Economics In 5 Minutes

Most people think Economics is inscrutable. To some extent it is. All those equations with Greek symbols lying on the side. It is easy enough to miss the reality when caught up in the details.

If we try to understand economics without the equations we come up with three things:

  1. Scarcity
  2. Incentives
  3. Trade-offs

Scarcity

Economics is about how we allocate goods and services. There is no good in such supply as everyone can have as much of it as they want, nor is there way to guarantee someone will want whatever we produce. We need a way to allocate.

There are many ways to do it. One way is by fiat, another by price, yet another by theft.

Fiat. One form of this is socialism. In general goods are supplied and allocated by some authority, usually the government. The allocation tends to be more arbitrary than it would be if the people had some other way to get what they want or need. Two packs of cigarettes a month is not especially attractive if you are not a smoker. It tends to create a market system though. The unwanted cigarettes can be traded for some desired good. A fiat system always has a market system internal to it. It is an inefficient market system though because absent a medium of exchange, there is no certainty the barter can be carried out as and when needed.

Price is the fundamental of a market economy. In this system you may have as much of a good as you wish so long as you have enough money to pay for them. The price will tend to fluctuate with demand. As you buy up the inventory the price will tend to rise because others want some of it too and will pay as much as it is worth to them.

When you notice that, you will find an interesting outcome. Price is a range. The lowest sustainable price is the price that covers the cost of production. The highest sustainable price is the most anyone would pay for what you are selling. That may eb a variable. A liter of cold water in the desert is worth more than a liter from the tap. Between the two prices both producer and buy win. If a cup of coffee at Starbucks costs them $2.00 to produce and you are willing to pay $4.00, the in between price of $2.75 will please both and we can expect trades of money for coffee to happen often.

The question of having money is a political thing not an economic thing. Money is what you receive when you trade some good or service for someone else’s money. If you want more money you need to provide more or better products, or services. That limit becomes political when the idea of taking from some with more and giving to others with less becomes viable. A thought for another day.

Theft. In some circumstances theft is the order of the day. While it may be unlike armed robbery, it exists. Sometimes people can organize the rules so they have an advantage others must submit to. Eminent domain is one such. The price offered for the taking is usually some estimate of fair market value for real estate, but is often zero, when a person or business is required to do or pay something for continuing use. Many environmental regulations fit here.

The ultimate example is from Collis Huntington, one of the four American railroad barons in the 19th century.

“Whatever is not nailed down is mine. What I can pry loose is not nailed down.”

If we think of theft as deprivation of value, it will come more clear. Over charging because you have been granted a monopoly is an example. The idea of a fair price is also a topic for another day. Fair is situational and we seldom agree on the meaning of the word.

Incentives

People do the things that they are motivated to do. If dish washer pellets go on sale $5 off, people tend to buy more or sooner. If the price rises they see that as a disincentive and buy less or wait. Government actions leading to inflation or scarcity tend to confuse the buyers. The signal is not sending the right message.

When we address how economic factors provide incentives and disincentives, we can better understand how we and the system of supply and demand come together.

Every system, even a family has incentives and disincentives within it. That’s how behaviour is guided. You might enjoy this article that deals with how people can manipulate the game once they have an incentive to do so. Ship platinum, receive gold It makes a valuable point. The incentives need not be in a single system. Understand what incentives exist and be sure you know how they will be gamed. Every incentive and disincentive will be.

Tradeoffs

Once we catch on to the idea of scarcity we immediately grasp the idea of tradeoffs. Within your resource limit you must make many choices. A little less car and a little more vacation.

Under scarcity you must learn to optimize your personal position both now and in the future. It is error prone so you must pay attention. If you need a simple guiding principle to apply, try this. You can spend a dollar only once. The method of doing it doesn’t matter. Credit card, line of credit, mortgage, savings, or the money in your pocket. It’s all the same. If you send it one it’s gone.

Be very cautious with tradeoffs that appear in time. They will confuse you. When you borrow money and spend it now, you have committed some future dollar to the purchase. Just because you cannot see that future dollar just now does not mean you have not spent it.

Connect to your life

Economics and its principles are fundamental to your life. Once you know you cannot have everything, you can begin to learn about tradeoffs. Budgeting and planning will help with that. If you stay inside your capacity life is easier.

When you recognize the incentives built in, you will behave differently. The easiest to see is how education and experience can enhance your ability to have more money.

Watch for the disincentives too. Divorce will give you some idea of the cost of misunderstanding relationships. Business partnerships can serve in the place of divorce if that feels better.

Incentives and disincentives are our behavioural guides.

The takeaway

You don’t have to be an economist to use economics usefully. We are all intuitive about it to some extent. We do better if we clarify some ideas and then apply them constructively.

Pay attention to what is rewarded and punished.


I help people have more retirement income and larger, more liquid estates.

Call in Canada 705-927-4770, or email don@moneyfyi.com 

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