Economic Principles

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The Scope of Economics

Economics is a subset of the science of Human Action. Human Action is the science of purposeful human behavior.

It is divided into two branches: Praxeology and History

Praxeology

Praxeology's main tenet is: At any time, in acting, humans choose in a purposeful manner between options at their disposal in order to remove felt uneasiness. Each human being decides for himself what he considers a removal of uneasiness (, meaning value judgments as to what ends to attain cannot be contested via scientific analysis). The only judgments that Praxeology can render is whether or not a chosen option will attain the end sought and whether or not it will lead to a state that is even less desirable than the current one from the point of view of the acting man or men.

Praxeology does not examine how an idea to perform an action came into existence. It takes the action and its consequences as such. The science that deals with the emergence of ideas in the human mind is Psychology. Praxeology starts where Psychology ends.

Economics, as a subset of Praxeology analyzes those actions that are triggered by and that lead to changes in money prices of products, factors of production, and services. All actions analyzed within the scope of Economics can also be explained on a higher level by Praxeology. However, there are actions that Praxeology can explain but that Economics is not concerned with. Hence, Economics is a subset of Praxeology.

Other branches of Praxeology, viz those actions and ends sought that are not connected with monetary values, are not very well developed yet and leave a lot of room for research and literature.

History

History is the science that deals with purposeful human actions as they occurred in the past. It uses all records and information at its disposal in order to reconstruct actual datums. However, it also needs to resort to a measure that is unusual in science: Understanding (in German: Das Verstehen der Geisteswissenschaften). It needs to attach meaning to the actions performed. It needs to speculate what goals the actors in question were trying to attain and interpret actions and consequences based upon concepts rendered by Praxeology.

If it weren't for the tool of Understanding, historical events would be nothing but a meaningless juxtaposition of events involving human beings. It would not be substantianlly differnent from physics or mechanics where the behavior of atoms and elements and their impact on one another is observed, noted down, and used in order to determine causal relations and constant factors.

There is no such thing as constant factors in Praxeology and History. There are causal relations, but the extent to which one action precipitates a certain effect cannot be determined apriori.

People often make the mistake of trying to come up with general economic laws based on historical events. This is a serious blunder. Economic laws can only be conceived by the means of clear ratiocination, logic and reasoning and have to be refuted in the same manner.


Economic Concepts and Terms

Value

Each man juxtaposes all products and services available and decides which ones are more and which ones are less valueable to him, meaning which ones he feels remove more and which ones he feels remove less felt uneasiness, or, to put it different, which ones make him more or less happy. He places them, as it were, on a relative ordinary scale. Values are always relative and always spring out of the human mind.

Exchange

Voluntary exchange is a purposeful action. People exchange things when they feel that what they receive removes more uneasiness than what they set aside. An exchange between two people can only occur if each party deems the thing that the other party will provide more valuable than what he will give away. Economics in particular examines those exchanges that can be expressed in monetary terms.

Division of Labour

Humans have evolved from a system of autarky to a system of division of labour. Where in the past they used to homestead, till the soil, feed the cattle, harvest the crops and prepare their own food, they have started producing goods for other people and obtain other goods in exchange. This is a direct outcome of the concept of value preferences and judgments. If what people can obtain in exchange is to them worth more than what they produce for themselves they will enter into an exchange. The system of division of labour makes people specialize in certain fields and by that increases their labour's value to others who in return specialize in other fields. This system is hardly opposed by anyone. Its merits to society have been so obvious that it can hardly be imagined to ever be abolished. Even the socialist theory has adapted the concept of the division of labour as a necessity for a societal organization that provides what people need.

Money

The term money is tantamount to the term medium of exchange. A medium of exchange is a thing that people posess in order to exchange it for another product at a later point in time. More on money in the article History of Money.

Prices

A price occurs during an exchange. It is the direct outcome of the acting individuals' value preferences. It expresses how much of one thing a person is asking for in order to set aside another, eg. a seller of bread sells one loaf of bread for 5 tomatoes. In this transaction the price of the loaf of bread in terms of tomatoes would be 5 tomatoes. The price for a tomato would be 1/5 loaf of bread. As the division of labour intensifies and people begin accepting one common medium of exchange, one money, all prices are implicitly expressed in terms of money. They can only be made public and function in a society where people can exchange products and services based upon their own value judgments. They are the focal indicator of human value judgments and preferences in society.

Marginal Utility

The formation of prices on the open market does not occur at once and it never rests lastingly. The price a man is willing to accept for something, eg. a loaf of bread, is initially infinite. He then notices that he has to lower the price in order to find an exchange partner whose value judgments are being expressed by it. In doing so he may at one point arrive at, say, 10 tomatoes for one loaf of bread. He might want to sell more than 1 loaf of bread in order to obtain more tomatoes. He will then have to lower the price again in order to find the next highest bidder and so on. He will keep doing this until the additional number of tomatoes he could obtain from selling one additional loaf of bread (his marginal utility) does not suffice and does not represent his value preferences.

Inflation

Inflation is an increase in money prices of products that is due to an increase in the supply of money. It can be explained by consistently applying the theory of price formation to money. Producers of money have to lower the price for money expressed in other goods if they wish to sell additional quantities of their money.

Economic Goods

Because economics is only concerned with goods that have prices, it deals with scarce goods. The land that nature has bestowed upon us and the labour available are not infinite. All land, land transformed into factors of production, labour, and ultimately consumption goods are by necessity limited in number. It is the our task to find out which system of societal organization ensures the largest number of people are supplied with the largest number of demanded goods possible, always under the constraint that land, labour and factors of production are limited.

Interest

The true source of the formation of interest rates is the fact that all men, everything else being equal, prefer a product now to a product received in the future. Where prices establish an indication of value preferences at any point in time, the originary interest establishes an indication of time preferences. When a man enters into a contract where he provides 10 tomatoes now for 12 tomatoes in exchange in one year, the annual interest rate would be 20%. In a money economy, where one common medium of exchange has been accepted by everyone, interest rates are the subject of monetary loan contracts, viz the provision of money now in exchange for money in the future.

What has been said about the formation of prices applies accordingly to the originary interest. It emerges based on considerations of the marginal utility for each additional loan contract. It emerges in a different way for different contract durations. Thus we have different originary interest rates for durations of 3 months, 1 year, 3 years, etc.

In addition to the originary interest based on time preferences comes a risk premium. The person providing money now adds an amount to the money paid back that makes up for the fact that there is a certain risk that the money may never be paid back.

Thus the final rate of interest for each loan contract is determined by a) the originary interest based on the individuals' time preferences and b) the risk premium.

Consumption Goods

Consumption goods, or goods of the first order, are products or services that are used for the immediate satisfaction of wants. They are not transformed any further and are not used for anything else other than consumption. Their prices are established on the market based upon individuals' value judgments and preferences, as explained above. Example: Milk, Bread, Paintings.

Factors of Production

Factors of production, or goods of the higher order, are products or services that do not immediately fulfill any needs or wants. They are transformed or used up in order to turn out consumption goods in the future. They will only be demanded if the future produce they can turn out makes up for the foregoing of immediate consumption in their place, based on individual time preferences. Their prices are determined based on the prices of the future consumption goods that they are expected to turn out. Example: Labour, machinery, cattle, shares in a company.

Capital

The value of factors of production can be expressed in monetary terms. The monetary expression of the value factors of production is called capital. The total amount of capital available in a society represents the total value of factors of production available. Captial can only be formed by savings, meaning the foregoing of immediate consumption. Everyone who works and does not consume the full produce of his laobour adds to the capital stock available. He provides more than he withdraws from society. The total savings surplus in a society is necessarily used for additional factors of production as there is no equivalent consumption that uses up the surplus products or services.

Economic Roles

Economic roles describe modes of acting in society. They are abstract concepts to explain individuals based on their actions. In reality, they do not have to be separated from person to person. One person can embody several or all of these economic roles at once:

Entrepreneur

The entrepreneur realizes that a certain demand for a certain product or service exists in society. He estimates the prices that consumers would be willing to pay for this product or service based on their value preferences. He also estimates the number of people who would be willing to purchase the product or service. He then goes on the open market and tries to find out if factors of production are available that currently fulfill less urgent needs or satisfy fewer people than he expects to satisfy, meaning they cost less than he expects to earn from putting them into use. He then borrows the factors of production or funds to acquire them from the capitalists, combines them and turns out the products and services that he expects a demand for. If he was right, and his project improves the well being of more people than before or satisfies more urgent needs for the same number of people, he earns a profit, the entrepreneurial profit. He returns the factors of production to the capitalists that he has borrowed them from. This whole process can go on over a very long period and can be performed repetitively. All actions that the entrepreneur performs are geard towards this profit. It is his objective to maximize it at any point in time. All the decisions he makes in arranging factors of production, employing people, appointing managers are nothing but a means to maximize his profit. The entrepreneurial profit is the remuneration for an improvement in the standard of living in society. If the entrepreneur fails to make a profit, it means that he has withdrawn factors of production from lines of production where they would have fulfilled more urgent needs or satisfied more people. He is punished for this action by suffering a loss. If he consistently fails to make a profit he will have to give up his activity as entrepreneur and enter kinds of work where he is of better use to society.

Capitalist

The capitalist owns capital. He has acquired it by foregoing immediate consumption: savings. The capital he owns represents factors of production. He appraises these factors of production based upon the expected prices of the goods that they can turn out. He makes them available to the hightst bidding entrepreneurs when demanded.

Labourer

The labourer sells the service of performing work and in return receives a guaranteed payment from the entrepreneur. Different kinds of labour are of different use for different projects. Like for all other factors of production the entrepreneur has to offer his labourers a price that is derived from the price that consumers will be willing to pay for products turned out. If the labourer is remunerated higher in his current job he will decline. The more labourers for the same kind of work the entrepreneur wants to withdraw from the market, the higher a price he will have to pay per additional labour contract.

Consumer

The consumer purchases the consumption products sold by the entrepreneur. He is free to arrange his value preferences at his whim. All economic activity starts with the consumer who demands consumption goods. All prices for consumption goods and factors of production are ultimately the outcome of the value judgments of consumers. As has been said above, in the real world multiple roles can be embodied by one person. It is a known fact that virtually everyone in a free society is a consumer.

Equilibrium

Equilibrium is a theoretical construct. It is the state where no further changes can occur. It is the state where every single person is completely satisfied with what he has and does and does not desire anything in addition to that. Under equilibrium humans would not be required to act anymore as there would be no need to remove uneasiness. All humans would be perfectly happy. Economic equilibrium is never lastingly attained in reality. Everywhere and at any point in time do people desire change. It is true that they seek to attain equilibrium. However, this equilibrium is in constant flux. The market always moves towards equilibrium but the equilibrium always changes its parameters. It is the entrepreneurs' activity that at any point in time, unwittingly or not, moves the market closer to this equilibrium.


Violence

Violence is an act where one individual forces another individual to do something against his own will. It is in stark contrast to voluntary exchange.

Government

A government is an organization that, in last resort, can only exist by exercising violence over a certain definite territory. It needs to employ policemen and purchase armaments to supply them with. It forces the individuals that are under its supervision to pay a certain amount of money and hence withdraws goods from the market in order to maintain its existence.

Beauraucracy

Beauraucracy is a form of directing resources and putting them into use. It is in stark contrast to profit management as described under Economic Roles >> Entrepreneur. The bureaucrat gets allocated a certain amount of money beforehand. He then has to purchase whatever factors of production he thinks are necessary and make their produce available to the target market. The main challenge of bureaucracy is the fact that products are not sold at prices determined by consumers. It is hence impossible for the bureaucrat to determine whether or not the factors of production he has withdrawn are being put into better use. It is all based on his own value judgments, not on the consumers' value judgments.

Bureaucratic management is the mode of management that governments have to use. This is because government raises money based on arbitrarily determined taxes, not based on the market value of the services it is seeking to provide. If this were the case, governments would be able to bill people for the services provided at market prices. This is obviously not the case because most of the services that government provides are outlawed or highly regulated on the free market.

Ownership

Ownership in the economic sense is exercised by a man over a thing or a number of things. It means control over their location in time and space. The owner only decides what happens with the owned things. Ownership must have emerged out of initial occupation of land, where land refers to whatever nature has to provide. In the early days men would homestead land, build their homes on it, cut down trees, till the soil and produce their own food, hence own the land they transformed and the produce it yielded. From then on, ownership could be transferred to others, either voluntarily or by violent occupation. It is true that in early days most land was swiftly occupied by the strongest men and their initial owners turned into serfs who had to turn over most of the produce to the occupiers and new owners. This was the system of feudalism.

Capitalism

Capitalism is the societal organization under the private ownership of the means of production. All factors of production are traded freely amongst the capitalists based upon their expected yield, and hence upon consumers' value judgments and preferences.

Freedom

Freedom in the economic sense means absence of violence. It necessitates that the government is solely dedicated to the task of protecting the individuals property from violent intrusion. It necessitates that the police is dedicated to nothing but staving off any violence directed from one man towards another. It requires an absence of arbitrary violence from private individuals just as much as from government officials. The struggle of mankind, from the early days up until today, has been nothing but a struggle for freedom. All the societal advancements that we hold dear and hope to maintain today, like representative government, bills of rights, equality of every man before the law, congressional oversight, are nothing but a means to curb the government officials' arbitrary abuse of their power. Because the government's main skill is the exercise of force and coercion, freedom is by necessity a thorn in its side. The people in the executive branch of every government wish that there was no oversight, or if there is one, that it would not ask uncomfortable questions. For those peoples who have accepted freedom as their principle, it has always been considered the most precious thing to be preserved. Freedom can only permeate all of society if its merits are understood and realized by the broad mass, by public opinion. Freedom is not for granted. It is always at risk. If it is desired to be preserved, it is in every individual's best interest to be sceptical of what its government does, and by electing candid represetatives whose intention is to limit any arbitrariness that might be in opposition to peoples' individual value judgments.

Democracy

The idea of democracy is the outcome of the human desire for freedom. Democracy is a form of appointing government officials. The officials are elected by the majority. Recurring election cycles constantly ensure that different people be entrusted with the management of the societal apparatus of compulsion and coercion. Even under democracy a minority of people exercises power over the majority of people. Its objective is not to ensure at any point in time that the will of every single person is represented by the acting officials. This would be impossible. Just as a consumer cannot direct every action the entrepreneur takes, a voter cannot completely control the elected official's actions. Democracy's objective is rather that, to the extent possible, the government officials are always being questioned and monitored, that their arbitrariness be curbed as much as possible, and that they are always under the risk of being removed from power. Democracy's main merit is inner peace. Governments are replaced in a peaceful manner, rather than via violent subversion.


Socialism

Socialism is the societal organization of the division of labour under public ownership of the means of production. This means that all factors of production are put into use by a person or assembly that represents all people in society. The individuals' value judgements and preferences don't count. Because factors of production cannot be traded or owned by private individuals there can be no prices for factors of production. The central planning authority, when gathering its factors of production has no way of knowing if the factors it withdraws from other lines of production are currently fulfilling more urgent needs than their prospect employment will. The objective of supplying all of society with the maximum demanded produce possible, has to fail under socialism due to the absence of prices necessary for economic calculation. The only reason why in the Soviet Union prices could emerge was because the government used the prices of equivalent goods abroad which were turned out in capitalistic countries. They would completely disappear if the concept of socialism was consistently expanded around the whole globe.

Interventionism

Interventionism is, like capitalism, a system of division of labour under private ownership of the means of production. However, under this system, the government assumes certain responsibilities which would usually be assumed by private individuals. Also, the government tries to use force to declare prices that deviate from the market prices. The government expands its scope beyond the task of protection. This is the system of our age. All around the globe it has been adapted as the system of choice. It is said to combine the best of both worlds, socialism and capitalism. Economists have long proven that every attempt to improve peoples' well-being by intervening and exercising force will fail and precipitate results that are even less desirable than the current state of affairs from the point of view of the person or the group who intervenes or whomever they represent. Their analyses have never been refuted. It is the main objective of this blog to analyze different types of government interventions and determine whether or not the end sought will be attained.