Here's a subject that we'll all need to know something about in the coming free-market society, yet which is extraordinarily badly taught in today's government schools. So this offers a simple primer. Economics is not as formidable as it may sound: it has to do with voluntary exchange of goods (things we make or wish to buy) and services (help we hire or offer to provide) and as learned in Segment 3, that's what life will be about a few years from now.
Students who are comfortable already with operating a lemonade stand for profit will find this easier than will rocket scientists unable to balance a checkbook.
An important part of economics is money, and we discussed that in Segment 11. It may be no bad idea to visit that for a quick refresher, before returning here. Recall that in a free society, money will be whatever its members choose it to be, but we can predict that that choice may very well be gold in both physical and electronic form.
Gold coins contain a large amount of value; one ounce, in 2006, equated to over $650 and even though smaller ones may well be minted it will be tricky to make and handle any that are worth less than a hundred 2006 dollars. So for smaller transactions facilities like E-bullion will be more convenient; there, payments can be made in units of one cent or less. Likewise plastic debit cards will be denominated in gold for use when shopping.
It may well be that the metric system of measurement will be preferred in the market; thus prices may be expressed not as "0.001 gold ounces" but as "0.03 gold grams" or "30 milligrams" or "30 mg" of gold (one milligram equated to about 2.1 US cents in 2006.) Metric measurement always uses multiples of ten, so one need not even think of remembering how many ounces there are in a pound, nor pounds in a ton, tablespoons in a pint, etc.
1. Macro or Micro?Economics is not an exact science like physics, so opinion and judgment play large parts and there are different and rival "schools" of the subject. For most of the 20th Century and into the 21st, most of what gets taught in government schools and government-supported colleges has favored "macro economics"; that takes a top-down view of what is going on in a country and passes judgment on whether the Fed should raise or lower interest rates, whether more or less money should be supplied, and whether tax rates should be lowered or raised so as to stimulate investment or "consumption" (that's the word they give to what you and I might buy and use.) The underlying assumption of macro economics is that wise men and women close to government can twiddle knobs and control what the economy does. There are truckloads of textbooks and mathematics unlimited to show how right they all are - or would have been, had not Unexpected Factor X intervened.
It's arrogant, and it's ruinous; for nobody is actually smart enough to do it right and the proof of that is that for 70 years the Russians, who include some very smart people indeed, managed the Soviet economy so fully that they drove it in to the ground; so little of value was being produced by 1989 that the people just walked away from the system and the puppeteers in charge gave up the impossible task. So macro economics is not what Segment 15 is about - even though it provides the language for most of what gets reported every day on TV, by news readers who don't understand it either but who dare not admit it for fear of looking foolish.
Micro economics in contrast concerns itself with what individuals may or may not do, and then tries to add it up to form a total for the economy; it gives, with due humility, a bottom-up perspective. With scores of millions of individuals to understand it too is imprecise, and for that reason there are several viewpoints or "schools" within this broad grouping; but at least micro economics starts the right way up. The two that favor a free society in varying degrees are the Chicago School, led by Milton Friedman, and the Austrian (or "Vienna") School, founded by Carl Menger, whose great 20th Century exponent was Ludwig von Mises. The two are well compared in a 2005 book by Mark Skousen, "Vienna and Chicago: Friends or Foes?"
Demand, supply and price. There are a few key concepts of economics that ought to be understood by everyone; and this first is the strong, real-world relationship between those three parameters. They are not mysterious factors set for ever by unknown forces, but move daily in a kind of dance, responding to each other, for any product or service in the marketplace.
Here's a chart showing how the three relate, in concept. Notice that the higher the price, the lower the demand quantity; and "demand" in economics means the quantity buyers will purchase. Most drivers would like a Porsche or a Mercedes; but most drivers buy a cheaper brand. Why? - because "would like" is not the same as "demand"! Demand is the wish plus the money. So this first reality check is that for real people, price matters. There is no bottomless pit of taxpayer money to be spent. The green line in the graph may not be straight, and may not slope at that attractive angle; but it will always slope down from left to right.
Next, notice the purple "supply" line. This indicates that what manufacturers or suppliers will make or supply also depends on the price they can sell something for! Back in 1979, all suppliers stopped selling oil derivatives in the USA because the Federal Government, starting with a decree by Nixon in 1971, forbade the retailing of gasoline at prices over about 85 cents a gallon - even though actual buyers were quite willing to pay more. Since the suppliers could not sell it that low and still make a profit, they quite naturally quit. The result was mile-long gas lines all over the country. Supply dried up, and stayed that way until Jimmy Carter repealed the prohibition; supplies were back to normal within two weeks and prices rose to about 120 cents and later moderated. Incidentally, a 1979 price of 85 cents is about the same as a 2005 price of 240 cents a gallon; and 120 then equates to 340 in 2005. The real gas price may actually be fairly stable over time, at about (315/2.1=) 150 gold milligrams!
So, the higher the price buyers are willing to pay, the higher the supply that will be produced, and vice versa. This holds true for virtually all goods and services - but again, the purple line may not be straight, nor may it slope at that nice angle. But it will slope up, from left to right.
Lastly notice the point at which the two lines cross: that is the price at which suppliers and buyers are equally satisfied with the deal, and so - until something changes, which it may do in half an hour - P* will be the price prevailing for sales of that particular good or service, and Q* will be the quantity sold. Isn't the market elegant? There is great beauty in the balance here; that all players take part on a voluntary basis, and respond to each others' bids and offers; and that nobody is forced to be a slave to anyone else and the buyers ("consumers" in econ-speak) are just as powerful in the market as the suppliers.
Competition is an important component in any market - the one for vegetables, the one for jobs. It's good to have a choice of veggies, of veggie buyers, of employers and of employees. That gives a better chance that all will be fully satisfied. Quick test, though: does it change what we just saw, about how price, demand and supply relate to each other? Why, or why not?
Visibility is another factor at play in the market represented by the simple chart above; is it important for all prices being bid and offered to be equally visible to all participants? Some economists say yes it is, and since that is never fully possible, that this picture of economic activity is false or simplistic. (Translation: "you need to hire an expert like me to understand what's really going on.")
It's a factor, of course, and the more everyone knows about the market the more likely everyone will end up satisfied - but no, of course it's not essential. If there are four greengrocers in town, do you really have to know the price of lettuce at all of them? - not really. If you find later you were overcharged, you may not patronize that vendor again; and he knows that. Partial knowledge is quite good enough in practice, and as the Internet becomes more and more of a marketplace, visibility will become closer and closer to perfection.
2. JobsQuite a lot of people get paid today when government steals money from others and hands it to its workers in exchange for work they do. That work may be done well or poorly; it may perform a function (like mending roads) that would get done in a free market with proper ownership and honest accounting, or it may be entirely useless; but always, government hires get paid from loot stolen from taxpayers at gunpoint. Yet when (probably in the 2020s) everyone understands what freedom from government really means and walks out on the latter, everyone including former government employees will need to live and work in that free market. So it's worth getting ready, and this offers a little help. First, a reality check. Supposing you work for an employer, who has the right to the job you do?
Sell Yourself. Key consequence, of that reality: anyone wanting to be paid has to "sell himself;" and that means to offer benefits to someone who might be willing to pay for them.
That in turn brings us right back to the demand, supply and price chart above. If you're job-hunting (or job-holding) you are the supplier, of services, and your salary is the price the boss is to pay. His demand will be his wish to hire you (to benefit from the service you bring him) plus the money he pays you. So if your services aren't bringing him at least as much profit as the money he's handing you every month, it will be perfectly rational for him to let you go - subject of course to the terms of the contract between you.
Conversely if your services are bringing him more profit than your wage is costing him, he has good rationale to keep you on. In fact, it may be a good time to negotiate a raise... though be careful, there may be a jobless competitor out there willing and able to work just as well but for less money. So all in all, you'd do very well repeatedly to make sure you are worth your pay.
Full Employment will prevail when society becomes free. By "full" is meant: everyone who wants a job will have a job (except those in the process of changing jobs, which is generally reckoned to be about 5%.) How so? - because nothing will stop that. The main factors that prevent full employment today are:
That's not to say that all jobs available would pay well. It just means that nothing would prevent any jobless person obtaining one, at some wage. Many, of course, will have saved up for a rainy day and will prefer to ride out a rough situation and wait for a better offer.
- "Minimum wage" laws that prohibit jobs being offered for less than some specified hourly rate, even though both parties would accept one, and
- Mis-allocation of capital or other distortion of the economy, due to government manipulation of resources; more on that below.
3. What Brings Prosperity?Countries differ widely, in measures of prosperity such as per-capita income, even though they might have very similar cultural backgrounds. Why?
Two reasons above all: investment and trade - and both depend on freedom or in other words, on the extent to which TOLFA's self-ownership axiom (Segment 1) is implemented in practice. Let's check.
Investment means not consuming all that is produced, but taking some of it and buying equipment that will make future production easier. For example, a subsistence farmer might have to eat half of all he grows and spend 80% of what he can sell the rest for on clothes, shelter and heating - but the remainder he spends on upgrading his plow. Literally, he is "plowing back" some of what he produced. Next year, the new plow enables him to grow more - to expand his business - without any extra labor. So he can put aside even more, and plow that back by trading his horse for a used tractor, and so the cycle of prosperity has begun, for him. In a decade or two he will prosper and his children will own Porsches.
Tragedy is, governments usually intervene in a variety of ways to monkeywrench that process; so in most countries of the world, even in the 21st Century, grinding poverty remains.
Trade means that members of a society are free to exchange what they produce not only with each other, but with foreigners who wish to do so. Such cross-border exchange is usually called "free trade." This freedom is critically important because very few countries have all they need for economic growth; land on which to grow all the food they want, minerals to yield all the raw materials required for machinery, fuel (coal, oil) to provide power to run those machines, and so on. That doesn't matter, provided they can freely exchange their surplus of one kind of product to make good their shortage of another.
Thus, Japanese since about 1850 have had too little agricultural land to feed everyone - but they have been very skilled and hardworking in manufacturing a wide range of things from toys and watches to computers to ships. They export ships and cars, and use the money to buy-in food. Problem solved. Hong Kong, similarly, had virtually no space to grow food - yet by free trade has been able to achieve the highest standard of living in the Pacific.
Tragedy is, government often intervene to prevent or hinder free trade by imposing import tariffs to distort the apparent prices of available foreign goods. Result: continuing poverty.
4. Savings, Capital and InvestmentConsider a small town, one of whose residents has just invented a New and Improved Widget, which holds the promise of making life more pleasant for millions of people; a highly saleable product. Such is the expected demand that a new factory is needed to produce it, which will need to hire fifty people to work at the task. One problem: our inventor doesn't have the $15 million it will take to set things up. So where do you think that money might come from?
So, all three ways would make the needed $15 million available, but only one of them would do so with maximum care and with no inherent disruption of the economy such as inflating prices by creating new, paper "money". In a free society, that's the method that would always apply, and therefore only a free society would provide such "capital" with the least risk of loss and, so ensure that of all possible business ventures considered, the maximum number succeed.
Nobody spends or invests other peoples' money as carefully as he does his own.
The project may fail anyway - but notice what happens in the three cases. In all of them, of course, the inventor is deeply disappointed; and those people whom the new plant had hired will be let-go, perhaps suddenly. They will need to find new jobs, fast.
If the money came from the government, all taxpayers will have to kiss it farewell; but they lost it anyway, the moment it was stolen from them - so it makes little difference. They were never promised any return on their forced investment, and they won't get any. The only consequence is that $15 million was created and, in effect, thrown away. The whole society is the poorer.
If the money came from the bank by the strong magic of Fractional Reserve, the same will apply; though if it came that way honestly, from depositor money, the bank may well go belly up and depositors will lose $15 million that they never expressly chose to place at risk. Big trouble.
But if the money came from shareholders, they of course will lose it but they knew they might. They assessed the risk, judged it was worth it when compared with the lucrative returns from the sales of the new Widget, but unhappily lost. They will be worse off but (apart from those laid off) nobody else. The risk is carried exactly where it ought to be carried.
If the project succeeds on the other hand, those shareholders will become very wealthy - as will the inventor who made it all possible, presuming he wrote a good contract when offering the shares for sale. And so they all should; those are the rewards of taking carefully considered risks. That's capitalism, freedom and responsibility.
You now know why the Soviet Union was a total disaster, and why relatively free countries have a standard of living so very much higher than those with relatively heavy government management of the economy. And you understand why it matters so very much that America is moving relentlessly from the latter to the former, and so how critically important it is that everyone learns what TOLFA teaches.
The "Business Cycle" theory from the Austrian School of economics explains why some times are good and some, hard.
The natural, free-market way that capital is generated for business expansion is that ordinary people save some of what they earn, and directly or indirectly invest the savings where they think it will yield a high but safe return. They have a "preference" balance between spending it now or keeping and increasing it for later use.
In the first phase of the business cycle, government artificially lowers interest rates and increases the supply of paper "money" so as to create a "boom" that makes voters feel rich - and grateful. This bonanza of cheap money is borrowed by businesses and others who suppose it really reflects that preference of real people to save and invest (and if that were truly the source, the borrowing and investing would be a very rational response.)
In its second phase, the Cycle sees an increase in the proportion of investment projects that fail - partly because the loans were so cheap that insufficient care was taken in using them, partly because the reasonable expectation that, having saved up, ordinary people would then spend some of the savings on what manufacturers produced with the money they borrowed. That expectation is false, because the loans never came from individual savers in the first place. So there are collapses and layoffs.
The third phase is one of liquidation; items bought in the first (often capital equipment, by businesses) which are found not to be needed are sold off for what they can fetch, to those who can use them; some companies go under, and provided no new money is "created" to slow down the process of correction, the "bust" completes the cycle quite rapidly. It's nasty while it lasts but historically - before 1931 - two years proved ample. The problem in 1931 was that then and for for 15 more miserable years the government intervened to block the necessary falls in wages and prices and to continue to manipulate money supply. Thus did the Feds prolong the Great Depression until 1946, distracting attention from its disastrous failure by needlessly involving America in a terrible four-year war.
When the free market replaces government, the disruption and discomfort of boom-bust business cycles will end; for their cause will have been removed. Money for borrowing and investing will be exactly as plentiful as individual owner-savers choose to make it, neither more nor less. There will of course still be investment errors as well as successes, with consequent losses falling on those who erred; but there is no reason for the error rate to vary over time.
5. Segment ReviewEconomics is a huge and fascinating subject and Segment 15 has done no more than to hit the high spots; so do take some time to acquire and read some of the excellent books recommended below - starting, perhaps, with Hazlitt's and/or Grant's. Also as usual before you move on to Segment 16, answer the following Questions to your own satisfaction, running any difficulties by your Mentor.
Q1 Q2 Q3 Q4 Q5 Q6
For further reading:
Minimum Wage: Minimum Sense, or Maximum Savagery?
"Capitalism and Freedom" by Milton Friedman
"Economics in One Lesson" by Henry Hazlitt
"Vienna and Chicago: Friends or Foes?" by Mark Skousen
"The Incredible Bread Machine" by Richard Grant
"Power & Market" by Murray Rothbard
"America's Great Depression" by Murray Rothbard