Reading: Introduction to Microeconomics
“Every individual...
neither intends to promote the public interest, nor knows how much he is
promoting it... he intends only his own security; and by directing that
industry in such a manner as its produce may be of the greatest value, he
intends only his own gain, and he is in this, as in many other cases, led by an
invisible hand to promote an end which was no part of his intention.”
- Adam Smith
“The
Theory of Moral Sentiments”
Adam Smith was an 18th century Scottish philosopher renowned as
the father of modern economics, and a major proponent of laissez-faire economic
policies. Smith was a fierce opponent of mercantilism. These characteristics of
Smith led him to become
known
as the father
of modern free trade and the creator of the concept now known as GDP. In
his first book, "The Theory of Moral Sentiments," Smith proposed the
idea of the invisible hand—the tendency of free markets to regulate themselves
by means of competition, supply and demand, and self-interest. Smith is also
known for his theory of compensating wage differentials, meaning that dangerous
or undesirable jobs tend to pay higher wages to attract workers to these
positions, but he is most famous for his 1776 book: "An Inquiry into the
Nature and Causes of the Wealth of Nations."
* Laissez-Faire is an economic system in which transactions between private parties are free from government intervention such as regulation, privileges, tariffs, and subsidies.
*Mercantilism
promotes governmental regulation of a nation's economy for the purpose of
augmenting state power at the expense of rival national powers. Mercantilism
includes a national economic policy aimed at accumulating monetary reserves
through a positive balance-of-trade, especially of finished goods.
Historically, such policies frequently led to war and also motivated colonial
expansion
Adam Smith’s “Invisible Hand” quote is at
the core of capitalism. Smith’ book “The Wealth of Nation’s”, which reinforced
the idea of the “Invisible Hand” and free market capitalism, was published the
same year as the Declaration
of Independence
was written in 1776.
America promotes
free democratic society, while Adam Smith promotes the ideas of true free
market capitalism. Not surprising the economical sentiment was correlated to
the political sentiment of the time, freedom.
Adam Smith thought that self-interested action
frequently
leads
to greater innovation, better
investment, and
more productivity,
which will lead to more individual
wealth.
Adam Smith’s “Invisible Hand” quote is a prime example of Microeconomics as a study of individual economic actors: firms, people, households, etc. and how they make cash allocation decisions about scarce resources.
Scarce
Resources
Scarcity refers to the basic economic problem, the
gap between limited – that is, scarce – resources and theoretically
limitless wants. This situation requires people to make decisions about how to
allocate resources efficiently, in order to satisfy basic needs and as many
additional wants at possible. Any resource that has a non-zero cost to consume
is scarce to some degree.
Money and time are quintessentially
scarce resources. Most people have too little of one, the other, or both. An
unemployed person may have an abundance of time, but find it hard to pay rent. A
hotshot executive, on the other hand, may be financially capable of retiring on
a whim, yet be forced to eat ten minute lunches and sleep four hours a night.
Even
resources that we consider infinitely abundant, and which are free in dollar
terms, are scarce in some sense. Take air, for example. From an individual's
perspective, breathing is completely free. Yet there are a number of costs
associated with the activity. It requires breathable air, which has become
increasingly difficult to take for granted since the industrial revolution. In
a number of cities today, poor air quality has been associated with high rates
of disease and death. In order to avoid these costly affairs and assure that
citizens can breathe safely, governments must invest in methods of power
generation that do not create harmful emissions. These may be more expensive
than dirtier methods, but even if they are not, they require massive capital
expenditures. These costs fall on the citizens in one way or another. Breathing
freely, in other words, is not free.
We are going to study how people use scarce
resources and how this impacts prices and markets. We will attempt to quantify
economics, to make them mathematical by
illustrating market assumptions through charts and graphs. We should start with trying to understand
how people think and observe if people make rational economic decisions, and
how these decisions impact markets.
In the philosophy of making decisions in
microeconomics, economists
must make some
assumptions to
simplify the mathematical process. Most economists feel people
are rational and will act in their own self-interest to maximize
their gains. This isn’t always true because people are motivated by many
different things.
Economists
look to
simplify these motivations so they can deal with the
decision making process in
a mathematical sense. Quantifying
the decision making process is valuable because now economists
can
prove their
rationale and
quantify the
economic decision
making
process. This allows economists to have a good idea as to what is going
on in the markets, relative to supply and demand and pricing. It is very
valuable to have these tangible calculations to help guide future decision making.
Unfortunately, the simplified assumptions economists are making in these economic graphs and charts can be misleading due to the fact that these are simplified conclusions, which you may feel very strongly about, because it looks like you have proven them with the charts, graphs, and data. These conclusions are based on some assumptions that might be wrong, or might be over simplified, or might not be relevant to the context that you are trying to make conclusions about. Take all the simplified economic data with a grain of salt, because it is all based on simplified assumptions.