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The Laws Of Economics Won’t Ignore You

A paradox is a statement that is seemingly self-contradictory or defies expectations. It often describes some confusing phenomenon in reality, or in some cases, simply demonstrates cleverness in story telling. An old familiar one is the water-diamonds paradox: why does water, which is so necessary to life that anyone would die in a matter of days without it, have a low value, whereas diamonds, which have little practical value other than industrial uses, are highly valued. People pay ridiculously high prices for jewelry.

A paradox, however, cannot exist in reality. The laws of nature and logic are always in operation. When you run into an apparent paradox, the first question is “What am I missing?” The problem is necessarily misstated. Terms are being used inconsistently or different things are conflated as being the same. In the case of water and diamonds, the term “value” and the units being evaluated are vague. Yes, water is important to life, and yes people can live their whole lives without owning or even seeing a diamond. The choice, however, is not between all of the water in the world and all of the diamonds in the world evaluated by all of the people in the world at once. It isn’t whether or not people should value the life-giving properties of water. The real question is about the value of the next unit of water or the next unit of diamonds for the individual making the choice.

Every person values everything differently from other people. No two are alike, and their preferences are based on present circumstances, all of their assumptions about reality, determined by previous experiences and education, as well as their expectations for the future. Two different people will value the same things differently, and the same individual will value the same thing differently at different times, based on changed circumstances, assumptions and expectations.

Someone standing next to a fresh, clean stream, able to scoop up water at will, will not likely trade a diamond in his possession for a gallon of water, but that same person in the middle of the desert, dying of thirst, may very well be willing to trade that same diamond for that same gallon of water. Everyone has a set of subjective preferences that are constantly changing, depending on present conditions. Someone who has just had a sumptuous meal likely will not make the same decisions as someone who hasn’t eaten all day.

These subjective, changing decisions are the foundation for such things as the laws of supply and demand, two of the most important concepts that influence a good portion of the rest of economic life. People trade only because each party values what the other person has more than what he or she has at that time. At any point in time, a higher price means fewer buyers who value what they get more than they value what they give. Some will buy even at high prices, because they have a significant need that causes them to value the item more. Supply is the opposite, with more being offered as price increases, and the market price is where the two meet. Marginal buyers and sellers determine prices.

There really are no exceptions to the laws. As with a paradox, the problem with apparent exceptions is typically the definition of terms. Price in reality includes every trade off made, including money price, but also emotional costs, relationships, profit opportunities, or anything that is forfeited. Politicians may make laws that ignore economic principles, but that simply distorts decision-making processes, causing shortages or gluts, and hurting people, even if they do so with the best of intentions. You can ignore economic principles but they won’t ignore you.

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