Basic Economics: A Citizens Guide to the Economy

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One of the best ways of understanding the for example, is by understanding what happens w not permitted to play their rolein the market. How d omy respond when prices are set or controlled by ment, rather than being allowed to fluctuate with demand? What happens in an economy that is cent as distinguished from onein which decisionsabout h sources and distributegoods and services are made b separate individuals, whose decisions are coordin their responses to pricemovements?

All sorts of economies-capitalist, socialist, feuda determine in one way or another how the available directed toward their various uses. But how well the to poverty or affluence for a whole country. Yet this dom understood by the public and itis often disregard by politicians. Many people see prices as simply obstacles to th the things they want. Those who would like to live i front home, for example,may abandon such plans whe cover how expensive beach-frontproperty is.

But high not the reason we cannot all live onthe beach front. O trary, the inherent reality is that there are not nearly beach-front homes to go around andprices are just a w veying that underlying reality. When many people bid tively few homes, these homes become very expensive supply and demand.

Basic Economics: A Citizen’s Guide to the Economy

But it is not the prices that cause th which would exist under whatever other social arra might be used instead of prices. If the government were to come up with a "plan" f sal access" to beach-front homes and put "caps" on the could be charged for such property, that would not c underlying reality of the ratio of people to beach-front a given population and a given amount of beach-fron rationing without prices would now have to take pla reaucratic fiat, political favoritism random or chance-bu tioning would still have to take place. Even if Congr Supreme Court were to decree that beach-front hom "basic right" of all Americans,that would still not chan derlying reality in the slightest.

Prices are like messengers conveying news-somet news, in the case of beach-front property desired by fa 8 BASIC ECONOMICS ple than can possibly liveat the beach, but often als For example, computers have been getting both che ter at a very rapid rate, as a result of the developme logical ingenuity. Yet the vast majority of beneficia high-tech advances, insights, and talents have not idea of what these technical changes are specificall convey to them the end results-which are all that m own decision-making and their own enhanced prod well-being fromusing computers.

Similarly, if vast new rich iron ore deposits were perhaps no more than one percent of the populati likely to be aware of it, but everyone would discove made of steel were becoming cheaper. People thinki desks, for example, would discover that steel desks more of a bargain compared to wooden desks and undoubtedly change their minds asto which kindof chase because of that. The same would be true whe various other products madeof steel tocompeting pr of wood, aluminum, plastic or other materials.

In short, price changeswould enable a whole so automatically to a greater abundance of iron ore, ev percent of the people in that society were whollyun new discovery. Prices not only guide consumers, they guide p well. When allis said and done, producers cannot p what millions of different consumers want. But p least equally important in situationwhere consumers A and B, as well as manyother things, some of which same ingredients in their production.

For example, not onlywant cheese, theywant ice cream and yogurt of which are made from milk. How do prices help the e determine how much milk should go to each of these p In bidding for cheese, ice cream,and yogurt, consu effect also bidding for the milk that produces them. T than comes in from the sales of these products is what producers to buy more milkto use to continue produc spective products.


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When thedemand for cheese goes u makers bidaway some of the milk that before went into cream or yogurt, in order to increase output the of their uct to meet the rising demand. In other words, the coo to everyone when cheese-makers demand more, so users have to cut back on howmuch milk they buy. As ducers then raise the prices of ice cream and yogurt to higher price of the milk that goes into them, consume to buy less of these otherproducts at these higher pric How will each producer know just how much m Obviously they will buy only as much milk as wil higher costs from the higher prices of ice cream and 10 BASIC ECONOMICS consumers who buy ice cream are not as discourag prices as consumers who buyyogurt are, then very lit ditional milk that goes into making more cheese wil expense of ice cream and more will comeat the expen What this all means as ageneral principle is that t one producer is willing topay for milk orany other i the price that other producers are forced to pay for t gredient.

Since scarce resources have alternative us placed on one of these uses by one individual or c comes a cost that has to be paid by others who wan of these resources away for their own use. Whatthis the standpoint of the economy as awhole, is that res flow to their most valued uses. This does not mean that one use categorically p other uses. On the contrary, adjustments are increm that amount of milk which is as valuable to ice crea or consumers of yogurt as it is to cheese purchasers to make ice cream or yogurt.

Whether considering c cheese, ice cream, or yogurt, some will be anxious to tain amount, less anxious to have additional amo nally-beyond some point-indifferent to having a even unwilling to consumeany more after becoming Prices coordinate the use of resources, so th amount is used for one thing which is equal in value worth to others in other uses.

Thatway a price-coord omy does not flood people with cheese to the poin are sick of it, while others are crying out in vain cream oryogurt. Absurd as such asituation would b pened many times in economies where prices do scarce resources. The Soviet economy, for exampl salable goods piling up in warehouses while people w in long lines trying to get other things that they wan cient allocation of scarce resources whichhave altern not just an abstract notion of economists.

It determin or how badly millions of people live. Again, as in the example of beach-front property vey an underlying reality. From the standpoint of socie the "cost" of anything is the value that it has in alternat The Role of Prices cost is reflectedin the market when the price that one is willing to pay becomes a cost that others are forced order to get a share of the same scarce resource or th made from it. But, no matter whether a particular so capitalist price system or a socialist economy ora feud system, the real cost of anything is still its value in uses. The real cost of building a bridge are the other could have been built with that same labor and mater also true at the level of a given individual, even when is involved.

The cost of watching a television sitco opera is the value of the other things that could have with thatsame time.

Basic Economics: A Citizen's Guide to the Economy

Different economic systems deal with this underly in different ways and with different degrees of efficien underlying reality exists independently of whatever economic system is used. Once we recognize that, w compare how economic systems which use prices to f to share scarce resources among themselves differ in from economic systems which determine such things kings, politicians orbureaucrats issues orders saying w how much of what. During the brief era of glasnost openness and pere structuring in the last years of the Soviet Union,two S omists named Nikolai Shmelev and Vladimir Popo book giving a very candid account of how their econom and this book was later translated into English.

As Sh Popov put it, enterprises in the U. The consequence was that far more resources we produce a given output in the Soviet economy as com price-coordinated economic system, such as that in States. We use 2. This correlation even without special calculations: we produce an to 2 times more steel and cement than the United lag behind by at least half in production of items der them.

Recently, in Soviet industry the consump cal energy exceeded the American level, but the vo dustrialoutputinthe U. The Soviet Union did not lack for resources, bu one of the most richly endowed nations on earth. W was an economic system that made efficient use sources.

In other regions of the world in other political systems, there have been similar tween places that used prices to ration goods and The Role of Prices sources versus places that have relied on heredita elected politicians orappointed planning commissions When many African nations achieved independe s, a famous bet was made between the presiden and the president of the neighboring Ivory Coast a country would be more prosperous in the years ahe time, Ghana was not only more prosperous than the Iv it had more natural resources, so the bet might have se less on the part of the president of the Ivory Coast.

H knew that Ghana was committed to a government-ru and the Ivory Coast to a freer market. By , the Iv had so surpassed Ghana that the poorest 20 percent of had ahigher real incomethan most of the people in Gh This couldnot be attributed to any superiority of t or its people.

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While history can tell us that such things happen ics helps explain why they happened-what there is that allows them to accomplish what political contro omy can seldom match. There is more to economics but understanding how prices function is the found derstanding the rest of economics. In a society of millions of consumers, no given i set of government decision-makers sitting around a ta sibly know just how much these millions of consume product to another,much less thousands of products of other products.

In an economy coordinated by pr has to know. Knowledge is one of the most scarce of all reso pricing system economizes on its use by forcing th most knowledge of their own particular situation to m goods and resources based on that knowledge, rat their ability to influence other people. In a price-coordinated economy, any p uses ingredients that are more valuable elsewhere is cover that the costs of those ingredients cannot be what the consumers are willing to pay for the produ he has had to bid these resources away from altern paying more than these resources are worth to some ternative users.

Basic Economics: A Citizens Guide To The Economy

If it turns out that these resources a valuable in the uses to which he puts them, he is g money. There will be no choice but to discontinue product with those ingredients. For those producers blind or too stubborn to change, continuing losses w businesses into bankruptcy, so that the waste of sources will be stopped that way. The Role of Prices In a price-coordinated economy, employees and c sist on being paid, regardless of whether the managers ers have made mistakes.

This means that businesse only so many mistakes forso long before theyhave to or get stopped-whether by an inability to get the labo plies they need or by bankruptcy. In a feudal economy ist economy, leaders can continue to make the same indefinitely. The consequences are paid by others in th standard of living lowerthan it would be if there were ficiency in the use of scarce resources. As already noted, there were many productswhich unsold in stores or in warehouses in the Soviet Union, were desperate shortages of other things.

But, in a pr nated economy, the labor, management, and physica that went into producing unwanted products wouldh go into producing something that could pay its own sales-that is, into producing something that the con wanted more than they wanted what was actually pr the absence of compelling pricesignals and the threat o losses to the producers that they convey, inefficiency could continue indefinitely or until such time as e reached proportions big enough and blatant enough to attention of central planners in Moscow, who were p with thousandsof other decisions.

Ironically, the problems caused by trying to run an by fiat or by arbitrarily-imposed prices created by g dictates were foreseen by Karl Marx and Friedrich Eng ideas the Soviet Union claimed to be following. By the same token, produce goods or supply services tend to supply mor price and less at a lower price. Yet the implications principles, singly or in combination, cover a remarka economic activities and issues-and contradict an markable range of misconceptions and fallacies. Seldom, if ever, is there a tity demanded. Likewise, there is no fixed supply.

Statistics on th petroleum, iron ore, or other natural resources seem that this is just a simple matter of how much physical in the ground. The quantity supplied varies directly with the pri quantity demandedvaries inversely with the price. When the price of oil falls,certain low-yield oil down because the cost of extracting and processing these wellswould exceed the price it would sell forin If the price later rises-or if the cost of extraction or lowered by some new technology-then such oil we back in operation again. There is no fixed supply most other things. But shortages are precisely what cause At higher prices, it may be no harder to fill vacanc neers or teachersthan today and no harder to find ho The Role of Prices ing rents cause more homes and apartmentbuildings t Price fluctuations are a way of letting a little knowledge way.

Yet he can grow his competitors who guessed wrong go bankrupt. Rationing by Prices There are all kinds of prices. The prices of consum are the most obvious examples but labor also has pri wages or salaries, and borrowed money has a price ca est. In addition to prices for tangible things, there are services ranging from haircuts to brain surgery and fr ogy to advice onspeculating in gold or soybeans.

In so far as these prices result from supply and de free market, they play very similar roles in allocating sources whichhave alternative uses. So long as people spend their money for what they see fit, price chang sponse to supply and demanddirect resources to wher most in demand and direct people to where their desi satisfied most fully by the existing supply. Simple as all this may seem, it contradicts many w ideas. It may well be true that some-or allprefer to get the highest price that they can.

More important, the comp merous buyers and numerous sellers results in pric each individual buyer and seller with very little leew depends onboth parties agreeing to the same terms. The valu this particular community has simply declined with job opportunities, and housing prices reflect that un The new and lower prices reflect the new reality a previous prices reflected the previous reality.

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A sur prices in a number of upstate New York cities tha population in the s found that home prices w these communities, while home prices were rising the state and around the country. Thisis exactly wha expect on thebasis of basic economicprinciples. Conversely, when some natural disaster such asa flood suddenly destroys many homes in a given are hotel rooms in thatarea may suddenly rise, as many pete for a limited number of rooms, in order to av outdoors or having to double up with relatives an having to leave the community.

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Prices ar forming one of their most important functions-ratio The Role of Prices resources.