National Output

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Just as there are basic economic principles which apply in particular markets for particular goods and services, so there are principles which apply to the economy as a whole. (Sowell, Basic Economics) Example: Just as there is demand for particular goods and services, so there is an aggregate demand for the total output of the whole nation. Moreover, aggregate demand can fluctuate, just as demand for individual products can fluctuate. In the four years following the great stock market crash of 1929, the money supply in the United States declined by a staggering one-third. This meant that it was now impossible to continue to sell as many goods and hire as many people at the old price levels, including the old wage levels. o If prices and wage rates had also declined immediately by one-third, then of course the reduced money supply could still have bought as much as before, and the same real output and employment could have continued. There would have been the same amount of things produced, just with smaller prices on their price tags, so that paychecks with smaller numbers on them could have bought the same as before. o In reality, however, a complex national economy can never adjust that fast or that perfectly, so there was a massive decline in total sales, with corresponding declines in production and employment. The nations real output in 1933 was one-fourth lower than it was in 1929. Unemployment rose from 3% in 1929 to 25% in 1933, creating the greatest economic catastrophe in U.S. history, which was not confined to the U.S. but had effects worldwide. The Fallacy of Composition When thinking about the national economy, a special challenge will be to avoid what philosophers call the fallacy of composition the mistaken assumption that what applies to a part applies automatically to the whole. o Example: The 1990s were dominated by news stories about massive reductions in employment in particular American

firms and industries, with tens of thousands of workers being laid off by some large companies and hundreds of thousands in some industries. Yet the rate of unemployment in the U.S. economy as a whole was the lowest in years during that same era, while the number of jobs nationwide rose to record high levels. o What was true of the various sectors of the economy that made news in the media was the opposite of what was true of the economy as a whole. The fallacy of composition threatens confusion in many aspects of economics, but especially in the study of the national economy, because what is true of an individual or even an industry is not necessarily true for the economy. o Example: Any given individual who doubles the amount of money he or she has will be richer, but a nation cannot be made richer by printing twice as much money. That is because the price level will rise in the economy as a whole if there is twice as much money in circulation, bidding for a given supply of goods. o Example: Adding up all individual investments to get the total investments of the country. When individuals buy government bonds that is an investment for those individuals. But for the country as a whole, there are no more real investments factories, office buildings, dams, power plants, etc. than if those bonds had never been purchased. What the individuals have purchased is a right to sums of money to be collected from future taxpayers. These individuals additional assets are the taxpayers additional liabilities, which cancel out for the country as a whole. What is at the heart of the fallacy of composition is that it ignores interactions among individuals, which can prevent what is true for one of them from being true for them all.

o Among the common economic examples of the fallacy of composition are attempts to save jobs in some industry threatened with higher unemployment for one reason or another. Any given firm or industry can always be rescued by a sufficiently large government intervention, whether in the form of subsidies, purchases of the firms or industrys products by government agencies, or by other such means. The interaction that is ignored by those advocating such policies is that everything the government spends is taken from somebody else. The fallacy is not in believing that jobs can be saved in given industries or given sectors of the economy The fallacy is in believing that these are net savings of jobs for the economy as a whole.

Output and Demand

What is Economics?

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George J. Stigler Whether one is a conservative or a radical, a protectionist or a free trader, a cosmopolitan or a nationalist, a churchman or a heathen, it is useful to know the causes and consequences of economic phenomena. Sowells Introduction Understanding most of the economic issues discussed in the media and in politics requires knowledge of only the most basic principles of economics and yet these principles are unknown to most of the public, and are widely ignored by politicians and journalists, and even by many scholars outside the field of economics. Principles of economics apply around the world and have applied over thousands of years of recorded history. They apply in many different kinds of economies capitalist, socialist, feudal, or whatever and among a wide variety of peoples, cultures and governments. Policies which led to rising prices under Alexander the Great have led to rising price levels in America, thousands of years later. Rent control laws have led to a very similar set of consequences in Cairo, Hong Kong, Stockholm, Melbourne, and New York. So have similar agricultural policies in India and in the European Union countries. Differences in economic practices from one country to another are also revealing. There were economic reasons why manufacturing enterprises in the days of the Soviet Union kept almost enough inventory on hand to last a year, while inventories of supplies in some Japanese companies like Toyota are only enough to last a matter of hours, with new parts and equipment arriving at the factory at various times during the day, to be unloaded from trucks and installed immediately on cars as they are being assembled.

Both of these very different inventory policies had a rational basis, given the very different kinds of economic systems in which they existed. Economics fundamental concern is with the material standard of living of society as a whole and how that is affected by particular decisions made by individuals and institutions.

One of the ways of doing this is to look at economic policies and economic systems in terms of the incentives they create, rather than simply the goals they pursue. This means that consequences matter more than intentions. o Not just immediate consequences, but also the longer run repercussions of decisions, policies, and institutions. o Nothing is easier to have good intentions but, without an understanding of how an economy works, good intentions can lead to disastrous consequences. Most economic disasters have been a result of policies

intended to be beneficial, which could have been prevented if those who originated and supported such policies had understood economics. To know what economics is, we must first realize what an economy is. An economy is a system which produces and distributes scarce resources. Without scarcity, there is no need to economize Economics is the study of the use of scarce resources which have alternative uses. Economics studies the consequences of decisions that are made about the use of land, labor, capital and other resources that go into producing the volume of output which determines a countrys standard of living. Those decisions can be more important than the resources themselves, for there are poor countries with rich natural resources and countries like Japan and Switzerland with relatively few natural resources but high standards of living. o Example: The values of natural resources per capita in Uruguay and Venezuela are several times what they are in Japan and Switzerland, but income per capita in Japan and Switzerland in about double that of Uruguay and several times that of Venezuela. In analyzing all decisions and examining the evidence of their consequences, it is crucial to keep in mind at all times that the resources being used are both scarce and have alternative uses.

When a politician promises his policies will increase supply of some desirable goods or services, the question to be asked is: At the cost of less of what other goods and services? Scarcity means that what everybody wants adds up to less than there is. This implies no easy win-win solutions but only serious and sometimes painful trade-offs. o These implications are grossly misunderstood, even by the highly educated. Example: Article in the New York Times laid out the economic woes and worries of middle-class Americans one of the most affluent groups of human beings ever to inhabit the planet. Although this story included a picture of a middle-class family in their own swimming pool, the main headline read: The American Middle, Just Getting By. Other headings in the article included: Wishes Deferred and Plans Unmet Goals That Remain Just Out of Sight Dogged Saving and Some Luxuries

In short, middle-class Americans desires exceed what they can comfortably afford, even though what they have already would be considered unbelievable prosperity by people in many other countries around the world or even by earlier generations of Americans. o It is not something as man-made as a budget which constrains them: Reality constrains them. There has never been enough to satisfy everyone completely. That is the real constraint. That is what scarcity means. o To all people from academia and journalism, as well as the middle-class people themselves it apparently seemed strange somehow that there should be such a thing as scarcity and that this should imply a need for both productive efforts on their part and personal responsibility in spending. Yet nothing has been more pervasive in the history of the human race than scarcity and all the requirements for economizing that go with scarcity.

Regardless of our policies, practices, or institutions, there is simply not enough to go around to satisfy all our desires to the fullest. o Unmet needs are inherent in these circumstances, whether we have a capitalist, socialist, feudal, or other kind of economy. These various kinds of economies are just different institutional ways of making trade-offs that are inescapable in any economy. Alternative uses is the fact that not only are these resources scarce, but their inputs can be used in various different ways producing various different outputs Each resource has variable uses How much of each resource should be allocated to each of its many uses? o Every economy has to answer this question. Doing so efficiently is what economics is all about. o Different kinds of economies are essentially different ways of making decisions about the allocation of scarce resources and those decisions have repercussions on the life of the whole society. Example: Soviet Union industries used more electricity than American industries used, even though they produced a smaller amount of output. More steel, cement, and other resources used for producing a given output likewise resulted in less output in the Soviet Union than in countries such as Japan or Germany. Such inefficiencies as turning inputs into outputs resulted in a lower standard of living, in a country richly endowed with natural resources perhaps more richly endowed than any other country in the world. Russia is one of the few industrial nations that produces more oil than it consumes. But an abundance of resources does not automatically create an abundance of goods.

Example: Early 21st-century China, seven times as much energy has been used to produce a given value of output as Japan uses to produce that same value of output. Huge differences in efficiencies have meant huge differences in standards of living for million of human beings. o Efficiency in production the rate at which inputs are turned into output is not just some technicality, but affects the life of whole societies. Although the word economics suggests money to some people, for a society as a whole money is just an artificial device to get real things done. Otherwise, the government can make us all rich by simply printing more money. It is not money but the volume of goods and services which determines whether a country is poverty stricken or prosperous. Economics is about the material well-being of society as a whole. Analyzing various sources of data by economists is done from the standpoint of how decisions in various parts of the economy affect the allocation of scarce resources in a way that raises or lowers the material standard of living of the people as a whole. It is the systemic study of what happens when you do specific things in specific ways It is a tool of analysis and a body tested knowledge and of principles derived from that knowledge. Its analysis and understanding has brought millions of people out of poverty and can bring millions of more out of poverty if its basic principles were understood by more people. Life does not ask us what we want. It presents us with options. Economics is one of the ways of trying to make the most of those options.

The Role of Prices

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William Easterly The wonder of markets is that they reconcile the choices of myriad individuals. Intro: However much we may think of ourselves as independent individuals, we are all dependent on other people for our very lives, as well as being dependent on innumerable strangers who produce the amenities of life. Few of us could grow the food we need to live, much less build a place to live in, or produce such things as computers or automobiles. Other people have to be induced to create these things for us, and economic incentives are crucial for that purpose. Prices are at the heart of these incentives in a market economy. There are some relatively simple, but important, principles of economics which together explain how a complex society of millions of human beings supply one another with the countless goods and services that sustain, enhance, and prolong their lives. Since we know that the key task facing any economy is the allocation