Seeking Liberty

Liberty is the Fruit from Which All Progress Grows

Basic Economics

With Apologies to Thomas Sowell

In observing the mass of articles, blogs, tweets and web postings, it has become clear why so many people do not understand why the Health Care legislation that the President signed into law today will harm our economy and increase health care prices. Explaining why it will harm our economy is futile without first illustrating how it raises health care costs and prices.

Economics is called the “Dismal Science.” I think this has less to do with predictions of Doom and Gloom, as many people claim, and more to do with Economist’s obsession with abstract ideas, like Utils (a unit of measurement for “utility,” an economic concept that can’t actually be measured). Indeed, until I learned to apply these abstract concepts to real-world situations, I was as lost as anyone who supported this bill.

Fortunately, Thomas Sowell wrote an engaging (for an economist, at least) book called Basic Economics: A Citizen’s Guide to the Economy, which anyone with an interest in understanding economics should read. It is a long book, so if you’d rather have something shorter and a bit more fun, check outCommon Sense Economics: What Everyone Should Know About Wealth and Poverty, by Gwartney, Stroup and Lee. Both books paint the picture of economics, but pull away from the abstract and focus more on the real-world.

Now class, time to explain the basics of why the Health Care Takeover will be certain to raise prices for health insurance and health care in the long run.

Go back to your high school economics class. Do you remember the Supply-Demand Graph every economics teacher is required to draw on the chalk board? The one that looks like the graph in algebra with an “X” on it. Remember how you didn’t really understand it when they were done? It’s probably because they didn’t understand it either, but it’s really quite simple, and I’ll be able to explain in just five or six paragraphs what your text book and teacher took three chapters and six weeks to try. I’ll start from the beginning as if you’ve never had it explained to you before. Because in reality, you probably haven’t.

First, that’s not an “X” on it. It’s two sloped lines, usually represented as concave curves. The one sloping down to the right is the “Demand” curve. The one sloping up to the right is the “Supply” curve. Knowing which one is which and how they react is paramount to understanding economics. The point where the meet, where the “X” crosses, is called the “Equillibrium Point.” I’ll explain more on that in a moment.

The up-down axis (Y-axis for you math geeks) measures price. The left-right axis (X-axis) measures number of units. So, get out a piece of paper and draw your graph: Two intersecting curves on a chart. Got it? Good! Just for now, label the Demand curve and Supply curve; as you become more familiar with it, you’ll remember which one is which without labeling them. Now, where the X- and Y-axis meet, put a zero. This means the bottom of the graph is zero dollars, and the left of the graph is zero units. At the top of the Y-axis, label 100, and at the right of the X-axis do the same, so that the maximum of the graph is $100 and 100 units. Now, at the top of the graph put “PEACHES”. This graph represents demand for bushels of peaches, let’s say in a small town somewhere. We’ll never be able to accurately draw this graph for a real life situation, but it helps us to understand what is going on.

At the far left of the supply curve is its lowest point. Let’s say for the sake of argument that it’s at (5,5), or 5 units for $5.00. The farmers who grow peaches are willing to supply 5 bushels of peaches at $5.00 each. At the top-right, we’ll say it’s at (85,90). This means the farmers are willing to supply 85 bushells at $90 per bushell. The demand curve is the reverse of the supply curve. The demand curve is highest to the left, let’s say at (5,95), or 5 bushels at $95. On the right it’s at its lowest, at (90,8), or 90 bushels at $8. The curves themselves represent the intermediate points: How many bushels people will buy at a certain price, and how many bushels the farmers will supply at a certain price.

This is where the equillibrium point comes in: That’s the point where the buyers (townspeople) and the suppliers (the farmers) meet. In this case, let’s label it (55,28), or 55 bushels at $28 per bushel. This is the point where the most people are happy. The farmers could try to raise prices, but they would sell fewer bushels. The townspeople could choose to buy more bushels, but they will have to pay a higher price. This is the essence of free market economics, whether the product demanded is peaches, pizza, housing, gasoline or health care.

Now, draw a line parallel to the demand curve and just a bit to the left. Draw an arrow pointing from the first curve to the second. This represents demand having decreased. If you redrew your demand curve correctly, the equilibrium point should be to the left and below its previous position, even though the highest and lowest points on the curve haven’t changed. Let’s say the new equilibrium point is at (47,23), or 47 bushels at $23. With less demand (demand shifted to the left), prices fall. So now, do the opposite: Draw a curve slightly to the right, with an arrow from the first demand curve to this lastest one. Demand has increased. Once again, your equilibrium point has moved: This time up and to the right. Let’s say it’s now at (60,35), or 60 bushels for $35. With greater demand (demand shift to the right), prices increase.

This same principle applies to the supply curve as well, but in reverse: Move it left (decrease supply) and prices rise. Move it right (increase supply) and prices fall.

Do you understand? It’s really that simple. If you’ve got it, you’re better off than most people in the world. If not, don’t worry: A lot of those Ivy League guys in Congress, the Department Executive offices and in the White House don’t either. They have high-powered degrees from the “best” universities the worldhas to offer, and they don’t understand what’s going on.

So now go back to your graph. Cross-out “PEACHES” and write “HEALTH INSURANCE”. Now take a critical look at the graph: This Health Care Takeover law is forcing everybody to buy health insurance or pay a penalty. More people buying premiums. More demand. It is artificially shifting the demand curve to the right.

Knowing what you’ve learned today about the Supply-Demand Graph, what happens when you shift demand to the right?


Someone said this was supposed to lower health insurance prices?

Cross-posted at The Minority Report.

Filed under: economics, Government, insurance, , , ,

4 Responses

  1. […] Read the original here:  Basic Economics « Seeking Liberty […]

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  3. Logical says:

    Wow, that’s about the dumbest post I’ve ever seen. Supply and demand only works if the is a limited supply. The insurance company just has to write another policy and take your money. There is no limit to it’s supply. It can write policies all day. The supply is unlimited.
    Wow, are you really that stupid or was this a joke?

    • fmaidment says:

      Your contention is that there are an unlimited supply of insurance policies.

      Hypothetically, this is true. But people don’t buy insurance simply to have insurance. A policy does not merely represent insurance: It represents the potential payout the insurance company must provide if needed.

      The only way a supply of “insurance” becomes unlimited is if each customer pays into the insurance company exactly the amount they eventually take out. Such a thing is only possible if everybody can afford healthcare, thus negating the need for insurance coverage.

      Such sophomoric reasoning on your part belies a clear misunderstanding of economics. Economics is founded on a single principle: That there is always scarcity. That we can never find as much resources as we’d ever want.

      If it were as simple as you describe, then insurance companies wouldn’t need risk pools or aggregated premium structures. To simply “write another policy” sounds easy enough, but in the end, that policy is only one small payment against a lifetime of care. If the cost of that care exceeds the price of that premium, then the insurance company loses.

      Supply and demand applies to EVERYTHING for which we exchange resources (or money, if you must). If you cannot accept that, then you do not accept the single most basic precept of economics.

      And you are a fool.

      Before calling somebody “stupid,” perhaps you should learn a little something about the subject you comment upon.

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