A Citizen's Guide to the Economy

Basic Economics

A Citizen's guide to the Economy

By

Thomas Sowell

Author of the Vision of the Anointed

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Economics is the study of the use of scarce resources, which have alternative uses.

When a military medical team arrives on a battlefield where soldiers have a variety of

wounds, they are confronted with the classic economic problem of allocating scarce

resources, which have alternative uses. Unless their time and medications are allocated

efficiently, some wounded will die needlessly.

The inherent reality is that there are not nearly enough beachfront homes to go around

and prices are just a way of conveying that underlying reality. When people bid for a

relatively few homes, these homes become very expensive because of supply and

demand. But it is NOT the prices that cause the scarcity. Even if Congress were to

declare that beachfront homes were a basic right of all Americans, it still would not

change the realities of the situation.

Prices act as a guide for consumers and producers. A free market economic system is

sometimes called a profit system, when it fact it is a profit and loss system. And the

losses are equally important for the efficiency of the economy, because they tell the

manufacturer what to stop producing.

Resources tend to flow to their most valued uses. From the standpoint of society as a

whole, the COST of anything is the value that it has as in alternative uses. The real cost

of building a bridge are the other things that could have been built with that same labor

and material. There is also a scarcity of time to consider and the alternative uses of that,

as well. The cost of watching a television sitcom or soap opera is the value of the other

things that could have been done in that same time.

In a price-coordinated economy, any producer who uses ingredients that are more

valuable elsewhere is likely to discover that the costs of those ingredients cannot be

repaid from what the consumers are willing to pay for the product. There will be no

choice but to discontinue making that product with those ingredients.

Prices

There are all kinds of prices. The prices of consumer goods are the most obvious

examples but labor also has prices called wages or salaries, and borrowed money has a

price called interest.

Price changes in response to supply and demand. These changes in price then direct

resources to where they are most in demand and direct people to where their desires can

be satisfied most fully by the existing supply.

A sudden and widespread destruction in housing in a given area means that there may not

be nearly enough hotel rooms for displaced people to get the kinds of accommodations

they would like. If prices remained at their previous levels before the disaster, a family

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of four might well rent two room - one for parents and one for kids. But when the hotel

shot the price up, all four family members will crowd into one room, to save money,

leaving the other room for other people who likewise lost their homes and are equally in

need of shelter.

In short, prices force people to share, whether or not they are aware of sharing.

Prices rise in the first place because the amount demanded exceeds the amount

supplied at existing prices. Prices fall because the amount supplied exceeds the

amount demanded at existing prices. The first case is called a "shortage" and the

second is called a "surplus" - but both depend on existing prices.

Economics is a study of consequences of various ways of allocating scarce resources

which have alternative uses. It is not a study of our hopes and values.

While scarcity is inherent, shortages are not. Scarcity simply means that there is not

enough to satisfy everyone's desires. Right now that scarcity is money based on poor

cash flow. With nothing, or very little coming in, every company is looking to stop the

bleeding by drastically reducing their spending. This includes wages, inventory, power,

and whatever else it takes to survive this. A shortage, however, means that there are

people willing to pay the price of the good but are unable to find it.

In a price coordinated economic system that shares its resources, those who want to use

wood to produce furniture, for example, must bid against those who want to use it to

produce houses, paper or baseball bats. Those who want to use milk to produce cheese

must bid against those who want to use it to produce yogurt or ice cream.

For example, whenever the price of oranges goes up, some people switch to tangerines.

If a vacation on the beach becomes too expensive, people may take a cruise instead. This

is