Everyone is an Economist
By Jan Larson (01/16/06)
By all objective accounts, the U. S. economy is growing at a healthy rate – jobs are being created while inflation remains in check. Ask the man in the street just what the “economy” is however, and nine times out of ten you’ll get a blank stare.
The “economy” refers to the production and distribution of goods and services at all levels, e.g. wholesale, retail, etc. In other words, the “economy” refers to all that goes into the buying and selling of goods and services by businesses and individuals.
While it may be helpful to have a PhD in economics to understand the relationships among such things as the GDP, money supply, federal funds rate, producer price index, etc., the simple fact is that everyone who buys or sells anything is engaging in economic activity and, to a degree, is an economist. That is, the simple decision to buy an ice cream cone priced at a dollar but not to buy one priced at ten dollars is a practical application of economic theory.
There are a lot of misconceptions about economics, but economics for all but the PhDs really boils down to nothing more than answering the question, “What would I rather have?”
Every decision that we make involves a tradeoff. An economics professor of mine described this tradeoff using the concept of “utils.” A “util” is defined as a unit of value. Each of us assigns a different number of utils, e.g. a different value, to ice cream, a dollar, a car, etc. When we determine that the number of utils is greater for one of the choices, that is the one we choose.
While it is likely that few actually think of economic decisions in this way, asking, “What would I rather have?” or “Which choice gets me more utils?” is how we make economic decisions.
Personally, I would never assign the same number of utils to a Starbucks’ coffee as I would a five-dollar bill. However, since many people pay five dollars or more for a cup of Starbucks’ coffee, they have assigned more utils to the coffee than to the money. This determines the balance between supply and demand and establishes the price at which both buyer and seller are happy. The seller (Starbucks) believes the five dollars has more utils while the consumer believes the coffee has more utils. Raise the price and fewer people are willing to make the trade. Lower the price and the coffee runs out before 10 a.m.
The concept of “utils” applies to other economic issues as well, such as the minimum wage. The economics of the minimum wage suggest that the higher the minimum wage, the fewer people will be employed. Why? Because the “utils” that a business owner gains by employing a minimum wage worker is constant, but the number of “utils” (dollars) he must trade for that worker increases if the minimum wage is increased. If that tradeoff no longer makes sense, some businesses will make do with fewer workers. Others may have the incentive to replace minimum wage workers with illegals willing to work for less than minimum wage.
Minimum wage advocates seem to think that just giving low-wage workers more money will solve their economic woes. If that were true, it would be better to raise minimum wage to $100 per hour. The fact is that no matter where the minimum wage is set, unless the worker can provide sufficient utils to make his or her wage a worthwhile trade for the employer, the worker will find him or herself unemployed.
There was a lot of discussion in the media about price gouging following the hurricanes last year. Economic theory suggests that there is really no such thing as price gouging, but rather the forces of supply and demand simply reaching a balance.
If the price of gasoline goes to $5.00 per gallon after a disaster, for instance, the concept of utils again comes into play. Is it worth it to fill up the tank at $5.00 per gallon or just buy a couple of gallons at that price leaving more gasoline available for others? The price of any commodity regulates the availability of that commodity. After a hurricane, if gasoline prices are held artificially low while supplies are cut off or limited, shortages result as some people hoard gas, leaving none for anyone else. Increased prices mean that consumers must adjust their “util-for-util” trade decision.
It seems many people, or at least many in Washington, don’t understand the economics of taxes. Federal tax revenues are currently growing despite lower tax rates. How can this be? It is because with low tax rates, the incentive to avoid or delay taxes is reduced thereby enabling investment decisions to be made based more on the underlying economic factors and less on tax factors. In addition, low taxes put more money into consumers’ pockets, allowing them to buy more which allows businesses to sell more (economic growth) which, in turn, means higher incomes and thus greater tax revenues. Opponents of tax cuts generally consider the effect of those cuts in isolation, which in practice, is not the way economics works.
If you buy a used Toyota instead of a new Lexus, it isn’t simply a matter that you have more money left in your pocket. Having that money allows you to make further economic decisions – maybe you’ll pay someone to wash that Toyota instead of doing it yourself and maybe you’ll have an ice cream cone while you wait. The cumulative effects of such decisions ripple throughout the economy. This ripple effect makes the ultimate effect of economic policy decisions difficult to quantify and makes it doubly important for policy makers to not consider economic effects in isolation.
While we may not all be economists by profession, we all practice economics every day and it is not surprising just how many current issues are so much easier to understand if the underlying economic factors are understood first.
Copyright ©2006 Jan A. Larson All rights reserved.
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