|I have always known intuitively how the economy has worked but I have never
been able to put it into words. Through plenty of deep thinking as well as a
couple of economics courses, I finally believe I have a good grasp on how the
My premise for the underlying function of which the economy runs is simply the
desire for a better standard of living. Call it greedy, self-interest,
materialistic or just wrong we must face its truth. We can't deny that the
majority of the worlds population works hard their entire life to buy a BMW or
nice house or clothes. I admit that I desire the same material items as any
other. However, greediness and self-interest are what make this country run.
It provides people with the motivation to invent new technologies and provide
services, all for money. Then they can afford the higher material items.
Fortunately, microeconomics agrees with my line of thinking, and vice versa.
Adam Smith had this idea back in the 18th century. Smith expressed this
working system of self-interest as "the invisible hand". A economy that runs
so smoothly from self-interest that it seems an invisible hand is making the
whole thing run.
Once one understands this underlying premise, the rest is quite easy. For
example, I can illustrate the details of how people interact on the economic
plane. As before, we start with the assumption that people will go to great
efforts for monetary benefit. This gives rise to what our textbook calls a
firm. A firm is a general name for a business. A firm will try to create a
product or sell a service. Since the firm is motivated by money, they will try
to provide the best product or best service in order to have happy paying
customers. They will also try to maximize their profits by making a product
efficiently. This self-interest model (or theory) naturally encourages
efficiency which is a positive externality for the environment.
However in the pursuit of money, some firms may disregard the effects of their
business to nature, thereby creating negative externalities (a limitation to the
self-interest model). Society ends up paying for these negative externalities.
A person might also point out that this theory also gives rise to firms mass
producing products will less attention to their quality. Although this may
seem to be a limitation, it is actually a positive attribute. This gives
variety to the marketplace whereas it may have not existed. It provides goods
at a variety of prices, for consumers of varying income.
So it seems that this self-interest model of the economy is pretty good? Yes,
it is; although we have pointed out its down-falls. I believe the most
beautiful aspect of the model is its efficiency. Just like we have learned, a
firm will try to maximize its profits by attaining a balance between the
quantity that it produces, and the demand for the item. A proper balance
(where the demand curve meets the supply curve) will result in maximum profits
and minimum waste.
Some more complicated negative aspects of this theory exist such as natural
monopolies (as Doug pointed out!) and oligopolies. However this self-interest
model is quite efficient and smooth, the best bet in my conservative opinion!