Chapter 1: A Wealth of Opportunities in a World of Limits

Few people approach the study of economics with excitement. Economics has a reputation for being difficult and dull. In fact, it's commonly known as the dismal science. But economics doesn't have to be difficult, and it certainly shouldn't be dull because it provides insight into something we are all interested in—producing wealth and having the freedom to enjoy it.

Economics can make you appreciate how fortunate you are to live in America. It explains why we have achieved a level of wealth inconceivable not long ago and how the personal freedom Americans enjoy is critical to producing that wealth.

But getting wealthy is not easy. The power of economics comes from understanding the obstacles to creating wealth. Wealth doesn't simply fall from the sky; it has to be coaxed out of natural resources with effort and ingenuity, neither of which is plentiful enough to accomplish all we would like. Creating wealth requires that we cooperate with each other to make the most valuable use of our limited time, effort and resources. But no matter how successful we are, limits will remain on the desirable things that can be accomplished.

Recognizing limits to what is possible, however, is not the same as yielding to pessimism. By understanding what the limits are, we can push them back when it's possible and accept them when it's not. We would never have sent men to the moon without understanding gravity. And no one thinks physicists are pessimists because they point out that trying to invent a perpetual motion machine is a waste of time.

Concentrating on limits may seem dismal, but it is the key to creating a wealth of opportunities. As this book makes clear, economics delivers the hopeful message that human progress can continue to be made through communication, coordination and cooperation. There is a lot of optimism to be found in the dismal science.

This first chapter introduces the fundamental economic problem of scarcity, along with some basic concepts that will help us understand the implications of scarcity and how we can best deal with it. As we are about to see, the most obvious implication of scarcity is that there are costs to everything we do. But the bright side is that costs always mean attractive opportunities.

Chapter 2 deals with the social cooperation needed to push back the limits of scarcity by taking full advantage of the opportunities that exist. Interestingly—and at first glance paradoxically—the competition that exists in market economies is a powerful force for social cooperation.

Sometimes the best way to understand the benefits realized from the cooperation of the marketplace is by considering the problems that arise when we mess with the market—the subject of Chapter 3. Chapter 4 continues our look at social cooperation by examining the importance of profits in keeping producers responsive to consumers' interests.

Finally, Chapter 5 looks at the connection between freedom and the entrepreneurship that fuels economic progress. Without freedom, the spirit of entrepreneurship could not be unleashed, and without the cooperation of the marketplace, we would quickly find limits placed on many of our freedoms.

The Abundance of Scarcity

No matter how much we have, we continue to face scarcity—the inability to have as much as we want. Average life expectancy at birth has increased by over 30 years in the past century, yet we want to live longer. We can travel from Dallas to Tokyo in far less time than it took Thomas Jefferson to travel from Charlottesville, Va., to Washington, D.C., yet we want more on-time flights. E-mail has made it routine to send a written message halfway around the world and receive a reply in seconds, instead of the weeks it took by regular mail; yet we want more broadband hookups and faster modems.

Most of our activities can be explained as attempts to deal with scarcity. As Adam Smith, the founder of economics, wrote in The Wealth of Nations (published in 1776), "There is scarce perhaps a single instant in which any man is so perfectly and completely satisfied with his situation as to be without any wish of alteration or improvement of any kind."

Scarcity doesn't result from people wanting more just for themselves. Mother Teresa couldn't help nearly as many as she wanted to because of scarcity. Indeed, in a world without scarcity—a world hard to even imagine—there would be no need for the generosity and self-sacrifice she exemplified.

It's not even clear that we would enjoy the complete absence of scarcity very long, though it would be fun temporarily. Overcoming obstacles to achieve worthwhile goals gives our lives meaning and provides satisfaction. What would there be to achieve if scarcity didn't exist—if everything you, and everyone else, could possibly want was instantly available?

The Implications of Scarcity

The implications of scarcity are profoundly important. Ignoring them can—and often does—result in serious mistakes.

Opportunity Cost
The most fundamental implication of scarcity is that everything we do carries a cost. When you are doing one thing, you are using time and resources that cannot be used for the next most valuable thing you could have been doing. The cost of doing more of one thing, then, is the value that is sacrificed by doing less of something else. This is why economists are so fond of pointing out that there is no such thing as a free lunch.

Economists refer to the value forgone every time we do something as opportunity cost. In fact, all costs are opportunity costs. We commonly think of cost as the money we spend to obtain something. But spending money on one thing is sacrificing the opportunity to spend it on something else. The money spent on something simply provides a convenient measure of its real cost, which is the value of an opportunity forgone.

The biggest cost of doing something often has nothing to do with spending money. For example, the biggest cost of going to college is the income forgone, not the money spent on tuition and books. This explains why college enrollment typically increases when high unemployment makes it difficult for college-age people to get good jobs. The biggest cost of making a telephone call is often that it prevents you from doing something else, like watching TV, reading a book or cooking dinner. This explains why so many people talk on cell phones while driving: The cost is low because there's little else they can be doing. (Of course, not paying attention to your driving can be forgoing the value of safety.)

Concentrating on opportunity cost may seem to be emphasizing the negative. But there are two sides to the coin of opportunity cost. One is forgone value resulting from scarcity, and the other is opportunity. There would be no opportunity costs without opportunity. If there were only one thing you could do with your time and talents, there would be no cost to doing it. The larger the number and the more valuable the opportunities you have, the better—although this increases the cost of the choices you make.

Competition and Cooperation
Another implication of scarcity is that cooperation is desirable but competition is inevitable. The best way to push back the limits of scarcity is by working in cooperation with others. More can be accomplished when people coordinate their efforts with each other and take the concerns and talents of others into consideration. But because scarcity always leaves people wanting more, competition is unavoidable. Fortunately, competition does not have to be at the expense of cooperation. In fact, as we will see, competition can be the most effective way of ensuring cooperation. But first we need to consider some other implications of scarcity.

Rationing
Since there is never enough to satisfy everyone, there have to be ways to ration the things we want.

Rationing requires rules, and those rules determine the type of competition that occurs. For example, using the rule "first come, first served" is one way to ration things. This rule causes people to compete by waiting in line, with the competition favoring those willing to wait the longest—those with the lowest opportunity costs. Unfortunately, this does nothing to promote the type of cooperation that makes everyone better off. Waiting in line does nothing to produce more of what people are waiting for.

Another way to ration scarce goods is by having the government distribute them. Government distribution is typically justified as a way of ensuring things go to those who most deserve them, instead of to those best able to compete. But the rules of government distribution don't eliminate competition, they just change the type of competition that occurs. The more wealth government allocates, the more money interest groups spend contributing to political campaigns and hiring lobbyists to influence officeholders' decisions. Such competition may provide politicians with some information, but it does little to produce more of the wealth people are competing for. When one group gets more through political competition, some other group gets less.

The most productive competition takes place in response to the rules of the marketplace. As we will see, market competition excels at promoting the type of cooperation that allows each of us to get more of what we want by helping others get more of what they want. Market competition doesn't eliminate scarcity, since people never get as much as they would like. But the cooperation of the marketplace enables us to do a better job pushing back the limits of scarcity.

Doing More with Less
Another implication of scarcity is so obvious it shouldn't need to be stated. But it does.

Because of scarcity, we should take advantage of opportunities to produce more value with fewer resources (less opportunity cost). The reason for making such an obvious point is that it is so often ignored. People commonly object to automation that allows us to produce more with less effort because they fear it will destroy jobs. A common complaint about international trade is that it destroys American jobs by allowing us to get products from other countries for less than we can produce them domestically. People become upset when a company lays off lots of workers, even if it no longer needs as many of them to maintain, or even expand, production.

It is true that doing more with less destroys some jobs, but that doesn't mean fewer employment opportunities. Because of scarcity, there are always more jobs we would like done than can be done. There is no limit to the goods and services we would like to consume, and everything we consume has to first be produced. (Consumption comes before production only in the dictionary.) So there are really too many potential jobs, and the problem is not providing people with jobs but providing them with the jobs in which they produce the greatest value. When technology enables us to do a job with fewer workers and resources, those workers and resources can be used to produce other desirable things that we would otherwise have done without.

While no one wants to lose a job, we are all better off because millions of jobs have been destroyed over the years. Over half the American workforce were farmers in the first half of the 19th century. Today, only about 2 percent are farmers because technological advances allow us to produce more food with fewer workers (and less land).

Those advances haven't resulted in massive unemployment. People who would have been producing food are now able to produce medical services, cell phones, computers, airline travel and many other things that would be produced in smaller amounts, or not at all, had farming jobs not been destroyed.

It has been estimated that if we made as many telephone calls as we do today, but with the technology that existed in 1900, well over half the adult population would be working as telephone operators. Of course, we would never employ that many operators, so without the jobs lost because of improvements in telephone technology, we would have had far less of many nice things—including telephone service.

Living at the Margin

In our world of scarcity, we constantly have to make choices. Making them sensibly requires comparing the value of alternatives. But we seldom have to make choices between all of one thing or all of another. For example, we don't choose between food but no clothes and clothes but no food. If we did, the choice would be between eating in the nude or starving in style.

Fortunately, we make most decisions at the margin, choosing a little bit more of one thing at the cost of having a little bit less of something else. So the comparisons we make are between the marginal values of goods— the value of another unit of the good. It is sensible to spend our money on a variety of things, with an extra dollar going for the product with the greatest marginal value.

People recognize the importance of comparing marginal values in their personal choices, which explains why even very poor people usually wear clothes when they dine. But people commonly take positions that ignore the importance of comparing marginal values.

For example, we have all heard arguments like this one: Something is wrong with the economy when wrestling stars are paid a lot more than nurses, since nurses are obviously more valuable than wrestlers. As we will see, such arguments sound plausible but are flawed because they ignore the importance of marginal considerations. For a long time, even economists didn't understand marginal arguments.

Marginal Value vs. Total Value
For years, economists puzzled over why the price of diamonds is far greater than the price of water, even though water is obviously far more valuable than diamonds. This diamond–water paradox wasn't resolved until the 1870s, when Austrian economist Carl Menger and British economist William Jevons independently recognized the difference between marginal value and total value.

The price of something is a measure of its marginal value—the amount people are willing to pay for one more unit—not its total value. The total value of water is obviously much greater than the total value of diamonds; we would pay far more to avoid going without water than we would to avoid going without diamonds. But because water is so plentiful, the amount people are willing to pay for one more (the marginal) gallon is close to zero; the marginal value of water is low. On the other hand, diamonds are so rare that people are willing to pay thousands of dollars for just one more.

Which brings us back to wrestlers and nurses. Because so few have the physical attributes to satisfy the demand for wrestling, some people are willing to pay a lot to attract one more person with those attributes into the ring. Conversely, many have the attributes to satisfy our demand for nurses, so it takes much less to attract one more person into nursing.

Although the total value of nurses far exceeds the total value of wrestlers, the marginal value of nurses is far less. And it is the marginal value of workers—not the total value—that helps determine salaries.

So there is nothing remarkable about professional wrestlers earning a lot more than nurses, although some consider it objectionable. But the real objection is to how others choose to spend their money. Many who don't believe wrestlers should make more than nurses spend their money in ways that ensure talented opera singers and symphony conductors also make more than nurses.

Marginal Considerations and Personal Success
The marginal way of thinking (which is not the same as marginal thinking) helps us understand many public issues. It also helps us understand how to achieve personal success. Thousands of books have been written on personal success, and few if any ever point out the importance of marginal considerations. Many, however, extol the importance of the old saw that if a job is worth doing, it's worth doing as well as possible.

The problem with following this advice is that it would guarantee failure. Fortunately, people seldom do tasks as well as possible, and they are more successful because they don't. The marginal way of thinking explains why.

No matter how much time you spend doing a task, you can always do it a little better by spending yet more time on it. But before you spend enough time to do a task as well as possible, the marginal value of time spent on it is less than the marginal value of time spent on another task. Another minute on the first task adds less value than the first minute on a new one.

Recalling opportunity cost, before one task is done as well as possible, the marginal value of spending more time on it becomes less than the marginal cost (the marginal value sacrificed by spending less time on another task). So even if perfection were possible, it wouldn't be sensible.

We often hear that if we want to get things done, it's important to get started. This is good advice. Starting a task is often the hardest part, and many people fail to accomplish much because they never postpone a chance to procrastinate. But marginal considerations tell us that to do a task right, you also have to know when to stop. Like spelling banana, you have to know when to quit.

Consider doing well in school. Teachers often complain that students would get more out of their courses if they would study more. The teachers are right, but they shouldn't be surprised at, or critical of, their students' behavior. Doing well in class can be important in achieving the objectives students have, but so are lots of other things, such as working part-time, making friends, developing social skills, or just hanging out and having fun.

More time on class assignments adds value, but it means less time on other valuable activities. And long before a student has done as well as possible in his or her course work, the marginal value of time spent studying will have fallen below the marginal opportunity cost—the marginal value sacrificed in other activities.

So the student doing her absolute best in class is getting less value from the marginal minute spent studying than she would if she spent that minute doing something else. She increases the value realized from her time by equating at the margin—reducing the time spent studying until study time has the same marginal value as time spent doing other things. Even if the student is a complete nerd, she will still do better equating at the margin over her different courses, since she will get more out of all of her courses by learning less than possible in each of them.

Decreasing Marginal Value
The point of equating at the margin is not to provide an excuse for being sloppy in the jobs you do or for trying so many different things that you do them all poorly. But generally, the marginal value of doing something eventually begins decreasing as we do more of it. Putting the first coat of paint on a house adds more value than adding a tenth coat. Putting the first coat of wax on a car adds more luster and protection than putting on the third coat. Economists refer to this as decreasing marginal value.

Of course, it is also important to recognize that we get better at doing many things as we spend more time on them, which means the marginal value of time in these activities can increase for awhile—maybe quite awhile—before it starts decreasing.

So you don't want to attempt so many things that you never become very good at any of them. Developing real skill in the relatively few things you have talent in or you really enjoy (talent and enjoyment generally go together) increases your productivity and enjoyment.

But no matter how much you enjoy an activity, or how good you are at it, eventually the marginal value of doing it begins to decline relative to other things. So you still want to equate at the margin over a number of activities. And although this means you will end up doing nothing as well as you possibly can, you can still be extremely good at what you do. Not doing your absolute best at any one thing is not the same as not doing your absolute best overall. Being as successful as possible requires being somewhat less successful than possible in everything you do.

Your personal success obviously depends primarily on your own efforts and productivity. But it is also true that your efforts will be more productive if you coordinate your actions with those of others. How market economies help all of us pursue our dreams in cooperation with others is the topic of the next chapter and the overarching theme of this publication.

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