Economic Principles

Principles play a critical role in the development of any theory. Including economic theory.

Definition

Principle:
“A fundamental truth or proposition that serves as the foundation for a system of belief or behavior or for a chain of reasoning.” from Oxford Dictionary

Introduction

Reasoning begins with principles. We tend to ignore principles because, frequently, they seem so obvious. When we want to throw a ball over a fence, we don’t think about gravity, air pressure, friction, and other principles. But, they all affect the process of getting the ball over the fence. But, we just want to get it over the fence.

If we want to calculate exactly where the ball will land, we must define all of these principles explicitly and precisely.

The same use of principles applies to economic reasoning.

Implicit Principles

An infinite number of principles influence economic behavior. Even for sound economic reasoning, many principles can remain implicit. The existence of gravity, weather, the curvature of the earth, etc. can remain implicit unless they play an essential role in our analysis.

To think more clearly and precisely, however, we need to make some principles more explicit.

Explicit Principles

Quite a number of economic principles need explicit statement just to acknowledge their influence. Such statements avoid misunderstanding resulting from mistaken assumptions about the principles in play.

Fundamental Elements

All economic goods come from two fundamental elements: land and labor.

Land

All agricultural and “capital” goods originate with land. Agricultural goods require land on which to grow. “Capital” goods originate from elements either grown on land or excavated from land. Goods that come from water also fall within the category of land.

Labor

All goods also require labor for their production. Even the most basic goods found in nature require processing by labor. Hunters and gatherers must expend some labor to make their goods usable.

Value

Value lies at the core of many economic theories. In spite of the disagreement about the source and measure of value, all economists agree that value does exist. Because it plays such a critical role in the development of economic theories, I will discuss the theory of value in more detail in other sections of this blog.

Action

Ludwig von Mises usually gets credit for introducing the “action axiom” to economic thinking. He recognized that all economic activity begins with the action of individuals.

Mises developed this axiom using pure reason. He realized that to attempt to prove non-action a person must act—which verifies the validity of the axiom. The axiom requires no empirical testing. Its truth results from reasoning alone.

Exchange

The principle of exchange might seem obvious. It gets ignored, however, in many discussions of “buying,” “selling,” “international trade” and other market activities. These terms all represent internal references. (Left and right are internal references; north and south are external references.)

Accurate discussions of market transactions require the use of an external reference: “exchange.” A consciousness of the principle of exchange reminds people that all market transactions, as observed by third parties, involve two parties.

When discussing internal references, such as buying and selling, we must always ask about the influence and impact on the other party.

Markets

The combinations and interrelationship of exchanges created the related principle of “markets.” Most economic theory involved markets.

Money

I include money as a principle because its existence and use remains beyond a doubt. That existence provides the basis for chains of reasoning. Much reasoning regarding money remains flawed because of misunderstanding the definition of money and the source and measure of its value.

I will devote most of “Money Matters” to clearing up much of the flawed reasoning regarding money.

More…

I will discover (or reveal) more principles as I examine various topics on this blog.

Conclusion

Without principles, we cannot make theories. Without the explicit statement of important principles, precise reasoning becomes difficult.

I will expand on these principles as I continue the discussions on this blog.

Value: Summary

Before I move on to describe market exchanges in a bit more depth I would like to summarize the previous comments on value—in part because I encountered a bit of delay since my last post.

Understanding value provides a foundation for understanding all other economic concepts. In order to distribute resources effectively and efficiently the system must have a source of value and a way to measure value. Without a consistent source and measure of value the effective, efficient, allocation of resources would prove virtually impossible.

The Source of Value

Individuals provide the only uniformly consistent source of values. We might use gravity as an analogy for values. Although every discrete body in the universe exerts a different force of gravity, this attracting force always exists between bodies of mass throughout the universe. In a similar fashion, although each individual assigns value differently, value always emanates from individuals. As we will discuss later, only the actions of individuals reveal relative values.

No objective value exists apart from the subjective values of individuals. No intrinsic value exists as a part, or characteristic, of any economic good.

The Measurement of Value

Since the individual always assigns value to economic goods, the individual also determines the measure of that value. The method of valuation remains consistent amongst all individuals. They simply assign an ordinal ranking to all economic goods. Of course that ranking generally only applies to the goods with which they engage in exchange.

No definitive measure of value exists apart from the preferences of individuals.

Value Revealed by Exchange

I have included the first part of the discussion of exchange in my discussion of value because it is through exchange that economic actors reveal relative values. Before an exchange occurs economic actors and observers have no real clue as to the relative values of various economic goods. After an exchange occurs, however, we can say with certainty that each party to the exchange values what they got more than what they gave.

We have no way of assigning a unit to the degree with which they value one thing over another, but we do have objective evidence of the relative preferences. That evidence appears in the form of a price, which we will discuss in depth later.

Individuals and Value

Because value lies at the core of economic activity and individuals provide the source and measurement of value, individuals play a central role in all economic activity. It could be said that economics represents the study of exchanges that fulfill the values of individuals.

I will begin to discuss exchanges in a bit more detail in later posts.


Next, I will begin a discussion of the Conflicting Value Theories.

Value: Source

It seems that, when expounding on various economic theories, most economists simply avoid in-depth discussions about the source and measurement of value. They might, on the one hand, consider the source and measurement of value so obvious that they require no further attention; or, on the other hand, they might have such little confidence in their theories of value that they avoid the topic altogether.

Value, however, remains such an elementary concept in any economic theory that it requires explicit explanation to assure that the theory in discussion rests on sound footing. Without sound principles and theories with regard to value no economic theory can withstand logical examination.

In this post, I will examine very briefly the source of economic value. I will address the measurement of value later.

People make frequent references to value, either directly or indirectly, in their day-to-day conversations. “I think the Ferrari is not worth more than the Ford.” “I can’t imagine that you think the Android is worth more than the iPhone.” “The food in that restaurant is really quite a bargain.” Comments like these, and many more that you might find more reasonable, make reference to the values of various economic goods. They indicate how important we view value in our daily interactions, yet they make no reference as to the source of value.

A common source of value must exist. Otherwise, how can we make these comparisons? Everything that you value does indeed have a common source of value. And, quite simply, you provide the source of value for yourself. The same holds true of every individual. Each individual provides the source of his or her own values.

Thus, the individual represents the only source of economic value. Each individual by himself or herself determines what they value. This statement remains true for all items that have economic value. Only individuals can determine value.

You may already question how an economic system can operate effectively when the judgment of individuals provides the only source of value. I will tie together the notion of subjective value — the formal reference to individual value — and the operation of an effective economic system in future posts.

In the meantime, please ask yourself the source of the values you place on various items in your life. Did someone tell you the value of those items? Or, did you decide their value on your own?


See my next post on the measure of value.