By Christopher Zimny
If you have ever seen something that defied explanation, did you think it to be something you merely couldn’t explain, or that perhaps it was actually was pure magic? Perhaps you have seen David Blaine’s street magic specials and saw something like this. Magicians gain fame and reputation by performing illusions for eager spectators who wish to be fooled. In this case, a glimpse at the unknown is a tantalizing bit to savor. When someone sees such a trick, they are baffled, but because of this they usually try to figure out how it was done.
Regular people do this with economic phenomena every so often too. For instance, laymen sometimes wonder why the owner of a business raises his prices and remains highly successful. The laymen might attribute an arbitrary reason to the phenomenon at hand without thinking about it any further. The same is done with a baffling magic trick; it’s realized that a trick was done by some sleight of hand, though usually no further thought is given to what the magician actually did. So a vague notion is attributed to how each of these things happened, and I want to encourage the reader to pursue this initial spark of investigative work as far as he or she possible can.
What I want to suggest here is that we must embrace—and take as far as possible—this desire to understand. In order to come to a correct conclusion about we observe—whether with magic tricks, social phenomena, or anything else—we must stringently focus on the logic of the situation at hand, for only then can we actually make sense of what we see.
Ludwig von Mises stresses this point, telling us that a logically consistent theory is necessary in order to understand the human story (see the work suggested at end of this article). The reason why we find things such as magic tricks so confounding is precisely because they do not mesh with the way we think the world works. We correctly tend to place logic above what we observe. Thus, most of us realize that this is not actual sorcery, but some sort of illusion. And we are right.
Take for instance the magic trick called the Ambitious Card. The ‘effect’ of the Ambitious Card is that one selected card is plainly placed in the middle of the deck only to end up on the top again. But it does not do this by magic; it is accomplished by practiced sleight of hand. We came to this conclusion because logic tells us not to believe what we see right off the bat, but to match what we see with our intuitive logical insight. Here, then, is where we begin to figure it out. We must ask ourselves: What means (the magician’s ‘method’) can be used to achieve the end (the effect of the trick) sought? From this point we logically move forward until we have sufficiently explained it.
I’ll save you the trouble of figuring it out: the method for the trick (and I apologize for breaking the magician’s code) is usually that the selected card is actually the second card from the top. The magician picks up both cards and shows the face of the bottom card in what is called a double lift. He turns them back over, so that when he takes the top card—what we think is the selected card—, and places it in the middle of the deck, the selected card is still on top. Thus, when the magician snaps his fingers and says the magic words, the selected card “magically rises” to the top. However, this is only one way the magician might accomplish his goal. (I don’t want to spoil all the fun.) Should he choose this effect, many more methods could be used to achieve it. The magician’s choice of such methods depends on the time, the place, and the social environment in which the magician finds himself, just like any other person who decides to undertake a particular action. If you change the terms ‘method’ and ‘effect’ to the more general terms ‘means’ and ‘ends’, you will be at the starting point for understanding economics.
If we can figure out how such a feat as the Ambitious Card was accomplished, it no longer seems miraculous to us. The same goes for seemingly unexplainable economic events. Now, while knowing the method of magic tricks might take the fun out of the whole thing, this is not the case with economic theory. Rather, theory puts the magic into what happens around us, because it enables us to give a true explanation of what occurs in reality. Indeed, figuring out the method to this trick—by applying logic to the situation—is similar to how the economist figures out what happens in society using economic “theory”.
To go back to our earlier example, using consistent, logical theory, we can understand why we see a businessman raising the price a thing that he sells. I’ll save you the trouble of figuring that out, too. First, we must consider the person who is undertaking that action, namely the owner. Here we realize that, as an entrepreneur and as a human being, he prefers to have more than to have less. This fact is true for every person. (Note too that the want for things does not always mean money). Thus, it must also apply to the buyer of the good. The seller prefers to gain the most amount of money that he can per item sold, while the buyer wants to spend the least amount of money per item bought. The amount that the seller prefers to charge for each of his goods is shown on the ‘supply curve’ below. At the same time, the buyer will purchase a certain amount of the good at a given price, shown on the ‘demand curve’. Only at a price on which each person agrees will an exchange be made. The point at which the businessman can reach the maximum number of agreeable exchanges is called the ‘equilibrium point’. To give a visual example of this, each curve in the graph below shows the respective preference of the businessman and the consumer, as well as the equilibrium point.
Also consider what happens if the seller—who wishes to gain as much profit as possible—sets his price elsewhere. If he went above the equilibrium price, buyers prefer not to buy as much as they would have otherwise, thus the seller does not gain as much as he could have had his price been lower, so he lowers his price. And if he went below equilibrium, buyers prefer to buy more than they would have before; the seller realizes that he could make more money per item if he raises his price, so he does so. (This is precisely why the point at which the seller will make the most money is called the equilibrium point, for every deviation from it will eventually bring it back to this point.) This is the built-in mechanism in the economy called the ‘price system’.
Now we are in a position to answer the question at hand: Why has the seller raised his prices and still remains successful? We have just seen that the seller will not raise his prices above the equilibrium point arbitrarily, else he will lose profit. Thus, we are left with the necessary conclusion that he has done so because his buyers are willing to pay more for his goods. So the seller’s raise in price is no longer a mystery to us. Using logic, it can be explained, just like a magic trick.
(And it should be mentioned while we’re at it that the agreed upon price does not render each good’s “value” equal to one another, as you might be led to believe. In fact, in an exchange, each person must value what he is receiving more than what he is trading away, otherwise the exchange cannot take place. In this case, the buyer values the good he is receiving more than the amount of money that he is trading for it, while the seller values the money he is receiving more than the good he is trading away. Thus, each item’s value relative to each person is necessarily different and in no way can the two items be considered equal in value to one another.)
The proper method of economics is to form a consistent body of knowledge (theory) and then apply it to reality. Indeed, this is the only way to go about things. Some schools of thought wish to explain reality using history as a guide. But this will lead us astray and give us mistaken explanations. For example, if we tried to explain reality after seeing a magic trick, we might well come to the conclusion that some events in the world are simply miraculous and defy all explanation. This might be well and good if we want to settle there, but operating in this fashion would not get us anywhere in the pursuit of truth. So what we must do is use the tools of logic—which come prior to observation—to give an accurate account of why things happen the way they do. The entire edifice of economics is built with this purpose in mind. Indeed, this way of reasoning is the only way that we could properly explain the Ambitious Card, and it is the only way that we can properly explain economic phenomena.
Try this as mental exercise: Whenever you see something that baffles you and you think that there must be a logical explanation for it, follow this thought process as far as you can. If you let logic assemble the pieces to reality—so that you come to one precise conclusion—you will not be led astray. Economic theory, far from being a “dismal science”, does explain a lot about human reality. It always helps to have a head start, so pick up the following works in order to get one:
Economics in One Lesson by Henry Hazlitt
Chapter 1 of Epistemological Problems of Economics by Ludwig von Mises
Economic Science and the Austrian Method by Hans-Hermann Hoppe
Man, Economy, and State by Murray Rothbard
As a bonus, this work uses the method of economics to explain social phenomena outside of economics proper: Democracy: The God That Failed by Hans-Hermann Hoppe
Prices of specific goods and services change all the time as the supply of and demand for goods and services constantly change. If the stock of money in society remained the same, prices could only fluctuate in that fashion: if the price of one thing goes up, the price of something else must go down, so this does not explain a rise in all prices. Instead, this can only be done by an increase in the stock of money (what is called ‘inflation’). When people generally have more money, they are willing to spend more of that money on the same goods and services, and prices go up accordingly (called ‘price inflation’). So the “effect” of inflation is that prices rise, and the “method” of accomplishing this is continued injection of new money into the economy.