Posted by PITHOCRATES - October 1st, 2012

Economics 101

When Prices Rise Businesses Increase Output and when Prices Fall they Decrease Output

No one likes losing their job.  Even if you hate your job.  In fact, that’s why so many people stay in jobs they don’t like.  Because it’s easier than finding a new job that provides decent pay and benefits.  Sure, there are some aggressive go-getters out there who advance themselves up the earnings ladder by making career moves.  But most people prefer a steady paycheck that meets their needs.  At least, meets their needs with only a modicum of complaining.

But resigned to our places of employment as we may be change happens.  And we lose our jobs.  For a variety of reasons.  Mostly through the ebb and flow of the free market economy.  The normal business cycle.  The boom-bust cycles of the economy.  On the boom side prices rise as people are buying a lot of things.  High prices translate into business profits.  So businesses increase output to sell at those high prices.  And other businesses enter the market.  Adding jobs to the economy.  Retailers increase their orders at their wholesale suppliers.  Who increase their factory orders.  And the factories increase their orders with their suppliers.  Adding a lot of jobs to the economy.  And lowering the unemployment rate.

But eventually too many businesses flood the market with their goods and services.  Supplying more than the people can buy.  So stuff sits on shelves longer.  Retailers reduce their orders at their wholesale suppliers.  So inventories grow at the wholesalers.  So they cut their factory orders.  Leaving the factories with excess production.  So they cut back and reduce their orders with their suppliers.  As everyone cuts back on their business operations they lay off workers.  Removing jobs from the economy.  And increasing the unemployment rate.

When Capitalism destroys some Back-Breaking and Unpleasant Jobs it creates New and Better Jobs

The business cycle is normal.  And necessary.  By using prices in the market place it constantly adjusts supply to demand.  Making sure we efficiently use capital (raw materials, factories, equipment, etc.).  And human resources (labor, research, engineering, etc.).  When we under-utilize capital and human resources prices tend to rise (demand increases).  Encouraging an increase in supply.  The boom time.  When we over-utilize capital and human resources prices tend to fall (demand falls).  Encouraging a decrease in supply.  The bust time.  Or recession.  The business cycle maintains the optimum amount of economic activity automatically.  If we let this process operate automatically.  Yes, there will be recessions.  But they will typically be short in duration.  The less prices rise during the boom the shorter the duration.  The higher prices rise during a boom the longer the duration.  But one thing for certain is that prices have to fall to correct to actual demand.  And that only happens with a recession.

There are other contributors to unemployment besides the normal business cycle.  Like structural unemployment.  Such as when technology changes and makes old jobs obsolete.  A lot of ditch diggers lost their jobs when we developed mechanized excavating equipment.  People in the whale oil business lost their jobs when John D. Rockefeller brought kerosene to the market.  The Pony Express riders lost their jobs with the advent of the telegraph.  The telephone put telegraph operators out of work.  Cell phones put people in the phone booth industry out of a job.  And destroyed a lot of jobs in the pager industry.  The personal computer put a lot of secretaries and typists out of work.  The DVD destroyed jobs in the VCR industry (and those little video cassette rewinding machines).  When they found asbestos caused lung cancer it destroyed the asbestos industry.  The Internet is putting the printed newspapers out of business.  Digital cameras destroyed jobs in the instant camera business (e.g., Polaroid).  And email and texting is causing the U.S. Postal Service to go bankrupt.

There are always unemployed people.  Thanks to the normal business cycle.  Structural unemployment.  Even to changes in consumer preferences that puts some businesses out of business.  (Wearing legwarmers was a fashion trend that sold well in the Eighties but disappeared by the Nineties.)  So there are always people losing their jobs.  But that’s normal.  And necessary.  For all of those new technologies and new consumer preferences create new industries.  And new jobs.  Jobs they staff from the unemployed.  So while free market capitalism destroys some jobs it creates new ones.  Jobs that are often better than the ones destroyed.  Such as back-breaking and unpleasant manual labor jobs replaced by less back-breaking and less unpleasant jobs.  Such as the ditch diggers being replace by a machine and an operator.  And all those workers who build, transport, fuel and maintain those machines.

Some of our Worst Recessions have happened since the Keynesians set out to make Recessions a thing of the Past

Then there’s a worse kind of unemployment.  The kind government causes.  In part with their policies that are not business-friendly.  That increase the cost of business.  Which reduces the number of jobs they can create.  Such as increasing taxes and tariffs.  And mandatory employee costs.  Such as Social Security, Medicare, unemployment taxes, health insurance, etc.  As well as corporate income taxes.  Regulatory compliance costs.  And a minimum wage.  Which discourages hiring unskilled workers.  As well as increases pay levels for those earning above the minimum wage.  Who expect a much higher pay than minimum wage because of their education and/or experience.

So these policies depress the job market.  Because they increase the cost of business.  Then they compound their anti-business policies with bad monetary policy.  Keynesian economists don’t like capitalism.  Or the private sector.  Because of the business cycle.  Keynesians say they can get rid of the business cycle.  By doing what the private sector won’t do.  Hire people during times of recession.  Keynesians encourage the government to run deficits during recessions so they can spend money.  Creating government jobs.  And by creating government projects (e.g., building roads and bridges) for the private sector.  Creating jobs that the private sector won’t.  They even push interest rates below where the market would have them.  By expanding the money supply.  To encourage business to borrow money to expand their businesses for a consumer demand that isn’t there.  And they encourage consumers to buy big ticket items like houses and cars.  To further go into debt to stimulate economic activity.

The problem with these Keynesian policies is that they interfere with the automatic price mechanism to match supply to demand.  So when prices tell suppliers to reduce output these policies encourage them to increase output.  So while they may actually stimulate some economic activity it is not real economic activity.  Not driven by real demand.  Prices will continue to rise as if the boom is continuing.  The inflation created by that expansion of the money supply will even increase prices further still.  Which means when the correction happens those prices have a lot farther to fall.  Making the recession longer.  And more painful.  So the Keynesians not only failed to remove the bust-side of the business cycle.  They made the bust-side last longer than it normally would have had there been no government intervention.  Which is why some of our worst recessions have happened since the Keynesians set out to make recessions a thing of the past.



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