Implications of the Basic Principles of Economics:

• Many of the basic principles of economics may seem obvious but the implications to be drawn from them are not.

• Economists have understood for centuries that when prices are higher, people tend to buy less than when prices are lower.

• Understanding any subject requires that it first be defined, so that you are clear in your own mind as to what you are talking about and what you are not talking about.

• Economics is an analysis of cause and effect relationships in an economy.

Cause and Effect:

• Analyzing economic actions in cause-and-effect terms means examining the logic of the incentives being created.

• Systemic Causation:

  • Systemic causation involves more complex reciprocal interactions.

  • In an economy, the plans of buyers and sellers are transformed as they discover each other’s reactions to supply and demand conditions, and the resulting price changes that force them to reassess their plans.

  • Economics is concerned with what emerges, not what anyone intended.

  • Systemic causes, such as those often found in economics, provide no such emotional release for the public, or moral melodrama for the media and politicians, as such intentional causes as greed, exploitation, gouging, discrimination, and the like.

• Complexity and Causation:

  • Although the basic principles of economics are not really complicated, the very ease with which they can be learned also makes them easy to dismiss as simplistic by those who do not want to accept analyses which contradict some of their cherished beliefs.

  • Evasions of the obvious are often far more complicated than the plain facts.

  • Complex effects may be a result of either simple causes or complex causes.

• Individual Rationality versus Systemic Rationality:

  • The tendency to personalize causation leads not only to charges that greed causes high prices in market economies, but also to charges that stupidity among bureaucrats is responsible for many things that go wrong in government economic activities.

  • Where a policy or institution has been established by top political leaders, officials subject to their authority may well hesitate to contradict their beliefs.

  • Officials carrying out particular policies may be quite rational, however negative the impact of these policies may prove to be for society at large.

  • Incentives and constraints are different in different institutions.

Incentives versus Goals:

• Incentives matter because most people will usually do more for their own benefit than for the benefit of others.

• While systemic causation in a free market is in one sense impersonal the market is ultimately a way by which many people’s individual personal desires are reconciled with those of other people.

• The mechanisms of the market are impersonal but the choices made by individuals are as personal as choices made anywhere else.

• The real contrast is between choices made by individuals for themselves and choices made for them by others who presume to define what these individuals really need.

Scarcity and Competition:

• Scarcity means that we do not have the option to choose whether or not to have an economy in which people compete.

• Economic Institutions:

  • Most people may be unaware that they are competing when making purchases, and simply see themselves as deciding how much of various things to buy at whatever prices they find.

  • One of the incidental benefits of competing and sharing through prices is that different people are not as likely to think of themselves as rivals, nor to develop the kinds of hostility that rivalry can breed.

  • Rationing through pricing also limits the amount of each individual’s claims on the output of others to what that individual’s own productivity has created for others, and thereby earned as income.

  • Luck and corruption are other substitutes for price rationing.

• Incremental Substitution:

  • As important as it is to understand the role of substitutions, it is also important to keep in mind that the efficient allocation of resources requires that these substitutions be incremental, not total.

  • Whenever there are two things which each have some value, one cannot be categorically more valuable than another.

• Subsidies and Taxes:

  • Ideally, prices allow alternative users to compete for scarce resources in the marketplace.

  • Prices charged to the consumers of such specially taxed or specially subsidized goods and services do not convey the real costs of producing them.

  • From the standpoint of the allocation of resources, government should either not tax resources, goods, and services or else tax them all equally, so as to minimize the distortions of choices made by consumers and producers.

• The Meaning of “Costs”:

  • One reason for the popularity of price controls is a confusion between prices and costs.

  • Once the distinction between prices and costs is recognized, then it is not very surprising that price controls have the negative consequences that they do, because price ceilings mean a refusal to pay the full costs.

  • The most valuable economic role of prices is in conveying information about an underlying reality while at the same time providing incentives to respond to that reality.

  • Prices, in a sense, can summarize the end results of a complex reality in a simple number.