Tohm Curtis continues his slightly sarcastic journey into the underpinnings of economics

Okay in Lesson 1, I concluded with the not so startling revelation that the economy was ultimately limited by the external environment or reality. Economics is a science because it’s constrained by reality, and hence people use observations to make predictions on how the natural environment will behave.

But so too is physics, mathematics etc. Lets go further now and look at economics as the study of decisions and what makes a good or bad decision. What is the result of a good decision?

Profits – Doing More with Less:

I’m from a business school and thus naturally in my mind, the result of a good decision is profit. Don’t let that turn you off as an activist though. Hopefully you would agree that profit occurs as a result of a decision where our return exceeds the cost of making that decision. The cost – benefit analysis.

So the recipe for profit is efficiency, in every manifestation in the corporate world, the business world, in trade, in economics, profit is derived from doing more with less. Sometimes it is getting more of the customers’ money, for the same product, then you are using your customers efficiently. Or it is from selling the same product to new customers, instead of developing new products which are expensive. Or it is from reducing your product and selling it at the same price.

Staff cutbacks intend to deliver the same product using less staff. They are trying to gain a greater return from their investment in wages.

Wanting Less Now, and More Later:

Imagine some cave person. Their aim in life is simple; eat enough to live long enough to reproduce. Maybe they are trying to choreograph a dance masterpiece in their lifetime, but let’s keep it simple.

This cave person has access to a stream with a bunch of fish in it, and they also have access to a sharp stick. The cave-person can skewer a fish out of the stream and eat it.

Simply put, the cave-person made a good decision to skewer the fish, because they profited in terms of energy, the fish they caught provided more energy than was expended catching the fish.

What if they caught 7 fish? At some point presumably they would have a surplus. They couldn’t eat all the fish they caught. So not only is the energy expended catching that surplus fish wasted, imagine if the dead fish spoiled overnight. If left in the stream it would stay fresh and be eaten tomorrow when it was useful/profitable to do so.

Cave-person in the Corporate World:

So in the above example the cave-person attempted to consume what it wanted, which unfortunately was not only more than it needed, but more than it could consume. Bad, inefficient decision.

Imagine though that that cave-person is now head of a big company listed on the share market. It makes $1 million dollars of profits, and the cave-person or CEO has to decide whether to pay out all these profits and make the shareholders happy now, or reinvest these profits to make shareholders happier in the future. Does it want more today or more tomorrow?

Same for any wage earner, do you save your money to consume another day, letting it accumulate into a big pile you can roll around in naked, or do you go out today and drink it all? Do you want your money more today or more tomorrow?

Under-consumption for Activists:

Thus we establish the basic criteria for good vs bad economic decisions, and by extension good vs bad policy. Paying attention to the fact that policy is a piece of paper that dictates what decisions are to be made in what circumstances.

For example, I, a rebellious youth, often jaywalk. But I have a policy when very drunk to ALWAYS wait for the green man before crossing the street, often mumbling ‘green-man, green-man, green-man’ to myself. …back to the mythical criteria. Since we live forwards and not backwards, we generally should take good economic decisions to be those that will make our lives easier in the future or long term and bad decisions to be those that make life harder, period. There’s a quasi middle ground that muddies up the issues and allows defenders of lies, injustice and stupidity to get away with sounding like they know stuff about economics. This grey area is called the short term. A decision can look good in the short term, but be bad in the long term.

To avoid confusion, let me be clear, a decision fitting the above criteria is a bad decision. It is inefficient.

Homework exercise 2: Short Essay Competition

Why in Australian society do people need to pay for gym, in order to lose weight gained from eating food they also paid for? Are they efficient consumers? Think about it.

photo credit: technicolorcavalry

The most common constraint on fulfillment of wants is time. I cannot write this post, and go to the beach and swim. I have to do one or the other in that same portion of time. There are only so many days I am alive, I have to decide what to do with my time, all the time. I want to do more with my life than I ever possibly could. I wouldn’t mind studying 16 university degrees whilst working 8 or 9 different careers while actively participating in at least 10 different sports that I would enjoy dedicating myself to. I can only pick a few of these because I don’t have time.

I also don’t have the resources at my disposal, namely money, so again I can only choose to do what I can afford in both time and money. But what is money worth? It is worth what you can buy with it. So taking the statement relative to wants, resources are limited a step further. The only things we can buy exist. We can’t buy things that don’t exist, things that exist are part of nature, and nature can only provide so much. There is only so much oxygen that we have access to, there is only so much water that we have access to.

Economics < Natural Environment

So if there is one thing you take away today, it is exactly what that means, the natural environment places definite, finite limits on what we can consume and how large an economy can grow. It cannot grow indefinitely. Even a resource that replenishes itself has definite finite limitations, like trees, you could increase consumption of trees 100 fold and maybe they will grow back. But you have to wait for them to grow back. In fact in that example, nature would impose limits from a lot of different angles, time, oxygen, our capacity to actually cut down trees, the point is you can do it, up to a point. But eventually the question is going to be answered for you, BECAUSE ECONOMICS MUST CONFORM TO REALITY.

In that sense you might look at economics as a study of decisions. We look at reality, observe its behavior and come up with rules. These rules supposedly guide the decisions we make in regards to consumption and production. Good rules closely reflect reality, and last a long time. Bad rules create distortions because they don’t closely reflect reality and eventually reality exposes the rules.

So if someone is peddling bullshit and calling it economics, they can be as fancy and intellectual and statistical as they like, but they eventually will be proven wrong by reality when the decisions resulting from the bullshit gets out of hand. That is when it gets carried to its logical limit.

If you understand that the Economy is a subset of the Natural Environment, you know enough to figure out the rest. If you are too lazy to figure out the rest, keep watching this blog, and I’ll go through it for you.

Homework exercise 1: The Cake Game

This game is a useful analogy for exploring the long term sustainability of our current Economic system. All you need is 4 friends, and a cake. You can find a recipe for chocolate cake here. Or I guess you can just buy one from the supermarket. Anyway here are the rules of the game.

The Cake: The cake represents the natural environment.

The Players: The players represent national economies; the ranking of the economies is based on their consumption. Whoever consumes the most cake is the best off economy.

Aim: Progress in the game is made by increasing your consumption. This is called your GNP (Gross National Product). GNP is measured per round.

Step 1: Cut a thin slice of cake for all four players. It should be a small wedge about 1-2cm thick. The first four slices are round one. Take the slices away, preferably eat (or consume) them. Proceed to round two.

Step 2: Players take turns to cut their own slice of cake, anyone who takes a piece smaller than that of round 1 is eliminated. If you take a piece the same size you are eliminated. If you take a bigger piece, remark at how much better off you are and proceed to round 3.

Step 3: Repeat step 2.

As you can see, you can play this game potentially forever;). This represents roughly the game being played by most of the worlds governments. If you ran out of cake and couldn’t play any more, rest assured the cake the governments are playing with is very, very big, so it is reasonable to assume that we can play for ever.

photo credit: mhalon

as according to Tohm Curtis

a new series outlining why Economic Rehab is crucial

What does ‘Economics’ mean…there’s some confusion as to whether it is a science or a philosophy? Wikipedia can provide some insight into the history of economics. I think though that maybe the simple starting point is:

Economics is the study of reality.

Okay so what do I mean when I say Economics is a study of reality? What I mean is that this is really what makes it a science. I would say the exact same thing of Physics, I would say the exact same thing of Mathematics. Bertrand Russell incidentally said ‘Pure mathematics consists entirely of assertions to the effect that, if such and such a proposition is true of anything, then such and such another proposition is true of that thing.’

In Physics this means Isaac Newton’s description of gravity as any two masses exerting a constantly attracting force on each other is true. That is what happens in reality. For Physics to work, you can’t have a law of gravity that has exceptions. A theoretical world where some people fall towards the earth and other people float up into the sky would not hold as science. The laws have to conform to reality. They must be based on observations of things that happen.

Economics supposedly represents a scientific reality. Just we seem to get surprised in Economics much more regularly than we do in Physics or Mathematics.

When Richard Dawkins talks about the difference between religion and science. He says that a science is capable of accepting that if you go your whole life believing one thing and then are presented with evidence to the contrary, the scientist accepts the new contrary position. Once the evidence has been peer reviewed, the new evidence is what is taught from then on.

However, he suggests a religion is something that holds its truths to be absolute and rejects any new evidence no matter how compelling.

So you can’t just have an ‘Economic Theory’ that doesn’t conform to reality. Because reality places constraints on what Economic Theory can be. Economics, as the study of the management of the household, is challenged by the reality of scarcity.