Economics in Six Minutes

by Fred E. Foldvary, Senior Editor

Demand is a list of prices and the quantities bought at those prices. The law of demand is that at lower prices, people usually buy greater quantities and never fewer quantities. The law of supply is that, holding production methods constant, greater quantities are produced and provided with higher prices. The law of diminishing returns says that adding a variable input to a fixed input eventually yields ever less output per extra input unit.

Where supply intersects demand is where market prices and quantities are determined. Price controls above this equilibrium such as minimum wages create a surplus, and prices below it such as rent control create a shortage. Without price controls a surplus drives the price down, and a shortage drives the price up, like an invisible hand directing prices to equilibrium. Eliminating restrictions and taxes on labor creates full employment.

Firms maximize profits at the quantity where the marginal (extra) revenue equals the marginal cost. In a very competitive market, economic profits, above normal costs, lead more firms to enter the industry, increasing supply and decreasing price until the profits are just normal. Losses lead to fewer firms and a shift to less supply until profits are normal.

The factors, categories of inputs and resources, are land, labor, and capital goods, yielding land rent, wages, and capital-goods rentals. Entrepreneurs organize the factors and drive the economy to better directions with better products and marketing, earning their wages in the form of economic profits. Other labor earns its marginal product, what it contributes to output.

Land varies in quality, and the production in the better land relative to that of the least productive marginal land yields a rent to the more productive land. Speculative holdings reduce the margin of production, hiking up rent and pushing down wages.

Civic services such as parks, streets, and security increase the demand for land, raising the rent. If these are paid for by taxes on labor and capital goods, the users pay both the tax and the extra rent. When rent is used to pay for the public goods, the landowners get neither subsidized nor penalized, since they pay back to the provider the rent generated by the works. Paying the rent to the community and charging market prices for utilities also eliminates urban sprawl by making the best use of urban land.

Taxes on labor and goods must be added to the costs, raising prices and reducing quantities, placing an excess burden on the economy beyond the actual tax. Land is fixed in supply and has no cost of production, so taxing the rent does not shift the supply or reduce the rent. Taxing the rent keeps wages high and eliminates poverty both by letting workers keep their full product and by making the most productive use of resources.

Folks tend to prefer goods today rather than in the uncertain future. This time preference and difference in present versus future prices gives future goods a discount and present-day goods a premium, the difference creating the natural interest rate. Market interest rates then make savings equal to investments as we get more investment with lower rates.

Money is a medium of exchange and can either be based on a commodity such as gold or be fiat, based on nothing but laws and custom like today. If the growth of money is greater than the growth of goods, this is monetary inflation that leads to a continuous increase in the level of prices, or price inflation. Free-market banking with money based on a commodity leads to a flexible supply of money and purchasing media without inflation.

Business cycles are caused by speculative real-estate buying and building, fueled by excessive money growth. Depressions can be avoided by using the rent for public revenue and with free-market banking, avoiding the financial and real causes for cycles.

Pollution is caused by making the public rather than polluters pay the social cost. Charging polluters will make them avoid pollution or pass the cost to consumers, reducing quantities and pollution. Likewise, cars and parking should be charged during the most congested times. Eliminating restrictions on private transit and using rent for more public transit eliminates traffic congestion.

Trade is mutually beneficial. Even countries with higher costs benefit from free trade by concentrating on their comparative advantage, what they are most productive in. Global free trade with a common environmental policy leads to universal prosperity.

Public choice is the branch of economics that studies the decisions of voters and government officials. Having concentrated benefits while spreading the cost thinly among consumers and taxpayers leads to seeking privileges, subsidies, special protections, and other transfers. Mass democracy and the need for expensive media campaigns leads to this transfer seeking. Switching to small-group voting with bottom-up multi-level governance, along with constitutional constraints, minimizes this corruption.

The French Physiocrats of the 1700s such as Quesnay advocated a single tax on rent and also free trade. Adam Smith in the late 1700s said a market turns self-interest into public benefits, but benevolent giving in addition to that is virtuous. David Ricardo came up with the margin of production and comparative advantage.

Karl Marx thought labor creates all value and get exploited when they don't get the whole value, but the Austrian economist Carl Manger said no, values are subjective. American economist Henry George said the surplus is rent, so tax that, and have free trade. Austrian economist Ludwig von Mises pure socialism would be hopelessly inefficient, and government intervention makes the economy worse. Friedrich Hayek said so too, because knowledge is decentralized, so just let the spontaneous market order work.

John Maynard Keynes in Great Britain thought government should make and spend money during depressions, but New Classical economists point out that when people expect inflation, government stimulus just raises prices. Milton Friedman in the USA says don't try to manipulate the money, and let folks choose for themselves.

The bottom line to all this is that economic freedom leads to the most prosperity. Don't restrict labor and capital other than to prevent coercive harm to others. Don't tax labor or enterprise. Get public revenues from rent and pollution fees. Let the market handle the money and banking. True free trade and enterprise are good; decentralized and market-based governance works best. As Henry George said, economics and ethics are one. The environment and the economy are one. Good governance and economics are one. Share rent, charge for damage, don't steal wages.

That's economics in six minutes, and the path to prosperity.

-- Fred Foldvary