Tuesday, May 22, 2012

Notes on Economy — Part I

All ideas in the following post are taken from 'A citizen's guide to economy by Thomas Sowell'. It's an excellent book which makes economy more comprehensible for non-economists like me. I've tried to extract major themes from the book.

What is economics? 

In the words of Lionel Robbins, "Economics is the study of the use of scare resources which have alternative uses". Economy is all about managing the natural resources for the best use of the majority. We can't have economics in heaven because the amount of resources in there is infinite. Therefore, no planning is required, and hence no economics.

Essentially, economics is about the material well-being of the society. Humans have developed two major economic systems in the last three centuries, i.e. capitalism and communism. Capitalism is a modern form of Mercantilism which from developed between 16th and 18th century, while soviet Communism got it's roots from the writing of Marx and Engels (Das Kapital, Communist Manifesto, and the German Ideology).

Capitalism — as the book explains — is a price-coordinated economic system. A system in which the demand and supply compels production and consumerism. A more efficient and creative company takes a larger part from the profit share.

Communist economy is highly centralist in nature. A centrally planned economy doesn't believe in the idea of making profit, as profit is inherently detrimental to humans. Centrally planned economies believe on the idea of fulfilling all basic human needs, rather than improving product efficiency.

This is a very raw comparison of both systems. A detailed analysis will follow.

What is price?

Thomas Sowell writes, "Price performs the most important function, i.e. to allocate scare resources." It functions as a measure of demand and supply in a society.

For example, nowadays Manto's book 'Manto Nama' costs around 1,200 rupees because Manto's 100th birth anniversary celebrations are on it's peak. The book costed only 600 rupees eight months ago. Why is this 100% increase recorded? In a price-coordinated economy, a increase in the cost of a product means that either the demand has increased or the supply has fallen. In this case, because more people are now reading Manto, therefore the demand increase, causes a price increase.

Another example — this one is from the book — when a hurricane hits a city, the hotel's price of reservation sees a sharp increase. This increase is due to the fact there are no houses are left in the area. Many people are now competing from a small number of hotel rooms, hence the price of reservation automatically increases.

It should be noted that this is not due to individual 'greed', but rather due to simple rule on how a price- coordinated economy works. As the development work starts again, hotel reservation prices begin to fall, gradually coming back to its original position.

This is precisely the reason why houses are expensive near a coastal region compared to suburbs. The coast always has a limited space for development while the construction space in a suburb is many times more compared to the area in a coastal region. More people compete to get a plot in a coastal area, due to its aesthetics or any other reason, which causes a price hike. Prices give a measure on how much a resource is left. As more coastal area is sold, the prices increase proportionally making the land much more expensive.

Making laws to manage a free market

Laws are the basic hindrance in the functioning of a free market. Market laws create an artificial scarcity of resources in a price-coordinated economy, which is essentially an obstacle in the flow of services.

Market laws which try to control free-markets have devastating results on economy. Thomas Sowell gives an example of the rent control law in Sweden, Australia, and United States. He writes, "The rent control laws in these countries increased the number of homeless people, rather than decreasing them. This is a direct co-relation with price control in these areas. There was no scarcity of house construction, but on the other hand, people acquired bigger homes than their need." This caused a decrease in the area of house per person, hence increasing the number of homeless people. Even today, due to rent control laws, many people live homeless in New York and San Francisco.

An example from Pakistan is the government's ban on importing re-conditioned cars. This has increased the prices of the formerly imported re-conditioned cars in the country. Note that — as in the case of rent control laws —  a restriction through market law creates an artificial scarcity of re-conditioned cars. As a result, fewer people can now buy a car in Pakistan.

No comments:

Post a Comment