Basic Principles of Economics

These principles are generally agreed upon by most contemporary schools of economic thought, but they are presented here as elaborated by the Austrian School of Economics.

People are rational.

The first principle is that people are rational. By rational, we don't necessarily mean logical, but purposeful--there is a reason for the things they do, no matter how smart or stupid seeming. For example, a drowning person will often desperately grab onto a would-be rescuer, thereby drowning both of them. The drowning person's actions are completely rational; the rescuer floats, so holding onto them must help the drowner float as well. Unfortunately, their actions lead to their doom instead of salvation. Continuing with our example, being rational, professional lifeguards and rescue swimmers are taught this and how to escape from drowning victims. (See Kevin Costner's The Guardian for a visual.)
People are imperfect and have desires. These desires are infinite.

Every person has desires and wants...even if it is simply to take another breath or scratch an itch. As long as we live, we will require food, water, and shelter. But even having these, we will want better and more. When you combine the first principle with the second, you get: People are rational (purposeful) in their actions to satisfy their desires. (Note that just because they are rational does not mean they will be successful in any particular degree, and even if they do meet with success, their will always be more desires.)

Resources are scarce.

Even though demands are infinite, the resources to satisfy those demands are not. This concept of scarcity does not mean that there are only a few resources available, simply that they are finite. If you eat an apple, that means you cannot also use it to decorate your table. If you throw an egg at your neighbor's cat, you cannot also eat it (the egg that is). This is called opportunity cost. Your time and effort are also finite and subject to opportunity cost. If you spend your time in school studying, you will have less for partying. The time and effort it took to write this booklet is time that I was not working on a tan or learning how to kite surf. Economics is about learning the consequences (opportunity costs) of our actions.

Production is king.

Wealth in a society is based on its production. There are only two kinds of goods that can be produced: consumer goods and capital goods. Consumer goods are consumed (used up). Despite the name, a consumer good can be quite durable. For example, a tennis raquet is a consumer good, but a person can get several years of enjoyment out of it. Capital goods are any goods that are used to produce consumer goods (or other capital goods). For example, fire wood is a consumer good. An axe or saw would be a capital good that is used to produce the fire wood. The key aspect to economics is that capital goods allow more consumer goods to be produced, making society richer, because Production is King. Hail to the King, Baby!

What's Labor Got To Do With It?

In order to produce goods, resources are mixed with labor and sometimes capital goods. For example, fallen wood can be gathered (labor) without the use of any capital goods, but its collection (production) can be increased with a wheelbarrow (capital good), and its quality may be enhanced by splitting it with an axe (capital good). Capital goods are usually technological but can also be information or knowledge.

Specialization is the key.

In primitive societies...so primitive that we don't really know of any...everyone had to do everything for themselves (produce food, clothing, shelter, protection, and entertainment). Very quickly, people figured out that people with big pudgy hands weren't as good at sewing; people with big muscles were better at protection; etc. Thus specialization was born. People who specialized in one or two things were more productive than someone who had to do everything for themselves. Economists call this division of labor. The division of labor can happen on any scale, from families, to cities, to entire countries.

Trade makes the world go round.

Once people began to specialize, they had to begin to trade. The sewer had to trade the weaver for cloth. Both had to trade with farmers or hunters for food. The hunter had to trade with the fletcher for arrows. And so on. When two people trade, they both become richer because they both have something they want more. We call this a win-win trade or a positive-sum gain. The weaver has more cloth than she could ever wear. When she trades it for food, the hunter now has clothes and food, and the weaver now has food and clothes. They are both better off...as long as they enter into the trade willingly and knowingly.

This introduces us to one of our first crimes: fraud. Fraud is simply misrepresenting oneself or one's goods. The misrepresentation can be about the quantity of the good, the quality of the good, the ability to deliver the good, or one's ownership of the good.

Value is marginally subjective.

Everyone has different desires, and different ideas about how to satisfy them. This is called the subjective theory of value. Think about what you would like for dessert tonight. Some of you thought about fruit, while others cake or ice cream, and others cheese. Think about how much you would be willing to pay for that dessert. Some of you would be willing to pay more than others.

This brings us to our next concept: The marginal theory of value. This simply means that more of something that someone has, the less he values any one of them. For example, someone who has 2 Chocolate Sin Cakes is more likely to share than someone who has one. Someone who has a bag of marbles is more likely not to care if one marble is lost than someone who only has one. Someone who has a wallet full of cash is less likely to notice when their son steals a bill than someone with only a few dollars. This concept is extremely important.

  1. Other things being equal, it's better to have more of something than less of something.
  2. The more of whatever you have, the less valuable any one of them is.
  3. The lower the value, the lower the price.

Which bring us to THE LAW OF DEMAND: The greater the quantity, the lower the price someone is willing to pay, and conversely, the higher the price, the lower the quantity demanded (all other things being equal).

And what if things aren't equal? Then you can increase (or decrease) price and quantity simultaneously. For example, during the New York power outage a few years ago, all the dollar stores sold out of candles, and people were reselling them for $5 on the sidewalk. People suddenly valued the candles more highly because of the blackout, leading to an increase in both price and the quantity demanded. Under ordinary circumstances, a rise in the price of candles would result in fewer candles being sold.