A small economic example

I finally have the time to write another post here. I have decided to write about the general theory of economics. I have been reading "The Undercover Economist" and it has been very enlightening. I have read other economic books, but this one really explains the fundamental aspects of economics.

First of all, I think that most people don't really focus on what really happens with economics... Our economy is so big, so complex, that we lose sight of what is really happening. So, I want to use an example to explain my ideas, and then we can expand that out to the US and then global economy. I'm going to make this really confusing and add in my comments about the real economy with the simple example. I'll try and put the comments in red. I might forget....

Lets say we are on a deserted island with 20 people. We know we are there for life, and no one will ever come and find us. It's okay, because there are trees, water, fruit, etc.

We have slightly more than 20 people on the earth, but the ideas are the same. We are here, and we have to work together.

Economics is the utilization of scarce resources. That's all it is. Currently, on this island, our scarce resource is man power. We have to decide what is most important. Should we all work at building houses? Should some work at gathering food? We have a limited amount of time, and we can't do everything at once.

This is where socialism breaks down in real life. If there are only 20 of us, we can decide what is the best use of our time, all together. We can truly work together and get more done than if we were competing... but, with Billions of people, it's impossible to work like that. The best way is capitalism, but that's another post for another day.

So, say we all divide up, and get lots of stuff done. One person's job (Hannah) is to fetch water and carry it to our settlement. Well, that's a hard job, and takes Hannah all day, every day. Someone decides that if they make a sluce, we can have water run straight to the settlement, and Hannah won't have to waste the time getting the water. That seems like a great idea, right? Hannah can now do something else to be productive. (I bet you see where this is going...)

So, Hannah just lost her job because of innovation. Isn't that sad? I think we shouldn't allow that to happen. Let's start subsidizing Hannah so she can keep hauling water.... It doesn't make sense, does it? But that's what we do. We talk about people losing their jobs because of better technology, better business practices, more streamlined processes. GM can make more cars with less people, but we complain about the employees losing their jobs. What it really means is GM is more productive, so now those workers can do something else which will help society.

Then something horrible happens. There's a hurricane, and most of the trees are blown away. We do some math, and decide that we can only use 20 trees a year.... We now have a dilemma. What should we use the trees for.... We could make nicer huts, so we don't get as cold at night... We could make some boats so it's easier to fish. How about some plumbing fixtures, those would be useful. In our society, we all sit down together and decide what is best. 5 people want plumbing fixtures, 5 people want nicer huts, and 9 want fishing boats, and 1 thinks we should let the trees grow so that in the future we can have more. Somehow we come to an agreement on what we use the trees for.

Everything is a scarce resource, whether we think it is or not. We have a limited number of trees, apartments in NYC, oil, people, etc. We have to decide what to do with them. How do we decide? How can we decide who should get the apartments in NYC? Maybe the government should decide, isn't that what socialism says? We'll decide for you what is best for the country... But, how do we know it's actually best for the country? Maybe we should just divide it up evenly... But what if I would much rather have an apartment in DC rather than NYC? How do we determine what it's worth.... Why don't we let the people decide? It's hard enough making it "Fair" when there are only 20 people.... what about when there are 300 million? That's where capitalism comes into play. We let our desires chose for us. Sure, it's selfish, but we use that selfishness to better society.

Hannah is out of a job. Everyone wants her to work, and she does to. She looks around, and sees Aaron fishing. Aaron is a great fisherman. He can catch 30 fish a day, plenty for the entire settlement. But, Aaron is not very good at picking stawberries. He eats almost all of them before he puts them in the bag. Hannah is very good at picking stawberries, but can only catch 3 fish a day. Well, Hannah thinks she would really like to be a fisherman, that was her secret desire when she was carrying water. So, she decides she is going to fish. Well, the whole community tells her that it is better if she picks strawberries rather than fish, because it helps out society.

What if I wanted to be a cowboy. I like the outdoors. Of course, I don't know how to ride a horse, or raise cows. How does society allocate the scarce resource of my man power? The government can tell me what I should do.... But how do they do that? Do they ask me what I'd like to do? Then I'd be an inefficient cowboy, rather than the engineer that I am. How about they determine the benifit to society. And pay me that amount. If I would be a really bad cowboy, I would make much less than if I were an engineer. That would encourage me to do what I do best... If very few people have the ability to do a certain job, than because of the scarcity of people, it will be more valuable.

So, what has our little example shown us about economics? What drives economics is scarcity. We didn't have to worry about trees until there weren't enough. We had to worry about manpower. Who did what is very important. We had to focus the scarce resources to what people wanted most. How do you compare the benifits of having a bathroom to having a boat to go fishing.... Everyone has their own criteria. Some might want it one way, other's another way. With 20 people, you can probably get something to work, but not with 300 million. If you have a free, capitalistic society, than people will pay what it is worth to them. If having an ipod is more important to someone than having a nice toilet seat, then that's what they will buy, and that is what will be built, because it's not profitable to build the toilet seat.

If, on the other hand, you have the government decide.... Then you might have a beurocrate decide that an ipod is a want, while a toilet seat is a need, so everyone will get new toilet seats....

Throughout this blog, this idea of scarcity will come up quite often, because it is so vital to everything we do. It affects health care, global warming, national defense, pretty much everything. Please share comments or thoughts. I will answer comments in the comment section, so be sure to go back to other posts to see what is new.