Naked Economics

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Naked Economics: Understanding the Dismal Science (2002, 2010) by Charles Wheelan offers a general introduction to the principles of economics. Putting economic principles into practice is often difficult to accomplish because the correct actions for stability and progress are often counterintuitive.

Economics is the study of how resources are distributed among participants in a market. Market forces act through participants, who are looking for personal gain, to make resources as productive as possible. Everything in a market has a cost, which is set by how much of their resources people are willing to give up for it. The price could be monetary or could involve non-monetary costs such as the lost opportunity to pursue additional options or the time it takes to acquire the item.

The combined forces of price and demand create a market that efficiently serves the needs of most participants and automatically adapts prices and supplies in the event of the change.

Sometimes governments attempt to intervene in markets to force a specific change in prices or supplies. This intervention might result in the opposite of the intended effect. Taxes, for example, are often increased to raise funding for the government, but if a tax is so high that it discourages work, the government may lose money overall.

In general, governments have a useful role in markets. They can ensure that participants who harm people in the pursuit of a market benefit will pay the cost of that harm. Governments enforce property rights and prevent companies from manipulating markets. Additionally, the government provides for public needs that the market has no incentive to fill.

On the other hand, government policies can prevent competition and offer resources to people who do not put them to the best use. Poorly implemented regulations punish consumers while giving producers incentives to act against the market’s best interests. If the government protects an industry that would otherwise be made more efficient by the market forces that threaten it, the industry ceases to price and produce competitively, and as a result, the consumer must pay the higher price of the inefficient producer. Nevertheless, special interests often convince governments to enact protectionist measures.

Human capital, which refers to an individual’s intangible assets, is an important component in achieving success within the market. Increases in the available human capital, such as raising the population’s average level of education or skill, is strongly correlated with economic growth. The high level of human capital in an industrialized nation prevents employers from simply moving to an area where labor is significantly cheaper.

One of the most widely misunderstood aspects of economics is investment strategy. Many people believe that secret, wildly successful strategies exist that make some people very wealthy, but the reality is that those methods are already widely known. The best strategy relies on diversification to ensure that one failed investment is cushioned by other stable or successful ones.

A gross domestic product, the value of everything that a country makes in a year, is among the growth metrics that the Federal Reserve uses to set fiscal policy for the United States, with the goal of annual growth generally around three percent. The Federal Reserve has the ability to give banks cash when they purchase government bonds, and it also sets the rate of interest on those bonds, which affects rates of lending and inflation. Achieving the targeted growth rate is a complicated process, but the Federal Reserve’s policies allow markets to withstand unexpected shocks.

The policies that influence inflation affect a country’s ability to trade with other countries. Most currencies continually change in value relative to each other, unless a country attempts to undervalue the currency to gain a trade advantage.

Global trade can have both negative and positive effects. Although global trade is often criticized for contributing to sweatshop labor and loss of local trade, developing economies often benefit from globalization. Rather than enacting protectionist policies, developing countries should welcome specialized global competitors. Developing economies benefit most from effective, democratic government that protects the rights of citizens without restricting the economy with excessive regulations. Those economies can increase human capital and eventually contribute to the global effort to increase environmental preservation.

The key insights for this book are:

  1. A market’s ability to benefit its participants depends on incentives, which may be affected by government policy. Incentives can encourage behavior that benefits all participants or none of them.
  2. Government plays the vital role of preventing unnecessary harm to non-participants and providing services and regulations that the market would not provide on its own.
  3. In some markets, governments are too heavy-handed or full of self-interested people, and as a result, their policies make the market inefficient and unfair.
  4. Participants in an exchange may have differing amounts of information before a transaction, which can dictate who gets involved and how they present themselves.
  5. Human capital is a strong resource for economic growth, and it is a significant factor in who benefits the most from that growth.
  6. The strongest investment strategy recognizes that increased potential rewards are accompanied by greater risks, and risks can be mitigated through diversification. Nobody has a secret strategy or insight that will lead to unprecedented success.
  7. Special interests have the ability to convince the government to engage in protectionist policies, but often these policies hurt them and the economy.
  8. The Federal Reserve sets monetary policy in the US. It sets interest rates and sells bonds, which in turn regulate how much banks can lend and how much a dollar is really worth.
  9. The international currency market works like any other market; its value is set by supply and demand, and it has its own manipulative actors.
  10. Globalization benefits the world economy and developing countries, even though the effects of globalization can be seen as distasteful.
  11. Factors that are strongly correlated to successful economic growth include open global trade without protectionism and an effective democratic government.

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