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’.
(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.)
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.
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:
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
Every
year, the Mises Institute holds an economics seminar called Mises
University. It attracts many eager students of Austrian economics from
both the United States and abroad. I happily attended this year’s
seminar for the second year in a row. I originally wrote this as a letter to a friend while there and slightly amended it for publication on the Daily Anarchist.
