Discover more from Economics in One Lesson in the 21st Century
The 7 Economic Actions
The building blocks of economic activity
People can own things (tangible assets), be owed things (debt assets), and owe things (liabilities).
Since raw net worth is just a person’s assets minus their liabilities, there are only 6 ways in which one person’s RNW can change. They can:
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Gain a tangible asset (RNW↑);
Gain a debt asset (RNW↑);
Gain a liability (RNW↓);
Lose a tangible asset (RNW↓);
Lose a debt asset (RNW↓); or
Lose a liability (RNW↑).
Take the first one. If Alice gains a tangible asset, there are exactly two possibilities: either (a) it was someone else’s tangible asset before, or (b) it was nobody’s tangible asset before.
In case (a), a tangible asset has been transferred to Alice from someone else.
In case (b), Alice has produced a tangible asset (e.g. harvested an apple).
Something similar applies to all 6 options. When Alice gains an asset or liability, either (a) someone else had it before, or (b) nobody did. And when Alice loses an asset or liability, either (a) someone else subsequently has it, or (b) nobody does.
That means that there could be 12 types of event, or action, which can affect someone’s RNW. But it turns out that 5 of these are duplicates, just with the roles reversed e.g.
1. (a) Alice receives an apple from Bob, and
4. (a) Alice loses an apple to Bob
are the same type of action—transfer of a tangible asset. That leaves 7 unique types of action:
Produce (one person gains a new tangible asset)
Consume (one person loses an existing tangible asset)
Transfer tangible asset
Create debt (one person gains a new debt asset; another gains a new liability)
Write off debt (one person loses a debt asset; another loses a liability)
Transfer debt asset
All 7 action types
The table below has one row per action type, for actions involving Alice and Bob (and an apple). For each row, it shows the following columns:
Name of action;
Changes to Alice’s assets/liabilities;
Changes to Bob’s assets/liabilities;
Changes to Alice’s RNW;
Changes to Bob’s RNW;
Changes to RNW of Charlotte (representing anyone other than Alice and Bob);
Changes to the whole world’s RNW;
Arrow representing the action, showing increases (arrow tip) and decreases (arrow base) to each person’s RNW.
Effects of the action types
There’s a lot in the table, so let’s look for some patterns.
The first thing to notice is that Charlotte’s RNW column contains nothing but zeroes. This means that her RNW is never changed by any action which doesn’t involve her. There is nothing special about Charlotte: she represents anyone not involved in the action. So we can say that actions only affect the RNW of the people directly involved.
Next look at the whole world’s RNW column. The world’s RNW is unchanged by any action apart from production (which increases the world’s RNW by the thing produced) and consumption (which decreases the world’s RNW by the thing consumed). Apart from production and consumption, economic actions are a zero-sum game for RNW.
Now look at Alice’s and Bob’s RNWs. When Bob produces an apple, his RNW increases, and nobody else’s decreases. (This is why the whole world’s RNW increases with production).
When Alice consumes an apple, her RNW decreases, and nobody else’s increases. (This is why the whole world’s RNW decreases with consumption).
All of the other action types decrease Alice’s RNW, and increase Bob’s by exactly the same amount. (This is why these 5 action types are a zero-sum game). A useful way to think of this is that these actions transfer some of Alice’s RNW to Bob.
Finally, look at the arrows. When an arrow points to someone, it increases their RNW by whatever appears abovethe arrow. When an arrow points away from someone, it decreases their RNW by whatever appears above the arrow. For production and consumption, only one person is involved, so the other end of the arrow has a “void” icon to represent nobody.
The colours of the arrows represent what type of asset or liability was gained or lost to change the person’s RNW. Purple represents a tangible asset, green represents a debt asset and pink represents a liability. So, for example, a purple arrow tip represents gaining a tangible asset, a green arrow tip represents gaining a debt asset, and a pink arrow tip represents losing a liability (which increases the person’s RNW), each of which you can see from the A/L columns.
Action diagrams and intuition
Action arrows between two people are an extremely concise way to represent a lot of information. Each says whose RNW has changed, by how much, and via what changes to assets and liabilities. In other words, the final column of the table contains all of the information from all of the other columns.
Perhaps even more importantly, action arrows show how the whole economy can be seen as transfers and exchanges of RNW. When you look at it this way, the modern global economy works in almost exactly the same way as a barter economy (where there are no debts). Drawing diagrams of actions makes economics extremely intuitive. To find how someone’s RNW has changed, simply add the arrows pointing to them, and take away the arrows pointing away from them.
Applying the One Lesson
Now that we’ve looked at action diagrams, which show how everyone’s RNW changes, we’re ready to start applying the One Lesson in future posts. Following Henry Hazlitt’s lead, the first question to investigate is whether or not breaking windows is good for the economy.
Or below in some diagrams, if it fits better.