Economy World

Inventory is a substitute for knowledge. Since you don’t always know just how much inventory you are actually going to need and since inventory costs money, a business enterprise must try to limit how much inventory it has on hand. Those businesses, which have the greatest amount of knowledge and come closest to the optimal size of inventory, will have their profit prospects enhanced. Just as prices in general affect the allocation of resources from one place to another at a given time, so returns on investment affect the allocation of resources from one time period to another. A high rate of return provides incentives for people to save and invest more than they would at a lower rate of return. – A higher rate of return encourages people to consume less in the present so that they may consume more in the future. It allocates resources over time. The present value of an asset is in fact nothing more than its anticipated future returns, added up and discounted for the fac

Whatever the merits or demerits of various political proposal, what must be kept in mind when evaluating them is that the good fortunes and misfortunes of different sectors of the economy may be closely related as cause and effect - and that preventing bad effects may prevent good effects. It was not accidental that Smith Corona was losing millions of dollars on its typewriters while Dell was making millions on its computers. It was not accidental that Safeway surged to the top of the grocery business while A&P fell from its peak to virtual oblivion. The efficient allocation of scarce resources, which have alternative uses, means that some must lose their ability to use those resources in order that others can gain the ability to use them Typewriters were no longer what the public wanted after they had the option to achieve the same end result and more with computers. Scarcity implies that resources must be taken from some places, in order to go to other places.

Economics, in reality is the study of how a whole society uses scarce resources that have alternative uses. Economics is about how a society economizes and how individuals share, without even being aware of sharing. There are many other possible ways of allocating resources, and many of these alternatives are particularly attractive to those with political power. However, none of these alternative ways of organizing an economy has matched the track record of economies where prices direct what resources go where and in what quantities. Thus, when a hurricane, flood or other natural disaster strikes an area, emergency aid usually becomes both from FEMA and from private insurance companies whose customers’ homes and property have been damaged. Allstate cannot afford to be slower in getting money into the hands of its policy-holders than State Farm is in getting money into the hands of its policy holders. A government agency, however, faces no such pressure. There is no government rival

Production costs are reduced when the fixed overhead costs can be spread out over a large volume of output, adding little to the cost of each individual item. Scheduling also affects production costs. When a high-volume retailer signs a contract for a large order from a given manufacturer, that manufacturer can then schedule the work evenly throughout the year. This avoids the additional costs that go with ups and downs in the orders that come in unpredictably from the market, leaving the manufacturer’s workforce idle during some weeks. The fact that profits are contingent upon efficiency in producing what your customers want, at a price that customers are willing to pay – and that losses are an ever present threat if a business fails to provide that – explains much of the economic prosperity found in economics that operate under free market competition. Profits as a realized end-result are crucial to the individual business, but it is the Prospect of Profits – and the threat of loss

Fact: Most big businesses are not monopolies and not all monopolies are big business. Take cranberry juice. How do we know that the price being charged is not far above their costs of production? We don’t. We actually have no idea of how much it costs to produce a bottle or can of cranberry juice. Competition makes it unnecessary for us to know. If the price of apple juice is higher than necessary to compensate for the costs incurred in producing it, the result is a high rate of profit. Only, this is never done in a vacuum. Word gets out that there is a lot of money to be made in cranberry juice. This automatically attracts more investment into the cranberry juice industry creating more competition. Eventually, these additional competitors will drive prices down to a level that compensates the costs with the same average rate of return on similar investment available elsewhere. When that happens, the in-flow of investments from other sectors of the economy stop. The incentive of a hi

Everyone always wants to eliminate the middleman but they can’t because of economic reality. Beyond some point, there are “middlemen” in the channel of getting your goods to the end customer who can perform the next step in the sequence more efficiently and more effectively than you can. At that point, it pays a firm to sell what it has produced to some other channel that can carry on the next part of the operation more efficiently. Oil companies discovered they can make more money by selling gasoline to local filling station operators. When they did, they no longer had the burden of getting their product to the public. It was out of their hands and not their problem. When a product becomes more valuable in the hands of somebody else, that somebody else will bid more for the product than it is worth to its current owner. Go back to the oil companies. The filling station operators see the product to be more valuable to them than it does to the oil companies because the oil companies

Genuine plunder of one nation or people by another has been all too common throughout human history. During the era before the First World War, when Germany had colonies in Africa, only 4 of its 22 enterprises with cocoa plantations there paid dividends, as did only 8 of 58 rubber plantations and only 3 out of 49 diamond mining companies. At the height of the British Empire in the early twentieth century, the British invested more in the United States than in all of Asia and Africa put together. Quite simply, there was more wealth to be made from rich countries than from poor countries. For similar reasons, throughout most of the twentieth century the United States invested more in Canada than in Asia and Africa put together. Only the rise of prosperous Asian industrial nations in the latter part of the twentieth century attracted more American investors in that part of the world. Perhaps the strongest evidence against the economic significance of colonies in the modern world is tha

Economics is not a value in and of itself. It is only a way of weighing one value against another. Economics does not say that you should make the most money possible. Anyone with knowledge of firearms could probably make more money working as a hit man for organized crime. But economics does not urge you toward such choices. What lofty talk about “non-economic values” usually boils down to is that some people do not want their particular values weighed against anything. If they are for saving Mono Lake or preserving some historic building, then they do not want that weighed against the cost – which is to say, ultimately, against all the other things that might be done instead with the same resources. For instance, how many Third World children could be vaccinated against fatal diseases with the money that is spent saving Mono Lake or preserving a historic building? We should vaccinate those children and save Mono Lake and preserve the historic building—as well as doing innumerable ot

It doesn’t matter what we charge, unless others to agree to pay it. Virtually everyone would prefer to get a higher price for what he sells and pay a lower price for what he buys. The history of most great American fortunes—Ford, Rockefeller, Carnegie, etc.—suggests that the way to amass vast amounts of wealth is to figure out some way to provide goods and services at lower prices, not higher prices. When Richard Sears tried to overtake Montgomery Ward, he did it, not because he did not have enough money to live on, but because he wanted more. If that is our definition of “greed,” then he was greedy. Realistically speaking, do keep in mind that when prices go up, it is far more likely to be due to supply and demand than to greed.

Brand names are another way of economizing on scarce knowledge. Brand names are not guarantees. But they do reduce the range of uncertainty. If a hotel sign says Hyatt Regency, chances are you will not have to worry about whether the bed sheets in your room were changed since the last person slept there. Like everything else in the economy, brand names have both benefits and costs. A hotel with a Hyatt Regency sign out front is likely to charge you more for the same size and quality of room, and accompanying service, than you would pay for the same things in some locally—run independent hotel if you knew where to look. Both Kodak and Fuji film have to be better than they would have to be if boxes simply said “film,” without any reference to the manufacturer. McDonald’s not only has to meet the standards set by the government, it has to meet the standards set by the competition of Wendy’s and Burger King. If Campbell’s soup were identified on the label only as “soup” (or “Tomato Soup

Physically identical things are often sold for different prices, usually because of accompanying conditions that are quite different. If a camera store sells a particular make and model of camera for $300 and the discount house sells it for $280, it may still pay to go to the camera store where another make and model of camera is available for $250 that does what you want to do just as well or better. If the camera store’s larger selection and more knowledgeable sales staff enables you to buy only what meets your own needs, there may be financial savings there, as well as better advice on operating the camera, even if the discount house charges a lower price for each particular camera that both stores carry. The point here is not to claim that it is generally better or generally worse to buy cameras at a camera store or at a discount house. Instead, the point is that what is being sold in the two places is not the same, even when the cameras themselves are physically identical. The

The first sentence of Smith’s classic The Wealth of Nations says: “The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes, and which consists always either in the immediate produce of that labour, or in what is purchased with that produce from other nations.” By the late nineteenth century, however, economists had given up the notion that it is primarily labor which determines the value of goods, since capital, management and natural resources all contribute to output and must be paid for from the price of that output. More fundamentally, labor, like all other sources of production costs, was no longer seen as a source of value. On the contrary, it was the value of the goods to the consumers which made it worthwhile to produce those goods—provided that the consumer was willing to pay enough to cover their production costs. This new understanding marked a revolution in the development of ec

In his 900-page classic, The Wealth of Nations. Smith warned against “the clamour and sophistry of merchants and manufacturers,” whom he characterized as people “who seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” David Ricardo, spoke of businessmen as “notoriously ignorant of the most obvious principles.” Knowing how to run a business is not the same as understanding the larger and very different issues involved in understanding how the economy as a whole affects the population as a whole. Free market competition has often been opposed by the business community, from Adam Smith’s time to our own. It was business interests which promoted the pervasive policies of government intervention known as “mercantilism” in the centuries before Smith and others made the case for ending such intervention and establishing free markets. Business leaders are not wedded to a free market ph

Money that is saved does not vanish into thin air. It is lent out by banks and other financial institutions, being spent by different people for different purposes, but still remaining just as much a part of purchasing power as if it had never been saved. According to Say’s Law— supply creates its own demand. What a group of French economists known as Physiocrats showed in the late eighteenth century was that the production of goods and services automatically generates the purchasing power needed to buy those goods and services. When the economy creates another hundred million dollars worth of output, that is also another hundred million dollars worth of wealth that can be used to buy this or other output. Production is ultimately bought with other production, using money as a convenience to facilitate the transactions. During the Great Depression of the 1930s, for example, there was a massive increase of unemployment, along with business losses for the economy as a whole. The great

A popular fallacy that has become part of the tradition of anti-trust law is Predatory Pricing. This where a big company that is out to eliminate its smaller competitors and take over their share of the market will lower its prices to a level that dooms the competitor to unsustainable losses and forces it out of business. A remarkable thing about this theory is that those who advocate it seldom provide concrete examples of when it actually happened. A company that sustains losses by selling below cost to drive out a competitor is following a very risky strategy. Even if our would-be predator manages somehow to overcome these problems, it is by no means clear that eliminating existing competitors will mean eliminating competition. Even when a rival firm has been forced into bankruptcy, its physical equipment and the skills of the people who once made it viable do not vanish into thin air. A new entrepreneur can come along and acquire both. Bankruptcy can eliminate particular owners

Wealth may be transferred from country to country in the form of goods and services, but by far the greatest transfers are made in the form of money. Just as a stable monetary unit facilitates economic activity within a country, so international economic activity is facilitated when there are stable relationships between one country’s currency and another’s. It is not simply a question of the ease or difficulty of translating dollars in yen, francs or yuans. It is a far more important question of knowing whether an investment made in the United States, Japan, China or France today will be repaid a decade or more from now in money of the same value – whether measured in purchasing power or in the currency originally invested. Various attempts at stabilizing international currencies against one another have followed the disappearance of the gold standard. Some nations have made their currencies equivalent to a fixed number of dollars, for example. Various European nations have created t

The great Supreme Court Justice Oliver Wendell Holmes said: “Think things, not words.” Nowhere is that more important than when discussing international trade, where there are so many misleading and emotional words used to describe and confuse things that are not difficult to understand in themselves. The terminology used to describe an export surplus as a “favorable” balance of trade goes back for centuries. As early as 1776, Adam Smith’s classic The Wealth of Nations argued that the real wealth of a nation consists of its goods and services, not its supply of gold. If the goods and services available to the American people are greater as a result of international trade, then Americans are wealthier, not poorer, regardless of whether there is a “deficit” or a “surplus” in the international balance of trade. If Americans buy more Chinese goods than the Chinese buy American goods, then China gets American dollars to cover the difference. Since China is not just going to collect thes

In a prosperous country such as the United States, a fallacy that sounds very plausible is that American goods cannot compete with goods produced by low-wage workers in poorer countries. Both history and economics refute it. High-wage countries have been exporting to low-wage countries for centuries. The key flaw in the high-wage argument is that it confuses wage rates with labor costs—and labor costs with total costs. When workers in a prosperous country receive twice the wage rate as workers in a poorer country and produce three times the output per man-hour, then it is the high-wage country that has the lower labor costs. It is cheaper to get a given amount of work done in the more prosperous country simply because it takes less labor, even though individual workers are paid more. The higher-paid workers may be more efficiently organized and managed, or have far more or better machinery to work with. A prosperous country usually has a greater abundance of capital and, because of

Sometimes a particular product requires such huge investment in machinery and in developing a skilled labor force that the resulting output can be sold at a low enough price to be competitive only when some enormous amount of output is produced, because of what economists call “economies of scale.” If General Motors produced only a hundred Chevrolets, the cost per car would be astronomical, since all the expensive machinery and all the engineering research and development that went into creating the automobile would have to be recovered from the sale of just 100 vehicles. It has been estimated that the minimum output of automobiles needed to achieve an efficient cost per car is somewhere between 200,00 to 400,000 automobiles per year. Producing in such huge quantities is not a serious problem in a country of the size and wealth of the United States. But, in a country with a much smaller population—Australia, for example—there is no way to sell enough cars within the country to be

International Trade  Before NAFTA was passed, Congressman David Bonior of Michigan warned: “If the agreement with Mexico receives congressional approval, Michigan’s auto industry will eventually vanish.” But what actually happened was that employment in the automobile industry increased by more than 100,000 jobs over the next six years. What happens when a given country, in isolation, becomes more prosperous? It tends to buy more because it has more to buy with. And what happens when it buys more? There are more jobs created making the additional goods and services that are now in greater demand. Make that two countries and the principle remains the same. There is no fixed number of jobs that the two countries must fight over. If they both become more prosperous, they are both likely to create more jobs. The only question is whether international trade tends to make both countries more prosperous. What it comes down to is the fact that the only reason international trade takes place in

One of the most important roles a bank plays is in serving as intermediaries to transfer savings from some people to others who need to borrow. Modern banks do more than simply transfer cash. It creates credits, which in effect add to the money supply through what is called “fractional” reserve banking. Goldsmith’s have for centuries had to have some safe place to store the precious metal that they used to make jewelry and other items. Once they had established a vault, or other secure storage place, other people often stored their own gold with the goldsmith, rather than take on the cost of creating their own secure storage facility. Goldsmiths gave out receipts entitling the owners to reclaim their gold whenever they wished to. Since the receipts were redeemable in gold, they were in effect, “as good as gold” and circulated as if they were money, buying goods and services as they were passed on from one person to the next. From experience, goldsmiths learned that they seldom had to r

Everyone wants money, but there have been particular times in particular countries when no one wanted money, because they considered it worthless. When you can’t buy anything with money, it becomes just useless pieces of paper or useless metal disks. Money is equivalent to wealth for an individual only because other individuals will supply him with the real goods and services that he wants in exchange for his money. But, from the standpoint of the national economy as a whole, money is not wealth. It is just a way to transfer wealth or to give people incentives to produce wealth. Whatever the money consists of, more of it in the national economy means higher prices. Many countries have preferred using gold, silver or some other material that is inherently limited in supply, as money. It is a way of depriving governments of the power to expand the money supply to inflationary levels. Gold has long been considered ideal for this purpose, since there is a limited supply of gold in the worl

During the Great Depression of the ‘30s, as many as one fourth of all workers were unemployed and American corporations as a whole operated at a loss for two years in a row. GM’s stock, which peaked at 72 3/4 in 1929, hit bottom at 7 5/8 in 1932. US Steel stock went from 261 3/4 to 21 1/4 and GE fell from 396 1/4 to 70 1/4. For the entire decade of the 30s, unemployment averaged more than 18%. It was the greatest economic catastrophe in the history the United States. The fears, policies, and institutions it generated were still evident more than half a century later. In thinking about the national economy, the most fundamental challenge is to avoid what philosophers call “the fallacy of composition” – the mistaken assumption that what applies to a part applies to the whole. What was true of the various sectors of the economy that made news in the media was not true of the economy as a whole. The fallacy of composition is not peculiar to economics. In a sports stadium, any given individ