The last financial crisis (which we are still suffering from) has made us all become economists or at least to make an effort to understand the bases or roots of this usually believed tough and boring science. To give you an idea of this effect, currently it is not unusual to end up talking about credit default swaps, banking bailouts and Keynesian measures to your hairdresser while she refutes or nods like a financial pundit.
But I am not an “expert”, my education lacked in financial training and the basic concepts and ideas I have acquired are due to self-learning by grappling with them during my day-to-day work or my daily life. Now, we see the importance of knowledge in economics to understand the world we live in and the consequences of its reckless abuse, and thanks to my broken ankle and sick leave, I have deepened my understanding.
So, I have just finished reading a book than has helped me to accomplish my objective partly. The Naked Economics: Undressing The Dismal Science by Charles Wheelan, offers the clear and plain explanation I was looking for as the root of my self imposed drill.
This entry is an exam-like test of what I have really learned.
The book is laid out in an introduction and thirteen chapters with a final set of questions summarizing some current issues whose answers and solutions will become increasingly important in the coming years if we want to ensure a global growth pace that will guarantee the well-being of ourselves and our offspring. I will keep the same chapters structure and dedicate one blog entry per each of them.
To make a start, Wheelan introduces the book by catching our attention via curious examples and ideas on how economics provides alternative or original explanations for long time discussed items, to common daily subjects or current breaking hits. Have you ever thought that the faulty allocation of resources without a price system rushed the Soviet Union collapse or that smokers can be “beneficial” to non-smokers because they make less use of the social security and pensions payment or a even how social policies can have a negative effect to society as increasing maternity leave period for women looking for a job? Do you know why Ben Bernake is in all daily papers headlines lately and why the laureate Nobel economists still alive were not able to anticipate or, if they knew, to prevent us from the real gravity of current financial crisis? We will find out in this and following entries.
Immediately after, the author drives us into its particularly odyssey and in the complexities of modern economy whose main vehicle is the market that (in words of Wheelan) “aligns the incentives in such a way that individuals working for their own best interest leads to a thriving and ever-improving standard of living for most (though not all) members of society”. The market economy, if flawed, has proved to be the best choice among the different alternatives and the best tool to allocate scarce resources under demand in a competitive environment. Meanwhile, other fully controlled politics (such as communism) has been unable to put in order the handful of small operations needed to move the world around.
Where does the complexity of markets stem from?
On the one side the individuals and consumers in particular “seek to maximize their own utility”. This utility is different case by case even changing as we grow wealthier. The concerns for the rich are not the same as for the poor. We have got a case in the environmental protection. Although it proves that the environmental destruction jeopardized the future for all, the less favored can maximize their utility currently by cutting trees or working in heavy pollution factories. They probably would not do that if they received more help from wealthier countries.
The chase of a maximum utility involves a continuous trade-off on costs and benefits (not only monetary) and each time we invest effort or money in something we stop doing something else (opportunity cost). Besides, maximize utility is no a naive question and our decisions may be proved wrong in the long term for us an for society (real-state bubble, financial crisis, smoking...). If we are not able to take the best choice, it is the government as society tool who has to be there to direct the market to get the best of us as individuals and as a group(congestion taxes, regulation controlling reckless investment via dubious products, affirmative action, etc...). Due to its importante, lately and harmfully proved, the economists also study this irrationality or lack of “self-discipline” in what has been called behavioral economics.
On the other side we have firms and groups that attempt to maximize their profits for longer. A firm, independently of its size, takes inputs and tries to convert them in something more valuable that the cost of such inputs, the product. This is not easy since it implies to decide what product (the consumers want, not what they need, and the firm is able to product), where (the most profitable, depending on resources needed, human capital, effective labor cost), how and how much (depending on prices and if they are fixed, focusing on quality or service).
So the market price is needed like a thermometer that measures firms and consumers relationship. As Wheelan says “the price will settle at the point where the demand matches the offer” but beyond the Ivory tower most on the markets do not look like this. Notwithstanding the stock market where the a stock price is fixed at the point that equals seller and vendor, the firms do not change the market price every second and have a certain market power to charge whatever they want and even to discriminate prices as technology advances and more consumers information is available (buying online vs over the phone, frequent – customers follow up/loyalty programs etc...)
In the end, the market economy that fosters competition is great for consumers where the goal of profits spur firms to research and to developments that improves our lives. It sounds good but not always is so nice. The market rewards the swift, the strong and the smart and although every market transaction makes all parties wealthier (even controvert sweatshops offer a better alternative to poor countries that the internal local works they can apply for) the protection for the losers should be granted by the society itself as it also contributes to make all better off.
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