Basic Economics, Part 2 – Maximizing Total Wealth

This is a second in a series of posts based on the concepts from the book “Basic Economics” by Thomas Sowell.

In my last post I explained how there are many different ways of allocating resources.  As an example I talked about many different ways of allocating beachfront real estate.  The next question is how we can evaluate whether one allocation method is superior to other allocation methods.  Fundamentally, there are two different ways we can evaluate allocation methods.

  • Practically;  Which method maximizes total wealth?
  • Morally:  Which method is the fairest?

Today I will only start to address the practical question.  I will address the moral question later.

What do I mean by maximizing total wealth?  Isn’t total wealth fixed and the only question is how we allocate it?  After all, we can’t create any more beachfront real estate no matter how we allocate it.

Let’s say you visit a coffee shop and buy a coffee.  As you take your coffee, you thank the clerk and the clerk thanks you.  Why do you both thank each other?  Each of you believe you are better off with this transaction.  At the time you want the coffee more than you want the money.  The coffee shop wants the money more than it wants the coffee.  Both sides of this transaction think they are better off due to this transaction.

Total wealth produced is the sum of all goods and services.  Whenever there is a transaction the extra value that each party perceives from the transaction increases the wealth.  When you buy your coffee, the total wealth increases because each side is better off for the transaction.

The best way to assure that both sides are better off from a transaction is for the transaction to be voluntary.  When you buy your coffee, nobody is forcing you to buy it and nobody is forcing the coffee shop to sell you the coffee.  Whenever there is a voluntary transaction then, at the moment at least, each party feels they are better off, that their wealth is increased.  Of course, this momentary perception can be wrong and in the long run, one or the other party is not better off.  I will address this later in this series.  For the moment, assume that the momentary perception is correct and each party actually is better off.

Of all of the allocation systems discussed in my last post, the only system that is totally voluntary is the free market priced based system.  If buyer and seller can agree on a price, there is a transaction where both parties believe they are better off.  When we have this voluntary transaction, wealth is increased.

In a central planning economy, a government official could either decide who buys or sells the coffee or the government official might set the price.

In the next post I will continue this discussion by contrasting the  central planning approach to the free market approach.

 

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