The Forgotten Free Market

It appears that some voters need a refreshing dose of economic theory since our overly-trusted politicians are successfully convincing society to reject the irrefutable.  The aim of this post is to set the stage for discussing the problems associated with manipulating the economy. If there was ever a single concept to understand in economics, above all else, it would be the problem of scarcity.  Humans have unlimited wants in a world of limited resources.  The process by which these resources are allocated efficiently occurs within a voluntary exchange between two individuals acting in their own self-interest.  The terms of this exchange are determined by a function of supply and demand.  The implicit requirement for this voluntary exchange to occur is a respect for private ownership.  These fundamental concepts of self-interest, competition, and free markets is elaborated upon by Adam Smith in his book, “The Wealth of Nations.”  

“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest.”

There seems to be a misplaced negative connotation placed on the term "self-interested." A proper understanding of how this term is defined should solve the moral dilemma imposed on the self-righteous.  Self-interest is simply stating that humans, by nature, are motivated by their own goals.  We go to work to make money to buy what we desire.  We go to school to satisfy our intrinsic desire to be more knowledgeable and to compete for higher paying wages.  The baker is motivated by his self-interest to maximize profits in order to feed his family by competing to produce a good that is valuable enough for you to feed your family.  Self-interest does not mean greedy or selfish. In fact, the pursuit of your self-interest may result in donating to your church or building a school.  Any anecdotal examples that claim to disprove humans as being self-interested agents are not sufficient.  It is out of self-interest that you are reading this article right now as opposed to operating a homeless shelter out of your home.  Furthermore, the free market is not responsible for fostering this quality in human nature, on the contrary, it is what strengthens the success of the free market by accepting this reality.  Humans are no less self-interested in socialist states than they are in free market states.  Additionally, because of the problem regarding scarcity, humans are confronted to make decisions by balancing costs against benefits that maximizes personal advantage. 

Scarcity is what gives goods and services economic value.  It is the result of our wants exceeding available resources. For instance, air is not considered a scarce resource under ordinary circumstance; however, while underwater air is considered scarce.  Moreover, there are not enough hours in the day for me to binge watch a Netflix series and still pass my economics test, thus scarcity is imposing a trade-off that has an associated opportunity cost.  I would forgo the leisure time since I value my grade more.  In terms of spending my hard earned money, it is hard to ignore the problem of scarcity when it comes to paying my bills versus having a night out with friends. Moreover, for a firm to offer higher wages may mean an opportunity cost of investing in new technology to increase production capabilities. 

Similar to self-interested agents, competition is vital to the marketplace. Competition is what keeps the baker’s bread affordable and maintain quality.  If the baker wants your business, he must allocate scarce resources more efficiently than his competitors to produce at the lowest cost while maintaining the quality demanded by consumers.  The baker would find it difficult to make money selling stale bread even if it was cheaper than his competition.  This means that what to produce is determined by consumers, how to produce is determined by firms, and who gets these products is determined by the purchasing power of consumers.  

The farmer harvests the wheat, the miller grinds the wheat, the truck driver delivers the flour from the mill to the market where the baker buys it to produce bread that will be exchanged for money to feed your family.  All individual agents are motivated by their own self-interest in their goals which eventually complement your self-interested goals.  The competition of allocating scarce resources is what regulates this motivation.  This process is described by Adam Smith as the “Invisible Hand” in free markets.  All of this happens without any central planning or collective goal, yet producers can maximize profits while consumers can purchase affordable goods. 

The voluntary interactions between buyers and sellers, free from intervention, is a mutually beneficial exchange.  The very willingness of this transaction is necessary and sufficient to claim that both parties benefit.  In fact, the only legal way to coerce this interaction is by government force. Thus, arguments that claim capitalism and free markets are exploitative are categorically invalid.  The exchange in this interaction occurs at prices that are set by market supply and demand.  This function is not simple nor easily manipulated, at least not without disastrous consequences.

The demand curve slopes downward representing that the higher the price, the quantity demanded will be lower. The supply curve slopes upward representing the higher the price, the quantity supplied will be greater.  The point at which the two curves reach equilibrium is the "win-win" for producers and consumers at that given price.  

The price of a good or service transmits vital information to consumers that directly impacts their behavior.  Not only is any manipulation of prices, exogenous to the supply and demand model, exploitative but also impossible to sustain.  There is no successful process that exists to determine prices other than through the function of supply and demand, although that has not stopped many governments from trying.  Consider for a moment the often forgotten beauty of the free market in the way prices is determined. This unique ability for the free market to adapt to changing times and changing circumstances that reflect, as closely as possible, "fairness" is not to be taken for granted.  

Just a few Things That Matter

Diamonds or Water? Which do you value more?

Diamonds or Water? Which do you value more?