Economics 101

Is the Economy a Pie?

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All this talk we have been doing on economic principles allows us to consider “the economy” in an entirely new light.  We now know that the broad and somewhat nebulous notion of 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; all of these millions of personal trades based on individual needs, wants, and preferences constitute “trade.”

We can’t understand the bigger notion of an economy if we don’t first understand why and how individuals choose, which has been our focus. I remember a conversation with a neighbor recently, whom I had just met, asked me what I did and I replied 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.  Remember Hayek’s insight:  because of how knowledge is held, 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 with the most willing demanders and individual needs are met.  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.

Last week’s video with Art Carden drives home this point even in its title:  “Trade is Made of Win”.  If we have learned anything about market exchange, it is that it 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 valued more.

Many people view trade as a zero-sum game:  If I benefit than you must lose.  But when trade is voluntary, this is not possible; the trade will always benefit each party, or else 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.  So what is left must be rationed out to everyone else.  But the pie analogy misses the most critical aspect of the economy that Mises and Hayek understood so well.  The pie is fixed; it is one size. To get more pie you have to bake another one.  The economy, however, is dynamic and always changing; it’s not “one-size”.

It grows because when we trade we both benefit.  It’s not a “taking-game”, it’s a “serving-game”.  And the economy is wealth-creating (which to my knowledge, pies are not).  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.

But it’s not just about the fact that we are all happier because we are getting what we want.  All of this comes back to a holistic understanding of stewardship, and that is the reason for understanding these economic principles.  Trade based on comparative advantage allows us to be better steward of our gifts from God, both personal gifts and natural resources.  Trade allows us to be better stewards because we economize on our time, labor, capital and land—all done toward the end of better serving others.  Here is another video from Art Carden on how voluntary trade allows us to better conserve and grow the economy:

Question: Have you envisioned the economy as a fixed pie? What do you think about it being a dynamic, wealth-creating engine in which your trade decisions make an impact? Leave a comment here.

 

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