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.