Fact 1: Our Limited Pie
The first stop for any pedestrian on a leisurely stroll through the busy economic streets of Shady Valley is Scarcity Stan's Ye Olde Bakery Shoppe and Confectionery Palace. The most noted pastry on Scarcity Stan's list of delectables, wedged between his mouth-watering apple danishes and scrumptious jelly donuts, is economic pie. My mouth waters with the thought.
Economic pie isn't like other donuts, cakes, and confectioneries with their gobs of sweetness, but very little nutritional sustenance. In fact, given that it refers to the sum total of the economy's resources and productive activity, economic pie is filled to the brim with sustenance. Unfortunately, Scarcity Stan and the congregation of people we call society, has only one economic pie, and while it's pretty large, it's never quite as big as we would like.
Scarcity Stan's economic pie resides at the source of the first of the seven facts of economic life that we'll encounter on our economic stroll:
FACT 1 OUR ECONOMIC PIE IS LIMITED -- The economy has a finite amount of production, income, resources, and wealth at any given time.
What is this economic pie and why is it limited? Scarcity is One Big Problem Scarcity Stan's conceptual namesake -- scarcity -- lies at the heart of our limited economic pie. An extended discussion of scarcity is presented with all of the other definitions in section III, however, for our current purpose a shorter definition will do. Scarcity simply means that there is not enough "stuff" for each and every one of us to get everything that we want. It's a problem because all members of society want or need an unlimited number and variety of products. But, here's the catch, the resources and means to create these products are limited. So, you say that you want beach-front property, an expensive sports car, and a private jet? You're not alone. Can our economy can provide you, me, and everyone else with beach-front property, expensive sports cars, and private jets? No! And not because you, I, and the other five and a half billion people on the planet are undeserving. The problem, quite simply, is that we don't have enough resources to produce beach-front property, expensive sports cars, private jets, and a gadzillion other products -- way too many to list here -- that we all want.
Our Economic Pie Begins with Resources
Limited resources lie at the root of this problem of scarcity and are ultimately responsible for the limits on our economic pie. What are these resources?
- Natural Resources. Any listing of society's resources needs to start with natural resources -- land, water, air, wildlife, vegetation, sunshine, mineral deposits, fossil fuels, and everything else that comes with the planet. This is the "stuff" from which everything is made. (See NATURAL RESOURCES in section II for more on this topic.)
- People. Of course people and their labor are another important resource. This includes factory workers, clerical staff, executives, managers, accountants, educators, legislators, auto mechanics, and, well, basically anyone who puts forth the mental or physical effort to transform natural resources into the products we all want and need. (It's often useful to isolate a special type of human effort -- entrepreneurship -- which does the job of getting production started.)
- Capital. The last, but by no means least, of society's resources is capital, which includes all of the factories, buildings, machinery, and equipment used to transform natural resources into products.
It's probably evident that without these resources -- all of which are limited -- we wouldn't be able to satisfy our wants and needs. Whenever we eat food, watch a movie, visit a doctor, or warm a house, we use these resources. Here's a challenging exercise for you. Think of something, anything, you consume that doesn't use these three resources.
Resources Beget Production, Which Begets Income, Which Begets Wealth If we stopped with resources, we would have a pretty good grasp of our limited economic pie. However, our limited pie only starts with resources. Because resources are limited, a whole bunch of other stuff is limited, too. Here's why.
Limited resources -- natural resources, labor, and capital -- also limit our production of goods and services. Once our factories are cranked up to capacity and labor is working to the point of exhaustion, then we have pretty much reached the limit on production. You've probably come across the official term that newsguys and government-types use when talking about production -- gross domestic product. Its status is reported regularly, creating major headlines if it goes up a bunch or down even a bit.
Limited production also limits our income. As we explore further in Fact 7, Our Circular World, the income we spend comes from producing stuff. If our economy produces less, then we have less income to spend. Even though some people are occasionally given income, there would be no income to give without production by others.
Our limited production and income also restricts our wealth -- the stockpile of stuff we own. Like your personal wealth is the amount of assets and things of value that you own, the wealth of our economy is the assets and productive resources that we all own. And like you're able to accrue wealth by saving some of your income, our economy's wealth goes up by saving part of our production and income. Because production is limited, our accumulation of wealth is also limited.
No matter how we label our economic pie, it's limited. A limited economic pie is the source of some of our more interesting economic, political, and social predicaments. Let's explore of few.
EVERYTHING has a Cost Contrary to many advertisements and promotional "give-aways" nothing is truly "free" -- everything has an opportunity cost. A slice of pie consumed by one person can't be consumed by another. For example, when our resources are being used to make you a sweater, they aren't being used to make me a sport coat. The cost of making your sweater is not necessarily the price you pay for it, but the satisfaction that I don't get from the sport coat.
This is, unfortunately, an often overlooked fact of economic life. Special interest groups, lobbyists, and others who are prone toward seeking favors from the government, have a tendency to champion the benefit of their pet program, without fully disclosing, or even recognizing the opportunity cost.
For example, car companies, farmers, veterans, teachers, lawyers, or __________ (fill in your own favorite group) might lobby Congress for a tax break, subsidy, or other benefit. But (and here is an important "but"), whatever they get someone else loses. Because our pie is limited, what one person gets, another one doesn't.
This is important for any card-carrying member of the third estate. As we see in Fact 3, Our Unfair Lives, the third estate includes those who don't have as much wealth and control over resources as the first and second estates. The political and economic power of the first two estates often allows them to gloss over opportunity cost -- especially when it's paid by the third estate. For that reason, you need to keep your eyes peeled, your ears opened, and your mouth ready to ask questions about any undisclosed opportunity cost.
You might get some help uncovering opportunty cost from the fourth estate journalists, who have long held the self-proclaimed role as watchdog over the first two estates and protector of the third. Unfortunately, though, the fourth estate tends to be eaten by the first two. (Ask yourself if a "journalist" who was once a high-level presidential advisor and now makes 20 times the salary of an average worker in the service of a Fortune 500 conglomerate can be truly considered a watchdog for the third estate?)
In section II, we'll see how and why opportunity cost enters into many ongoing public debates. For the time being, however, let's ponder the widespread use of the word "free", "Free", "FREE".
When a "Free" Good Isn't Because nothing is truly "free," you need to be on guard anytime the word "free" appears within a hundred miles of you purse, wallet, or checkbook. Every "free" give-away has a cost somewhere along the way. That "free" Captain Amazing decoder ring in the bottom of the Frosted Honey-Coated Super Sugar Junks cereal box, that "free" car wash given with a tankful of OmniGuzzle gasoline, and those "free" steak knives provided to hearty travelers willing to consider a time-sharing summer retreat cottage along the banks of the Cheatemifucan Lake are anything but free" -- someone pays.
The question, however, for those with limited incomes and wealth is who does the paying. The cost of "free" goods are paid in one of three ways:
What does this mean for anyone trying to get the most out of a dollar?
- Higher price. The price you pay is high enough to cover the cost of the desired good (Frosted Honey-Coated Super Sugar Junks) and the "free" good (Captain Amazing decoder ring). Businesses can't remain in business very long if they give away too many "free" products.
- Subsidization. Someone else wittingly or unwittingly pays the opportunity cost of the "free" stuff -- a subsidy. Unwitting participants often include other customers of the same business who pay higher prices but don't get the "free" stuff. A witting participant in this alternative is often the government (but with unwitting taxpayers). Government is well-known for subsidies -- a theme we'll encounter frequently on our journey.
- Promotional investment. The stockholders or owners of a business might willingly pay the opportunity cost when they give "free" stuff to customers. This, however, is best viewed as an investment, not charity Businesses see "free" promotions as an investment in future sales. Like a business invests its profit in a factory to increase future production, it invests in "free" samples to increase future sales. We'll return to this investment idea in a few pages.
Consumer Tips for "Free" Goods:
- If the cost of the "free" good is part of the purchase price, then don't be fooled by the promotional propaganda into thinking that you're getting something for nothing. Ask yourself, if the price you pay -- your opportunity cost -- justifies all products included in the package.
- If your "free" good is subsidized by other consumers or taxpayers, then enjoy their unwitting good nature. Be careful, though, that you're getting the subsidy and not giving it.
- If your "free" good is part of an investment promotion by business, then lay back and enjoy their hospitality. However, once more you should recognize the underlying intent of the business. They aren't giving you a "free" good out of the kindness of their altruistic heart, but expect greater sales in the future. If you like the "free" product enough to buy it, then do so, if not, don't.
But how can you know why a particular good is "free"? Many businesses are pretty shrewd in their ability to disguise who pays for "free" stuff. Other businesses might not even know. The best advice is to ignore the word "free" entirely. When you make a purchase, compare the benefits that you get from the stuff with the opportunity cost you pay.
Pies are Made to be Shared
One of Scarcity Stan's biggest problems -- and our's as well -- is slicing up the economic pie. Distributing our economic pie has always been, and probably always will be, one of our (that is, human beings) most interesting and controversial topics. The reason for the controversy is pretty simple:
- Everyone needs a slice of our pie to perpetuate the phenomenon we call life. If you don't eat, you die!
- Everyone does not or can not help contribute to our pie. The very young, the very old, the very sick, and the very disabled all often relegated to the economic sidelines when others do the producing.
As such, while some get the same amount of pie they make, others get more, and some of get less. As a general rule, though, it's pretty clear that those who create most of our economic pie get out less than they put in. In other words, we have our "worker bees" with the awesome responsibility of producing enough for everyone. Those who don't contribute to the creation of the economic pie are therefore dependent on those who do.
- Net Benefits. The first question that we need to ask is whether redistribution from the haves to the have nots gives us a net gain. If recipients benefit more than givers lose, then society has a net gain. An example of this would be if you are well fed and share the last bite of your food with a starving person. This bite of food is likely to have a very small opportunity cost to you, but just as likely provides ample benefits to the recipient.
- Growth. A second question is whether redistribution helps or hinders future economic growth. It might be, metaphorically speaking, better to redistribute food from the hungry to the well-fed, if the well-fed can use the food today to produce more food tomorrow. This is an ongoing controversy because wealthier people tend to invest more in productive resources (such as capital) than the poor. A redistribution of our pie from the poor to the rich might not give us a current net gain, but it might promote a future net gain by creating a bigger pie.
- Waste. We not only need to consider the cost to the givers and the benefit to the recipients, but also the cost of redistribution itself. That is, many resources -- including thousands of workers in government and business -- are used to redistribute our pie and thus do not do anything to help create it. While the government is often singled out for wasteful redistribution, many areas of private business are also redistribution-oriented, including some (but not all) of the efforts of lawyers, stock brokers, and real estate agents. We need to add in the redistribution cost to see if we really get a net gain.
Like it or not, our limited economic pie will be redistributed. Of course, those who like it least, are those who have the most to lose -- they've contributed the most to the pie. And those who like it a bunch, are on the receiving end and have made little or not contribution to our pie.
As voters, taxpayers, and consumers you should consider three tips when evaluating government redistribution programs:
Redistribution Voting Tips
- Consider the benefit acquired by the recipients of the redistribution and the cost of the givers. Don't be fooled into thinking that there is only benefit or only cost. The beneficiaries of redistribution can make a strong case that their programs will be costless to society. We know that this can't happen. Likewise the disgruntled givers will try to make a strong case for excessively high cost and no benefit.
- Consider the long-term effects of any redistribution program. Does it promote or limit economic growth? When the benefits of greater growth or the cost of reduced growth are included with today's net gains (or losses) is the program justified? Once again, don't listen to just one side.
- Consider the cost of actually doing the redistribution -- taking from one and giving to another. When this cost is included, are we really better off?
The most intriguing part of redistributing our economic pie is the complete and total lack of absolutely correct answers. Should income be redistributed from the rich to the poor? Should wealth be redistributed from the elderly to the young? Should production be redistributed from the workers to the idle? Yes, of course it should! And no, it shouldn't! Both are right, but neither one is. There are no right answers for all times and all situations.
Ah, the sort of controversy that warms your heart!
A Slice of Investment, Please While our economic pie is limited today, it need not remain the same size forever. Economic growth -- the process in which our economic pie is increased -- is accomplished with investment in productive resources. In its simplest terms investment is giving up a little bit today to get even more tomorrow. Unfortunately like all activities investment is not without cost. The ability to move the economy two steps forward tomorrow usually requires one step backward today.
Investment surfaces in many of arenas, including the most obvious example in which businesses make factories or other forms of capital. Other equally important forms of investment are in the areas of education, work, and household chores. For example, students attend college and forego income that could have been earned from four to five years of productive work in the real world because they hope to increase their income-earning capacity with their newfound knowledge (also termed human capital). A mechanic spends several minutes laying out tools to make a subsequent engine overall less time consuming. Housemakers spend a few hours organizing kitchen cupboards to facilitate future meal preparations. These are investments on and all -- give up some now, get more later.
Investment, in its many varied forms, is perhaps most intriguing because of the uncertainty of the future. You give up a known "something" hoping that you'll get "something better" later on. But, you might not! For example, a student who's after an accounting degree when entering college would be sadly disappointed if accounting salaries dropped through the floor four years later. All investments are necessarily risky propositions because the opportunity cost is paid today, but the benefit comes sometime later. Those who guess right make bundles of money (gadzillions or more). Those who guess wrong, lose out. (At this point, I'm inclined to refer you to Fact 6, Our Unknown Future, for further insight into uncertainty. If you jump to Fact 6, however, you'll miss a lot of neat stuff in the four facts that come first. Remember that patience is a virtue.)
Here's a simple tip on investing:
An Investment Tip
- Ask yourself if the anticipated future return justifies the current opportunity cost of the investment.
Without investment our economic pie remains unchanged and, in fact, is very likely to shrink if an increasing number of people devote an increasing share of the pie to wasteful redistribution.
What Does It All Mean? Most consumers, voters, taxpayers, business leaders, and politicians, recognize somewhere deep down in their economic souls that (1) our economic pie is limited, (2) we can't have everything that we want, and (3) there simply isn't enough to go around. But actions often belie rationality. The first step on the path to an economic consciousness, which frees the repressed economic soul inside us all, is to recognize the limitations of a finite economic pie. Then, and only then, can we begin to address our more schizophrenic economic neurosis, including, but not limited to, an understanding that every activity has an opportunity cost. Once accomplished, we can divide our pie in a reasonable, rational way, noting that every distribution, by helping some people and harming others, is inherently subject to criticism. But, our pie can be enlarged if the distribution process includes a slice set aside for investment, making the hurt less painful and the critics less strident.
While our pie is been quite tasty, it's time to continue our sojourn through the economy. As luck would have it, Scarcity Stan's Ye Olde Bakery Shoppe and Confectionery Palace is located in the same general geographic confines as the next stop on our pedestrian's stroll -- Shady Valley's low-priced wonderland -- Mega-Mart Discount Warehouse Super Center. After dodging a few distracted motorists across a newly paved parking lot, we can enter the expansive automatic doors of the Mega-Mart Discount Emporium, pausing only momentarily to soak in the grandeur of 20 gadzillion square feet of merchandise under a single roof. A long loiter, however, is not possible, because there's stuff on sale. OUT OF MY WAY!