The Economics of Everything I: The Basics

Author: Joost Haddinga                                                                                                                                                                          Date: 30-05-2022                 

Where do we come from and where are we heading – or: do we know what are we are doing?

Could you answer the question “what is economics actually”? Turns out, it is more than just “a study of the (optimal) allocation of scarce resources which have multiple uses – and that there is not even a final answer to that problem. Behavior, human qualities and biases, mathematics, philosophy, and sociology are all part of this study as well. The fundamentals are clear to most, though: Most have heard of Adam Smith as the grandfather of Economics, disregard the homo economicus as a useless prick, understand that somehow there are supply and demand (although the workings are not always clear) and that pure Economics are not Economics – and especially not life. So let’s take a deep dive into The Economics of Everything. This is the first of four parts of this mini-series.

If you take just one thing out of this, then it should be to look at everything in life as an interplay of supply and demand. Whether in dating, work, raising children or purchasing just about anything, there are always demanders and suppliers – varying in power and number, but they are always there – if they weren’t the life as we know it would not exist. The second thing is, we humans are clearly not rational (at least not always), so all the beautiful graphs and models are basically useless in reality. So far so good, thus economics is alienated from reality, and we shouldn’t bother apart from this first point, right?

Of course not, Economics weren’t Economics if it could not also find models for some irrationality or find ways to incorporate human behavior into this discipline: There we go with Behavioral economics. Sounding a bit sketchy with Game theory, Nash equilibria or Prisoner’s dilemmas, it can actually provide some good insights how humans behavior socially and with others. Not everything is classical economics, not everything is linear and to be built on clear premises. But some things are fundamental, and they just hold true – with which we are back at Adam Smith again: Even though disliked by some for his egoistic approach, it still holds true that economic progress stems from the fact that people want more and better for themselves. For that, just look at yourself: Why do you work, why did you go to school? Maybe to live a good life or maybe to provide for your children so they might once have it better than you? If yes, then it likely that your self-interest boosted some processes and contributes to economic welfare and progress. And with that we are back a supply and demand again: Someone demands labor or education; another one offers it – and in the negotiation for salaries you can apply game theory. 

To get this negotiation, we need a market. In our lives markets seem either intangible as in Global Capital Market or very small as in ‘going to the local market’. And that is how it is – markets are everything, every place in which people come together for any, and yes: any, transaction or exchange. This can be goods, money, love services or anything you like. This does not always sound appealing – and a drawback of economics is that become a bit more cold-hearted in some situations – because treating a friendship as a market exchange of mutual feelings sounds more than just a bit off, but it remains still the reality. When thinking about any transactions you also don’t get around applying economic principles, namely: Cost-benefit-analysis – what must I give, what do I get in return and is the result good for me or not. Mostly this is done automatically (e. g. which milk or bread to buy, when to go to bed) and sometimes it involves a careful weighing (e. g. purchase of a new car, changing jobs). But given the complexity of our world this is where things go astray: You can never weigh all costs and benefits, and most have absolutely no price tag involved. So, what to do – let the taste reign or succumb to austerity and only look at what looks best pecuniary? Just be aware that tastes matter and when in doubt trust your gut – know that utility does not just depends on numbers, but also your feelings. The only thing you absolutely have to consider are opportunity costs. Often also done implicitly, they clearly deserve their place: They are the net benefits of everything you do not do in order to do what you do. It is not enough that working for a bank gives you €50k a year and you think that is worth it if you could just earn €60k per year as a football coach, with less working hours and more enjoyment. What goes here also goes in relationships, what do you give up by going out with your boyfriend to the movies – maybe a sleepover with the girls (and what is worth more?), you get the gist.

When all these exchanges are taken care of and all negotiations and actions were carried out, you may enter a stage that can be called the wet dream of every economist: Equilibrium. This is like marrying the woman of your dreams, relaxing on your own private yacht on travelling the world – your end goal. This is a situation in which all involved parties are conditionally happy with their outcomes, and no one wants to deviate anymore. Your home is in equilibrium when everyone willingly accepts their tasks and carries them out, leaves each other enough space and is satisfied living there. This does not mean though that things are efficient – not everything must go perfect in equilibrium – just good enough so that everybody does not desire change: Knowing that a glass will break every once in a while or the bus might block your entrance is fine as long as the glass is cleaned up quickly and you still always find a parking sport nearby, and even enjoy a beautiful garden view which you could hardly get anywhere else.

We can clearly go somewhere else after this – just because Economics is not always about you, at least not you in person. Some things are just bigger than you and some things are just not for you. Still they influence you in ways you might like or dislike – just to give a glimpse: The macroeconomy with industry, electoral cycles, growth and trade. Stay tuned for the next episode!

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