Talking Sense: Economics

An Easy Introduction

Jana Licht

Talking Sense: Economics

An Easy Introduction

Jana Licht

The Illustrator: Numair Abbas is founder and director of the animation study Numairicals. www.numairabbas.com

Friedrich-Naumann-Stiftung fr die Freiheit would welcome reproduction and dissemination of the contents of the report with due acknowledgments. Friedrich-Naumann-Stiftung fr die Freiheit Post Box 1733 House 19, Street 19, F-6/2, Islamabad 44000 Pakistan Tel: +92-51-2 27 88 96, 2 82 08 96 Fax: +92-51-2 27 99 15 E-mail: pakistan@fnst.org Url: www.southasia.fnst.org No of printed copies: 3,000 First Edition: 2012 ISBN: Disclaimer: Every effort has been made to ensure the accuracy of the contents of this publication. The authors or the organization do not accept any responsibility of any omission as it is not deliberate. Nevertheless, we will appreciate provision of accurate information to improve our work. The views expressed in this report do not necessarily represent the views of the Friedrich-Naumann-Stiftung fr die Freiheit.

Contents

About the Author Introduction 1) Basic Economic Rules I: Individual Decision Making 1.1) All Individuals Have to Balance Alternatives 1.2) What You Have to Give Up when You Buy 1.3) Individuals React to Incentives 2) Basic Economic Rules II: How Individuals Act Together 2.1) Trade Improves the Situation of Everyone 2.2) Markets: The Great Organisers 2.3) Government Interventions: Good or Bad? 3) Basic Economic Rules III: How an Economy Functions 3.1) How to Get a Good Standard of Living 3.2) Why Do Prices Increase? 4) Market Demand and Market Supply 4.1) Demand 4.2) Supply 5) The Market Equilibrium and the Consequences of a Minimum Price 6) Time Is Money. And Wasting Time Is Wasting Money.

iv 1 2 3 5 6 8 9 11 13 15 16 17 21 23 27 31

38 iii

About the Author

Jana Licht, Economist (Diplom-Volkswirtin): After studies as a scholarship holder of the Friedrich-Naumann-Foundation for Freedom in Economics, German Law, Business Adiministration and Sociology at the Dresden University of Technology in Germany, Jana Licht is now working as research fellow and university lecturer for Macroeconomics, International Trade and Foreign Economics, Economic Growth and Business Cycle Theory at the Brandenburg University of Technology Cottbus, Germany. She is also working as a free lecturer for German Constitutional Law. She teaches students of varying levels of education: trainees in public service, undergraduate and graduate university students. In her research, Jana Licht is specialised on Development Economics and is doing her Ph.D about corruption in Pakistan. She is a member of the German Liberal Party, FDP (Freie Demokratische Partei), chairwoman of a local party group and a local politician in her hometown Dresden. She is mainly involved in the political fields of economic and domestic policy.

iv

Introduction

Introduction
Hello and as-salmu alaykum! This booklet is not the normal schoolbook which you can find in every library, because, in this booklet, I am directly talking to you, my honoured reader, as I do it every day as a university lecturer. But first things first: for a start, I have to introduce myself. I am Jana Licht, research fellow and university lecturer at the Chair of Macroeconomics at the Brandenburg University of Technology Cottbus in Germany; in short, I am an economist. I am, in fact, obsessed with economics; and I have plenty to feed my obsession on, because we are surrounded by economic issues. Not a day goes by without an individual making economic decisions. From an academicians perspective, every decision can be described as an economic one. Hence, if one is to make informed, deliberate, and conscious choices and decisions, it is essential to understand the basic rules and mechanisms of economic decision making, how individuals act together and how markets behave; such knowledge enables us to critically assess political pronouncements and media opinion. In this booklet you will find basic economic knowledge, described as easy as possible. In the first three chapters, I am going to explain a set of essential economic rules. You will understand the incentives which drive the individual decision making and the coaction of individuals, as well as the basic ideas how an economy functions in its entirety. In the fourth and fifth chapter, we will also analyse how demand and supply are defined and how they interact on a market to constitute the price. In the last chapter, all these ideas are put together to illuminate an important economic insight: Time is money. And wasting time is wasting money. 1

1
Basic Economic Rules I: Individual Decision Making

Basic Economic Rules I: Individual Decision Making

You are the starting and the endpoint of this you as an individual. Every individual is the source, the core, the beating heart of every social structure. Understanding the imperatives driving individual decision making thus helps us when it comes to understanding the imperatives and exigencies that drive an economy. There is thus nothing mysterious on the question what an economy is; quite simplistically, it is a group of individuals who interact as they go about seeking ways to fulfil their needs and wants. An economy is a group of individuals who interact as they go about seeking ways to fulfil their needs and wants.

1.1 All Individuals Have to Balance Alternatives

Our whole life is an endless chain of decisions: Should I get up and go to work or should I sleep one or two hours longer? Should I wear a shirt or a sweater? Should I drink coffee or tea? Should I buy a bus ticket or should I go by bike to work? And so on And within every deciAll individuals sion, we have to decide between two have to balance or more alternatives. Normally, we alternatives. have to give up something we want to get another thing we also want. Individual decision making is thus all about balancing alternatives and solving conflicts of aims. This first lesson is pretty summarised in the wellknown slogan: There is no such thing as a free lunch. Nothing is for free. Even if you do not have to pay for your lunch with There is no such thing as a free lunch. money, you always pay with your time; because in the same time, you could have done other things than having lunch. For instance, you have made the decision to read this booklet. You do not have to pay for this, so it might appear to be free, but you have yet made a tradeoff in that you could have been reading a newspaper article, listening to music or calling a friend at this particular point in time. In every moment of our lives, we have to face conflicts of aims, trade-offs. Even larger economic systems, and politico-economic systems, have to deal with such conflicts of interests, desires, and aims, and try and strike and appropriate balance. One of the most important of these is that between efficiency and justice. Efficiency means that a society makes optimal use of its limited
4

Basic Economic Rules I: Individual Decision Making

resources. Distributive justice is the fair allocation of the goods produced with these resources among the citizens of the society. Efficiency is about the size of the whole cake, justice about the size and the number of the pieces of the cake. Often, these two aims come into conflict with each other while political operations are developed and enforced, and economists and politicians are forced to prioritise one or the other. Efficiency

inefficient

efficient Justice

unjust

just

1.2 What You Have to Give Up when You Buy

Even if we are aware of the fact that individuals are confronted with trade-offs, we do not know how, or why, they should decide, in favour of any one specific option or tradeoff. To make a decision, one has to weigh the costs and the ben5

efits of all alternatives. But often the costs are not plainly discernible. As we saw above, costs are not always, or only, monetary. The costs of an alternative are the other alternatives which could not be realised, that is to say, opportunity costs. These must be accounted for making a rational decision. Thus it is said that the cost of a good equals the worth of the things which must be given up for the purchasing of the good. The cost of a good equals the worth of the things which must be given up for the purchasing of the good.

1.3 Individuals React to Incentives

Because we balance costs and benefits for every decision, we often will change our behaviour if costs or benefits of the alternatives change. In other words, we react to incentives. For example, if the price of coffee rises, most people will tend to drink more Individuals react tea instead of coffee. At the same to incentives. time, more workers will be hired at coffee plantations as the owners of the plantations will want to harvest more coffee, because the return on every coffee bean will be higher. It is very important to consider incentives while fixing political programs. If politicians are not able to correctly gauge or assess the behavioural changes which could be caused by their arrangements, a whole political program can go wrong and make the situation worse.

Basic Economic Rules I: Individual Decision Making

Lets recap the initial ideas to understand how individuals make decisions: 1) 2) 3) All individuals have to balance alternatives. The cost of a good equals the worth of the things which must be given up for the purchasing of the good. Individuals react to incentives.

2
Basic Economic Rules II: How Individuals Act Together

Basic Economic Rules II: How Individuals Act Together

In the last chapter, I talked about how individuals make decisions. They have to balance alternatives, because the cost of a good equals the worth of the things which must be given up for the purchasing of the good. That is why individuals react to incentives. But our decisions do not only influence ourselves. We affect other persons as well with our decisions, and vice versa. That is the reason why we now put our focus on how individuals act together.

2.1 Trade Improves the Situation of Everyone

You often hear media or political voices claiming that another country is a rival of your country in the world market, because it produces and exports products or raw materials similar to those your country does. This argument, however, is not sus9

tainable. Trade cannot be compared with a sporting competition where one side wins and one side loses. Trade can have winners on all sides. Trade improves the economic situation of every trading country. To understand this better, have a look at your family and how it is influenced by trade and exchange. If one of your family members is looking for a new job, he or she rivals members of other families who are also searching for a new position. Also your family vies with other families, when they go shopping, because every family wants to have the best goods for the lowest price. One might say that every family in an economy competes with every other family in that economy. But what would happen if your family were to seclude itself from the other families? The situation would not get better for your family, because your family would have to grow its own food, breed its own animals, produce its own clothes, build its own house, teach its children by itself, produce its own electricity, and so on. Obviously, your family profits by the exchange with other families. Trade allows everyone to
10

Basic Economic Rules II: How Individuals Act Together

concentrate on his or her best abilities. This could be, for example, farming, breeding, sewing, building houses, teaching or even repairing computers, writing books or doing research on astrophysics. Because of the exchange, everyone can purchase a bigger diversity of goods and services for lower costs. This insight holds true for the trade between nations and economies as well. International trade allows an economy to specialise in the goods which it can produce at the lowest costs and gives people the possibility to enjoy a great variety of different goods and services. Trade improves the International trade improves the situation of everyone. situation of everyone.

2.2 Markets: The Great Organisers

Trade happens on markets. And free markets are the best tool with which to organise economic life. The collapse of most of the centrally planned economies was one of the most important changes of the world in the last century. Nowadays, these economies are, or are trying to Normally, markets are be, market economies. In a good for the organisation market economy, the decisions of the economic life. of a central planning administration are replaced by non-central, distributed, independent and largely autonomous decisions of millions of businesses, companies, households and individuals. Enterprises and firms decide for themselves who they want to employ and what they want to produce. Households and individuals decide where they want to work and what they want to buy. These businesses and households act together on markets where their decisions are driven by prices and self-interest.
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At first glance, the success of market economies is mysterious. One might think that millions of apparently non-coordinated decisions would lead to great chaos. But market economies are successful at promoting healthy economic life and boosting social welfare simultaneously, without compromising on either. As Adam Smith said, all All individuals act individuals act together on together on markets as markets as though they are though they are being being led by an invisible led by an invisible hand. hand. Few centuries before Smith the Prophet Muhammad (PBUH) replied when prices became to high and people asked him to fix them: Allah is the One Who fixes prices, Who withholds, Who gives lavishly, and Who provides, and I hope that when I meet Him none of you will have a claim against me for any injustice with regard to blood or property.1 Prices are the instrument used by this invisible hand to conduct all economic activities, because prices mirror both the social worth of a good and the social costs of its production. Enterprises and households include the prices in their decisions and in this way, they respect automatically the social benefit and costs of their decisions. If political administrations constrain the prices from adjusting freely to supply and demand, they hamper the coordination of the millions of single decisions which constitute an economy. Market planners cannot have
1

Reported by Ahmad, Abu Daoud, al-Tirmidhi, Ibn Majah, al-Dari and Abu Yala. Refer to Risalat al-hisbah by Ibn Taimiyyah, as well as to Al-turuq al-hikmiyyah by Ibn al-Qayyim, p. 214 ff. Source: The Lawful and the Prohibited in Islam Yusuf Al-Qaradawi.

12

Basic Economic Rules II: How Individuals Act Together

the information which is included in free market prices. A market of millions of individuals knows itself better than any market planner. Socialist planners favouring centralised topdown economic planning erred when they tried to organise economies by restraining, or tying up, the invisible hand that regulates the markets. 2.3 Government Interventions: Good or Bad? If, then, the invisible hand works so well, why do we need the government? Well, the duty of the government is to protect the invisible hand and create an environment in which it can function freely. Markets can Markets can only function, only function, if property rights if property rights are made secure. No farmer are made secure. would grow corn if he could not be sure that it would not be stolen. But there is another reason as well why we need economic policy. One important exception to the last rule, that markets are the best way to organise economic life, exists: if the invisible hand malfunctions. These situations, in which the market does not succeed in allocating resources efficiently, are called market failure. One of the possible sources of a market failure is an excessive concentration of power, when an individual or a small group is able to influence market prices excessively. Imagine, for example, a monopoly situation: Everyone in a city needs water. But, imagine, there is only one source of it. The owner of the source controls the market and has power over it. He is a monopolist and free to manipulate
13

the price of water. He is not subject to the rigorous competition which normally keeps self-interest in check. You can see that, in this situation, governSometimes, government mental regulation of the price interventions can demanded by the monopolist enhance market results. can enhance the market result by raising the efficiency. But and this is the crucial point to say that political regulation can enhance the market results does not mean that this will always be the case. Politics are not made by angels. Politicians are often guided by their own self-interests, sometimes influenced by powerful groups, and mostly not well-informed especially about the functioning of economic systems. So you always have to analyse whether a political intervention in a free market will in fact to boost efficiency, justice and welfare or not.

In this chapter, we discussed how individuals act together. What did we learn? 1) 2) 3) Trade improves the situation of everyone. Normally, markets are good for the organisation of economic life. Sometimes, government interventions can enhance market results

14

3
Basic Economic Rules III: How an Economy Functions

15

We have already discussed how individuals make their decisions and how they act together. All decisions and interactions together constitute the economy. That is why the last of the basic economic rules will explain how an economy functions in its entirety.

3.1 How to Get a Good Standard of Living

The differences in standards of living around the world are enormous. The per capita income of Luxembourg, the country which, in 2010, had the highest per capita income in the world, is 64 320 $ - and, by the way, never had a colony. On the other end of the spectrum, the Democratic Republic of the Congo had a per capita income of 290 $ in 2010. Of course, these huge differences in per capita income are reflected in the quality of life: individuals in countries with a high per capita income have more TVs, more cars, better food, better social welfare and a longer expectancy of life than individuals in poor countries. How can these differences of income and standards of living Productivity is the amount be explained? The answer is of goods produced during surprisingly simple: they are one working hour. mostly caused by differences in productivity, the amount of goods produced during one working hour. In economies in which workers produce many units of goods per hour, people have high standards of living. In economies with less productive workers and less efficient production technology people end up in rather more humble living conditions. This link between standards of living and productivity, the ability to produce goods and services has far16

Basic Economic Rules III: How an Economy Functions

reaching consequences for economic policy. To enhance the standard of living, governments must raise productivity by ensuring that their people are able to attain a high level of education, a good capital endowment and have access to advanced technology. The standard of living depends on the ability to produce goods and services.

3.2 Why Do Prices Increase?

Currently, Pakistan has an inflation rate between 13 and 14 per cent. In 2009, it was more than 20 per cent. What does this mean? It means that you have to pay 13 per cent of Rupees more for all the things you buy this year than you paid in the last year. That means if something, for example a silk scarf, cost 1000 Pakistani Rupees in 2010, you would now have to pay 1130 Rupees for the same scarf. Nothing has changed, especially not your income, save the price of

17

the good. That is the phenomInflation is the rising of the enon which is called inflation: price level in an economy. the rising of the price level in an economy. But inflation burdens an economy with costs. For example, if the inflation rate is too high, menus in restaurants and price labels must be reprinted often so as to accurately reflect prices. That is why these costs are also called menu- or shoeleather-costs. If inflation spirals upwards rapidly, goods might cost ten times as much tomorrow as they do today, and you might have to withdraw all your money just to be able to buy basic, everyday necessities. This happened in Germany in the early 1920s, and, more recently, in Zimbabwe. Nowadays, most of the economists think that two to five per cent is the best inflation rate for an economy. But what is the reason for a high long-term inflation rate? Mostly, there is just the one culprit: increase in money supply. The price level increases if too much money is in circulation. If a state or a central banking authority increases the amount of money in circulation, the worth of the money decreases. More money in circulation The price level increases means that the central banking if too much money is in authority gives more money in circulation. the market, for example by printing money and buying bonds from the market with this new money. If the supply of money increases while the demand of it is stable, its worth must decrease (see chapter 5 for the dynamics of demand and supply). That means that you can buy fewer goods for the same amount of money, or you have to
18

Basic Economic Rules III: How an Economy Functions

pay more money for the same amount of goods as before. And, as we already know, high inflation inflicts damage to an economy. But politicians have many incentives to raise the inflation rate by printing new money and bringing it into circulation. One of it is the attempt to repay debts with the new money. That is why it is very important to have an independently functioning central bank as the only institution which is allowed to authorise the printing of, or to bring money into circulation. The central bank should not be influenced by politicians or other interest groups and be solely committed to keeping down the inflation rate. An example for a very independent central bank is the European Central Bank which controls the volume and the circulation of the Euro. No European country is allowed to impose pressure upon the ECB. Its only duty, which is regulated by law, is to reach an inflation rate of a maximum of two per cent every year.

19

Lets now put together all the things we discussed in the last three chapters. At first, we learned how individuals make decisions. They have to balance alternatives, because the cost of a good equals the worth of the things which must be given up for the purchasing of the good. That is why individuals react to incentives. After that, we discussed how individuals act together. We found out that trade improves the situation of everyone and that markets are normally good for the organisation of economic life. But sometimes, in the event of market failure, government intervention can put the markets back on track. Recognising these ideas, we now have discussed basic findings how an economy functions in its entirety: 1) 2) The standard of living depends on the ability to produce goods and services. The price level increases if too much money is in circulation.

With these basic economic rules, we can go on, in the next chapter, to analyse the mechanisms how a market functions.

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4
Market Demand and Market Supply

21

In the previous chapter, we have already discussed basic economic rules. We know that free markets are normally good for the organisation of the economic life. And we have already touched the ideas of demand and supply. The next two chapters will focus on market mechanisms. I am going to explain the emergence of market demand and market supply, and how these act together to generate a market equilibrium which determines the market price, the instrument of the invisible hand. At first, the basic concept of a market must be defined, because the words demand and supply refer to the behaviour of individuals while interacting in the marketplace. A market consists of groups of potential buyers and potential sellers of a good or a service. The group of potential buyers dictates the demand for the good, while the group of potential sellers determines its supply. The market is the place where demand and supply of a good or a service meet. A market does not

22

Market Demand and Market Supply

have to be a physical place like a bazaar. Even the financial market is real, despite not being bound to a real, concrete location.

The market is the place where demand and supply of a good or a service meet.

4.1 Demand
Lets start the analysis with the demand side of a market. For the whole analysis we will use the example of a simple, every day good: milk. The milk quantity demanded is the quantity of milk buyers want or are The quantity demanded able to purchase. The quantity is the quantity buyers want demanded is influenced by or are able to purchase. many factors, but we will concentrate on the most important and decisive one, the price, because, as we have previously learned, all individuals have to balance costs and benefits before making a decision. If the price of a litre of milk were zero, you would consume as much milk as you could drink, for example ten litres. If the price were to rise, you would lower the quantity of milk you buy, and probably switch to other beverages like water. If the price of a litre of milk rises, for example, to over 500 Rupees, you would completely stop drinking milk, because it would be too expensive. That is to say, the milk quantity demanded is related inversely to the price of the milk. This is called the law of demand: the quantity demanded declines, if the price rises. The Law of Demand: The quantity demanded declines, if the price rises.
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The milk example is illustrated in the chart below: there you can see explained the individual demand for milk. This is a so called price-quantity-chart.
Price in Rupees 600

500

400

300

200

100 Quantity in litres

10

11

12

The quantity demanded is inscribed for every possible price of one litre of milk. For example the first point: it says, that an individual will demand six litres of milk, if the price is at 200 Rupees.
24

Market Demand and Market Supply

If the price is zero, ten litres will be demanded. This situation is illustrated with the second point in the below chart.
Price in Rupees 600

500

400

300

200

100 Quantity in litres

10

11

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25

If the price is above 500 Rupees, no milk will be demanded anymore. This situation is illustrated with the third point in the chart below.
Price in Rupees 600

500

400

300

200

100 Quantity in litres

10

11

12

If you connect every point, you get the demand curve. The demand curve slopes downwards from left to right; it is a negative curve because of the law of demand.
Price in Rupees 600

500

400

300

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100 Demand Quantity in litres

26

10

11

12

Market Demand and Market Supply

A chart like this is a very useful tool for representing demand and supply trends in an easily comprehensible form. What we see is the individual demand of one consumer; how many litres of milk this consumer would demand at every price. To calculate the whole market demand, the aggregate of the individual demands of all the consumers in the market, we have only to add together the quantities of milk demanded by every consumer at every price. In this way, we will get to know how much milk is totally demanded at every possible price. This is the market demand. 4.2 Supply Lets now go on to the other side of the market, the supply; in our example the supply of milk. The quantity of milk supplied is the quantity of milk The quantity supplied sellers want or are able to is the quantity sellers want sell. Again, the price of milk or are able to sell. is the crucial factor which determines the quantity supplied. If the price for a litre of milk is high the sale of it is more profitable for the seller. The seller will buy more cows, work harder and sell more milk. If the price falls, the sale becomes less profitable. As a reaction to it, the seller will downsize the quantity of milk they supply. If the price of a litre of milk becomes zero, the sellers would not

27

The Law of Supply: The quantity supplied increases, if the price rises. supply milk anymore. That is called the law of supply: the milk quantity supplied is related directly to the price of milk. The quantity supplied increases, if the price rises. I am going to illustrate the individual supply of a milk seller in a chart similar to the chart for the demand. The quantity supplied is inscribed for every possible price of a litre of milk. For example, the first point in the chart below, it says that a seller will supply four litres of milk, if the price is 200 Rupees.
Price in Rupees 600

500

400

300

200

100 Quantity in litres

10

11

12

28

Market Demand and Market Supply

If the price is zero, zero litres will be supplied. This situation is illustrated with the second point in the chart below.
Price in Rupees 600

500

400

300

200

100 Quantity in litres

10

11

12

If you connect every point, you get the supply curve. This curve slopes upward from left to right because of the law of supply.
Price in Rupees 600

500

Supply

400

300

200

100 Quantity in litres

10

11

12

29

If we add together the amounts of milk supplied by every seller in the market, we get the market supply. In this way, we will know how much milk is totally supplied at every possible price. In the next chapter, we are going to see what happens when demand and supply meet. We will understand how the invisible hand works, how a market functions and how the market price arises.

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5
The Market Equilibrium and the Consequences of a Minimum Price

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In this chapter, we will try to analyse and understand how a market works and why a political intervention in an efficient market is not a good idea. In the last chapter, I have already shown how demand and supply emerge. Lets recap. The quantity demanded of a good is the quantity of the good buyers want or are able to purchase. The quantity supplied of a good is the quantity of the good sellers want to, or are able to, sell. Now, we will focus on the market, which is, of course, where demand and supply meet. Lets go back to our example of a milk market. As you remember, this is the demand curve of milk: it shows how many litres of milk are demanded at each possible price. The demand curve slopes downwards because of the law of demand: the quantity demanded declines, if the price rises.
Price in Rupees 600

500

400

300

200

100 Demand 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity in litres

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The Market Equilibrium and the Consequences of a Minimum Price

This is the milk supply curve: it shows how many litres of milk are supplied at each possible price. This curve slopes upwards because of the law of supply: the quantity supplied increases, if the price rises.
Price in Rupees 600

500

Supply

400

300

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100 Quantity in litres

10

11

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To identify the market equilibrium we have to put both sides together. The milk demand meets the milk supply on the milk market. In the chart below, we can see both: the demand and the supply.
Price in Rupees 600

500

Supply

400

300 250 200

100 Demand 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity in litres

There is one point, where demand curve and supply curve intersect. This is the so called market equilibrium. In the market equilibrium, the milk demand In the market equilibrium, the demand equals the milk supply. The price where the curves cross is equals the supply. the so called equilibrium price. In our example, it is 250 Rupees. This is the price at which there is an equal demand and supply of milk. This is the price you will have to pay if you buy a litre of milk, and it is the price the sellers get for a litre of milk. The corresponding quantity of milk, in our case five litres, is called the equilibrium quantity. This is the demanded and supplied quantity of
34

The Market Equilibrium and the Consequences of a Minimum Price

milk at the equilibrium price. In the equilibrium, the both forces in the market, demand and supply, are balanced. At the equilibrium price, the quantity buyers want or are able to purchase exactly equals the quantity sellers want or are able to sell. That is why the market, or equilibrium, price is also called the clearing price; because at this price, all market actors are satisfied and the market is cleared: the buyers have fulfilled their purchase intentions and the sellers have fulfilled their sales plans. And that is the way how the invisible hand works: without any external intervention, the market is cleared by forces operating and interacting within it. Market demand and market supply are adjusted by the market price which itself automatically emerges as a response to the amount demanded and supplied at a particular point in time. Thus, we do not need political intervention to satisfy all market actors. Everyone is automatically satisfied in a free nonmanipulated market. By the way, this is the basic definition of capitalism: a system where you have private ownership and you are free to sell and to buy under equal rights. As such also an Islamic economy is always and automatically a capitalist economy with the Prophet Muhammad (PBUH) as role model as trader and businessman. To always balance demand Everyone is automatically satisfied in a free non-manipulated market. and supply, the market price has to adjust freely to all changes in demand and supply. If, for example, in a dry season, it is difficult to find grazing grounds for milk cattle, the costs of producing milk will rise, because extra fodder will have to be
35

bought for the cattle. To cover all costs, the sellers of milk have to ask for a higher price per litre of milk. This is illustrated in our chart by a leftward shift of the supply curve.
Price in Rupees 600 Supply dry season

500

Supply

400

300

200

100 Demand 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity in litres

The price asked by the sellers is now higher for each quantity of milk supplied. Thus, the market equilibrium also changes. The amount of milk at which the equilibrium is reached decreases and the equilibrium price increases. But, again, demand equals supply, and the market adjusts itself to this new equilibrium point, until every market actor is satisfied. Only with freely moving prices Freely adjusting prices which are not fixed, can a are the distinctive mark market adjust to every of a free, well-functioning change in demand and supmarket. ply. Freely adjusting prices are the distinctive mark of a free, well-functioning market.
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The Market Equilibrium and the Consequences of a Minimum Price

Imagine, now, a government mandated price of 350 Rupees for a litre of milk. Maybe the government wants to underpin and support the farmers who own cows by fixing the milk price at this level, so that it cannot fall under 350 Rupees per litre. What will this Minimum Support Price cause on the milk market? Lets go back to our chart to analyse a situation with a minimum price.
Price in Rupees 600

500

Supply

400 Minimum Price = 350 300

200

100 Demand 0 1 2 3 4 5 6 Supply excess 7 8 9 10 11 12 Quantity in litres

As you can see, the minimum price for milk is inscribed as a line. That is to say, the price is not allowed to fall below 350 Rupees per litre. This minimum price is above the market price which would normally emerge without external intervention. At the mandated Minimum Support Price, the sellers want to sell seven litres of milk, but the buyers only want to purchase three litres. Because the minimum price is above the market price, the sellers want to sell more milk than the equilibrium
37

quantity and the buyers want to purchase less milk than the equilibrium quantity. That is to say, more milk is supplied than is demanded, the market is not cleared, and not all suppliers are satisfied. The result of a minimum price is an excess on the supply side. Well-intentioned governmental intervention thus disturbs the work of the invisible hand and the market does not function efficiently anymore. Additionally, prices are absolutely necessary indicators for decision-making for both consumers and producers. Any regulation distorts this process and will lead to wrong decisions, mostly only visible in the future.

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6
Time Is Money. And Wasting Time Is Wasting Money.

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After analysing basic economic rules and market mechanisms, I want to conclude this booklet by putting all ideas together to discuss a topic which is fundamental for understanding the performance of an economy and which is very important for me: the usage of time. The achievement potential of every economy depends on the fact how efficiently time is used in the economy. Time is the basic limiting factor of every production process and every political program, because, as we already know, time is the input factor which is needed for every good or service, beside other costs. As we have already discussed, nothing is for free, you always have to pay with your time if you want something, because you could do another thing in the same time. Time is limited. Everyone has only 24 hours in a day. That is why time has a real economic worth. Time is money. For example, you are paid for the working time you supply to your employer with money, your wage. In short: time is money. This is an old, well-known and often cited dictum by Benjamin Franklin. And it is deeply true. If time is money, wasting time is wasting money. Every lost minute And wasting time in a production process burdens the is wasting money. producing enterprise with costs. At last, these are costs which have to be borne by all of us, by the whole economy, because time has to be used efficiently to produce in a cost-minimising way to induce an efficient market price which satisfies all market members.

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Time Is Money. And Wasting Time Is Wasting Money

Using time efficiently applies to two different levels: your usage of your own time and your usage of the time of others. Lets start with the first point: your usage of your time. From this point of view, using time efficiently does not mean making everything as fast as possible, regardless how well it is made. If you do a job carelessly and inattentively, only regarding the time, you have to do it again to really accomplish your mission. That is wasting of working time. And that is not only your problem. If everyone works carelessly and has to repeat every job, the whole economy lacks efficiency, because in the same time while you were repeating your duty, you could have done another job, you could have produced more goods or services. And as you remember, the standard of living in an economy depends on the ability to produce goods and services. That is to say, using your time efficiently means that you should use as much time as you need for a job to do it carefully and completely, but not one minute more as much time as necessary, but as little as possible.

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Normally, we do not life and work alone. We need other people to produce goods, to supply services and to satisfy our needs. This insight leads us to the second point: if we stress the time of other people, we should As much time as use their time as carefully and effinecessary, but as ciently as possible. You should always little as possible. remember the fact that giving you time is the same as giving you money, with one important difference: you cannot give time back. If time is bygone, it is elapsed forever. Using the time of other people efficiently means observing deadlines and being punctual. If someone has to wait for you or your work, he or she loses time, because they could have done other things meanwhile than waiting. For example if a workshop of twenty participants with an average income of 500 Rupees per hour is delayed due to you by one hour you have created Your punctuality is you a loss of 10.000 Rupees. benefiting finally. Imagine the loss for 180 million Pakistanis! As already mentioned this burdens the whole economy with costs and as a result, reduces the standard of living, if everyone does it. But there is another point: let someone wait for you is extremely disrespectful. And disrespectful behaviour destroys relationships. But, remember, you need relationships with other people to satisfy your needs, you cannot do it on you own. That is why your punctuality is you benefiting finally.

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