Tag Archives: wants

Economics Explained — Part II: Economic Principles in Perspective

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This is the second installment of a long post. I may revise it as I post later parts. The whole will be published as a page, for ease of reference. If you haven’t read “Part I: What Is Economics About?“, you may benefit from doing so before you embark on this part.

What Drives Us

Humans are driven by the survival instinct and a host of psychological urges, which vary from person to person. Those urges include but are far from limited to the self-aggrandizement (ego), the need for love and friendship, and the need to be in control (which includes the needs to possess things and to control others, both in widely varying degrees). Economic activity, as I have said, excludes matters of love and friendship (though not calculated relationships that may seem like friendship), but aside from those things — which influence personal economic activity (e.g., the need to provide for loved ones) — there are more motivations for economic activity than can be dreamt of by economists. Those motivations are shaped genes and culture, which are so varied and malleable (in the case of culture) that specific knowledge about them is useful only to the purveyors of particular goods.

Therefore, economists long ago (and wisely) eschewed models of economic behavior that impute particular motivations to economic activity. Instead they said that individuals seek to maximize utility (something like happiness or satisfaction), whatever that might be for particular individuals. Similarly, they said that firms seek to maximize profits, which is easier to quantify because profit is measured in monetary units (dollars in America).

Irrational Rationality

Further, economists used to say that individuals act rationally when they strive to maximize utility. Behavioral economists (e.g., Richard Thaler) have challenged the rationality hypothesis by showing that personal choices are often irrational (in the judgment of the behavioral economist). The case of “saving too little” for retirement is often invoked in support of interventions (including interventions by the state) to “nudge” individuals toward making the “right” choices (in the judgment of the behavioral economist). The behavioral economist would thus impose his own definition of rational behavior (e.g., wealth-maximization) on individuals. This is arrogance in the extreme. All that the early economists meant by rationality was that individuals strive to make choices that advance their particular preferences.

Wealth-maximization is one such preference, but far from the only one. A young worker, for example, may prefer buying a car (that enables him to get to work faster than he could by riding a bus) to saving for his retirement. There are many other objections to the imposition of behavioral economists’ views. The links at the end of “No Tears for Cass Sunstein” (Thaler’s co-conspirator) will lead you to some of them. That post and the posts linked to at the end of it also provide insights into the authoritarian motivations of Thaler, Sunstein, and their ilk.

The Rise of Corporate Irresponsibility

Turning to firms — the providers of goods that satisfy wants — I have to say that the profit-maximization motive has been eroded by the rise of huge firms that are led and managed by bureaucrats rather than inventors, innovators, and entrepreneurs. The ownership of large firms is, in most cases, widely distributed and indirect (i.e., huge blocks of stock are held in diversified mutual-fund portfolios). This makes it possible for top managers (enabled by compliant boards of directors) to adopt policies that harm shareholders’ financial interests for the sake of presenting a “socially responsible” (“woke”) image of the firm to … whom?

The firm’s existing customers aren’t the general public, they are specific segments of the general public, and some of those segments don’t take kindly to public-relations ploys that flout the values that they (the specific segments) hold dearly. (Gillette and Dick’s Sporting Goods are recent cases in point.) The “whom” might therefore consist of segments of the public that the firms’ managers hope will buy the firm’s products because of the firm’s pandering. and — more likely — influential figures in business, politics, the arts, the media, etc., whom the managers are eager to impress.

“Social responsibility” fiascos are only part of the picture. Huge, bureaucratic firms are no more efficient in their use of resources to satisfy consumers’ wants than are huge, bureaucratic governments that (at best) provide essential services (defense and justice) but in fact provide services that politicians and bureaucrats are “needed” in order to buy votes and make work for themselves.

The bottom line here is that the satisfaction of consumers’ wants has been compromised badly. And the combination of government interventions and corporate misfeasance has made the economy far less productive than it could be.

The Flip Side of Economics: Failure to Produce

Economics, therefore, is about the satisfaction of human wants through the production and exchange of goods, given available resources. It is also about the failure to maximize the satisfaction of wants, given available resources, because of government interventions and corporate misfeasance.

The gross underperformance of America’s economy illustrates an important but usually neglected principle of economics: Every decision has an opportunity cost. When you choose to buy a car, for example, you forgo the opportunity to buy something else for the same amount of money. That something else, presumably, would afford you less satisfaction (utility) than the car. Or so the theory goes. But whether it would or wouldn’t isn’t for a behavioral economist to say.

Individuals (and firms) often make choices that they later regret. It’s called learning from experience. But “nudging”, government interventions, and corporate sluggishness reduce the opportunity to learn from experience. (Government interventions and corporate sluggishness also prevent, as I have said, behaviors that are essential to economic vitality: invention, innovation, and entrepreneurship.)

Government interventions also incentivize economically and personally destructive behavior. There are many estimates of the costs of government interventions (e.g., this one and those documented quarterly in Regulation magazine) and a multitude of examples of the personally destructive behavior engendered by government interventions. It is impossible to say which intervention has been the most harmful to the citizenry, but if pressed I would choose the thing broadly called “welfare”, which disincentivizes work and is an important cause of the dissolution of black (welfare-dependent) families, with attendant (and dire) results (educational, occupational, criminal) that bleeding hearts prefer to attribute to “racism”. If not in second place, but high up on my list, is the counterproductive response (by government at the prodding of bleeding hearts) to homelessness.

Thus we have yet another principle: the “law” of unintended consequences. Unintended consequences are the things that aren’t meant to happen — but which do happen — when an actor (be it governmental, corporate, or individual) doesn’t think about (or chooses to minimize or ignore) when it or he focuses on a particular problem or desire to the exclusion of other problems or desires. Individuals can learn from unintended consequences; governments and, increasingly, corporations are too rule-bound and infested by special interests to do so.

None of what I have said about corporations should be taken as an endorsement of governmental interventions to make them somehow more efficient and responsible. (The law of unintended consequences applies in spades when it comes to government.) The only justification for state action with respect to firms is to keep them from doing things that are inimical to liberty and can’t be rectified by private action. In an extreme case, a business that specializes in murder for hire is (or should be) a target for closure and prosecution. A business that sells a potentially harmful product (e.g., guns, cigarettes) isn’t a valid target of state action because the harmful use of the product is the responsibility of the buyer, product-liability law to the contrary notwithstanding.

What about a business that collaborates (perhaps tacitly) with other businesses or special interests to prevent the expression of views that are otherwise protected by the First Amendment but which are opposed by the managers of the business and their political allies? There are good arguments for a hand-off approach, in that markets — if they are allowed to operate freely — will provide alternatives that allow the expression (and wide circulation) of “objectionable” views. If anti-trust actions against purveyors of oil and steel (two take two examples from the past) are inadvisable (as I have argued), aren’t anti-trust actions against purveyors of information and ideas equally inadvisable? There is a qualitative difference between economic rapacity and what amounts to a war that is being waged by one segment of the nation against other segments of the nation. (See for example, “The Subtle Authoritarianism of the ‘Liberal Order’“.) Government action to defend the besieged segments is therefore fitting and proper. (See “Preemptive (Cold) Civil War“.)

Economics and Liberty

This brings me to the gravest economic threat to liberty, which is state socialism and its variants: communism, fascism, and social democracy. All of them vest control of the economy in the state, when not through outright state ownership of the means of production, then through laws and regulations that dictate allowable types of economic output, the means and methods of its production, and its beneficiaries. The United States has long been burdened with what has been called a “mixed” economic system, which is in fact a social democracy — an economy that has many of the trappings of free-market capitalism but is in fact heavily managed by governments (federal, State, and local) in the service of “social justice” and various trendy causes.

The most recent of these is the puritanical, often hypocritical, and anti-scientific effort to rescue the planet from “climate change”. The opportunity cost of this futile undertaking, were it conducted according to the dictates of its most strident supporters, would be a vast share of the economic output of the the Western world (inasmuch as Russia, China, India, and even Japan are disinclined to participate), thus demoting America and Western Europe to Third-World status and rendering them vulnerable to economic and military blackmail by Russia and China. (Old grudges die hard.) You can be sure, however, that even in their vastly diminished state, the Western “democracies” would find the resources with which to cosset the ruling class of politicians and their favorites.

Proponents of state action often defend it by adverting to the paradox of collective action, which is that individuals and firms, acting in what they perceive to be their own interests, can bring about a disaster that engulfs them. “Climate change” is the latest such so-called disaster. What the proponents of state action always omit to consider (or mention) is that state action itself can bring about a disaster that engulfs all of us. The attempt to control “climate change” is just such an action, and it is of the more dangerous kind because government programs, once started, are harder to turn around than the relatively modest and inexpensive projects of individuals and firms.

You may think that I have strayed a long way from the principles of economics. But I haven’t, if you’ve been following closely. What I have done — or tried to do — is put economic activity in perspective. Which is to say that I’ve tried to show that economic activity may be important and even crucial to our lives, but it is not the only important and crucial thing in our lives. Economic activity is shaped by government and culture. If the battle to contain government is successful, and if the battle to preserve a culture of personal responsibility and respect for traditional norms is successful, economic activity will thrive and be worth the striving.

Economics Explained – Part I: What Is Economics About?

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This is the first installment of a long entry. I may revise it as I post later entries. The whole will be published as a page, for ease of reference.

Economics, as a discipline, often seems counterintuitive, when it is not downright paradoxical. Perhaps the most counterintuitive principle of economics is that unregulated markets are the best mechanism for meeting human wants, given limited resources. Despite that principle, most economists emulate politicians and rabble-rousers in their penchant for second-guessing market outcomes and devising ways of manipulating those outcomes. This penchant does not negate the principle; it merely underscores the unwarranted vanity of the “intellectual” class.

Economics is mysterious to laymen because its practitioners have embellished it with unduly complex mathematical theorizing. In other words, when economics is not counterintuitive it is simply incomprehensible.

There is no need for economics to be counterintuitive or mysterious. Many writers have essayed simple — and correct — expositions of the principles of economics. The most notable effort, perhaps, is Henry Hazlitt’s Economics in One Lesson. Another good source is The Concise Encyclopedia of Economics at The Library of Economics and Liberty (a web site). (Good places to start there are “Basic Concepts” and “Ten Key Ideas“.)

Unfortunately, Hazlitt’s short book is more than 200 pages long. And the entries at The Library of Economics and Liberty are disjointed. What the world needs is a truly concise but coherent and comprehensive statement of the principles of economics. Thus this post, in which I use not a single equation or graph. Why? Because equations and graphs can be off-putting to readers who are not habituated to them. Moreover, equations and graphs imply a degree of precision that is not found in the real world; verbal explanations, hedged with qualifications, give a more accurate picture of reality (albeit one that necessarily remains incomplete).

I begin with the basic question: What is economics about? The answer to that question leads to observations about the principles of economics, which are shaped by politics and culture. From there, I illustrate the principles by working through an example that eventually takes them all into account.

What Is Economics About?

Economics is about the satisfaction of human wants through the production and exchange of goods (a term that encompasses information, services, and tangible products). That simple definition raises several issues, which are the fundamental subjects of economic inquiry:

  1. What are human wants, and how do they arise?
  2. Are all human wants (e.g., love) the proper domain of economics?
  3. By what mechanisms are resources transformed into goods and then matched (or not) to human wants?
  4. What determines the rate of output of all goods, that is, the aggregate degree of satisfaction of human wants?
  5. What is the proper role of government in the satisfaction of human wants?

The brief answers to these questions, upon which I elaborate below, are as follows:

1. Human wants arise from basic human requirements and impulses (e.g., the need for food, clothing, shelter, transportation, and status). Another way to say it is that human wants are both biological and emotional. Particular human wants, therefore, arise from a combination of biological impulses and cultural influences. Some wants clearly are essential to life (e.g., food); some wants clearly are nonessential but nevertheless fill emotional needs (e.g., yachts and mansions). But, like mountains and molehills, the extremes are distinguishable but they are connected by many indistinguishable intermediate stages; that is, there is no telling when wants transition from essential, to beneficial, to frivolous. Moreover — and this is an essential point to which I will return — the striving to fulfill what might seem to be frivolous wants can lead (by steps to be discussed later) to the creation of jobs that yield income from which the job-holders are able to fulfill essential wants (and others, as well).

2. Some human wants arise from impulses that economists should be wary of trying to analyze and measure. The most obvious of these is the kind of love that leads to marriage, sex, and children. Yes, there are sexual arrangements outside marriage that are purely economic transactions. But love of the kind that leads to marriage, sex, and children (and thence to love of parents for their children) is beyond the ken of economics. So, too, are other relationships that are non-transactional, such as friendship and membership in various voluntary organizations (churches, clubs, etc.).

3. Economics is therefore about arms-length transactions — transactions that aren’t bound up in non-contractual relationships like marriage, family, friendship, church, and club. Voluntary exchange and prices are the default mechanisms for matching goods with wants in arms-length transactions. The simplest example is barter: Andy makes bread and wants butter to put on it; Babette makes butter and wants bread for it: Andy and Babette strike a bargain that yields a rate of exchange between bread and butter (i.e., a price for bread in terms of butter and vice versa); the exchange makes both Andy and Babette better off (i.e., there are mutual gains from trade). The prices established by Andy and Babette also serve as signals (provide information) to others who seek to exchange bread and butter; for example, Chuck (a potential producer of butter) might be willing to make butter and trade with Andy on more favorable terms than those offered by Babette.

4. There is no such thing as an aggregate measure of the output of goods — though aggregation is implicit in macroeconomic constructs (e.g., gross domestic product). Thinking only of the United States, for example, how is it possible to aggregate the value of myriad goods that are produced and bought by dozens of millions of businesses and individuals? Hint: Because statistical sampling is arbitrary and uncertain, the answer cannot be found in the common denominator of money. It is nevertheless possible for an economy to move generally in the direction of growth or decline, with exceptions around the trend. It is obvious, for example, that most Americans use goods that are superior in number and quality to the goods that most Americans enjoyed 50 years ago. It is also obvious that during the episode known at the Great Depression, most Americans were materially worse off than they had been before the depression began, and that relatively few became better off. How such things happen, and how economic growth can be sustained and economic declines can be reversed, are valid subjects of economic analysis.

5. Voluntary exchange, unalloyed, can leave some persons “behind” (e.g., those who are incapable of producing bread in exchange for butter, those whose output is worth less to buyers than it used to be). But there is another human impulse (call it “altruism” for now) that leads to the voluntary redistribution of wealth and income, thus enabling the beneficiaries of the redistribution to buy more goods than they can afford on their own. Government action taken in the name of altruism displaces and discourages private altruistic action. More generally, government action throttles economic vitality, causes and exacerbates economic disruptions, and interferes with the constructive resolution of those disruptions. The proper role of government is to provide a framework of defense and justice within which economic actors can operate voluntarily and with little fear that their efforts to improve their lot (and the lot of others less fortunate) will be stymied by force or fraud. Government intervenes legitimately only when it prevents or discourages force and fraud (e.g., defending foreign sources of oil, detecting and preventing terrorism on U.S. soil, prosecuting thieves and murderers, prosecuting “boiler room” operators).

Economics from the Bottom Up

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This is the sixth entry in a series of loosely connected posts on economics. Previous entries are here, here, here, here, and here.

NEEDS AND WANTS

What human beings want and what they need are popularly thought to be distinguishable things. Needs are said to be those things that sustain life: food (the minimum daily requirement, with no frills), clothing (just enough to protect us from the elements), and shelter (ditto). Wants are generally thought to be everything else.

But individuals vary in their perceptions of what they need; one person’s need is another person’s luxury. If a rich playboy “needs” a $300,000 Lamborghini, that’s for him to say. Accountants of the soul — moralists who believe that they know how the world should be ordered — will assert that the rich playboy can make do with a $10,000 Kia. But if that’s true, everyone can make do with a $10,000 Kia. And if that’s true, why not a bus token? (Only the older folks will remember those.)

Once the accountants of the soul are loosed, the people are allowed to need (or want) whatever the accountants of the soul approve. Except for those people who are in the good graces of the accountants of the soul. If you suspect that I’m alluding to places like the the former Soviet Union, the former German Democratic (sic) Republic, and the present Cuba and Venezuela, you’re right.

Given that “need” is a loaded word, I use the less-loaded “want.” Thus the rich playboy wants a $300,000 Lamborghini. Whether he needs it is not for economists or accountants of the soul to determine. It’s for the rich playboy to determine as he allocates his available income and wealth to competing products, services, and investment vehicles.

Wants are limitless. I may want a $300,000 Lamborghini (though I am not a rich playboy), a villa on the Mediterranean, and a collection of Rembrandts. Those wants lie far beyond my reach, and the reach of most human beings.

The main attribute of wants, other than their inherent limitlessness, is their vast variety and changeableness. Wants and their ordering can change from minute to minute, depending on what a person was doing a minute ago, what he happens to be doing now, where he happens to be doing it, the conditions in which he is doing it, who or what happens to impinge on his consciousness, how he is feeling (emotionally and physically), and so on. It takes free markets — not command economies run by soul-accountants — to respond to the vast variety and changeableness of wants.

TASTES AND PREFERENCES

A particular want is sometimes referred to as a taste. My taste for ice cream has persisted for more than seven decades. But I may, at various times, want different kinds of ice cream. And I may, at various times, prefer a certain ice cream to, say, chocolate cake, or vice versa.

To take another example, a middle-aged man may have only a residual taste for action movies; that is, he rarely wants to view one, given the alternative ways in which in can use his time and given his recently acquired taste for technical non-fiction books. Yet, twenty years earlier, when he had a strong taste for action movies, the now middle-aged man had no interest in technical non-fiction; it didn’t enter into his thoughts when he pondered whether to watch an action film or do something else.

If tastes represent the kinds of things wanted by a person, preferences are the order in which a person wishes to satisfy those tastes. Preferences, like tastes, change with time (often rapidly), and are also situation-dependent. For example, when I’ve finished eating a large bowl of chocolate ice cream, I’m likely to prefer a glass of cold root beer to another bowl of chocolate ice cream.

The preference for a glass of cold root beer rather than another bowl of ice cream doesn’t necessarily mean that the second bowl of ice cream would give me less satisfaction than the first bowl. It might or might not. But, in the circumstances, I would enjoy a glass of cold root beer more than another bowl of ice cream. (The concept of diminishing marginal utility may apply to particular things at particular times, but it is neither generally true nor a valid reason for redistributing income by force.)

UTILITY AND DEMAND

There are two classic microeconomic constructs that reduce wants, tastes, and preferences to discrete quantities: indifference curves and demand curves.

An indifference curve is said to depict the rate at which a consumer is willing to exchange units of product X for units of other products, while holding constant his level of satisfaction (utility) and his preferences (ordering of wants). Given the rapidity with which preferences can change, I see little utility in indifference curves — except as a pedagogic device.

A demand curve for X can be derived from indifference curves by showing how the amount of X preferred by the consumer varies with the price of X, where (at each price) the consumer chooses the mix of X and other economic goods that maximize his utility. (I use economic goods to stand for products — material items — and services, which require the use of material items but which aren’t material (e.g., a haircut, the use of a credit card to make a purchase).

But an individual’s wants, tastes, and preferences are fuzzy at any given time. So, an individual’s demand for X at any given time is fuzzy — and then it changes, in fuzzy ways.

The summation of all consumers’ demand curves for X yields, in theory, an aggregate or market demand for X at an instant in time — holding constant wants, preferences, income, and the prices of other goods. In other words, the demand for a given economic good is very fuzzy. It may be possible to estimate approximately the demand for a particular economic good for a brief period of time, though the approximation will necessarily come with a range of uncertainty.

SUPPLY: THE SATISFACTION OF WANTS

If demand is one blade of a scissor, supply is the other blade. By supply I mean the ways in which human beings contrive to satisfy at least some of their wants some of the time. Supply comes in three basic forms: individual action, cooperative behavior, and voluntary exchange.

Individual action is just that: what each of us does to satisfy his wants without the help of others, and without recourse to the exchange of one’s resources for the resources of others.  Needless to say, individual action is limited mainly to Robinson Crusoe cases: situations in which a person must fend for himself, to the best of his ability and given the resources at hand.

Cooperative behavior is more relevant to the satisfaction of wants. It is the kind of behavior that wasn’t uncommon in the rural America of decades past, when each farm family operated as an economic unit. The combined efforts of a family — joined at times by neighbors — yielded shelter, food, and (sometimes) clothing, all of which were shared within the family.

To the extent that the family’s efforts failed to yield all of the kinds of food and clothing wanted by the family, it would then turn to voluntary exchange. It would trade some of its products (or labor) in order to acquire things that it could not produce or — this is a key point — could not produce as efficiently as another family or business. Voluntary exchange is of course today’s main mechanism for satisfying wants.

Voluntary exchange in a complex economy is a roundabout process, through which persons with marketable skills (e.g., real accountants) trade their services for monetary income, which enables them to choose from myriad products, services, and investment vehicles.

SUPPLY CREATES DEMAND (BUT NOT VICE VERSA)

Say’s law — popularly rendered as “supply creates its own demand” — is explained by Steven Horwitz in “Understanding Say’s Law of Markets“:

In the passage where he gets at the insight behind the notion that supply creates its own demand, Say writes: “it is production which opens a demand for products. . . . Thus the mere circumstance of the creation of one product immediately opens a vent for other products.” Put another way, Say was making the claim that production is the source of demand. One’s ability to demand goods and services from others derives from the income produced by one’s own acts of production.

Can demand exist without supply? Only if the person who wants something but lacks the wherewithal to pay for it is able to finance his purchase in one of three lawful ways:

  • He may receive a gift of money. But that gift reduces the purchasing power of the giver, either directly as a subtraction from his income or indirectly as a subtraction from his wealth. So the net effect on the demand for all goods may be zero.
  • He may receive a subsidy from government. But the subsidy reduces the purchasing power of the persons who are compelled to finance it through taxes, or the purchasing power persons or companies who are able to borrow less because government borrowing (to finance the subsidy) displaces their borrowing.
  • He may receive credit, either from the seller or a third party. Credit usually will be extended on the basis of the borrower’s prospective future earnings.

The third case is the only one that clearly results in an additional demand for goods. And it is the one in which demand is financed by supply. Demand creates supply only when demand is financed by a claim on the demander’s future supply of economic goods. The ability of a creditor to finance demand rests ultimately on the creditor’s previous production (and sale) of economic goods.

The Keynesian proposition that demand can create supply of thin air, simply by throwing money at unemployed resources, is a fantasy perpetuated by mathematical trickery.

MEANINGLESS AGGREGATION

Are you better off, as a consumer, than you were 5, 10, or 15 years ago? That’s a question which only you can answer. And the answer won’t necessarily depend on your rate of spending today as compared with your rate of spending 5, 10, or 15 years ago. It will depend on how you — and only you — feel about the enjoyment that you derive from your expenditures.

Like you, A and B will derive different kinds and amounts of enjoyment the goods that they buy. And those different kinds and amounts of enjoyment cannot be summed because they are unique to A and to B, just as they are unique to you. If meaningful aggregation is impossible for A and B, how can it be possible for an economy that consists of millions of economic actors and an untold variety of goods and services? And how is it possible when technological change yields results such as this?

GDP, in other words, is nothing more than what it seems to be on the surface: an estimate of the dollar value of economic output. It is not a measure of “social welfare” because there is no such thing.