Economics

Economics is the science of production and trade under a division of labor (market) society.

Economics

Economics is the science of production and trade under a division of labor (market) society.

By systematically and logically discovering the principles that underly an economy, economics explains how a market works, and how it can sometimes fail.

Microeconomics is the branch of economics that examines how an economy works at the individual (micro) level. It analyzes the actions of entrepreneurs (firms) that produce goods and services for trade in a market price system.

The results of the operations of the economy at the microeconomic level form the basis of macroeconomics which studies the economy as a whole at a collective, aggregate level (national and international level).

If macroeconomics can be said to study the forest than microeconomics examines the trees.

Economic Actor

The economic actor — the entity that performs all economic decisions and actions — is the individual.

A given individual may assume a variety of economic roles during their life or may specialize in one or more roles: as a consumer, as a producer, as a financier, as an employee or laborer, as a manager, and most importantly as an entrepreneur/capitalist, etc.

All organizations are groups of individuals.

All organizations — shops, unions, businesses, corporations, nations, etc. — are an organized group of individuals in specific roles with specific relationships and responsibilities. In all such cases, it is individuals who are making the decisions and taking action, either individually or in coordination with other individuals based on their hierarchical roles and responsibilities.

Economic Value

The economic value of a good or service is what an individual would exchange for a given good or service (usually in terms of money). Economic value is personal (“economically subjective”) to the context of an individual. It is not intrinsic to the good. [1] Writes economist Carl Menger:

“Value is a judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being. Hence value does not exist outside the consciousness of men.” [1]

For example, a glass of water is of more value to someone dying of thirst who has been stranded on a deserted island, then the diamond necklace they are wearing. Put that same individual at home where they have sufficient access to all the water they want, and they would be hard-pressed to give up their expensive necklace for a glass of water. This explains the “paradox of value” that puzzled earlier classical economists like Adam Smith: why are diamonds sold for a higher price than water, given that water is biologically more important to life?

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When two individuals believe they gain more value from exchanging goods or services, they will make a trade, and exchange a value (say shoes) for a value (say a shirt), creating a win-win situation, as both personally value the goods they are receiving then the goods they are exchanging.

The market price (or market “value”) of a good or service is the price it actually trades for at a given time in terms of money.

 

Notes

[1] Quoting Carl Menger, founder of the Austrian School of Economics and co-founder of the Theory of Marginal Utility, remarks in his Principles of Economics (1871):

Value is thus nothing inherent in goods, no property of them, nor an independent thing existing by itself. It is a judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being. Hence value does not exist outside the consciousness of men. It is, therefore, also quite erroneous to call a good that has value to economizing individuals a “value,” or for economists to speak of “values” as of independent real things, and to objectify value in this way. For the entities that exist objectively are always only particular things or quantities of things, and their value is something fundamentally different from the things themselves; it is a judgment made by economizing individuals about the importance their command of the things has for the maintenance of their lives and well-being. Objectification of the value of goods, which is entirely subjective in nature, has nevertheless contributed very greatly to confusion about the basic principles of our science.

By “subjective”, Menger means personal to the individual, and thus cannot be determined by an outside figure.

Production

Production is the act by entrepreneurs of creating economic value by shaping given materials into goods (and services) for future consumption.

In the case of services, an entrepreneur (like a doctor) renders these services immediately, though much planning and investment is required (from building a hospital to getting the medical knowledge as certified via a medical degree).

 

Consumption

Consumption is the act of consuming or using (up) values.

Such consumption can be productive consumption (consuming energy to mine metals to sell to another business) or non-productive consumption or final consumer consumption (eating a slice of cake).

Wealth

Wealth is a material good or service that has value to human life (that has economic value.)

Examples of material wealth can be goods for personal consumption (consumer goods) like food or a house; or goods used for the production of other goods (capital goods), such as tool or a factory; or services such as those rendered by a doctor, or musician at a live concert (consumer services), which are consumed instantaneously on production, or services rendered for the production of other goods (human capital).

Division of Labor

In a division of labor society, individuals create values for future trade as opposed to self-consumption.

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Writes Adam Smith on the importance of specialization and the division of labor in his book The Wealth of Nations:

“To take an example, … the trade of the pin-maker; a workman not educated to this business (which the division of labour has rendered a distinct trade), nor acquainted with the use of the machinery employed in it (to the invention of which the same division of labour has probably given occasion), could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them.”

“I have seen a small manufactory of this kind where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day; that is, certainly, not the two hundred and fortieth, perhaps not the four thousand eight hundredth part of what they are at present capable of performing, in consequence of a proper division and combination of their different operations.”

“In every other art and manufacture, the effects of the division of labour are similar to what they are in this very trifling one; though, in many of them, the labour can neither be so much subdivided, nor reduced to so great a simplicity of operation. The division of labour, however, so far as it can be introduced, occasions, in every art, a proportionable increase of the productive powers of labour. The separation of different trades and employments from one another, seems to have taken place, in consequence of this advantage. This separation too is generally carried furthest in those countries which enjoy the highest degree of industry and improvement; what is the work of one man in a rude state of society, being generally that of several in an improved one.”

Trade

Trade is the act of voluntarily exchanging one value for another. (Theft is when the value is exchanged involuntarily).

Under Capitalism — the social system based on individual rights — one may obtain property from others only by their voluntary consent. By banning the initiation of physical force from all relationships (compulsion), capitalism leaves only one way for people to deal with each other: through the peaceful means of persuasion, by appealing to another’s self-interest. This form of dealing with others is the highest form of voluntary social cooperation: trade.

A trade is a voluntary exchange of values between two (or more) parties for their mutual benefit. In a free-market, trade only takes place only when the seller and the buyer agree to the same terms of exchange free from the threat of physical violence and fraud.

Voluntary means that either party initiates no force; that both parties enter the trade of their free-will. That is with no guns, knives, or fists pointed at their heads, hearts, or backs.

Mutual benefit means that both parties benefit since they think they both think are will be better off by trading then if they did not.

For the buyer, trade means that one is free to buy on whatever terms the buyer finds agreeable. If the buyer does not like the seller’s offer, the buyer is free to refuse, and is free to go somewhere else, or is free to produce the good himself, if so able. No one is morally allowed to physically force the buyer to change his terms of buying, by threatening to expropriate the holdings of the buyer’s bank account, or by threatening to imprison the buyer, if the buyer does not voluntarily agree to the terms.

For the seller, trade means that one is free to sell on whatever terms others voluntarily agree to. If the seller does not like the buyer’s offer, the seller is free not to accept them and is free to find another buyer. No one is morally allowed to physically force the seller to change his selling terms, by pointing a gun to his head, or by threatening to fine him a million dollars a day, or by threatening to imprison the seller, if the seller does wish to change his terms of sale for his property.

Barter (direct trade) is where a good/service is exchanged directly for another good/service for consumption, i.e., not for further trade.

A monetary (indirect) trade is where a good/service is exchanged for money, which is then used to be exchanged for another good/service for consumption.

Prices

The price of a good or service are the values it is exchanged for.

In a division of labor, market society, goods are exchanged for money, which is then later exchanged for other goods or services.

The money price of a good/service is what it is exchanged for in terms of money.

Money

Under capitalism, money is an asset (typically gold) used in a division of labor society as a medium for indirect exchange. These can be in the form of deeds, certificates, or notes which can be exchanged for the asset on demand.

In today’s world, money is created literally out of thin air by government-created and run central banks.

Legal tender laws give a monopoly to this fiat money forcing market participants to use this money (by making other money substitutes more costly to use.)

As the paper money is not tied to an asset, there is no limit to how much money central banks create. If the rate of money creation for an economy is greater then the increase in general production for that economy this leads to a general rise in prices. This process is known as monetary inflation (increasing the money supply).

Free-Market

“Intellectual freedom cannot exist without political freedom; political freedom cannot exist without economic freedom; a free mind and a free market are corollaries.” — Ayn Rand

A free-market is a market, where individuals (or groups of individuals) compete against each other to trade goods and services with other individuals (groups), under a legal system based on the protection of individual rights (capitalism), free from the coercive effects of the initiation of physical force (and its corollary, fraud).

Observe that the competition among buyers and the competition among sellers leads to cooperation between buyers and sellers, as the buyer and seller exchange values for mutual gain and mutual benefit (else no trade would take place).

By economically empowering the individual, the free-market leaves one free in the personal sphere to choose (and be responsible for): one’s lifestyle, personal relationships and associations, and one’s own artistic, moral, esthetic, (cultural) choices.

It is important to note that, in reality, the division between economic and non-economic spheres as opposites is illusory. Personal decisions are made possible through private property rights. As examples: an artist expresses their vision with paint, an author with a physical book or letter, a fashionista through their dress, etc. The two are merely the two different sides of the same coin. As Ayn Rand has noted, a free market is a corollary of a free mind.

References

[1] Ayn Rand “For the New Intellectual” 25

Market Competition

Market competition between sellers of products and services for buyer’s money, and between buyers for seller’s goods and services results in cooperation between buyers and sellers when a trade is made.

It is important to note that the distinction between seller and buyer is an issue of focus, as individuals are buyers are sellers, and all sellers are buyers.

They are two sides, so to speak, of the same coin. Sellers trade (sell) products (supply) for money. That same seller will later use the money acquired to buy products as a buyer. Buyers trade (buy) products (demand) with money. That same buyer previously acquired money by selling products and services as a seller.*

The idea that one’s supply constitutes one’s demand is known as Say’s Law of Markets, i.e., that one pays for one’s products with the products one has produced.

Notes

[1] One can also obtain the money from someone else (who produced the products and services) either by voluntary charity or by coerced, involuntary transfer payments (taxation and theft).

 

Business Enterprise

A business (enterprise) is an organization that creates products/services to sell on the market with the goal of making a profit for its owners. Such enterprises are formed when an entrepreneur sees an opportunity to create a product or service in order to obtain a profit (create value in excess of the costs involved).

Such an organization is made up of individuals who serve in various roles as entrepreneurs, managers, owners (shareholders), laborers (employees), etc.

These roles in larg organizations may be further subdivided under the principle of division of labor to gain further efficiencies through increased specialization (employees can be R&D, accounting, distribution, marketing, administration, line staff, etc.), or as in the case of a single-owner business (sole proprietorship), the owner may serve in all the various roles.

The business may be in the form of a corporation (trust) that operates under a condition of limited liability in regard to its shareholders. Limited liability means a shareholder’s liability is limited to no more than the capital invested in a business.

 

Profit and Loss

A business makes a financial profit/loss when its revenues (sales) are more/less than its costs (expenses).

Savings

The financial profits from a business endeavor can be either spent on personal consumption or saved (and reinvested) for further production.

Economic savings is wealth (productive assets like factories, fuel, buildings, raw materials, etc.) that is not used for immediate consumption.

Capitals

Financial (nominal) capital is the money used to finance a business enterprise to purchase the factors of production.

The factors of production include economic capital, land, labor, entrepreneurship, and knowledge (technology).

Economic (real) capital is savings from production (factories, raw materials, raw materials, etc.) invested in a business enterprise to produce wealth.

Entrepreneur

A capitalist (or entrepreneur) is an individual who invests (and risks) capital in a business concern in the hopes of earning a profit in the future.

The capital may be from their personal savings or obtained from others directly, or through a financier.

Interest

Interest is the premium on a loan, that is added to the principal (amount loaned) when the loan is due. Like rent is the price of using someone’s building or land, interest is the price of using someone else’s money.

Interest generally consists of two components a rent (time) component and a risk component.

  • The rent component is the price of someone forgoing the use of their money in the present. The longer the time they forgo the use of their money (the longer the money is tied up as a loan) the greater the interest rate.
  • The risk component is the price to paid to cover the risk that the loan may not be repaid.

Capital and Consumer goods

Capital goods are those goods that businesses use to create products and services for consumers (consumer goods).  Capital goods can be first-order or intermediate goods in the structure of production.

Consumer goods are that are sold directly to the consumer. They are the final goods in the structure of production.

Profits

Under a free-market, a profit is made by creating something of economic value that is more than the cost of producing it, as judged by other producers in their role as consumers.

When an entrepreneur enters into a productive endeavor, one starts with a given sum of capital (unspent wealth). If after a period of time, if one is left with more than one started, one has earned a profit. If one is left with less then one started, one has incurred a loss.

The profit motive is the pursuit of making a profit from one’s production. The opposite is the loss motive — to pursue a loss. The pursuit of profit is the moral right to pursue one’s happiness applied to one’s economic endeavors. To pursue profit is to pursue creation. It is an act of virtue and not a vice.

Stealing wealth from others, through fraud or force, whether done by a private citizen or government bureaucrat, is not profit, but theft (initiation of force). Whether that theft is called a mugging, welfare, or “voluntary” taxation [a contradiction in terms], it is still theft.

Is there such a thing as an “excessive profit”? There is no such thing as a profit that is too high or too low. That is, there is no such thing as an “excessive” profit. There is only the profit that men earn.

What happens when a company starts to make a higher profit in its industry, in comparison to other industries? If any company is a single seller in any industry and starts making profits higher than other industries, due to high prices; it will attract competition into its industry, as other capitalists move their capital from less profitable markets to more profitable ones. If the profits are due to lower production costs, which other companies are unable to match, then the company deserves its profit.

What happens if a business attempts to charge prices lower than his competitors (“dumping”)? If a business attempts to “corner the market” by charging prices that are too low (i.e., below its’ variable costs of production), the business may drive competitors out of the market temporarily (at the price of eating up its financial capital and eroding its profits); but, as soon as the business raises its’ prices (in order to reap profits in order to build back the capital it has given away by selling products below their variable cost), new competitors will enter the market. The only way a company can gain profitably gain market share by lowering its’ prices, is if it can lower its costs of production. If a business can charge the lowest price because it has figured out how to build a better mousetrap (i.e., produce more for less), then it deserves whatever market share it can obtain.

What happens if a business attempts to charge higher prices than its competitors (“gouging”)? If any business attempts to charge prices higher than the market will bear, he will lose all his business to his competition, since he cannot force his competition out of business. The businessman’s power is dollars — not guns.

Are profits extorted from labor? The profits of capitalists are not the surpluses extorted from labor, but are the result of the proper use of one’s capital, as losses are the result of the improper use of capital. If an employer pays a worker a lower salary than the worker wants, the worker is free to leave the job and look for a higher paying job. Let any worker in Soviet Russia, Nazi Germany, or Communist China try to attempt such a feat as leaving his job without the permission of the state, and he will soon find what actual exploitation means.

Do laborers have a right to a share of the capitalist’s profits, in addition to their wages?* Why are the laborers who demand a share in the capitalist’s profits, silent in demanding their share of the capitalist’s losses?  Why don’t they return their past wages when a business ends up running at a loss for the year? If labor is the cause of profits, then is it not also the cause of losses? A moment’s reflection will point out that laborers are only responsible for their job description — they are not directly responsible for the losses or profits of business — and that the cause of an enterprise’s profit and loss lies primarily with the entrepreneur. * Assuming the employee has not entered into a voluntary profit-sharing agreement with their employer — which is really considered as wages. Capitalism does not forbid such arrangements so long as they are voluntary.