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Economics in One Day

Companion Study Guide

Compiled and written by: Jason Riddle Dan Sanchez

FEE.org/Courses

The Foundation for Economic Education (FEE) is a non-political, non-profit, tax-exempt educational foundation and accepts no taxpayer money. FEE’s mission is to inspire, educate and connect future leaders with the economic, ethical and legal principles of a free society. This work is licensed under a Creative Commons Attribution 4.0 International License, except for material where copyright is reserved by a party other than FEE.

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Introduction Economics in One Day is a workshop that provides an essential introduction to economic thinking for the non-economist in a 3-5 hour experience with a focus on the humane value and ethical principles of free markets. This guide explains the learning objectives of the Economics in One Day workshop. Also included are links to additional resources that may be helpful for facilitators to review prior to delivering the workshop to their local audience. This guide may also be useful for participants to review after completing Economics in One Day. The list of contents below provides an outline of the topics covered in the workshop.

The Economics in One Day workshop includes interactive, hands-on activities and guided discussions centered on themes from ‘‘I, Pencil’’, the classic essay by Leonard E. Read. Leonard Read established the Foundation for Economic Education (FEE) in 1946. Now in our 70th year, FEE continues to champion the economic, ethical, and legal principles of a free society. Our expertise is teaching students how freedom matters to their lives and the lives of all. Economics in One Day leverages and amplifies that expertise by equipping local teachers, parents, and community leaders with everything they need to deliver this important message.

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Contents Introduction ................................................................................................................................................................................... 2

The Story of I, Pencil ..................................................................................................................................................................... 4

Vision for a Better Future ............................................................................................................................................................. 5

Human Well-being ................................................................................................................................................................... 5

Social Cooperation .................................................................................................................................................................... 6

Personal Character .................................................................................................................................................................... 7

Introduction to Economics .......................................................................................................................................................... 8

Fundamental Concepts ............................................................................................................................................................ 8

Individual Action .................................................................................................................................................................. 8

Scarcity ................................................................................................................................................................................... 8

Choice ..................................................................................................................................................................................... 8

Subjective Value .................................................................................................................................................................... 9

Tradeoffs and Opportunity Costs ..................................................................................................................................... 10

Incentives ............................................................................................................................................................................. 11

The Market Process................................................................................................................................................................. 12

Voluntary Exchange ........................................................................................................................................................... 12

Gains from Trade ................................................................................................................................................................ 13

Specialization and Division of Labor ............................................................................................................................... 13

Emergent Order (Spontaneous Order) ............................................................................................................................ 13

Competition and Cooperation .......................................................................................................................................... 15

The Intersection of Politics, Law, and Economics .................................................................................................................. 16

Rules and Institutions ............................................................................................................................................................. 16

Property Rights ................................................................................................................................................................... 16

Rule of Law .......................................................................................................................................................................... 17

Culture and Values ............................................................................................................................................................. 18

Politics and Economics .......................................................................................................................................................... 19

Politics without Romance .................................................................................................................................................. 19

Knowledge Problem ........................................................................................................................................................... 21

Seen and Unseen ................................................................................................................................................................. 21

The Role of the Entrepreneur in Society .................................................................................................................................. 23

Value Creation ......................................................................................................................................................................... 23

What is Entrepreneurship? .................................................................................................................................................... 23

The Heroic Entrepreneur ....................................................................................................................................................... 24

Happiness and Success ........................................................................................................................................................... 25

Conclusion .................................................................................................................................................................................... 25

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The Story of I, Pencil The activities for Economics in One Day are developed around the themes of Leonard E. Read’s classic essay, ‘‘I, Pencil.’’ The links below may be helpful for those wishing to become more familiar with the ‘‘I, Pencil’’ story before or after the workshop.

ARTICLE: I, Pencil: My Family Tree - Leonard Reed (FEE.org) [http://at.fee.org/1yAq6Jf]

‘‘Not a single person in the world knows all the processes required to make a pencil and yet voluntary exchange enables hundreds of people to cooperate together in their production without any central direction.’’

VIDEO: I, Pencil: The Movie (Competitive Enterprise Institute, 6:32 min) [http://at.fee.org/1WtBN3N]

A film from the Competitive Enterprise Institute, adapted from the 1958 essay by Leonard E. Read.

VIDEO: Milton Friedman - I, Pencil (Free to Choose Network, 2:25 min) [http://at.fee.org/1Os9vPu]

‘‘Milton Friedman, Nobel laureate, discusses the market forces involved in creating a single pencil in his telling of the classic story written by Leonard E. Read.’’

VIDEO: How to Make a $1500 Sandwich in Only 6 Months (How To Make Everything, 3:44 min) [http://at.fee.org/1siuArB]

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Vision for a Better Future For all our political differences, we have much in common. When you walk out into a busy public place, most people you see are essentially decent. When their minds turn to society, they all have the same basic goals. Like you, they want their families to thrive, their communities to flourish, and their society to prosper. They also hate to see suffering and hardship, and hope to see improved conditions for the needy and persecuted. Where they differ is their opinion about which social arrangements best achieve these common aims. As the economic philosopher Ludwig von Mises taught, most political battles of ideas are over the ‘‘how,’’ not the ‘‘what.’’ And economic understanding is necessary for appreciating what truly are the most effective means to our common ends. This is why, as Mises wrote:

"...economics cannot remain an esoteric branch of knowledge accessible only to small groups of scholars and specialists. Economics deals with society’s fundamental problems; it concerns everyone and belongs to all. It is the main and proper study of every citizen."

In the spirit of this conviction, the Economics in One Day workshop helps the non-economist discover how freedom and the market empower us to achieve economic and social progress for all people. It does this through the exploration of three overarching topics: human well-being, social cooperation, and personal character.

Human Well-being How did some countries grow so incredibly rich so rapidly in modern times? The answer to this question contains the key to reducing abject poverty and improving the well-being of people in our country and around the world. Over the past 200 years the rich have indeed become richer. But in relative terms the principal beneficiaries of economic growth have been the poor, however counterintuitive that may seem. In Economics in One Day we explain how markets promote individual well-being, especially for the most disadvantaged members of society. While an economic system based on cooperation through voluntary exchange does not guarantee immediate gratification of everybody’s wants, it is the surest and quickest path toward human flourishing for all.

VIDEO: The Hockey Stick of Human Prosperity (Marginal Revolution University, 4:54 min) [http://at.fee.org/1Oml1kM]

‘‘In this series, Professor Don Boudreaux explores the question economists have been asking since the era of Adam Smith -- what creates wealth? On a timeline of human history, the recent rise in standards of living resembles a hockey stick -- flatlining for all of human history and then skyrocketing in just the last few centuries. Without specialization and trade, our ancient ancestors only consumed what they could make themselves.’’

VIDEO: Hans Rosling's 200 Countries, 200 Years, 4 Minutes - The Joy of Stats - BBC Four (BBC, 4:47 min) [http://at.fee.org/1R0xSDB]

‘‘In this spectacular section of 'The Joy of Stats' he tells the story of the world in 200 countries over 200 years using 120,000 numbers - in just four minutes. Plotting life expectancy against income for every country since 1810, Hans shows how the world we live in is radically different from the world most of us imagine.’’

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Social Cooperation As Aristotle wrote, ‘‘Man is a social animal.’’ Humans not only crave friendship for their spiritual needs, but require cooperation for their material wants. The wider the scope of that cooperation, the more abundantly it provides for those wants. It is human awareness of this fact that is the foundation of all society. Economic cooperation, especially through voluntary exchange (or ‘‘free trade’’), creates economic interdependence, which fosters peace, mutual trust, and friendship.

Only the cooperation of millions is productive enough to support modern living standards: the abundance of basic staples, the marvelous gadgets, etc. As we have already seen, even the manufacture of a simple pencil involves a massive global network of producers. Only the market can coordinate the collaboration of so many strangers.

Commerce is an integral part of civil society, which also includes all other voluntary associations: the family, religious groups, charities, clubs, mutual aid societies, etc. Civil society provides help and security for the individual. However, many falsely assume that only government can offer such provision. As a result, government often ‘‘crowds out’’ and eliminates voluntary institutions, only to then fail to fulfill the responsibilities it has taken on.

Critics often unfairly denounce support for individual freedom as anti-social and atomistic. But Economics in One Day explains how freedom strengthens social bonds, leading to widespread cooperation, camaraderie, and harmony.

ARTICLE: Social Cooperation by Sheldon Richman (FEE.org) [http://at.fee.org/27kvMKI]

‘‘It is through cooperation and the division of labor that we all can live better lives…As a result of expanding cooperation, human beings compete to produce, not to consume. Mises expressed this with my favorite sentence in Human Action: ‘‘The fact that my fellow man wants to acquire shoes as I do, does not make it harder for me to get shoes, but easier.’’ The expansion of cooperation also means dealing with strangers at great distance-----a further incentive for peace.’’

ARTICLE: Competition and Cooperation by David Boaz (FEE.org) [http://at.fee.org/1Xpugmm]

‘‘The market is an essential element of civil society. The market arises from two facts: that human beings can accomplish more in cooperation with others than individually, and that we can recognize this. If we were a species for whom cooperation was not more productive than isolated work, or if we were unable to discern the benefits of cooperation, then we would remain isolated and atomistic…Without the possibility of mutual benefit from cooperation and the division of labor, neither feelings of sympathy and friendship nor the market order itself could arise. Throughout the market system individuals and firms compete to cooperate better."

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Personal Character Strong personal character is essential for individual success, as well as for economic and social progress more broadly. Moral virtues such as a strong work ethic, enterprise, integrity, courage, and individual responsibility translate into value creation and career advancement. Furthermore, a free society is impossible without strong character. Freedom cannot hope to survive among people lacking self-restraint and self-reliance.

Freedom demands strong character, but it also reinforces it. Economics in One Day illustrates how rewards for ethical behavior in business are realized as profits for serving others well. Market profits are a gauge of public service. Lack of freedom undermines character by fostering dependence, irresponsibility, and lethargy.

ARTICLE: Character, Liberty, and Economics by Lawrence W. Reed (FEE.org) [http://at.fee.org/225nN0h]

‘‘Bad character leads to bad economics, which is bad for liberty. Ultimately, whether we live free and in harmony with the laws of economics or stumble in the dark thrall of serfdom is a character issue.’’

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Introduction to Economics What is economics? Economics is the study of human behavior when choice is involved.

Let’s begin with a few foundational economic concepts: Individual Action, Scarcity, Choice, Subjective Value, Tradeoffs, and Incentives.

Fundamental Concepts

Individual Action Action is behavior that is purposeful, or goal-seeking. When rain falls from the sky, it is not seeking the ground as its goal. So rainfall is not action. But when a person walks down stairs, he/she is seeking the bottom as a goal. So that is an action.

In economics, we start from the understanding that individuals act purposefully to satisfy wants by achieving certain ends. The individual is the basic unit of economic analysis. Only individuals act. Groups do not act. When we say that a nation or a government ‘‘acted,’’ that is only short-hand for saying that certain individuals we identify with that nation or government acted. Individuals act because: 1) they are not perfectly content with the present circumstances, 2) they can imagine a way to achieve a preferable future state, and 3) they believe their action can succeed in reaching that desired state. While individual action is purposeful, this does not mean that people are perfectly wise and never make mistakes.

Scarcity Scarcity is a state in which two conditions apply: (1) limited resources with alternative uses, and (2) virtually unlimited wants and needs. Scarcity is an inescapable fact of reality and a fundamental part of the human condition. All human action involves coping with scarcity. The challenge of scarcity is why individuals must take care how they use the resources at their disposal. Economics is thinking logically about the various ways of dealing with scarcity: production, consumption, exchange, etc. If there were no scarcity, then there would be no economic problems and nothing for economics to study.

ARTICLE: Scarcity by Russell Shannon (FEE.org) [http://at.fee.org/1Yqxkg7]

"Scarcity comprises two integral and conflicting aspects-----unlimited human wants and limited resources…We cannot satisfy all our desires. We all are always forced to choose… What should we choose? How should we go about making choices? First we must understand the underlying essence of scarcity."

Choice Choice is the act of deciding between two or more possibilities. The unavoidable condition of scarcity forces individuals to choose. Which goals will be pursued using a given scarce resource? Not every conceivable goal can be pursued due to limited supply. So some goals must be selected, while other goals must be sacrificed.

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Subjective Value When A is chosen over B, that means A has a higher value than B, according to the chooser. Just as beauty is in the eye of the beholder, value is in the mind of the valuer. In other words, value is subjective. This means that the value of something is based on an individual’s tastes, goals, and priorities. Different people like things differently, and the same person can desire the same thing differently at different times. Note also that value is not a quantity, but a ranking of preference.

Each of us is the only judge for how much we subjectively value something. The value of a resource to an individual is determined by the relative importance of the wants it will satisfy. Different goods satisfy different wants at different times. If an individual must choose between two goods, he or she will choose the one that satisfies the more important want over the one that satisfies the less important want. It is important to understand that the value of a good is not determined by the amount of effort, time, or material it took to make it. While resources such labor or material may factor into the quality of a good or service, they do not determine its value. Quite the opposite: it is the value of the product that determines the value of labor and resources used to produce it.

VIDEO: Subjective Value (Learn Liberty, 3:50 min) [http://at.fee.org/1Yqxlkj]

‘‘Prof. Don Boudreaux demonstrates that value is determined by the preferences of individuals. The value is not in the thing itself. It doesn’t come from the amount of labor or materials that goes into producing it. Ultimately, things have value only if and only because human beings want those things.’’

ARTICLE: Subjective Value by Max Borders (FEE.org) [https://fee.org/articles/subjective-value]

Subjective value can be a tough idea for some people to grasp. It can be even harder for people to accept. But here’s the hard truth: Value does not inhere in things. Sunsets are not inherently beautiful. Vanilla ice cream is not inherently tasty. Jazz is not universally loved.’’

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Tradeoffs and Opportunity Costs The inescapable reality of scarcity forces us to make choices, and every choice involves a tradeoff. A tradeoff is the alternative we give up when we pursue a certain course of action. Because every decision we make involves tradeoffs, the first question a good economist usually asks is, ‘‘Compared to what?’’

Every decision to use a scarce resource has a cost. The cost of your action is the value of the next highest alternative that has to be foregone as a result of your decision. This is what economists call opportunity cost. In other words, the opportunity cost is the value of the best alternative forgone. It’s what you have to give up to get what you want. Opportunity costs should always be considered so we can make more informed decisions about ways to best use our scarce resources.

Because every decision has an associated cost, the next question a good economist asks is, ‘‘At what cost?’’

The evaluation of choices and opportunity costs is subjective. Individuals have different values and preferences. As a result, opportunity costs are unique for each individual decision.

ARTICLE: Opportunities and Costs by Dwight Lee (FEE.org) [http://at.fee.org/1TT2qvI]

‘‘Because of scarcity, everything we do involves sacrifice….Only when the costs of choices are imposed on those who make those choices can we best use the opportunities available.’’

ARTICLE: Getting the Most Out of Life: The Concept of Opportunity Cost by Russell Roberts (Library of Economics and Liberty) [http://at.fee.org/1Wv6Tc4]

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Incentives Incentives are factors that motivate and influence human behavior. When a change in conditions increases the cost of an activity, individuals will tend to do less of it, other things being equal. If instead the benefits increase, people will tend to do more of the activity.

Incentives are key for the functioning of the market economy. High prices motivate sellers to supply more of a good, and buyers to demand less. Low prices have the opposite effect. The interplay of supply and demand results in prices that reflect the scarcity of the good and its relative importance for human desires. Profits and losses are also market incentives. Entrepreneurs are motivated to pour capital and labor into profit-making enterprises, and pull them out of loss-making ones. In the market, this is how resources flow toward what, according to the public, are their best uses.

When governments intervene in the economy, they distort market incentives. Price ceilings disincentivize production, leading to shortages. Minimum wages disincentivize hiring, leading to unemployment. High taxes on profit disincentivize investment, leading to relative poverty.

Incentives are not only monetary. Some of the most important incentives come from our desire to find love, to earn respect, to make the world a better place, and to provide for our families.

Institutional incentives are also important. If an activity is supported by public opinion, that may increase its benefits. If an activity is considered immoral or illegal, that will increase its costs. For the market, the most fundamental institutional incentives are provided by property rights. We will cover these issues further in the ‘‘Rules and Institutions’’ section below.

VIDEO: Incentives Matter (Learn Liberty, 2:15 min) [http://bit.ly/1TT2wTW]

‘‘According to Prof. Angela Dills, incentives are important and help economists predict individual behavior. Recognizing that incentives matter is fairly straightforward. What’s difficult is determining all the different ways a policy might affect people’s incentives and change people’s behavior. A good economist looks not only at the obvious incentives created by a particular policy but also looks for the less obvious effects.’’

ARTICLE: The Power of Incentives by Dwight Lee (FEE.org) [http://at.fee.org/1TfbMSy]

‘‘The market economy is the ultimate example of how a set of rules can create a setting in which private incentives motivate social cooperation. Market economies don’t create incentives directly. Indeed, in a literal sense, markets don’t create incentives at all. Markets are the rules of conduct that harmonize these various incentives by making it possible for people to communicate their desires to others. The prices, profits, and losses commonly referred to as market incentives, are created by people’s interacting with one another. These incentives, which can be communicated only through markets, contain information that promotes social cooperation.’’

ARTICLE: Incentives Matter by Russell Roberts (Econlib.org) [http://bit.ly/225owyn]

‘‘When an economist says that incentives matter, the non-economist sometimes hears only that people respond to prices. But what the economist really means is that holding everything else constant-----the amount of fame or shame, glory or humiliation-----and increase the monetary reward, and people will do more of it…. The role of incentives plays a critical role in the way that individuals treat their own property relative to the property of others or communal property.’’

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The Market Process The market is not a thing. It is a process. The free market is the complex network of all the voluntary exchanges between individuals in an economy. It is the interaction of people exchanging value for value. We are participating in the market every time we buy, sell, or trade. Economics in One Day demonstrates how the market process tends to direct resources toward their most valued uses. In addition to increasing general wealth in society, the market promotes community and encourages social harmony.

To understand the market process, we will now explore the following concepts: Voluntary Exchange, Gains from Trade, Specialization, Division of Labor, and Emergent (or Spontaneous) Order.

Voluntary Exchange Trade, or voluntary exchange, is an act of freely and willingly giving goods or services and receiving goods or services in return. We can know that all parties involved expect to gain, because otherwise they would not have participated in the exchange. Trade not only increases the wealth of individuals, but also increases the wealth of societies and entire nations.

Because each market transaction entails a voluntary exchange, the market process both reflects and encourages social cooperation. Economists like Ludwig von Mises recognize the market as the cornerstone of civil society. We can think of the free market as ‘‘cooperation through exchange.’’

VIDEO: Why Do We Exchange Things? (Learn Liberty, 4:04 min) [http://at.fee.org/1TbfEoJ]

‘‘Professor Michael C. Munger explores what makes exchange more equitable than simply giving gifts. He finds that exchange is important for two reasons: 1) It corrects mistakes in allocation by moving things toward higher-valued uses. 2) It makes everyone involved in exchange happier. Exchange can even make people better off when they have different items and different preferences. This is the power of markets.’’

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Gains from Trade Trade creates wealth by directing resources from people who value them less to people who value them more. Value created simply from exchanging is called gains from trade. Even when no new goods or services are produced, the act of trading can create wealth.

Trade increases the wealth of individuals, societies, and nations. In an exchange, one party need not lose for the other party to gain. In other words, trade is not ‘‘zero-sum.’’ People choose to trade because each believes the trade will make them better off. Trade not only creates material wealth, it also tends to promote cooperation, peace, and harmony among people.

VIDEO: ‘‘Trade Is Made of Win,’’ Part 1: Wealth Creation (Learn Liberty, 2:46 min) [http://at.fee.org/1qiMwA8]

‘‘How does trading make people better off? Economics professor Art Carden explains in this quick lesson on one of the most important concepts in Economics 101.’’

ARTICLE: Free Trade and the Climb Out of Poverty by Steven Horwitz (FEE.org) [http://at.fee.org/1XpuR7j]

"Progress comes from good policies that let individuals use their local knowledge to their own benefit, and in doing so, unintentionally benefit others. The path toward development requires free trade. To restrict it is to condemn to prolonged poverty those who most need to escape it."

Specialization and Division of Labor One reason we benefit so much from society is that we are all so different. There is a great diversity of skills, talents, and interests between individuals in society. Due to the diversity of people in terms of their abilities to perform certain tasks, everyone is better off if they specialize and trade. Through specialization and cooperation through trade, we can create greater wealth than we could hope to achieve working in isolation.

Division of labor is an arrangement in which workers perform one step or a few specialized steps in a larger production process. Exchange and specialization lead to a system where ‘‘everybody works for everyone else’’ to provide things we want. In other words, exchange and specialization promote interconnectedness and harmony.

VIDEO: Specialization and Trade: Because We Can’t Be Good At Everything (Learn Liberty, 2:43 min) [http://at.fee.org/23Ocucb]

‘‘Professor Art Carden is able to mow his yard, build a fence, and install a faucet all at the same time. How? He does this by specializing through trade. Rather than try to do those things himself-----especially since he isn’t very good at doing them-----he uses the money he earns doing what he specializes in to pay others to mow his yard, build a fence, and install a faucet for him.’’

Emergent Order (Spontaneous Order) Emergent order (spontaneous order) occurs when order emerges in society not from a central plan, but from individuals following their own plans and acting for their own self-interest. It is a logical order that emerges from individual human action and is not constructed by deliberate human planning or design. Examples of emergent order

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include: language, traffic patterns, markets, culture, and music. For each of these examples, there is no mastermind. Yet, beautifully complex order emerges spontaneously through the undirected participation of individuals.

It is a common misconception that for order to exist in human society there needs to be a central planner or mastermind. In fact, history shows that attempts to centrally plan society result in chaos and havoc. One of the key insights of economist F.A. Hayek is that complex social orders are emergent and cannot be centrally designed or controlled. He referred to the notion that the economy must be centrally planned as the ‘‘fatal conceit.’’ Understanding the emergent order that results from the process of cooperation through voluntary exchanges is one of the most important insights we can learn from the economic way of thinking.

VIDEO: Can Order Be Unplanned? (Learn Liberty, 3:26 min) [http://at.fee.org/1Wv7cDA] ‘‘Can order be unplanned? Some people assume that for there to be order in human society, there needs to be some central planning or direction. But as Chapman University Professor Tom W. Bell explains, much of the order we observe in our lives is not the product of human design; it's a product of spontaneous order. Drawing from the work of Adam Smith and Friedrich Hayek, Bell describes how an understanding of spontaneous orders helps us to understand markets, language, social norms, customs, and society itself.’’

ARTICLE: The Reality of Markets by Russell Roberts (Econlib.org) [http://at.fee.org/225oRRL]

‘‘It's easy to divide the world we experience into these two types of phenomena-----things like the temperature in your house that are the result of human activity and human intention and things like the rain outside that are not the result of human activity or human intention. But there is a third category of experience-----phenomena that are the product of human action but not of human design.’’

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Competition and Cooperation Cooperation is the act of voluntarily working or acting together for mutual benefit. Each day we benefit from countless acts of cooperation. Civilization and progress rely on our ability to cooperate.

Competition is a contest for some prize, resource, or advantage. Competition is everywhere. The fact that we live in a world of scarcity means we have to choose. This gives rise to competition. It has nothing to do with being ‘‘greedy.’’ Even in a world without greed, or without businesses, where everyone cared only about others, there would still be competition because there would still be scarcity.

Many falsely believe that markets encourage a sort of competition that erodes our ability to cooperate. In reality, markets are extensive networks of cooperation. Learning to cooperate essentially means you learn to trade well with others. In an important sense, competition and cooperation are two sides of the same activity in the market. In the market, people compete over ways to better serve others. Competition within a free market economy is actually a competition over who can best cooperate.

Free markets encourage cooperation, which leads to social progress and prosperity in a civil society. Competition, specialization and the division of labor are important elements necessary for free markets to prosper. Through trade, we are increasingly becoming connected to one another.

ARTICLE: Competition Is Cooperation by Sheldon Richman (FEE.org) [http://at.fee.org/23OcDMC]

‘‘For human beings competition is not the negation of cooperation but a form of it…Competition is what arises when people are free to choose with whom to cooperate… Thus freedom plus cooperation equals competition. Those who would banish competition would also have to banish free cooperation.’’ Compulsory cooperation is what went on in the gulag and concentration camp. In fact, there’s nothing cooperative about it at all. It’s just compulsion.’’

ARTICLE: Competition and Cooperation by Steven Horwitz (FEE.org) [http://at.fee.org/1UZrrri]

‘‘Competition and cooperation are often juxtaposed, yet in the market they are two sides of the same activity... modern goods and services are the product of immense cooperation among human beings. That network of institutions and exchanges facilitates cooperation via competition, with the result being the progressive enrichment of humanity.’’

VIDEO: ‘‘Trade Is Made of Win,’’ Part 2: Cooperation (Learn Liberty, 2:43 min) [http://at.fee.org/1NtrOZO]

‘‘Prof. Art Carden examines how trade creates wealth by allowing people working together to produce more than they could individually. Using a simple two-person example, he shows how cooperation during production increases total output and benefits everyone.’’

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The Intersection of Politics, Law, and Economics Economics is the study of human behavior involving choice. Politics and law, both seeking to influence human behavior, are closely related to the study of economics. Through the political and legal process, rules are created to instruct people how they must, must not, or may use scarce resources (including their own bodies). While politics and law are intended to create rules for how people should behave, economic insight can tell us how people might actually behave when faced with certain conditions.

Thomas Sowell once remarked, ‘‘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.’’ Let’s find out if there is any truth to Sowell’s comment as we learn about two topics: (1) Rules and Institutions and (2) Government Intervention.

Rules and Institutions Remember our discussion about incentives? We learned that people respond to incentives in somewhat predictable ways. The ‘‘rules of the game,’’ or what economists call institutions, condition the incentives people face, and as a result, the choices individuals make. Basic institutions like laws and cultural customs establish the fundamental incentive structure of an economic system.

A key benefit of sound economic thinking is that it enables us to better understand which institutions promote or discourage beneficial exchanges. For example, societies with an institutional environment that encourages entrepreneurship tend to see greater numbers of individuals involved in wealth creating activities.

If we want to make the world a better place, we need to think about how we can best achieve social cooperation among countless strangers in a world of scarce resources. This is made even more challenging by (1) the great diversity of humanity and nature, (2) perpetually changing individual circumstances, and (3) imperfect knowledge. How we confront these challenges largely depends on the rules of the game (social institutions). What rules do you think might expand prosperity?

To understand the importance of institutions, we will explore the following concepts: Property Rights, Rule of Law, and Culture.

VIDEO: The Importance of Institutions (Mercatus Center, 5:00 min) [http://at.fee.org/1OoJyFK]

‘‘The power of institutions illustrated. But what causes institutions? Can we change institutions?’’

Property Rights As discussed above, even the solitary individual must decide between competing goals when putting scarce goods to use. But what if those competing goals are held by different people? When multiple individuals are involved, scarcity means the possibility of conflict. Whose goals will be pursued with the resource and whose will not be pursued? Who gets to use what? For example, we may disagree on the best way to use your car. I may want to use your car for a demolition derby. You may want to use your car to drive to school for the rest of the semester. Property rights help resolve such conflicts.

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The social institution of property rights is a bundle of claims giving the owner the authority to use, modify, exchange, and dispose of his or her property. It also gives the owner the right to exclude non-owners from using his or her property. Having property rights in your car prohibits me from smashing your scarce resource for my entertainment without your permission.

A system of property rights can help diverse groups of individuals effectively cope with disagreements about how resources should be used. It does this through clear rules according to which individuals can come to own scarce resources, and by making such ownership secure. Imagine that instead of having property rights in your car, a group of other people had the power to decide whether or not you had to use your car to give all the other students a ride to school each day. Or imagine your car could be arbitrarily seized from you at any moment. Unnecessary conflict is introduced when property rights are not established and respected.

Property rights also make planning possible. Lack of enforced property rights discourage people from being innovative or producing more since they have no confidence in being able to keep what they earn. To interfere with private property rights is to infringe on the very purpose of an individual’s life. Property is not just about efficiency; it is about justice and morality. Showing respect for someone’s property is to show respect for them as a person. Showing respect for someone’s plan of action means not unreasonably interfering with his or her property.

Property rights enable us to freely choose the things we want and need, and to pursue our vision of a good life. Both theory and history have overwhelmingly shown that the most efficient means of coping with scarcity in society is the institution of private property. It enables us to care for both ourselves and each other as human beings.

ARTICLE: Private Property and Opportunity Costs by Dwight Lee (FEE.org) [http://bit.ly/24X2u6e]

‘‘Private Property Motivates Cooperation’’

VIDEO: What’s So Great about Economic Freedom? (Learn Liberty, 4:25 min) [http://at.fee.org/24TVUNR]

‘‘Economic freedom is about the freedom to buy and sell things, says Professor Antony Davies, but it’s also about the freedom to interact with people, to converse with others, to travel, and to say what we want to say…’’

Rule of Law Each person is an individual deserving of respect and dignity. A fair legal system should show equal respect for persons by respecting their rights equally. A system of rules that is impartial and applied uniformly to everyone is the rule of law. This does not mean most laws are a codification of justice or even politically neutral. However, stable rules and expectations are essential for economic growth. In contrast to the rule of law, when rulers and lawmakers arbitrarily interfere with economic outcomes, it discourages entrepreneurs from taking risks and creating value.

Furthermore, a few simple and stable rules tend to promote economic growth and social harmony far better than bulky volumes of obscure regulations. In fact, excessive laws and regulations introduce unnecessary confusion, chaos, and conflict into society. The more barriers that government creates, the more difficult it is for aspiring entrepreneurs to pursue productive ventures, and for workers to find the jobs those ventures create. Overly burdensome regulations and licensing laws impede value-creating entrepreneurial activity and restrict the liberty of average citizens to live out their dreams in meaningful ways.

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VIDEO: Essential Hayek: Rule of Law (Fraser Institute, 2:49 min) [http://at.fee.org/1Yqy2u1]

‘‘This is part of a Fraser Institute project to present the ideas of F.A. Hayek. In this video, we explore one of Hayek's lifelong pursuits: understanding the difference between legislation and law.’’

Culture and Values Economic growth occurs when institutions promote and encourage entrepreneurial activity. Areas of the world where extreme poverty still exists today largely lack the institutional incentives that encourage entrepreneurship. We have already learned that rule of law and respect for property rights are necessary for economic and social progress. But customs and culture are also powerful social institutions that influence our behavior (e.g. desire to follow cultural norms).

Societies are shaped by the ideals they embrace. A society that embraces entrepreneurship creates more jobs, produces more wealth, and allows individuals to exercise their creative talents. Cultures that value ambition, honesty, integrity, courage, productivity, long-term planning, and individual responsibility tend to create more economic growth and individual well-being than those who do not.

Specifically, some economists argue that the wealth and living standards we enjoy today can be traced to a shift in social attitudes: to a point in history when people began regarding merchants, inventors, manufacturers, and entrepreneurs with dignity and prestige instead of distrust and contempt.

Finally, understanding cultural influences can help economists better understand how specific incentives may affect individual behavior across cultures in different ways.

VIDEO: What Caused The Economic Boom of Wealth? (Learn Liberty, 3:18 min) [http://at.fee.org/1TaZg9E]

‘‘Throughout the history of the world, the average person on earth has been extremely poor: subsisting on the modern equivalent of $3 per day. This was true until 1800, at which point average wages-----and standards of living-----began to rise dramatically. Prof. Deirdre McCloskey explains how this tremendous increase in wealth came about.’’

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Politics and Economics

‘‘This i s not a di spute about whether planning i s to be done or not . I t i s a di spute as to whether planning i s to be done central ly , by one authority for the whole economic system, or i s to be divided among many individuals . ’’

--- F . A . H AYE K

We have already studied the market process. Now let’s take a look at government intervention in the market process. Government can intervene in the market to influence economic outcomes when it:

• collects revenue-----and discourages behavior-----using taxes • encourages certain behaviors using subsidies • requires certain products or activities by mandates • prevents certain products and activities through prohibitions • attempts to control market activity through regulation

The question we are concerned about is not, ‘‘Should there should be economic planning?’’ All humans plan. The better question is, ‘‘Who should do the planning?’’ Should economic order emerge from the plans of many, decentralized individuals in the market? Or, should economic activity follow the centralized plans of the few with power? What should be decided in the political sphere, and what should be left to the interactions of free people? Economics might not give us all of the answers, but it can help us ask better questions.

To understand the implications of government intervention in the market process, we will explore the following concepts: Politics without Romance, Knowledge Problem, and Seen and Unseen.

Politics without Romance A free market of cooperation through voluntary exchange will not bring us Utopia. The market will not solve all of the challenges individuals in society face. However, just as advocates of markets should not uphold the fantasy of perfect solutions, advocates of government alternatives should also not be naïve about what can be accomplished through policy in the real world.

All too often, advocates for government solutions compare an imperfect market reality to an imaginary government ideal. They think of what government should do instead of what it will actually do. When deciding between laissez-faire and intervention, we have to compare the imperfect reality of the market against the imperfect reality of government. Romance is best left for moonlit walks on the beach, not politics. Let’s shed the romance and think about how public policy works in the real world.

Here are a few lessons from the economic study of human behavior that can be applied to the actions of government agents:

1. Human beings are self-interested. Government officials are no less self-interested than people in the private sector. It is incorrect to think that the same people who are self-interested in the market suddenly become angels when they go to work for the government. In fact, politicians face strong perverse incentives to do things that are not in the best interest of their constituents or the public at large in order to win elections or gain power.

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2. Whenever government power exists to control economic outcomes, special interest groups have strong incentives to seek political privilege to influence outcomes for their benefit. Seeking economic favor through government is what economists call rent-seeking and the rest of us might call cronyism. Rent-seekers manipulate the political process in an attempt to grab the wealth generated by others. As Jason Brennan wrote in his book Markets without Limit, ‘‘The more politicized an economy becomes, the more private actors try to rig regulations and the law to cheat consumers and competitors.

3. Government policy bestows concentrated benefits upon specific politicians and specific special interest groups. However, the cost of these special benefits is spread among everyone else in the economy. Special interest groups have strong incentives to lobby for large concentrated benefits, but the taxpayers do not have a strong incentive to fight the cost dispersed across the rest of the population. Politics becomes a vehicle for grabbing other people’s property.

We can only conclude along with Professor Brennan that, ‘‘Instead of trying to keep the nasty market away from pristine politics, we should be trying to keep nasty politics away from the market."

VIDEO: Why Is There Corn in Your Coke? (Learn Liberty, 3:24 min) [http://at.fee.org/1s7w3jw]

‘‘Coke is made with corn syrup, not real sugar. Why is this? According to Professor Diana Thomas, part of the reason is because government policies artificially raise the price of sugar.’’

Video: How Cronyism is Hurting the Economy (Learn Liberty, 3:36 min) [http://at.fee.org/24X2XoR]

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Knowledge Problem

‘‘The curious task of economics i s to demonstrate to men how li t t le they rea l ly know about what they imagine they can design. ’’

--- F . A . H AYE K

Knowledge about the resources available to meet the needs of people is dispersed in tiny, localized bits throughout an economy. This knowledge is always and constantly changing in response to changing circumstances. By its very nature, it is impossible that this kind of situational knowledge can ever be collected, aggregated, and used by a central authority to effectively plan and engineer society. No person or group can possibly have sufficient knowledge to make a pencil, much less plan the actions of millions of people. Everyone has their own unique, subjective valuations of resources in a world that is constantly changing.

This is one reason that massive, top-down legislation to improve economic outcomes invariably fails to achieve its stated goals. Even if central planners had the best of intentions, it would be impossible for them to have anywhere near the knowledge necessary to administer an entire economy so as to achieve general prosperity. On the other hand, prices communicate the local knowledge of individuals in the market and provide incentives for people to act on that information and coordinate with one another. Prices are incentives wrapped in knowledge that help people coordinate in a complex economy.

VIDEO: What Do Prices ‘‘Know’’ That You Don’t? (Learn Liberty, 4:33 min) [http://at.fee.org/1YqyacZ]

‘‘According to Professor Michael Munger, prices (as in, the price of a carton of milk or a new car) are akin to magic. Prices ‘‘magically’’ convert countless pieces of dispersed, complex information into a single signal that conveys to sellers what they should do to best benefit society. By ignoring the price system, you’re really ignoring the needs of those whom you want to serve. This is the ‘‘magic’’ of the price system --- it merges the needs of society with each seller’s desire for profit.’’

VIDEO: The Price System, Part 1: Information by Dan Smith (Learn Liberty, 2:25 min) [http://at.fee.org/1skTmao]

‘‘Why are prices important? Prof. Daniel J. Smith of Troy University describes the role that prices play in generating, gathering, and transmitting information throughout the economy. Information about the supply and demand of different goods are dispersed among different buyers and sellers in an economy. Nobody has to know all this dispersed information; individuals only need to know the relative prices. Based on the simple information contained in a price, people adjust their behavior to account for conditions in supply and demand, even if they are unaware of that information.’’

Seen and Unseen Economic policies have immediate, direct impacts on certain known groups; these consequences can be called ‘‘the seen.’’ They also have less visible, but no less important, impacts for all groups, especially over the long-term; these consequences can be called ‘‘the unseen.’’ All too often people focus merely on the highly-visible, narrow, and/or short-term effects. The art of economic thinking is to give appropriate consideration to both the short-term and specific consequences and the long-term and widespread consequences of an action or policy. Thinking more carefully about, not just the seen, but the unseen consequences can help us make better decisions. This is the central lesson in

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Henry Hazlitt’s classic work, Economics in One Lesson. Henry Hazlitt was a founding board member of the Foundation for Economic Education, and the title of his book inspired the title of this workshop!

Unintended consequences are results of an action-----positive or negative-----other than those intended by the actor.

VIDEO: Broken Window Fallacy (Learn Liberty, 3:09 min) [http://at.fee.org/1qiNpsx]

‘‘Does destruction create jobs? After natural disasters, terrorist attacks, and wars, some people argue that these disasters are good for the economy, because they create jobs and prosperity. As Prof. Art Carden explains, this is an example of the "broken window fallacy," a term coined by Frédéric Bastiat. When a shopkeeper's window is broken, he will spend money on a new window, which gives income and jobs for glaziers. This activity is "seen," but the "unseen" is just as important: the money spent on a new window could have been spent on other things. Wealth has not increased, but only been reallocated from some people to others, and society is worse off by one window.’’

ARTICLE: The Broken Window by Henry Hazlitt (FEE.org) [http://at.fee.org/1R1iMxR]

‘‘This selection from Hazlitt’s Economics in One Lesson tells the parable of a broken window to illustrate that destruction of value does not benefit the economy. Though it may seem that the window repair business benefits from the broken window in the form of extra work, we must look at the unseen to get the full picture of the story.’’

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The Role of the Entrepreneur in Society Entrepreneurship is about identifying ways to better satisfy unmet needs. It is about discovering opportunities, innovating new solutions for problems, and creating value. In short, entrepreneurs make money when they serve other people well.

Value Creation Wealth is a measure of the value of economic goods. Wealth does not exist naturally in the world. All of the goods we want and need must be created, arranged, packaged, harvested, or gathered before they can be enjoyed. Before something of value can be consumed it must first be produced. The process of arranging the resources to satisfy people’s wants and needs is called value creation. The only ways to obtain something of value are either to produce it yourself, trade for it using another value that you have produced, receive it as a gift from someone who has produced it, or steal it from someone who has produced it. How do you want to get the values you need to live a good life?

What is Entrepreneurship? An entrepreneur is someone who discovers and provides for an unmet need by producing value for others in the community and for themselves. In short, entrepreneurs are both problem solvers and wealth creators. In the pursuit of profit, entrepreneurs combine the factors of production (land, labor, and capital) to efficiently produce goods and services people need. They also set the stage for future economic growth and prosperity by creating opportunities for work experience and encouraging further entrepreneurship. Entrepreneurship is an ongoing process that is essential for economic progress. Entrepreneurship can be thought of as both an activity and as a way of thinking.

Entrepreneurship as an activity refers to someone who starts, organizes, manages, and assumes the risks of a business or enterprise. An entrepreneur is an agent of change. Entrepreneurship is the process of discovering new ways of using resources to meet a need. Entrepreneurship as a way of thinking emphasizes innovation, drive, and creativity. Entrepreneurship is judgmental decision-making under uncertainty. Entrepreneurship is alertness to identifying and discovering an unmet need and then acting to satisfy that need.

ARTICLE: Small Business and Entrepreneurship by E.C. Pasour (FEE.org) [http://at.fee.org/23Oedhv]

‘‘In a free enterprise economic system, expected prices and profits provide incentives for entrepreneurial activity….Entrepreneurship may be aptly defined as an alertness to profit opportunities which have not been grasped and acted upon by others. It should be stressed that the potential for (and expectation of) profits in the competitive market process creates powerful incentives for profit-seeking individuals to discover and make use of information before it is widely known by other people.’’

ARTICLE: Entrepreneurship by Russell S. Sobel (econlib.org) [http://at.fee.org/1OoKslQ]

‘‘Russell S. Sobel is a professor of economics and James Clark Coffman Distinguished Chair in Entrepreneurial Studies at West Virginia University where he was founding director of the Entrepreneurship Center. In this article, Professor Sobel explains entrepreneurship and introduces what notable economists have thought about the topic.’’

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The Heroic Entrepreneur Entrepreneurs play a key role in value creation. They create value for themselves by creating value for others. Entrepreneurship is the essential foundation for economic growth. Societies that encourage entrepreneurship through economic freedom tend to see much faster economic growth than those that do not. Entrepreneurial discoveries and insights build on one another to create new and better products and processes. Entrepreneurship creates opportunities for more entrepreneurship. It is an ongoing process. A society that embraces entrepreneurship creates more jobs, produces more wealth, and allows individuals to exercise their creative talents. If we think entrepreneurship is a good thing, we should encourage more entrepreneurship by celebrating entrepreneurs and encouraging economic freedom.

ARTICLE: The Entrepreneur on the Heroic Journey by Dwight Lee and Candace Allen (FEE.org) [http://at.fee.org/1Tfdbbu]

‘‘In our modern world, the wealth creators-----the entrepreneurs-----actually travel the heroic path and are every bit as bold and daring as the mythical heroes who fought dragons and overcame evil. With conventional virtues, the entrepreneur travels through the three stages of the classic journey of the hero to achieve unconventional outcomes and should serve as a model of inspiration and guidance for others who follow.’’

To learn more about the role of the entrepreneur in society and how you can start your own business, please see FEE’s complete 40-lesson course on the Economics of Entrepreneurship at courses.FEE.org

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Happiness and Success

"Economics is everywhere, and understanding economics can help you make bet ter deci sions and lead a happier l i fe ."

--- T Y LE R C OW EN

Conclusion Free markets based on cooperation through voluntary exchange are essential for economic progress. A free economy improves individual well-being, strengthens communities and the bonds of civil society, and encourages the development of strong personal character. If we think human well-being, social cooperation, and personal character are important, we should encourage more economic freedom and seek fewer solutions through political means.

Individual Well-being

Many people feel that the emphasis economists place on individualism, freedom, and markets indicate a lack of concern for other important values such as fairness and charity. What do you think?

As we have seen, many of the criticisms against free markets are unfounded. A move toward freer markets in the future is a goal worth striving for if we care about economic progress, especially for the least well-off members of society.

Social Cooperation

The cooperation that emerges in the market has created systems where millions of people are all working to the mutual benefit of each other. What we call civilization is essentially an organic and dynamic interaction between millions of people on a daily basis, most of whom we can never meet or know. The story of I, Pencil uses the story of an ordinary object to illustrate the ways in which we are all connected.

Our social and economic arrangements are amazingly complex. One of the most fascinating miracles is the way by which beautifully intricate order emerge from the voluntary actions and interactions of people and continuously evolve in a bottom-up fashion. Orders in complex systems of human interaction are the ‘‘product of human action but not human design.’’ The market economy is the ultimate example of how a set of rules can create a setting in which private incentives motivate social cooperation.

Personal Character

In a free society, people are free to make their own decisions and follow their own plans, hopes, and dreams so long as they show equal respect for others by respecting the choices they make. As the comic book saying goes, ‘‘with great freedom comes great responsibility.’’ A free society both requires and reinforces strong personal character. If you think freedom is worth having, you must strive to live up to the lofty standards freedom requires of you.

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When you produce, create, and trade, you are leaving a legacy. What kind of person do you want to be? Do you want to create value for your community? I hope so. A prosperous future for us all depends on entrepreneurs like you!

VIDEO: I, Pencil Extended Commentary: Connectivity (CEI, 3:26 min) [http://at.fee.org/1XnWfmh]

‘‘We are connected to people in distant places in ways that are unimaginable. When you buy a pencil, you are helping people do things they value through markets.’’

VIDEO: Economic Freedom & Quality of Life (EconFree, 2:26 min) [http://at.fee.org/1Yqyqsq]

Please email Courses@FEE.org with any questions or comments about Economics in One Day. This work is licensed under a Creative Commons Attribution 4.0 International License, except for material where copyright is reserved by a party other than FEE.