Key Principles of Economics

Once you grasp the key principles of rational economic theory (i.e. Austrian economics) you will never see you and your children’s relationship with government in the same way again; your world-view may be flipped upside down, which can be a little disorientating, but is ultimately liberating. You will see the world for what it is, not as politician’s tell you it is. You’ll find you will have a lot more questions after emerging from the mainstream current of thought, and will realise that there’s far more uncertainty around how to solve complex social problems than politicians and the media would have you believe.

As economist Thomas Sowell once said “The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.”

After reading the primer below, I highly recommend reading ‘Economics In One Lesson’ by Henry Hazlitt, ‘Economics For Real People’ by Gene Callahan and ‘Economics Made Simple’ by Madsen Pirie.

The following is an excerpt from Austrian Economics A Primer by Dr Eamonn Butler. You can download the full book in PDF format here. I have extracted the section entitled Key Principles of Austrian Economics.

Dr Eamonn Butler is director of the Adam Smith Institute. He has degrees in economics, philosophy and psychology from the University of St Andrews. He worked for the US House of Representatives, and taught philosophy in Hillsdale College, Michigan, before returning to the UK to help establish the Adam Smith Institute in the late 1970s. He is author of books on the economists Milton Friedman, F. A. Hayek and Ludwig von Mises, and of primers on von Mises and Adam Smith for the Institute of Economic Affairs. He contributes frequently to print and broadcast media, and his recent popular books The Best Book on the Market, The Rotten State of Britain and The Alternative Manifesto have attracted considerable attention.

Key principles of Austrian Economics

• The economic decisions from which all economic phenomena derive are inherently personal and unpredictable.

• Value does not exist in things, but in the minds of the individuals who value them. Trade occurs and prices emerge precisely because people value things differently. Markets steer goods to their most valued uses. Private ownership is essential to achieving the best results.

• Government intervention, and policy mistakes such as inflation, disrupt this highly complex market process and invariably produce perverse results.

A number of key principles, or points of emphasis, distinguish
the views of Austrians from those of mainstream economists. Let
us start with ten. They cover all parts of the subject, from the very
nature of what economists ought to be studying, through how
individual prices come about (and their importance in directing
production and consumption), through the workings of the overall
economy, to policy prescriptions.

The first, methodological, points can be difficult for many people
to grasp. But a clear view of what science can and cannot tell us
about our economic life is essential if we are to explain everything
else correctly, and so it is right that we should start from here.

The foundations of economics

First, economics is all about individuals. That is because
economics is all about choice. We can’t have everything, so we
have to choose which things are most important to us: would we
prefer a new car, for example, or a summer holiday? To go out with
friends, or to relax at home? Invariably, we have to give up one
thing (an amount of money or time and effort, say) to get another
(such as a new pair of shoes or a tidy garden). These are economic
decisions – even when no money is involved. They are questions of
how we juggle scarce resources (cars, holidays, company, leisure,
money, time, effort) to best satisfy our many wants. They are what
economics is all about.

And they are decisions that can be made only by the individuals
concerned. A society does not choose; a collective has no life or
mind of its own; a state may decide things by elections, but it is the
individuals who choose which way to vote. The role of economics is
to understand choice and its effects, and we can only understand
that if we focus on how individuals make decisions.

Second, economics is quite unlike natural science. That is
because the things it studies are entirely different. The physical
sciences deal with natural objects, which can be observed and
measured. The facts of their nature and behaviour can be known,
and scientists can make predictions on that basis. Economics is

about how people choose, which means that it is about what they
prefer, and value, and intend, and believe about the world. These
are personal, individual feelings, which we cannot observe and
measure – nor therefore predict.

What we can do, though, is to explain human choices. We can do
this because we too are human individuals and we know how we
think. We can understand preferences, and values, and intents,
and beliefs about the world because we experience all of those.
And we can advance that understanding by working out the logic
of where those things take us – how markets and exchange actually
work, for example. But a natural scientist who looks at us as mere
objects, pushed around by outside forces, misses everything inside
us that gives us motivation and explains how we live.

Values, prices, and markets

Third, everything in economics rests on human values. Value is
not a quality that resides in objects, and which can be measured,
like their size or weight. The same good has different value to
different people, depending on how much use they have for it.
Someone in a rainy country may have very little use for a cup of
water, but someone in a desert may value it greatly. And people’s
wants and values change: a thirsty person may greatly value a
drink, but have no use for more once they have had their fill.
Goods, then, do not contain some fixed quantity of usefulness,
or ‘utility’. Usefulness is in the mind of the user: utility, and value,
are subjective.

But goods are limited, as are our own time and resources. We have
to make choices and weigh up the implications of those choices.

To take one course of action, we have to give up something else.
And what we give up we call the cost. It does not have to be a
financial cost – it might just be the time and effort we expend to
achieve some goal, or the various alternative possibilities we forgo
(what economists call opportunity costs). But these costs are
subjective too. What we weigh up is the value to us of what we
achieve against the value to us of what we surrender for it. That is a
personal decision: other people might make a completely opposite
choice. So economists must remember (say the Austrians) that
every economic decision – from investment to production to trade
and final consumption – is inherently subjective and depends on
the values of the individuals involved.

Fourth, prices help us maximize value and minimize cost. It is
because people value the same goods differently that they are
prepared to exchange them in market transactions. Each values
more what the other has than the thing they have to give up to get
it. We should not fall into the trap of supposing that because a pair
of shoes (say) sells for a particular sum of money, that this price
equals the value of the shoes. Value is personal. The person selling
shoes values the cash more than the shoes; the buyer values the
shoes more than the cash.

What prices do summarize, though, is the quantity of one
thing (shoes) that people in the market are in fact prepared
to sacrifice for another (cash). Prices are the going rates of
exchange between different goods. And they send out important
signals to market participants. If the price of something rises –
for whatever reason – it prompts buyers to use less, and switch
their spending to things they value more; and it prompts sellers to
produce more, and enjoy the extra money. Thanks to the crucial
information sent out by the price system, buyers and sellers

automatically adjust their choices to the new reality, and the
activities of millions of people are coordinated.

Fifth, competition is a discovery process. Markets are not perfect.
Indeed, it is the imperfections that drive them. They work because
people in the market spot new opportunities to trade for mutual
gain. Perhaps they see a cheaper way of making a particular
good, or a niche for services that nobody else is providing. Filling
these gaps enables them to make a profit by taking resources to
where they are most needed, and diverting them out of less valued
roles. And the lure of profit encourages people to be alert to such
opportunities and to innovate so as to capture them – that is, to act
as entrepreneurs.

The bigger the need that entrepreneurs fill, the bigger the profit
they can hope for – until their competitors follow suit. So the
pressure to develop new and better products and processes is
constant. Competition is a constant process of entrepreneurial
exploration, from which we all gain as better and cheaper ways of
satisfying our wants are discovered.

Sixth, private ownership is essential. Socialists believe that we
can do without the lure of profit by taking property into collective
ownership. Obviously this cannot work for consumer goods,
like shoes or spectacles, which cannot practicably be shared,
so socialists focus on the collective ownership of the means of
production. But if factories and machines are never sold, they
have no price. And where there is no price, there is no market
to help us to discover which things are scarce and to steer
resources into the gaps. The result is that socialist planners can
never know whether the means of production are producing
value, or being wasted.

The wider economy

Seventh, production is a difficult balancing act. Production
decisions may be impossible for socialists with no prices to go on,
but they are not easy for private owners either. The sole purpose of
production is to make the goods we consume. But all production
takes time, and may require complex intermediate steps that are
brought together in just the right way. At any time and point in this
intricate process, changes in prices (say, rising energy or labour
bills) or demand (say, a competitor produces a better product) can
knock things off course.

If the capital goods used in production could be re-used for any
purpose, then entrepreneurs might be able to recover from such
disappointments. But many capital goods (such as steel mills or
newspaper presses) have only one specific purpose. Production,
then, is a risky business, and carries a real risk of loss.

Eighth, inflation is deeply damaging. The risk of loss is widespread
when governments make mistakes with money. To Austrians,
money is a good like any other: it has a supply (usually determined
by government authorities) and a demand (people value it as a
convenient medium for making exchanges). If government increases
its supply, then that value slips. Sellers demand more of it for the
goods they sell – so money prices rise. This is the process of inflation.

Inflation is good for debtors, who find themselves repaying loans
in money that is not worth so much, and bad for savers, which
unbalances the loan markets and the production processes that
depend on them. But worse, prices in an inflation do not rise
instantly and uniformly. They rise first where the extra money
goes in (government enterprises, for example), and then spread

gradually to other sectors, like treacle pouring onto a table. So
resources are drawn first to one sector, then another, creating
temporary booms. But as the money spreads out, the booms
subside, businesses find their investments wasted, and the result is
an inevitable and widespread bust.

Society and government

Ninth, actions have unintended consequences – good and bad. On
the good side, it does not always take conscious planning or design
for human beings to create something that works well. Often they
do it unintentionally, as a by-product of their action. People walking
between one village and another think only of finding the easiest
route, but gradually wear down a path that helps everyone. Buyers
and sellers think only of getting value for themselves, but millions
of such exchanges create a price system that draws effort and
resources to their most valuable uses. Money emerged simply
because people wanted some generally accepted medium of
exchange. Language grew from the need to communicate. And a
body of common law grew up as people resolved their differences
case by case.

The moral is that we should not presume institutions to be
unstructured and inefficient just because they have not been
deliberately designed and planned. On the bad side, our attempts
to ‘improve’ on social institutions – such as the free market economy
– often unbalance the intricate mechanisms that make them work,
and lead to catastrophic consequences that we did not intend.

Tenth, government intervention is almost always malign.
Individuals have limited ability to disturb the balance of our intricate social institutions, but the huge and concentrated power of government makes it easy. Central banks, for example, like to keep interest rates low, encouraging entrepreneurs to borrow and boost production. But as the boom ripples from sector to sector and then fades away, productive resources are wasted and the population are made poorer.

Governments may advocate minimum wage laws to help poor
workers; but then some workers are not worth that amount to
employers, so unemployment rises. Rent controls, similarly, may
be adopted to help poor tenants; but that just prompts owners to
stop renting out their property and do something more profitable.
Regulators may impose tough new standards to protect the public;
but the extra costs make it harder for new operators to come in,
competition declines, and the public end up with a worse deal.

And government action is usually misplaced in another important
way. There is no way that officials can know what individuals do in
fact value. They cannot look into our minds and know whether we
would gladly pay more taxes to have better schools or hospitals,
for example. Market prices could tell them what the public is
prepared to give up for such things, but by ignoring prices and
trying to ‘improve on’ the market, they inevitably fail to maximise
our values. In a vibrant market, where people constantly adjust
their plans against changing conditions, officials could not even
collect the necessary information before it became out of date, and
could certainly never know what people would choose. Perhaps the
government has a role in making sure markets work smoothly; but
as far as Austrian economists are concerned, it has no business
intervening in them.

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2 thoughts on “Key Principles of Economics

    1. I guess I’ve read it a couple of times. I always use my Kindle to highlight extensive sections of everything I read, though, and refer back to the list when needed.

      Liked by 1 person

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