Economics deals with those things that we want but that are "scarce." We economists care about commodities whenever there are not enough of them for all of us to be satisfied that we have all that we want. Under those circumstances societies then have to--we have to--figure out whether it is worth making more of these scarce commodities. And then, if we do make more of them, we then need to figure out who is going to get to use them.
Where things are not scarce (the air, for example), that is not economics. Where we do not, care that is not economics either. Where things are both scarce and where we care, we have the economic problem.
How ought a society to go about dealing with the economic problem? How should we--collectively--decide whether it is worth our while to make more of any particular commodity? And if we do decide to make more of them, how ought we to decide who is been going to get use them?
At this point I need to pause and note two facts about the world. Most scarce things that we care about are "rival." And most scarce things that we care about are "excludable." By "rival" I mean the only one person can use it at a time. I am now using this iPad to read my lecture notes. Because I am now using it, you cannot be. By "excludable" I mean that it is relatively easy to keep someone from making use of a commodity. I can keep your cows from eating my grass by putting up a barbed-wire fence.
Because commodities are "rival," somebody's use of a particular good imposes an opportunity cost on the rest of society. Because I am using this iPad, there is one fewer iPad for the rest of you to use. My use restricts your opportunities. A good economic system would make me take account in my decision-making of any reduction in your opportunities and resources that might be caused by my actions.
This is where the market economy comes in.
Let us assign each newly-produced commodity a particular person. Call this person the "owner." Let the owner decide who is going to get to use the commodity. Let the owner exclude all others who from using the commodity. And let the owner charge the designated user he or she has decided upon a "price" for the right to make use of this commodity.
This simple institutional arrangement has a huge number of advantages as societal mechanism for planning and coordinating the production and distribution of scarce, rival, excludable commodities.
It solves the problem of production--what commodities we should try to make more of. Individuals look forward into the future and recognize that others will be willing to pay them high prices for commodities they greatly desire. That gives individuals an incentive to figure out how to make more of those scarce, rival, excludable commodities that are scarcest.
It solves the problem of economizing--of how to get people to economize on their own consumption and not hog too great a share of society's total resources for themselves. Because they have to pay the owners the prices the owners ask, their eyes may be bigger than their stomachs but their wallets generally will not be.
It solves the problem of distribution--of determining who is going to get to use newly-produced commodities. The owner has an incentive to choose the person willing to pay the highest price--and the person willing to pay the highest price is, in some sense, the person who values it the most, to whom it is scarcest.
Moreover, it solves the problem of coordination: As long as market prices are free to move to equalize quantities supplied and demanded, there does not need to be any huge centralized computer bureaucracy keeping track of everything and making sure that plans add up. The market will coordinate itself.
And it solves the problem of information: In a market economy with commodities with owners, decision-making is pushed out to the periphery of society where people already know what is going on. You don't need any huge centralized computer bureaucracy collecting and processing information--and where people do discover that there are things that they don't know but need to learn, why knowledge of something and that somebody else would like to learn it is also a commodity and those who know those two facts are its owners.
It is hard to imagine a simpler institutional framework--owners and prices--that could solve those five problems so very well.
At this point I need to pause and point out a lucky consonance between the requirements of a societal institution for producing and allocating rival, excludable, scarce commodities on the one hand and the psychological propensities of us East African Plains Apes on the other. That we believe that things are ours and that we own them is perhaps not so surprising--it appears deeply deeply engraved in mammalian psychology. Squirrels certainly act as though they believe that they "own" nut-foraging sites. Dogs believe that they "own" bones. We East African Plains Apes, however, not only believe that we own things--we like to give them away. We are animals that solidify our own societal bonds via relationships of gift-exchange. And it is this psychological propensity to engage in gift-exchange--what Adam Smith called our natural propensity to truck, barter, and exchange in such a way that both sides are happy because they feel that they have gained something from the deal--that serves as the underpinning of our market economy.
That is the first thing I want you to remember from this course: The market economy, based on deep human psychological propensities, is an extraordinarily effective societal instrumentality for planning and coordinating the production and distribution of scarce, rival, excludable commodities.
Remember this. Keep it as an active process running on your wetware always. Lay up this idea in your heart and in your soul. Bind it for a sign upon your hand, that they may be as frontlets between your eyes. Teach it to your children when thou sittest in thine house, when thou walkest by the way, when thou liest down, and when thou risest up. And write them upon the door posts of thine house, and upon thy gates: that thy days and the days of thy children--or at least the commodities they own--may be multiplied.