Economic Glossary

The other day I was listening to the radio in the car; it was a “best-of” program from a couple of years ago, so not related to specific things in the news today. But a caller was having a conversation with Michael Medved, making the assertion that when a person makes money—such as Steve Jobs at Apple—it is at the expense of others, who will be worse off. Michael Medved tried to point out that the products Steve Jobs had provided to society, for which he earned the money, actually made consumers better off, so it was an even exchange, or even an improvement for all. The caller refused to agree, and insisted that there was a set amount of wealth, and if someone got more, others got less. Which shows a glaring lack of understanding of economics.

Economics may be a challenging prognosticating social science. But there are some things that aren’t too arcane for basic understanding. It doesn’t take an expert. So, as a public service, I thought I’d share a few basic definitions—with the purpose of helping good citizens feel confident enough to assert their right to decide how they spend the money they earn. (These terms are all defined with a little more depth in the economic section of the Spherical Model website.)

Wealth: the accumulation of the results of labor. It is created with additional labor and innovation, so there is no maximum amount that can be created. Wealth includes both money and material goods and real estate—anything that could be exchanged for value.

money image found here

Money: a representative, or symbol, of wealth, to make it easier to exchange. The purpose is to preserve surplus that has been produced. The materials used may have some intrinsic value, but mainly money is of value because people who exchange it agree that it symbolizes units of the results of work. There is an estimated total amount of money in the world, called, M3, which includes currency, bank accounts, certificates representing value (stocks, bonds, etc.), or anything quickly liquidated. It goes up as word wealth goes up. If there is inflation in the type of money used to measure (dollars, for example), then the number could appear to go up even though the actual value (representation of units of labor) has not gone up. I wrote about it in 2011.

Price: the point at which buyer and seller of goods and services agree that both are better off by making an exchange. Price conveys a lot of information, allowing buyers and sellers to decide if an exchange is worthwhile to them. If a seller prices something too high, it will have fewer willing buyers. If a seller prices something too low, there will be more buyers than supply.

Supply and Demand: Supply is the amount of goods available or the availability of a service; demand is the willingness of buyers to exchange money for a good or service. Willingness to make the exchange is determined in large part by price—just as price is determined by an accurate assessment of supply and demand. If there is no interference (government regulation, taxes, tariffs, price setting, etc.), then the interrelationship of supply, demand, and price are clear to the experts—the people involved in making an exchange.

Profit: the amount of money that exceeds the costs the seller put into a good or service; it allows the seller to then count that additional money as pay for labor—or as income.

Capital: represents work above and beyond what is essential, followed by careful use of the surplus toward a good idea, for the purpose of creating even more surplus. Capital itself is always moral—surplus work is an economic and social good.

Free Enterprise (or Free Market): an economy in a society in which choices of what work to do , how to make exchanges, and what to do with earnings are decisions made by the individuals involved in the exchange. The term capitalism is sometimes used. Capitalism is actually a subset—a way of investing and making use of capital, leveraging the power of wealth to put a good idea into action in an attempt to make more wealth. Free enterprise generally means government doesn’t interfere, but only assures that contracts are kept, and wealth is safeguarded from theft. It is a system that leads to prosperity wherever it is tried. But for reasons of power being a greater priority than prosperity, it is seldom tried. The alternative to free enterprise is a controlled economy—with central planners deciding basic economic decisions, like who works in what jobs, how much people get paid, what prices are set, and how money will be spent. Central planning is a form of tyranny that always leads toward poverty rather than prosperity. 

If there is nothing else you know about economics, you should at least understand that the person who knows best how you should spend the money you earn—is you.

Alternatives

There’s a lot of talk (justifiably so) these days about how bad Obamacare is. Which brings up a couple of questions:

·        If we get rid of it, doesn’t that put us back in the same mess we were in before Obamacare was put out there as a solution?

·        Instead of just being negative about the mess that is Obamacare, why not offer some positive alternatives?

The best starting point is often principle. The economic principle behind the problem of high health care costs is—something has interfered with the natural market price. Get rid of the interference, and prices reach an equilibrium point with demand.

We went through some of this in the November 6th post, showing the history of government interference leading to separation of who gets services from who pays for services. I remember a student paper I edited back in college on socialized medicine. My purpose as a writing tutor was to help the student make his/her point clearly. But this one I had to say just wasn’t convincing. And it was with a fellow tutor, so I was allowed to be tougher than on a regular student. His point was that medicine isn’t like other free market services, because you never know when you’re going to need the service—so the solution is for government to step in. I argued that, while I might not know all the solutions, the pricing problem would be better solved by getting closer to the market rather than further away.

I did have to think, though, about whether medical care was different in some way from all other goods and services. It can be unexpected and unplanned for.

But so can car care. Even with an aging car, there are some things you can predict. You can, for relatively low cost, do some basic maintenance that will help the car’s longevity: change the oil, check the fluids, clean whatever needs cleaning, replace whatever needs replacing. You can budget in for those things. As the car reaches a certain age, you start expecting bigger things to need repair or replacement—like transmissions. If you own an aging car, a good rule of thumb is to expect to pay in repair close to what you’d be paying in payments on a new car—and then if you get lucky enough not to have that many problems, you’ve got savings in your budget.

Most of us do typically get insurance for accidents—to help pay for our own repairs, if necessary, and, even more important, to pay for repairs of anyone we cause damage to. We can try to avoid accidents with all kinds of safe driving, but, still, accidents happen. So insurance coverage for those car versions of catastrophic illnesses is probably worth putting in the household budget.

We don’t buy insurance to cover basic car maintenance, because the basic principle is to insure against the unpredictable, not against the expected. You can, of course, buy maintenance plans, if that helps even out your budget—but you can be certain the seller of those extended warranty plans is doing it as a money maker, not as a service-out-of-the-kindness-of-their-hearts.

Is health care different? Most medical services are basic maintenance and repair. The costs would have been responsive to market pricing, if the payer had stayed in touch with the cost. Some people have pointed out how responsive veterinary medical care still is—because the pet owner, not a distant insurer, is directly paying the cost.

Would it be a good idea to also budget for unforeseen catastrophe? Yes, that is what insurance actually is.

The point is, medical care is still like other things we address through the marketplace. It just looks impossibly expensive—it is. Because the connection between the service receiver and the payer has been broken. Any solution has to move in the direction of the market, so that prices can realign.

Are there any such solutions?

Yes. Yes, actually, some of these have been on the table since long before Obamacare. The standard list includes: allow insurers to offer policies across state lines, increase use of health savings accounts, encourage low-cost clinic care for the uninsured rather than emergency rooms.

The list was repeated by Senator Ted Cruz on Tuesday’s Mark Levin radio show. Cruz suggests we repeal the entire Obamacare bill and start over. And what then? I transcribed a few paragraphs:

[At 5-minute mark]: We ought to enact real healthcare reform, that allows people to purchase health insurance across state lines…. Economics 101: if you want to expand access, cost is the biggest barrier, and ideally we should see a marketplace where cost goes down and people have a lot more choices…. We ought to empower patients so that insurance is personal, it’s portable, it’s affordable. Like your car insurance, it goes with you from job to job and you own it. And you can buy it across state lines. That would do far more to improve healthcare than anything in Obamacare.

[At 7-minute mark]:  If we would simply allow people to purchase health insurance across state lines, what we would see is a 50-state marketplace—real competition—so that, for example, young healthy people, many of whom don’t have health insurance now; if they had the access to low-cost catastrophic policies, they may well choose to buy it. But if a 22-year-old single man has to buy a comprehensive plan that covers everything, including a hip replacement, which he’s not going to need for 50 years, he’s not going to buy the insurance, because no one wants to spend the money that Obamacare is trying to get people, to use to subsidize other folks. It’s a totally misguided policy.

[At 14-minute mark]:  Imagine three years ago, when this was being debated, if President Obama said, “I’ve got a great plan. I’m going to take away the healthcare of 5 million Americans in order to cover 100,000. And while I’m at it, I’m going to jeopardize the healthcare of 100 million Americans who have employer-provided plans…. And while I’m at it, I’m going to cost millions of jobs and force millions of people into part-time work, working 29 hours a week.” Is that a good deal for America? People would have laughed at it. If he’d simply been honest, he would have been laughed out of the room…. [When he said you could keep your plan] He “misspoke”? He said it 28 times, unambiguously. Because the only way to sell this law was to mislead the American people.

There are a few out-of-the-box ideas as well—as you’d expect from a real free market. I’ve heard a couple of interesting interviews recently on radio, with doctors who suggest a new model for basic medical care. A few days ago I wrote down a name to look it up later. I found an article about the model presented by Dr. Josh Umbehr. He has a practice in Kansas, along with two other doctors and one nurse.

Dr. Qamar of MedLion Direct Primary Care
on Fox Business News

He calls it a concierge model. It’s also called direct primary care practice. Families pay a set fee, something like $50 per month per person, and get access to their primary care doctor as needed—by phone, in office, whatever is needed. Like having your doctor on retainer.

Prescriptions can be filled at very low wholesale rates. Many tests can be done at minimal costs as well. Off the bat, there’s an overhead savings of 40% just by avoiding insurance paperwork. This type of service covers the basic maintenance issues that you need to budget for, not hedge your bets against with insurance. They encourage people to additionally get a low-cost catastrophic policy, or self-insure with a health savings account if they can.

When I was searching for more information about this idea, I came across an interview on Fox Business News on November 13, with Dr. Samir Qamar, of MedLion Clinics. His plan seems similar to Dr. Umbehr’s. It’s a model that can be picked up by primary care doctors across the country—to save money for themselves and their patients.

When there are pricing problems, there are always market solutions. Even when the product is medical care.

Interference and Consequences

Last week’s Economics 101 lesson (week 6, through Hillsdale College, online for free) was on “Incentive and the ‘Information Problem.’” There were several points worth repeating.

Hillsdale Courses online

Early on, lecturer Gary Wolfram, asks the question, why can’t centrally planned systems provide wealth for the masses?

Market Capitalism, Wolfram tells us, solves a number of problems:

·        Information Problem—how can a central planner possibly know what all the Americans are going to want for breakfast tomorrow, or what they’ll want to read seven months from now? Market capitalism answers this through the price system.

·        Incentive Problem—innovation requires risk taking, and without an incentive to take risk, producers don’t innovate; they do the safe or easy thing.

One example he gives about the incentive problem, near the end of the lecture, is a caveman example—because economists like to demonstrate principles with simple societies. Suppose you’ve got a caveman, and he comes up with the idea of a stone axe. He has to form the axe head out of stone. He has to fashion some kind of handle, and figure out how to attach the axe head to the handle. All this is going to take time—time that he could have been spending grubbing for roots and berries. That’s his opportunity cost.

Suppose then, some other big ol’ caveman comes and takes it from him, because there are no property rights. It wasn’t worth the risk of time and effort, if he couldn’t guarantee that he could keep what he’d made for his use. Without property rights, there’s no incentive to innovate.

There are two types of systems that fail to protect property rights. I’ll give you a clue: on the Spherical Model, they are both southern hemisphere. There’s the anarchy side, like in the caveman example. And there’s the statist/government control side.

The pleasant alternative is the northern freedom zone. In economic terms, it’s where you find free markets. And, he agrees with the Spherical Model, that political freedom and free market systems go together.

Wolfram offers comparative examples between free market capital systems and centrally planned systems. Think about where you’d rather be planted, if you were destined to be poor. Always it’s better to be poor in a market-based economy, rather than an authoritarian ruled system. Think about, if you had to be poor, but could choose anywhere in the world to be born and live, where would it be.

As he points out, “Nobody says, ‘Send me to North Korea.’ They all say, ‘Send me somewhere that’s a market economy. Send me to Australia. Send me to the United States. Send me to Canada….’” We know centrally planned states cannot produce wealth for the poor. Only market capitalist states can do that. [31:30 into the video]

He referred to studies comparing economic freedom across the globe, done by the Fraser Institute and the Heritage Foundation—the Index of Economic Freedom, and compared countries in the to 25% of economic freedom—Hong Kong, Singapore, Australia, New Zealand, Switzerland, Canada, Chile, Mauritius, Denmark, and the United States—and the bottom 25% of countries, including Iran, Turkmenistan, Equatorial Guinea, Democratic Republic of Congo, Burma, Eritrea, Venezuela, Zimbabwe, Cuba, and North Korea.

The average per capita income of those in the top 25% countries is $36, 691. The per capita income of the bottom 25% countries is $5,188. If you’re in those top 25% countries—the ones most like market capitalism and least like authoritarian centrally planned—you’re seven times wealthier on average than those countries in the bottom 25%. [34:00]

It’s even clearer when you compare the poorest of one set of countries to the poorest in another. The poorest 10% in those freer countries make on average $11, 382 (per capita income). Or more than double the average per capita income of those in the centrally controlled countries. Worse, the poorest 10% in those controlled countries make on average $1,209. The poor in market system countries are nearly ten times wealthier than the poor in controlled economies.

Wolfram says, “It’s not a matter of theory; it’s a matter of fact. Governments that rely on central planning simply can’t produce wealth for the masses.” [35:00]

Why is that? Why are centrally controlled governments/economies such abysmal failures at providing wealth? One of the problems is the ever-increasing unintended consequences of interference. He referred to Ludwig von Mises, in his 1927 book Liberalism [a term that refers to freedom the way our founders thought of it, rather than the way the word has been co-opted by central controllers since then].

Once government begins to intervene in a system, intervenes in a market, it’s going to create these unintended consequences…. When it creates these unintended consequences, what happens is we get further government intervention, because there’s a political clamor. “Oh, now we need to deal with this problem.” So the government intervenes again. More political clamor as it creates more unintended consequences. With Mises arguing that eventually you end up with central planning. The government continually intervenes, creates more problems, intervenes again, creates more problems, intervenes again—until it’s intertwined with our economic system in such a way that markets aren’t allocating resources anymore; the political system is allocating resources. [35:30]

If we were to look at current events, and try to come up with some example of this happening, what could it possibly be? Oh yeah, Obamacare.

He gives us the  history, in more detail than I’ve done in the past. (The transcript of that section more than doubles this blog post length, so I’ll summarize, but, really, you should listen to the whole 40-minute speech, and especially this example, from about 36:00 to 44:00.)

·        There was a labor shortage during WWII, with labor resources going to the war effort.

·        Government didn’t want the price of labor to rise, so it set price controls on labor, which guaranteed greater shortages.

·        Someone who wanted to attract manufacturing labor came up with the idea of supplementing wages with employer-based health care insurance—as additional pay for labor that wouldn’t count as higher wages.

·        Employer-based health care insurance separated the receiver of care from the payment, thus causing a rise in demand for health care.

·        A rise in demand for health care increased costs of health care.

·        In 1954 the IRS ruled that employer-based health care insurance did not count as income, which was a way for employees to receive higher payment without paying the exorbitant (91% top margin) income tax.

·        This meant that employer-based health care insurance became more widely used, raising demand for health care from people who weren’t paying for it, and thus raising health care costs.

·        In 1965 government stepped in to help those who were retired or not employed, who could no longer afford to pay the artificially high health care costs without insurance, and government created Medicare and Medicaid.

·        So of course, with more people getting health care they weren’t paying for, health care costs rose further.

·        Eventually government intervenes with the Affordable Care Act, which forces employers to provide health care coverage, forces insurance companies to provide insurance for pre-existing conditions, and forces healthy young people to purchase health care insurance they wouldn’t otherwise purchase, and forces everyone to purchase a standard of plan the central planners decide, rather than the individuals making the purchases.

·        Results of the interference: higher health care costs, lower quality of service, bankruptcy for insurers, devastating costs and fines for people who can’t afford the new standards.

We have this system of health care insurance tied to employment. We don’t have that connection for car insurance, or homeowner’s insurance. The only reason health care is tied to employment is government intervention, followed by unintended consequences, followed by clamor to fix the new problems, followed by more government intervention, then more unintended consequences, and on and on.

It looks like it might be a good idea to just get rid of government. But that’s not the solution either; remember the caveman anarchy problem? What we need is just enough government to protect us—our lives, liberty, and property. In economic terms, government is there pretty much just to protect our property rights: with contract laws, police, armies, courts for settling disputes.

Wolfram gives this rule of thumb:

So when we look at a law, we ought to decide, does that law in making it easier for markets to work, or does it make it harder for markets to work? And fundamentally, is that law expanding our property rights? Is that law expanding our ability to act according to our own plan? If it is, it’s a good law. If it’s making it harder for markets to work—if it’s infringing on our property rights—if it’s making it harder for us to act according to our own plan, then that law ought not be there.

I think that’s pretty much what the writers of our Constitution had in mind when they delineated limited government.

Prices

I’m still reading Poverty of Nations, as I mentioned in the last post. So I’m tuned in to some basic economic concepts right now. A couple of times this week I came upon the concept of prices as a shortcut to a lot of truthful information.

For background, let’s take from the Spherical Model definition of money, and a few other terms. (I also wrote about basic money terms here and here.)

Wealth

Wealth is the accumulation of the results of work above what is needed for subsistence. Let’s quickly review the Robinson Crusoe (simple world) example:

Robinson Crusoe illustration
from the first edition of
Daniel Dafoe's book

At first, whatever Crusoe has, it’s a matter of what he is able to obtain for himself. He fishes. He gathers. He hunts. He plants, irrigates, and harvests. And barring a catastrophic hurricane or some such disaster, he is free to enjoy the fruits of his labor. This is his wealth—the results of his capacity to recover from the shelterless, foodless situation he finds himself in right after a shipwreck.

But his wealth is limited by his personal time, talents, and energies. It might be that, once he discovers another person on the island, Friday, they commiserate about their limitations. And somewhere along the way they discover differences in abilities. Crusoe is pretty good at farming, but fishing is tedious and frustrating, so he often goes without that protein source. Friday, on the other hand, finds fishing easy, but he’d sure like his garden to yield more veggies and rice to go with it.

Specialization and Exchange

An idea finally dawns on them. How would it be if Crusoe gave up fishing altogether and spent more of his time farming, expanding his garden to provide for the entire population of the two of them? And at the same time, instead of struggling to farm without success, Friday would spend even more hours fishing. Then he would trade his surplus fish for Crusoe’s surplus harvest. They try this, and it works so well, they both have more to eat than they had before, and they both have more spare time for climbing coconut palms or hunting—necessary tasks which neither one is particularly good at.

But this trade thing is working out so well that, when they meet a native who has no trouble at all shinnying up those palm trees, they make exchanges with him. And another native is very handy with a spear and can easily take down a wild boar, which is much too big to use up by himself before it spoils, so he’s glad for the exchange, and the others are very glad not to have to face those wild boars any more.

They specialize. They all work mostly at what they are best at. The result of their total labor is now considerably greater than the total would be without specialization. This leaves them all more actual wealth (results of labor) and even more time to enjoy the wealth.

Money

Money is a more convenient means of exchange than bartering goods; a unit of money represents a particular value, equivalent to a standard unit of work. Money is used for convenience,

When it becomes convenient for the laborers making the exchanges. It’s up to the society. If Crusoe wants more coconuts, but the palm tree climber doesn’t happen to want more veggies right now, but he would like more fish—and it turns out Friday wants more veggies, not coconuts, but he already checked with Crusoe, who didn’t need more fish. They can make a three-way deal. Bring in more if you want. But it gets more complicated to barter without some standard of exchange. Money, to symbolize that standard value, can be useful.

It’s also up to the society to decide what the symbol of exchange (money) will be. On this island, they might use clam shells, as some primitive societies have (bringing us the slang term “clams” for money). Some societies have used salt, which has some intrinsic value to everyone; that’s where the term salary came from. Early Central American societies used cacao beans, which were easy to carry, measure, and trade, and also useful for their own properties. These people also had incremental units based on a measure of grain; their units of gold and silver could always be exchanged for a measure of barley, so they had a standard value. More societies have used gold than any other single commodity as money. It’s usable as a decoration, because of its luster, and it’s easily malleable, making it easy to form into coins. It’s relatively rare, beautiful, and fairly heavy, which makes it natural as a representative of wealth. Silver, with many similar qualities, is next to gold in common use as money, most often used for smaller monetary units….

If Crusoe saved himself enough rice to last through a famine, he could safely exchange the rest of his surplus into clam shells, or gold. And that would even preserve his work, since his produce other than the rice is quickly perishable. In an ideal economy wealth would be represented by something that always exactly equals a standard amount of accumulated work-value. 

Price

Price is an agreement from the seller to the buyer regarding how much money (representing effort put into obtaining the good being sold) he is willing to exchange for the item/service being sold.

Do Robinson Crusoe and friends need a government bureaucrat stepping into their little island world and passing edicts about what would be a fair exchange? No. The price is set by the worker willing to exchange his labor. If it isn’t worth it to Crusoe to exchange a basket of veggies for a mended net, he is free not to make the exchange. But if Friday, who needs nets for fishing, prefers to spend his time fishing without having to stop and mend his own nets, he can figure out what a fair exchange is and offer it to the net mender. If his offer of fish is too low, the net mender is free not to make the exchange with him, until a bargain can be reached with a number of fish that will satisfy him. The price is set, then, by the experts on what they value—those willing to make the exchange.

 

OK, that’s enough background to help you appreciate these quotes on price that I came across this week.

This first is from Poverty of Nations:

Nothing conveys information faster than prices.

Prices convey objective information on the subjective attitudes and feelings of buyers and sellers. As relative prices change, options are altered and decisions are made. Perceived benefits and costs are continuously affected by changing circumstances, including many important variables that are never constant. In other words, not a person in the world knows how to make a market work or how to make even a simple thing like a pencil. But it still happens, because enormous complications are simplified when decentralization and prices take charge. In these ways, prices serve as an amazing, worldwide source of instant economic information [Kindle location 3495-3500].

So, price is what gives us accurate truth as buyers and sellers.

This next is from a Mises introduction of a new book by global investor and blogger Hunter Lewis, called Free Prices Now! I think the words are from the press release about the book:

The most reliable barometer of economic honesty is to be found in prices. Honest prices, neither manipulated nor controlled, provide both investors and consumers with reliable economic signals. They are the foundation for a successful economy.

A corrupt economic system does not want honest prices, honest information, or honest results. The truth may be unprofitable for powerful government leaders, private interests allied with them, or economic “experts” whose careers have been devoted to price manipulations and controls….

Can it really be this simple, that economic prosperity and job growth depend on allowing economic prices to tell the truth, free from the self-dealing and self-interested theories of powerful special interests?

Yes.

What do prices do? Tell the truth, in the most efficient way, about the value of a commodity to both the seller and the buyer—the experts involved in the exchange. No interference in price (particularly including manipulating the value of the monetary unit) can help convey that truth. Truth surrounding these exchanges helps economies prosper.