We live in a world of scarcity. This fact is beyond question. Our time, land, and work are scarce. Producer and consumer goods are scarce as well. Human needs, however, are limitless. Economics studies the relationship between limitless goals and scarce means used to realize these goals. Though these means indeed can help us achieve our goals, due to their scarcity we must constantly decide on which needs are the most urgent, while taking into account which goods we can use to satisfy them.
First, consider the concept of scarce means, or simply goods. For something to be called a good, it must meet two conditions: People must consider it able to satisfy their needs, and its amount must be limited. An example might be a nice way to explain this:
Imagine you have a very rare germ that causes a terrible disease. Is it a good? Of course not, because you cannot use it to further your goals. Just because something is scarce does not mean that it is useful.
But sunlight and air are useful. True, both are very much needed, though they are not scarce – in most situations anyone can easily get any needed amount of them.
Of course, we can imagine some exceptions. For example, the germ we mentioned can be used as a biological weapon, and as such can be valued on the black market. Or we can imagine someone selling a diving cylinder filled with air to a person who wants to dive at great depths. In most situations, however, these are not goods.
Now let’s deal with types of goods. We can divide them into three categories:
The first category is natural resources or original factors of production – these goods are supplied by nature itself and are not created by use of human action. Such resources are both human work, understood as expenditure of human energy, and land. When we talk about land as a natural resource, we are not talking about farmed land. Land that is already farmed is a capital good. Land is a natural resource if untouched by human hand, and includes raw materials, climate and all other elements that humans can use.
The second category is capital goods or intermediate goods. They are called intermediate, because they are not directly serviceable in the satisfaction of wants, but may be transformed into such directly serviceable goods. In other words, they are only used in production of goods that consumers can use directly. Suppose you want to satisfy your need to eat bread. You need an oven to bake bread. An oven cannot satisfy your need directly, but can be used as a mean to this end. Thus, capital goods include machines, factory buildings, tools, or computers used in the process of production.
Natural resources and capital goods can be called by a common name of factors of production.
The third category is consumer goods or final goods. They satisfy human needs directly.
The production process is as follows: People transform natural resources into capital goods, and then transform capital goods into consumer goods. Consumer goods can then be consumed.
As we mentioned earlier, human needs are limitless, and in that they differ from natural resources. Natural resources are scarce in any point of time, and because of that you cannot have everything at once. So you must always judge what you value the most at the moment or, in other words, what specific use of scarce means will satisfy your needs the most. Confronted with the necessity to choose between different uses of scarce means, you create your own value scale that ranks the ends you value. The values are completely subjective. As an illustration imagine an employee working in a high position whose great results were rewarded with a bonus of 50 thousand dollars. The 50 thousand dollars are a scarce resource, so he must decide on the use of the money most valuable to him. Assume that the employee has the following value scale, and each value can be satisfied by use of exactly 50 thousand dollars:
- Having a yacht – this would make his childhood dream come true, and he values it the most
- Going on a trip around the world – this is his second-best choice, as he always wanted to do it
- Having a motorcycle – buying a Harley is his third-most valued choice
- Having his house renovated – his fourth-most valued choice
- Setting up his own bar – this is his last choice that will allow him to lead a more modest but calmer life.
As the employee values the yacht’s purchase the most, he will do exactly that. Can we assume that he judges other things unimportant? Obviously, the other things are important as well. All these things are worth more to him than 50 thousand dollars. He values the yacht the most, however. If he had gotten a bonus of one hundred thousand dollars, he would have bought a yacht AND taken a trip around the world. If he had gotten two hundred thousand dollars, he would have bought a motorcycle and renovated his house as well. However, scarcity of means allows him to satisfy only one of his needs.
Every time you decide on how to use scarce means, you create a subjective value scale by assigning ranks to your various ends in a process of value judgment. Obviously, such value scales are fluid. Subjective value judgments can and do change. And they are inseparable from human action, as only action can reveal one’s priority.
Let’s say that you are walking along a street after receiving your wage. You had your expenses planned in your head, but suddenly you see your favorite band’s album displayed in a store window, so you buy the album. Does it mean that you have acted against your value scale? No. It only means that your situation has changed and you have adjusted your value scale to include your valuation of the album.
Before taking any action, you judge how it might satisfy your needs, and compare it with every other value on the scale. To satisfy your most valued want in your value scale, you need to forgo the opportunity to satisfy your second-most valued want. And this foregone opportunity is called cost. For the employee with the bonus, the 50 thousand dollars are not an end in itself. The bonus is merely a means to an end. So the real cost here is not the money, but the second want on the value scale, that is going on a trip around the world. The employee decides on a yacht, because he judges that satisfying this need will outweigh the cost. Every person taking action believes that the resulting satisfaction will outweigh the cost. From this perspective, human action is always rational, even if it seems otherwise to an external observer.
Of course, after taking action, it may turn out that you have made a mistake, and that the need was actually less urgent than expected. You may think that if you could turn back time, you would make a different choice. This is because the future is uncertain. It might turn out that the employee who bought the yacht is prone to seasickness, which he was unaware of before, and for him every trip on his new yacht is a nightmare. Looking back, he will regret not spending his money on a trip around the world. But it does not mean that his decision to buy a yacht was irrational.
People are always trying to improve their future situation precisely because the future is uncertain. If the future was known and certain, everyone would just wait idly for the inevitable to happen instead of trying to act.
Only a choosing person knows his subjective value scale, and through action reveals only a small part of it. If I buy a mug for 10 dollars, it means not only that at this moment the mug is worth more to me than having 10 dollars, but also that it is worth more than anything else you can buy for 10 dollars.
Meanwhile, the role of the producer is to try to anticipate the future human needs and act to satisfy them. If his anticipation is correct, then he will succeed. If not, he will fail.