Economics lesson part 2

The US economy, the world economy…really complex. No one really understands it well, except in small pieces. Anyone who says they do is lying to you, and probably has a hidden agenda.

Does it take an Advanced Degree(™) to get your head around it? Well, yeah, probably. And a bunch of separate lessons. Here's #2.

This is a tiny-scale lesson. It's going to involve analogies. They're not going to work very well, because it's hard to invent an example that works and is small enough to understand.

Let us think back to an imaginary social situation 10 thousand years ago (why? because there's essentially zero technology).

There are three actors in this scenario. We'll call them Tom, Suzy, and Herbert. Each actor has a thing they can do to participate in the economy. They are completely different things.

Tom makes furniture.

Suzy makes clothing.

Herbert cooks meals.

Remember that this is 10 thousand years ago. Tom doesn't even have a knife, maybe a bit of stone he can scrape tree branches with. But he is able to make a table, of sorts, chairs of sorts, and bed frames that are above ground to avoid there being too many bugs. Furniture consists of tree branches that are tied together using vines. It's all very Tarzan.

Suzy makes clothing from animal skins. They're not high fashion, but provide some insulation.

Herbert grills meat over a fire. No knives, no skillet or pots. Primitive.

How much furniture do they need? Well, three beds, three chairs, one table. Let's say it takes Tom one week to make a chair, two weeks to make a bed, and three weeks to make a table. Once made, the items last one year before falling apart (because the vines don't last).

Suzy's clothing takes one week per person.

Herbert cooks every day.

Where do the raw materials come from? Tom's come from the forest. Suzy's come from the animals the Herbert uses for food. Herbert has to go hunting once a week to acquire a week's worth of food.

This started out sounding trivial, but as we try to make it more accurate, it gets more complex.

So the economy goes like this: Herbert cooks, Suzy makes clothing, Tom makes furniture. For All. There's no "money", there's no "barter". It's too small.

On day one, there's no food, no clothing, no furniture. Tom goes to the forest for sticks, Herbert goes hunting. At the end of the day, Tom has enough sticks to make everything, and Herbert has a week's worth of food. Tomorrow Suzy will have animal skin for one person's clothing.

After three weeks, Suzy has made clothing for everyone. Tom has made three chairs. Herbert is still doing the cooking.

How things are working so far. Well, they sleep on the ground still, but they do have chairs. They have clothes, and food.

But now, animal skins will start to pile up because they have enough clothing for the first year. We'll ignore this for now.

Herbert's work is a just-in-time process. He hunts for deer, he cooks them. 

But Suzy runs out of work after three weeks. Tom keeps chugging and after 12 weeks there are three beds, three chairs, and one table. That's probably not enough tables, so Tom makes another table just for Herbert's cooking usage, and a table for Suzy to use while making clothing. But after three weeks Suzy already has nothing to do. She is not longer contributing to the economy. What does she do? After several months, Tom is in the same situation. 

After six months, Herbert gets tired of being the only worker. Plus, deer are getting scarce, because they run away when Herbert appears. 

So they capture some deer, Tom makes a "pen" and the deer go in there and can't get out. (Ok, analogy is breaking down now, deer can jump decently, and aren't docile enough to have gotten caught in the first place.) Deer take management, but they are a self-renewing resource. As long as they only need to eat 52 deer per year, and they have at least that many in captivity, food is a self-sustaining activity, and now Herbert doesn't have to go hunting for meat. He can go pick fruit instead. Tom and Suzy have to manage the deer, which means making sure they have enough food, water, etc. AND, captive prey animals means predators discover them. Tom has to provide security.

This is a collectivist operation. Now everyone is busy enough.

Until Maria shows up. What can Maria do to join in? Maria needs a chair, a bed, and a table. What is Maria going to create in the economy? Maria is going to make grass huts. No one had shelter before.

It takes 3 months to make a grass hut, so it will take her a year to make one hut each for four people. Beds go in the huts. Each hut needs another chair, and another table. Tom is busy with furniture again, but he's also providing security for the deer, so it takes him a lot longer to get more chairs made.

All these primitive creations have a short lifetime, because the materials and craftsmanship are crude. So let's say that one hut out of four is destroyed every six months. Maria will be busy half the time make huts. During the winter they discover that the animal-skin "clothing" they've worn isn't sufficient, so Suzy makes new heavier stuff. OK, now everyone has twice as much clothing. 

There's no money here yet, because the economy isn't complex enough, but it's headed there. There aren't any "managers" yet either.

And everyone in the economy needs everyone else's services, albeit not all the time. And they are dependent on the wear-out rate.

OK, this example is already getting complex.

Let's change one aspect. Suppose it takes Maria four months to build a hut. Now there's trouble, because she can't build four in a year, but one out of four collapses every year. So at the end of her first year there's a good chance that instead of 3 huts there are two. In year two she has to build two huts to fill original demand plus first-year wearout, in addition to the next one that is going to collapse. She's losing ground.

So next Roger shows up. He makes jewelry, at one week per item. Well, he wants all the same things everyone else has, which mostly works, except that Maria is only just barely keeping up. And Roger doesn't want to wait a year for his hut.

The wearout problem is getting difficult. In addition, Herbert is starting to have trouble feeding everyone enough.

Yeah, the economy, and the society are going to start to break down at this point.

Roger wants his hut NOW. We'll ignore the possibility of violence in here, and argue that Roger offers Maria something extra to build his hut first. OK, now the money question approaches. How do we value peoples' work properly, in order for demand to cause a change in construction priority because Roger is "willing to pay more"?

What happens when Maria figures out to how to make a fancier hut, but it takes longer? What if Maria runs out of customers (i.e., no population growth one year) and makes no new ones? Or does she just keep on making them anyway, figuring that "if she builds it they will come"? If she makes more, that means that Roger can just arrive and walk into a hut. OK, Tom was bored and made extra furniture too, the hut already has a bed, table, and chair. What is Roger going to contribute to the economy?

Problems arise. Alternatively, Tom doesn't furnish the hut in advance, but he has some extra inventory. Roger can have a table, but Tom doesn't want jewelry, so he can't barter with Tom for it. But Maria wants a jewelry but can't barter with Roger for a jewelry because he only needs a little bit to get a bed, and her sales quantum is four months work of work whereas his is one week.

So let's say that the get together and conclude they need a bartering abstraction, using coconuts. One coconut equals one week of work. To initialize, they gather one coconut each. (We'll assume for the moment that no one cheats and goes out in the dark to collet more coconuts down by the beach.)

One coconut won't buy a bed, but Roger can, after two weeks, trade two jewelrys for two coconuts, and can then trade three coconuts for a bed. He makes one more jewelry, and trades with Suzy for clothing. At this point, Roger has no more customers wanting another jewelry.

But everyone needs to eat, and Herbert now has to get paid for the food he makes. One coconut per week is good, he says, and he can cook for six. So at the end of week one, they all pay a coconut, and that means Herbert earns five coconuts. But he has a hut, and furniture, and clothing, what does he need to spend coconuts on? At the end of the second week people are starving, and have to figure out how to prepare their own food, because they have no coconuts to pay Herbert with. Maybe at this point Herbert has to drop his price, or the others have to raise theirs. 

And here we are at the supply and demand balance. Herbert's product has a constant demand ("inelastic" if you prefer). Furniture is an occasional demand. Clothing likewise. Food, though…you need it every day.

Edward comes along and he can do the food thing too. And he's willing to charge less than Herbert. Herbert's price has to come down, at least to the point that there's balance, because once Edward is maximum busy, Herbert takes the overflow. But Edward has customers getting angry he can't do more, and he raises his price a little, because this will drive off enough marginal business that there's balance. Herbert still takes the slack.

And one day Herbert discovers black pepper. Suddenly everyone wants it, and wants to buy from Herbert again. HE can't keep up with demand, and raises HIS prices to drive off marginal business, and those customers are back to Edward.

But at this point Edward and Herbert are not competing on price. Not completely. Herbert has a better product, and it costs more. Herbert has all the business he wants. In fact, more than he wants, so he decides to raise his price further, and then only work six days. He still cooks for himself on Sunday. Some folks have to save a little bit out of each meal and eat leftovers on Sunday, because altho Edward can pick up some slack, he can't feed everyone even one day during the week.

This is all about balance. Supply, demand, pricing. All about balance.

Until Walter shows up, and he can cook more food than Herbert AND Edward, because he's got a Dutch Oven, and his cost is therefore less. Herbert and Edward are out of business, caused by automation. Well, OK, maybe Herbert is not, because he has black pepper. But the folks who bought from Edward now buy from Walter. So Edward is guaranteed out of business. Herbert probably loses some, maybe he has to lower his price, or go back to working all seven days…

Complex, no? And we don't even have babies in the mix yet. That's automated low-speed creation of new customers.

The economy is always in flux, because there are new people created, and old ones die out (the wearout factor applies to humans as well). Technological changes = automation improvements, and that causes job loss. Edward is going to have to figure out something else to do. Or maybe he goes to work for Walter.

Edward invents doors for huts. He can make one door per week, one coconut's worth of work. But he thinks a door is worth TWO coconuts. A door means that your hut can be closed off to critters wandering in, so it's really useful, and now Edward is earning twice as much as other folks. But there's a limit to demand--huts only need one door. Maria is still building huts, and she contracts with Edward to make a door for her every time she makes a hut.

Then Edward invents the window. Whoa! Whole new product. Same customers, but a window is priced at one coconut. Everyone wants a window, so some other prices start to go up, in order that people make enough profit to buy a window.

Everyone's needs can be meet by earning the equivalent of 52 coconuts/year for food, and about ten more coconuts/year for the other stuff. Herbert is earning around 100 coconuts, so they start to pile up, because he has nothing he can spend them on. With a fixed money supply, very rapidly Herbert has all the coconuts, and the economy collapses. So Herbert has to spend them, else his customers either come and steal all his coconuts, or worse. Herbert has to find something else to buy. A fixed money supply is not good (this is part of why the "gold standard" is a disaster at some point dependent on the overall size of the economy--economy big enough and the gold supply is constant means the gold price-equivalent goes up, and the inevitable "bubble-burst" will cause a bank run and collapse).

(A lousy alternative: people can go down to the beach and collect more coconuts, and thus enrich themselves, but if it's too easy, that is going to devalue the coconuts--if they're too easy to get then prices will go up, causing an inflation spiral and economic collapse. ("I went down tot he beach this morning and gathered five coconuts; I'll pay TWO for that clothing now" -- Suzy likes this, but now there's a bidding war for her product, thus the inflationary spiral.)

Aaaauuuggghhh! It's complex. I guess you DO need an Advanced Degree(™).