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easy economics

A crash course in everything Economics – Part 2

Stephen Kinsella’s new book, QuickWin ECONOMICS, answers 100 questions you might have on the subject. In this excerpt: What happens to demand for gin when the price of tonic changes?

ECONOMICS, ECONOMICS EVERYWHERE – and not a person to explain them.

Economics lecturer Stephen Kinsella has decided to wade through the terminology to create a layman’s primer to help us understand the economic factors that are shaping our present – and our future. His new book, Quickwin ECONOMICS: Answers to your top 100 Economics Questions does exactly that. brought you two of the questions and answers in the book to get you started yesterday. Now you’ve got a taste for it, here are two more:

Q: What happens to demand for gin when the price of tonic changes?

A: Elastic and inelastic goods often interact with one another. The cross-elasticity of demand measures the responsiveness of demand for one good (gin) to a given change in the price of a second good (tonic). We calculate the cross-elasticity as:

Cross-elasticity = Percentage change in quantity demanded of gin / Percentage change in the price of tonic

If the cross-elasticity is positive, then the two goods are substitutes. If is negative, then the two goods are complements.

Two goods are substitutes if, when the price of one rises, demand for the other increases. Examples of substitutes are Mercedes and BMW cars, both luxury brands. If the price of a specific Mercedes model rises, buyers will switch to the now cheaper, equivalent BMW model.

Two goods are complements if, when the price of one rises, demand for the other decreases. Examples of complements are fish and chips. If the price of fish rises, the quantity demanded falls, and the quantity of chips demanded also falls – as few people want to eat just chips without fish.

Using the simple cross-elasticity equation of: Cross-elasticity = Percentage change in quantity demanded of gin / Percentage change in the price of tonic, do you think the cross elasticity will be negative, or positive?

Q: What is ‘rent’?

A: The economic notion of ‘rent’ goes back to the classical economists of the 18th century, Adam Smith and David Ricardo, who described as rent the amount a capital owner receives from their investments above and beyond what a market in perfect competition would give them. Effectively, it is a measure of the amount capitalists extract from the system by virtue of their position in it. Rent, therefore, is a measure of the difference between a factor’s cost to the capitalist and its opportunity cost.

However, ‘rent’ can be extracted by labour, too. Imagine you are a nuclear scientist. You have trained for 10 years to become knowledgeable in your area. You command a wage above the average, because of your specific skill-set. This extra wage is also ‘rent’, because you could work instead for minimum wage, or at least for a much lower salary. The professions (medicine, the law, and so forth) ensure their members can extract
rent from employers by keeping the cost of entry to the professions high (with exams and limited licensing), and so reducing the supply of entrants, ensuring that the investment made by the individual in gaining admission to the professions is recouped by large salaries.

Marxist economists define the ‘circuit of production’ around rent. Say you want to build a bread factory. You save up, and buy the flour and the labour of some workers and lease a building to make bread. You sell that bread on the market, and, after paying your costs for inputs to the bread making process, you have some profit (economic rent) left over.

You can choose to save that profit, to spend it on yourself, or to reinvest it in a bigger factory, more workers, more wages for the same workers, and so forth. This creates more output (more bread), and if you sell all of that bread, you’ll have higher profits (economic rent) again. The ‘circuit’ of capital is from your initial savings to the ever-expanding process of rent creation.

This circuit can be broken, and can experience cycles, making the system unstable as a result. Say that, instead of reinvesting your own money in the bread factory, you borrowed from someone else. Say now that you do not sell all that extra bread, and cannot service the debt repayments and increased costs of your new factory.

The system might collapse if enough people were to have this happen to them. So instability is at the heart of capitalist processes.

Stephen Kinsella is a lecturer in economics at the University of Limerick. He holds a BA (Mod) from Trinity College, Dublin, in economics, an MEconSc and PhD from NUI Galway and an MA, MPhil and PhD from the New School for Social Research, New York, all in economics. He is interested in computable economics, experimental economics and Irish public policy.

QuickWin Economics is published by Oak Tree Press. It is also available as an iPhone app and an e-book.

A crash course in everything Economics – Part 1>

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