If you think about it...you fall over.
That's the problem with teaching your kid how to ride a bike.
You've already learned that the key to riding a bicycle successfully is to put out of mind all the things that can go wrong.
And all the ideas you have about how you approach steering a bicycle have to be completely disregarded. In other words, all the thinking in the world will do nothing to help you learn how to ride a bike. You get on, you let the physics of motion take over and allow your mind and body to acclimate itself to the sensation of dynamic motion. You push instead of pull. And once you allow all the various intuitively incorrect notions of what you should do to ride a bike to leave how you actually ride a bike, you're able to achieve bicycling equilibrium.
If you had to think about how you would construct a market, I'm pretty sure that you would get it wrong. Especially if you had goals that you wanted the market to achieve that actually have nothing to do with the purpose of the market. In Oregon, we have a political class that has moved from free market economics to Tinkerbell economics. A little pixie dust, and you really, really have to believe. This allows a marauding political class to regulate and restrict on its way to
imposing socially desirable outcomes that free men acting freely wouldn't spend a nickel on. That the marauding political class in Oregon has found allies in Arizona, British Columbia, California, Manitoba, Montana, New Mexico, Ontario, Quebec, Utah and Washington isn't surprising. Our political class is populated with people with legislative power and the determination to do good. If these people were your mom or dad, you'd never learn how to ride a bicycle.
What is the purpose of a market?
A market is a place where buyers and sellers come together. Pretty simple, isn't it? When we talk about "free market" economics, what we are referring to is the lack of outside control or influence over the decisions made by buyers and sellers. Want to sell carrots? In a free market there are no barriers to you, as a seller, to actually sell carrots. Whether you grow carrots or buy carrots, you can go to the market and sell carrots.
Want to buy carrots? Find a carrot seller. And buy carrots.
And when the number of carrots being sold equal the number of carrots being bought, the market is said to be in equilibrium. That is another way of saying that between buyers and sellers, the price that induced sellers to freely bring carrots to market was equal to the price that freely evoked a purchase by buyers of carrots.
Qui bono? (Who benefits?)
When markets are in equilibrium, I posit that all have benefited. The buyer from paying no more than he was willing, and the seller from receiving no less than he was willing, to complete the transaction.
Ah! but you say, there's only one problem with example of a perfect, free market in equilibrium. It doesn't exist. How true. That is why most economists refer to "widgets" instead of carrots when introducing a model of markets. The intrinsic value of the widget lies in its nature: it is fully and completely only a widget; it can only be used as a widget and one widget is perfectly substitutable for any other widget.
Whew! We've blown through a lot of economic principles in a very short time. If this is your first introduction to economic theory, your time will not be wasted if you write down some of these different principles and refer to them from time to time. And make a mental note: there are different ways to approach the analysis of economic problems. The method we're using right now is referred to as "static analysis". If you've a background in math that includes algebra, geometry, trigonometry or, more importantly, linear analysis or calculus, you can probably guess that the other form of analysis that economists use is referred to as "dynamic analysis". In dynamic analysis we take a look at mathematical "moments" to view the interrelationship of various forces that are at work simultaneously and independently of each other, yet which contribute to the same economic outcome, market equilibrium.
But for static analysis, if you can follow 2 + 2 = 4, you have the necessary math skills to follow the mathematical arguments that I will be proposing here. So, chill.
Let's start by defining what is meant by the expression "argument".
Did you ever get into an argument with your sister? Your dad? If you have, you probably have a connotation of "argument" that would dissuade you from using an argument in polite discourse. I use the word argument often, so I'm going to share with you, from Merriam-Webster's 1934 Unabridged, the definition:
1. Proof; evidence; indication.
2. A reason or reasons offered in proof, to induce belief, convince the mind, or persuade to action; reasoning expressed in words; as, an argument about, concerning, or regarding a proposition, for or in favor of it.
Many words pass many lips purporting to form an argument. But the above definition is the one we'll incorporate here. It will keep my writing on track, and hopefully lead you to express your comments in positive ways, rather than as simple contradiction.
Why do economists tend to prefer talking about widgets rather than carrots when explaining the basis of fundamental economic analysis? Because the utility of one widget is exactly equal to the utility of another widget. Or, given two widgets, we would be indifferent as to which one we chose because there are no characteristics of color, size, texture, odor, taste, and weight that would allow us to choose one widget over another. (Fans of Star Trek can name the episode where this phenomenon was used to thwart Harry Mudd.)
Utility is the basis for understanding the value of things. Before we ask the price of a thing, we need to reckon its utility. Widgets are again handy devices because we can ascribe a certain level of utility as one of its characteristics. If I tell you that widgets are in high demand, you would be correct in assuming that the price for an item in high demand is greater than the price of a widget in low demand. That is, if you perceive the value of a widget as having a greater utility to you than all other things, a car, a house, a dog or cat, diamond ring or gram of plutonium, the utility of this widget must be perceived as being rather high.
Where politicians seem to get into trouble is when they decide that they will set the utility of a thing, whether a good or service, without actually looking at whether their view of utility matches the view of the people who live and work in the world they legislate in. Let's get back to carrots.
What is the utility of a carrot?
There's a funny scene in Airplane! where Johnny describes the various uses of an item he's holding in his hand. So, let's look at the carrot. You can use it as a bow, you can use it as a broach, you can use it to fill up your pockets. When we look at common practise--the practical application--we see that the carrot is traditionally used as a foodstock. We can use it as a bow, but if we were to describe the utility of a carrot, we would tend to look at its practical utility. We can see from general use that few people wear carrots as bows. We can see from general use that many more people either eat them or give them to others as food. Utility described from common, ordinary practise.
How do you determine the utility of a carrot? If there's only one, we can ask that question as a comparative. What has greater utility to you, carrot or no carrot? Even if you choose not to use--utilize--the carrot, I would postulate that you would be better off having the carrot. Wouldn't you? (I can think of a case where this is not true. Actually, a seemingly limitless number of cases where this is not true, so we need to further refine our reduction.)
You are a naked man, alone, with no one and nothing around for hundreds of miles. You have nothing at your disposal other than a carrot. Then, we take away the carrot.
Are you worse off, or better off, now that I've taken the carrot? (If you haven't read Sartre yet, now is a good time. Start with Being and Nothingness.) Yes, I had an existential twinge when I imagined myself alone with but a carrot, and then, without the carrot. Even if the carrot had no normal utility, because I'm deathly allergic to carrots, the simple existence of the carrot added to my general sense of well-being. That is, even if the carrot had no apparent utility, it was through it's absence that a certain utility was revealed. My state and condition have changed. Before, I was a man with a carrot. Now I am just a man. And even though we may not be able to state how much we valued our dear carrot, we are aware that without the carrot, we are worse off and, with the carrot, better off.
This is why we begin discussions of value with discussions of utility. Because the value of a thing relates to our own sense of the utility of a thing, even if that utility defies description.
What is the utility of love? Is the utility of love such that you are better off loving, or being loved? Are you better off with love, or without love? If we compare love to carrots, the problem of determining the utility of each results in a dilemma for Man. How can you compare the utility of love against the utility of a carrot? We can look back to John Taylor to define another word used to describe the nature of things; fungibility. "Called fungibiles, quia una alterius vice fungitur." (John Taylor, "Elements of Civil Law", 1755.) Or, a "thing that is fungible, a thing of a class or kind such that one individual or part may be used in place of any other individual or part in satisfaction of an obligation. The classification is important with reference to the rights of the borrower in the contract of mutuum (which see), the usufructuary of goods that perish or are alienated in the using, etc." (ibid.)
Or, love is not a thing. Carrots are. Love can take a licking and keep on ticking. Carrots can't. (Neither can Timex watches, although the opposite has often been asserted.) So arguments that rely upon things that aren't fungible have utility, but aren't a thing. This is an important distinction to make, since most of what we hear from our current crop of policy makers has much more to do with the Tinkerbell economics than with practical economics.
So, returning to our dear carrot, how do we determine its value? Remember that we're using static analysis to help us make some choices. Think of it this way: there's a brick. Red, hard, a standard brick that has the dimensions of 3-1/2 by 8 by 2-1/4 inches. Sitting in your front yard, or on your desk. When we think of that single brick we can talk about doing things to it, examining it, holding it, throwing it through your neighbor's window. We can change single variables like size, temperature, load and examine what happens to the brick when it faces these individual external variables. These external variables are generally referred to as "exogenous" variables. The things that help compose the basic nature of a brick, like the sand, amount of water, and the kilning process are generally referred to as "endogenous" variables. Since our brick exists in its fungible form, and it's "brickness" (still haven't hit the Sartre yet?) is unchanged, we can say that the form of the brick is constant and exists in a state of ceteris paribus with the exception of our introduction of change in the form of our external, exogenous variable. Now, contrast our brick with a brick found on the 52-story of a 100-story building. Even though a brick is a brick, the state of the brick is very different from the state of the brick in our hand. As weight shifts in the building, as trucks and subways rumble by, as wind and rain affect the building, so to is our new buddy up there on the 52nd floor. Our new buddy is constantly strained by various loads, as winds, the tenants and the earth changes. Our new buddy is constantly undergoing different loads and pressures, so that any new outside variable--like a sharp strike or rapid change in temperature--could result in outcomes that wouldn't be predicted by any tests which we subject our Lone Brick. That would require dynamic analysis.
The principle I'm trying to demonstrate here is that while we're going to have a better understanding of how markets work, relying solely on one set of tools--static analysis--while dealing with problems better understood with another set of tools--dynamic analysis--this means that policy prescriptions based on static tests are not necessarily the right policy prescriptions that would be determined through dynamic tests. Filling up your bicycle's tire means that you need to inflate it. Attempting to inflate your bicycle tire with a hand-pump while you're riding it is probably not going to work.
Just looking at carrots allows us to view several layers of complexity when it comes to talking about the market for carrots; and what it means to the buyers and sellers of carrots when economists talk about market equilibrium.
We've seen what happens when we have only one carrot, and then none. But what happens when you have two carrots? In a free market, would you be better off with two carrots, or a carrot and an apple? You have two carrots. I have two apples. How many carrots are you willing to give me to get one apple? Again, we're struck by the individual assessment of utility given by the carrots or the apples to the holders of the carrots and apples, an assessment that requires us to also assess the possible utility we each would derive if we changed from being solely the holder of carrots or apples to the holder of a carrot and an apple.
In an attempt to describe the utility of a carrot or of an apple, economists use the words "tastes and preferences". As the holder of two carrots, I would argue that you would be better off if my view--in taste and preference--was that carrots were better than apples. Even though you may feel differently, your view of the utility of holding a carrot and my view of holding a carrot are important views if we are going to come together and create a carrot-to-apple transaction. If my view of the utility of having a carrot is higher than the utility I have of holding an apple, I can be induced into a transaction that would result in my having fewer apples and more carrots.
At this point I can leave you to your own conjecture as to how this rhetorical transaction actually turns out. What I hope I have demonstrated is that your choice, and my choice, about whether to own carrots or apples is purely a decision that is based upon our own tastes and preferences. And that those tastes and preferences will create choice. A choice that you can either make, which will result in a greater utility, or you can refuse, which will result in a greater utility! (That's right, in either condition, either trade or no trade, you as the holder of carrots can result in greater utility for you, since you base your utility on a set of tastes and preferences that set the for you the value of the carrots' utility. If you prefer carrots to apples in any and all cases, how can you be better off trading on of your carrots for one of my apples?)
The question for us, then, is how do we describe the market for carrots? And how do we describe the market for apples? In this case, does equilibrium exist?
Nope.
Not if I wanted a carrot and was willing to give up one or both apples to get one. Et maintenant, ma petite chou, I have a question. What is the role of the policy maker? Especially if I call up my local policy maker and complain to him about your apparent unfairness (as exhibited by your monstrous behaviour, not selling me your carrots!) I have been wronged, I have no carrot and, I can demonstrate that the market is not in equilibrium!
I am now, the Policy Maker. I am elected. I need to make a decision. Do I side with the carrot holder or the carrot wanter? If I side with the carrot holder, what does that mean? And what tools do I bring to bear to determine the outcome of this market problem? And wouldn't I be seen as a Good Guy if I forced you to sell your carrots?
And is the lack of market equilibrium a good thing or a bad thing? It's bad if you're an apple guy looking for a carrot. But is it bad for the carrot guy who doesn't want an apple?
You've been given a lot to think about. And during the "current economic crisis" you're going to be told a lot of different things about "what we should do". And I've listened to our policy makers. And most of them know no more about economics than you. The big difference is that they want to dictate certain outcomes that have nothing to do with you and your carrots...even though they may end up taking your carrots from you.
Enjoy. Land of the Free. Home of the Brave.
