Money Choices—To Save or Not to Save

March 5, 2012

New born babies do not work for those items that will sustain their life. New-borns are exempt because they are unable to work. They are completely dependent on their parents for survival. They cannot find and create their own food and clothing, nor can they volitionally create goods and services to trade with others. Eventually they gain enough reason and physical ability to provide for themselves. If they choose to exercise this ability, they will gain independence.

After one achieves independence, she can create value and trade for money. Initially one will create value in the form of simple services such as selling lemonade or mowing lawns. Over time, services and/or goods become more complex and require more skills. As one gains money, she will trade it for goods that provide for their survival such as food, clothing, and shelter. People make more money than they need to survive. Individuals can choose to spend all of their money on survival and pleasure, or they can choose to save a portion of their money.

Why would anyone want to save a portion of their money? There are 3 main reasons:

1. To insure against temporary loss of the ability to produce value for others.
Since the current conditions of life are uncertain, everybody should save money. If one has not saved and she losses the ability to produce value, then she will loose her independence and will have to depend on others for survival. Examples of insuring against the loss of the ability to produce include becoming severely injured.

2. To make larger purchases than their regular income would allow.
Cars, homes, computers, jewelry, etc can cost more money than our usual income of money will allow. We can obtain such items through saving or borrowing. I will cover borrowing and debt in later post.

3. To intentionally stop working for a period of time.
For most of human history, people would die before they were too old to work. They did not have to save money for retirement. In modern times, people will likely survive past the point that they are too old to work. If people want to maintain independence, then they must save money for retirement. Otherwise, they will become a financial burden on others. Most people make enough money to retire before they are too old to work if they save money wisely. Other reasons to stop work are vacation and education.

Discussion Leave a comment Category Economics, Finance, money

Money—An Origin Story

March 4, 2012

Money solves a huge problem. As I explained in my last post it is better to specialize and trade, than to try to produce everything alone. Imagine that money does not exist. People simply barter. The word barter means that people simply trade goods for goods without using a medium of exchange. Now imagine that I am a designer and I have appendicitis. I can either die, or I can find a surgeon that is willing to trade design work for an appendectomy. I will likely die before I can ever find such a surgeon. This problem is what economists call the double coincidence of wants problem. Simply defined, if I am in an economy that trades goods for goods, then I have to find somebody that wants what I have and simultaneously has what I want. This is a huge transaction cost.

In virtually every known society or culture something called “money” evolves to solve the double coincident want problem. Instead of trading goods for goods individuals trade goods for something that is commonly traded, that everybody wants and then they use that thing to trade. Money is anything that is commonly accepted in trade. Money does not have to be issued by the government to be used as money. In fact there are many government issued monies that people don’t commonly accept for trade.

The earliest known form of money was red ochre in Aboriginal Australia. Ancient Mesopotamia traded in wheat. Marco Polo records that spices were used as money in the East. The Herodotus recorded that the ancient Lydians were the first people to use coins for money. Prisoners have been known to use cigarettes as money. The big stones in the picture below was used as money (That money didn’t move much but was exchanged often in word only.)

We could agree on anything to be money—even invisible bits of data. It doesn’t matter what we use. It only matters that we commonly accept it. Money is one of the most important inventions of all time. Individual and societal success depends on wise usage of this most valuable invention.

Discussion Leave a comment Category Finance, money, Theory

Adam and Eve and Finance

December 30, 2011

Welcome to my new blog about finance and economics for everyday life. In this blog you will find a combination of fun theory and practical application. I will write about how people can improve their individual financial situation and I will talk about some of the interesting political implications behind finance and economics. Whenever I address any subject, I like to be thorough and start at the beginning. I will create a foundation that I can use to build upon in later posts. So here we go.

Finance

What is finance? Finance is the management of money.
What is money? It is a medium of exchange.

Would a lonely Adam in the Garden of Eden have any need for the concept of finance? No, because he would have no one with whom to exchange goods. Would Adam and Eve together have any need for the concept of finance? The answer is still no because Adam and Eve have no reason to exchange anything. Neither would want anything the other has since they both can get what they want with no effort in the Garden of Eden.

What would make Adam and Eve want to exchange? If they can get what they want with less effort by exchanging than if they tried to obtain it alone. After Adam and Eve left the Garden of Eden, effort was required to obtain food and clothing. Let’s say hypothetically that Eve was better at making clothes. And let’s say that Adam was better at gathering food. If each specialized in what they are better at, they would have more than if they both obtained food and clothing independently.

Now would they need a concept of finance? Not yet— because they exchange and share goods directly. They have no use for money.

Why would two people want to use money when they exchange? To answer this question, we need more than 2 characters. Imagine that Adam and Eve have lots of children and all of them specialize in different activities and they exchange with each other. Abel specializes in raising sheep, Cain specializes in producing carrots, and Methuselah specializes in making tunics. What if Cain wants a tunic but Methuselah does not want carrots. Cain cannot directly exchange with him. For Cain to exchange, he would have to get Abel to trade sheep for carrots so that he can then exchange sheep for a tunic. If Abel does not want carrots then Cain will have to make his own tunic, or find a fourth person that wants carrots and simultaneously has something that Abel wants so that Cain could trade with Abel, get sheep, and then trade with Methuselah.

This exchange between multiple people is much easier through the use of money. All parties would be better off if they could agree to use something as a medium of exchange. Money greatly reduces the cost of trading.

Now do Adam and Eve and their posterity need a concept of finance? In a very simplistic way, yes. We all need to understand the basics of finance to live better lives. Finance today is much more complex than this rudimentary story. But, ignoring finance would be one of the most expensive mistakes of all.

Discussion 2 Comments Category Example, Finance, money, Theory Tags , , ,