Reviewing econ 101

The four economic questions Colorado businesses should be asking

Here’s a quiz: What are the four “economic questions” from your Intro to Econ class you should keep in beyond when school is out?  The correct answers are:

  1. What to produce 
  2. How much to produce
  3. How to produce 
  4. Who gets the production

The last question considers the distribution of production, income and wealth created by the first three questions.     

Consider these questions using Colorado as the place of production. The first two are largely market driven. Businesses produce what people want, whether it’s a black, gray, or green market. Production will occur when producers are compensated for the cost and risks incurred. Marijuana distribution occurred even when it was illegal, although the volume of production within Colorado was probably much less under a black market.

Whether a product or service is produced by Colorado’s people, businesses or governments depends on the state’s ability to produce locally at competitive quality and prices.

Much of this comes from our natural endowment. We produce snow skiing instead of water skiing. We produce more cattle and crops, like potatoes, that are suitable to our cold winters and semi-arid climate.

With the internet and Denver International Airport, we can access the world, thereby providing a large customer base.

How we produce is somewhat market driven. Here managers combine different resources to produce profitably or at least break even. When choosing among production resources, businesses must contend with a greater dose of government control. Government might require certain processes for environmental protection. 

Globally, and increasingly here in the United States, governments might impose less efficient processes to promote the goal of full employment or local business growth. Colorado’s liquor industry is a good example. Large, international food and sundry retailers enjoy economies of scale and can provide consumer products at lower prices if they choose. In doing so, they acquire their products from larger, and often foreign manufacturers and wholesalers, which typically restricts small, local producers from the market.

One can argue the flourishing Colorado craft beer, wine and spirits market results from these protectionist policies and creates more jobs and small businesses both in manufacturing and retail. There would be far fewer neighborhood liquor stores without government influence.

Who gets the production?

On the surface, this, too, is market driven – whoever is willing to pay the price. In competitive markets the consumer tends to get some surplus (value above the price paid) because companies will lower prices to compete.

However, as markets become less competitive – which is the natural tendency with free, unregulated markets – competition declines and more surpluses go to companies, their managers, workers and investors. 

Karl Marx posed a question when dividing the surplus value or profits among different stakeholders. If managers and shareholders receive most of the surplus value, then income inequality grows over time.

One commonly used income inequality metric is the Gini index.  If everyone earned the same income, the Gini index would be zero. If one household gets all income, then the index would be one. The World Bank reports the U.S. index ranks 95th out of 157 countries – close to China and Russia. The Congressional Budget Office reports the U.S. Gini index rose from .36 in 1979 to .44 in 2013 after considering the redistribution effect of taxes. 

The Census Bureau estimated the 2013 national Gini index at .48 with the more liberal states of New York, California and Massachusetts having a higher index. Colorado is in the middle of the pack.

What and how much we produce, being largely market driven, changes more rapidly than production methods and distribution of surpluses due to greater government involvement in the latter.

While we could be entering decades marked by labor shortages, which holds promise to lower the Gini index in the U.S., the ultimate outcome will be determined by how we produce. Will we target training of less skilled workers along with selective immigration to meet production demands?  If more skilled workers are not forthcoming, greater automation and capital investment is required, possibly increasing inequality.

How we solve this problem will certainly become a more heated topic in economics and politics

Categories: Management & Leadership