Economics 101

Beyond the Pie Model: How our Economy Is More than the Sum of the Slices

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“The economy” is a broad and somewhat nebulous notion. In the simplest terms, an economy is built upon individual trade and exchange: your trip to the grocery store to buy milk, to Home Depot for nails, to Starbucks for your daily fix. These millions of personal trades based on individual needs, wants, and preferences constitute “trade.”

IFWE and other scholars explore the roles of individual need and choice in trade, among other economic concepts, in a new book, Counting the Cost: Christian Perspectives on Capitalism, due out in August. Looking at the freedom to choose, trade, and provide something of value to others, Joy Buchanan and Nobel laureate Vernon Smith observe that, for example,

The iPhone, unimaginable fifty years ago, is a prime example of the solutions that people have brought to others when they are free to create and exchange.

But we can’t understand the bigger notion of an economy if we don’t first understand why and how individuals choose.

The Freedom to Choose

A neighbor once asked me what I did and I told her that I was an economist. She replied “wow, can you help me decide how to invest in the stock market?” “Uh, no, you wouldn’t want me to!” was my reply.

This reveals a common misperception of economics. The economy is not the stock market. The stock market reveals some portion of economic activity, but there is much, much more going on. We aren’t even aware of most economic activity that goes on each day—and the beauty is we don’t need to be. Prices do the heavy-lifting in terms of market activity—they bring together the most willing suppliers and the most willing demanders to meet individual needs.

This is the economy. It is dynamic, fluid, and even the smallest exchange contributes to how the overall economy operates.

Economist Ludwig von Mises wrote in his influential book Human Action:

The market economy is the social system of the division of labor under private ownership of the means of production. Everybody acts on his own behalf; but everybody’s actions aim at the satisfaction of other people’s needs as well as at the satisfaction of his own. Everybody in acting serves his fellow citizens. Everybody, on the other hand, is served by his fellow citizens.

Mutual Value in Exchanges

Market exchange is based on voluntarism. When I trade with you, I give you my dollar(s) in exchange for things like food, shelter, and clothing, because I would rather have your thing than my money. I view giving up the dollars as a value-enhancing activity. This means that trade is a positive-sum game. This is a term used in economics to mean that we are both better off because we each gave up one thing for some other thing we value more.

Some people view trade as a zero-sum game: if I benefit then you must lose. But when trade is voluntary, this is not possible; the trade will always benefit each party, otherwise we would not have traded.

This has big implications for the economy. Many people view the economy as a pie. If I take a piece of pumpkin pie, that piece is gone forever. What is left must be rationed out to everyone else. But the pie analogy misses the most critical aspect of the economy that Mises understood so well. A pie is fixed; it is one size. The economy, however, is dynamic and always changing; it’s not fixed or finite.

It grows because when we trade we both benefit. It’s not a “taking-game,” it’s a “serving-game.”  I only benefit if I create something that serves others. If they don’t want it, they choose not to purchase it and thus I must redirect my creativity and resources.

The Pie Gets Bigger

So, the economy is not really a pie that gets divvied up and then we’re done. Amazingly, when we’re free to use our God-given creativity and personal preferences and respond to the needs of others, we can increase the size of the pie.

The Parable of the Talents illustrates this principle. The first two servants use the varying resources they have been given to create more of those resources. And the master is pleased with the results. In Counting the Cost, Smith and Buchanan conclude about this parable:

The master is rich because he knows that in trade, you have to give in order to receive, and that you cannot sustainably benefit from trade unless you benefit others.

So…more pie, anyone?

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