August 20th, 2015
Have A Question?
I remember when I came home for the summer after my first year in college. I went to visit one of my good friends from high school and her cousin from Germany was visiting. The cousin and I struck up a conversation, and she asked what I was studying in college. When I said “Economics,” she looked at me with disgust and said: “Oh! So all you care about is Money!” Needless to say, we didn’t really hit it off. In her defense, I have learned over the years that many people think Economics is about money.
The word economics, derived from two Greek words: one meaning “home” and the other, “custom or law.” The concept of “Scarcity” is the foundation of economics. The two conditions of scarcity are limited resources and unlimited wants. Ever since humans left the “Garden of Eden,” scarcity has been unavoidable. You might say, “Matt, as long as everyone has food, shelter, water, health care, entertainment, etc., they should want for nothing.” In the words of John Pinette (God rest his soul). I say: “Nay, Nay.”
Example in point: people living in poverty (as defined by government statistics) in the U.S. today, are actually in the top 10% of everyone else on the planet. In fact, the “poor” in America have a higher standard of living than 99% of all people that ever have lived. Yet who would begrudge their desire to improve their standard of living? Consider your own situation. Wouldn’t you like to drive a nicer car, dress in better clothes, eat more expensive food and take more vacations and so on? It is a fact of life that enough is just never enough! Since we all (individuals, countries, the whole world) have limited resources, we are confronted with scarcity.
In light of scarcity, we are forced to decide what we want most, given the resources we do have, and make choices. We must determine our unique preferences, make trade-offs and sacrifice one thing for another. In other words, scarcity requires us to economize. If we economize effectively, we maximize our satisfaction, given our limited resources. This is the heart of economics. Economics is the study of the production, distribution and consumption of scare resources.
Day-to-day human behavior (choices as determined by individual preferences) transforms scarce means into ultimate ends (standards of living). Since scarce resources have alternative uses, how people in a society make choices (interactions and exchanges) has a significant impact their ultimate standard of living. Indeed, human behavior is directed by incentives; therefore, the economic system that is most consistent with human behavior will result in the most effective use of scarce resources (“effective” in terms of maximum satisfaction).
Societies can choose how to use limited resources through centrally-planned decisions (Socialism, Communism, Fascism, Progressivism, Totalitarianism) or through voluntary individual decisions (Free Market Capitalism). All societies fall somewhere along the spectrum between these two mutually exclusive systems. The “term” of any exchange is the “price” (dollars-per- pound, pay-per-hour, etc.). Centrally Planned and Free Market economies determine these prices in very different manners.
In a centrally planned economy, officials dictate the price of every exchange. In a free market economy, preferences (regarding the quantity offered and the quantity demanded of any good or service) determine prices. As we discussed in “The History of Economics in Three Lessons,” exchange occurs in only one of two ways: “political exchange,” whereby coercion is used to effect the exchange, OR “economic exchange,” whereby both parties to the exchange willingly make a trade. A free-market determined price is where a willing buyer and willing seller make a deal.
An economy may have millions of people, all with their own individual preferences (some prefer food to travel; others prefer a bigger house to having more vacations). These millions of people conduct billions of choices and exchanges each day. This complexity makes it very difficult for central planners to set prices (terms of exchange) that would maximize the preferences of these millions of people.
If central planners set a price too high, more of that good or service will be produced than people actually want (at that price) resulting in a surplus (wasted resources). If central planners set a price too low, less of that good or service will be produced than people actually want (at that price) resulting in a shortage (wasted resources). In the Soviet Union (a country greatly endowed with resources), people constantly suffered from shortages of the things they wanted and surpluses of things they already had enough of.
In a Free-Market economy, preferences are expressed through free-floating prices. If demand exceeds supply, prices rise, incentivizing producers to make more and consumers to consume less (until supply equals demand). Prices fall for the same (but opposite reasons). This expression of preferences and desires of individuals, through free-market prices, allows for maximum satisfaction given limited resources (scarcity).
What is in fact, far too scarce is a basic appreciation of this simple concept. We often forget that what we may want (low gas prices, free health care, free education, income equality, affordable housing, minimum wages, etc.) we cannot necessarily get—at least not without giving up something else we want. We simply can’t “have it all.” Given this scarcity, the best thing that economics can provide is the maximum standard of living, given limited resources. The wrong economics can provide a lot less! Make the best of scarcity, it is important for The Future of Your Wealth.