Saturday, November 1, 2014

An Econ 101 Look at Choices and the Magic of the Market

                Krugman does not phrase it this way exactly, but the generalized definition of the study of economics is that it is the study of how you allocate finite resources in the face of unlimited wants. There is in modern society almost anything that an individual could want, excepting jetpacks. The problem is that all these wants have some sort of cost, in terms of time and / or resources, so these costs add up. An individual economic actor only has so much time, and only so much money. This situation means that choices have to be made.
                These choices can seem minor. Somewhere a student is working on a paper instead of going out with his friends. The cost of writing that paper are not just the easily thought of accounting costs like the electricity to run the paper and the amortized portion of his Comcast bill. Instead the costs also include the things that were not done, in this example the fun that may have been had with the student’s friends, this cost is known in economics as the “Opportunity Cost” (Krugman & Wells, 2013, p. 7).
            `The choice to stay in and work on the paper the student makes is not made in a vacuum. An important part of the choices an economic actor makes is that the choices made are in response to incentives. The student likes to go out, but he knows that going out on the day he had set aside for working on his paper would be a detriment to his grade. Instead of a short-term myopia about what the student is missing out on, he is acting in response to a long-term incentive where he knows that the success in the class will be positively correlated with success in his academic program and it will help in his career (Krugman & Wells, 2013, p. 9).
            The choices are not just seen at the individual level. Companies and governments have the same issues, only writ larger. Just as the student is an accountant, and has worked hard at getting to the place in the career he is at, companies and governments also can specialize. GM has made cars for over 100 years, giving it an advantage and institutional knowledge on how to makes cars. The United States leads the world in healthcare, higher education and manufacture of airplanes. This specialization leads to advantages where those who are good at something are also less good at something else. They are able then to trade with other firms or states that have an advantage in manufacture of different items. GM can focus on the design and manufacture of their automobiles because they can import the tires from China, the manufacture of which does not require the specialized labor force the United States employs. Likewise, the US can send those finished autos abroad an import Bangladeshi clothing because the Bengal workers enjoy a comparative advantage in clothing. It is important to note that the US could also manufacture those clothes more efficiently than the companies in Bangladesh, but that would require giving up so much more than the Bengals give up. Because the imported clothes have a lower opportunity cost, they are cheaper overall. This is comparative advantage in action. This trade means that everyone is better off than if each country tried to be self-sustaining. Trade makes all economic actors better off (Krugman & Wells, 2013, p. 12).
            It sounds like all these individual choices would just make a mess, but the magic of the market and Smith’s Invisible hand means that it all works out. Markets move towards equilibrium, where the price people are willing to pay nicely intersects the amount of goods suppliers are willing to bring to the market. Over time, there are no shortages or surpluses and the market makes everyone better off through their choices – unless the government finds it politically expedient to stay the movement of the invisible hand (Krugman & Wells, 2013, p. 16).