Economic Foundations

by Don Boudreaux on September 1, 2009

in Economics

The late Arthur Seldon offered a darn good, and nicely concise, list of the important foundational tenets of economics:

Production takes place for consumption (derived from the Scot Adam Smith), not the other way round.  Value is measured not as an average but at the margin (the Englishman W. S. Jevons, the Frenchman Leon Walras, and the Austrian Carl Menger).  The cost of producing a commodity or service is not the labour required (the German Karl Marx) but the commodity or service thereby lost (the Austrian Friedrich von Wieser).  The instinct of man is to “truck and barter” in markets (Adam Smith).  He will find ways round, under, over or through restrictions created by government (the Austrian Eugen von Böhm-Bawerk).  There is no such thing as absolute demand (for education, medicine or anything else) or supply (of labour or anything else) because both vary with price (the Englishmen Alfred Marshall, Lionel Robbins and many before and since).  Not least, without the signalling device of price, man cannot spontaneously and voluntarily co-operate for prosperous co-existence (the Austrian Ludwig von Mises and the Austrian-born but voluntarily-British Friedrich Hayek).

(From page 6 of Vol. 7 of The Collected Works of Arthur Seldon.)

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{ 54 comments }

Anonymous September 1, 2009 at 1:42 pm

I think the “and many before and since” should also be applied to the final parenthetical. Excellent list!

Anonymous September 1, 2009 at 2:21 pm

I would offer one refinement:

“Production must precede consumption — otherwise, there will be nothing to consume.” – Ayn Rand

sandre September 1, 2009 at 5:05 pm

Say’s law. Long before Ayn Rand

Anonymous September 1, 2009 at 5:08 pm

Say had a stronger and less definsible version of it… I think the Smith citation is good. Besides, Smith preceded Say anyway.

sandre September 1, 2009 at 5:24 pm

I was responding to Michael Smith, which Smith are you talking about?

Anonymous September 1, 2009 at 5:44 pm

Adam – a slightly weaker version of the stronger version of Say’s law was mentioned in the post and attributed to Adam Smith.

Sorry – didn’t even think of that source of confusion!

Anonymous September 1, 2009 at 9:52 pm

Good point. I read it first in Rand’s non-fiction, but you are correct, it is Say’s observation.

Now if only we could get someone in the Obama administration to understand it.

Anonymous September 1, 2009 at 11:18 pm

I thought Say’s law was that production produced its own consumption (meaning you pay consuming workers to produce).

Justin P September 2, 2009 at 1:30 am

Silly rabbit.

Anonymous September 2, 2009 at 1:59 am

??

CRC September 1, 2009 at 2:54 pm

I would add the fact that value is subjectively determined by each individual which is why things end up not being a zero-sum game.

Anonymous September 1, 2009 at 11:20 pm

Which is also why forcing people into an exchange destroys wealth, while allowing them to do so voluntarily creates wealth. Both, BTW, increase GDP and make the Keynesians smile.

simon... September 1, 2009 at 4:09 pm

“Value is measured not as an average but at the margin” – I don’t think I understand this – could anyone please elaborate?
Thank you!

Sam Grove September 1, 2009 at 4:55 pm

My uninformed take is this:

For any product or service on the market, it’s subjective value varies according to customers and prospective customers. Some may value it not at all.

The actual market price arrives at the intersection of the supply/demand curves, not at the average of those subjective values.

The price is closer to that above which no one would buy it than it is to zero.

JohnK September 1, 2009 at 4:59 pm

I think that means that profit as a number by itself is meaningless unless is is related to the cost of doing business.

Guest September 1, 2009 at 5:23 pm

Good question. I will endeavor to answer it as fully as possible.

I have found that that best possible way to convey marginal value is by illustrating it.

Let’s say that you are craving M&Ms, and you only have about twenty or so to eat. (I’m going to use some numbers here, but only for purposes of clarification). So you value each individual M&M at about 1/20th of the whole.

Now, let’s say that you win the M&M lottery and that you now have twenty thousand M&Ms. As a result, you value each individual M&M at about 1/20,000.

What it means is that each additional M&M means less to you, right?

Name September 1, 2009 at 6:31 pm

This is not exactly true. You are still averaging the value of the M&Ms. If you were REALLY craving chocolate and there were a pile of 20,000 M&Ms in front of you, you’d value the first M&M far above 1/20,000. (If an M&M cost $0.01, you may want one so much that you would be willing to pay $1 to get one). As you ate more and more, the value would approach 1/20,000 (i.e. You’d pay the $0.01) and would eventually fall below 1/20,000 (i.e You would rather spend your $0.01 on something else). The value of M&Ms is NOT the average of the $1 you’d pay for the 1st + the price for the 2nd + … divided by 20,000. The value of any individual M&M (to you) depends on how many you’ve had and how much you want another. It’s not based on the average of how much you would pay for all of the M&Ms.

Anonymous September 1, 2009 at 7:46 pm

Well yes and no. The average value of the M&Ms is indeed the “$1 you’d pay for the 1st + the price for the 2nd + … divided by 20,000″. And the total value is that sum, just not divided by 20,000.

I think the initial framing of the issue was odd. I think Seldon was wrong to write “Value is measured not as an average but at the margin” – value is enjoyed as an average per M&M, or simply as a total value figure. The point is that DECISIONS are made based on marginal value, not average or total value. You still enjoy the average or total value.

So the insight of the marginalists that Seldon mentions was that when you weigh the marginal benefit of one more M&M against the marginal cost of one more M&M, you will keep buying and eating until these two values are equal, because THAT is the point that maximizes the average value of M&Ms eaten. So average value is still definitely important – that’s the whole point. But decisions are made on the margin.

Guest September 1, 2009 at 8:02 pm

Right. This is why I hesitated to use numbers. You and I are saying the same thing.

I used the 20 and 20K figures to make each unit more stark. Don’t get so caught up in the figures I used to miss that you miss the point I was illustrating. If I had used say two M&Ms and said that you value the first more than you value the second, the subtlety between the two would have caused many to miss the point (or at least, I felt that it would).

Rereading my post (sorry, I was in a rush when I typed it) I realize that I didn’t make it clear that each individual unit means less as they’re consumed; my mistake.

simon... September 1, 2009 at 5:45 pm

OK. So it means that value could be measured only against specific set of circumstances, i.e. value of a lifeboat in the middle of the ocean vs. value of exactly the same lifeboat in the middle of a desert. And the average of two is completely meaningless.

Guest September 1, 2009 at 5:59 pm

Hammer meet nail. Well said.

Anonymous September 1, 2009 at 11:28 pm

How much you value a particular type of your property depends upon how many units of it you have. E.g., if I own a truckload of apples, then an apple has one value. If I only own 1 apple, then an apple probably has a greater value.A real life example is energy. 30-year-old nuclear power plants produce the cheapest energy. Natural gas energy costs more. Nuclear power plants therefore run continuously regardless of demand (provide base load), while gas plants are only added in as the price increases to make it profitable. But if gas power is being used, ALL power costs the gas-rates. Power is priced on the margin, and the most expensive power brought on line determines that price. And that price is the same whether the nuke:gas production ratio is 1:100, or 100:1. Even a single unit, at the margin, will determine the price.

simon... September 2, 2009 at 3:58 am

Am I completely wrong here or several posters confused price and value as they were the same thing… are they the same thing?

Aren’t the prices (in unregulated market, so energy is probably not a very good example) set by supply and demand, not by cost of production?

Anonymous September 2, 2009 at 4:54 am

“confused price and value as they were the same thing… are they the same thing?”

The principle of marginal utility, or marginal value has several corollaries, or applications. The underlying abstraction is that of a unit on the margin determining the value (individual or collective) of all units.Your personal value for something is determined by those things you’d be willing to exchange for it. Dollars is usually one of those things. Supply and demand are the summation of a whole population of such individual choices.

“so energy is probably not a very good example”

There is a private market component to energy production, and as a matter of fact, not all energy production is profitable at the same price levels. If demand (or set rates) is such that you cannot get enough to cover the costs of energy production in the plant that you own, then you won’t produce. If demand grows and prices become profitable, then you will produce–BECAUSE prices are at your profitable level. Thus, the price of energy is said to be set by YOUR price level–you being the plant on the margin. The old nuke plant in the next county with lower production costs also gets those higher prices.

“set by supply and demand, not by cost of production?”

The “supply” part of “supply and demand” has something to do with cost of production. Supply and demand curves are aggregates. One person’s demand or supply “curve” for a unit purchase is a step function determined by the highest (or lowest) price at which he will buy (or sell) (this is a little different than the traditional utility curve description). The summation of many different individual step functions (reflecting many individuals’ different valuations) approximates the usual supply and demand curves.

Mike September 1, 2009 at 5:08 pm

http://webpages.charter.net/windchill/Economics/EconomicsFactors.html is my attempt to assimilate the foundational factors of economics from various economic “laws” lists and writings.

Anonymous September 2, 2009 at 12:51 am

Nice condensation.

DG Lesvic September 1, 2009 at 5:46 pm

The most important “idea” in economics today was that of people with no thought it, the idea of the Internet. For, it has transformed economics as much as Adam Smith.

There have been three major phases of economics.

The first was the hundred year period after Adam Smith, the golden age of economic freedom, and of amateur economics.

The second was the hundred years of professionalized and institutionalized economics, and of war, holocaust, and genocide, that followed.

And, now, the Age of the Internet, is, again, an age of the amateur in economics.

During the age of the professional, and the closed shop of economics, with amateurs like myself on the outside looking in, like little children with our noses pressed up against the candy store window, I wrote, for an unlikely reader:

“Imagine, in a completely free market society, a journal of professional economics with a layman’s corner. How long do you think it would be before all the rest of it disappeared and there was nothing left but the layman’s corner?”

Now all that has come to pass. With no closed shop on the Internet, economics is once again a wide open free market of ideas, with the “consumers” again in charge.

Rather than the amateurs forced to conform to the language of the professionals, the professionals must conform to that of the amateurs, and there are no more obstacles to theconomics, no more impenetrable, intimidating language, no curves, angles, and tangents, but the straightforward, plain and simple, logical and literary economics of the amateur founders and pioneers of the science.

And, if the politicians don’t blow up the world before they get the chance, amateur economists will again usher in a golden age of economics and economic freedom.

sandre September 1, 2009 at 6:29 pm

Excellent Comments, DGL.

Anonymous September 1, 2009 at 7:55 pm

You seem to suggest that the division of labor, which has worked so marvelously in all other disciplines, occupations, and industries, has somehow failed the economics occupation.

Sam Grove September 2, 2009 at 12:37 am

I think he’s suggesting that monopoly is a negative in economics dialog.

Justin P September 2, 2009 at 1:35 am

No, just like the horse buggy maker had to adapt to the model-T, now economic elites like Krugman, Summers, Mankiw, and Delong have to compete with an emerging market in economic thought.
Like Sam said, monopolies cause deadweight loss. Competition is the key!

Anonymous September 2, 2009 at 9:45 am

I guess I just don’t see how thousands of professionals that fight and argue constantly (have you ever been to an economics workshop? It’s brutal) constitute a monopoly, why amateurs couldn’t submit their ideas in past decades (exactly what was stopping them??? Can someone fill me in?), and why dg characterizes it as a “closed shop”. Of course competition is good. How do you think Krugman, Summers, Mankiw, and Delong got identified as some of the best of the best? Competition. Division of Labor.Dg lesvic likes to wax poetic – but I think the heart of it is that he just didn’t like the kind of econonomics that most people came up with in the last century or so. There was no closed shop. There was no monopoly. Dg lesvic just gets a rush because he can have his own website now. And that’s great – it’s great that he is finding it easier and easier to get his ideas out.

Anonymous September 2, 2009 at 9:49 am

I also like how you call them “economic elites”. Gives them an air of entitlement. But the fact is they worked at it and they all came up with brilliant stuff. They’re no more elite than you or me. They’re just successful. It would be a shame to hold that against them!

Justin P September 2, 2009 at 8:23 pm

There are huge entry barriers to publish anything in any Scientific Journals. Even then, if you don’t write about the pop topic of the day, you’ll never get your paper published. Ask Don, Russ or Pete how hard would it be for Mises or Hayek to get publish in today’s econ journals.

Anonymous September 2, 2009 at 12:37 am

Sadly, economics has become, predominantly, the study of government financing. Economists’ creativity is diverted toward that end.

Justin P September 2, 2009 at 1:32 am

Very Hayekian….excellent!

Dano September 1, 2009 at 6:28 pm

I quoted Jevons earlier today:

“Value is the most invincible and impalpable of ghosts, and comes and goes unthought of while the visible and dense matter remains as it was. ” “Investigations in Currency and Finance,” pt. 2, ch. 4 (1884).

louh September 1, 2009 at 10:21 pm

Isn’t Jevons the fellow who believed the stock market moved in 10 year cycles following the pattern of sun spots?

louh September 1, 2009 at 11:02 pm

It may be easier to visual the value as derived from the marginal theory of labor. That is the worth of the first marginal employee. That marginal employee who contributes less than unit of labor. In the marginal theory of value it’s the tipping point where one more unit of production drives supply to exceed present demand.

Anonymous September 1, 2009 at 11:35 pm

The value I place on a product has nothing to do with how somebody values the labor that went into it.

Value is subjective, but subject to some objective rules.

louh September 2, 2009 at 1:14 am

absolutely, marginal utility is the pleasure one derives from the extra unit produced

DG Lesvic September 2, 2009 at 11:00 am

Daniel,

I don’t know how much experience you have in economics, but I’ve been at it for forty years or more, and can tell you that this wonderful new world of the Internet is the free market of ideas that I could only dream of, and feared I’d never see. So, I go to sleep every night saying thank you to its inventors, to our hosts, and all the rest of you here, the amateurs, in spirit if not always name, and the best people in the world..

to Ludwig von Mises, to our gracious hosts, and even to you, and all the other lovers of the science, the amateur economists.

all I can tell you, whether you believe it or not, that for forty years or more, I have been challenging the economics establishment in every way imaginable and at great expense, but to no avail, until I entered into this wonderful new world of the Internet. Here, for the first time, I have found the free market of ideas.that before I could only dream about. And that’s a fact.

Anonymous September 2, 2009 at 1:47 pm

I hope you’re not thinking I’m saying the internet isn’t a fantastic development.But dg, the sad truth is if you didn’t make a dent before the internet it could possibly be because what you offered wasn’t up to snuff. I can’t say, because I have no idea what challenge you’ve been putting out there for forty years. But just because you weren’t successful for forty years doesn’t mean the market for ideas wasn’t competitive. Don could tell you this – it’s the basis of his views on antitrust. Just because a few producers dominate a market doesn’t mean that that market isn’t competitive.Take your theory about redistribution and inequality.That might not have gained traction because it COULD be that it’s a closed shop or a monopoly and you’ve been unfairly restricted as an amateur.Or, it COULD be that it’s just a bad, wrong, unconvincing idea.The internet lowers transaction costs – it allows you to more easily share your ideas with other people. But don’t suppose that the absence of the internet is responsible for your past failures, or that some elitist insularity is responsible. There have always been thousands of economists with lots of disagreements among them. No journal or conference ever restricted you from submitting your thoughts because you’re an amateur. If you failed in the past it was probably because someone measured you up against these “professional” economists that you’re so angry about and concluded that the professionals did a better, more convincing, more preferable job.I’m sorry but you can’t conclude that the market, competition, and the division of labor disappear just because you weren’t successful.

Anonymous September 2, 2009 at 4:12 pm

“Or, it COULD be that it’s just a bad, wrong, unconvincing idea.”

No, that couldn’t be. It is basic supply and demand. It derives from the same econ 101 theory that Keynesians and everyone else uses. Draw your curves, shift for progressive taxes, and see what happens to pre-tax income disparity as incomes move toward the new equilibria.

Anonymous September 2, 2009 at 5:19 pm

Well that will depend on the wage elasticities for different groups across the income spectrum – I’m not sure it’s quite as easy of a question to answer as you think it is. But either way, definitely. That’s the approach to take. Or don’t cite any existing economic framework and make your own original argument, as dg usually likes to.

The WRONG approach is to whine that you’ve somehow been wronged by an imagined “closed shop” of professional elites.

Anonymous September 2, 2009 at 5:50 pm

“Well that will depend on the wage elasticities for different groups across the income spectrum”

No. The FACT of growing pre-tax income disparity with progressive taxation (as opposed to the DEGREE of disparity) does not depend upon those things, unless you are asserting the unusual circumstance of perfect in/elasticity or Giffen good, in which case the burden is on you to demonstrate that oddity holds true. And in this case, I wish you luck.

“Or don’t cite any existing economic framework and make your own original argument, as dg usually likes to.”

For thinking people, that is not an issue. The merit of any argument lies ENTIRELY within its own validity and premises. Appeals to popularity or experts or age or convention is decidedly anti-intellectual.

I find supply and demand theory to be a very useful shorthand for diagramming many economic ideas, but I don’t confuse the theory, which is a useful tool, for the ideas themselves. The tool, in fact, is flexible enough to explain pretty much any conflicting ideas. Taking the theory as primary exposes a lack of understanding. Being able to understand and explain an idea without using those tools reveals an understanding.

DG Lesvic September 2, 2009 at 4:34 pm

Why did I allow myself to get dragged into a discussion with Daniel?

Vike, you’re right. I was tired.

Anonymous September 2, 2009 at 4:59 pm

At least he’s an easy target.

Anonymous September 2, 2009 at 5:21 pm

dg – when you attribute something unfortunate that’s happened to you to the exclusivity of a professional elite – and not to the merits of your own work – you need to expect a little criticism.

Anonymous September 3, 2009 at 1:08 pm

And one more foundational tenet that Dr. Seldon forgot: In spite of the preoccupation of classical and neo-classical economists with the virtues of competition, the actual fact is that we live in “a world of monopolies” (Joan Robinson – Economics of Imperfect Competition.)

DG Lesvic September 3, 2009 at 1:14 pm

I keep seeing contributions to this discussion in my e mail that don’t show up here.

What is that all about?

The whole subject of the professionalization and cartelization of economics is something that I dealt with very extensively in Intellectually Incorrect, The Amateur Science of Economics, and the Professional War Against It, which is Book II of my overall book. Straightening Out the Spectrum or Why I’m an Extremist is Book I. The overall book is called Dumb Jews. It is all available at http://www.econotrashtalk.org,, or by clicking on my name below. That site is still “under construction,” But, in a rough form, everything is pretty much there.

One of the main points I make is that new ideas are never excluded because they’re wrong, but only because they’re right.

Anonymous September 3, 2009 at 4:59 pm

Excellent list!

Politicians should learn it by heart (let alone some economists)

Anonymous September 2, 2009 at 5:56 pm

“For thinking people, that is not an issue. The merit of any argument lies ENTIRELY within its own validity and premises. Appeals to popularity or experts or age or convention is decidedly anti-intellectual.”

Yes, I agree

Anonymous September 3, 2009 at 9:49 am

Well I see Hayek cited all the time in journals. But once again, nobody is preventing anybody from submitting. If Mises doesn’t get in, maybe it’s worth considering that Don and Russ have a unique and often unshared opinion on the quality of Mises. And of course it’s hard to get in a journal – that doesn’t mean there’s an entry barrier. Everyone goes through the same review process. I just don’t get this “I’ve had a tough time so it must not be competitive” perspective.

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