Practice English Speaking&Listening with: Praxeology - Episode 16 - Economic Calculation

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Why is Capitalism called Capitalism? Hi Guys, Praxgirl here.

In our last lesson we learned that direct exchange has inherent problems that can only

be solved through indirect exchange. We found that there is a quick tendency in society

for goods that are highly valued to become the predominant medium of exchange and this

is called money.

In this lesson we will look closer at the qualities and implications of money, and how

and why money allows an economy to grow past the limitations that are inherent to direct


Money opens to a market the ability to enormously expand the scope for specialization and the

division of labor. Now, people no longer have to worry about the problems of divisibility

or double coincidence of wants. What this means is that a blacksmith can now trade his

swords for money, rather than having to find someone who wants to accept swords as an exchange

and has exactly what he wants in return. A teacher in a school is now able to teach for

money, rather than trading for specific goods which he must evaluate before he trades. A

man can produce a machine (a capital good) and exchange it for money, and he can trade

money for food at the supermarket.

Modern society is thus built on the use of money. And the establishment of prices now

has a common denominator. Its important now to explain what having a common denominator

and prices in term of one common good really means in order to avoid misinterpretations

and fallacious thinking.

What do money prices really mean? First let look at how prices are determined in direct

exchange. Prices are nothing but exchange ratios between two goods. When two individuals

engage in an exchange, the price of a good in terms of another is simply the number of

units of the first partys good that must be offered in order to receive one unit of

the second partys good in exchange.

For example, suppose a baker wants to trade with a blacksmith. They reach an agreement

and trade 4 pies for 1 sword. The price of a sword in this case is 4 pies. If we want

to find the price of one unit, we simply look at the ratio, and divide one unit of a good

against the trading ratio of the other. In this case, the price of one pie would be one

fourth of a sword.

Its important to note that prices are nothing but historical facts; they are the exchange

ratios between two goods at the instant of transaction in the given historical conditions.

They can tell us nothing about how people will assess the value of the respective goods

they want to trade in the future. They simply tell us that at one time, a baker valued a

sword more than the 4 pies he was willing to give up in exchange. And vice verse, the

blacksmith valued 4 pies more than the sword he gave up.

Prices are merely exchange ratios between two goods. Therefore a money price means the

unit of the goodmoneywas exchanged for some other good. The only change with

money prices is that now one good can serve as the common denominator against all other

exchangeable goods. In our first example, the pie price of one sword was 4 pies. If

the baker trades a pie for 1 ounce of gold, then the money price of a pie is 1 ounce of

gold. What this means is that money prices consist of what they are traded against some

good, rather than a measurement of their objective value.

Having a common denominator in a market opens to man the ability to perform Economic Calculation.

A man can quantify the units of money in his stock and know his ability to acquire

goods and services very quickly. His method of calculation follows from observing money

prices. Since we now understand what prices really are--the number of goods exchanged

for another good--its easy to transfer this idea to money prices.

Economic calculation means that a man can compute his successes and failures, or how

close or far he is in achieving his desires in terms of a single good he has in his possession.

Economic calculation can comprehend everything that is exchanged against money. To fully

grasp what I mean by calculation, take this example: if a computer is sold on the market

for 1 ounce of gold, and a car is sold for 5 ounces of gold, everyone can now understand.

very quickly, that a cars market worth is 5 computers.

Computing with a common denominator allows men to keep balance sheets. Using their knowledge

of day-to-day prices, businessmen can appraise and estimate the price at which their current

stock of goods or services will sell on the market. This clearly helps a businessman to

perform his operations with much more efficiency and avoid wasting resources.

This does not mean that money is a unit for the measurement of value. It is not possible

to measure value and the science of Praxeology would never contend to do so. A process of

measurement consists in establishing the numerical relationship of an object with regards to

another object of the same kind. There is no such fixed unit for value. Value is a subjective

concept. Therefore, it would be a mistake to try and relate the number of units of money

to the numerical calculations of technology and the natural sciences. The natural sciences

have the ability to measure with precision and thus predict with relative accuracy the

outcome of a definite action. But as far as the concept of value is involved, there is

no such standard.

Let me illustrate this difference with an example.

Suppose that Matt wanted to build a bridge. By using his knowledge of engineering he can

establish how a bridge must be built on a river to carry definite loads. But engineering

cannot answer the question of whether or not the construction of such a bridge would take

away material factors of production and labor from a task where they could satisfy more

urgently felt needs. For instance, without money Matt cannot figure out if his construction

of bridge is taking away labor and goods from construction of a school, or building houses.

It also cannot tell Matt whether or not the bridge should be built at all, where it should

be built, what capacity for bearing burdens it should have, and which of the many possibilities

for its construction should be chosen. Money solves this problem. Money, as the common

denominator and primary medium of exchange in a society transmits the information of

all the transactions that are being engaged in through money as to where the most profitable

place to build a bridge will be. “Most profitablemeans the best and most efficient use of resources

in order to satisfy the highest and most urgent desires.

Economic calculation has its own limitations. It cannot comprehend things which are not

sold and bought against money. There are things in this world which cannot be bought and sold

using money. Self-worth, vigor, life itself. These things play an important role in society,

yet they are not part of economic activity.

However, this isnt a problem for economic calculation because these things do not require

calculation. Things that cannot enter into accountancy are either ends themselves or

simply nonexchangeable consumer goods. No economic calculation is needed to determine

their value by an actor. A man merely has to choose.

For example: suppose a boxer named Butch is asked by his manager tothrow a fight

for money. Butch is an aging boxer and is in desperate need from the money to get out

of debt. But Butch also has a lot of pride as a formerly successful boxer. Pride is something

that cannot be put into money terms. On the night of the fight, all that Butch needs to

consider is whether to purposefully lose or not, whether to value his pride over the money.

Things that cannot be put into money terms are actually put in a particular position

that makes decisions rather easier. It would be a gross mistake to complain that money

somehow affects societys morality or aesthetic values. They do no suffer from the fact of


Money is merely a good which has emerged as the common media of exchange in a society.

It is therefore not the fault of money that it is profitable for businesses to make a

Twilight movie series or that people prefer to listen to Lady Gaga over Beethoven symphonies.

Money prices merely communicate information for those things that are bought and sold

against it. It is neither more complicated nor simpler than this. And as a matter of

fact, Praxeology finds that the existence of money has the complete reverse effect.

Money as a tool for better planning, greatly increases the supply of material goods. It

therefore allows for men to spend more time enjoying their nonexchangeable goods. To put

it simply, the less time you have to worry about feeding yourself, the more time you

can focus on aesthetics, virtue and love.

In conclusion, what we have learned is that money is a commonly exchanged good which facilitates

indirect exchange. It serves as a common denominator to all economic transactions, which allows

economic computations or calculations.

The importance of money will be emphasized again and again in our lessons. Economic calculation

is the guiding principle of action in any society with a division of labor and this

only becomes possible when money emerges. Potential actions are evaluated on the basis

of expected costs and revenues, and past actions are evaluated with the accounting of profit

and loss.

It should start to become clear why money allows a society to prosper. Because it best

serves to communicate whether capital is being preserved or consumed. Someone building a

bridge is not engaging in a production process that will satisfy his ends immediately but

after a lengthy process and they need a device to transmit information to them, through each

step of the process, whether they will be able to achieve their end. We can call those

who engage in producing or acquiring capital goods, Capitalists. This structure of society

has been labelled Capitalism as a smear in the past. But we can now see, its actually

a very appropriate term. It emphasizes the importance of the role the Capitalists--those

who save more than they could consume--have in the prosperity of mankind.

Ill see you guys in next lesson.

The Description of Praxeology - Episode 16 - Economic Calculation