The Ten Principles of Economics: Part II, Principles 5 - 7

The Ten Principles of Economics: Part II, Principles 5 - 7

As conceived by Dr. Gregory Mankiw

For Jessi and Tim

Principles 5 - 7 involve how people interact, and some of the simpler "emergent properties" of the market (remember, the market is an "emergent order" composed of buyers and sellers, and its emergent properties cannot be applied to its components).

5. Trade can help everyone

The economy works most efficiently, as in, the most value gets created, when each of us specializes in the one thing we can do better than anything else. This is true on the individual level, the social level, and the international level.

Say that we are neighbors. You are a repairman and I am a landscaper. We could each work for ourselves alone; you would do your own repairs and take care of your own lawn. Same for me. Or, you could do repairs for me and I would fix your lawn. Even if you are better at both things, you can still be more productive by focusing on your own personal specialty. In the end, more stuff gets fixed, and more square feet of yard gets prettied up, when we specialize. No matter how we divide up the products (a matter to be determined my market forces—supply and demand), there's more to divide between us.

You specialize in repair, I in landscaping. Florida makes oranges, California makes computers. China makes toys, the U.S. makes medicine. More value is created when we specialize and trade.

Oh, and there are some fairly intelligent people who support trade restrictions between countries (cough cough, China). But at least in the particular field of basic economics, those people are complete idiots.

6. Markets are awesome

Market: noun, a group of buyers and sellers who are buying and selling stuff.

This is really a profoundly awesome principle, when you look at why it is so true. Here is an example of how.

How many people does it take to screw in a light bulb? One. Really, just one. But how many people does it take to create a pencil? Hundreds of thousands, maybe more. The process is inconceivably complex. Trees were cut, and lumber was delivered to a plant. Machines sliced boards into little sticks (and someone built those machines, with metal that was mined, transported, refined, transported again, and pressed into shape by other machines). The same goes for the paint, the little silver metal thing, the eraser, and the graphite.

Every step of this process is crucial to the formation of the end product. But almost no one said "I am doing my job because I want to build a pencil." The market functioned as a sort of "invisible hand" that guided laborers, factory owners, shippers, and investors into the right places at the right time to produce what people needed. It works because people realize they can make money whenever there is a market for transportation, wood, machines, trucks, or whatever. Supply chases after demand. Then, when there are "just enough" in one industry (like the pencil industry) the profit dries up because demanders aren't desperate for suppliers anymore (so the suppliers cut prices until they are earning just enough to stay afloat).

7. Governments can sometimes improve the market

"Making money" (the profit motive) drives many firms to change the world in awesome, creative ways. The profit motive drives people to invest money in the stock market, providing the financial resources for firms to stay alive. Markets harness these selfish motives and transform them into socially beneficial outcomes, like the creation of new products or the more efficient use of input resources.

But those motives screw things up in a couple of ways. Sometimes, a firm can obtain so much control over the market it is in (like the market for oil) that no one competes with them. Thus, they keep their profits at this maximum level by curtailing production at less than optimal levels (because when they increase production they have to lower the selling price in order to sell the whole supply, and at some point this eats into marginal and total profit). Another example is pollution: if there aren't laws to regulate belching smoke and gasses into the air, firms will keep on doing it till we all die of lung cancer. Public goods are another example, but we'll hold off on those.

The final three principles deal with the macro-economy: the emergent order on top of the market and the rest. Those principles govern how much stuff humanity creates and consumes, the properties of money, and the distribution of all sorts of capital across society's broad variety of needs. I hope you're excited!