A Primer. A Conversation about Economics – Richard Werner CMA/CFM.

Today most nations focus on managing the balance of trade rather than seeking out ways to increase trade in a fair and sustainable way. Sustainable trade is critical to the long-term success of our modern society.

We have all had them, that conversation at work around the coffee station or with family on a holiday visit. We discuss, we listen, and we learn. Certainly it’s not like a school setting but nonetheless we are in a situation where we are immersed in an interesting conversation that often ends up teaching us something. The conversation might be about politics, cars, restaurants, or why your employer’s business is or is not doing so well.

You may have conversations that regularly touch on the subject of economics, or maybe you have overheard others discussing economic concepts, or perhaps you just have a natural and healthy curiosity about a subject that impacts every aspect of your life. Whatever your reason, and in the hope of developing a better understanding of how economics impacts your world, you scoured the earth (or internet) to find this informative, yet entertaining, book.

On the other hand, you may have accidently tripped and stumbled nose first into this book and you may be thinking… “I might like to read up on economics sometime after I have finished watching the paint dry or have counted all the sand grains on the beach”. If you are harboring any thoughts along these lines then I suspect I had best pique your interest quickly.

Much like a car enthusiast might want to engage another person in talking about what makes their car exceptional or someone who has a medical issue may want to delve into a discussion about their condition, someone who is affected by the economy (and that would be all of us) might want to spend some time trying to understand what makes our world tick. All of us have a vested interest in the economics of our world, we are all involved in our economy and through our decisions (including our choices at the polls) we all play a leadership role in how effective our local, national, and world economies perform.

Most of us, at one time or another, have played a game (be it football, golf, or a board game) and at some point in time we chose to learn the rules and strategies of that game. The reason we made the effort and found the time to learn is obvious… we wanted to understand what we needed to do in order to be successful. No reasonable person would want to spend their time doing something without knowing the rules or at least having some semblance of what it takes to win the game. And, just like you wouldn’t play a board game without reading the rules first, it’s important to develop an understanding as to how economics affect you in the game of life especially since you’re already playing the game… every day when you go to work, make a trip to the store, or choose where to invest your retirement savings you are interacting with the economy.

Economics is fundamental to living in a free society and it’s important to understand it in order to know how and why you should try to preserve it. Every day there are reports in the news citing economic concepts and no shortage of talking heads engaging in debates related to them, yet the concepts remain a mystery to many of us. We hear terms on the news such as “the economy grew 0.5 percent in March” or “consumer confidence is down which forebodes a potential recession” but few truly understand what they mean and how, or in what ways, they affect us. My hope is to help you understand basic economic concepts, help you put them into context, and help you to understand how any number of factors in our economy often, but not always, can lead to certain resulting economic conditions.

If you are still toying with counting the sand on the beach you may be asking yourself about now, “Why should I, or anyone, else take the time to learn more about economics?” or more importantly “Why did I buy a book on the subject?” Well, if you watch any amount of news or engage in political debates with friends and family, you will not be able to avoid the topic of economics for very long and chances are pretty good that you would like to come across as knowledgeable and well informed and, while economics is too complicated to glean a competent understanding and knowledge level of from a talk show or from a commercial, you don’t need a Ph.D. on the subject to be an informed citizen. Going a step further, a significant part of our political decision making process is driven by economics which means understanding the basic processes of economics is essential to performing that most important of civic responsibilities… informed voting.

Economics, at least the parts we expect our government to influence, is in many ways like tinkering with an old car or developing a better cooking recipe. More of the same is unlikely to fix a problem, like adding more salt to a favorite dish, at some point more becomes too much and you need to reverse direction. A mechanic working with an old car might start by adjusting the fuel mixture to make it richer but at some point it becomes too rich. Economic topics like taxes, jobs, and entitlement programs (to name just a few) cannot be addressed by the same answer every time. But by understanding the interworking of factors within the economy and how one affects the others, you can then be better able to make sense of the news and intelligently engage in political debates about economic matters.

Like many complex subjects, economics is one that most of us tend to develop opinions about based on what experts tell us. As an example, one such expert and a noted economist, made a comment that he thought it was impossible to effectively prosecute white collar crime. If you know more than a little about business, or have worked in situations where you have come into direct or indirect contact with any type of white collar crime, you might be appalled by the thought that an expert would propose that we cannot hold white collar workers to any kind of legal standard. As a society, whether we realize it or not, we all support or oppose beliefs, such as the one put forward by this economist, and through our voting we either support or reject these concepts. Knowing a little more about economics can help you make informed judgments and the better informed our voting population is on matters affecting economics the more likely we are to enjoy a better economy. Among the objectives of this book will be to explore concepts embodied in statements, such as the one about regulations and white collar crime, in order to give you a better understanding of the workings of our economy.

Why should you or anyone else take the time to learn more about how the economy works? There are many reasons but I am of the opinion that the two most important are (1) to be a more competent consumer and (2) to be able to make better decisions as a member of the voting population.

The reason for the first is fairly obvious, (if you don’t know just smile and nod your head, I’ll explain it in a second), and the reasons for the second are as varied as the population (I’ll get to this too, just give me a minute).

What does being a more competent consumer mean?

If you, as a consumer, are aware of how prices are set and why prices rise, you can better judge the value you are giving up (your cash) in exchange for the value in the good or service you are buying. By educating yourself on what works and does not work in economics, can clue you into what is real value and what is hyperbole. I will provide an example of this later in the book (chapter sixteen) when we delve into why marketing people earn very good livings convincing consumers (us) to spend money buying what may be just an image of greater value. This image of value conflicts with what is best for the consumer whose focus should be on the more tangible attributes of the good being purchased. For example, as a consumer buying a chair, would you be better served to buy a product based on a sexy commercial or based upon careful research of the chair manufacturer’s quality record? (and don’t say “sexy commercial”).

Throughout this book I will use examples to demonstrate how understanding economics can help shine light on what may be faulty thinking. So as not to keep you in suspense let’s get started with my first example. Suppose you are shopping for a can of chicken soup and you have two choices, a nationally recognized brand name and a lesser known brand that costs 50% less. When you do your homework you may find that both products have been made at the exact same factory using the same formulas and quality controls. So in this case what are you getting for the added cost, nothing, right? Or, maybe you might find that the cheaper soup is exactly that a cheaper, lower quality, and a less satisfying product. Now while you might not want to spend a lot of time researching soups, there are purchases that do warrant a consumer taking the time to evaluate which purchase choice is a better use of their financial resources.

Making better decisions as a member of the voting population

Earlier I mentioned that we each play a leadership role at the polls… as voters we choose which leaders to hire to manage our society. Being a knowledgeable person in the voting booth is probably the best way we can avoid our country becoming another Nazi Germany, Soviet Union, or some other failed society. This truth is probably something that extends well beyond economic knowledge but, within the confines of this text, we will stick to the economic reasons.

Opinions are strong and varied on this point, but arguably many voters do not go to the polls armed with sufficient facts and therefore cannot reflect and make decisions based upon the facts. Having moved around a bit in my career I have had the benefit of living in districts that leaned in opposing political party directions. I have personally thought that in some overwhelmingly Christian districts, Jesus himself could run against Satan and, if Jesus was of the district’s minority party, he would maybe generate the closest race in the district’s history but would still lose by a comparative landslide. Look, it’s normal to become indoctrinated into one party or the other due to family leanings or that of the city, town, or county in which you live and it’s just human nature to adopt the values of those close to you. The goal of this book is not to try to make independents out of Democrats or Republicans, but instead to help develop an understanding of what economics is and how the system works. In this way, as a voter, you can come to a more informed decision when listening to a candidate’s position on the various economic issues.

Further to the point, let me share a brief personal observation about politics, economics, and some possibly less informed voters I have known. A relative of mine is very vocal about his political leanings, his history has been one of frequent unemployment, lengthy stints on workers compensation, and prone to often be on public assistance. Another family member, who is also very politically vocal, is church going, hardworking, has never taken a dime of the government’s money, and staunchly defends the other political party. If you think the first one leans democratic and the second republican guess again. By all accounts both of these individuals are good people, never ones to cheat another and equally likely to help a stranger who has a disabled car. The point is not that either one is wrong but that neither one really understands fully what their party of choice tends to support as economic or social policy.

I am not trying to say that strong supporters of one party or the other are ignorant or that they blindly vote based on what they grew up with as children, I’m just saying that many subjects, including economics, are more mysterious than they need be. Just like the cave men of 10,000 BC, because the knowledge was not yet available to them, did not understand the movements of the Sun and the Moon in the same way if we don’t have the knowledge of basic economics the workings of our society will be just as mysterious to us. So let’s focus on taking the mystery out of economic concepts.

My intention throughout this book is to steer away from political arguments and stands on the many economic issues such as taxes (on who and how much) and whether government should or should not have a role in healthcare. Instead my goal will be to put into view how economics, within a free nation, can work in a pure state and provide insight into what really happens and why. With that said I believe everyone is subject to some form of intellectual blindness on any subject and, while I will try to keep my prejudices from tainting the descriptions here, you should keep in mind that I, like every other writer, have preconceived notions as to what is correct and as a result it is possible that facts I present may be twisted by those influences. That warning not only applies here but it also applies every time you tune into MSNBC, Fox News, or CNN and while you may not frequently hear that warning elsewhere please remember it as you go forward through this book and beyond.

In providing insight into the world of economics I will share with you stories from my life where l was confronted by economic concepts in action, description of historic events and how they demonstrate an economic concept, and the story of a fictional island where the economic concepts come to light through working examples. Often seeing the humor in a situation can be an aid to understanding and hopefully you will be amused occasionally along the way.

In terms of opinion, I will share many but in doing so will endeavor to keep my explanations closely aligned with recognized economic theory. I will only intentionally try to sell the reader on one concept… that free enterprise is a powerful economic model, one that has beaten out all challengers thus far on the planet Earth. Understanding free enterprise economics is everyone’s responsibility whether you are a voter, a parent, or a participant in an economy. I hope you will find reading this book both enjoyable and informative.

Chapter 1

The Beginning

Most Americans do not have a good understanding of the workings of our economy or how the global economy interacts with the United States’ economy. This is unfortunate because the important concepts of economics do not require an advanced degree in this science; our basic education, as provided in the United States, along with a little outside reading will provide what we need to know about economics. This book will help put the concepts in terms that will take away a good part of the mystery.

While understanding economics, or at least the basics of economics, is within the grasp of most Americans, developing that understanding does require a little study and the willingness to consider dependent activities.

Much of economics in action is just simple common sense… a matter of considering what logical choices people will make when trying to fulfill their wants and needs. If you keep in mind that the root of economics is based on that simple concept you will have set for yourself the foundation for understanding economics.

Each day you play a role in the United States’ economy whether you are a producer or a consumer of products and/or services. Your contribution to the economy can be obvious (as in a worker producing a product in a factory) or less obvious (as in an ad designer who, though not directly connected to making a good, works to facilitate the sale of that good). The economy is a complex web of people producing goods and services for each other’s consumption.

Obvious contributions to the economy can be easy for us to understand, such as how the person who makes the proverbial indispensable widget adds something of value for the rest of the population to consume. However the value of other roles in the economy, such as finance and marketing, can be more difficult to understand because the connection between what is being produced and the end value to the consumer is not as obvious. I will attempt in this text to provide the context necessary to understand what makes the economy go, what causes the economy to not work so well at times, and how interconnected jobs and resources all work together.

Economic terms, such as inflation and productivity, are used every day in the news and are as much misunderstood as they are understood. Throughout this text we will attempt to help you develop a working knowledge of what is meant by many basic economic terms. The approach we will use is to provide both real world and fictional examples using easily understood language to walk you through a demonstration of the economic concept

Since we all participate in the economy (by helping to guide our economy through the choices we make at the polls and by producing and consuming resources) it is crucial that we understand economics and develop the knowledge we need to make wise decisions. As a contributor to the economy, understanding your role will enable you to make better choices in your life whether you are a top level executive or an entry level worker.

Anyone who has ever spent time among entry level employees knows that there is no shortage of stories describing mind boggling missteps by management. These perceived missteps may simply be a case of the story teller not understanding the bigger picture but it is also just as likely that management, not having a clear understanding of what happens on the front line, made decisions that have led to a waste of economic resources.

Why should we care about economics as it relates to our work? Does it really matter if entry level workers mistake good management decisions for foolish actions? Among the selfish reasons to care about economics is any waste of economic resources diminishes the quality of life for everyone.

After graduating from high school I spent my last year as a teenager working in a high end, small lot production, furniture factory, which meant most of the jobs we ran only consisted of a couple dozen pieces up to a few hundred pieces. This factory used a job costing system that involved each employee, who performed a step in the production process, to fill out a time card for that job. To explain by example let’s say there is a job to make 30 chairs. One person in the process has the responsibility for making the chair legs; this person retrieves a rough cut board from the lumber pile and cuts it to the appropriate length. For 30 chairs this person will make 120 cuts. In our example it takes this person 30 minutes to complete the 120 cuts (four chair leg pieces per minute). This employee then fills out a time card for the job reporting he spent 30 minutes on the 30 chair project. This data leads factory management to assign a cost of one minute of work by this employee to each chair. As the chair passes through all the steps in the factory the dollar cost of each of these manufacturing operations are added together providing a cumulative labor cost per chair. The cumulative labor cost plus the cost of materials (i.e. wood, fabric, finishing chemicals, and etc.) are then totaled together to give us the final cost of the chair.

I, as the factory newbie unschooled in the ways of the factory world, was assigned to work with a very large man, who went by the nickname of Mule. Mule ran one of the most complex machines in the factory called a sticker machine. This machine took in the cut-to-length and -width pieces of wood and made all four sides’ smooth and uniform and, in some cases, applied an additional shape to one or more sides of the wood. My job was to take the finished pieces coming off the machine and stack them on a factory production cart. In this arrangement I could only work as hard as Mule chose to run the machine. Mule was very good at what he did so he could get a lot of production out in a short time. I grew up on a family farm so for me work meant getting the work done as quickly as possible and staying at the job until it was complete. Mom and Dad drilled into the heads of all of the kids in my family this approach to work, which I was soon to find out ran into conflict with this factory’s generally accepted approach to work.

From our first day in kindergarten we have had to learn to adapt to our social environment and I quickly learned that a big part of fitting into the environment and the socialization process of my new job was learning the “art” of time card completion. As you might suspect, what was reported on the cards was not a true reflection of what actually happened on the factory floor. On any given day, Mule and I would run ten to twenty jobs each requiring a separate time card. Our day would start at 7 am and for an hour an fifteen minutes we would run several jobs. Mule would then sit down with me to fill out our time cards and would account for a full two hours of work (including the 45 minutes between 8:15 and 9 am that we hadn’t worked yet). Mule would assign that 45 minutes to the various jobs we had just completed and then head off to the restroom for about a half hour, spend the next 15 minutes visiting some of his buddies around the factory, and then start his 9 am general factory break.

Mule was an intimidating guy who was nearly twice my size so I guess I could maintain that it was out of fear that I adopted a work style that was very foreign to me but, in all honesty, my true motivation came from the desire to fit in with this sub element of the local society. Unfortunately, this work style was not unique to Mule (and now me); it was a plant-wide behavior that only varied based on the creative ways individuals could come up with to waste time. The cumulative result was 25% to 50% of wasted time was absorbed into each day’s work.

What I didn’t realize, and I am sure Mule didn’t either, was that by our actions we were making the cost of furniture produced by that factory more expensive. For simplicity’s sake, let’s assume that one chair had a manufacturing cost of $100 and that the final cost included 20% materials and 80% labor (a good part which was wasted time) then taking the math forward some $20 to $40 dollars of each chair’s cost was due to this socially enforced “art” of time card completion.

Because of these shenanigans you might think that the company where Mule and I worked would have gone out of business fairly quickly but it continued producing expensive high quality furniture for more than twenty more years. Now you may be thinking, “This was probably a union plant where the union was the cause of the bad work habits”. Well you would be partly right, it was a union plant but, from the best that I could tell, the union had nothing to do with these costly work habits. I can say this because this particular union was pretty weak and all it seemed capable of achieving was securing the lowest pay and worst benefits in the area… I might go so far as to say that, at its best, this union could not get its members sunlight on a sunny day. So to blame the union environment for the inefficient use of the factory labor is most likely wrong.

What causes this type of mentality among workers, management, and others within our society? The most likely cause… a lack of understanding amongst workers as to the connection between low productivity and employee rewards, the next most likely reason is poor management. But, at the root of both, is the lack of understanding economics.

Let’s focus on the workers first, is it reasonable to assume the workers in this plant, in 1975, were not taking actions to deliberately put the plant out of business or lessen the company’s ability to give raises to its workers? Obviously neither of these goals was driving the workers to act in this wasteful way. So why did this happen?

In order to answer this question let us first examine the motivations of management; we assume that management would have more information than the plant’s nonmanagement workers on the effects of lower productivity. Anyone who has ever managed people knows how difficult it can be to motivate people to work harder. So how do we do it? Well, the easiest means to motivate people is to get them invested in the results. This is not necessarily invested in the company, in terms of stock ownership, but, in general terms, invested in working to insure its success. This brings us to a basic and well known principle known as the carrot and stick motivation approach.

Almost every company seeks to employ the carrot and stick approach in order to achieve company objectives. During my short youthful stint with this furniture company I was able to see both techniques in practice with a heavy focus on the “stick”.

On a daily basis the plant manager and foreman would look to discipline poor performance, verbal and written warnings, suspensions without pay, and firings happened frequently. One of the most talented employees, we’ll call him Jerry, went through all the discipline processes twice during his career, including being fired. Jerry was brought back about the time I was hired so I got to see him start the process all over.

Jerry taught me how to run a machine that was probably forty years old at the time and in doing so I was able to learn more than a little about what made him tick. Jerry primarily wanted to take care of Jerry. He was a man of action however his actions seldom benefited the company or his standing within the company. Jerry would prioritize his work based on which jobs he liked to run the most, he was as adept as anyone at taking the long bathroom breaks during the day, and he felt entitled to use company equipment, time and materials to complete personal projects. At different times, Jerry used the company equipment to convert company lumber into finished pieces for home projects. At one point he found some rosewood in the lumberyard and decided to use it for knife handles and we spent the better part of a couple days using the wood along with some metal from the factory to make ourselves two knives.

Jerry had the skills and intelligence to be a major contributor at this plant, he was talented and capable of doing great work and could be very productive when he wanted to, he just seldom wanted to unless of course it was for one of his personal projects. Jerry just never stayed focused on using his skills, talent, and intelligence to the benefit of the company and ultimately he chose to leave and work for another local company, a company that was known for offering the best wages and benefits.

At this point in my career I was already studying accounting and I found it curious that this free spirited and intelligent man went to work for a company that had a reputation for running a tight ship (an employer that would on the surface seem ill suited for Jerry and his propensity to avoid productive work) while at the same time the furniture company, which desperately needed a person with his skills, seemed incapable of retaining him.

The underlying reason for an individual and company mismatch, like in the case with Jerry and the furniture company, is a lack of understanding of what each needs from the other. Just like in the workplace, our role in the economy is often not clear to us and we are not able to see a clear correlation between doing well at work and being more financially successful. Understanding the workings of economics is the key to remedying this, for example, if Jerry had a clear understanding between how working hard and efficiently affected his pay and/or job security, Jerry possibly would have been more likely to perform better. Additionally, if management had been better educated in the psychology of the worker and the workings of economics they might have been better able to construct an effective method of managing and motivating Jerry. Absent this Jerry consistently underperformed and the company lost valuable production output and ultimately a very skillful employee.

As an example of this let’s say that Jerry, working at his optimum capacity, could generate an extra chair’s worth of production each day. If that chair sells for $200 then the economic cost of this lost productivity is $200 minus the cost of any direct materials going into the chair, in this case and let’s say that is $50. If you told the workers that their lack of effort was costing the company $150 each day per employee I doubt you would have heard much of an outcry from the workers. If, however, you could convince the company and the employees that the $150, if earned, would benefit both the company and employees then the collective team would view this lost productivity differently.

The company, at one point, contracted with outside consultants to create the proverbial “carrot” to provide motivation for employees to improve productivity. Unfortunately, the “carrot” that the consultants developed and implemented, a gain sharing plan, was so complex that no one, other than a finance guru, had any chance of understanding it. At that point I was well into completing an accounting degree, and though still far short of a guru, I would like to think I had enough knowledge to at least see some vague connection between my performance and a potential financial reward but the dots just weren’t there for me to connect. But let’s not digress into a commentary on the design and implementation of gain sharing plans. The important point here is that even though management knew, to some degree, it needed to gain the cooperation of the workforce in order to drive better performance, and despite knowing and attempting to do the right things, they were still unsuccessful in gaining the workers’ cooperation.

The struggle described here is a common one within working environments across our planet but, even though the goal is simple enough, you seldom hear of companies who are successful in gaining optimal employee participation in the company’s success. You can make an argument that there are simply not enough workers who have a strong work ethic in our economy. It’s certainly true that some people would not work hard on a consistent basis even under the threat of physical harm, but this does not accurately describe all or even most American workers. Generally speaking, people in this country desire to work for successful companies and want to be a success at what they do.

We all have a universal desire for many of the same basic things, food, security, and love. Within the sciences of psychology and economics these are described as a hierarchy of needs. Each person has their own weighting for these needs and because of this it makes finding a single solution to universal motivation difficult. For our purposes here it is simply important to recognize the fulfillment of these needs is desired by most people and concurrently most humans are willing to work to satisfy their various needs.

Opposing desires and needs coexist within people, among these is the need for leisure time, and it’s this need for leisure time that often comes into conflict with the need to be productive. It is this desire for leisure that prompted workers at the aforementioned furniture factory to spend hours each week in the bathroom sleeping, resting, or reading rather than working. Most would agree that few people would choose to spend hours in a restroom as their first leisure time destination. Given the choice Mule, Jerry, or I would have worked our butts off to get to go home twenty minutes early or to make an extra ten bucks. The collective failure of employees and employers to align their economic and social desires caused the loss of the productivity to be spent, among other places, in the company restrooms resulting in a waste of resources. Given the incentive of going home early or making a few extra dollars, versus taking the half hour all expenses paid vacation in the john, most employees (there will always be the exception) would have willingly forgone extended bathroom breaks in order to put out the production of an extra job or two.

Our purpose in this text is not to do an exposé on the waste at a factory several decades past but, instead, to enable you to develop an understanding of how the science of economics works. Possibly the next time you read a news story regarding a drop in factory productivity in the United States, you can now envision what that loss looks like and more importantly what that means to our economy. (I offer apologies to any reader who has just had the disturbing vision pop in their head of several thousand workers sleeping seated in innumerable company bathrooms throughout the United States). If you can, after finishing this book, better understand the connection between higher productivity and a better lifestyle for society, then the time you spent reading and the time I spent writing this book will have been worthwhile for both of us.

Chapter 2

The Island Economy

Imagine there is a small island, we will call it Adam’s Island named for a famous Scotsman, Adam Smith, who visited the island during the time it was being first settled in eighteenth century. On Adam’s Island there live three families, Farmer, Sheppard and Fisher who, in the beginning, made up the entire population of the island. These families split the island into three parcels, Farmer’s parcel is rich farm land, Sheppard’s parcel is made up of rolling grassland, and Fisher’s parcel has a bay with the best fishing access on the island.

This island represents a complete economy that has everything needed to sustain the simple needs of these three families. For a number of years each family has subsisted only on what they have been able to produce on their part of this island. Each family has 180 hours a week that they are able to devote towards producing products for their family’s consumption and, by working very hard, each family has been able to be met their basic needs without any dependence on the other two families.

Each family’s part of the island has very different capabilities in terms of producing the basic goods needed to survive.

The Farmer parcel has six hundred acres of land, the best of which can produce forty bushels of wheat per acre, requiring eight hours of work per week per acre to farm. The parcel can also be used to raise sheep however, the land is not well drained so it cannot be used for pasture much of the year and, in order to raise the sheep, the land must be used to grow hay which then needs to be harvested, stored and feed to the sheep. The family can raise three sheep per acre and each sheep requires the family to spend twelve hours per week per acre caring for them. The Farmer parcel also has access to the sea but it is a challenging walk that involves going down a steep path to the sea. The Farmer family can catch one fifth of a pound of fish per hour spent fishing.

The Sheppard family also has six hundred acres of land most of which they can use to either raise sheep or grow wheat. The family can raise five sheep per acre and the labor required to care for the sheep is twelve hours per week per acre. The land is well drained and the family must irrigate the land part of the year in order to produce wheat. Even with irrigation the best yield possible is thirty bushels of wheat per acre and requires ten and half hours of work per week per acre to produce. There is also access to water for fishing however, the waters have difficult currents resulting in poor fishing and the family is only able catch one sixth of a pound of fish per hour fishing.

The Fisher parcel, also six hundred acres, is mostly in a low lying area of which only forty acres are suitable for farming or pasturing sheep and another twenty acres can only be used for pasture. The forty acres can produce thirty-two bushels of wheat per acre but it requires fourteen hours per week per acre to grow the wheat. The land, if used for sheep pasture, can support four sheep per acre and requires eleven hours of labor per week per acre. The family has the best fishing access on the island enabling them to catch one quarter pound of fish per hour spent fishing.

To survive on this island each family needs to have a minimum of two hundred bushels of wheat, wool from twenty sheep, and five hundred pounds of fish each year. Each family can, on their own, produce enough of each of these essential goods. The following table shows the number of hours each family will spend to obtain the minimum amount of wool, fish, and wheat needed to survive.

Each family, based upon their need for the three products, is working almost every available hour and still is only just meeting their minimum needs for each of these essentials.

Much of the early history of man was spent as subsistence hunter-gatherers where each person, or family, sought to find what they needed in order to feed and clothe only their selves. Trading, which no doubt developed overtime, most likely came about when one family, who found themselves with an excess of one type of good, offered to exchange the excess for another good held by another family. You can possibly imagine a family ten thousand years ago who successfully hunted a wooly mammoth offering their near term excess supply of meat to a family who had an excess supply of dried berries.

Later in the history of mankind, humans began making a habit out of being inter-reliant. For example, tool makers provided hunting supplies to hunters and in return the hunters provided meat to the tool makers. This reciprocal type of relationship led the way for individuals to focus on improving their skill set and to become experts at generating a specific commodity that they could then trade to an expert who specialized in another type of commodity. So, as in our example, our expert tool maker could craft, not only more but, more effective weapons and then trade them to our hunters who could then spend more of their time hunting. This arrangement allowed both groups to live better than when they lived their lives completely independent from each other. Even our ancient ancestors were likely to have had special skills that set them apart from each other. If you lived in the days of our cave dwelling forefathers, you may have been the person who could rapidly make a very sharp and deadly arrowhead but could not hit a deer with a bow and arrow if it was standing still ten feet in front of you. If this was your situation, to survive in ten thousand BC, you would have needed to find a great hunter whose ability to quickly make a quality arrowhead was less than stellar.

As humans our natural tendency is to continually work towards improving our lifestyles and the same is true for our islanders.

On our little island, the heads of the Farmer and Fisher families met one day to discuss the struggle to meet their family’s respective needs. Farmer recognized that Fisher was able to catch fish faster and in greater quantities because his family’s parcel offered easy access to great fishing areas that were only available on the Fisher side of the island. Fisher, on the other hand, realized that the Farmer family was able to more easily produce greater quantities of wheat than his family could produce on their parcel. To take advantage of each family’s core commodity, Farmer offered to raise an extra eighty bushels of wheat in trade for five pounds of fish per week. Fisher gladly accepted and the two heads of family shock on the deal. Farmer returned home to her family to boast of her deal making prowess, the results of which will have the family working an additional sixteen hours per week producing wheat but, in exchange, the family will save twenty-five hours per week previously spent fishing. At the same time Fisher tells his family that by spending only twenty extra hours per week fishing they will save thirty-two hours the family would have spent each week raising wheat. Both families were very pleased with this new arrangement.

You can probably think of a time when you struck a good deal where you thought you got the better end of the bargain because the other party overvalued the good being sold or traded to them. In this case did Farmer take advantage of Fisher or vice versa? You can do the math because you have the benefit of knowing the intimate details of both families’ production capabilities but, in most trading situations, those trading or selling goods would generally not have knowledge of those details. In the case of the Fisher and Farmer families, both believed they cut a great deal and neither knew exactly how good the deal was for the other party. The important thing in trading is not that one or the other got the better deal but that both parties are better off following the trade than either was before the deal.

After the first year under this arrangement the head of the Sheppard family inquired how the other two families could have so much free time without any apparent reduction in their quality of life. After a little prodding Farmer could no longer resist telling Sheppard of the shrewd deal she had made with the Fisher family. Sheppard, being particularly sharp, recognized that Farmer had better farmland and Fisher had better fishing access and that somehow the two families were capitalizing on their respective strengths. After some thought Sheppard suggested to Farmer that his family had some unused pasture land which was superior to Farmer’s and they would be willing to use a portion of this to produce additional wool to exchange for wheat. After a bit of haggling, Sheppard agreed to produce wool from five sheep in exchange for eighty bushels of wheat from Farmer each year.

Farmer once again told her family of her negotiating prowess. By working two additional acres of wheat, adding sixteen wheat production hours per week, they could have Sheppard raise five sheep for their family. This new trade would save the Farmer family twenty hours per week. Sheppard too, thrilled his family with the news that they will save twenty-eight hours per week they would have spent growing wheat and to do so they would only need to work an extra twelve hours per week raising the five additional sheep, or a net savings of sixteen hours of work per week.

At this point all three families are trading with one another resulting in a reduction in time spent working each week… the Farmer family has saved thirteen hours each week, the Fisher family twelve hours, and Sheppard family sixteen hours. This savings will initially become an increase in the amount of leisure time each family gets to enjoy increasing the quality of life for everyone on the island.

Trade on the island continued to develop until Farmer grew all the wheat, Fisher caught all the fish, and Sheppard raised all the sheep. Under this arrangement, the following table shows the average hours per week each of the families worked in order to meet the islander’s needs.

The families each reduced their work week by more than thirty hours so, at least initially, all three families were very happy with the trade agreements and the resulting lifestyle improvements. However, despite the universal improvement not every family benefited equally. As you can see by the table, the Sheppard family is working twenty-four hours more per week than either the Farmer or Fisher families. Later we will see how this disparity in the benefits from the trading arrangement will come to cause problems for our island families.

Once trading on the island had fully evolved each family began to use a portion of their free time to produce more of what they were most efficient at. They used some of their additional production for their own consumption and the remainder they traded to the other families. Farmer grew more wheat, Sheppard produced more wool, and Fisher caught more fish. Each family began to consume more, worked less than before, and had a higher quality of life. The result was growth in the collective wealth of the island and this is exactly how the world economy has benefited since the dawn of trade.

Unfortunately throughout history most nations, and more importantly the individuals within those nations, failed to grasp the benefits of trading. If you consider what has happened on the island and how logical this move to trading appears to be, why then in the real world do people resist trading? Doesn’t it seem obvious to have the people who can create goods most efficiently do so and then trade those goods for other products the people need? Let’s return to the island to consider why this kind of change might not be welcomed.

One of Fishers son’s, Sam, was the family expert in raising wheat on their property and as such was held in high regard up until the families began trading. Once the Fisher family began to trade for its wheat instead of growing it, Sam had to join the family on the boat each day. While Sam enjoyed a shorter work week and more food and clothing as a result the intra-family trading, he did not feel like it was worth it to him personally. Sam enjoyed working the land, when he was out on the fishing boat he would often get seasick and then dockside at the end of the day he found cleaning fish to be disgusting. Sam lobbied his father constantly to allow him to resume growing some of the family’s wheat and to get out the fishing work. Ultimately Fisher relented and allowed Sam to grow wheat thereby reducing the trading with Farmer and forcing Farmer to do some of their own fishing.

What happened on our island is what happens in the real world when a good, let’s say shoes, are imported from a foreign economy at a lower cost. Most people are happy to be able to buy shoes at a lower price. But what about the shoemakers, how does this benefit them? Unfortunately they quickly lose their jobs and lobby their representatives to put a stop to the foreign shoe imports. You, as a well educated economist, meet with the shoemakers in order to convince them not to resist the new shoe import agreement because they, along with everyone else, will benefit from the increase in trade. You explain to them, using well laid out charts and graphs, how all shoemakers will have the opportunity to go to work in a new industry and that this will allow our country to operate more efficiently. If you are successful in doing so, stop studying economics and begin your career in sales you will make a fortune! The reality is the shoemakers will not see how importing shoes will do them any good. In the real world changing careers is scary, costly, and difficult and those forced into changing careers, as a result of cheaper imports, are almost never happy about having to do so.

Today we have the benefit of some education in economics being included as a part of our high school and/or college experience; however, early in the history of trade, economics education was not prevalent in most of the population and honestly, in the earliest years of trade, even the best educated people did not understand how the mutual benefit of trade worked. Most trade occurred based solely on the desire to achieve a profit and the benefit to the respective economies was accidental. Even today most nations focus on managing the balance of trade rather than seeking out ways to increase trade in a fair and sustainable way. Later in this book we will delve deeper into why sustainable trade is critical to the long-term success of our modern society.

Throughout this book I will try to show the various sides of the arguments around economic concepts especially those concepts which are controversial. Let’s start with looking at an example of a managed trade program and the negative aspects of a long-term imbalance in trade. At the start of the twenty-first century, China rose to be the preeminent area of low cost manufacturing. China has been accused of trading unfairly with the West by manipulating exchange rates of its currency (which appears to be a fair criticism in that China is managing to grow its exports and minimize its imports). The product of this manipulation resulted in the accumulation of foreign funds rather than allowing the Chinese consumers to use the currency received in trading to purchase goods and services from the West. By doing this, China has held down the cost of goods coming out of China thereby enticing further foreign investment and accelerating the movement of manufacturing from the western economies and into China. The result of China’s managed trading program has been a more rapid development of the Chinese economy and industrial base at the short-term expense of the quality of life for the consumers in China. Opponents of free trade are often quick to point to this example and others like it where trade with a foreign partner hurts one partner and benefits the other (very unlike the example I used with Adam’s Island).

One of the goals of this text is to examine why overly manipulating trade in the long-term hurts the overall world economy. Admittedly trade and the underlying economic effects are not simple enough to understand without some education on how this complex exchange works best. As we proceed, keep in mind how sensible the trade gains achieved by Farmer and Sheppard were and how that concept often works for us every day in the real world.

Chapter 3

The Introduction of Money



A Conversation about Economics

by Richard Werner CMA/CFM

get it at Amazon.com

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