By Simon Grey, on January 12th, 2012
But, in the first study of its kind, the MAC – set up by the last Labour government, and independent of Whitehall – said large-scale immigration was having a significant impact on the job prospects of the ‘native’ population.
The report, which follows years of controversy over whether immigration leads to fewer jobs for British workers, showed that every increase of 100 foreign-born working-age migrants in the UK was linked to a reduction of 23 Britons in employment between 1995 and 2010.
Between 2005 and 2010 alone, the number of working-age migrants in employment rose by 700,000 and displaced 160,000 British-born workers, it said.
As can generally be expected, increasing the supply of something—in this case labor—without a similar increase in demand for that thing will generally lead to lower prices. When there is a price floor of sorts (minimum wage, workers’ rights, etc.), the better labor will win out at the margins, which is what appears to have happened here. Since those who decide to emigrate usually tend to be of a rather hardy stock, it should come as no surprise that they are often viewed as marginally better labor, and, as such, get hired more often. And it should also come as no surprise that the marginally superior laborers (immigrants) are offered jobs that would otherwise be offered to natives.
But more than that, it is philosophically consistent to support both free trade and free labor, as the arguments or them are rather similar. The problem, though, with both free trade and free labor is that domestic regulation of both tends to discourage domestic production/producers. As such, both free trade and free labor operate essentially as foreign subsidies. However, free labor is the more pernicious of the two seeing as how it not only undermines domestic production, but also domestic culture, what with the sudden influx of people from other cultures. Ad while people from another culture may enjoy the consequences of living in another culture, this is no guarantee that they will ever do anything but support and further their original culture.
The lesson to be learned from this is that free labor—or even limited regulation—is not particularly beneficial for the native population, economically. As such, it can reasonably be said that any politician who advocates an increase in immigration, tolerance for illegal aliens, or otherwise promotes the migration of foreign workers of any sort is one who is ignorant, hates his country, or is simply stupid.
By Simon Grey, on January 10th, 2012
For centuries thinkers have assumed that the uniquely human capacity for reasoning has existed to let people reach beyond mere perception and reflex in the search for truth. Rationality allowed a solitary thinker to blaze a path to philosophical, moral and scientific enlightenment.
Now some researchers are suggesting that reason evolved for a completely different purpose: to win arguments. Rationality, by this yardstick (and irrationality too, but we’ll get to that) is nothing more or less than a servant of the hard-wired compulsion to triumph in the debating arena. According to this view, bias, lack of logic and other supposed flaws that pollute the stream of reason are instead social adaptations that enable one group to persuade (and defeat) another. Certitude works, however sharply it may depart from the truth.
Basically, humans have a tendency to make a variety of decisions and take sundry ideological stances before thinking them through. Most of us do this unconsciously on a daily basis (think of driving a car, for example). However, we don’t generally think of a reason why we do what we do, and when confronted with the why of our behavior and opinions, we craft an ex post rationale for it.
Often, our rationales are deceptive and self-serving. The 2008 bailouts, for example, were touted as a way to save the economy. Perhaps many of those who proposed the bailouts really believed that the bailouts were good for the economy. What’s interesting is how some who supported the bailouts and benefited directly from them argued for them in selfless terms. What’s even more interesting is how all humans do this, albeit in regards to different things.
Anyhow, the point made in all this is that we are not as rational as we would like to suppose. We often do many things out of subconscious habit, laziness, greed, and self-promotion. Sometimes we don’t even know why we do something; we simply “feel” something and act accordingly. And only when we’re confronted with the “why” of our behavior do we even think to provide a reason for doing what we did.
Thus, the lesson to take away from this is that those who assume humans are rational (most notably economists) are completely bonkers, and any behavioral model predicated on the assumption of human rationality is most likely completely wrong. Humans are finite beings with near-infinite desires. Being rational is not optimal in this event, for a careful consideration of every potential decision will inevitably lead to having fewer enjoyable experiences and goods by mere virtue of the fact that time spent contemplating decisions reduces the number of decisions that will eventually get made. Therefore, the rationalizing tendency among humans in light of their finiteness is perhaps the most rational thing they do. And those who ignore this fundamental rationality are fools.
By Simon Grey, on November 30th, 2011
Economist Diane Coyle has noted that migrant workers in the UK tend to be either very highly skilled or low skilled, which suggests that they are filling gaps in specific areas of the labour market, not taking jobs from the native or resident population. And Bryan Caplan explains that by doing low-skilled work migrants enable more productivity in the native labour force. [Caplan’s post can be found here. –ed.]
Caplan argues that the native workers don’t have to spend time doing daily, menial chores and are free to focus on improving their skills, and working harder. And this increases wages.
For a fun little experiment, I propose that Britain deport 50% of its migrant workers and see what happens to unemployment. If Alabama is any indication, unemployment rates will decline.
Why? Because wages, aka prices, are determined by two things, and two things only: supply and demand. Increase the former without increasing the latter and wages decline. Decrease the former without decreasing the latter and wages increase. And so on.
Caplan’s fallacy, and by extension ASI’s, is that there is an ever-increasing demand for highly productive labor. This may or may not be the case, and I suspect that it’s the former. Labor laws make it difficult to determine how much demand exists for highly productive labor. Not only that, economists seem to forget that some employers are rather satisficing in their approach to hiring. Furthermore, many jobs are part of a sufficiently complex process that attempting to maximize labor productivity in one specific role is likely an exercise in futility. In essence, Caplan’s theoretical model bears little resemblance to the real world, which is why it is wrong.
By Simon Grey, on November 21st, 2011
The other side of all this, which I’m surprised the article doesn’t mention, is that lower costs mean that addicts find it easier to pay for their habit. They’re less likely to resort to theft and mugging, and so on. It’s also noteworthy that crack probably only emerged as a way to get more “bang for the buck” out of cocaine while trafficking was harder.
Here’s an interesting question for proponents of the drug war: assuming that demand for drugs remains stable, what do you suppose will happen if you reduce the supply of drugs? Answer: the price will rise.Here’s another interesting question: if violence increases directly with rising drug prices, what will happen when the prolonged war on drugs succeeds in reducing supply without reducing demand? Answer: violence will increase.
It’s easy to say that drug use is immoral, and it’s easy to say that drugs have negative effects on society. However, knowing that the drug war is going to ratchet up the violence, and impose significant negative externalities on society, is it really so rational to say that the drug war is worth it?
By Ajay Shah, on October 18th, 2011
A lot is being written about inflation in India today. I thought it’s worth writing about the fascinating insights into inflation that come from focusing on the distinction between tradeables and non-tradeables.
What is a tradeable
A tradeable is a product which can be transported across the world at relatively low cost. As an example, steel is tradeable while cement or paint are mostly non-tradeable barring special short-hop opportunities like Gujarat-Karachi or Amritsar-Lahore or Calcutta-Chittagong or Trivandrum-Colombo.
Steel is a nice tradeable that one can think clearly about. There are no barriers to the movement of steel worldwide. Hence, there is only a world price of steel. The quoting convention used worldwide is to express the price of steel in USD. The price of steel in India is thus the world price of steel multiplied by the INR/USD exchange rate, plus a markup for freight (The cif/fob ratio).
If there is a customs duty of (say) 10%, then the price of steel in India is 1.1 times the world price of steel expressed in rupees. For the rest, nothing changes when a customs duty is introduced. Gram for gram, every fluctuation in the INR/USD or the world price of steel shows up in the domestic price of steel.
Non-tradeables are things like cement (which are hard to transport) or haircuts (which are impossible to transport).
Measurement
Before we can analyse and control inflation, we must measure it well. Inflation is defined as the rise in the price of the average household consumption basket. The CPI is the best measure of inflation in India.
Everything in the CPI basket can be classified into the two categories: tradeable vs. non-tradeable. As a thumb rule, WPI non-food non-fuel is a rough measure of tradeables inflation. Fluctuations in food and services prices, which make the CPI diverge away from WPI non-food non-fuel, are a measure of non-tradeables.
Year-on-year inflation reflects an averaging over 12 months. If you want to get a faster sense of what is going on, you need to look at point-on-point seasonally adjusted changes. These yield early warnings of inflation, which are 5.5 months ahead on average. Such data is updated every Monday by us. The shift from y-o-y inflation, to p-o-p SA inflation, is a free lunch in measurement and monitoring.
The WPI is a useful database of many price time-series in India. But the overall WPI is useless in thinking about inflation in India: there is no household in India which consumes the WPI basket.
The use of WPI inflation, and the exclusive use of y-o-y inflation, are litmus tests of professional competence in the Indian landscape.
The function of the central bank
The job of RBI is to deliver low and stable inflation: to deliver y-o-y CPI inflation of between 4 to 5 per cent.
They have failed in this task. From February 2006 onwards, in every single month, y-o-y CPI inflation has exceeded 5 per cent. This is an important time for introspection at RBI and outside it. What have we done wrong, in the structuring of RBI, which has got us into this mess?
It is useful to think of this as a principal-agent problem. The people of India are the principal. RBI is the agent. The principal hires the agent and gives him resources. In return, the agent has to be held accountable. Delivering low and stable inflation is the accountability mechanism. It is a quantitative monitorable measure of the performance of the central bank. That we have sustained failure on this function, from February 2006 onwards, suggests that we should be modifying the nature of the contract between the principal (the people of India) and the agent (RBI).
How RBI can influence the price of tradeables
RBI has absolutely no say on the world price of steel. In that sense, the prices of tradeables are beyond the control of RBI.
When RBI raises the interest rate, more capital comes into India, which tends to give an INR appreciation, thus making tradeables cheaper. Thus, an RBI rate hike does impact upon the domestic price of tradeables.
It is also worth pointing out that the central banks of most major countries are high quality inflation targeters. They deliver on their mandate of delivering low and stable inflation. As a consequence, inflation in the global tradeables basket tends to be low and stable. Tradeables prices are a helpful source of price stability, most of the time.
(That a large part of the CPI basket is tradeable, and seemingly beyond the control of the central bank, is no excuse. There are dozens of high quality central banks visible in the world, with very large shares of the CPI basket in tradeables, who are delivering on inflation targets. We in India should not accept excuses).
How RBI can influence the price of non-tradeables
Non-tradeables reflect aggregate demand and aggregate supply in India. RBI can influence these by raising or lowering the short-term interest rate. When interest rates are made slightly higher, household consumption and investment demand are slightly lowered.
A critical feature of non-tradeables inflation is expectations. If people expect 10% inflation, they tend to wire high price rises into their negotiation of wage and other contracts. This generates inflationary momentum. Particularly in a place like India, where the institutional structure of monetary policy is primitive, economic agents have little confidence in the ability of policy makers to rein in inflation. As a consequence, inflation is highly persistent. Once high inflation sets in, economic agents expect high inflation to continue. There is a great deal of momentum in inflation.
For years now, some economists have argued that inflation will subside by itself. It will not. Inflation does not mean-revert to the target zone of 4 to 5 per cent by itself. We are now in a trap of high inflationary expectations. This structure of expectations will need to be broken. This can happen in two ways. RBI needs to turn a new coat, and convince people that it now cares about inflation without any other conflicts of interest. And, rate hikes have to take place.
There are two paths to inflation control: changing the structure of expectations and reducing aggregate demand. The former is almost a free lunch. It only requires institutional change. The latter is hard work; it inflicts pain.
What about supply factors?
Some argue that supply bottlenecks in India – such as hideous rules about mandis – are the cause of inflation.
The trouble with this explanation is that the supply bottlenecks have always existed. They have existed in high inflation times and in low inflation times. It is, thus, not possible to claim that supply bottlenecks have caused the inflation crisis which began in February 2006.
Can rate hikes deliver inflation control?
When C. Rangarajan was RBI governor, there was an inflation crisis, and rate hikes did deliver on inflation control. The phase of price stability ushered in then lasted all the way till February 2006. This shows us that even in India, it can be done.
We have to remember that in his time, the monetary policy transmission was much weaker than what we see today. With a bigger wall of capital controls, domestic rate hikes did not deliver inflation control by impacting on the INR (through higher capital inflows). With a smaller and weaker Bond-Currency-Derivatives Nexus, the monetary policy transmission from the short rate into aggregate demand was inferior, then. Yet, he got it done.
Conversely, with a very primitive financial system and monetary policy transmission, the central bank of Zimbabwe delivered a nice hyperinflation. We can quibble about the potency of the monetary policy transmission, but we should not doubt the ultimate domination of monetary policy in shaping inflation. In the long run, little else matters in shaping inflation.
Part of the story of the 1990s lies in clarity of purpose at RBI and policy credibility. Rangarajan’s period had good quality speeches, which did not dilute the message on inflation control as the dharma of the central bank. In contrast, in recent times, RBI has repeatedly written low quality speeches. To an expert reader, they have conveyed the lack of knowledge on monetary economics at RBI. To the non-expert reader, they have waffled on the subject of taking responsibility, and have encouraged the average economic agent to think that high inflation is here to stay.  
By Bron Suchecki, on October 10th, 2011
I missed this piece dated 6 September 140 Year of Silver Volatility where Fekete picks up on Bob Moriarty’s Facts on Silver from 25 April with this cutting comment: “Beware of the fund manager, crying from his rooftop that the paper silver market is a joke, while down there under the roof he is selling paper silver at a 25% mark-up.”
Also worth reading Bob’s article with these five facts on silver:
1. When charts go parabolic, it ends badly.
2. The actual ratio of silver to gold in the earth’s crust is not 16 to 1.
3. There is no shortage of silver. There never has been a shortage of silver. Until the laws of supply and demand are repealed, there never will be a shortage of silver.
4. The most illogical thinking and worst use of “facts” is common among the silver uberbulls and the parrots that follow them.
5. There cannot be a run on Comex. The rules do not allow the chance for a run.
By the way, Bob is certainly in the “Repeat of 1980″ category with comments like “You can’t profit if you don’t sell and all the permabulls are screaming “Buy, buy, buy.” As they will at every top.”
PS I missed the Schoon and Morairty posts because those sites don’t run RSS feeds, which I think are essential. I’ve got around 100 feeds giving approx 250 posts a day to get through, just not possible to include manual site visits in that. 
By Simon Grey, on May 12th, 2011
In theory, all prices are determined by supply and demand. If there is a large supply of product x and little demand for product x, the price will be very low. If, on the other hand, there is a small supply of product x and high demand for it, the price will be rather high. This assertion is not new, but it can lead to a puzzling question.
Specifically, the question that can arise on occasion is: if prices are determined by supply and demand, why do economists talk about prices being impacted by taxes and regulations? Two reasons come to mind.
First, taxes reduce supply of a product. As has been discussed elsewhere, taxes are a way of redistributing resources. If a government directly taxes a product, it is essentially claiming some of the resources used to make the product for itself. If the government makes use of other taxes, it is still laying claim to some resources, and consumers then determine which resources are eventually consumed.
Second, regulations change the type of product. In the unfettered market, there might be times when, say, a car company would offer a two-ton car that gets twenty-five miles per gallon and produces 240 HP. Once the state begins to regulate the market, the car company might be forced to meet, say, a fuel efficiency target, and will thus seek to cut the car’s weight and decrease the car’s horsepower. As such, the product is no longer the same, and thus faces a different supply schedule and demand schedule.
Thus, it should be easy to see that the law of supply and demand is ironclad, and that there is no inherent contradiction between claiming that all prices are set by supply and demand and also claiming that taxes and regulations affect prices. Of course, it would be more accurate to claim that taxes and regulations directly impact supply and demand and indirectly impact prices. Still, the final assertion is correct, and there is no contradiction between the two claims.
By Trace Mayer, on March 24th, 2011
[Disclaimer: The follow article is a fictional account of a persuasive argument and should not be construed as an assertion of facts although written in the first person.]
My nuke pills, commonly known as potassium iodide, have been languishing unloved in my emergency supplies for years since I bought them for about $5.99 each. They expire next month. I would like to have donated them to a charity that would get them to people in Japan who so badly need them.
But potassium iodide is only available by prescription in Japan and I am not interested in engaging in the international smuggling of controlled substances. So I did the next best thing: I just sold them for $99.99 apiece representing a net realized gain of approximately 1,500%. One of my best investments yet. But with the nuke pill market’s backwardation more severe than the silver backwardation why would I sell them?
The price, where a producer and consumer meet in negotiations, is an extremely valuable, even vital, tool.
PRICE GOUGING DEFINITION
Price gouging has a nasty connotation. This is mostly due to the true cause of shortages, governments, attempting to spread disinformation about how markets work. For example, the Florida Division of Consumer Services asserts:
In the wake of natural disaster, essentials — such as food, ice generators, lanterns, lumber, etc. — may be in short supply. Charging exorbitant or excessive prices for these and other necessities following a disaster is not only unethical, it’s illegal.
Under Sections 501.160 and 501.205 Florida Statutes, it is illegal to charge unconscionable prices for goods or services following a declared state of emergency.
Individuals or businesses found guilty of price-gouging could face fines up to $1,000 per violation.
HOW AND WHY VOLUNTARY TRADE WORKS
If I own potassium iodide pills there are two mutually exclusive ways for you to acquire them. One option is for me to voluntarily sell or gift you the pills. The other option is for you to steal or rob the pills from me.
Trade works because everyone has different preferences, talents, abilities, competitive advantages, knowledge and desires. For example, Mozart had different talents than Einstein. The baker and the painter are each able to perform work the other values and when they engage in a voluntary trade then it implies that the baker derives more value from what the painter offers than from his bread. Because the baker is better at baking than the painter and because the painter is better at painting than the baker therefore when a trade is voluntarily concluded then both the painter and baker are better off which raises the standard of living for both. Even nations have comparative advantages.
However, when property is either stolen or robbed then only one party benefits to the detriment of another party. This type of parasitic behavior does not encourage additional productive activities. In fact, it decreases wealth by requiring the aggrieved party to expend additional resources on protection which ultimately gets passed on to legitimate moral consumers in the form of higher prices.
It should be noted that since governments are force and force is violence they are by nature parasitic in this stealing and robbing way. And they have the nerve to call a party to a purely voluntary transaction unethical. Thus, the Florida division should probably be named something a little more accurate like the Florida Division of Victimizer Services.
THE VALUABLE NATURE OF THE PRICE
The price, where a producer and consumer meet in negotiations, is an extremely valuable, even vital, tool. It helps the baker know whether he should produce 5 loaves or 500. Because the baker is also a consumer therefore a price is communicated by the baker to the farmer about whether he should plant one acre or 100 acres of wheat.
And so on through the increasingly complex economy with people being able to build up considerable comparative advantages by learning such disciplines as xenotransplantation, mechanical engineering, robotics, proctology, hematology or biomedical gerontology. It is through the price that individuals, all acting according to their own dictates, decide how to allocate their time, talents and capital to meet the needs and desires of each other.
When the pricing mechanism is immorally interfered with by the use of aggression then individuals are hindered in their ability to know how much demand exists for a particular good or service. Misallocation of wealth happens which results in its destruction and a lowering of living standards for society. When a price control is implemented through the use of force then it leads to shortages which are often used as an excuse to implement rationing. In the modern world with such technological advances there is a sole cause for all the starvation and shortages: governments.
For example, there always seems to be a shortage of blood, particularly the rarer kinds, for transfusions. But there are billions of able-bodied adults who could voluntarily agree to sell their blood. Theoretically there should never be a shortage of blood as it should merely be a function of price. But instead many governments have implemented price controls. In exchange for about an hour of one’s time and getting stuck with a needle, sometimes multiple times, the most you can receive is a cookie. Sometimes a T-shirt and some warm fuzzies are thrown in.
The reasoning is that if people were able to legally sell their own blood, oh the irony to think one is free, then there would be a higher probability of contamination in the blood supply. But that does not make any sense because the medical companies already perform extensive screenings of the blood supply. The real issue is that a pint of blood goes for a couple hundred dollars. The government imposed price control serves at least two functions for those who make a profit selling blood: (1) reduction of raw material costs to zero and (2) decrease in supply.
But these types of violent interferences are not limited to necessities like food, water, potassium iodide or blood but are extended through licenses for hair cuts to medical services, are found in regulations limiting the type of light bulb or toilet you can buy and of particular interest to the bureaucrats is healthy food and why raw food recipes are going underground.
With potassium iodide pills available in Japan by prescription only; thus, even though many may have rationally prepared for this emergency the costumed criminal gangs made it illegal and threatened to violate offenders with fines or jail. As Rand Paul teased out during his Senatorial questioning; these bureaucrats found throughout the world are not pro-choice or pro-consumer but violent aggressors against freedom of choice and a primary cause for lower standards of living.
PRICE GOUGING ECONOMICS
How are producers supposed to know what consumers demand? Without the ability to charge what the market will bear it is impossible to find out. When that knowledge is buried or price discovery prevented then entreprnuers are unable to make calculated risks in hopes of profit. When entreprenuers fail to perform thier vital service of bringing goods and services to market then price gouging is not an issue. As the old saying from communist Russia goes, “Sausage is one ruble per link. But there is no sausage.” Pretty soon the only noble profession left will be that of a smuggler.
As David Brown observed in Price Gouging Saves Lives:
“Price gouging” is nothing more than charging what the market will bear. If that’s immoral, then all market adjustment to changing circumstances is “immoral,” and markets per se are immoral. But that is not the case. And I don’t think a store owner who makes money by satisfying the urgent needs of his customers is immoral either. It is called making a living. And, in the wake of Hurricane Charley, surviving.
Be prepared.
NUCLEAR FALLOUT ON THE WEST COAST
The jet streams show it is possible that the Japanese nuclear meltdowns could deliver nuclear fallout to California, Oregon, Washington and other states. At the end of the day, governments and bureaucrats do not care about your personal safety. They will lie, deceive, cover-up and exacerbate problems if they find it politically expedient. No one cares as much about your health and well-being as you do. Therefore, you must take whatever precautions and actions you deem necessary and prudent.
CONCLUSION
So why did I sell my nuke pills? Sure, the 1500% gain was nice. But the real reason was because I wanted to make sure that particular good went to its highest and best use at this particular moment in time. How else would I know what that use was without a price signal? In my opinion the probability of someone in California or Oregon needing the nuke pills within a month for a life saving purpose is extremely low; less than 1%.
Thus, I derive more value with the FRN$s than the counter-party to the trade. Plus, if needed I will just get on a plane and head down to La Estancia de Cafayate, which has a very favorable geographic location for nuclear fallout concerns, for their two events this month. I sure hope the counter-party to my nuke pill trade derives sufficient value from being prepared and I hope even more they never have to actually use the potassium iodide.
But even if they never do use them I bet having them in the hand relieves a lot of anxiety that comes from being unprepared! And if you are ever in a situation where there is a shortage of something know who to blame: governments.
By G.L.C., on March 11th, 2009
Minimum wage laws are against the law of supply and demand. Wages are based on the supply of and demand for labor. If the supply is low, wages will be higher and if the supply is high, the wages will be lower. If the demand is high, the wages will be high and if the demand is low, the wages will be lower. The market price of an individual labor’s wage is determined by the supply of and demand for particular skills of that labor. Employers pay the lowest price for the specific skills and labor attempts to find the employer paying the highest.
If the consumer does not value a product in the market, the prices of all factors involved in the production of that product including labor will fall and vice-versa. Real wages will also rise if the workers become more productive.
If the government through legislation raises the wages, the demand for labor will fall and some labor will not have any employment. It is more likely that the less experienced and young workers will be the ones at the receiving end. Minimum wage legislation prices the least employable out of the market and makes them unemployable. If an employer feels that a worker is not likely to produce at least the value of the wage paid to him.
Increase in minimum wages pushes up the cost of individual businesses. Most businesses will pass on the increased in the wages to the end consumer.
Minimum wage legislation will inevitably create unemployment. The ones who are most affected are those at the bottom of the economic pyramid. Labor valued by employers at less than the mandated minimum are likely to be unemployed. It increases unemployment amongst the young and unskilled.
The most obvious beneficiary of minimum wages legislation are unions and their members. The median weekly wage for union members is higher than for nonunion workers. How successful an union is depends on its ability to maintain high wages and job security for its members or else it will loose its members. To obtain higher wages, it becomes necessary to exclude some labor from the market. Only a small percentage of the population will be benefited by increase in the minimum wages. This benefit comes at the expense of the least experienced, least productive, and poorest workers.
Supporters of minimum wage legislations claim that without minimum wages employers would drive down the wages to extremely low levels which would make it very difficult for the workers. This is just not true. Many businesses pay higher wages than mandated by law.
Increasing the minimum wages will not result in an increase in the real wages. Although minimum wages have been fixed over the last few years, the average pay in the United States had been increasing steadily. This is not due the efforts of the policy makers in Washington DC. Any attempts to increase the minimum wages would have a negative impact on the economy. It will affect the capacity of the economy to generate prosperity for the less skilled.
Instead of trying to influence minimum wages through legislation, the government could do very well to ensure a booming economy in which lots of businesses are opening and expanding thereby increasing the demand for labor which in turn increases the wages.
By Dan McLaughlin, on January 16th, 2009
Some people would rather rub a raw onion in their eye then try to understand economics. That is unfortunate because the basics of economics are not that hard to understand. The fact is that you and I and everyone else use economics every day of our lives. It is liberating to understand why economic things happen, in the same way that it is liberating to know why a car takes longer to stop on ice or gravel. The essence of politics is the use of economic law to manipulate the behavior of citizens to the will of the politicians. Political motivations become more understandable in that light, though no more moral or justified.
Economics is merely an attempt at understanding the basic laws that work in our lives. It seeks to define and simplify our knowledge of the forces that affect us so we can make appropriate decisions. We similarly use the physical principles of gravity, momentum and force every day of our lives. In both economics and physical sciences, there are relatively few laws, which can be applied in understanding very complex systems. Unfortunately, many modern economists actually add confusion and complexity by repudiating simple economic laws, substituting complex macro-economic theories, mathematical models and personal policy preferences.
With that said, the basic laws of economics are truly straight forward and powerful, and arise from the way that humans act and make decisions. Because the logic of human choice hasn’t changed, the economic laws that governed ancient societies are the same ones that govern our lives today, as well as all future civilizations of any time. We can relate to historical characters from any place on the globe because they acted like we do. Their wisdom and their follies are reflected in our experiences today. All that has changed over time is the technology we use to satisfy our needs and wants.
One of the key concepts in economics is that incentives matter. Humans take specific actions to achieve specific goals. If the incentives change, it will affect the means and the ends chosen by the actors. Related to this is the idea that choices are made at the margin. The law of diminishing marginal utility implies that the higher the quantity of a good a person has, the lower the marginal utility, or value, the next available unit holds for that person. If you are dying of thirst in a desert, you would pay almost any price for the first cup of water. You wouldn’t value the fifth cup nearly as much because your thirst would be quenched. You would value the 1000th cup of water much less because you can’t carry it and it does you little good. It’s marginal utility is very small.
The fact that the current market price for a good is $1 doesn’t mean that everyone is willing to pay a dollar. Some people would have a higher marginal utility and be willing to pay more, while others wouldn’t buy it unless it was cheaper. It only means that, at that price, the number of buyers at the margin, those willing to pay at least $1, are about equal to the number of sellers at the margin, those willing to supply it for $1 or less.
This is typically stated as economic laws of supply and demand. If the price of a specific good is lowered, buyers will be enticed to purchase more. We see this in every day life as retailers so often use discounts and sales to move inventory. If the price is raised, the quantity demanded will be less. On the other side of the coin, suppliers are in business to make profits. It will be difficult to make a profit if prices are too low, and very little will be supplied. As prices increase, it becomes easier to earn money, thus suppliers produce more, and new competitors are drawn to the market. Supply increases with increasing prices.
The incentives for buyers and sellers are at odds, and for every good in a particular market at a point in time, there will be a price where the number of willing buyers about equals the number of willing sellers. Any price above that point will produce an excess of sellers, a glut of goods. Any price below it will produce an excess of buyers, a shortage of goods. That simple relationship is one of the most powerful keys to understanding economic phenomena, whether it is Hurricane Katrina shortages or gluts of labor, more commonly called unemployment. Prices, demand and supply are all mutually dependent and reflect the market environment at a particular time. Imposing an artificial limitation on any of them will have inevitable unintended consequences, often very powerfully.
With this understanding, it is possible to comprehend the bulk of the phenomena occurring in society, and in politics, on a day to day basis. There is a lot more to it, of course. A very important aspect of economic laws and concepts from an overall point of view is that they can help to understand why an economy progresses or regresses over time.
The laws of comparative advantage and division of labor are related and work together in determining the level of productivity and prosperity of an economy. Comparative advantage means that any person, organization or geographic region has specific advantages, whether that is because of natural resources, innate skill, education and any number of other characteristics. If the actors concentrate on those things that they are most productive at and pay other people to do the things they less productive at, everyone will be better off overall. A typical example may be an attorney who may have better secretarial skills than any secretary available. But since attorney’s make a much higher hourly rate than secretaries, the attorney will be better off by doing attorney work than secretarial work. The secretary likewise would probably be better off leaving attorney work to the attorney and concentrating on the areas where relative skills are the highest.
Division of labor is the recognition that everybody has only 24 hours a day. It takes a great deal of time and effort and the right tools to be highly productive in any endeavor. Nobody cannot develop all of the skills and purchase all of the tools needed to be highly productive at all types of activities. People or geographic regions that try to be self sufficient will lead a very poor, difficult life and work very long hours.
A surgeon may be very good with his hands, but will probably hire someone to do his plumbing, carpentry, auto repair and so on. He could probably develop some low level of competence in each of those areas, but in order to do that, he would probably sacrifice very valuable time at which he is most productive. In an advanced society, there is a strong tendency toward specialization because it leads to higher productivity and a higher standard of living.
Because people who specialize are generally more productive, they have more income with which to buy the goods and services of other people. Most people in modern society outsource most of their requirements to other people or businesses. They outsource their food requirements to grocery stores and farmers. They outsource their automobile needs to car manufactures. They outsource their homebuilding needs to experienced carpenters, and so on. By building a high level of competence in one area, you are able to trade with others for the things for which they have built a high level of competence. That is what trade is all about. We outsource our requirements to others who are more highly qualified in those areas, and thus, both sides reap the benefit.
If you define progress in society as that state of affairs where people have to work less hard for less hours in order to provided for themselves and their families, then the higher the level of division of labor and the more people can apply their comparative advantage, the more quickly they will progress to a higher level. The wealth of a society comes from people producing more than they consume. Over time, that wealth can be used for capital investments that enhance the productivity of participants, and thus, further raise their income and standard of living. Societies that restrict trade and inhibit capital accumulation and specialization are those that remain in perennial status of less developed countries.
The laws of economics hold many important lessons on a day to day basis. You can try to disobey them, but it is similar to disobeying the law of gravity. You can step off a tall building and think you won’t fall, but your funeral will be just as sure as if you realized you would fall and die. The most critical lesson that economics can give is that actions have consequences. Good intentions and powerful politicians don’t make a bit of difference. The more we can gauge the true consequences without sentimentality or blinders, the more likely we are to make decisions which avoid the pitfalls and lead us to our goals, as individuals and as a society.
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