Posted: April 11, 2022
Basic Economics
If you're expecting a dry economic treatise (given that cover) I'm happy to report that "Basic Economics" is a page turner. Here are some of the wonderful concepts I picked up:
Prices Manage the Economy
Prices, dictated by demand and supply, is a mechanism that effectively regulates millions of transactions going on in a capitalistic economy. Command economies, on the other hand, have to do this through a ministry, and no, it did not prove effective.
Managers Are Not Useless
Managers, whom I secretly wished were useless, are apparently extremely important to the success of economies. Apparently, Lenin, just like me, thought they were useless. But, years into the revolution, Lenin had to admit that management was just not a a skill, it was an important skill. The book also states that managers typically work more hours than the rank and file. So there.
Competition Creates Efficiency
Profits and losses and the success and collapse of corporations make for efficiencies that ultimately lower costs for consumers. By contrast, command economies result in inefficiencies that result in a lower standard of living. The whole explanation proves the adage "business is war". This is another bummer for me. I was hoping that my life as an employee could be more laid back but it turns out that well, "business is war". This explains perfectly why I'm stressed out - and, why, ultimately, it's a good thing.
Low Margins Can Translate to Big Profits
Another great insight concerns the difference between profit from sales and profit from investments. When a particular product cost 99 cents and a business sells it for a dollar. The 1 cent profit is profit from sales. The business then uses the dollar to create or buy more products at a cost of 99 cents and sells it again for a dollar. During the course of a particular time period, say, a year, this sales cycle repeats. The 99 cents the business uses to produce or buy a product keeps being reused to produce 1 cent sales profit. If, for example, this happens ten times during the year the combined sales profit is 10 cents. So for the year the business makes 10 cents of profit for every 99 cents invested - this is profit from investment. This is why grocery stores, for example, can earn a lot on low margins. The repeating turnover of sales over the course of time can add up to a significant amount even if the margin is very low. The key factor is the number of buyers a business manages to attract.
Economies of Scale and Diseconomies of Scale
Economies of scale refers to the advantages of being big or producing more. Diseconomies of scale refers to the disadvantages of being big and the advantages of staying small.
When a firm produces more products the tendency is for the cost per product to be lower. Cheaper products would most likely sell more. Firms that invest in labor-saving machinery or technology tends to achieve economies of scale.
It is not enough for firms to be able to produce products at a lower cost they must also sell these products. There have been times when I wondered why companies spend so much money on what is obviously expensive advertising. It turns out that advertising more than pays for itself by making it possible for firms to sell more products. Firms will in fact make more money by spending on advertising.
Diseconomies of scale happens when a firm becomes so big that the cost of monitoring its business rises. A big firms processes can become so elaborate that processes are no longer efficient and mistakes become more likely. The costs of being too big can actually result in a higher cost per product. Sometimes staying small makes more sense. The example given here is a restaurant which produces better value if it stays small and manageable.
Middlemen
Middlemen are not unnecessary sources of product cost. They exist because they add value by being specialists in a certain stage of the supply chain. For example, some middlemen specialize in transporting goods from one place to another.
It is also noted that poorer countries tend to have more middlemen than richer countries. This is so because businesses in wealthier countries tend to be able to afford value-added services that they need. A farmer in a rich country for example would most likely be able to afford the storage for his produce. A farmer in a poor country would need to rely on a middleman for storage.
The Weakness of Cartels
Cartels are small groups of businesses in the same industry that collude with each other in order to create the advantages of a virtual monopoly. Cartels may undertake activities such as price fixing or creating barriers to entry in their industries. Fortunately, history bears witness to the volatile nature of cartels. The tendency with cartels is that members will find violating the mutual agreement too tempting. The result is that cartels will collapse after some time.
Productivity is Dependent on Externals
If a typical worker in a poor country works 60 hours a week and his or her counterpart in a rich country works 40 hours a week, is the worker in the poor country more productive? Chances are the answer is "no". This is because the worker in the poor country would most likely be working in an economy which offers him less advantages. He would have inferior equipment when compared to his counterpart. His nation would have less infrastructure. Systems like banking and communication would be less daveloped than in a rich country. All these "externals" have a direct impact to productivity. Developed economies offer the best chance for workers to be more productive.
The Myth of the Rich Getting Richer and the Poor Getting Poorer
The statement "the rich are getting richer and the poor are getting poorer" based on statistics that show, over time, the percentage of the national wealth owned by the rich getting larger while the equivalent ownership of people classified as poor gets smaller bears some looking into.
The book points out that the specific people occupying the brackest labeled as poor, middle class, and rich keep changing over time. One determinant is age. Young people have relatively less skill and certainly less experience than other workers in the economy so they would most likely belong to the "poor" bracket. But overtime as their skills and experience inprove they might move up to the "middle class" or "rich bracket". Yesterdays poor can be today's rich; so the poor did get richer.
What the data does say is that it is harder to be poor these days because the amount of wealth the poor have, on aggregate, is shrinking. The rich, on the other hand, have more wealth to spread around among themselves. The more accurate statement would be: "The amount of wealth among the poor is shrinking while the amount of wealth among the rich is increasing".
Capital Rich vs. Labor Rich Economies
Many workers in poor countries move to rich countries in hope of living better material lives and the book supports this strategy. Poor countries are labor-rich countries where labor is cheap and capital expensive; salaries, therefore, would be lower. The reverse is true for rich countries.
Minimum Wage Increases Unemployment
A minimum wage requirement prevents people from being employed who otherwise would be. If there were no minimum wage, the drop in wages would allow employers to hire more people. That said, minimum wage laws protect current job holders by ensuring that they have more pay.
Financial Institutions As Monetary Aggregators
An essential feature for countries to move from poor to rich status is a strong banking and finance industry. This industry allows for the pooling of funds in order to finance large enterprises needed by any nation to progress.
Speculation Allows Risk To Be Transferred
Here is an example of speculation: A farmer gets a guarantee of a crop price before he even starts planting crops. This guarantee is given by a speculator. By doing this the farmer transfers the risk of a failed crop to the speculator.
But why would the speculator want to take on this risk? Because to him it is an acceptable risk. The speculator may have made several other investments in order to defray any possible loss from a specific speculation.
The risk has been effectively transferred to someone better able to handle it and both parties are better off. The farmer is better off because he is protected from low crop prices. The speculator is better off because he has a chance of profiting from higher crop prices while his other speculations keep him statistically safe from experiencing a total lost of his investments.
Supply of resources and cost of exploration
This has to do with the popular fear that resources are running out. This has also has to do about comments regarding particular countries having a lot of resources in spite of being poor.
The book makes the point that the supply or resources is dependent on the capital and technology necessary to process and leverage those resources for economic purposes.
In the case of "running out of resources", that may be the case for the current level of technology and capital. But if technology improves and capital increases, more resources will become available.
In the case of poor countries having "lots of natural resources", it really does not because it doesn't have the technology and capital needed to take advantage of the resources it has in such abundance.
Political policies
When assessing the economic impact of a political policy it is important to ask what incentives are created by the policy. These incentives, rather then the intent of the policy, will determine the true impact of the policy.
Increase in GDP
An increase in GDP could be caused by the movement of production to businesses where output can be monitored and reflected in the GDP. In essence, no increase in product and services really happened, existing products and services simply appeared in the economic radar.
Decrease in Per Capita Income Due to Lower Mortality
A decrease in per capita income could be a sign of lower mortaliy rates. This would naturally increase population size resulting in a decrease in per capita income.
Taxes vs Increasing the Money Supply
Governments in need of money could either hike up taxes or print more money, thereby increasing the money supply. The latter is the more politically sensible path but increased money supply could lead to inflation.
Fractional Reserve Banking
Fractional reserve banking is a central bank's ability to dictate how much funds banks should hold as reserves. This allows central bank to control the amount of money flowing through the economy.
Property Rights Create Self-Monitoring
If a person is allowed to own property he or she will naturally takes steps to protect, improve, and efficiently use the property. This is contrasted to a socialist scenario were all property belongs to the people. In such a scenario people won't be as protective or careful with the property since they do not own it.
Lower Tax Rates Can Result in Higher Government Revenues
Lower tax rates provide incentives for engaging in more economic activities which in turn provides more tax revenues for the government.
Private Annuities vs Government Pensions
Private annuities invest premiums in economic assets that will produce future wealth. Government pensions take money from the current generation to give to the previous generation. It is It is therefore important for government ot have a sizeable enough base of tax payers to pay for the pension of retirees. This is why governments do not like population decline.
Balance of Trade
The balance of trade is the balance between imported products and exported products. It does not include services. It is not a proper measure of a nation's wealth. A nations wealth is better measured by GDP - the total products and services produced by the nation.
Labor Costs
A country with lower labor costs does not automatically have competitive advantage vs a country with relatively higher labor costs. There other factors that determine overall costs such as cost of capital and equipment. These factors could make laborers in the country with higher labor costs more productive and therefore more competitive.
Balance of Trade vs Balance of Payments
The balance of trade refers to the movements of products between two countries while the balance of payments is about the movements of money between two countries.
Foreign Direct Investments
Foreign direct investments will flow to countries that could best create profits for these investments. These countries are typically the rich countries rather than the poor ones.
The Importance of Property Rights
A country with a strong property rights system will allow the financial sector to leverage such property as collateral. This engages the financial system as a tool to building a country's wealth.
Human Capital
Human capital refers to the combined attitudes and skills of people. It a strong foundation for building economies. Physical capital may be lost but human capital is the capability to rebuild the lost physical capital.
Cultural Isolation
Cultural isolation has been shown as detrimental to building strong economies. Both China and Japan practiced cultural isolation during their history, each time they emerged very much lagging relative to the rest of the world.
A Word About Economics
Economics does not dictate what people should value, it simply compares the different values to each other.
Supply and Demand
The economic concepts of supply and demand took a century to develop.
The Value of a Product
Is the value of a product its cost of production? Yes, according to the Cost of Production Theory. Is the value of a product its utility? Yes, according to the Utility Theory. Both theories have been superceded by the Marginal Utility Theory. The Marginal Utility Theory states that each additional product produced and consumed will have a unique level of utility that will dictate its value. This unique level of utility is dependent on the worth a product has as assessed by the consumer of the product.