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Wednesday, December 07, 2005

Econs Laws Are Always In Play

While discussing the Kyoto protocols and environmentalisms failure to recognize the play of economics to provide lasting improvement for the environment, Roy Spencer provides his 6 economic principles that apply to all subjects regarding public policy. They are:

1. Wealth is created; it is not static. Russia has immense natural resources, but remains a very poor country. Japan has very few natural resources, yet has one of the world's strongest economies. Why is this? Because what people do with the natural resources, not how many natural resources their country has, is what is important. If a society constantly strives to produce what its people want, maximizing efficiency in the process, then that society will develop a rising standard of living. A society that doesn't, won't.

2. Hard work does not necessarily create wealth. If half of us spent our time digging holes in the ground, and the other half fill the holes up again, we would be doing a lot of work, but we would have a very low standard of living. In a free market, people are paid wages based upon the value of their services and knowledge to other people, balanced against the supply of other people who make the same skills available to the labor pool.

3. Free markets improve the standard of living. When individuals determine what is of value, through purchases of goods and services whose prices depend upon supply and demand, their standard of living will be improved. The interplay of supply and demand is an impressively self-regulating process. While well-intentioned governmental planners have attempted to do a better job than the market, they have been unable. No subgroup of people can be more knowledgeable about what society wants than the people who make up that society (i.e. those involved in each and every transaction.)

4. Profits positively motivate free markets. Profits are good for the economy as a whole. On average, transactions in a free market result in about 10% profit and 90% recovery of the costs of doing business. The hope of sharing in that profit, though relatively small on a percentage basis, is part of what motivates people (and companies) to increase efficiency and develop new products or services that the public desires. If someone becomes immensely wealthy, it is because the public has "voted" through their purchases. That means, the products that the wealthy person produces are more valuable to his customers than alternative products or services they could have purchased elsewhere.

5. Higher prices can spur competition and prevent shortages. No one likes high prices, yet they play a crucial role in a market. When prices rise -- whether due to shortages, the increased cost of raw materials, or increased demand -- free market mechanisms will act in such a way as to reduce those prices. Demand will subsequently go down. New types of materials will be found to replace those that have become too expensive. More efficient production capabilities will be developed. High prices also attract greater investment, which helps to facilitate these changes. If you prefer, call high prices a necessary evil. But they are indeed necessary for the system to work. Government price controls (to prevent prices from going too high) or price supports (to prevent prices from going too low) ultimately hurt the economy. That's because prices have important information in them.

6. Governmental interference in the economy is almost always harmful. Other than preventing either the formation of a monopoly (which is extremely rare) or collusion to fix prices among companies in a particular sector (which is like a monopoly), the best role for government is to simply stay out of the way. Interference with an economy's price mechanism limits the benefits to be obtained from flourishing free markets.

Marxists can live with their famines, poverty and totalitarianism (the final being the goal of its leaders throughout history) but I'll go with individual liberty creating the means of personal fulfillment, a clean environment and wealth.

Point 6 is one to consider as the Chuck Schumers call for confiscation of oil company profits for the "good of the people". As Professor Walter Williams explained while sitting in for Rush 2 weeks ago, the law of supply and demand is like the law of gravity. You may wish to see your folks in Florida more often but you will have to pay for an expensive plane ticket to get there. You may not like paying $3 for a gallon of gas but that is the price. But then you really want that gallon of gas so you should be happy with the transaction.

Oh, I forgot. Gas is a necessity.

Writes Williams:

If I voluntarily purchase the gas, I do so because I deem it better than my next best alternative. Of course, at a high enough price, I wouldn't deem it as such.

But the exchange is totally voluntary. Quoting Williams today:

Here's the essence of what transpires when I purchase a gallon of gasoline. In effect, I tell the retailer that I hold title to $3. He tells me that he holds title to a gallon of gas. I offer to transfer my title to $3 to him if he'll transfer his title to a gallon of gas to me. If this exchange occurs voluntarily, what can be said about the transaction?

One thing we know for sure is that the retailer was free to retain his ownership of the gallon of gas and I my ownership of $3. That being the case, why would we exchange? The only answer is that I perceived myself as better off giving up my $3 for the gallon of gas and likewise the retailer perceived himself as better off giving up his gas for the $3. Otherwise, why would we have exchanged?

Exchanges of this sort are called good-good exchanges, namely "I'll do something good for you if you do something good for me." Game theorists recognize this as a positive-sum game -- a transaction where both parties are better off as a result.

When government gets involved in setting the price there is a loss. And you readers of this blog know about what will happen with the future supply. That lesson is called "unintended consequences". That, however, is something we can control.


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