Some believe that there is a limited amount of wealth in the world, and that it is essential to have someone in charge of making sure it gets distributed fairly. These people want to make sure there aren’t any individuals left at the bottom of a pyramid holding the bag with nothing left to fill it. It is important to understand how wealth is created, because only with this understanding can you have what is needed to be sure no one is left holding that bag. Wealth is created by producing something of value. Knowing this, anyone can then find ways to bring value to others and be rewarded for it, even if there is not much money to go around at the time. That wealth is created is clear when you consider that the poor today live better lifestyles than the kings of the middle ages, yet the population has grown exponentially. How would that be possible if there was always a limited amount of wealth in the world?

Now you may be thinking, that this doesn’t apply to you, that it doesn’t matter how wealth is created since you have a job and are making a living. It get’s to be important to understand when you consider that most people’s objections to what is to follow in this article stems from the people’s need to make sure the poor are cared for, and knowing that there are many ways that this can be done.

Economics as a whole  is important to understand because regardless of what you may think of the subject, it affects everyone. If you are working a job, running a business, or staying at home raising a family, any economic decision made by others will have an effect on you even if it is not immediately seen.

The decisions of a nation, or even a smaller community like a town, has a huge input on the standard of living of the individuals in the society. Let’s look at the contrasts between two very different ideas. In a communist or extremely socialist society, everything is planned for you. A central planner, or a Czar, will tell you what you do, when you do it, for how long, and how much you get paid. In a free country, you decide what you will do, and you decide to if the income is worth it. You can choose to do something else, or even work more in order to earn more.

A drawback seen by many here is that some who can’t work as well as others can’t earn as much, and that this isn’t fair. I leave it to you to decide if someone working more and getting nothing for the extra work is more fair. It is important to understand that in a truly free society this issue is much less a problem than in the current society of Corporatism or State Capitalism. The explanation of this goes too much in depth for an introduction, but I encourage you to be skeptical and investigate this further.

A free society of people making their own choices for their own interest and desires will always beat a society where the choices are made from the Czar. There is no person or small group  that can possibly know what it best for society because of the astronomical amount of self serving choices individuals make to improve their lives. Keep in mind that everyone has different desires and needs. It is hard enough to know your neighbors desires yet someone is supposed to know the desires of all individuals in a city? A country? These people make decisions that is supposed to be good for everyone, when clearly if applied to individuals it is not good. Think of public debt. Most would agree it is bad to be in debt, that you get less money in the end since a big portion goes to interest. Many people that think individual debt is bad, thinks it’s OK for the nation to be in debt.

Henry Hazlitt, who is one of my favorite economists, gives the best reasoning in his book ‘Economics in One Lesson’. He says that if something is good for an individual or family, then overall it makes sense when applied to groups or nations. If every individual is making choices for their greater good, then society overall must also be getting better since it is made up of those individuals. Of course, this only makes sense if people are free to choose what is best for them in the first place.

Let’s look back at the idea of economics being about interactions; or trade. Think about the axiom, the inherent truth, that Murray Rothbard provided on the concept of human action,

All action is an attempt to exchange a less satisfactory state of affairs for a more satisfactory one.

If I choose of my own free will to give you a cow in exchange for a horse and you choose of your own free will to give me a horse in exchange for a cow, it means that you value the cow more than the horse, and I value the horse more than the cow. We are both better off from our free exchange. In a free society where there is no coercion involved in an exchange, everyone gains and no one loses. If one part did not see themselves gaining from the exchange, the exchange would never happen. No one will ever make any exchange, after taking all considerations into account, where they see themselves being worse off. You might think this is not true when considering gifts, but psychic value is also part of an exchange, and one can get satisfaction from giving to others and making them happy.

Government and Economics

If a third party were to come along like the government and say you have to give up the cow in exchange for something you don’t want under the threat of some nasty consequences, there is a loss. We can also look at it from the economic viewpoint of incentives. If someone or some group has the ability to force the government to make you give them the cow without having to work trade something you value for it, it creates a huge incentive to use the government to get what they want instead of doing any productive work.

Frederic Bastiat explains this best in ‘The Law’

Now since man is naturally inclined to avoid pain—and since labor is pain in itself—it follows that men will resort to plunder whenever plunder is easier than work

Throughout history, you can see that when rules and regulations hampered free trade and free choiceeconomies have suffered. Where they were removed, economies have prospered.

The only way a communist or socialist system can work is if the one in charge was a god, going through the millions of possible decisions for each and every individual, knowing each person’s value structure. A society of individuals making their own choices based on what they want is better than a third party making decisions based on what they think is going to better for those individuals. One of the best examples of this can be found by looking at the 3 ways of spending money, showing that spending money on yourself is always put to better use in terms of what you want than someone else spending it for you.

What being selfish does to a society

It always works better with people being able to make choices looking out for themselves. This sounds selfish, but it is actually logical when you draw the idea out to it’s conclusion. A great historical example of how selfishness helps society is what some see as the events that started thanksgiving.

In the early 1600s, colonists were arriving in what would later be the United States, and were put into a socialist system. All the food they produced was put into a general storehouse and divided among all the colonists. It didn’t matter how much work you did, you still got an equal share of the food and people were dying of starvation by the hundreds. It did not seem worthwhile to put in the effort to grow more food if you were not allowed to eat it, since the lazy ones would take most of what you produced. Many did not see themselves as better off for doing the work, and got more satisfaction doing other things. Sure there were some individuals who did still work, hoping to survive, but it was not nearly enough for the colony. Finally, the rules were changed, and the governor divided the land in equal plots for the people to work and keep what they produced. The following harvest had so much extra food, and they thanked god for the great harvest. The selfish individuals producing for themselves created a better standard of living for society than when the individuals were only working for the greater good.

Everyone wants to satisfy their needs and wants as much as possible. In a free society, the only way to get something you want is through service to others. When you exchange a product or service with someone, that person gains from the exchange since they get what they value more. Sometimes people make a mistake and do something that makes them worse off, but under a free enterprise system they made the choice of their free will. This person can learn from the mistake to avoid making it in the future. Without being able to learn from mistakes, it is impossible to figure out what is really best for people, and to serve them in better ways. It get’s very hard to improve their lives without the freedom to figure out what they want most. You may be out for yourself, but if you are not doing something to help others, you won’t get very far; not in a free market society.

Today in the western civilization we don’t have pure communism or socialism, nor do we have a free economy. What is important to know is that any central decision, whether it is complete or partial, is never as good as individual decisions. When you have central decisions, they are made with people who have an interest in remaining in positions of power, and will often look out for themselves before society as a whole. If a decision means hurting society but allowing them to stay in power, they will generally do so. This leads to giving out subsidies, putting tariffs in place, protections, tax breaks, and many other regulations to benefit special interest groups.

Distortion

Most of these, on top of not being fair to those not getting the special deals, cause people to do what they would not normally do, creating distortions in the economy.

A great example of this was given by Chris Brady. He gives an analogy of owning a house. Imagine you just built a new house, and a zoning guy comes along with a rule saying you have to build a partition in the middle of your living room. Having to do this or go to jail (or lose the house) you comply. 6 months later, a new law is passed forcing you to build a new partition in the middle of the main hallway. After a couple years of this stuff you will have completely changed your behavior, having to walk around everything and moving furniture around to accommodate the new structures. Eventually you will probably have to build an extension in order to have room again. That is if you still have money left over! If you take this silly example and apply the same principles to a nation, things can get very messed up.

A good real life example would be the housing bubble and it’s crash. Governments had this idea to make housing more affordable and available to more people, who would have normally not bought these houses. With all the rules and incentives put in place, there was a lot more credit available for people, who then started bidding up the prices of houses much higher than they would have been able to do prior to the policies. This made prices rise higher and higher until the bubble popped, destroying the economy.

This is what happens when you have politicians making decision without looking at the whole picture; don’t forget that it is almost impossible to see the whole picture.

Looking at What is Not Seen

Henry Hazlitt get’s to the root of the problems in his introduction to the topic of economics.

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups

Frederic Bastiat gives the ultimate example of this with his broken window fallacy, showing how easy it is to not look at the whole picture. Read it in detail here. There are many people who believe war is good for the economy because of all the money that gets spent on personnel, weapons and the rebuilding of anything that get’s destroyed. The broken window fallacy points out how no extra money gets spent at all, and only leaves behind the destruction of wealth.

Imagine a boy breaks a shop keepers window. A crowd of people will often come to the conclusion that this is good for the economy, and gives the person who builds windows a job. It is true that this gives money to the window maker, and creates demand in that industry. This is what is seen, but only on one group, and not all groups. They fail to take into consideration that the money spent on the new window will not be spent on something else. Maybe the store owner would have bought a new suit if he did not need a new window. The money was spent in either case, so society as a whole is not improved. With the window being broken, there is more demand for windows, but less demand on other goods like the suit. In the first case, the shop keep has a window in the end. However, if the window had not been broken the same amount of money would have been spent, but the shop keeper would have a window and a new suit. This means there is more wealth in total without the destruction.

What is important to understand from all that is that whatever happens, whatever policies are in place, money will always be put to use, even if you don’t see where.

This also shows how the government can’t spend money to boost the economy because they first have to take it, borrow it or print it. If they take it as a tax, it means it is no longer being spent by those who are taxed. if they borrow it, it means the lender is no longer lending it to someone else. It is important to note that lenders will always lend whatever they can because that is how they earn profits. It does not pay for them to keep it since they get no interest. The only one that is really hard for most people to understand is the idea of printing it. This is like a tax on everyone because more money in circulation means the money is worth less, and prices will go up. Think of everyone getting a cost of living raise at their job, but how it never seems to cover the whole increase in prices. Money is getting printed and spent while it is worth more by the people who get it first, and the general public has less wealth because of it once the prices go up.

Because of the failure of most people to see this, special interest groups are allowed to swarm governments in order to get special deals, to get wealthy without actually having to serve people.

Success should be about serving the customer, which it would be in a free market. Instead, today you have many companies spending more money on the government than they do on serving customers. The government should not be a customer at all, let alone the biggest one! This gives a big advantage to those who have the time and money to work on the government, giving little chance for the little guy to succeed. Many corporations will get the government to pass regulations under the guise of helping protect the public, but often these companies are already following the rules, or can afford to comply. New start-ups don’t stand a chance to earn profits with all the extra money they will need to spend, and so small businesses can’t even get started in these industries. In essence, even though there are rules against monopolies, that is exactly what many government regulations cause. A great example is when Wall-Mart pressured the government to raise the minimum wage in order to stifle competition since they were already paying above that threshold. Regardless of whether or not minimum wage is good, it is one example of many where big businesses like regulations you think would hurt them.

This scenario is not right, but that is exactly how our economy works under Corporatism, or State-Capitalism. We can get mad at these corporations all we want, but it comes from the style of government we as a people allow. This is why it is so important to understand economics. We should not be mad at the corporations for playing by these rules, or at the very least we should not be blaming them. It is the fault of the incentives being in place for them to do these things that should be to blame, and this is where we need to be focusing our energies. The way to do that is to introduce people to the truth about economics.. This requires understanding the basics of economics, and sharing this information with everyone you know.

Comments
  1. My Homepage says:

    I was looking for this. Really refreshing take on the information. Thanks a lot.

  2. I think this is a great post for clarifying this quagmire of a topic. Not being versed in this topic myself, I was able to comprehend your explanations with ease – unlike most explanations elsewhere which generally leave me feeling like I’m reading a foreign language with no language dictionary on hand!

  3. this is invaluable, Thanks for taking your time to write this.

  4. hair weaves says:

    well said.. this article was really good

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