Unlocking the Deadbolt

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Economics 101

First let me start off by saying that I am an economist by training and at heart. I appreciate scientific methods to research and data. I prefer specific and defined empirical evidence. I enjoy thinking about a sensible pattern of logic stemming from a set of assumptions. I like to take the conceptual framework of economics along with the its terminology and apply it towards different facets of my life, but especially religion and morality.

So to start, what is economics at its basics? What is Economics 101?

At its core, economics seeks to explain human decisions given relative scarcity of resources. Classical economics works within a framework of basic assumptions to explain supply and demand models. Adam Smith is largely credited as the father of economics for being the first to observe and record informally the concepts of cooperation and exchange. He coined the famous term, the invisible hand, to show the propensity in humans to engage in this sort of behavior, and subsequently point out the social benefits it unintentionally produces. The basic division of economics becomes Macroeconomics and Microeconomics. Macro focuses on the entire economy as a whole, while micro focuses on individual firms. In macro, we typically look at formulas, different sorts of measurements, and economic growth/unemployment/inflation models. In microeconomics, we study firm behavior, which includes firm measurements, firm models, and studying marginalism.

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Supply and Demand Graph: Economics 101

I will emphasize that I am trying not to go on into details that are irrelevant to the subjects we are covering. I’ll largely be sticking to the basics. So, what we have in the graph above is an illustration of a generic, economic market. In practicality, we derive this from the spontaneous order that arises from cooperation among individuals to meet each other’s desires through trade. As you can see in the graph, equilibrium shows the point where the most needs/desires are met; it is the optimal place for a society or group. Now, this graph only works under certain, strict assumptions*, but it can nonetheless work. Furthermore, many argue a good institutional framework is necessary for markets to work well, such as a limited government role, well-defined property rights, and a conflict/dispute resolution system (court/judicial system).

As an economist, I like to observe what happens when exogenous interruptions like government policies, irrational preferences, externalities, etc, come in to the framework. For the sake of time, I will demonstrate only one of these examples below when discussing negative externalities.

*Assumptions include agent rational preferences, human self-interest, agent full and relevant information, no negative externalities, flexible wages and prices. Here is a link to learn a little more.

Now as markets develop, and subsequently, societies develop, we observe another phenomenon that takes place. Adam Smith coined the term, division of labor, or in other words, the specialization in a particular occupation or field. This allows for someone to specialize in a particular task, allowing for relatively more efficiency than everyone doing everything. Generally, larger, more developed economies will always display a greater level of division of labor (think diversity of types/available jobs) than smaller, undeveloped economies.

As far as specialization, consider the efficiency gains for a person that solely produces carpets and then trades the extra carpets that he can produce within a market. Another individual, specializing in bread, can then exchange the bread for carpets. Specialization produces less energy waste between switching tasks and takes advantage of task-specific knowledge. The trade-off is that specialization produces an interdependent framework, because the person who produces much of good A relies on the person who produces good B and so on and so forth. For more on this subject, glance at this short page, and also check out the book, The Choice by Russ Roberts.

Below is fascinating display of world trade.


Now if these assumptions are not met, then either the government or some sort of third party will come in to mitigate the problem or help the market to reach equilibrium. For example,  there are positive and negative externalities that can disrupt normal market-clearing outcomes and cause market failures. Let’s look over the case of negative externalities. Negative externalities occur in a situation where one party who produces a certain good does not bear all the costs of producing that good; a very common example of this is pollution. This problem would prevent the market from reaching its equilibrium because Say, the government may come in to regulate the pollution so that the environment maintains a level of cleanliness.

In some cases, pollution may be concentrated and effect a particular group of individuals. Say in the case of a polluted stream. A factory dumps leftover chemicals into a stream. The individuals downstream suffer from the waste chemicals. Both parties can debate the property rights to the stream and work out a legislative solution via the courts without the intervention of a government body.

Here’s a nice, quick video demonstrating this concept.

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A Graph Depicting a Negative Externality: Economics 101

Everything shown above is the underlying philosophy for the subject of Classical Economics. There are various branches of economic thinking, which carry their own set of assumptions, and where we are moving is into a branch of economics that places an emphasis on institutions and different functional mechanisms. This is known as Complexity Theory (CT).

Before I move on, I just want to recognize that everything above is simply a static model. Those models do not reflect dynamic changes that can be endogenous to the system in any way. They are simply taken as is, in a static, unchanging format – a fundamental way of seeing the world with some benefits and several limitations. Now, the next subject component of economics that I am about to look at is a bit more complex… but here is a nice quote for summarizing why the Econ 101…

“The models we teach in economics are often irrelevant in understanding particular issues, but they are nonetheless useful in training one’s intuition and in increasing one’s ability to understand economic issues because they are the calisthenics of the mind.” – David Colander in The Stories Economists Tell

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