The Rudiments of an Economic System

( Peter Cooper Dec. 2012 )

Economics is the study of how society employs scarce resources to produce and distribute various goods for consumption among people and groups in society, with or without the use of money. 1 "Money" is a designated medium of exchange and serves in a marketplace as a store of value, the unit of account, and a standard of deferred payment for debts. "Price" is the quantity of payment by one party to another in exchange for goods or services. 2 The factors of production are "land" (natural resources), labor, and capital. The term 'land' denotes those resources, both material and energetic, which originate in the natural environment in supposedly fixed supply and from which society produces goods for consumption. 'Labor' is the societal (i.e., "human") factor of production determined only by social and biological factors, and not by any response to economic conditions. Labor employs and directs natural resources ("land") and capital to produce goods or services. 'Capital' is the means within an economic system by which labor produces goods or services. Capital goods are distinguished from consumer goods. A consumer good is produced primarily for personal consumption. A capital good is a produced good that can be used as an input factor for further production. That is, whereas labor and "land" are primary factors in the sense that their supplies are determined largely outside the economic system itself, 'capital' is any intermediate factor produced by the economic system and, as such, is useful, in turn, as a further "means of production". 3 Capital can be either "real" or "financial". The term "finance" is defined simply as the management of money or of monetary funds. "Real capital" consists of physical, non-financial goods that assist in the production of other goods and services. "Financial capital" refers to the monetary funds provided by lenders and by investors to producers for the purchase of real capital. Banks are the primary financial intermediaries which channel funds between lenders and borrowers. The banking system produces financial capital by regulating the money supply. 4 Every society asks three fundamental, interdependent economic questions: 5 1. What goods are produced and in what quantities? 2. How shall goods be produced? That is, by whom and with what resources and in what technological manner are they to be produced? 3. For whom shall goods be produced? That is, how is the total product of society to be distributed for the enjoyment and benefit of the people and groups in society? Therefore, economic systems are typified by the answers given to what, how, and for whom are goods produced. In a "command" economy a central governing authority coercively decides these questions by arbitrary decree or fiat. In a "capitalist free enterprise" economy the production of goods is determined by a system of prices within free markets. "Capitalism" is here defined as private ownership of capital (i.e. the means of production). In contrast, "Socialism" is defined usually as public (spec., government) ownership and/or control of capital. The U.S. does not presently have a pure price economy but a "mixed" capitalistic enterprise system in which "elements of government control are intermingled with market elements in organizing production and consumption". 6 Free markets and private property are essential to the manner in which a capitalist free enterprise economy answers what, how, and for whom goods are produced. Remarkably, in a true system of free private enterprise no individual or organization is consciously concerned with these economic questions. As if led by an "invisible hand", every self-interested individual achieves the best good for all, while freely and competitively pursuing his own good. This optimal prosperity is made possible, within realistic limitations, by the price mechanism of the marketplace. 7 Within a free market, goods and services are exchanged such that their prices and costs of production tend to match with their demand and supply. What supply of goods will be produced is determined by the demand of consumers - by the price consumers are willing and able to pay. How goods are produced is determined by competition among different producers who employ innovative techniques to produce the greatest good at the least cost. For whom goods are produced is determined by supply and demand in the 'factor' markets. 8 Goods thereby flow to the providers of productive factors and services. The compensatory prices of these services - rents, wages, interest, etc. - constitute returned earnings which go to make up consumer incomes. By this mechanism goods are allocated to those who have earned sufficient incomes to pay the market prices. In a

competitive free market, goods are produced by each according to their service and are first distributed to each according to their earnings from this service - that is, the distributive rule is "to each according to their production". 9 Private property rights are necessary for free markets. Property in goods is, by definition, the right to possess, use, and dispose of those goods. Within a free market, goods are freely exchanged between private individuals and organizations. Without private property rights, free enterprise is impossible. When legal property rights within a capitalist economy are significantly curtailed by a central, governing authority, the market exchange of capital goods is not free and may be quite limited. Although capitalist enterprises would have legal ownership of the real capital which constitute their respective means of production, the use and disposition of this capital would be considerably circumscribed by law. That is, the means of production, although owned privately, would not be controlled privately. Without private individuals having an unambiguously exclusive right to use and to dispose of the goods of production, free markets cease to function and, as history shows, impoverishment ensues. What goods are produced is no longer determined by consumer demand. How goods are produced is no longer determined by competitive, technological advantage among different producers. For whom goods are produced is no longer determined by a free market distribution of consumer goods to those individuals who provide the necessary productive services and justly earn their incomes. Such a so-called "capitalistic" economic system in which the means of production is privately owned but publicly controlled by a central governing authority, is actually a type of "socialistic" economic system called "fascism" - not "free enterprise". 10 The American Revolution was inspired by ideas antithetical to the very notion of a "command" economy, whether generally socialistic or specifically fascistic. The founding principles of the American Republic and its Constitution posit all human beings are naturally equal in their fundamental humanness and, as such, each individual has inalienable rights to life, liberty, and the pursuit of happiness. The American people have recognized that these natural rights are best protected by limiting the coercive power of the state and its governing authority over the economic life of society. This historical fact is reflected in the Federal and the respective State constitutions where government is ostensibly limited to a relative few enumerated powers. The premium put on freedom of contract and private property means the American people are oriented constitutionally to a capitalist free enterprise economic system. Figure 1 depicts the rudiments of an economic system and holds true for a so-called "mixed economy". The role of government services regarding production, consumption, banking, taxation, etc. is left undefined. An output factor, "waste", is included for the sake of completeness. Consideration of 'Balance of trade' (viz."import/export") and 'consumer debt' is indicated.

Figure 1

The rudiments of an economic system

1. Paul A. Samuelson (1967), Economics - An Introductory Analysis, p.5 2. http://en.wikipedia.org/wiki/Money http://en.wikipedia.org/wiki/Price 3. Samuelson (1967), p.48, p.570 4. http://en.wikipedia.org/wiki/Finance http://en.wikipedia.org/wiki/Financial_capital#Financial_capital_vs._real_capital 5. Samuelson (1967), p.15 6. Samuelson (1967), p.46 7. Samuelson (1967), p.41 8. Samuelson (1967), p.42,43 9. http://www.kelsoinstitute.org/pdf/whatlouiskelsoknew.pdf, P.3 10.Samuelson (1967), p.781