Fundamental Theorem Of Economics

Adam Smith is the father of economics but Jean-Baptiste Say stated the most important fact about economics, “Supply creates its own demand.”  In recent decades this statement known as Say’s Law has been sneered at by believers in the current orthodoxy that the consumer drives the economy.

smith

Reflect upon this statement for a moment.  What do we mean by “demand”?  We all want lots of stuff, but can afford to buy much less than what we want.  Therefore demand in this context means that which we can afford to pay for in the marketplace.

The next consideration is how we get the wherewithal to demand anything.  In common language we speak of where we get the money.  Someone can give it to us, we could steal it, or we could earn it.  Even if money is given to us, or stolen by us, someone had to earn it first.

This last point brings us just a step away from nailing down the principle involved here.  Someone had to earn the money first.  That means someone had to do something to get the money.  Someone had to act to create something of value (a good or service) for which another person was willing to give him money.

Now we have completed the circle.  In order to “demand” something someone had to first perform a creative act – an act that produces something.  Therefore, we can now restate Says Law as “Supply is the only source of demand.”  Without someone creating, producing, supply there can be no demand.  In more common terms this means that nothing can be consumed before it is produced.

This may sound trite, but it is a profound truth that is completely ignored by present day theoreticians and politicians.  It is a metaphysical truth.  Restated as The Fundamental Theorem of Economics we have “Production precedes consumption.”

Understanding this allows us to deduce and thoroughly understand the source of prosperity and points the way to deciding which policies promote prosperity.  If we want to consume more we must produce more.  This applies to each of us individually and all of us collectively.  If you want more you can work longer, harder and smarter.

Working longer and harder is viscerally understood.  Working smarter is a conceptual idea that can be reworded as working more productively.  Over the very short term we must work longer and harder to become wealthier.  Unfortunately, our individual mental and physical capabilities combined with time limitations severely restrict how wealthy we can become by only working harder and longer.

Beyond the very short term, in order to dramatically increase wealth and prosperity we must work smarter.  We must become more productive.  We must produce more, produce it better (higher quality), produce it faster, produce it more efficiently (at less cost).

This all derives form our fundamental theorem, “Production precedes consumption.”  Now we have a reference point and tool to help us make reasoned decisions about economic policy issues.  We can ask whether a proposed statute or regulation increases or decreases productivity. For that matter we can better understand what, if any, government activities enhance productivity.

Contribued by:
Steve Reiss @ SedonaSteve.wordpress.com

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