Economics often is considered a dry or “dismal” science. In schools, it is often taught with a focus on abstract supply and demand charts or complicated mathematical formulas. When we think about economics or “the economy,” we think about money, goods, or services—or perhaps government policy. Although these are aspects of an economy, economics at its core is about human actions.
It’s about the choices and actions we make as individuals. It’s about our individual wants, needs, and abilities. And it’s about how we interact with others to benefit each other and build the society around us.
Imagine, for example, if a single person were stranded on a deserted island.
For this person, let’s call him Bob, the top priority is obvious—survival. He needs water, food, and shelter. Some of Bob’s resources are obvious; there may be coconuts or berries that can be foraged for food. Just as important, however, is his time. He must economize his time, dedicating it so as to best ensure his own survival. Does Bob focus on finding water, or does he dedicate his first few hours to building a shelter? Right away, Bob is forced to make decisions about tradeoffs—the costs of making one decision over another.
Bob may decide that he can survive three days without water and so focuses instead on creating a shelter for the night. Another person in this situation may choose differently, but it is Bob’s individual judgment that guides the choices he makes.
Bob’s decision may not be the right one. Risk and uncertainty are an inherent part of our human existence. Perhaps Bob ends up spending so much time building a shelter that he does not give himself enough time to find water when he desperately needs it. Bob’s decision affects the number of days he can survive on the island. In this case, his profit is measured in terms of the number of days he is able to live having made this choice. A loss could be his death.
Notice that Bob’s economic decisions have nothing to do with money—they are simply the choices that he makes facing an uncertain future.
Luckily most of our economic decisions are not matters of life and death, but basic decisions that we all make every day. These decisions all have costs and benefits that must be weighed by the individual, and this is as true for every person anywhere in the world as it is for someone on a deserted island.
Economics does not tell us what any individual should do.
Instead, economics is about understanding the costs of our decisions, about understanding how we can create value by satisfying our wants and the wants of others, and about the ways that we as individuals all play a role in contributing to the rise—or fall—of human civilization.
- How often are your daily decisions actually economic decisions?
- Do you find it useful to think about tradeoffs when making decisions?
- Is economics about making you rich, or about better understanding the world around you?
- Economics Is Not Rocket Science — It's Even More Complicated by Gary Galles
- Star Trek Is Wrong, There Will Always Be Scarcity by Jonathan Newman
- Lessons for the Young Economist by Robert Murphy
When we think about “cost,” we often think about prices, such as comparing the prices of cars. But the proper way to think about costs is not simply to consider the money we're spending on a certain item, but all of the other possibilities we're giving up in order to obtain that item.
Henry Hazlitt was an American journalist who wrote the book Economics in One Lesson. In it, he starts with a story about a baker who owns a shop.
Imagine now that a kid decides to throw a ball through the front window of a bakery. The baker is understandably upset but is comforted by a friend who encourages him to see the larger picture. The baker now has to buy a new window, and this purchase will benefit the glass store. The glass store now has to buy materials and can pay its workers. Perhaps some of these workers end up buying the baker’s bread. So this act of destruction isn’t really a tragedy, but an event that will benefit the local economy and others!
Unfortunately, this clever scene doesn’t really tell the whole story.
After all, if the baker’s store window had not been broken, he would have both his window and his money, money which he could have spent in other ways than making repairs.
Perhaps he would have bought a new sign for his business or a new suit for himself. The gain for the glassmaker is a loss for the signmaker or the tailor. Unfortunately, now we will never see how the baker would have spent his money. Instead, we will only see the new window that he had to fix.
What Hazlitt described is called opportunity cost. The money spent on the new window is not simply the dollar price of his purchase, but of all the goods and services he could have purchased with that money.
In the words of Hazlitt: “The bad economist sees only what immediately strikes the eye; the good economist also looks beyond.”
If the mistake in the baker’s friend’s argument is obvious to you, you may be surprised to learn how many “bad economists” there are in the world today.
For example, Paul Krugman, a well-known economist who writes for the New York Times, has argued that incidents such as 9/11, national disasters, or even a fictional alien attack would stimulate the American economy, just like the baker’s broken window!
Although it’s certainly true that these tragedies create jobs in construction, cleanup, or anti-alien weaponry, that doesn’t mean society is actually better off. Just like with the broken window, the companies that benefit from these projects do so at the expense of others.
Remember, the purpose of the economy is not simply to work or make money—it is to satisfy our needs and wants as individuals. If no one actually wants or needs an anti-alien weapon, then the money, time, and resources spent on them are wasted, when they could have been used for producing things that people actually want or need.
The opportunity cost is everything else that could have been done with the time, the resources, and the money that are no longer available.
This is why we must look at the larger consequences of our actions—be it with how we spend our money or our time. When we think about this, it means that there will be more resources to make things we actually want, making each of us richer and happier.
Unfortunately, the government, like the baker’s friend, usually has a really hard time thinking like a good economist.
Governments are not producers, or manufacturers, or bakers who offer goods or services in exchange for money.
For example, if a government taxes the community to pay for a new football stadium, it is easy for a politician to point to a big game and say “This is what your taxes paid for!” But what no one can see is all the things the public lost because of the taxes the government placed on them.
If not for the taxes, the people would have that money to spend or save as they choose. As individuals, we may want to buy a new pair of shoes, go on a vacation, start a new business, or save for the future—the possibilities are endless. At the end of the day, we know what we need better than any government official does.
This is why it is important for everyone to think like good economists. Doing so allows us to make better decisions—in the long term—about how we spend our money. And it empowers us to hold politicians accountable when they try to take it from us.
- Do you ever regret buying something after you have purchased it?
- Have you ever wondered how politicians can make big campaign promises without thinking about who pays for it?
- Do you have a job? If so, have you ever looked at how much money is taken out of your paycheck because of taxes? What would you do if you could spend that money the way you would like?
What Is Money?
It is common to hear that “money is the root of all evil.”
We are told that money is synonymous with greed, and that desiring it is somehow inherently bad.
This is not true. Money is perhaps the single most important creation in the history of mankind. Just take a moment to consider a world without it.
Think about all the things in your life that you enjoy: a house, a cell phone, a book, a new computer game, new clothes, car, a meal at your favorite restaurant. How many of these things could you provide for yourself?
Luckily, thanks to money, you don’t have to. Instead, you can specialize in doing a specific task—maybe you play music, or build surfboards, or repair cars—and then you use the money you earn to buy products or services from others.
This wasn’t always the case.
Before money, peaceful societies used a system called barter, exchanging one object for another.
Imagine Bob has a fish and Tom has clean water. The two could trade with each other. But what if Tom doesn’t like fish? In order to get the desired water, Bob could trade with someone else for something Tom wants.
This is called indirect exchange.
In the different societies, there were certain items that everyone wanted. These made up the earliest forms of money.
Throughout human history all sorts of things have been used as money, such as salt, tobacco, grain, sea shells, livestock, or furs. Over time societies ended up embracing some form of metal, such as gold and silver, as their preferred form of currency.
Why is this? Many societies value these shiny metals as jewelry, luxuries, and for industrial use, but they also have many other benefits. Metals are hard to destroy, they are uniform and divisible—any two ounces of pure gold are the same—and they are easy to carry around if turned into coins. They are also scarce and difficult to mine, so you can’t manufacture new money as if it grew on trees.
It was the invention of money that truly allowed human civilization to thrive, because you could now buy things without having to make them yourself. This brought freedom and choice to people, a choice for a real livelihood instead of simply living hand to mouth. You could now be a farmer, a seamstress, a sea captain, pirate, or tradesman. This specialization, called the division of labor, allowed people to become more learned and skilled, and to produce more complex and useful things, improving the quality of life for everyone.
Money also made it easier to save for the future. By saving some of the money they earn for doing tasks, people are able to purchase larger and more complex items—like a new house.
Of course, when people began to have savings, they wanted new ways to protect their money. This gave way to banks, where you could deposit your coins with someone who would keep them safe, in exchange for paper receipts that you could redeem when you wanted to get them back.
The paper banknotes themselves became a form of money, since you could exchange them with others who could then go and claim the gold you promised them. In fact, many of the names for currencies today are derived from this system. The name “dollar” for example, was Spanish for a weight of gold.
The way Bob earns money is by producing goods or services that others want to exchange for. But what if instead of earning it, Bob simply prints new money? He’s now rich, without ever having created anything of real value.
Once societies began using paper, it was easy for governments to print new money, even if they had not collected any gold to redeem with the paper banknotes.
Throughout history, this has been a popular way for governments to generate new money, because it was easier than other options, such as collecting taxes. Although this was good for politicians, it was bad for the rest of us, as our money lost its value—this is called inflation.
During the twentieth century, we saw governments completely take over money. In America, you used to be able to exchange dollars for gold—a system called the gold standard.
In 1913, America created a central bank, the Federal Reserve, which began creating new dollars without new gold. In 1933, President Franklin Roosevelt made it illegal to own gold. In 1971, President Richard Nixon stopped exchanging dollars for gold with other countries.
And after that, there was nothing of value left backing the American dollar.
One hundred years before the founding of the Fed, the price of gold was $19.39.
One hundred years after the Fed, the price of gold was $1,204.50.
Why did this happen? With the full ability to create money, the government has been able to finance massive wars and government programs. All of this has come at the expense of the value of our currency and your savings.
- TVs are a lot cheaper today than they were ten years ago, while college degrees are a lot more expensive. Do you think the government plays a role in this?
- Do you think it's fair if some people receive money without earning it?
- How often do you think about saving money today so you can buy something more expensive in the future?
- What Harry Potter Can Teach the Federal Reserve by Tho Bishop
- The Origin of Money and Its Value by Robert Murphy
- What Has Government Done to Our Money? by Murray Rothbard
It is common to hear profit attacked as exploitation and greed. How many supervillains have appeared in TV shows, books, or movies with the diabolical plot of putting “profits over people”?
In reality, profit is a powerful mechanism for human cooperation, and serves to make sure that the earth’s resources are maximized to serve the best interests of humanity.
Think of profit as the reward for making good decisions.
Profit doesn’t have to be only about money—selling something for $5 that you made for $3. It can also be something immeasurable: volunteering time to a charity can be profitable if doing so benefits a cause you’re passionate about.
The benefits of profit are obvious. We want to benefit from our actions, rather than be disappointed by them.
Now let’s look at the benefits of profit beyond an individual level.
The world is a complicated place, full of billions of individuals with different opinions and interests, and a future that is never predictable. Add to this that there are many resources that have numerous uses. For example, iron can be used to make all sorts of things—from refrigerators to cars to medical devices.
Given this web of complexity, decisions on what to make and how to produce it are beyond anyone's comprehension. No single person can imagine a way to fulfill the needs and desires of every single other person.
Luckily, no one has to.
Instead of one single person trying to figure out how to use all the world’s resources, property rights allow individuals to own these resources. These individuals can then sell these resources on markets, where others can buy them and combine them with other resources to build new products.
The individual who risks his money buying resources to build products to sell is called an entrepreneur. In doing so, he also invests in capital goods (such as machines and buildings) as well as laborers, who have a variety of skills.
All of these parts of production have costs. The entrepreneur is hoping that he will be able to sell the end product for more money than it costs to make it. That money is the profit that he gets to enjoy.
It’s not just the entrepreneur who benefits, though.
Consumers benefit, because they get new and different products. Workers benefit, because they make money.
A successful entrepreneur is therefore helping other people while making a profit.
Just as important, however, is loss.
As we mentioned before, many of the components that go into producing a good have a variety of uses. This is true for natural resources, buildings, workers, and machines. If these resources are being used on a product and it isn’t profitable, this means that consumers don’t value that product enough to buy it.
By suffering a loss, an entrepreneur may sell his resources to other entrepreneurs who can use them better. The factory is sold to another company. The employees work new jobs.
This process plays itself out every day, in various ways, all around the world.
Even better, it adapts to all sorts of changes. Maybe people’s taste changes; perhaps people stop liking sweet candies and instead like salty chips. Some candy factories may close, but new chip companies will emerge.
When individuals get to choose how to spend their money, they end up influencing where entrepreneurs invest, and what is produced.
Unfortunately, governments interfere with this process of profit and loss. For example, politicians add costs to businesses and industries, in the name of taxes or regulation, that make businesses less profitable. This is bad for the entrepreneur, bad for their workers, and bad for the consumers, who don’t get the products they would like.
At other times, governments choose to bail out industries that aren’t making a profit.
Politicians do so by pointing to jobs they want to protect— failing to recognize the profitable jobs they are destroying. Bailing out unprofitable industries means that scarce resources—including labor—continue to be used for products that people don’t want enough to buy.
We have limited resources on Earth, and we should use them as wisely and efficiently as possible.
The market economy, where entrepreneurs are driven by profit and loss, is the best way to make sure we do just that.
- Are there are any businesses that you have a particular loyalty to? Why?
- What do you think is a better way of picking winners and losers in society: voting in a political election, or consumers "voting with their dollars" by choosing certain businesses and products? Why?
- Which group of people do you think have done more to improve your daily life: politicians or entrepreneurs?
- Why We Need Profits by Jakub Bozydar Wisniewski
- Economics: The "Other Side" of Politics by Per Bylund
- Profit and Loss by Ludwig von Mises
The civilization of mankind can be traced to the establishment of property rights. With property rights, individuals could own land, capital, and goods and then trade or sell them to others. This economic activity is referred to as “the market.” This doesn’t mean it necessarily takes place in a physical market; it simply means that goods and services are voluntarily traded.
For most of human history, property rights have been limited to those in power. For example, a king or lord had ultimate control over those who lived under their protection. If the king desired beets, farmers were to farm beets. If the lord needed horseshoes, blacksmiths forged horseshoes. Ordinary people had the ability to trade among themselves, but those in power could direct their production if they so desired, or punish those who resisted.
The emergence of capitalism changed this.
Capitalism is mass production of goods to satisfy the needs of the greatest number of people.
Capitalism was revolutionary by recognizing property rights for all, regardless of background and social standing. Under capitalism, even the most vulnerable in society had an absolute claim to their own labor and property. It did not guarantee equality of property, but capitalism eliminated any right by anyone else to infringe upon it.
In doing so, capitalism empowered consumers—rather than those in power—to influence what was produced in the economy. This happens via the profit mechanism. If enough people demand a good and it can be sold for more than it costs to produce, that means the production of that good is profitable.
Some of the richest people in the world today have made their money not by appealing to the rich, but by appealing to the masses. Walmart’s business model, for example, is geared toward selling goods cheaply to as many people as possible.
Critics of capitalism try to condemn it as “greed.” This is false. Greed and envy are human vices, and they exist in any economic system. What capitalism does is incentivize the production of goods and services that people desire on the market, rather than leaving those decisions to powerful individuals or governments.
Throughout human history, we have seen property rights and markets lift billions of people out of poverty. Everywhere in the world, property and economic freedom are correlated with improved quality of life, health, and life expectancy.
Capitalism is a peaceful system of collaboration between producers and consumers, and functions by the wants and needs of the greatest number of people. The government plays no role in a truly capitalist system. When the government interferes and forces regulations on producers and consumers, it ceases to be a capitalist system.
Capitalism is freedom of consumer choice.
Critics of capitalism accuse it of simply being "greed." Do you think it is greedy to profit from creating things that others want to buy?
Some people think that voting is the fairest way of making decisions for a group. What do you think?
If a majority of a group wants cheese pizza, but you want pepperoni, do you think it's fairer to allow you to buy your own pizza or go with the group?
Because capitalism empowers consumers, rather than politicians, the market often creates products that are just for fun, like video games. Do you think allowing consumers to spend money on these sort of things is good, or would we be better off if the only products we can get have value to the everyone (the "common good")?
Liberty and Property by Ludwig von Mises
Activists blame “capitalism” for the world’s biggest problems, like the high costs of healthcare. Some even argue that economics itself is simply propaganda for businesses to exploit workers. Government schools often celebrate regulations, subsidies, and other interventions, because they protect consumers against “exploitative” businesses and capitalist “greed.”
The truth is precisely the reverse. The profit-and-loss economy lowers prices and increases the quality of goods through competition, which benefits society as a whole. When government intervenes in this production of goods and services, it does so by passing laws and enacting regulations that benefit and favor certain businesses over others, all in the name of “protecting” the public. This granting of privileges and favored status to people because of their political power or connections is called cronyism. The beneficiaries of cronyism serve the politicians and bureaucrats who appointed them and not the consumers who buy the products from the regulated companies.
For example, imagine you run a small business that produces vegetable soup. Your top priority is satisfying customers. A satisfied customer is a returning customer. To this end you choose your vegetables, recipes, packaging, and distribution based on your best estimates of what the consumer wants. If consumers like and value your vegetable soup, you earn profits. If consumers don’t value it, you suffer losses. Competition and business reputation ensures efficiency and happy customers.
Now imagine that the government decides to regulate the vegetable soup industry. Bureaucrats, not knowledgeable businessmen, now decide the full process of making soups, mandating the quality of the vegetables, the type of ingredients, the techniques for making soup that can be used, and even how you can advertise your soup. To enforce these new regulations, the government requires licenses and compulsory inspections. As a soup producer, you must now spend considerable resources catering to political regulations.
Although the government justifies its intervention in the name of protecting consumers from “bad” soup makers, the new regulations create compliance costs and barriers to entry. This reduces competition by injuring the smaller soup producers and helps the larger soup makers. In this way, the law restricts the supply of soup and raises prices, to the detriment of all consumers. Since bureaucrats make and enforce the regulations, it should come as no surprise to learn that Big Soup lobbied for the new rules that benefit them, hurt rivals, and reduce competition.
The free market succeeds because competition makes businesses accountable to consumers. Cronyism doesn’t work because it favors politically connected insiders, hurts small businesses, and gives consumers fewer choices. Unfortunately, when cronyism fails—and it always does because it is based on favoritism and paybacks—we all lose.
Most people think the answer to any economic problem is to get the government more involved, enact more regulations, appoint more committees, etc. The truth is precisely the reverse, we need less intervention in all areas.
- Crony Capitalism and the Transcontinental Railroads by Ryan McMaken
- Coca-Cola, Cronyism, and the War on Drugs by Chris Calton
- The Middle of the Road Leads to Socialism by Ludwig von Mises
- What is Fascism? by Lew Rockwell
Economics is the study of human action. Using economics, we can understand how social orders can create different results based on how they allocate resources.
In a market economy, production is guided by enterprises seeking profit and innovation. In a crony economy, the government influences market outcomes by interference and intervention. A third economic system rejects markets entirely in favor of central planning.
This is socialism.
In this system, central planners set the stage and drive the economy while individuals serve less innovative roles in society in exchange for goods, services, and security. While a market economy rewards those who best serve customers, the promise of a socialist economy is that everyone's needs are taken care of equally.
This is a command economy, where central planners decide what is produced, in what quantity, and who should produce it. Instead of people being allowed to choose what goods and services they prefer to spend their money on, they are provided only with what goods and services the central planners have chosen for them.
Since some individuals prefer thinking for themselves and wish to pursue their own course of action and reject central planning, socialist countries tend to be politically authoritarian.
The economic consequences of central planning are just as bad.
For example, profits serve to reward and encourage innovation and efficiency. If you are the first to create a new product or find a cheaper way to provide a service, the individual that risks capital is financially rewarded. Under socialism, there is no incentive to innovate because the rewards go back to the planners.
Additionally, central planners only operate on their own knowledge and agenda, which is always less than the collective knowledge of society. Think of the difference between a published encyclopedia, which is static and unchanging, and a decentralized alternative—like Wikipedia, which is constantly evolving and growing.
One vital piece of knowledge is that markets coordinate prices.
Since many resources—such as steel—have a variety of different end uses, prices signal whether the use of a specific resource satisfies the top priority of the community. Should a factory produce car parts, or manufacture nails? In a market economy, prices indicate if there is a greater need for one product over another, that is for car parts or nails. In a command economy, it is the government that makes the decision.
The socialist goal of redistribution of wealth makes the basic mistake of not understanding how wealth is created. An economic system that does not reward innovation, savings, and production will see the quality of life for everyone decline.
For example, remember when everyone had a telephone in their home, but then the cell phone changed how we communicate. Everyone listened to music on their home radio, now it is streamed on your cell phone and you can take it with you. We used to unfold large cumbersome paper maps to find out how to get somewhere, now everyone has GPS on their phone and in their car. All this just with the invention of the cell phone. Without a profit incentive, why bother, and thus our lives are poorer. How many other such things might not have been developed without the incentive of profit?
Often, politicians today will not go so far as to call for the socialization of every part of the economy—only for certain sectors, like healthcare, transportation, and education, to name a few. While a mixed economy that includes a mixture of markets and socialist services can function better than a purely socialist economy, there are still problems that exist.
For example, a truly socialist healthcare system forces decisions about the use of scarce resources—like hospital beds, medical machines, and medicines—to be decided not by individuals, families, or doctors, but by government appointed central planners. While patients of socialist healthcare may not have to pay to visit the doctor, or for a hospital stay, or for a medical procedure, or prescriptions, they may face other critical obstacles like long wait times just to see a physician or to get an approved surgery, shortages of medicines, fewer doctors, centrally planned research, all resulting in a lack of medical freedom.
The case for socialism is not grounded in economics—but a sociological appeal to “equality.” Equality goes against basic human nature to better ourselves and is an artificial and forced condition that has to be centrally directed to function. In order to have choices and freedom over our lives socialism must be vigorously opposed in all ways.
In a command economy, the government controls labor—which means dictating what jobs individuals can have. If you were forced to work a job you didn't like, how would you respond?
Could a socialist government use punishment to overcome the knowledge and calculation problems featured in the video?
- Why Socialism Fails by Antony Mueller
- Socialism Always Fails by William Anderson
- VIDEO: Things You Should Know About Socialism by Thomas DiLorenzo
- Please visit mises.org for Mises Wire articles (written and audio), Power & Market blog posts, downloadable pdf and html books, podcasts, seminars, lectures, and so much more.
- Free copies of Henry Hazlitt's Economics in One Lesson, his timeless defense of free markets and property rights, are available from the Mises Institute at mises.org/onelesson
- Visit our bookstore for affordable, introductory-level books for adults and children.