Fundamentals

Understanding free markets and economics requires that one first understand some of the fundamental concepts upon which sound economic reasoning is based. Frequently, articles and discussions about economic issues begin based on faulty premises or unsound reasoning. I want the readers of this blog to have access to a clear description of some of the basic fundamentals in economic thinking.

Because of the dynamics of blogging if I describe these fundamentals on a blog post they would continue to recede into the past and would become relatively inaccessible to a reader. For that reason, I want to place the description of these concepts unfixed pages to which I can refer in future blog posts.

The first pages that I will include in the section will be:

By making these concepts readily accessible to readers I hope to make dynamic blog posts more meaningful.

Please leave comments for any ideas I express in this fundamentals section that you might find incomplete or confusing.

Production

Although the primary purpose of an economic structure consists of satisfying the preferences of consumers, production must always precede consumption.

Even in the most basic economic structure of a hunters and gatherers, they must first pick the berry or kill the deer before they can eat.

In more advanced societies methods of production become far more roundabout and develop into complex structures of production. I will describe the basics of the production structure in future articles.


Government

Because government has a monopoly on the use of force, it represents the primary source of market intervention. Elected officials do not have the capability to decide on the most efficient allocation of economic resources. Even with the best of luck governments can never allocate resources is effectively as the voluntary actors in a free market.

Money

A person cannot overstate the role of money in free markets. I recall an economist stating that you cannot understand economics until you understand money. I believe that this statement holds a great deal of truth.

Understanding money as a lot of aspects: who creates money, how does money get created, what role does money play as a medium of indirect exchange, etc. The complexity of money and the related topic of banking will require more than a single article. I will try to keep these articles as concise as possible and, where I require more detail, I will refer to explanations posted on The Free Market Center.

For now, keep these following ideas in mind:

  • Money has a special use as a general medium of indirect exchange. Keep in mind the significance of the words “general” and “indirect.”
  • Although money has a special use, it consists of a commodity like any other commodity.
  • As a commodity, it has the same source and measure of value as any other commodity (I will discuss the principles and theories of value in the “Fundamentals” section.)

I will expand on these ideas as I write and post articles about money.

Savings

Savings result from the passive activity of delayed consumption. That delay might be brief, in which case savings becomes relatively unimportant. More extended delays and consumption allow for you important developments in an economic system.

Savings allow our friends the hunters and gatherers to survive harsh winters. More extended savings allow for what we refer to as investment, which create production goods that increase future production.

Savings also provide a source of goods used for exchange, a topic that I will discuss in much further detail elsewhere.

Exchange

The process of exchange allows for the optimization of the effectiveness and efficiency of an economic system. Exchange provides the opportunity for the division of labor and comparative advantage.

Division of labor allows for production processes to be distributed most effectively.

Comparative advantage creates employment opportunities for all people wanting work.

Consumption

All economic activity ultimately leads to consumption. The actors in an economic system have no other purpose than to create goods used for consumption.

Although it seems easy to understand, patterns of consumption provide us with the vital information needed for the development of an advanced economy.

A lot more can be said about this topic, and I will cover it in the future.

Intervention

I have defined free markets, the primary subject of this blog, as markets free of intervention. Thus, I plan to post permanent articles about the role of intervention in disrupting otherwise free markets.

Since most intervention comes through government force, I find it impossible to avoid the topic of government intervention. As I may have stated elsewhere on this blog site, I plan to keep my political comments to a minimum. I want to focus primarily on the economic influence of intervention of all sorts — primarily government intervention.

In the briefest of summaries, I can say that intervention disrupts the effective and efficient operation of markets. Intervention creates the only distinction between free markets and non-free markets.

I will elaborate on the subject further in articles posted on this page, and I have written extensively about market intervention on The Free Market Center.

Principles

Any discussion of science — including the social sciences — must begin with basic premises or principles. Principles consist of assumptions that act as established truths at the beginning of any explanation or argument.

A clear understanding of the science of economics requires a few basic principles. I will begin my discussion with the following three: value, individualism, and action.

VALUE

Every school of economics excepts the principal of the existence of value. To understand production, consumption, and savings, one must understand that these things have value. The source and measure of value I will discuss in more detail under the topic of value theory.

INDIVIDUALISM

One principle frequently overlooked in discussions of markets and economics consists of the discrete nature of humans. Humans always exist and act as separate individuals. This principle plays an essential role in the building of sound economic theory.

ACTION

Ludwig von Mises gets credit for the development of what’s commonly referred to as the action axiom. The action axiom provides an a priori principle that acts as a foundation for the discussion of economic activity. The axiom states in its simplest form that humans act with purpose.

Theories

People frequently miss use the word “theory.” They often use the word theory when the more precisely mean hypothesis. I will describe these two terms in layman’s words to make a distinction:

THEORY

A theory explains why specific behavior occurred in the past and provides a basis for explaining expected behavior in the future. Sound reasoning or empirical evidence provide the basis for the explanations provided in theory. Although developed rigorously, theories always remain open to disconfirmation.

HYPOTHESIS

An hypothesis speculates about behavior in either the past or the future. The reasoning behind an hypothesis, although possibly sound, has not been subject to rigorous testing, either with logic or experimentation. Well-formed hypotheses may form the basis for the development of theories, but they still don’t fulfill the requirements of theories

This distinction plays an essential role in the development of economics. We can accurately describe economics as a theoretical science (as opposed to empirical science) because the only way to develop sound theories in economics consists of using reason. That fact, however, makes the soundness of economic theory no less valid.

When you hear someone dismisses a statement of economic theory as “only theory,” asked them whether they think the statement refers to a hypothesis or a statement of theory for which they have a disconfirmation.

Never underestimate the importance of theories. We require theories to conduct our day-to-day business. I will expand on this point when I add to this page on theories.