The 3 Most Important Lessons in 'Basic Economics'

Thomas Sowell’s introduction to capitalism is a clear guide to realities utopians would rather obscure.

Editor’s note: This article is Part II of an ongoing FrontPage series exploring the ideas of author Thomas Sowell. For Part I, see Compassion Vs. Guilt.

Economist Thomas Sowell drew from his years of teaching the subject at some of the nation’s most prestigious ivy league schools and gave himself a challenge: to create a book on economics for the lay reader without using technical language or visual aids. His book was a success, and is now in its fourth edition. Basic Economics: A Citizen’s Guide to the Economy is a straightforward and readable guide to economics’ core concepts.

It’s difficult to count the number of economic myths Sowell debunks. More challenging is to determine which are the most important. Political ideologies can be a bit like dominos – just disrupting a single idea can be the beginning of a chain reaction that will eventually result in a changed mind. These three insights are perhaps some of the most important talking points to keep in mind when stumbling into political discussions with those less informed on basic economic principles.

3. We do not have enough resources to meet everyone’s desires.

The very definition of Economics already begins to challenge any utopian scheme. Sowell cites the British economist Lionel Robbins:

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

Using resources to do one thing requires us to take resources away from somewhere else. And “resources” does not always refer to money or raw materials either. Time, manpower, talent, and knowledge are all resources too that individuals, businesses, governments, and families have to figure out how to use in the most effective way. And these resources can be used in any number of combinations, some much more effective than others.

With this point Sowell demonstrates that economics really isn’t about money or becoming rich:

It is about the material well-being of society as a whole. It shows the cause and effect relationships involving prices, industry and commerce, work and pay, or the international balance of trade—all from the standpoint of how this affects the allocation of scarce resources in a way that raises or lowers the material standard of living of the population as a whole.

In other words, Sowell and other economists are going to study what the real results are when certain policies are put into place, instead of focusing on the high-minded hopes and expectations of those who dreamed the into existence. It’s this approach that he brings to analyzing such misunderstood concepts as prices and profits.

2. Businesses cannot survive if they arbitrarily set high prices because their owners are “greedy.”

One of the most persistent memes to embed itself within the popular consciousness is the idea that those participating in capitalism are “greedy.” It’s all too easy to look at rising gas prices and rising oil company profits only to assume that it’s because of “greedy” oil executives just adjusting the price in their favor.

Sowell summarizes the flip side of this economic fallacy to make the logical error more apparent:

To say that prices are due to greed is to imply that sellers can set prices by an act of will. If so, no company would ever go bankrupt, since it could simply raise its prices to cover whatever its costs happened to be.

Driving the idea that the “rich” are out to “exploit” the less fortunate is the fact that often the same goods one can buy in a rich suburb are more expensive when sold in the inner cities. Self-proclaimed advocates of the poor will point to this as evidence of malevolent, “predatory” capitalists taking advantage of those who supposedly cannot afford to travel to discount stores. They do not factor into their thinking the fact that any number of causes can affect the price a business charges. Smaller food markets in inner cities both have to order stock in smaller quantities and spend more on security. Thus, of course the prices are going to be higher than at some suburban Costco far away from crime.

1. Profits often go up because a business has figured out a way to make something that’s actually at a lower price than someone else.

Sowell declares that profits are the most misunderstood idea in economics. He cites socialists such as George Bernard Shaw and Karl Marx who regarded profits as “overcharge” and “surplus value.” But profits are only half the story in a price-driven economy. The more important other half in Sowell’s view is losses:

The hope for profits and the threat of losses is what forces a business owner in a capitalist economy to produce at the lowest cost and sell what the customers are most willing to pay for. In the absence of these pressures, those who manage enterprises under socialism have far less incentive to be as efficient as possible under given conditions, much less to keep up with changing conditions and respond to them quickly, as capitalist enterprises must do if they expect to survive.

Contrary to the idea from the previous point that businesses will raise prices to raise their profits, actually the opposite is how businesses succeed. An entrepreneur who can take an expensive product and figure out how to make it for less (a more efficient use of scare resources) will enrich the lives of the poor who now have access to it. Where a few decades ago computers were bulky devices available only to the affluent now exponentially more powerful and less expensive cell phones are commonplace amongst those on welfare and food stamps. And in the process the profits for the technology industry have only grown.

That’s the hidden pattern that Sowell reveals throughout Basic Economics: the more efficiently a society utilizes its scarce resources the more everyone benefits. And humans have yet to find a more efficient system than a free market economy coordinated by prices, profits, and losses.