2012 fnf - talking sense economics by jana licht

Jana Licht

Talking Sense: EconomicsAn Easy Introduction

The Illustrator:

Numair Abbas is founder and

director of the animation study Numairicals.

www.numairabbas.com

Friedrich-Naumann-Stiftung für die Freiheit would welcome reproduc-tion and dissemination of the contents of the report with due acknowl-edgments.

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Disclaimer:

Every effort has been made to ensure the accuracy of the contents ofthis publication. The authors or the organization do not accept any re-sponsibility of any omission as it is not deliberate. Nevertheless, we willappreciate provision of accurate information to improve our work. Theviews expressed in this report do not necessarily represent the viewsof the Friedrich-Naumann-Stiftung für die Freiheit.

About the Author

Introduction

1) Basic Economic Rules I:

Individual Decision Making

1.1) All Individuals Have to Balance Alternatives

1.2) What You Have to Give Up when You Buy

1.3) Individuals React to Incentives

2) Basic Economic Rules II:

How Individuals Act Together

2.1) Trade Improves the Situation of Everyone

2.2) Markets: The Great Organisers

2.3) Government Interventions: Good or Bad?

3) Basic Economic Rules III:

How an Economy Functions

3.1) How to Get a Good Standard of Living

3.2) Why Do Prices Increase?

4) Market Demand and Market Supply

4.1) Demand

4.2) Supply

5) The Market Equilibrium and the Consequences

of a Minimum Price

6) Time Is Money. And Wasting Time Is

Wasting Money.

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Contents

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About the Author

Jana Licht, Economist (Diplom-Volks-

wirtin): After studies as a scholarshipholder of the Friedrich-Naumann-Founda-tion for Freedom in Economics, GermanLaw, Business Adiministration and Sociol-ogy at the Dresden University of Technol-ogy in Germany, Jana Licht is now workingas research fellow and university lecturerfor Macroeconomics, International Tradeand Foreign Economics, Economic Growth

and Business Cycle Theory at the Brandenburg University ofTechnology Cottbus, Germany. She is also working as a freelecturer for German Constitutional Law. She teaches studentsof varying levels of education: trainees in public service, un-dergraduate and graduate university students. In her research,Jana Licht is specialised on Development Economics and isdoing her Ph.D about corruption in Pakistan. She is a memberof the German Liberal Party, FDP (Freie Demokratische Partei),chairwoman of a local party group and a local politician in herhometown Dresden. She is mainly involved in the politicalfields of economic and domestic policy.

Introduction

1

Introduction

Hello and as-salāmu ‘alaykum! This booklet is not the normalschoolbook which you can find in every library, because, in thisbooklet, I am directly talking to you, my honoured reader, as I doit every day as a university lecturer. But first things first: for astart, I have to introduce myself. I am Jana Licht, research fellowand university lecturer at the Chair of Macroeconomics at theBrandenburg University of Technology Cottbus in Germany; inshort, I am an economist. I am, in fact, obsessed with economics;and I have plenty to feed my obsession on, because we are sur-rounded by economic issues. Not a day goes by without an indi-vidual making economic decisions. From an academician’sperspective, every decision can be described as an economic one.Hence, if one is to make informed, deliberate, and consciouschoices and decisions, it is essential to understand the basic rulesand mechanisms of economic decision making, how individualsact together and how markets behave; such knowledge enablesus to critically assess political pronouncements and media opin-ion.

In this booklet you will find basic economic knowledge, describedas easy as possible. In the first three chapters, I am going to ex-plain a set of essential economic rules. You will understand theincentives which drive the individual decision making and thecoaction of individuals, as well as the basic ideas how an econ-omy functions in its entirety. In the fourth and fifth chapter, wewill also analyse how demand and supply are defined and howthey interact on a market to constitute the price. In the last chap-ter, all these ideas are put together to illuminate an importanteconomic insight: Time is money. And wasting time is wasting

money.

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1Basic Economic Rules I:

Individual Decision Making

Basic Economic Rules I: Individual Decision Making

3

You are the starting and the endpoint of this – you as an in-dividual. Every individual is the source, the core, the beatingheart of every social structure. Understanding the imperativesdriving individual decision making thus helps us when itcomes to understanding the imperatives and exigencies thatdrive an economy. There is thus nothing mysterious on thequestion what an economy is; quite simplistically, it is a groupof individuals who interact as they go about seeking ways tofulfil their needs and wants.

3

An economy is a group of individuals who

interact as they go about seeking ways to fulfil their

needs and wants.

4

1.1 All Individuals Have to Balance AlternativesOur whole life is an endless chain of decisions: Should I getup and go to work or should I sleep one or two hours longer?Should I wear a shirt or a sweater? Should I drink coffee ortea? Should I buy a bus ticket or should I go by bike to work?

And so on… And within every deci-sion, we have to decide between twoor more alternatives. Normally, wehave to give up something we want

to get another thing we also want. Individual decision makingis thus all about balancing alternatives and solving conflictsof aims. This first lesson is pretty summarised in the well-known slogan: “There is no such thing as a free lunch.” Noth-ing is for free. Even if you do nothave to pay for your lunch withmoney, you always pay with yourtime; because in the same time, youcould have done other things than having lunch. For instance,you have made the decision to read this booklet. You do nothave to pay for this, so it might appear to be free, but youhave yet made a tradeoff in that you could have been readinga newspaper article, listening to music or calling a friend atthis particular point in time. In every moment of our lives, wehave to face conflicts of aims, trade-offs.

Even larger economic systems, and politico-economic systems,have to deal with such conflicts of interests, desires, and aims,and try and strike and appropriate balance. One of the mostimportant of these is that between efficiency and justice. Ef-ficiency means that a society makes optimal use of its limited

All individuals

have to balance

alternatives.

There is no such thing

as a free lunch.

5

resources. Distributive justice is the fair allocation of thegoods produced with these resources among the citizens ofthe society. Efficiency is about the size of the whole cake, jus-tice about the size and the number of the pieces of the cake.Often, these two aims come into conflict with each otherwhile political operations are developed and enforced, andeconomists and politicians are forced to prioritise one or theother.

1.2 What You Have to Give Up when You BuyEven if we are aware of the fact that individuals are con-fronted with trade-offs, we do not know how, or why, theyshould decide, in favour of any one specific option or tradeoff.To make a decision, one has to weigh the costs and the ben-

5


Efficiency

Justice

inefficient efficient

unjust just

6

efits of all alternatives. But often the costs are not plainly dis-cernible. As we saw above, costs are not always, or only, mon-etary. The costs of an alternative are the other alternativeswhich could not be realised, that is to say, opportunity costs.These must be accounted for making a rational decision. Thusit is said that the cost of a good equals the worth of the thingswhich must be given up for the purchasing of the good.

1.3 Individuals React to IncentivesBecause we balance costs and benefits for every decision, weoften will change our behaviour if costs or benefits of the al-ternatives change. In other words, we react to incentives. For

example, if the price of coffee rises,most people will tend to drink moretea instead of coffee. At the sametime, more workers will be hired at

coffee plantations as the owners of the plantations will wantto harvest more coffee, because the return on every coffeebean will be higher. It is very important to consider incentiveswhile fixing political programs. If politicians are not able tocorrectly gauge or assess the behavioural changes whichcould be caused by their arrangements, a whole political pro-gram can go wrong and make the situation worse.

The cost of a good equals the worth of the things which

must be given up for the purchasing of the good.

Individuals react

to incentives.


7

Let’s recap the initial ideas to understand how individuals make decisions:

1) All individuals have to balance alternatives.2) The cost of a good equals the worth of the things

which must be given up for the purchasing of thegood.

3) Individuals react to incentives.

8

2Basic Economic Rules II:

How Individuals Act

Together

Basic Economic Rules II: How Individuals Act Together

9

In the last chapter, I talked about how individuals make de-cisions. They have to balance alternatives, because the costof a good equals the worth of the things which must be givenup for the purchasing of the good. That is why individualsreact to incentives. But our decisions do not only influenceourselves. We affect other persons as well with our decisions,and vice versa. That is the reason why we now put our focuson how individuals act together.

2.1 Trade Improves the Situation of EveryoneYou often hear media or political voices claiming that anothercountry is a rival of your country in the world market, becauseit produces and exports products or raw materials similar tothose your country does. This argument, however, is not sus-

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tainable. Trade cannot be compared with a sporting compe-tition where one side wins and one side loses. Trade can havewinners on all sides. Trade improves the economic situationof every trading country.

To understand this better, have a look at your family and howit is influenced by trade and exchange. If one of your familymembers is looking for a new job, he or she rivals membersof other families who are also searching for a new position.Also your family vies with other families, when they go shop-ping, because every family wants to have the best goods forthe lowest price. One might say that every family in an econ-omy competes with every other family in that economy. Butwhat would happen if your family were to seclude itself fromthe other families? The situationwould not get better foryour family, because yourfamily would have togrow its own food, breedits own animals, produceits own clothes, build itsown house, teach itschildren by itself, pro-duce its own electricity,and so on. Obviously,your family profits bythe exchange withother families.Trade allowseveryone to


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concentrate on his or her best abilities. This could be, for ex-ample, farming, breeding, sewing, building houses, teachingor even repairing computers, writing books or doing researchon astrophysics. Because of the exchange, everyone can pur-chase a bigger diversity of goods and services for lower costs.This insight holds true for the trade between nations andeconomies as well. International trade allows an economy tospecialise in the goods which it can produce at the lowestcosts and gives people the possibility to enjoy a great varietyof different goods and services.International trade improves thesituation of everyone.

2.2 Markets: The Great OrganisersTrade happens on markets. And free markets are the best toolwith which to organise economic life. The collapse of most ofthe centrally planned economies was one of the most impor-tant changes of the world in the last century. Nowadays, theseeconomies are, or are trying tobe, market economies. In amarket economy, the decisionsof a central planning adminis-tration are replaced by non-central, distributed, independentand largely autonomous decisions of millions of businesses,companies, households and individuals. Enterprises and firmsdecide for themselves who they want to employ and whatthey want to produce. Households and individuals decidewhere they want to work and what they want to buy. Thesebusinesses and households act together on markets wheretheir decisions are driven by prices and self-interest.

Trade improves the

situation of everyone.

Normally, markets are

good for the organisation

of the economic life.

12

At first glance, the success of market economies is mysterious.One might think that millions of apparently non-coordinateddecisions would lead to great chaos. But market economiesare successful at promoting healthy economic life and boost-ing social welfare simultaneously, without compromising on

either. As Adam Smith said, allindividuals act together onmarkets as though they arebeing led by an “invisiblehand”. Few centuries beforeSmith the Prophet Muham-

mad (PBUH) replied when prices became to high and peopleasked him to fix them: “Allah is the One Who fixes prices, Whowithholds, Who gives lavishly, and Who provides, and I hopethat when I meet Him none of you will have a claim againstme for any injustice with regard to blood or property.”1 Pricesare the instrument used by this “invisible hand” to conductall economic activities, because prices mirror both the socialworth of a good and the social costs of its production. Enter-prises and households include the prices in their decisions andin this way, they respect automatically the social benefit andcosts of their decisions. If political administrations constrainthe prices from adjusting freely to supply and demand, theyhamper the coordination of the millions of single decisionswhich constitute an economy. Market planners cannot have

All individuals act

together on markets as

though they are being

led by an ”invisible hand“.

1 Reported by Ahmad, Abu Daoud, al-Tirmidhi, Ibn Majah, al-Dari andAbu Y’ala. Refer to Risalat al-hisbah by Ibn Taimiyyah, as well as toAl-turuq al-hikmiyyah by Ibn al-Qayyim, p. 214 ff.Source: “The Lawful and the Prohibited in Islam” – Yusuf Al-Qaradawi.


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the information which is included in free market prices. Amarket of millions of individuals knows itself better than anymarket planner. Socialist planners favouring centralised top-down economic planning erred when they tried to organiseeconomies by restraining, or tying up, the invisible hand thatregulates the markets.

2.3 Government Interventions: Good or Bad?

If, then, the invisible hand works so well, why do we need thegovernment? Well, the duty of the government is to protectthe invisible hand and create an environment in which it canfunction freely. Markets canonly function, if property rightsare made secure. No farmerwould grow corn if he couldnot be sure that it would not be stolen.

But there is another reason as well why we need economicpolicy. One important exception to the last rule, that marketsare the best way to organise economic life, exists: if the in-visible hand malfunctions. These situations, in which the mar-ket does not succeed in allocating resources efficiently, arecalled market failure. One of the possible sources of a marketfailure is an excessive concentration of power, when an indi-vidual or a small group is able to influence market prices ex-cessively. Imagine, for example, a monopoly situation:Everyone in a city needs water. But, imagine, there is only onesource of it. The owner of the source controls the market andhas power over it. – He is a monopolist and free to manipulate

Markets can only function,

if property rights

are made secure.

14

the price of water. He is not subject to the rigorous competi-tion which normally keeps self-interest in check. You can see

that, in this situation, govern-mental regulation of the pricedemanded by the monopolistcan enhance the market result

by raising the efficiency. But – and this is the crucial point –to say that political regulation can enhance the market resultsdoes not mean that this will always be the case. Politics arenot made by angels. Politicians are often guided by their ownself-interests, sometimes influenced by powerful groups, andmostly not well-informed especially about the functioning ofeconomic systems. So you always have to analyse whether apolitical intervention in a free market will in fact to boost ef-ficiency, justice and welfare – or not.

In this chapter, we discussed how individuals act to-gether. What did we learn?

1) Trade improves the situation of everyone.2) Normally, markets are good for the organisation of

economic life.3) Sometimes, government interventions can enhance

market results

Sometimes, government

interventions can

enhance market results.

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3Basic Economic Rules III:

How an Economy Functions

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We have already discussed how individuals make their deci-sions and how they act together. All decisions and interactionstogether constitute “the economy”. That is why the last of thebasic economic rules will explain how an economy functionsin its entirety.

3.1 How to Get a Good Standard of LivingThe differences in standards of living around the world areenormous. The per capita income of Luxembourg, the countrywhich, in 2010, had the highest per capita income in theworld, is 64 320 $ - and, by the way, never had a colony. Onthe other end of the spectrum, the Democratic Republic ofthe Congo had a per capita income of 290 $ in 2010. Ofcourse, these huge differences in per capita income are re-flected in the quality of life: individuals in countries with ahigh per capita income have more TVs, more cars, better food,better social welfare and a longer expectancy of life than in-dividuals in poor countries. How can these differences of in-

come and standards of livingbe explained? The answer issurprisingly simple: they aremostly caused by differences

in productivity, the amount of goods produced during oneworking hour. In economies in which workers produce manyunits of goods per hour, people have high standards of living.In economies with less productive workers and less efficientproduction technology people end up in rather more humbleliving conditions. This link between standards of living andproductivity, the ability to produce goods and services has far-

Productivity is the amount

of goods produced during

one working hour.

Basic Economic Rules III: How an Economy Functions

17

reaching consequences for economic policy. To enhance thestandard of living, governments must raise productivity by en-suring that their people are able to attain a high level of ed-ucation, a good capital endowment and have access toadvanced technology.

3.2 Why Do Prices Increase?Currently, Pakistan has an inflation rate between 13 and 14per cent. In 2009, it was more than 20 per cent. What doesthis mean? It means that you have to pay 13 per cent of Ru-pees more for all the things you buy this year than you paidin the last year. That means if something, for example a silkscarf, cost 1000 Pakistani Rupees in2010, you would now have topay 1130 Rupees for the samescarf. Nothing has changed,especially not your in-come, save the price of

The standard of living depends on the ability

to produce goods and services.

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the good. That is the phenom-enon which is called inflation:the rising of the price level inan economy. But inflation

burdens an economy with costs. For example, if the inflationrate is too high, menus in restaurants and price labels mustbe reprinted often so as to accurately reflect prices. That iswhy these costs are also called menu- or shoeleather-costs.If inflation spirals upwards rapidly, goods might cost ten timesas much tomorrow as they do today, and you might have towithdraw all your money just to be able to buy basic, everydaynecessities. This happened in Germany in the early 1920s, and,more recently, in Zimbabwe. Nowadays, most of the econo-mists think that two to five per cent is the best inflation ratefor an economy.

But what is the reason for a high long-term inflation rate?Mostly, there is just the one culprit: increase in money supply.The price level increases if too much money is in circulation.If a state or a central banking authority increases the amountof money in circulation, the worth of the money decreases.

”More money in circulation”means that the central bankingauthority gives more money inthe market, for example by print-

ing money and buying bonds from the market with this newmoney. If the supply of money increases while the demand ofit is stable, its worth must decrease (see chapter 5 for the dy-namics of demand and supply). That means that you can buyfewer goods for the same amount of money, or you have to

Inflation is the rising of the

price level in an economy.

The price level increases

if too much money is in

circulation.

Basic Economic Rules III: How an Economy Functions

19

pay more money for the same amount of goods as before. And,as we already know, high inflation inflicts damage to an econ-omy. But politicians have many incentives to raise the infla-tion rate by printing new money and bringing it intocirculation. One of it is the attempt to repay debts with thenew money. That is why it is very important to have an inde-pendently functioning central bank as the only institutionwhich is allowed to authorise the printing of, or to bringmoney into circulation. The central bank should not be influ-enced by politicians or other interest groups and be solelycommitted to keeping down the inflation rate. An examplefor a very independent central bank is the European CentralBank which controls the volume and the circulation of theEuro. No European country is allowed to impose pressure uponthe ECB. Its only duty, which is regulated by law, is to reachan inflation rate of a maximum of two per cent every year.

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Let’s now put together all the things we discussed in thelast three chapters. At first, we learned how individualsmake decisions. They have to balance alternatives, be-cause the cost of a good equals the worth of the thingswhich must be given up for the purchasing of the good.That is why individuals react to incentives. After that, wediscussed how individuals act together. We found out thattrade improves the situation of everyone and that marketsare normally good for the organisation of economic life.But sometimes, in the event of market failure, governmentintervention can put the markets back on track. Recog-nising these ideas, we now have discussed basic findingshow an economy functions in its entirety:

1) The standard of living depends on the ability to pro-duce goods and services.

2) The price level increases if too much money is in cir-culation.

With these basic economic rules, we can go on, in the nextchapter, to analyse the mechanisms how a market func-tions.

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4Market Demand

and Market Supply

22

In the previous chapter, we have already discussed basic eco-nomic rules. We know that free markets are normally goodfor the organisation of the economic life. And we have alreadytouched the ideas of demand and supply. The next two chap-ters will focus on market mechanisms. I am going to explainthe emergence of market demand and market supply, and howthese act together to generate a market equilibrium whichdetermines the market price, the instrument of the “invisiblehand”.

At first, the basic concept of a market must be defined, be-cause the words “demand” and “supply” refer to the behaviourof individuals while interacting in the marketplace. A marketconsists of groups of potential buyers and potential sellers ofa good or a service. The group of potential buyers dictates thedemand for the good, while the group of potential sellers de-termines its supply. The market is the place where demandand supply of a good or a service meet. A market does not

Market Demand and Market Supply

23

have to be a physical placelike a bazaar. Even the finan-cial market is real, despitenot being bound to a real,concrete location.

4.1 DemandLet’s start the analysis with the demand side of a market. Forthe whole analysis we will use the example of a simple, everyday good: milk. The milk quantity demanded is the quantityof milk buyers want or areable to purchase. The quantitydemanded is influenced bymany factors, but we will con-centrate on the most important and decisive one, the price,because, as we have previously learned, all individuals haveto balance costs and benefits before making a decision. If theprice of a litre of milk were zero, you would consume as muchmilk as you could drink, for example ten litres. If the pricewere to rise, you would lower the quantity of milk you buy,and probably switch to other beverages like water. If the priceof a litre of milk rises, for example, to over 500 Rupees, youwould completely stop drinking milk, because it would be tooexpensive. That is to say, the milk quantity demanded is re-lated inversely to the price of the milk. This is called the lawof demand: the quantity demanded declines, if the price rises.

The market is the place

where demand and supply

of a good or a service meet.

The quantity demanded

is the quantity buyers want

or are able to purchase.

The Law of Demand:

The quantity demanded declines, if the price rises.

24

The milk example is illustrated in the chart below: there youcan see explained the individual demand for milk. This is a socalled price-quantity-chart.

The quantity demanded is inscribed for every possible price ofone litre of milk. For example the first point: it says, that anindividual will demand six litres of milk, if the price is at 200Rupees.

Quantityin litres1 2 3 4 5 6 7 8 9 10 11 12

Price inRupees

600

500

400

300

200

100

0


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If the price is zero, ten litres will be demanded. This situationis illustrated with the second point in the below chart.


Price inRupees

600

500

400

300

200

100

0

If the price is above 500 Rupees, no milk will be demandedanymore. This situation is illustrated with the third point inthe chart below.

If you connect every point, you get the demand curve. The de-mand curve slopes downwards from left to right; it is a neg-ative curve because of the law of demand.


Price inRupees

600

500

400

300

200

100

0

Demand


Price inRupees

600

500

400

300

200

100

0

26


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A chart like this is a very useful tool for representing demandand supply trends in an easily comprehensible form. What wesee is the individual demand of one consumer; how manylitres of milk this consumer would demand at every price.

To calculate the whole market demand, the aggregate of theindividual demands of all the consumers in the market, wehave only to add together the quantities of milk demandedby every consumer at every price. In this way, we will get toknow how much milk is totally demanded at every possibleprice. This is the market demand.

4.2 Supply

Let’s now go on to the other side of the market, the supply;in our example the supply of milk. The quantity of milk sup-plied is the quantity of milksellers want or are able tosell. Again, the price of milkis the crucial factor whichdetermines the quantity supplied. If the price for a litre of milkis high the sale of it is more profitable for the seller. The sellerwill buy more cows, work harder and sell more milk. If theprice falls, the sale becomes less profitable. As a reaction toit, the seller will downsize the quantity of milk they supply. Ifthe price of a litre of milk becomes zero, the sellers would not

The quantity supplied

is the quantity sellers want

or are able to sell.

28

supply milk anymore. That is called the law of supply: the milkquantity supplied is related directly to the price of milk. Thequantity supplied increases, if the price rises.

I am going to illustrate the individual supply of a milk sellerin a chart similar to the chart for the demand. The quantitysupplied is inscribed for every possible price of a litre of milk.For example, the first point in the chart below, it says that aseller will supply four litres of milk, if the price is 200 Rupees.


Price inRupees

600

500

400

300

200

100

0

The Law of Supply:

The quantity supplied increases, if the price rises.


If the price is zero, zero litres will be supplied. This situationis illustrated with the second point in the chart below.

If you connect every point, you get the supply curve. This curveslopes upward from left to right because of the law of sup-ply.


Price inRupees

600

500

400

300

200

100

0


Price inRupees

600

500

400

300

200

100

0

Supply

29

30

If we add together the amounts of milk supplied by everyseller in the market, we get the market supply. In this way,we will know how much milk is totally supplied at every pos-sible price.

In the next chapter, we are going to see what happens whendemand and supply meet. We will understand how the “in-visible hand” works, how a market functions and how themarket price arises.

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5The Market

Equilibrium and the

Consequences of a

Minimum Price

32

In this chapter, we will try to analyse and understand how amarket works and why a political intervention in an efficientmarket is not a good idea. In the last chapter, I have alreadyshown how demand and supply emerge. Let’s recap. The quan-tity demanded of a good is the quantity of the good buyerswant or are able to purchase. The quantity supplied of a goodis the quantity of the good sellers want to, or are able to, sell.Now, we will focus on the market, which is, of course, wheredemand and supply meet.

Let’s go back to our example of a milk market. As you remem-ber, this is the demand curve of milk: it shows how many litresof milk are demanded at each possible price. The demandcurve slopes downwards because of the law of demand: thequantity demanded declines, if the price rises.


Price inRupees

600

500

400

300

200

100

0

Demand

The Market Equilibrium and theConsequences of a Minimum Price

This is the milk supply curve: it shows how many litres of milkare supplied at each possible price. This curve slopes upwardsbecause of the law of supply: the quantity supplied increases,if the price rises.


Price inRupees

600

500

400

300

200

100

0

Supply

33

34

To identify the market equilibrium we have to put both sidestogether. The milk demand meets the milk supply on the milkmarket. In the chart below, we can see both: the demand andthe supply.

There is one point, where demand curve and supply curve in-tersect. This is the so called market equilibrium. In the market

equilibrium, the milk demandequals the milk supply. Theprice where the curves cross isthe so called equilibrium price.

In our example, it is 250 Rupees. This is the price at whichthere is an equal demand and supply of milk. This is the priceyou will have to pay if you buy a litre of milk, and it is theprice the sellers get for a litre of milk. The correspondingquantity of milk, in our case five litres, is called the equilib-rium quantity. This is the demanded and supplied quantity of

In the market

equilibrium, the demand

equals the supply.


Price inRupees

600

500

400

300

200

100

0

Supply

250

Demand


35

milk at the equilibrium price. In the equilibrium, the bothforces in the market, demand and supply, are balanced. At theequilibrium price, the quantity buyers want or are able to pur-chase exactly equals the quantity sellers want or are able tosell. That is why the market, or equilibrium, price is also calledthe clearing price; because at this price, all market actors aresatisfied and the market is “cleared”: the buyers have fulfilledtheir purchase intentions and the sellers have fulfilled theirsales plans. And that is the way how the “invisible hand”works: without any external intervention, the market iscleared by forces operating and interacting within it. Marketdemand and market supply are adjusted by the market pricewhich itself automatically emerges as a response to theamount demanded and supplied at a particular point in time.Thus, we do not need political intervention to satisfy all mar-ket actors. Everyone is automatically satisfied in a free non-manipulated market. By the way, this is the basic definitionof capitalism: a system where you have private ownership andyou are free to sell and to buy under equal rights. As such alsoan Islamic economy is always and automatically a capitalisteconomy – with the Prophet Muhammad (PBUH) as rolemodel as trader and businessman. To always balance demand

and supply, the market price has to adjust freely to all changesin demand and supply. If, for example, in a dry season, it isdifficult to find grazing grounds for milk cattle, the costs ofproducing milk will rise, because extra fodder will have to be

Everyone is automatically satisfied in a free

non-manipulated market.

36

bought for the cattle. To cover all costs, the sellers of milkhave to ask for a higher price per litre of milk. This is illus-trated in our chart by a leftward shift of the supply curve.

The price asked by the sellers is now higher for each quantityof milk supplied. Thus, the market equilibrium also changes.The amount of milk at which the equilibrium is reached de-creases and the equilibrium price increases. But, again, de-mand equals supply, and the market adjusts itself to this newequilibrium point, until every market actor is satisfied. Only

with freely moving priceswhich are not fixed, can amarket adjust to everychange in demand and sup-ply. Freely adjusting prices

are the distinctive mark of a free, well-functioning market.

Freely adjusting prices

are the distinctive mark

of a free, well-functioning

market.


Price inRupees

600

500

400

300

200

100

0

Supply

Demand

Supply dry season


37

Imagine, now, a government mandated price of 350 Rupeesfor a litre of milk. Maybe the government wants to underpinand support the farmers who own cows by fixing the milkprice at this level, so that it cannot fall under 350 Rupees perlitre. What will this Minimum Support Price cause on the milkmarket? Let’s go back to our chart to analyse a situation witha minimum price.

As you can see, the minimum price for milk is inscribed as aline. That is to say, the price is not allowed to fall below 350Rupees per litre. This minimum price is above the market pricewhich would normally emerge without external intervention.At the mandated Minimum Support Price, the sellers want tosell seven litres of milk, but the buyers only want to purchasethree litres. Because the minimum price is above the marketprice, the sellers want to sell more milk than the equilibrium


Price inRupees

600

500

400

300

200

100

0

Supply

Demand

MinimumPrice = 350

Supply excess

38

quantity and the buyers want to purchase less milk than theequilibrium quantity. That is to say, more milk is supplied thanis demanded, the market is not “cleared”, and not all suppliersare satisfied. The result of a minimum price is an excess onthe supply side. Well-intentioned governmental interventionthus disturbs the work of the “invisible hand” and the marketdoes not function efficiently anymore. Additionally, prices areabsolutely necessary indicators for decision-making for both– consumers and producers. Any regulation distorts thisprocess and will lead to wrong decisions, mostly only visiblein the future.

39

6Time Is Money.

And

Wasting Time Is Wasting

Money.

40

After analysing basic economic rules and market mechanisms,I want to conclude this booklet by putting all ideas togetherto discuss a topic which is fundamental for understanding theperformance of an economy and which is very important forme: the usage of time. The achievement potential of everyeconomy depends on the fact how efficiently time is used inthe economy. Time is the basic limiting factor of every pro-duction process and every political program, because, as wealready know, time is the input factor which is needed forevery good or service, beside other costs. As we have alreadydiscussed, nothing is for free, you always have to pay withyour time if you want something, because you could do an-other thing in the same time.

Time is limited. Everyone has only 24 hours in a day. That iswhy time has a real economic worth.For example, you are paid for theworking time you supply to your em-

ployer with money, your wage. In short: time is money. This isan old, well-known and often cited dictum by BenjaminFranklin. And it is deeply true. If time is money, wasting time

is wasting money. Every lost minutein a production process burdens theproducing enterprise with costs. At

last, these are costs which have to be borne by all of us, bythe whole economy, because time has to be used efficientlyto produce in a cost-minimising way to induce an efficientmarket price which satisfies all market members.

Time is money.

And wasting time

is wasting money.

Time Is Money. And WastingTime Is Wasting Money

41

Using time efficiently applies to two different levels: yourusage of your own time and your usage of the time of others.Let’s start with the first point: your usage of your time. Fromthis point of view, using time efficiently does not mean mak-ing everything as fast as possible, regardless how well it ismade. If you do a job carelessly and inattentively, only regard-ing the time, you have to do it again to really accomplish yourmission. That is wasting of working time. And that is not onlyyour problem. If everyone works carelessly and has to repeatevery job, the whole economy lacks efficiency, because in thesame time while you were repeating your duty, you could havedone another job, you could have produced more goods orservices. And as you remember, the standard of living in aneconomy depends on the ability to produce goods and serv-ices. That is to say, using your time efficiently means that youshould use as much time as you need for a job to do it care-fully and completely, but not one minute more – as much timeas necessary, but as little as possible.

42

Normally, we do not life and work alone. We need other peo-ple to produce goods, to supply services and to satisfy ourneeds. This insight leads us to the second point: if we stress

the time of other people, we shoulduse their time as carefully and effi-ciently as possible. You should alwaysremember the fact that giving you

time is the same as giving you money, with one important dif-ference: you cannot give time back. If time is bygone, it iselapsed forever. Using the time of other people efficientlymeans observing deadlines and being punctual. If someonehas to wait for you or your work, he or she loses time, becausethey could have done other things meanwhile than waiting.For example if a workshop of twenty participants with an av-erage income of 500 Rupees per hour is delayed due to you

by one hour you have createda loss of 10.000 Rupees.Imagine the loss for 180 mil-

lion Pakistanis! As already mentioned this burdens the wholeeconomy with costs and as a result, reduces the standard ofliving, if everyone does it. But there is another point: let some-one wait for you is extremely disrespectful. And disrespectfulbehaviour destroys relationships. But, remember, you need re-lationships with other people to satisfy your needs, you cannotdo it on you own. That is why your punctuality is you bene-fiting finally.

As much time as

necessary, but as

little as possible.

Your punctuality is you

benefiting finally.

Friedrich-Naumann-Stiftung für die Freiheit

Tel: +92-51-2 27 88 96, 2 82 08 96Fax: +92-51-2 27 99 15

House 19, Street 19, Sector F-6/2,Islamabad 44000 - Pakistan

[email protected]

2012 fnf - talking sense economics by jana licht

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