Thursday, June 11, 2009

What is Economics?

Lionel Robbins, a British economist, said that "Economics is the study of the use of scarce resources which have alternative uses." This might be the best definition of economics I have come across. Resources are scarce which means that people want more than is available to them. Another way of saying it is that our wants are unlimited and the resources to fulfill our wants are limited. Scarcity required us to economize, therefore the need for economics was born.

Scarcity has also required us to study trade-offs or the various uses of resources. Thomas Sowell states in his brilliant book Basic Economics:

"Not only scarcity but also "alternative uses" are at the heart of economics. If each resource had only one use, economics would be much simpler. But water can be used to produce ice or steam by itself or innumerable other mixtures and compounds in combination with other things. A virtually limitless number of products can also be produce from wood or from petroleum, iron ore, etc. How much of each resource should be allocated to each of its many uses? Every economy has to answer that question, and each one does, in one way or another, efficiently or inefficiently. Doing so efficiently is what economics is all about."

Fallacy of Economics

You may have heard the saying that an economist thinks he knows more about money than the people who have it. This comes from a misunderstanding of economics and what it entails. Decisions don't even have to involve money to be economic. Economics is not about how to make money or how to run a business. It is about the study of relationships between items such as prices, commerce, wages, and international trade from the viewpoint of how it affects the distribution of scarce resources to society. Even more broadly defined, Economics is the inquiry of praxeology - the study of human action or conduct. Ludwig von Mises championed the inclusion of all human action into the study of economics and anything less was incomplete.

Benefit of Economics

How can we benefit from economics? Economics helps us determine how well the various uses of resources affects our society. More specifically, we can determine what particular actions or policies do to either increase poverty or wealth. This can be very valuable indeed.

Monday, June 1, 2009

Why Does Government Often Fail?

Government often fails not because of the people in it, but because of the nature of government itself. Government takes whatever individual brilliance exists and turns it into collective incompetence. Most activities of the government are to "solve" problems. However, once an agency or program is setup to "solve" the problem, it is in its best interest to simply "manage" the problem. Ronald Reagan said it well,

"No government ever voluntarily reduces itself in size. So, governments' programs, once launched, never disappear. Actually, a government bureau is the nearest thing to eternal life we'll ever see on this earth."
Let's look closer at why government fails. If a government agency solves a "problem", it gets less money as its funds are funneled elsewhere. If a government agency fails to solve its "problem", it complains of underfunding and gets more money.

If a business solves a problem for customers, it gets more customers and more money. If a business fails to help customers solve their problems, the customers go elsewhere and the business loses money.

As you can see, the incentives are backwards with government which explains its high rate of failure.

Can you imagine a business that paid employees more if they did less work and paid them less if they did more work? The idea is clearly foolish; anyone can see that if you pay people more for doing a poor job, it won't be long before all the employees are doing as little work as possible to increase their pay. Doing a good job is challenging, but any boob can do a poor job.