Economics, in the broad sense, may be defined as the study of human action under conditions of scarcity. Human action is purposeful behavior, the use of means for the attainment of ends. Scarcity is that ever-present state wherein the means available are not sufficient to attain all of one’s ends. This causes a necessity for choosing, for the selection of certain ends to be attained and the renunciation of all others. The attainment of an end brings about a certain satisfaction for the acting individual. The available means will be utilized to attain the end that the actor believes will provide the greatest satisfaction. We may call this the “most-valued end.” We may call the satisfaction obtained from the attainment of the most-valued end “revenue” or “psychic revenue.” However, as mentioned, to attain one end, the actor must give up another. We may call the satisfaction that would have been obtained from the next-most-valued end “cost,” “psychic cost,” or “opportunity cost.” When the actor chooses correctly, the psychic revenue will be greater than the psychic cost, and we may say that the actor has gained a “psychic profit.” When the actor chooses incorrectly, such that the psychic cost is greater than the psychic revenue, we may say that the actor has suffered a “psychic loss.” Clearly, man is always pursuing psychic profit. Action, then, is man’s attempt to gain more than he loses, to increase his satisfaction, to become “richer.” Economics, in the broad sense, may therefore also be defined as the study of man in his efforts to become better off.
An economy, therefore, may be defined as a system of allocating scarce means for the attainment of most-valued ends. Every individual operates his own personal economy through the actions he takes, every group of individuals may be attributed its own economy, and the global economy is simply a manifestation of all of the smaller economies that compose it. No matter its size, however, every economy is designed to allocate resources to the most-valued ends and maximize profits, psychic or otherwise. The purpose of every economy is to create more wealth than is consumed in the production of that wealth, and to produce as much wealth as possible with the means available, which is the same thing.
The traditional conception of an economy has been assumed to be capable of three forms: Capitalism, an economic system in which the means of production are privately owned; Socialism, in which the means of production are controlled by the State; and Interventionism, often called the “Mixed Economy,” in which private owners retain title to the means of production, but the uses to which they might put those means are restricted by the State. These three descriptions have traditionally been understood to refer to different types of economies. Upon reflection, however, it becomes apparent that there can only be one “type” of economy, and that these different “forms” refer only to varying levels of government interference.
Capitalism is better described not as an economic system in which the means of production are privately owned, but as the economic system resulting from private property in the means of production. Private ownership of the means of production means that in order to gain access to someone else’s resources, you must get them to agree to give you access. All interactions must be voluntary. And, given that every individual is seeking his own betterment, it becomes necessary to offer something in exchange for the use of another’s resources. Trade arises. These voluntary trades create the market, that wondrous tool of resource allocation that is the distinctive feature of capitalism and a free society, an engine of economic progress and growth. The market enables economic action on a community-wide scale and leads to increased psychic profits for all participating individuals. It does this in a number of ways:
It must first be recognized that every trade in the market, at least ex ante, produces psychic profit for both parties. It was a mistake of the early economists to describe goods that tended to trade for each other as being equal in value. In reality, there is a double-inequality of value between the two goods. If A gives B an apple in exchange for an orange, it is incorrect to say that the apple is valued the same as the orange. In fact, the apple is worth more than the orange for B, and the orange is worth more than the apple for A. An individual must value what he receives more than what renounces in order to participate in a voluntary exchange. As this is true for both parties, both must benefit from the exchange. Both believe that they’ve gained more than they’ve lost. Trade alone, then, creates psychic profit and makes actors better off.
Additionally, the existence of a market makes possible the division of labor, wherein individuals can specialize in the production of goods in which they have a comparative advantage at producing. The division of labor allows each individual to focus on producing a single good, one that they are relatively skilled at producing, because each individual is assured that they will be able to exchange their surplus goods for the surplus goods of others. Specialization leads to greater productivity, and this increased productivity leads to the satisfaction of more ends due to the increased stock of available means. This clearly creates psychic profit and makes actors better off.
More significant, however, is the fact that market forces yield market prices, which enable economic calculation for individual actors and provide a means of communication between all market participants.
Market prices direct all presently-available means to their most-valued ends by communicating to all active and potential market participants the relative scarcity and demand for each good. Through the market process, the interested parties engage in a competitive bidding process that ensures that the goods go to the parties who value them the most. For example, suppose that there is a given stock of milk available in the market, X. The demand for milk is such that, given the supply of X units of milk, the price of each unit of milk is Y. This means that to acquire a unit of milk, one must give up Y. Only the individuals who value the unit of milk more than Y will acquire the milk. Those who value the milk less than Y will not. The price directs the available supply of milk to those who value it more.
Now suppose that a disease strikes the cows in the area, and the supply of milk available in the market drops to X/3. The demand for milk remains the same, but there are less units available. Not everyone who would have previously acquired milk if there had been X units will be able to acquire a unit of the smaller supply. Through competitive bidding between the interested parties, the price of milk rises to 3Y. Now, only those individuals who value a unit of milk more than 3Y will acquire the milk. Their higher demand ensures that, even as the supply of milk diminishes, they still acquire the units they need. The price ensures that the available milk is always directed toward the parties who value it the most.
Market prices accomplish this by coordinating the actions of the market participants with respect to the milk. As the price of milk rises, many previous buyers will no longer purchase the milk, because the milk will no longer be worth more to them than what must be given up to acquire it. Remarkably, this means that less milk is bought, just as there was less milk to sell. The would-have buyers do not know about the cow disease, they don’t know that the supply of milk has been reduced. And yet, they know not to buy it. The price tells them that the milk is valued so much more by others than it is by themselves that it would be uneconomical to use the milk for the attainment of their own ends. They accordingly do not purchase any milk, allowing it to be directed towards the more valuable uses. Without more than perhaps a dozen farmers knowing the cause of the reduced stock of milk, the market price causes everyone to act so as to conserve the reduced supply. Moreover, the rising price signals that the demand for milk is greater than the available supply, attracting entrepreneurs who believe that they see opportunities for monetary profits. They accordingly set to work increasing the supply of milk available. Again, the entrepreneurs entering the milk industry may not be aware of the reason for the higher price. But they act to counteract the shortage anyway. The market price is all the information they need.
The market price alone coordinates the response of all market participants to the milk shortage, each individual either decreasing their consumption or increasing their production, depending on their role, while also ensuring that the reduced supply is directed to the uses for it that are most important.
But market prices do more than direct scarce resources to the individuals who value them the most; they enable individuals to determine how much they value the resources. Every action involves the potential for psychic profit and loss but, in a market economy, there is also monetary profit and loss. Producers purchase factors of production and sell the goods they produce. If the revenue gained from the sale of the goods exceeds the cost of the factors that went into the production of the goods, the producer will have made a monetary profit. If the costs exceed the revenue, then the producer will have made a monetary loss. It is the prices of the factors and the goods that make possible the producer’s determination of whether he has made a profit or a loss. Through economic calculation, the producer can adjust his demand for various factors based on the revenue he expects to receive from the sale of his product.
This economic calculation is crucial because every means can be used for the attainment of different ends, and every end can be attained through the use of different means. Platinum can be used either in the production of automobiles or in the construction of tunnels. Tunnels can be built out of either platinum or steel. Now, it may very well be that platinum is well-suited for the construction of tunnels, and that a tunnel made out of platinum would be far superior to a tunnel made out of steel. Without the guidance of market prices, then, it might seem sensible to construct tunnels out of platinum. But the price of platinum makes this impossible. The future income derived from the operation of the tunnel would never be great enough to compensate the builder for the present cost of the platinum. Economic calculation, the comparison between expected costs and expected revenues, ensures that the tunnel is built out of steel, and that the platinum is directed towards the production of automobiles, where the expected revenue from the use of the platinum does exceed its cost.
Without the use of economic calculation, some tunnel-builder may decide to use platinum to construct his tunnel and, by doing so, produce the greatest tunnel ever built. Yet, the magnificent tunnel would actually be a loss to society. The platinum used in its construction was more needed in other lines of production. In a market economy, such a massive misallocation would result in a massive monetary loss to the builder, ensuring that he could not make a similar mistake again. Meanwhile, a different tunnel-builder, who used steel to construct his tunnel, would reap profits from the operation of his tunnel. He allocated scarce resources in an economical way, and the market would reward him for his good work. In the next round of production he will have more money with which to purchase factors of production and provide for the needs of the consumers in a manner that is appropriate in light of the relative scarcity and importance of various resources. Market prices, therefore, not only make it possible for individuals to act economically in a cooperative society, but make economical action increasingly likely.
The economic system generated by the free-functioning of the market is capitalism. And, upon reflection, this makes much sense. A capitalist society is known for the prominence of capital, produced means of production, in its economic system. But capital is the accumulation of wealth from successive rounds of producing more than what is consumed. Capitalism, then, is nothing more than the result of many individuals engaging in economical (that is, profit-producing) action through the market process.
The market is the great tool of mankind in its struggle against the limits of scarcity, ensuring that valuable resources are not wasted and allowing individuals to achieve the most with the resources available, which is the same thing. It is the natural outgrowth of many personal economies, the spontaneous outcome of many people trying to arrange their available means in such a way as to maximize their subjective well-being. It is the most effective method of doing so known to man. Interference with the market economy, either through the erosion of property rights or through the imposition of price restrictions, reduces the market’s ability to function in the way that every individual so desperately needs it to function. Capitalism is the result of actors seeking to become better off. Interventionism and socialism limit the actors’ ability to do so; they limit the actors’ ability to act economically. But regardless of the level of intervention, the underlying economy is the same: it is always the striving of its constituent members to become better off. A move away from the market order does not change the “type” of economy, merely how economic it is.
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