Basic Economics

Thomas Sowell

📚 GENRE: Business & Finance

📃 PAGES: 704

✅ COMPLETED: June 7, 2020

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Short Summary

In Basic Economics, bestselling economist Thomas Sowell delivers a citizen’s guide to economics. Sowell explains the general principles underlying different economic systems and shows how to critique economic policies by looking at the incentives they create.

Key Takeaways

1️⃣ Economics and Scarcity — In the end, economics is the study of how scarce resources are deployed. There isn’t enough of everything to go around. In a free market economy, money will flow to companies producing products and services that the people want. Supply and demand drive prices and competition. 

2️⃣ The Ripple Effect — There is almost always a chain reaction when an economic policy change is made. There’s usually a ripple effect that affects a lot of different areas of the economy. When a politician is pushing for a certain change in policy, think about the ramifications it could have on other areas/people in the economy. 

3️⃣ Politicians Have Incentives— Sometimes the individuals and politicians that make up a government have their own incentives and agendas. This leads to some politicians following those personal incentives rather than doing what’s best for the people. Politicians are more concerned with meeting popular demand rather than looking at the economic consequences.

Favorite Quote

"Economics is the study of the use of scarce resources which have alternative uses."

Book Notes 📑

Chapter 1

  • The basics of economics hold true in all countries and all eras.
    • What made prices rise during the time of Alexander The Great makes prices rise in the United States today.
  • There is no economy or economics without scarcity.
    • Economy — System for production/distribution of goods and services.
  • Quote: “Economics is the study of scarce resources which have alternative uses.”
  • Scarcity — What everyone wants adds up to more than what is available.
    • There’s never been enough of everything to satisfy everybody. This is scarcity.
  • Production — Turning inputs into outputs.
    • Economics studies the consequences of the decisions that are made about the use of land, labor, capital, other resources that go into producing the volume of output that determines a country’s standard of living.
      • These decisions can be more important than the resources themselves.
      • Some countries are more efficient than others about their decisions and resources.
  • It is not money, but the volume of goods and services that determines a country’s wealth.
    • It’s about how efficient the country is with its input and outputs.
      • Inputs — Materials used to make something.
      • Outputs — The final product.
  • Economics — The study of cause-and-effect of decisions.
  • A good visual for economics: The medical staff on a battlefield.
    • There are not enough medics for all injuries. The medical staff has to decide who to treat based on who needs it most and who has a realistic chance of survival with treatment. These decisions are huge because they can’t treat everyone (scarcity). This is economics in a nutshell.

Chapter 2

  • A key task of any economy: Allocation of scarce resources, which have alternative uses.
  • In a free market economy, prices control all activity in the economy. Not the government.
  • Prices often reflect scarcity.
    • Ex. Beach House — These aren’t expensive for no reason. It’s because there aren’t enough beach houses to go around. They are scarce in comparison to the population. Therefore, the price for one is always high.
  • Prices guide consumers and producers. Supply and demand drives prices. 
    • If there is more supply than demand for an item, sellers compete to unload the product to customers by slashing prices. 
    • If there is more demand than supply, sellers raise prices.
  • Gas prices are often reflective of oil prices available to gas producers. If oil reserves are discovered somewhere, there is more oil available to producers, which lowers the price for them to acquire it, which gets passed on to consumers on the form of lower gas prices at the pump.  
  • Competition in the market limits what anyone can charge and still make sales.
  • Supply and demand dictate a lot of things.
    • Ex. Cheese — Demand for cheese goes up. The price for producers to acquire milk from farmers to produce the cheese will then go up. This affects the prices when producing ice cream and other dairy products because they also use milk. Therefore, the prices of ice cream and other dairy products will go up for the consumer.
      • The implications carry on even further. Basically, it’s a ripple effect in the economy.
      • That’s why centrally planned economies, like the former USSR, are impossible. Politicians and government can’t possibly keep up with all the implications.
  • If a country is using its resources to make stuff not needed by the people instead of things that people do need, it can lead to a poor standard of living for the people.
    • This is why the decisions made on how to use resources with multiple uses is vital.
  • The real cost of anything is its value in alternative uses.
    • Ex. Bridge — The cost of building a bridge is what that labor and materials could’ve been used to make otherwise.
    • Ex. Time — Cost of watching Netflix for an hour is the value of the other things that could’ve been done with that time.
  • Different economic systems around the world severely affect a country’s economy and the standard of living of its people.
    • Ex. Centrally-planned USSR had political leaders hand out resources to businesses. There was no competition for prices. If a business could convince the government they needed a certain amount of resources, they got it.
      • This led to excessive resources being handed out to businesses that made stuff the people didn’t even need. These resources could’ve been better used to make things the people did need. This directly affected the people of the USSR in a negative way.
  • Government-controlled economies historically have led to worse standard of living for people.
  • Why a centrally planned economy is worse than a free market economy, which is controlled by prices:
    • When producers must compete for resources via prices, producers producing things that the people don’t want will take a loss because there isn’t enough demand to cover the cost of getting the materials and resources. Therefore, resources will go to the producers who are making things people actually want and need. This results in happy people.
    • Alternatively, in a centrally-controlled economy, resources go to those who can persuade politicians. This can lead to resources going to producers that are not making things people want or need. This results in a low standard of living.
  • Competition and other various circumstances ate why prices fluctuate, not because of greed or anything else.
    • Competition forces prices towards equality and causes labor and capital to flow towards the point of highest return on investment.
  • Economics is about tradeoffs. Because you’re dealing with scarce resources, not everybody is going to be satisfied. You have to make tradeoffs in the economy.

Chapter 3

  • Prices rise because the amount demanded exceeds the amount supplied at existing prices. Vice versa.
    • This is referred to as surplus and shortage.
  • Price controls can be bad. Price controls are when the government sets the price for something lower than the price that would prevail under natural supply and demand conditions in a free market.
    • Ex. Healthcare in Britain — The government tried to make healthcare more affordable, but by setting the price low, people went to see the doctor for small things that weren’t all that bad, like a minor cough. This led to doctors being overwhelmed, and people that actually needed real treatment were forced to wait a really long time. This led to a lot of deaths. Also, doctors could not spend the right amount of time with each patient because they had so many people to treat. This is called quality deterioration.
  • A price set below the level that would prevail by natural supply and demand conditions in a free market tends to cause more demand and less supply, creating a shortage at the imposed price.
    • A price set above causes more to be supplied than demanded, creating a surplus.
  • A surplus, like a shortage, does not mean there’s too much of an item in relation to the population. It just means the prices are too high so people are not really buying.

Chapter 4

  • Prices are key to every economy.
  • Price controls can be very detrimental, despite usually having good intentions.

Chapter 5

  • Businesses have to be able to adapt to different circumstances in the economy to survive.
  • Lower costs result in lower prices.
    • Ex. A&P Grocery Store — Grocery store A&P was once the top store in the industry, but it failed to adapt to the introduction of the automobile and refrigerator. Competitors, like Safeway, swooped in and stole A&P’s customers because they adapted better and were able to offer lower prices via lower costs.
  • Businesses that can cut costs and operate under low cost conditions have the ability to offer lower prices to consumers because they can cover their costs fairly easily. 

Chapter 6

  • When one company finds a way to lower costs and therefore prices to consumers, it forces its competition in the economy to lower their prices, which benefits the consumer even more.
    • Basically, competition is good for the economy and consumers.

Chapter 7

  • Monopolies, oligopolies, and cartels cause disruption in a free market economy.
    • Monopoly — One seller
    • Oligopoly — Small number of sellers that cooperate with each other to set prices and get similar, dominant results.
    • Government has to get involved to stop these.
  • Anti-Trust Laws — Designed to stop monopolies, oligopolies, and cartels.

Chapter 8

  • Competition is what eliminates monopolies, oligopolies, and cartels.
  • Monopolies, oligopolies, and cartels can charge a premium for their products and services because they dominate the industry and market.
  • Anti-trust laws are pursued when some company’s actions threaten competition in the industry.
  • From an economic standpoint, it doesn’t really matter what percentage of the market a company owns; a monopoly is happening when a company can keep other competitors out.

Chapter 9

  • Market economies encourage competition. Industries or companies that struggle will not be bailed out. You have to compete to survive in a free market economy.
    • This is true because resources will naturally go to the companies and people that are doing the best with them and that customers value the most.

Chapter 10

  • Labor is a scarce resource. There will always be more work to be done than people able to do it.
  • Supply and demand dictate how much a person is worth and how much they are able to make.
    • Ex. Space Engineer — There aren’t too many qualified and well-trained space engineers. As a result, they are more valuable and will be paid more. There are millions of people who can make pizza dough, on the other hand.

Chapter 11

  • Unemployment — Surplus of labor in the market.
    • Tends to be higher when there are minimum wage laws in order. This is because when there is a minimum wage, some employers lay off low, entry-level employees because they don’t want to elevate the pay of those employees to match the minimum wage rate. This leads to higher unemployment rates.
      • When this happens, the laid off workers are missing out on their pay, but they’re also losing out on job experience that could lead them to higher pay in the future.

Chapter 12

  • Unemployment Rate — The percentage of people who are in the labor force, but are not working.
  • Companies try to keep employee wages from rising above the level dictated by supply and demand in a free competitive market, whereas labor unions try to raise wage rates above what you would see in a free competitive market dictated by supply and demand.
  • If labor unions are successful and get higher wages for their employees, it hurts the overall workforce because the employer will respond by hiring fewer people or replacing the labor altogether by buying machines to do the work.
  • Why monopolies don’t last:
    1. The company earns above average returns consistently.
    2. People see this and want in on it. They start their own firms to compete.
    3. Increased competition then drives down the average rate of return.
    4. Barriers to entry that prevent competition from entering the industry are the only way monopolies can last.

Chapter 13

  • Types of investments:
    1. Human capital
    2. Financial investments
      • From an economic standpoint, financial institutions provide a way to facilitate money to corporations that then use the money to build things and bring overall value to the economy and country as a whole. Small countries that don’t have financial institutions have no way of facilitating money from citizens to businesses and therefore suffer.
      • Investments by citizens give companies the money needed to expand and get better by building things that will help them in the future, like a factory used to produce goods.
        • When making an investment, it’s key to make sure the management is strong, as Warren Buffett says. This is because management and leaders are the ones deciding how and what to spend the money on. These decisions can be the difference between success and failure.
          • Investors are taking the risk and the reward occurs if the company’s share price goes up over time due to good decisions by management on how to use the invested money.
    • Interest rates follow the same supply and demand tendencies as products.
      • If the desire of citizens to save exceeds their desire to invest, interest rates will fall to encourage spending. Vice versa.
        • This is why interest rates are not constant. They change in response to supply and demand in the economy.
  • Too much, or too little, inventory is bad for a company.
    • Too much inventory = excess cost of doing business compared to competitors.
      • Competitors are able to then sell at lower prices and take away customers.
    • Two little inventory = you run out of what customers want.
  • Present Value — Anticipated future benefits added up and discounted for the fact that they are delayed.
    • If you install new stuff to your house, then your property’s market value is immediately worth more than your neighbors’, even if there is no visible difference in the way they are functioning today.
      • Ex. Mom and dad’s big window
    • If the city announces a new sewer system that runs by your house, the present value of the house immediately goes down despite nothing being touched yet.
  • The present value theory applies to looking for natural resources as well.
    • If the present value of current oil barrels is less than the cost of exploring and drilling for new oil reserves under the ocean floor, then it’s not worth doing.
    • Drillers will often leave oil down under the ocean floor and only extract a small amount because it’s very costly to extract oil. As technology improves and lowers the cost of extracting it, or if the price of oil rises a lot, then they will extract more. It all depends on the present value and costs. We are not “running out of oil”, we are just not extracting all of it at one time. 

Chapter 14

  • Capital Gain — When a home, business, stock, or other asset increases in value over time.
    • This is a form of income. It is taxed when the asset is sold. 
  • Bond prices go down as interest rates go up, generally speaking. Bond prices and interest rates have an inverse relationship.
  • Companies are legally contracted to pay you back for bonds, plus interest, whether they make money or not.
    • Stocks are riskier because companies are not guaranteed to improve and they aren’t legally responsible for giving your money back.
  • Venture Capitalism — Investing in risky and new companies. Venture capitalists require really high rates of return because of the risk they take on. They can also make a ton of money is the company successful.
  • Bonds are safer than stocks, generally, but stocks are the better long-term choice.
    • Bonds — Fixed rate of return. This means your rate of return will not rise with inflation over time.
    • Stocks — Variable rate of return. Stock prices rise with inflation so you don’t have to worry about inflation eating into your return like bonds.

Chapter 15

  • Quote: “The purpose of a capitalist market is to direct scarce resources to their best uses.”

Chapter 16

  • A country’s total worth is everything it has accumulated in the past.
    • Gross Domestic Product (GDP) — The sum total of everything produced in a country’s borders.
    • Gross National Product (GNP) — The sum total of all goods and services produced by the nation’s people.
    • These two measures show a country’s output for a certain year.
  • There are a lot of complications when comparing the outputs of different countries.
    • The best way, arguably, is to compare countries using GDP per capita for the same year.

Chapter 17

  • Banks help facilitate the flow of goods and services by facilitating money throughout the economy in an organized manner.
  • Money has two issues: Inflation and Deflation.
    • Inflation — A general rise in prices. Eats away at the purchasing power of your money.
      • When people have a lot of money and are spending it, prices across the board will rise if there is not a surge in output to match the demand.
      • The more money in the economy, the more inflation will rise.
      • Sometimes, the government purposely sparks inflation by printing more money to increase its wealth instead of raising tax rates, which are very unpopular for politicians and discourage spending for some people who don’t feel it’s worth it to spend at certain tax rates.
      • Runaway inflation happens when people realize their money is losing value rapidly and rush to spend what they have before it loses even more value.
    • Output tends to fall when inflation rises. Producers find it risky to produce. The money they earn might not be as valuable as what it will cost them to produce the products.
  • Deflation — Prices fall because there is more supply than what is being demanded by people.
    • The money supply decreases and less money are available in the economy, which leads to less spending. 
    • Deflation causes people to hold onto their money.
  • The Federal Reserve — The central bank run by the government to control all private banks.
    • The Fed can tell private banks what percentage of money must be held in reserves and what percentage can be used to loan to customers.
    • The Fed also loans money to private banks.
      • By controlling the interest rate for other banks to borrow at, the Fed indirectly controls interest rates for customers who borrow from banks.
    • The Fed has a big impact on the economy and the stock market. That’s why every public statement made by the Fed is carefully evaluated by investors.
  • How Banks Work — A bank takes in deposits from people, lends the money out to others at a certain interest rate, then gives depositors a percentage of the interest it has gained by lending to keep them as customers. The bank profits off the spread.

Chapter 18

  • Key functions of government:
    1. Establish a general framework of law and order that the economy can run on.
    2. Prevent corruption, which discourages spending and overall growth/investment.
    3. Set respectable and attractive laws that govern the people in the economy.
    4. Establish property rights.
    5. Social order
    6. External costs and benefits
  • Government Incentives — Sometimes the individuals and politicians that make up a government have their own incentives and agendas. This leads to some politicians following those personal incentives rather than doing what’s best for the people. 
    • Politicians normally do what’s popular, even if it’s the wrong move. Therefore, there is a line of separation between what a government can do and what government will do.
    • This can have bad economic consequences sometimes. Politicians are more concerned with meeting popular demand rather than looking at the economic consequences.

Chapter 19

  • Like everything else, a government must have resources to continue to exist.
    • The government takes a share of the national output in the form of money a.k.a. taxes.
      • Taxes change consumer behavior. People choose items with fewer taxes, so government financing really does impact the economy a lot.
    • Tax revenue and bond sales are the largest sources of money for a national government.
  • Balanced Budget — When all government spending is covered by taxes collected. 
  • Budget Surplus — If the money acquired by the government via taxes exceeds government spending.
  • Budget Deficit — If the money acquired by the government via taxes falls short of government spending.
  • National Debt — The accumulation of all government deficit and debt.
    • This does not refer to the total debt of all businesses in the nation. It strictly means the debt that the government is in.
  • The government usually uses money gained through taxes to spend on things that will help right away. It uses money gained through bond sales to fund future, long-term projects, like highways, dams, and bridges.
  • Raising tax rates does not necessarily lead to greater tax revenue.
    • People begin to move out of heavily taxed areas or buy fewer highly-taxed commodities
    • It all depends on how people react to changes in tax rates.
  • Rather than raise tax rates, local politicians will issue more tax-free municipal bonds to raise more money for the local government to use on political projects.
    • This is preferred over raising taxes, which is unpopular for politicians. Again, politicians have incentives. Raising the tax rate would not be popular with voters.
  • Government Bonds — Borrowing money from the people. These bonds are repaid using tax revenue.
  • As of 2011, 46% of the United States national debt (bond holders) were foreigners.
    • This means that future United States taxpayers are essentially paying foreigners.
  • Government provided goods and services, like entrance to national parks, bridge tolls, subway, golf courses, etc., are usually covered by tax revenue, so there is less incentive for these to be successful from a money standpoint.
    • Essentially, prices for these things can be very low or high because they are backed by taxpayer subsidies. The government doesn’t really care how successful these things are or what customers think about the prices.
      • Ex. Bridge Toll Fees — The government can get away with forcing a bridge fee for crossing.
  • Keynesian economics says the government should spend more money than it receives through tax revenue (deficit spending) to get out of a depression. This adds to money demand in the economy, leading to more purchases of goods and services by reducing unemployment.

Chapter 20

  • Government intervention during a financial crisis is not always needed.
    • Ex. Black Friday — In the 12 months following the Black Friday stock market crash in 1929, unemployment never got over 10%. President Hoover then passed a few bills and the unemployment rate rose over 20% for the next over three years.
    • Ex. 1988 — In 1988, following the largest single day drop in stock market history, President Reagan let the economy recover on its own and it did so successfully.
  • Government pension plans enable politicians to make promises that future governments are expected to keep.
    • Politicians offer the pension plans to future retirees to get elected, but don’t raise taxes to generate the money to fund these plans because that would be unpopular. Instead, they don’t raise taxes and let future politicians deal with the problem. 
      • In Brazil, government pension plans are already paying out more than they are taking in. This is a looming financial crisis that the United States is trying to stall.

Chapter 21

  • The North American Free Trade Agreement — A 1998 trade agreement made between the United States, Canada, and Mexico. Eliminated trade barriers for certain products.
  • Countries engage in trading because both sides benefit in some way. The three categories:
    1. Absolute Advantage — Trading with a country that has an advantage that can’t be replicated. 
      • Ex. The United States buys bananas from tropical countries in the Caribbean because it costs us less to buy from these countries then it would to replicate the climate through greenhouse gases here in our country.
      • Ex. Coffee Beans — It takes a very particular climate to grow these correctly. Therefore, countries with the right climate have a big advantage. In the 21st Century, over half of the coffee beans in the world are produced in Brazil, Vietnam, and Columbia.
    2. Comparative Advantage — When one country is able to make a product better and more often than another country.
      • Ex. Canada can make chairs easier and more frequently than the United States, but the United States makes televisions better and more frequently. The United States has a comparative advantage over Canada for making televisions, but Canada has the advantage for making chairs. Therefore, they trade each other.
    3. Economies of Scale — International trade is necessary for many countries to achieve economies of scale that will enable them to sell at prices that can compete with prices for similar products in the world market.
  • Tariffs — Taxes on imports to raise prices on those imports. This enables domestic companies to charge higher prices for their own, similar products.
  • Quotas — Putting a limit on the number of imported products that can come in. This affects supply and demand, which can manipulate prices.
  • Outsourcing — Direct transfer of jobs to another country.

Chapter 22

  • The United States provides more services than physical goods. As a result, the United States imports more goods than it exports. Vice versa for services.
  • The international trade balance does not include services, only goods.
    • This is why it is reported that the United States is in a deficit, but that’s usually not true.
  • The Marshall Plan — The United States sent wealth to countries in West Europe after World War II.

Chapter 23

  • It costs way more to ship things by land than by water or sea.
    • This is partly why there are a lot of big towns and cities next to the ocean.

Chapter 24

  • The Market — Where individuals engage in economic activities, taking into account competition and other individual factors.
    • Prices for the same physical assets can often be different based on several factors.
      • Ex. Safeway — The same items were bought at three different Safeways in the Bay Area. The prices were different at all three locations. This was because of the cost of land for each store. The store in San Francisco had the most expensive items.

Chapter 25

  • The government uses taxes that eat into people’s earnings to fund social programs and other endeavors. This is why people don’t like taxes.

Chapter 26

  • Everything is interconnected in economics. An economy is like a chain reaction.
    • Ex. The Fed raises interest rates to reduce the danger of inflation. This can cause house prices to fall, savings to rise, and car sales to decline, among other things.
  • No economic law or transaction takes place in isolation, regardless of how politicians might try to make it seem that way by providing certain “solutions” to a “problem.” There is almost always a chain reaction that results in consequences in areas of the economy that may not seem related.
  • Keynesian Economics became popular in the 1930s and 1940s after the Great Depression.
    • Keynes argued that government intervention could speed up a market’s recovery time in a depression. He argued that the risk of inflation that comes with government intervention was better than the risk of huge unemployment rates if the market took too long to recover on its own. He argued for this tradeoff. 
      • 1970s — Unemployment AND inflation were high for a period of down times in the economy, leading to doubt about the Keynesian Economics claim that governments could make that tradeoff.
  • Milton Friedman of the University of Chicago chipped away at many of the theories of Keynesian Economics. He won the Nobel Prize for Economics in 1971.
  • Just because a country has higher wages paid to workers does not mean the total output cost is higher than a country that pays workers less money for the same job.
    • This debate comes up often in international trade, where some people assume that we can’t compete with a country that pays workers way less to do the same job.
    • Usually in a more developed country that pays higher wages, machinery, organization, and other factors associated with the job are far superior, which, in the end, results in less total cost to do the job than the less developed country that can get away with paying workers less.

Chapter 27

  • Another example of chain consequences in economics:
    • Labor unions. These are designed to take a certain percentage of a company’s earnings away from investors and give it to workers. But this discourages potential investors from investing in the company, resulting in less money for the company, which results in the company hiring fewer workers. Therefore, labor unions can hurt employment and the overall success of the company. Unionized companies usually have worse employment rates than non-unionized companies.