Monday, September 29, 2008

The 33% Rule Part 1: Basic principles of economics

The current bad state of our financial system is a symptom of a massive disconnect with reality. In this article I would like to clarify the problem and propose the solution. Before I present the solution, I will clearly identify the principles involved with a simple rule called "The 33% rule".

Figure 1 shows a healthy economy where three producer/consumers (P/C) are participating as traders in a division of labor economy. The amount of value each individual consumes is dependent on how much value he can produce.

Observe what happens when one individual stops producing in Figure 2: the economy loses 33% of it's produced value. Now demand for the value produced increases and along with prices. This simple case demonstrates how a pure consumer (C) erodes the benefits of living in a society. Also, observe that C can only survive second-hand by the value produced and given away by a P/C.

Now let us examine the nature of production to identify why it works this way. Causality dictates that before a value may be consumed it has to be produced by someone. This fact makes it impossible to consume more than is produced. Any attempt to do so is an attempt to reverse the law of causality and will fail. Stated formally, the 33% rule is: A fictional economy of three participants is 100% efficient if all three are both producers and consumers. If one individual stops producing and turns into a pure consumer then the economy loses 33% of it's value.

Figure 3 models what is happening today in the United States and likely every other economy around the world. Each P/C produces more than he consumes which creates a surplus of value produced. The higher the surplus created by the P/C the more value produced is given to the Cs.

We must understand why P/Cs are giving value to Cs. In a free society this transfer is called charity and is left to the discretion of the P/C. Charity is both good and proper as long as all parties are participating by voluntary choice. If the number of Cs grows beyond the ability of the P/C to help then the P/C has the choice to stop giving value away which forces the Cs to either live by their own ability, exist second -hand off of another P/C, or die.

If this seems harsh then consider the the alternative depicted in figure 4. Without any P/Cs the Cs must either become a P/C or die. In part 2 I will expand on figures 2 and 3 and identify where the United States lies, how we arrived at that point, and what we need to do.

1 comment:

Jadu Kumar Saikia said...

good one, nice explanation. Thanks.