Economics lesson part 3

How do you measure the size of the economy?

Let's start over with Herbert, Suzy, and Tom.

Each of them make something the others needs. Once a year. Let's also say they all already have two coconuts.

The only need product A/B/C once per year.

Herbert make "A", and needs a "C".

Suzy makes "B", and needs an "A".

Tom makes "C", and needs a "B".

A, B, and C each cost one coconut. Beyond that, Herbert, Suzy and Tom are completely self-sufficient.

Sales each year are one each of A, B, and C, for one coconut each, per the above list, effectively in a circle.

Three sales transactions at one coconut each, per year, means the economy is three coconuts large.

Each of the A/B/C are consumed during the year, so each person needs one again the next year. So next year's economy will also be three coconuts.

After three years Herbert decides he also needs a "B", and he has one extra coconut. Suzy makes another "B" and Herbert buys it. Now the economy has FOUR sales transactions, and the size for the year is four coconuts, a 33.3% growth. Hooray! Next year Suzy has an extra coconut, and decides she wants a "C", so she buys that from Tom. Tom now has an extra coconut, so HE buys an "A". Sales for the year are now six coconuts.

But the same number of coconuts exist, no new coconuts were created, and yet the economy has doubled in two years. Each person has the same amount of coconuts at the end of the year: two. But they each bought two things during the year, so yes, the economy doubled.

This too is a weak example, because you could then increase it so that each of the three people buy 100 million A/B/C if they could actually execute the transactions that fast, and the economy would be 100 million coconuts. And you can do this without actually even CREATING the A/B/C, just rotate around what is being sold.

Creating and then selling A/B/C is what is called "real wealth", whereas just reselling the same things over and over is just "paper wealth". (Remember that regardless of how many transactions occur, at the end of the year there are still only six coconuts…even if the economy was 100 million.)

Turning raw materials into finished goods creates real wealth.

Continuing in a given product-creation business means that you need to have enough customers to buy all you can/wish to produce per year. This includes handling the wearout/return-rate. If the potential customer population is large enough, you can grow continuously. All of which contributes to the size of the economy.

But remember that "the size of the economy" does not equal the money supply, nor the "real wealth".