Austrian Economics 101, Part 2
Human action
Economic analysis is fundamentally the examination of human action. The Action Axiom states that humans act in order to achieve ends. This obvious statement has profound implications when applied to the economic sphere of production and exchange.
Human action is purposeful behavior. Or we may say: Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego's meaningful response to stimuli and to the conditions of its environment, is a person's conscious adjustment to the state of the universe that determines his life. Such paraphrases may clarify the definition given and prevent possible misinterpretations. But the definition itself is adequate and does not need complement of commentary.
—Ludwig von Mises, Human Action
In short, we use reason to choose actions which we believe will effect our desired ends. Humans are rational, acting beings. This obviously does not require that humans always act rationally, their reasoning always be correct, or their intended ends actually satisfy their wants. This then is the first hurdle if we are to understand economics.
Reasoning can be unsound. The information available may be incomplete or erroneous. Matters beyond the individual's control may interfere. None of this negates the rational nature of the individual, but it does affect the outcome of the chosen action.
Crusoe Economics
The first step in examining human action is examining the individual. The classic example is Robinson Crusoe. Narrowing focus to a single individual allows clear examination of the individual's hierarchy of wants as it changes due to circumstances, the purpose of saving for future needs, how investments in the production of capital goods improve his future productivity, and more.
The addition of Friday then adds another layer of economic thought to explore. The presence of another individual establishes the need to define property rights in order to prevent conflict. This also enables a simplified examination of exchange, mutual benefit, comparative advantage, specialization, and the larger issue of coercion versus cooperation.
These fundamental principles once explored at the smallest possible scale create the foundation to explore the wider web of human interaction and production as it expands exponentially with each new acting individual involved.
The market process
If the network of acting individuals is so complex, and human rationality so vulnerable to error, how can we promote wide information availability to all of these economic actors? Well, we actually have a system for that very purpose: The market.
"The market" is not a tangible thing, but rather a description for the effect of innumerable exchanges between individual economic actors. The price mechanism is literally an organic grassroots information network broadcast to each individual consumer, allowing the individual to choose how to allocate his resources in order to satisfy his wants. Sales volume informs the seller how well his price balances his supply with the demand for his product or service just as prices inform the buyer how he might balance his supply of money with the demand for sales. Voluntary exchanges are always a two-way transaction despite the common perception.
If sale prices vastly exceed production costs, and supply is low, there is an incentive for other providers to enter the market and compete for this consumer demand. As supply is provided to meet demand, prices drop through competition until an equilibrium is achieved. If supply exceeds demand, however, prices must drop until they reach a new lower equilibrium with demand.
This effect of a constant shift toward an ever-changing equilibrium point along with innumerable reponses to incentives in consumption and production is what was meant by Adam Smith's "Invisible Hand" analogy, where the result of many people acting in their own self-interests engage in voluntary exchanges and create the appearance of order out of the chaos.
Price controls
In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause — it is seen. The others unfold in succession — they are not seen: it is well for us, if they are foreseen. Between a good and a bad economist this constitutes the whole difference — the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, — at the risk of a small present evil.
—Frédéric Bastiat, That Which is Seen, and That Which is Not Seen
Many people fear the chaos inherent in the market. This often manifests in demands for political intervention to fix prices, impose regulation industries, and otherwise impose an artificial order rather than seek an understanding of the organic order of the market. Pandering to shortsighted desires and special interests invariably has adverse effects on the economy.
One of the easiest areas to examine these adverse effects of interventionism is in price control schemes. When price controls are imposed on a product or an entire industry, the price point is an arbitrary decision intended to serve political interests rather than an organic equilibrium discovered by market action. Price controls are impossible to maintain without governmental support due to the high cost of enforcement against the organic market process described above. But what are the effects?
If the price mandate is set high according to the wishes of corporate cronies in order to boost profits, the consumer is harmed by an artificial scarcity of the good or service in question due to excessively high prices, and potential competitors are harmed by being forbidden from serving the demand at a better rate. This kind of protectionism is quite blatantly obvious, and is perhaps the chief reason "capitalism" gets such a bad rap since it is quite popular in the US and Europe. However, this is antithetical to the market process, which is also called "capitalism" despite being in complete opposition to such interventionism.
Another problem occurs when the mandatory price is set too low. If there is no benefit to providing a good or service due to an artificially low price, not only is it unlikely to be produced in sufficient quantity due to the lower incentive for production, but the low price artificially increases demand as well, doubling up on the factors to create another kind of artificial shortage. Along with the economic calculation problem mentioned in part 1, this is one of the reasons centrally-planned national economies develop an inability to provide basic necessities.
As in part 1, this is just an overview of some basic concepts. Please comment below if you would like to discuss these ideas further!
Image 1 credit: Wikipedia
Image 2 credit: Faith is Torment
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