The Basic Laws of Economics

THE FIRST STEP TO UNDERSTANDING ECONOMICS IS TO UNDERSTAND THESE BASIC LAWS

  1. All wealth is a result of the interaction of desire and scarcity: In order to have value something must first be desired. The amount of value placed on the desired object (goods) or action (services) is based on both the strength of the desire and the scarcity of the object or action in question; nothing else matters including the amount of labor involved in the objects production.

An Axiom of this Law is:

  • Economics is the study of human interaction in the form of trade. Since trade itself is an act based in an emotion, desire, and influenced by emotions like fear and self esteem, it only follows that economics is primarily social science.
  1. Differing amounts of desire for objects or actions is the foundation of all trade: The strength of an individual’s desire for objects or actions differs from person to person and from one time to another. This fact is the power behind the desire to trade; the ability to trade what one desires less for something one desires more.

An Axiom of this Law is:

  • Trades (monetary or direct) in the absence of coercion or fraud are always mutually beneficial. Consequently in a world of free trade all parties tend to become better off.
  1.  The amount of wealth within a society is based on its productivity: Almost all things of desire either are consumed, wear out or lose their desirability in some way or another and must be replaced. Wealth increases when a society is able to produce more then it consumes and decreases when it does not.

An Axiom of this Law is:

  • Wealth or lack thereof is directly connected with a society’s productivity. Poverty is a result of a lack of productivity and correspondingly societies and individuals become wealthier as their productivity rises
  1. The production of wealth is linear: it moves from idea, to production, to desire, to consumption: It should go without saying something must be produced before it is desired, desired before it is purchased and purchased before it is consumed.

An Axiom of this Law is:

  • All reductions and increases in economic activity originate with producers. Consumers for their part are reactors, reacting to desires for products already produced and how secure they believe their income from their employers (producers) is. It is producers, who by laying off workers or threatening to do so, that create economic uncertainty and lowering consumer confidence. Consequently any economic recovery needs to first begin with producers.
  1. We measure value (amount of wealth represented) by the price people are willing to pay. Price is the primary means by which the desire and/or need for a product or service is transmitted to others: This is reflected by the fact it is prices that balance supply with demand, determine where and how fast goods and services are provided and are basis by which producers are rewarded or punished for their efforts.

Some Axioms of this Law is:

  • Since value (often represented by a product or service’s price) is based in desire and the amount of desire/what is desired is constantly changing; the only way to determine value of things is by through a free market where consumers tell what things are worth by what they are willing to pay. Managed markets consequently are inevitable dysfunctional markets.
  • One of the most important types of economic interactions that is based on value/price law involves labor (described better as applied skills and knowledge). Wages are nothing more than the price paid for services of applied skills and knowledge. The higher the skill and knowledge needed to do a task the rarer it is, this combined with desire for the application of that skill and knowledge creates wage levels.  This is again just a reflection of the price law.
  • Wages for applied skill and knowledge cannot exceed the wealth the applied skills and knowledge create (unless wealth is stolen from others to subsidize it). This is similar to the balancing function of prices. This also infers what studies have shown, artificial increases in wages make some jobs and people no longer economically viable as the price paid for their level of skill and knowledge exceeds its value. Just like raising the price of candy bars will reduce demand for them raising wages, even the minimum wage, increases unemployment.

Summary

These are the most basic of all economic laws. All other economic laws either are hung on these basic concepts or they are not laws at all. The basic laws stated above can also be used over and over again to understand the economy, how it functions and why things happen.

13 thoughts on “The Basic Laws of Economics”

  1. I want to take issue with #3. The level of wealth in society is based on its level of technology – which may be directly related to its level of production. The only way to increase real per capita income is to increase our level of technology. Of course then you have to reproduce that technology.

    “Economics is the study of human interaction in the form of trade.” I define Economics as the study of how humans produce the things they need to survive/thrive. Why I like this better is that it shows that economics applies even if you live on a deserted island. Try applying Keynesian ‘consumption equals wealth’ living alone on a deserted island. If you define economics in terms of trade this example tells you nothing.

    • Thanks for your response.

      I would agree that today technology is the primary means by which mankind has raised its level of productivity but it is not the only means. Many of the first societies to form cities and create more productive societies did so by specialization and more efficient allocation of resources not increases in technology. Technology in fact has played a limited role in wealth production until recent times (last thousand years or so). Therefore although technolgy is a way to increase productivity and today may even be the primary method it is not the only one. In the end it is productivity that counts no matter the method imployed to achieve it.

      I understand your “need to survive and thrive” definition but economics is a study of a system, a system based in human interaction. It is hard to describe the capitalist system if we take it down to a single individual.

      As far as Keynesian consumer based economics and genuine economics, I see them related in the same way alchemy and physics are related. Alchemy, the “science of trying to change lead to gold,” was once considered a legitmate branch of science but it is now nothing more then a historical curiosity. Hopefully the Keynesian theory of changing spending to wealth will meet a similar fate.

  2. This is nice, it helped alot.

  3. One and two are on fairly solid ground, but the condition placed on axiom for number two is very important and brings reality, as opposed to purity of thought, into the picture.
    trades (monetary or direct) IN THE ABSENCE OF COERCION OR FRAUD are always mutually beneficial. Consequently in a world of free trade all parties tend to become better off.

    Coercion and fraud are very prevalent in virtually all economies, the reason we have regulations, and why those regulations are important.

    Number 3 is highly dubious; there are places, including the US, where poverty is prevalent but productivity is high; what it ignores is how that wealth is distributed within the economy. If the economy produces a huge amount of wealth, but the government, company store, or dictator, takes it all, either by force or subterfuge, poverty will be the rule despite the existence of great wealth.

    Number four is nonsense and the axiom directly conflicts with rule number one. It is NOT obvious that something must be produced before it is desired; examples would be a cure for cancer or a perpetual motion machine. If 4 were true there would be no reason to do research.

    Similarly production does NOT drive demand. If one is very productive at producing something that no one wants they are going to go broke fast and no one will benefit. Neither the suppliers of materials or the people who actually produce the product will get paid, and the product will go to the trash resulting in a large net negative value. The idea that this could be true is a misinterpretation of Say’s law.

    In Keynesian economics an increase in demand will, theoretically, drive increased production. There is significant evidence that it actually works this way. In Supply Side economics aggregate overproduction will be corrected for in the markets resulting in lower profit margins and, if prevalent enough, recession. This is the corrective force is described by J.B. Say in his economic theory, and there is significant evidence that it actually works this way.

    It is only “Reaganomics”, which isn’t even a formal theory, that suggests that the cure for recession is increased production. In reality overproduction is often the CAUSE of recession.

    Since economics is basically an attempt to predict human response to changing conditions it really isn’t a hard science; it’s more akin to psychology. There are no “laws” just descriptions of probable interactions.

    Here are some principles that I apply when considering the economy.

    1) The rule of supply and demand is basic; anything that suggests action in opposition to this rule is unlikely to work well.

    2) Fair is not an operative concept in the economy, wealth tends to accrue to those who find a way to take it.

    3) The overall size of an economy is summed up pretty accurately by Gross Domestic Product, that is the value of all goods and services consumed domestically. This is the measure most economists use.

    4) At any given time the size of the economy is fixed; any percentage gains by entities within that economy are made at the expense of others.

    5) The medium of exchange does not need to have intrinsic value. It’s value ultimately lies in the trust of the users.

    6) Unregulated Capitalism is modeled pretty well by the game of Monopoly. Without regulation, and the ability of distributed power to act collectively, the end result is massive wealth controlled by a small concentrations of power and abject poverty for the rest.

    • Thank you for your comments, and since you bring up many conceptualizations common in modern culture it behooves me to respond. I’ll alphabetize the response to the comments in the body of what you said. Numeric response to your stated beliefs.

      A. As far as your assertion coercion and fraud happen so that infers a need for regulation and laws. The misconception here is that free markets (which you correctly presume I support) are free from law or regulations. A completely false but common assumption. Free markets are like freedom of movement. No one would suggest traffic laws prevent free movement, nor should we assume “proper” regulations would either.
      B. A cure for cancer is rather generic and nonsensical comparison. Drug x or gene therapy y must be produced before there can be demand for them. Making sweeping statements leads to such fundamental errors as the one you mistakenly have committed. The confusion rises from inserting inspiration for production.
      C.Say’s law, or basic classical economics, is not being misapplied. Classical economics was largely replaced by Keynesian consumerism but with little evidence for doing so. Again, look at styles as an example, are the latest styles created due to demand for them? Or, does someone have to dream it, and than create it before someone deems it worth buying?
      D. You’re partially right in regards to recessions. Normal fluctuations do happen in the dance of price directed asset allocation, but deep one’s are due to misdirected resources (can be natural, a large gold strike, or artificial like artificially low interest rates). Recessions are short when resources are allowed to correct this misallocation. Reagan tried to encourage this correction through lowering regulations and tax burdens. It worked,

      As far as your rules:
      1. The rule of supply and demand is a price and resource allocation mechanism. It is not good to take it beyond this and apply it too broadly.
      2. In some cases, yes. Soros is a prime example of a productive thief whose wealth came at others loss. Third world potentates are another example. Entrepreneurs and industrialist are not. Gates and even Buffet got rich providing value that enrich others. One man enriches millions through capitalism becomes very rich.
      3. Prefer GNP, but your are right GDP is more commonly used.
      4. B.S. Never been true. Wealth is dynamic and always has been. The amount of evidence is so massively self-evident little commentary is needed.
      5. Agreed, the question is merely one of controlling misuse, abuse and manipulation.
      6. Again, false premise. No one advocates no regulation, only proper regulations. Mostly this involves control for negative externalities, honoring of contracts, and punishment for fraud.

      Again, thank you for your comments.

      • Two points on the theory part of this discussion.
        I can think of no occasion when the rule of supply and demand is violated in ANY economic theory except Reganonmics. Both classical supply side and Keynesian economics cleave strictly to this basic rule of behavior. Can you show me a working economic system where it is not the basic assumption?

        While people like to misrepresent Keynesian economics as “spend yourself rich” theory, and Supply Side economics as “products creating their own markets”, both characterizations are just sound bites and are inaccurate. I can find no major area in which the two theories actually disagree, and they are just flip sides of each other. In Keynesian economics an increase in demand will drive an increase in production, in supply side an increase in demand will drive an increase in production. In Keynesian economics a decrease in demand will drive a decrease in production, and the same is true in Supply Side. The difference is only in emphasis.

        Say’s law says that producing a product creates a demand exactly equal to the value of that product. The word exactly is important in the discussion because it eliminates the sales price from consideration and force us to consider only the price of production. So what he is saying is that producing a product places demands on the economy for labor and material to build that product, and he assumes the product will sell. This assumption was valid in the mid 1700’s when production by hand was slow and demand for manufactured products virtually always outstripped the supply. It’s not true anymore.

        This interpretation is further bolstered by Say’s assertion that aggregate overproduction was not possible. He makes this assertion in the knowledge that if a product is overproduced, a market glut, with attendant fall in prices, would discourage manufactures from making the product until demand makes it profitable again, thus correcting for the overproduction.

        To see this in action all one need do is look at what modern businesses do when demand lags production. If manufacturer x has a warehouse full of unsold goods, and he somehow gets an increase in operating capital, he isn’t going to produce more stuff with it, he isn’t going to hire another worker to sit around and get paid for it, and he isn’t going to buy more production capacity. What he’s probably going to do is either invest it in the markets until demand returns, or give himself and the executive staff a big bonus.

        The assumption that any additional product produced will automatically sell and provide a boost to the economy is made by the proponents of Reaganomics, but businessmen don’t make that assumption unless they are bad businessmen. That doesn’t stop businessmen from supporting the idea that Reganomics works, it goes to the idea that wealth flows to those who find a way to take it.

        The thing is, Reganomics is not supply side economics. It’s a misapplication of Say’s law coupled with Laffers theory that there is a point where increased taxes will result in decreased revenues.

        While I don’t disagree with Laffer’s curve, it is not monotonic and no where does he estimate where on the curve revenues start to decrease in response to tax increased. Judging from the record of revenues I’d estimate that point to be between 70% and 90%. We are way below that, and the national debt reflects the fact.

        On your assertion that a product must be produced before it is desired. Try telling a engineering or drug company that they should produce stuff at random until they get something that the market wants. Desire ALWAYS precedes production except for products that are made for the joy of making them. Even then the producer has some desired end product.

        On your assertion that my statement that at any given time the size of the economy is fixed and any percentage gain by entities is made at the loss of others is false. The operative term is “at any given time”. If this were not not true you wouldn’t be able to state GDP, or GNP, or give any firm estimates of the size of the economy. The percentage thing is also obvious. It there is 100% of something and I go from getting 50% to 75% then someone else is going to lose 25%. This doesn’t mean that the economy is static, or even that anyone suffers a dollar loss.

        As for reference to monopoly and your assertion that no one advocates an unregulated economy: I specifically postulated an unregulated economy for the simple game analogy. However the result is the same for any economy that doesn’t somehow compensate for the tendency for wealth to gravitate to the already wealthy.

      • Sorry for the late reply, by the numbers: 1. The problem with Keynes is his assertion that directed spending is the equivalent of market orientated spending. Simply not true. That is the same mistake by those who try to equivocate tax cuts with increases in government spending. They simply are not. One builds on the market, the distorts it. Building a pyramid is not the same as people buying what they desire and hence rewarding those that satisfy those desires. Keynesian based gov. spending distorts and often destroys rather than build. 2. Increased capital disperses, and goes many places. Usually the small to mid-sized business put money back into the business in a big way, which is why they are the first to start hiring. Larger businesses, with their corporate boards and layers of bureaucracy, tend to utilize windfalls more cautiously. On this level long term structural changes are more important. Tax advantages, and regulatory reform is more likely to initiate investment than a cash dump. 3.Yes things must be made before they can be desired (self-evident). To say that means things are made at random until someone wants them is ludicrous. The engineer tries to make something useful/desirable as does the inventor. This fact does not negate the fact he is producing something whose desirability is only proven when it is brought to market. 4. Your assertion here seems nonsensical.4.The gain loss you are perceiving is built on static values.If consumers A and B trade items, it is because they value them differently. The worth is based on desire, unequal desire means unequal worth on a personal level. Which means each person involved in the transaction becomes richer in their own eyes. Culmulative wealth is merely the sum of individual wealth, and the businesses they own. So yes, even if A buys 25% of the worlds kips from B, the fact that B is compensated for them with something he desires more means there has been no zero sum game. 4. Monopolies, as many economist point out, are almost inevitably the result of government controls. The tendency of wealth to accumulate as you state is no tendency at all. Certainly wealthy individuals do rise in a capitalistic society, but in a properly functioning economy this can only happen if they are helping produce a much larger increase in wealth for the economy at large. (something that was certainly true of the so called robber barons). The children of the wealthy have often squandered their families wealth. Rich fall, and rich rise, but disproportionate concentrations in the hands of a few are not the result of lack of government involvement, but the result of it. Lastly, I kinda skipped over your Say’s law assertion. You seemed to be saying scarcity no longer is an issue, and value is no longer connected to supply. Are price mechanisms also no longer part of equation as well? All Say asserted in the statement referenced is the balance between goods and demand are balanced by price, which makes their values equal (in reality, constantly adjust their values to make them equal). He just came at it from a different direction. The speed of production is of no consequence except in the fact today people can have more stuff quicker.

  4. I made the statement above:
    On your assertion that a product must be produced before it is desired. Try telling a engineering or drug company that they should produce stuff at random until they get something that the market wants. Desire ALWAYS precedes production except for products that are made for the joy of making them. Even then the producer has some desired end product.

    This is an obvious overstatement, and I apologize for the hyperbole.
    In reality the product development cycle is not so simple. Some products are developed with no real certainty the market will respond while some are not developed until a market is pretty much assured. Your example of the fashion industry might be one of the former. What actually happens is that dozens of designers put together something they think the public might buy and, after a trial showing, those fashions that get a positive response might actually be produced. If that product is successful then other clothing manufacturers jump on the bandwagon with their own variations of the fashions that are in demand. Those designs that get a negative response are generally not mass produced in the expectation that they will sell.

    For complex products a thorough marketing research project usually precedes investment in production tools and materials and only after an estimated demand is established is the decision to produce actually made.

    Some products that are relatively simple and cheap to produce are put on the market with the hope they will be purchased, but their success is predicated on the demand produced, and demand for the product is anything but guaranteed.
    In all cases successful products are determined by demand for those products, not in the number produced. Just producing things does not guarantee a positive net result for the economy.

    • Of course, the better mousetrap guy seeks to build something that will be desired by others. That he must build it first was the obvious point here. Products are produced today with lots of research, as you note, to reduce the chance of failure. Except for the hobbyist or dedicated artist, at least minimal effort to reduce risk is attempted. It never negates it, but can mitigate it. In short, I find little to quibble with what you have just wrote.

  5. Anonymous said:

    There was a reply by me, in which I addressed A Conservative Mind’s critique of my original post. That discussion contained the statement

    “On your assertion that a product must be produced before it is desired. Try telling a engineering or drug company that they should produce stuff at random until they get something that the market wants. Desire ALWAYS precedes production except for products that are made for the joy of making them. Even then the producer has some desired end product.”

    which I later described as hyperbole.

    That discussion, which addressed the error in Reganomics interpretation of Say’s Law, and the reasoning behind it, was deleted.

    This seems to be a bit of judicious editing to preserve the myth of Reaganomics.

    • no readers comments are ever edited, the only exception being for vulgarity

      • Anonymous said:

        Well mine certainly were; and there was no vugarity, just solid reasoning, If there was no statement deleted, then what was my retraction all about? You responded to the thread, so you know very well there was an entire line of reasoning deleted from this thread.

      • I have looked back to the extent possible, no editing. As always, all views are welcome, whether in agreement or contrary.

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