Well, economics really begins with the concept of scarcity and choice.
We hear a lot of material, a lot of writings in the press by sociologists and bell-letterists
and other such low-types, low-type intellectuals, that we're now living in a post-scarcity age
And that maybe in the 19th century, there was such a thing as economics.
In the 19th century, there was economics, there was prices and things like that.
You had to worry about things like supply and demand.
But now in the 20th century, especially post-1970, we now live in a post-scarcity age, we don't
have to worry about such a thing as scarcity, and now there isn't any more economics.
Well, the first thing any economist is trained to think in terms of is that this is all nonsense because everything is scarce.
If it wasn't scarce, it's a very good test, I think, when something is scarce or not, when resources are scarce or not.
If it wasn't scarce, then everything would be free and not only free but immediate, instantaneous at hand.
I like to call the Garden of Eden model, the Garden of Eden model essentially that as soon as you wish for something, it's right there, as soon as you wish for the bottle of Pepsi, it's trickling down your throat with no effort or investment of resources on anybody's part.
And we obviously are not in that kind of situation. We never will be in that sort of situation.
And if we were in any way approximating that situation, we would be in a state where everything
was more or less almost free like that. I mean, catallact could be selling as a nickel,
as an approximate. And when we get to the stage when catallacts are a nickel or Pepsi
______ your wish, then we can think about revising or scrapping economic and going on to the more utopian post-scarcity future.
I used this ploy and debate, a very good debating tactic, against a post-scarcity type a couple of years ago and I said,
If you really live in a world with post-scarcity, all you people who are talking about post-scarcity will be burning your salary checks because there's no point in having a salary because everything is free, etc.
And my opponent shot back with a statement, well, since we still live in an evil capitalist world where everybody's brainwashed by capitalism, therefore they haven't gotten to the point yet where they can throw off the shackles.
Okay, resources are scarce. Resources consist of time, material objects, and all sorts of consumer capital goods, we haven't gotten to that yet.
I'm not explaining them yet, but what we have to do with these resources, we have to make
sure the resources are allocated to the most useful, most important ends rather than the
poorest ends.
And here we get to the difference between economics on the one hand and technology on
the other.
Many people don't really see the difference.
Technologically, lots of things are possible, feasible, they're not feasible at all economically.
For example, it might be, it might be, I don't know, since I'm not really technologically expert, but it might very well be technologically possible to build a tunnel from here to San Francisco.
Not only that, but a tunnel lined in platinum and precious jewels and so forth.
It might very well be possible. It will take, of course, 20 trillion dollars or something, and we wouldn't be able to eat for about five years, but we could do it.
The question then is, should we do it? What are we giving up in the process of doing this?
And so a tunnel, that sort of tunnel, might be technologically feasible, but obviously it would be economically unfeasible.
Economically unfeasible meaning that the resources, the precious, scarce land, labor, capital,
which would have to be used to build the silly tunnel, would much better be used, much more properly used, producing food, TV sets, clothing, automobiles, etc., etc., all the things that we need much more than we need the tunnel.
So, the economic problem is a problem of allocating scarce means, scarce resources to the most
important ends rather than the least important ends, and as a matter of fact, the definition
of waste, which is really an economic concept rather than a technological concept, the definition
of waste is taking scarce resources and applying them to less than the most important ends,
for example, building this tunnel.
It might be a great tunnel once it's through. It might be a feasible tunnel.
The tunnel might hold up. It might not collapse.
But, in other words, it would be technologically feasible.
But, it would be a waste of resources because almost anything else done with $2-3 trillion would be better than wasting it on this tunnel.
So, it would be economically ridiculous, even though it would be technologically feasible.
Alright, I'd like to, at this point, go into what's known in economics as Crusoe economics.
Crusoe is a, I find a very interesting figure here. First of all, students tend to get very confused at this point.
They say, why are we worrying about Robinson Crusoe? We're supposed to be worrying about the modern world.
And I try to tell them at that point that I don't really care about Robinson Crusoe or the other.
But the purpose of Crusoe economics is to isolate, it's the first to take one person, one man and pit him vis-a-vis nature, so to speak.
And isolate one man vis-a-vis nature and then see what happens, see how we can analyze his actions and then bring in other people, bring in Friday and other people, etc.
Because we find out we can grasp most of the basic economic concepts just by studying the actions of Robinson Crusoe.
Okay, let's take Crusoe on a desert island. Let's say, well, it's better if it's not a desert island. It's a pretty bountiful island.
If it's really a desert island, it'd be in pretty bad shape.
He's shipwrecked. He starts off with certain resources that have come in.
First of all, he's got his own personal energy.
Commanding this personal energy, he has his own technological knowledge built up over the course of the years.
He knows how to make a net, he knows how to make a bow and arrow and all that sort of stuff.
How to build a law cabin and so forth.
So he has technological knowledge, he knows what he, he certainly knows what ends he wants to pursue.
In fact, he has lots of ends that he has to pursue very, very quickly or else he's going to die out,
such as finding food, shelter, clothing, etc.
And then he looks around for these limited resources, his command, he tries to achieve, waste as little as possible, achieve his most important ends with the resources he's got.
He tries to achieve his most important values with as limited time and resources available.
Okay, so he's got his personal energy. What else has he got? He's got nature. He's got the island, whatever that happens to be.
So he starts off with personal energy and nature. These are the two original resources, they're called.
Energy is called, and here we have a heritage from late 18th century, early 19th century economics.
Personal energy is called labor, and this has caused a lot of confusion over the years because when we think of labor now, we think of labor in proletarian terms or Marxian terms as somebody who's employed by an employer.
This is not what labor means in economic language. Labor means anybody who's using personal energy in the process of, let's just say, production.
In the process of production, I haven't explained what production is yet.
Anyway, anybody who's using personal energy in the process of production would be a laborer.
So on that basis, on that, for example, where the president of General Motors would be a laborer, in this sense,
the stockholder, somebody who's simply flipping coupons, would not be a laborer.
So anybody who's involved directly in using personal energy is using labor.
This was the original 18th century, early 19th century definition.
And then there's nature. Nature has another term for it in economics, which again means sort of the same thing but not quite, which therefore leads to a lot of confusion.
That's called land. So the reason why it's sort of the same thing but not quite is that it's true there's land there, and there's the forest and so on, but also, for example, there's the river, which has fish in it.
Well, the river is called land in economics, in economic theory. In common sense, in English, it would not be called land, it would be called water.
So, in other words, land includes water.
On the other hand, land in economics does not include any structure, any man-made structure built on top of it.
It's the original nature given resource.
That means land would include the space underneath this building, but not the building on top of it.
That's not land.
Of course, usually we tend to think, again in the common sense in English, we tend to think of land including the buildings on top of it.
So, here's Crusoe.
He has his goals he set out for himself.
He has his values he's trying to achieve.
And he's got limited scarce resources, land and labor, which he has to apply very quickly to achieving these ends.
Now the ends that he has to achieve, he ranks on a scale of values.
He has to rank them because he's got to choose, how does he allocate his time, for example?
Does he spend the next three hours looking for berries or hunting fish or whatever?
So, you've got to decide whether, you decide how to allocate his time on the basis of the value scale.
And the value scale, it doesn't have to be very elaborate. As a matter of fact, it's something like,
an example again I use for students is, you know, a choice of how to spend a block of three hours a night.
And you have, you know, like eight choices. You actually have a lot more in New York.
You can go to half a dozen movies, a party and concert and so forth, and way down the list is reading your homework, number 20 or something.
You make up a little chart for yourself, and you pick what you think is going to be the highest in your value scale, and you allocate your three hours to that.
So, this value scale, it's amazing how much heavy weather is made out of this very simple concept of economics.
How much millions of wasted words have been spent on this topic.
At any rate, it's really a fairly simple concept, basically.
Namely, that it's a strictly ordinal scale in the first place.
In other words, you're ranking the first movie, second movie, and third movie.
You're not saying, well, I think I would prefer this movie 2.8 times more than the second movie.
That's obviously nonsense. What do you mean by 2.8? One second.
You're making strictly ordinal choices.
Rankings, first, second, and third.
Anything else is really meaningless if you prefer seeing this person 2.7 times more than seeing that person.
It's ridiculous, there's no unit that you can use for measurement.
So, Crusoe or anybody else ranks his values on this ordinal value scale.
And the scale can change over time.
It usually does, people learn more, they satisfy one want, another one pops up, and so forth.
And of course, different people have different values and different value scales.
The point that this value scale is strictly ordinal and cannot be measured is really still being thought out in economics. It's an amazing thing.
But I guess people need something to do. It's part of the activity.
Okay, so Crusoe finds that nature is bigger than we say, in other words, well, he's got that personal energy, all right, he's got the stream there and the fish, there's not too much else, so he's got to work hard to do what?
I work hard to take these natural resources, take the land, and transform it very quickly
into uses and methods and patterns by which he can start using enjoyingly the fruits.
In other words, he has to start getting, he has to construct a bow and arrow and hunt
deer or something.
I have to build a net and hunt fish, get a log, chop down, get an axe and chop down trees
and build a log cabin.
So it's only after he gets the fish and after he gets the, in other words, the fish he wants,
the fish in the cabin and the deer and the meat that he wants, the other stuff simply
means byways, paths by which he finally gets to the desired direct use, the directly useful
The final goal is consumer goods, so he eats the fish, he lives in a log cabin, he eats
the meat and so forth.
This is where he wears the clothing, these are direct consumer goods.
Everything else, everything else is a process of transformation, of getting from the original
nature or natural brook and so forth down to the consumer goods.
All these other things are called capital goods.
So now we have...all these other things are called capital goods.
So now we have a category of capital goods which are stations on the way to the consumer good.
Anything else, anything which is not either personal energy or land, original land, or
is not directly useful, which are consumer goods, all these other things are capital goods.
Capital goods are, of course, very heterogeneous, obviously, they consist of all sorts of stuff.
For example, in the case of Crusoe, there's only the axe, and there's not too many, there's
In the modern world, getting back to the modern world, there's an enormous number of capital
goods of all sorts of processes and stages of this process, this transformation process.
The transformation process is called production.
What we mean by production is the use of personal energy operating on land and transforming
Land into the process of the capital goods to finally get to the consumer goods.
Take for example early stages of production that are involved in me eating a ham sandwich tomorrow.
The enormous number of stages involving millions of people, literally, and scattered all over the world.
I can't even trace all the stuff going back.
going back, you start just with the ham, you have to then go to the wholesaler of the ham and then the jobber, then the meatpacker, and then the slaughterhouse, and then back to the pig raiser, and then back to the corn raiser who feeds the pig, so forth and so on, and the machinery that's used in all this process, plus the land that's used in all this stuff, plus the trucks that are used to transport them, the tires and the gasoline, all these things, you know, reduce all the way back.
Many, many decades, and scattered over a large area, and all these things are in the process
of production, whether it's the wholesale, whether it's the stockyards, or the trucks,
or the inventory of armor, ham, or whatever, all these things are capital, until they finally
get to the retail store, the restaurant, and you buy them.
And then, of course, you get to the bread and the whole process going up to the flour and the miller and all that stuff and back to the wheat farmer and the crushing machine and it's way, way back.
And when you get to the butter on the bread, you go through the whole process again.
And the amount of capital that is enormous, in each stage of production, land and labor
is involved in this whole process.
Okay we have Crusoe allocating his resources, I'm going back to Crusoe, he's allocating
He has, let's say, a bunch of logs. This is a famous example used by Boehm-Bawerk, an Austrian economist.
He has a bunch of logs, each of which are homogeneous. In other words, each can be just as good as, each log is just as good as every other log.
I think Boehm-Bawerk's example is of horses, which is trickier because some horses might be different,
So, here's Krusel with a certain number of forces, excuse me, a certain number of logs.
He has various uses he can apply them to.
He arranges these uses on a value scale, ordinal value scale, which can be something like this.
ranking, again, depend on his personal choices and his needs at the time, it can be something
like this, ranking number one, fire to cook tonight's food, number two, ranking number
19, second, building a fence, ranking third, keep the walls out, ranking third, extending
Ranking the log cabin, ranking fourth, storing the log for tomorrow's food, and ranking
fifth, a real luxury item, building a boardwalk down to the beach so you don't have to get
feet full of sand.
Okay, so you have, let's say, these five alternative uses for his logs, and the point is that if
If he has five laws available, he will then satisfy each one of these five uses.
He will then satisfy first, second, third, fourth and fifth use.
If he has only three available, then he's going to allocate them to the first, second
and third rank use and leave the fourth and fifth unsatisfied, because obviously he's not
going to bother building a boardwalk if he hasn't got enough food to eat at night.
So, if he loses, if he happens to have three logs available, and he loses one, one gets
washed away by the tide or something, then the value that he places on this log, the loss
of a log, how much it means to him is the ranking of a third, the third rank use, because
it's the third rank use he's giving up.
The other hand, if he has five logs, he loses one and he's losing only a fifth ranking use.
And still on the other hand, if he has only one log and that guy got squashed away and he doesn't eat tonight, he's going to feel very badly and he loses the highest ranking use.
So, from this we conclude the First Great Law of Economics, namely that.
The more he has of a product, more anybody has of a product, I should sayivid that will be any unit the lower any value be placed on any given unit of that product.
In other words, if somebody has a lot of something and loses one of it, that will not mean as
much to him, it will not be ranked as high to him as if he has only a little bit and
he loses one of it.
This is called the law of diminishing marginal utility.
The utility means the same thing as value in economics.
Again, it's a peculiar use of the term because utility usually is thought of meaning something
which is concretely useful, technologically useful. In economics, the word utility applies
to valuation, to the subjective value on the part of the CUSO or anybody else who happens
to do the valuing. So we just replace utility by value, instead of saying ordinal value
by utility, instead of saying ordinal value scale, we say ordinal utility scale. Very
The marginal refers to the individual unit. You lose one unit or you gain one unit of something, it refers to concentrating on individual units, either giving up a unit or gaining a unit.
So the rule of diminishing marginal utility means if you increase your supply of something, supply meaning N units of whatever product you've got,
If you increase your supply of something, the amount that you will value each given unit will be less.
If you decrease your supply of something, the amount you will value any given unit will be greater.
This can be obviously seen with, I'll take for example, water.
The amount of utility that you would place on any given glass of water right now is pretty low.
Hello. You can go out to the hall down here and get some water. You're not going to pay much, for example, for a glass of water.
In most cases, in New York, you can get it free, almost. On the other hand, if you're trudging down across the Sahara and your canteen is just about given out and your supply of water is almost zero, you're going to pay a heck of a lot for it.
some, you're approaching an oasis, because in New York City the amount of water is very abundant, the number of glasses of water available are very abundant, and so the value placed in any given glass is very low.
The other half here, out in the Sahara, the supply of water is very small, so the amount of value you place in any given glass is extremely high, so that's the law of diminishing marginal utility.
One might think this is fairly obvious, but as in all great truths in sciences, social or otherwise, it's only obvious after somebody has thought of it,
because centuries were spent worrying about problems that were finally solved with the law of diminishing marginal utility.
To be more specific, classical economics, which came in in the late 18th century and the early 19th,
In the mid-19th century, he was hung up on a certain basic problem. They couldn't really analyze consumption very much because they came up with a basic philosophical problem, so they said, look, here's bread, we all know bread is very important for the stack of life and all that, and yet bread is very cheap, the price of bread is very low.
The other hand here are diamonds, which everybody knows are luxury and frippery and so on, yet they're very expensive.
This was known for many years as a value paradox.
And they couldn't understand that the market can't solve it. They couldn't solve it.
They finally said, the classical economists finally said, well, the only thing we can say is that there are two kinds of value,
use of value and value in exchange and we have to say the bread is high in use
value and low in exchange value and diamonds are low in use value and high
in exchange value. It's not a very satisfactory way of handling the problem, the
obvious way, the best they could do. And then the classical economists spend very
little time on consumption, zipped over to the business men and they can analyze much
more readily because they can analyze the profit mechanism and that sort of stuff.
But there was a big whole in classical discussion. This problem of value paradox was finally solved in the early 1870s with the arrival of so-called neoclassical economics, where, as in many other cases in the history of science or invention, a given problem is solved by several people independently in different countries, in this case Carl Menger in Austria and William Jevons in England
and Leon Valra and Lausanne, Switzerland, each one came up independently with different forms, different ways of solving this question, basically coming up with a similar solution.
Namely, well, namely what they said was, on the market, people don't deal in terms of philosophical categories.
In other words, on the market, in the real world, people are not asked to choose between all the better in the world and all the diamonds in the world.
If somehow the Angel Gabriel came down to us and said, you will now be forced to choose
forever and ever between all the diamonds in the world, here and forever, and all the
bread in the world, we might very well pick all the bread in the world.
The point is we select or buy or not buy individual units, loaves of bread versus carats of diamonds,
And what must happen is that the supply of bread has been so expensive, so abundant,
that the value to any given loaf is very low.
On the other hand, the supply of diamonds is quite small, and therefore the price of
the value to any given carat of diamonds is very high.
In other words, you can't deal with consumption in broad, philosophical categories, you have to deal with them in terms of how much is this thing valued on the basis of their given supply.
Supplies are very abundant, I mean, if bread, as I say, if bread had a certain bread drought or something, if you can only get, if bread became extremely scarce,
We have to buy $1,000 a loaf of bread, we can easily get to that point sometimes.
So the point is that you always have to examine the relationship between the supply of the
thing available and the demand for it.
So that's the way in which the neoclassically autonomous solved the so-called value paradox.
And as I say, after after, it seemed self-evident, but it didn't seem self-evident before the
1870s.
It was at least a century or more of a headache before this whole question was resolved.
And this whole incidentally, the Austrian and other neoclassical, especially the Austrian
and Methods and analyzing economic problems in general was this sort of method of analyzing
individual action of how does the individual in the real world act.
And contrast the classically Thomas Smith and Ricardo, et cetera, who tend to think
in broad aggregate categories of who's getting wages, who's getting profits, and how are
these things being allocated and distributed and so forth.
and if you start with broad aggregate categories, that starts building blocks from the individual,
you get completely thrown askew, the whole analysis gets messed up and you wind up with
tremendous inherent fallacies in the argument.
In Crusoe, we have production, consumption, land, labor, capital goods, also another thing
about Crusoe is, which is true about us as well, he's a favor of achieving his wants
as quickly as possible.
He'd like to get his log cabin built today rather than next week, and the sooner as far
as he's concerned, the better.
This concept is a basic concept of human action, which is called time preference.
People are trying to achieve, if they have any goals at all, which they do,
and they try to achieve these goals now rather than later.
This is known in contrast to the motto,
we can revise the old motto and say,
a bird in the hand is always worth more than a bird in the bush,
one bird in the bush.
Also, the concept of psychic profit, Fusso is always trying to benefit from any action
that he takes, which we try to do also, at least in the psychic sense.
In other words, if he feels that he would rather rest for two hours than go and chop
about Chopped Trees.
He's doing it because he feels a need for leisure.
And so he's then saying, well, this is my most profitable
action for the next two hours, in the sense of psychic profit,
in the words, psychic gain or rising in his value scale.
If you don't reap the psychic profit from your actions,
then you'll be reaping a psychic loss.
It's something that's going back to the movie choices again.
If you choose, if you say, well, I'm going to spend the next two, three hours in movie A,
you're doing it because you think that movie A is a better movie than movie B or movie C,
or it's a better way of spending your time than some other way.
And if you go to movie A and you like it, then you say, okay, this is great,
I could reap the psychic profit from this action.
On the other hand, if the movie turns out to be a big bomb,
then you say, well, this is a terrible thing, I really took it with a waste of time,
Or, this was a psychic loss, in other words, you would rather have gone, if you look at it from hindsight, you'd rather have gone to movie B, which is the, and what then happens is you hope for the next time, the director makes another movie, you won't go and see it, so that you learn from your experience, learning on the market, the feedback relationship of the market.
So the concept of psychic profit, everybody's trying to gain a psychic profit, everybody's trying to avoid psychic losses and everything that he does.
And another thing about Rokuso and us is the concept of uncertainty. The world is always uncertain, we never can predict the future totally.
And this aspect of trying to anticipate the future, trying to predict it, trying to forecast and hoping it will succeed,
Trying to determine whether the movie is going to be any good, having a pretty good idea, hoping it would be right.
This is the entrepreneurial aspect of action, in other words, the aspect of meeting uncertainty of the future.
Okay, we have Prusso now, and he pretty well analyzes his action.
We now bring in Friday for the picture.
And either you can have a situation where CUSO is on one island and Friday is another island and one of them builds a rowboat contact with the other, or one of them is on one half of the island and the other one is on the other half and they contact each other, at any rate, you now have interpersonal contact.
And the question is what are they going to, what's going to happen now?
Basically, economically, there are two kinds of relationships that can now be hammered out, so to speak.
One is that either Crusoe or Friday can hit the other guy over the head and steal his
accumulated, his vast accumulated hoard of meat in the log cabin or whatever.
Obviously, it's not going to be very much, but he can do that.
He can knock him over the head or kill him or something.
This is the hegemonic relationship or theft.
It's not going to be too profitable, at least certainly at this stage, not going to be too
and what he's lost is the possibility of a division of labor specialization relationship.
The, fortunately, very fortunately for the human race, it turns out that the specialization
of the division of labor is extremely more productive for all people participating, fantastically
more productive than any kind of self-sufficiency, trying to produce everything in itself.
Just think of what would happen if we had to produce everything in itself.
There's a lot of people, strangely enough, sometimes I think there's, paraphrase H.L. Mencken,
nobody ever went broke underestimating the intelligence of American intellectuals,
because there's still a lot of intellectuals out there who not only say they're going to pose scares to the era,
but also say that we should go back or go on or whatever to a regime of self-sufficiency,
Specialization is evil and alienating, the division of labor also, and therefore everybody should sort of either do everything, which essentially is a Marxian solution, or either do everything and somehow rush around, well Marx put it, I think that everybody in the communist utopia of the future, everybody will spend like an hour a day at the factory and another hour a day at the field, another hour a day writing and rushing around with different, you know,
And in that way, developing themselves, all their facilities in every direction, the thing
is that sort of development in every direction is going to be pretty limited, I mean, nobody's
going to be a great mathematician, for example, by doing math for like half an hour a day
before you're rushing off to the fields, it's not the way it's done.
So creative development, intellectual development is going to be out the window, it's pretty
But aside from that, aside from the sociological aspects of it, there's the basic economic aspect, that by smashing the division of labor, you're really giving up most of the production of the human race.
The, even if it was sociologically or culturally or whatever, beneficial, philosophically beneficial,
ban on division of labor, everybody should do everything.
Most of us starting this regime would die out very, very quickly at the present time,
at the current population level.
Just think, for example, what would it mean to produce your own hi-fi set, trucks, food, clothing, et cetera, et cetera.
Obviously, you have to be reduced down to a very, very low, primitive level, but even there, we mostly die out,
because the entire productivity of the modern world industrial system rests on the division of labor.
Okay, so Crusoe on a Friday happily, hopefully will realize this and they start exchanging
and on a basis each one starts specializing either in what he can do best or and or what
happens to be the closest resource to him.
In other words, if Crusoe is part of the island, there's a lot of fish and if he's an experienced
fisherman from the old days, he gives up all this axe and log production he doesn't like
anyway, and so it's specializing in fish, and Friday might be a lumberjack back home
and he starts, you know, he looks at this kind of chopping logs, two of them then exchange
the logs for the fish. Both of them are getting more logs and more fish by far than they could
have gotten, you know, by trying to be self-sufficient. Now, if this is true for logs and fish, you
can imagine how much is true for high-five sets, etc., etc.
We also, extremely important for the development of the market, and we hear a lot about how
the market economy, the exchange economy, the rule of the jungle, where the weaker force
of the war, stuff like that.
Actually just the other one around, if we really had a situation where resources are
very scarce, there's one water hole and everybody's zeroing in on the water hole, there's no exchange
In a state of a situation where there's no market possible, that's when the law of the jungle does really apply.
But fortunately, not only does everybody participating in the market benefit everybody involved in it,
But, it turns out that even the shloppiest of us, even the least productive, can participate
in the market.
The market is arranged in such a way that even the we, even those, and take the Crusoe
Friday situation.
Supposing Crusoe is better than Friday, or Friday is better than Crusoe, both fishing
and the log cutting, so he's better on both.
And one might think, let's say Crusoe is better on Friday on both, and there's no possibility
for Friday to participate. There's no possibility for a market to be set up because Friday has
nothing to do in this situation. It's too inferior, so to speak. It's not true because
it pays for Crusoe. It's fizzing eight times as good as a log chopper and only five times
as good as a fisherman. It pays for him to concentrate on log chopping, where he's most
best at, and then buy the logs from Friday, where he's Friday being least bad at log chopping.
It takes for him to do that because his level of both incomes go up by doing that.
So, this is known, this was David Ricardo coined this concept,
the law, this is called the law of comparative advantage.
It was originally applied by Ricardo to international trade,
and it was only the Austrians later on who applied this individual exchange,
meaning that even if you're a poor country with very few resources
Pay for other nations to trade with you, because it pays for them to concentrate on what they're most best at, and buy the stuff where you're the least worst at, because they're better off, if for example the United States is six times as productive as Morocco in one area, and only twice as productive as Morocco in another area, it pays for the United States to concentrate on what it's six times as productive at, and buy the stuff from Morocco, even though it's twice as
This law of the power of advantage means that there's room for the shloppiest person or
the shloppiest nation on the free market, in other words, there's room for anybody
to participate.
It means instead of the weakest going under, the weakest have a useful role to play in
the whole process.
Process. So it's really an exhilarating and happy thought, and yet somehow it's not thought of that among the sociologists, intellectuals, etc.
Okay, we now come to, oh, and I've said the basis of this whole market setup,
and the law of comparative advantage and the whole exchange system is that the natural
variety of both individuals and resources known as the fact that every person is different
from every other person, has different abilities, tastes, intelligence, etc. and that every
land area is different, so that one land area has fish and the other land area has grow
wheat and so forth and so on.
These two things provide the conditions for this exchange system.
We now come to the more formal embodiment of these truths I've been saying here, more
than initially marginal utility, etc.
The coming to the famous demand curve, or supply and demand, is the basic concept, really,
in economics.
It used to be said in the 19th century by critics, harsh critics of economics used to
say that if you could teach a parrot economics by simply teaching it to say supply and demand,
supply and demand, and assess a certain amount of truth to that, because these are the two
basic concepts in the field.
The demand curve is how much any given individual will buy of any product at any given time
At any given range of prices, the demand curve is based on, derived from the law of diminishing
marginal utility.
In other words, you might be willing to pay, for example, I'm a chess player of a very
small ability, I might be willing to pay $30 for my first chess set, but then for buying
a second chess set, like for my den or something, a spare chess set, I might be willing to only
So, from this diminishing marginal utility, we get the truth that the man can make money
The demand curve, the demand schedule is falling, in other words, as the quantity of the good
increases and the price falls, the quantity of the purchase will increase and vice-versa.
So that if, for example, I happen to be a great chess fan, I might be willing to spend
$30 on a chess set, but when you get to the point where it's $100, I'm priced out of the market, so to speak.
The other hand, if it gets down to $5, I say I'll buy a second set.
So we get what's known as the fooling demand curve,
this is figure one.
Price is always on the y-axis, for some reason,
and quantity is on the x-axis.
So in this situation, for any given individual, the higher the price, the less he's going
to pay, the less he's going to buy of it, and the lower the price, the more he's going
to buy of it.
You have something like this.
You have a falling demand curve, or DD.
Why you might ask is the demand curve is a straight line.
That's an interesting footnote in the history of economic thought.
For a long time, they drew the demand curve, the textbook writers, as a rectangular hyperbola.
In other words, with the area underneath it always constant.
And they did this for many years, and then suddenly, by the mid-40s, one economist said,
why are they doing this? There's no evidence for it. There's no evidence at all.
Why not have a straight line? And so since then, the demand curve has always been a straight line.
There's no evidence for that either. It's easier to draw it that way.
The one thing you have to realize, I'm a fan of demand and supply curves in a sense, but the one thing I have to always be remembered about them, is we never know what they are.
The big problem with economics texts is that the economics texts say demand curve is given here, given the demand, given the cost, then you crank out the answer.
Crank out production, you can't crank out prices, that's it.
And it all seems like a very mechanical thing, it's like you're putting money in a slot and you get the answer at.
The thing is, in real life, in the real business world, we don't know the man curve. Nobody knows the man curve. Nobody knows the cost, really, either.
So the whole thing is a very uncertain kind of picture. You don't start off, hey, given the man curve, given the cost curve.
Because if that's true, you wouldn't have to, you know, all you have to do is take a course in economics. You can run the whole industry, the whole country, very, very simply.
So the problem is, you know, the economists got enamored of all the curves.
and it's got to the point now where the most people take economics courses come
away from thinking that they're sort of third-rate math courses, a lot of
tangencies and curves on the board and so forth and so on and not knowing too much
about what they mean because the ends of the means have become the ends in
themselves. Originally the curves are supposed to illustrate and clarify thought. What
We have this demand curve, the concept is that at any given time you buy so much of
this product and the price is lower, you buy a lot less, you buy a lot more.
It's pretty obvious if for some reason Wheaties became a nickel a box, there would be a lot more Wheaties purchased.
If for some reason Wheaties were up to a thousand dollars a box, very few people, except real Wheaties fanatics, would buy any.
So it's a fairly simple, again, fairly common sense kind of insight.
Alright, this is the individual demand curve.
Then what you simply do is you sum up, at least conceptually, it's not simple at all,
Conceptually, however, if you want to know, if you want to at least conceptually, how
many, how much, how many weedies will be bought at a certain, at a given price on, on the
whole market, not just for one person, but summed up over everybody, then you sum up
all these individual demand curves into one big market demand curve, which is also falling.
It's falling for two reasons, one thing is the individual demand curves are falling,
So if each individual man curve is falling, then the sum will also be falling.
And secondly, as you keep cutting the price, you tap new people come to the market at all.
In other words, I enter the chess market when it's $25, I'd say.
Other people enter the chess market when it's $10.
So as you keep lowering the price, more people enter the market altogether.
So as you do this, the market, the man curve keeps getting flatter.
So the individual demand curves are flowing and the market demand curve is flowing, and this really is the end of the individual demand curve for all purposes.
We arrive at least conceptually at the market demand curve.
Essentially, what it says is, what the market demand curve says is, at any given time, in other words, if we freeze right now, you know, as of this moment, if we freeze the country, like one of these free shots on the movies,
and if the price then were such-and-such, if the price of Wheaties were $1,000, how many Wheaties would be bought? If the price were $20, how much would be bought?
The
price of a nickel, how much will be bought?
And how do you're following the man curve?
Obviously you don't know what the man curve is,
you don't know how much will be bought, all you know is that it's falling. All you know, all we really know is, theoretically,
is that the more will be purchased when weedies are a nickel,
than if weedies were a thousand dollars a box.
And a lot of attempts of course to measure the man curves,
they're all on nonsense and I don't want to
take up the time in this course to explain why they're not assessed, but one of the basic rules of economic theory is that all the laws we have, all the truths we have are qualitative rather than quantitative.
As soon as anybody tells you about quantitative laws, watch out, because there aren't any.
Okay, we have the market demand curve, and then at any given time we have a certain amount of, whatever it is available, a certain amount of supply.
Supply meaning a number of, n number of homogeneous units, whether it's 1 unit, 20 units, 100, 2 million, or whatever.
Now this, since it's at any given time, since we're freezing the economy at this moment, that means the supply line is always vertical, like so, S being vertical.
Now, this of course goes against those of you who have taken economics courses before.
Of course, you all know that supply curves are supposed to be forward-sloping.
But they're really not. They're really vertical.
Because what this is saying is that what you have is you have a bunch of stuff which is there.
How it came there, we're not talking about yet.
That's of course important, but not at this moment.
We have a bunch of stuff, whether it's Wheaties, Hula Hoops, Copper, Spoons, it doesn't matter.
We have a bunch of units of things available.
And then we have people, the whole market, consumers in the market, evaluating them.
And the evaluations would be based on their value scales,
whether it's high on their value scale or low on their value scale.
And the land curve based on these value scales is falling, like so.
The vertical supply line would be vertical because that's what you've got.
You've got, regardless of what the price is, you have 100,000 boxes of Wheaties,
and you can't do much about it, at least for this moment.
Obviously, in the long run, you can change the supply.
But right now, you have so-and-so many spoons, so-and-so many Wheaties, so-and-so many hula hoops, and that's it.
So you have your vertical supply line, and you're flowing the man curve.
Now what this gives you, the interaction of these two, is the intersection point between
the falling demand curve and the vertical supply line, this point here, it's like the equilibrium
point, is the so-called day-to-day or market equilibrium price, and the reason it's called
The price of the equilibrium price is because this is the price at which the price of this product will tend to move and at which it will tend to stay.
If it's displaced from it, it will tend to remain there, roll back to it.
In other words, the intersection of the demand curve and supply curve will tend to determine the price of the product.
So, you want to know what the price of Wheaties is.
The price of Wheaties will be determined by the demand curve for Wheaties and supply line of Wheaties.
the intersection point will be the, when I say 10, I mean, you know, day to day, I mean, very quickly.
Okay, why is that? Why, what are the forces that cause this to be the price-determining factor?
The, okay, let's assume for a minute that the price of this product is higher than the equilibrium, so-called equilibrium price.
The word equilibrium, of course, comes from physics and so forth, meaning that tending to remain in this spot or coming back to it.
That's an attempt, again, of economics to ape so-called hard sciences.
Supposing the price is higher than the equilibrium price.
The price is higher, this means that this is $10 a case, whatever it is, widgets or readies, whatever.
Right now, it's really about the $18 a piece. At that point, supply, the amount offered for sale, by the widgets of Wheaties, is considerably greater than the amount that consumers would buy, the demand for it, quantity of demand.
What you have is this gap here, a surplus. People are trying to sell 100,000 boxes of Wheaties. However, at this high price, consumers can only buy 80,000 boxes. There's 20,000 left over, something which businessmen and sellers don't like. This is what is known as an unsold surplus. You can't get rid of it.
How do you get rid of your unsold surplus? Well, you start lowering your price. As you lower your price, businessmen begin to find magic, the surplus begins to disappear.
As the price is lowered, more and more quantities are purchased, until finally the price is lowered down to the equilibrium point where all the unsold surplus is gone and the market is what is known as cleared.
In other words, the quantity demanded is equal to the quantity supplied at that price.
Up here, at the price above the equilibrium point, the quantity supplied is greater than the quantity demanded and has trouble.
It has an unsold surplus.
There.
Supposing, on the other hand, that the price is below the equilibrium price.
Say, down here.
Well, in this case, Wheaties are 25 cents a box. At that point, well, the five cents a box only have, whatever it was, 100,000 boxes of Wheaties supplies.
People are trying to buy 180,000 boxes. Where's the Wheaties?
What happens is there's a big run on the Wheaties business, and there's a big what-developed shortage. Big shortage develops. You can't find it in the stores anymore.
If, for example, the government decreed tomorrow that Wheaties from now on can be sold in only $0.02 a box,
you can take my word for it, but Wheaties would disappear from the shelves very, very quickly.
Everybody and his brother would rush to get this bargain price for Wheaties.
Wheaties would be cleaning out at the end of it, because nobody is right and want to be producing Wheaties for $0.02 a box.
The shortage develops.
So there's been a response to this shortage, the fact that there's more demand and supply of that price without raising the price, and as they raise the price they find that the gap is eliminated and finally you get to the equilibrium price, again the market is clear, there's neither an unsold surplus nor a shortage, so here above, and any price above the equilibrium price, supply is greater than demand, any price below it, demand is greater than supply,
And at the equilibrium price you have the market being cleared where there's an exact balance between demand and supply.
That means that the equilibrium price, whatever, there's enough people to buy, just enough people to buy whatever is available of a product,
and just enough at that price available for whatever people want to buy.
So the market then has a beautiful built-in mechanism, so to speak, of balancing the amount available with the amount that people want to buy on the product.
And we will soon see what happens when the certain forces, largely the government, try to interfere with this process.
Yeah, this is an equilibrating, beautifully equilibrating mechanism.
So, this is the price determining method on the market.
No, well, alright, if this is true, and I think it's unexceptionable,
then how can a price ever change?
We have a price pretty well set here,
fixed by the net supply of a vertical supply line and the flowing demand curve.
In that case, what would cause a price to change?
Well, obviously either one of two things, or both.
Either the demand changes or the supply changes.
And then if we analyze any price,
or any price changes in the field,
we start looking for these two factors. What happened to the demand for it? What happened to the supply of it?
So, well, the man can change for various reasons. The man can change, for example, through fashion, the king, let's say, or the queen comes out with a, you know, I like a certain brand of martini.
Immediately half the country rushes to buy random martini as a price, the man skyrockets for that brand of whiskey, or vice versa, Jackie O'Nassos decrees something or other, seen wearing some kind of thing and everybody starts buying that, or vice versa, the thing drops out of fashion for one reason or another, so man change can change and does change for that race, people, the hula hoop for example had a big
The first big play a few years ago, there was a big increase in demand for hula hoops, then there was a big collapse after about a year or year and a half of hula hoop mania and then the frisbee came in after that, so there was a shift from the hula hoop market to the frisbee market.
The demand curve for hula hoops went up and the demand curve for frisbees, I mean hula hoops went down and the demand curve for frisbees went up.
That's one thing that can change it.
Of course, the supply can change.
Why will the supply change?
Well, the supply can change again for various reasons,
one of which can be in response to demand,
we'll see later.
But one reason, of course,
is purely technological.
In agriculture, for example,
if there's a big drought,
the supply goes down.
For example, in this figure one, the weak drought, half the middle west has too much rain or too little rain or whatever it is, there's a big drop in wheat supply coming in this season.
In that case, the supply curve shifts to the left. The vertical supply line, which this year was X million bushels a week, is now X minus whatever.
So this means that the old price, the old equilibrium price, which before this cleared the market, now doesn't perform this, because now it turns out that the old price is now a big shortage,
and of course, because not enough wheat now to satisfy the demand at that particular price.
So the result of that is, because of the shortage, the price quickly goes up, and as it goes up, the shortage is eliminated,
and we wind up with this new intersection point, or a new equilibrium point, which again clears the market.
It clears the market at a higher price, of course, in order to, again, see to it that there's just enough people to buy
The lower amount of weakness available.
So we now have a lower quantity for a higher price
at the new supply line of, say, S prime.
You can see that one of the functions
that the price system performs is a rationing function.
The fact that if the price of everything was free, everybody would
grab it unlimitedly, infinitely.
Since we don't have an infinite supply of anything, there has to be a price.
The more scarce the product or the more scarce the commodity, the higher the price tends to be.
And these people now get the price out of the market.
These people will have to drop out of the market because of the higher price of the so-called marginal buyers.
And so as the price goes up, the price system performs a very important rationing function.
The only other way of performing a rationing function would be for the government or somebody to choose who would get the product and who wouldn't, which for us leaves us up with many different kinds of problems, at least.
If, on the other hand, the supply goes up, it goes from S' to S, for example, and instead of a weak drought, there's a big increase in wheat production, the climate is very good this season, or there's a much better fertilizer use, or whatever, then the supply curve shifts from S' to S, shifts to the right, and it means that the old price is now a surplus, an unsold surplus, people don't want to buy this new increased product
And so, the price falls and we're back down again to a lower price in order to induce people to buy the increased amount.
So, we have supply curves or supply lines moving up and down given demand curves.
Given the demand curve, given the tastes and wants for a particular product by the public, supply line will move up and down.
In other words, as the supply falls, the price goes up, and as the supply rises, the price goes down.
The price will go down in order to induce people to buy the increased product.
Here we have, of course, one point, which is always a problem with the economic teachers and students.
The difference between the, when the supply goes up and the quantity demanded increases from here to here,
the difference between that and changing the whole demand curve,
and that was the whole demand curve increasing because hula hoops are more fashionable now than they're supposed to be,
the whole demand curve increases that, it means that at any given price more will be purchased than before,
And it's a completely different concept, of course, than going up and down the given demand curve.
Usually in economics, there's a shorthand, if you say.
There's an increase in demand. What's meant is the whole demand curve shifts up.
In other words, at any given price, more will be purchased.
Already, I think we're beginning to see something.
We should be able to see something at this point.
We're not going to get to the money question until much later in this course, but already we should begin to see what can cause all prices to go up.
I mean, we're in a point now, of course, of accelerating inflation.
What can cause a situation where almost every price is going up, some, of course, more than others?
Either because of the supply, everything is rapidly going down, which is obviously not true.
The supply of goods is more or less about what it is now.
is increasing each year, certainly not going down every year,
or because of the demand for everything is going up.
Because the demand for everything is going up,
and we're talking in terms of consumers of a certain given income,
consumers can shift their purchases, say, from Hoogahoops to Frisbees,
in which case the demand for Hoogahoops goes down and the demand for Frisbees goes up.
How can the demand for both Hoogahoops and Frisbees go up?
Where are they getting the money from?
How can, with the consumer getting a certain income, how can a man for everything go up?
Where's the magic source from which the money is flowing?
So they can increase all their man curves.
And this, of course, is the $64 or $54,000 question.
The skip ahead of that is a teaser.
The man curves can only all go up if somewhere now in the basement somebody's printing a lot of money,
and shoveling them out onto the public, so everybody thinks they're better off in spending, happily spending this new money which is going to cause the prices to go up.
That's, of course, just a teaser for later.
That's our first lecture.