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
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- 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
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