Video from the Mises Institute, Peter G. Klein explains how scarcity, opportunity costs and trade-offs are critic elements in decision making in the free market.
The fallacy that economic decisions only affect one group of people and one point in time, in the short-run is a dangerous idea to embrace, and has been the backdrop of much of the economic failures and destruction for decades. This 7-minute audio version of Chapter 1 of Hazlitt’s classic addresses this fallacy and other “tactics” of “bad” economists.
A Lesson in Economic Analysis from the Minimum Wage DebateBy Ken Zahringer
Supporters of government interventions like minimum wages often pretend the economy is far less complex than it really is, and then conjure up a statistic as evidence of success. Careful analysis reveals another story, however.
Read more here:: Mises Blog
Taxes are a necessary thing in the existence of a society that strives to be a community of individuals, working towards the common goal of an increased standard of living, through an increase in economic production. In this effort to increase the standard of living, there are some things that are the responsibility of the collective and not of individuals. These responsibilities include things like the paving of roads, providing the security achieved by employing a police staff or a military, and other goods and services that benefit the community as a whole.
Now, I have heard wild accusations against those conservative economists that believe in limited government stating that these people don’t believe in government at all or think that there should be no taxes levied at all. These ignorant claims come from those who have a political edge to gain. All economists, even those from the conservative/Austrian school of thought, believe some form of taxation is necessary, for the same reasons I have previously stated. The push-back on taxation focuses on the over-taxation of income for programs and projects that not only are unnecessary, but also are contrary to the outcomes that these projects and programs claim to support. While this article is not intended to be political in any way, I wanted to get this out of the way, lest someone claim that I am anti-taxation. Some taxes are necessary, but most are not.
In this 3-part article, I will focus on three things that are affected negatively by taxation. The first one is wealth, and the fact that it is destroyed by taxation.
Wealth Destroyed by Taxation
When taxes are collected from people who have the means to pay it, obviously they have less money to their name after paying these taxes. In other words, their overall wealth has decreased. Wealth is somewhat of a subjective word and can be used to describe different levels of economic success by different people. Nonetheless, whether we are talking about a person that has a modest savings or a person that is a multi-millionaire, each person enjoys a certain kind of “wealth”. If we take the strict definition as a “measure of the value of all of the assets of worth owned by a person, community, company or country” (source: Investopedia) then we see how this word can be subjective. And when any taxation destroys some level of wealth, over-taxation destroys more of wealth. It destroys wealth that is rightfully earned by an individual. It destroys wealth that in many cases creates jobs, gets spent in the economy, but otherwise is taken and used many times inefficiently by government entities that have no incentive to use the money wisely.
Wealth is what people have left over after the spend all of their resources to live their lives. What people do and don’t do with that wealth can have a huge impact on the economy. An individual will most likely use their wealth to buy things, which is a benefit. Entrepreneurs will most likely spend money and may even provide wages to someone in order to help their business become or stay successful. Companies will likely expand their business in the form off capital expenditures, essentially spending money to increase the efficiency and value of their resources (machines, employees, etc). Entrepreneurs and companies (and individuals at times) are all performing these activities in order to build more wealth. And when taxes are collected from these people, inherent in that is the reduction of wealth from those who rightfully earned that wealth. The over-taxation of wealth is both destructive and burdensome.
In the next part, we will look at the burden of income tax on individuals and business.
Profit is simply what is left over from the sale of a product after all of the expenses necessary to create it have been paid. It is an essential aspect of business in the capitalist, free market economic system and is the measure of success and failure of a business. With profit, businesses can continue to exist and grow, but without it, they simply cannot exist.
While profit determines the success and viability of a business, it is also the only means for jobs to be created. Employment is dependent on businesses being successful and thus, profitable, allowing the business to employ workers in its pursuit to become more profitable. In this sense, both the business owner and the employees of a business have the same incentive. The business owner’s incentive for the business to make a profit is that the business is at least sustained, allowing him more income to either grow the business, save or pay himself back for a job well done. The employee’s incentive for the business to make a profit is that the business is at least sustained, allowing him to continue to be employed. Employment happens in stages in the genesis of a business. In a sole proprietor business, the one business owner develops his business into one that turns a profit. He is the one employee of the business. As the business becomes more profitable and eventually grows (more customers), the nature of business requires more responsibility, which creates more work to be accomplished. As growth continues, the work required will become so much that the one employee (the business owner) cannot do it by himself and will eventually have to hire someone else to help him. Employment is created by successful businesses, which are only made successful because of profit.
Profit is the great equalizer in business because it dictates the winners and losers. The winners in business (the ones that are profitable) are the businesses that have found a way to produce a product efficiently enough to minimize expenses and maximize income (revenue). The losers in business (the ones that failed to become profitable) are the businesses that were unable to find a way to minimize expenses and maximize revenue. No matter how good or beneficial the product is, if it can’t be manufactured in a way that produces a profit, it will not continue to be made. The presence of profit indicates that there is some efficiency in production but it doesn’t necessarily mean it is the most efficient. That is the ever present quest of a business, to become as efficient as possible in order to maximize profits. When profits decrease or even disappear (expenses exceed revenue), then there are present some inefficiencies in production that need to be addressed. The winners address these inefficiencies effectively and the losers do not. When governments intervene in this process and “bail out” certain businesses (or even whole industries), they disincentive the business efficiency and delay the necessary changes needed for them to improve their efficiency, at the expense of the businesses that have been successful in being efficient.
Entrepreneurs (business owners) that start businesses do so at a huge risk. They risk their own money (and sometime other’s) in order to venture into a business with the hopes of being successful, but there are never any guarantees for success. Many times, for one reason or another, these ventures end up losing money and fail. Their reward for not operating efficiently enough to be profitable is the termination of the business. This is the negative side of business risk. For the successful business ventures, the reward for risking their own money is the profit that is generated from the business. For all of the work that goes into making a successful business, the reward is great. And the incentive of this reward of profit makes the business owner want to continue to sustain his business.
Economics is life.
The Wikipedia entry for “competition” reads as follows. “In economics, competition is the rivalry among sellers trying to achieve such goals as increasing profits, market share, and sales volume by varying the elements of the marketing mix: price, product, distribution, and promotion.” Let’s discuss.
The primary goal in any business is the same, no matter what level of competition that exists. A business operates with the primary goal of making a profit. Some business owners may say that they started their business for a number of reasons, but their goal is to turn a profit. Profit is what is left over after the business sells a product and then pays all of the expenses that were necessary to create the product. If a business cannot make a profit, then there is no reason for the business to exist. Not only is there no reason for it to exist, it will eventually naturally not exist because it cannot continue to operate when expenses exceed income. Competitive industries exist when companies in those industries are trying to make the most profit as possible, in order to continue the business and grow.
The goal of market share is one that stems from the existence of multiple businesses in the same industry, competing for the same customers (market). The portion of the customers that buy products from a particular business is that business’ market share. Market share is important because it dictates the business’ ability to impact prices in their favor. The bigger companies (ones with more market share) influence price with their ability to manufacture more efficiently and other reasons like brand name recognition. You can see why companies in the same industry are competing to gain more and more market share, giving them the ability to have more influence on price.
Sales volume is another important factor because it is generally that way companies grow. Every business wants to attract more customers than they already have to buy their products. The more sales (revenue) the more profit the business gets to keep, assuming everything else is equal. Meaning, if you sold a product for $100 and it costs you $60 to make it, you keep $40 worth of profit. Well, for each product you sell, your total profit is the number of products you sell times $40. And as the sales volume increases, the more $40 worth of profit per product sold you can keep. However, with most industries, the more sales you can achieve (the more sales volume increases) that $40 profit actually goes up, due to a phenomenon called “economies of scale”. As production volume increases, it actually gets cheaper to make, and the profit you make becomes larger.
Economics is Life.
An important factor in the study of economics is incentive. Incentive is defined as a thing that motivates an someone to perform an specific action. Obviously, there are different types or categories of incentives. Social or moral incentives are built on a persons character, where the motivation is the desire to do what is deemed to be the right thing to do. In economics, incentives are technically referred to as remunerative incentives, where the motivation is for some material benefit, usually money. Some economic incentives include profit, reduced prices, and wages.
An employee’s incentive to work is generally the expectation of a wage or salary. His incentive to work harder at his job or to take on extra responsibility is the expectation of a raise, or some other extra material benefit (perhaps even keeping his job altogether). He wouldn’t accept the proposition of the extra work without the expectation of a extra future benefit. And the employer knows that, also. The incentive for him to even sacrifice other leisure activities to further his education is the expectation of even more future material benefit, usually in the form of money, but maybe in the form of job security or leverage to find another job, if he is let go of his current job. With any economic incentive, there is an expectation of a future benefit (usually material) to the one the incentive applies to. The incentive of a sole business owner to hire a person to manage the finances of the business is the expectation that it will free up some of his time to expand his business or to focus on the current customers to maintain his clients. The incentive of a business owner to hire 40 full-time workers is expectation of the profit that those 40 workers will earn for the business, in one capacity or the other.
Incentive is one of the backbones of free market economics, as opposed to a socialist economic model where incentive is reduced or eliminated and the spiral of inefficiencies and waste rule the day.
Economics is life.
One of the most fundamental axioms to understand about economics is that resources are scarce. This means that there is no infinite abundance of resources in any market. There is only a limited amount (no matter how large that amount is) of any resource used to manufacture all goods and provide all services. There is nothing that is infinitely available and ready for our disposal. This truth explains why people have to make economic decisions and make other arrangements in response to the scarcity of these resources. In addition to resources being scarce, they also have alternative uses, which adds to the need to make wise economic decisions, lest there be waste. These ideas of scarcity and alternative usage is why the great economist Thomas Sowell himself defines economics as the study of scarce resources, which have alternative uses.
When I talk about scarcity, it is in the attempt to explain that of all the abundant raw materials, manufactured products or natural resources that are available on a world-wide scale, there is still some finite amount that can be used up until there is no more. This is scarcity on a macro level (globally). To further the point, if scarcity exists on a macro level, then it obviously exists on a micro level (locally). Because there is only a limited amount of all resources, human beings are forced into making wise economic decisions, both in manufacturing (on the supply side) and in consumption (on the demand side).
Take another example. Let’s say there is a small town and in that small town there is a small forest of trees that is currently not in use, other than to be enjoyed by the community in the form of camping and other recreational uses. The mayor of that small town understands that these are the only trees that the town “owns” and that they need to be very prudent about how they “use” these trees. You can start to see how scarcity is already a factor to be reckoned with. The mayor and most of the citizens of that town know that these trees are important, even if nothing is done with them at all. They are already being used and the economic decision may very well be just to keep using them as they are currently being used.
Along comes a man who proposed that the town use some of the trees that it already owns to construct a pavilion to enhance the recreational enjoyment of the forest area. Now, the mayor is presented with another economic decision that he and the citizens will need make prudently, because there is trade-off to be considered in this situation. If the trees are used for the pavilion project, then there are less trees available for the original recreational purpose. And it is because of the fact that the trees are not infinitely available for their disposal that this decision is necessary. The trees are scarce, in the sense that if they keep continuing to use them up, there will no longer be any trees at all for their use (short of planting new trees for use decades later).
As you can image, there are a number of decisions that can be made here by the mayor and the citizens. They may decide to do nothing at all, because they enjoy the trees more than they would enjoy the pavilion without the missing trees, knowing that they do not have an infinite amount of trees at their disposal and preserving the trees seem more important to them. Another economic decision that they can make is to go forward with the construction, because the added recreational opportunity of the pavilion is enough to make up for the missing trees, understanding the idea of scarcity. And maybe another decision that they can make is to keep the trees that they have and build the pavilion anyways. This economic decision would require buying wood from other sources (another town, perhaps) and using funds that they would otherwise be used for other purposes.
No matter the decision, each one involves factoring in the fact that the resources in question are not infinite and therefore, requires wisdom to avoid waste. After all, if the town had an infinite number of trees at its disposal, then each decision could be made strictly on the basis of preference. This is hardly, if never the case because of the idea of scarcity.
Free markets are somewhat of an enigma to some people and are even looked at by others as a threat to our current society. Some people have the idea that free markets are markets where companies can go un-checked and are free to take advantage of consumers for their own benefit. This view is one that assumes that companies are the ones “holding all the cards” in these markets. However, that is not the case at all. In fact, it is just the opposite. Additionally and contrary to the idea that free markets are a threat, they are what affords our society the high standard of living that we currently enjoy. It is also free markets that are responsible for the innovation that we continually see and for all of the advancements in technology, medicine, and every other industry that we could think of. Let’s look at a few of the benefits of the free market.
Demand Drives Supply
In a free market scenario, supply and demand forces dictate economic results. More specifically, it is demand (the consumers) that really dictates economic results, because demand is what drives supply. And manufacturers (supply) will “react to the market” in the form of responding to demand and manufacture the demanded products. Companies will only manufacture goods that consumers want and are able to buy, as long as it is economically viable (meaning, they can make a profit that will allow them to continue manufacturing the wanted good). They will not manufacture a good that customers do not want and are unwilling to buy.
In a free market, competition exists (naturally) also as a way to benefit the consumer in terms of quality of goods. Because consumers (demand) are the driving force in the free market, and manufacturers are competing with others for the same consumers, manufacturers have an incentive to use technology in a way that continually enhances existing products. They are always in the business of making their product more attractive to the consumer to purchase. We see that in
The competition that is naturally generated in the free market between manufacturers in the same industry also leads to better products for the consumer. The same reason that manufacturers have an incentive to work efficiently and prices their products at competitive prices is the same reason why they have the incentive to innovate their products, or create other products that are better.
In a market that is not purely free, there is always the danger of product shortages or even the need for rationing, especially in regard to essential products. For example, in times of fuel shortages, you will inevitably see consumers “stocking up” on gasoline, topping off their tanks in order to prevent the situation where the next time they need gas, they will be unable to find any (because everyone else it topping off and stocking up). Many states have laws which prevent businesses to increase their prices at a level politicians feel would be “unfairly” charge consumers in an emergency situation (price gouging). The fact of the matter is that if the free market were to be allowed to dictate the price, the law of supply and demand would take over and would allow for a more tapered shortage, and more availability to more consumers.
I will discuss more benefits of the free markets in future articles.
Please comment and discuss.