Economy Up-Close: A Tale of Sok and His Friends

*Note: If you hate reading facts, then jump right into the interesting story. I have already marked it for you.
*Another Note: I, however, encourage you to read everything if you are not a Cambodian. Or Laotian or Thai who shares similar tradition, culture and religious belief. Still, whether or not you are one, do read it if you can. Very useful information provided.
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Never before have I been so fascinated by Economics. Writing this article is the only way I can think of to express my impression on an awesome story I had the opportunity to witness with my own four eyes. The story I am going to tell you is about the birth of a small market economy driven by the laws of supply and demand and other factors that could make it happen.

Let me start by giving you a bit of an overview of Cambodia and poverty within this country. Cambodia is one of the developing countries of the global south. We are, however, very fortunate to have such a resilient country which persists and thrives despite the really bumpy road. I am proud to be a Cambodian, but being proud should never be on the same line as being arrogant. There are still many challenges now and in many years ahead. I see the many flaws the country has and the improvements to be made.

Just throwing in some facts. According to the most recent data by Asian Development Bank (ADB), the total number of population in Cambodia is 14.7 million (2013), and about 25% of the entire population is living under the set poverty line of $1.25/day while the poorest 20% only share about 7.9% of the national income. The data from the UNDP also gives us a more inclusive indicator called "multidimensional poverty" which is complementary to the traditional poverty indicator that is solely based on income. This new indicator measures poverty based on three primary aspects: Income, Health and Education. The data shows us that 45.9% of the population is living in multidimensional poverty. That means they are not just poor in terms of having little money, but also in terms of poorer health and education. For more details, please consult google.

Not to take it too far because the whole point of mentioning those basic facts is just to give you an idea of the current state of Cambodia from the half-empty-glass point of view, so we can figure out ways of how to fill the empty part.

Poverty, to be specific, is what I have seen everyday after leaving home to go to work, having a cup of coffee with friends, going for a ride along the riverside, going to restaurant... I am not even talking about what I have witnessed in the rural areas yet. It has become so apparent to me simply because poverty and affluence are occurring along side each other. At night, on the same street, you can see a family in their luxurious and high-class Range Rover, and you can see another family sleeping helplessly on the side of the street struggling to survive each day while suffering from chronic hunger, meaning they wake up hungry, they feel hungry the whole day, and they go to sleep hungry. The scary thing is that such contrasting states of being has become so familiar to us, to the people here, that we have started to become oblivious of it while some have chosen to ignore it.

Enough of this. I will now take you along with me to Prek Ta Tun village, Ksach Kandal district, Kandal Province. We are going to a pagoda named "Botum Raengsey" to join with many people there on a special religious festival called Pchum Ben or Ancestors' Day, which lasts for 15 days, celebrated by Cambodians every year to pay respect and make in-kind offerings to the deceased relatives up to 7 generations.

During Pchum Ben, almost everyone brings food as an offering to their ancestors who are believed to be released, for a period of 15 days, from the underworld in search of their descendants who brought along food-offerings for the starving ghosts of their predecessors. It is believed that by doing so, it is also a kind of merit-offering that is able to release their ancestors from their agony in hell so they can have peace in heaven. What if we do not make any offering at all? We will be cursed! I hope not. I do not know the detail. The explanation has never been very clear to me.

What I want to point out is just that there is normally lots and lots of food in pagoda during Pchum Ben period. You see, I do not know if ghosts exist. If they do, I do not know if they eat physical food, but I know for sure, with absolute certainty, that actual living people do. So, many of the poor gather in pagoda during the 15-day festival hoping to get something to fill their stomach and get some money from people who have become more generous because of the festival effect with the final destiny, heaven, as their incentive.

It works most of the time for the poor. I mean that is why many poor, or less-fortunate, people, especially children, go to pagoda during this religious festival period. Sometimes, to get more than just food, they beg (for money). It works better than on a normal day, but still, they do not get much, and they are often ignored and shunned by the better-off people (or so they seem).

A gloomy article it may seem, a cynical author you may say. However, starting from this point on, we will experience together how Economics can help make even a small change that can improve life quality for the poor, during Pchum Ben day at least.
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The story goes like this... (It is a true story, and this is where it gets interesting)

A woman praying to the Buddha statue

Welcome! This is​ a typical scene inside any Buddhist temples, at least here in Cambodia. You can see a woman praying to the Buddha statue in the picture. Well, there were many more people at the food hall (because it was lunch time!). Did I mentioned that the food hall is also a holy place in pagoda? Pretty much everywhere, except the restrooms.

Here we are, the Food Hall. Told you so! It was crowded!

There were many village children coming to Pagoda looking for something to eat and to bring home. Money is top in the list. What could those small children do to earn money? They begged. A typical scene all over Cambodia (but definitely not what the picture to your right is about).

Anyway, I am pleased to introduce you to our protagonist and his friends today (see the below picture and its caption). Let us call him Sok, a very typical Cambodian name. Of course, that is not his real name. I was stupid enough to forget asking him for his name. Still, this picture below is enough because a picture is worth a thousand words. Not to say his real name is that long. I hope he is not going to sue me in the future for posting it here. I did ask for his consent to take and post the picture... but without his signature. I doubt he understands what I meant when I said "May I post this on the Internet later on?". He will soon learn, I do hope.

Meet Sok (Red shirt on the left) and his friends! Sok said "Hello" to you too!

Just like any other kids walking around in the premise of the pagoda, Sok was at first begging for money. People did not welcome him, and he did not earn that much from begging either. It is sad, but aside from writing about his hardship, I can only do very little.

For some unknown reason, about an hour later, Sok seemed to have realized something, or maybe he was simply tired of walking around begging for money from people, with little success. His action caught my attention because he suddenly sat down at the entrance of the food hall in which the monk were chanting before having lunch offered to them by the people. Of course, everyone had to get into the food hall to listen to the unintelligible Sutta (in Pali language).

So what was he doing sitting at the entrance like that? Was he too tired of standing and walking? and just decided to sit and beg instead? Not really.

You see, for Buddhists, when going into a sacred place, we take off our shoes to show our utmost reverence for the Buddha and the monks.

This creates a problem. Poverty, Shoes. Povery, Shoes. Poverty, Shoes... Poverty, free Shoes... you got that?

Ain't nobody has the time to keep their eyes on their shoes. Most of the time, they are too busy concentrating on the chanting, whether or not they understand any of that. So shoes are there at the entrance for anyone brave enough to grab a few of them to sell and earn some bucks or riels (Cambodia's currency). Just a side note, since Cambodia is a partially dollarized country, we use both riels and dollars. Anyway, you see the problem. You go in, you lose your shoes, and worst of all, they don't go to your ancestors. Win-lose situation. Nobody likes it.

Sok somehow realized this problem that people were facing. Like many economists said, in an economy, the scarcest resources of all are knowledge and insight. Two working as one. Those with the right knowledge and insight at the right time and the right place, with the courage to initiate and the strong will to persist, will prevail regardless of who they are. This is what happens most of the time. A poor farm boy can even become the richest man of great sophistication because of his employment of his own knowledge and insight.

Tired of begging (probably), Sok might have at first done it out of his goodwill. He saw the problem, and he tried to solve it. He set up a spot where he would just sit and watch over people's shoes. As you have seen in the picture above, He and the other kids did not realize, at first, that this simple problem-solving service will not just help the people but the sole supplier of the service, Sok.

By the way, Sok was the only one who did the job at first. His friends (the three kids in the picture) just joined in for the photo shot.

I was very interested in Sok's initiation. So, I took a picture hoping to see something interesting happened. I wanted to turn it into something that could change his day. I waited and observed what would happen next. Suddenly, a woman walked out of the food hall and handed Sok 500 riels (about a dime). That is my friend, an incentive! Every business needs incentive to continue its operation. Where there are demand and supply, incentive will be made visible through the transaction.

At first, the other kids were just running around, playing, and begging for money from the passers-by from time to time like they usually do. That gave me an idea! I then kept walking in and out several times. Each time, I kept repeating the same act. I handed the shoes to Sok when I entered. When I left, I took the shoes back and gave him 500 riels as a thank for his service. By my 3rd or 4th trip, this act of passing benefit to Sok, the service provider, caught the other kids' attention.

About half an hour later after the fact, this was what happened.

Wait wait wait... they are not Soks! There cannot be more than one Sok. They are 2 other kids offering the same service.

4 more inside of the food hall? 5? So about 7 in total doing the same thing as Sok does.

Yes, a bunch of other kids started to imitate Sok and opened up their own shoes-keeping business, in hope to gain or surpass Sok in terms of profit! They have now become Sok's competitors!

"Where did they come from? They are taking away my customers!" Sok thought (I made this up). 

                                                                                                                                                              Sok was not very happy about this (See his face? ha!). But sorry kid, this is free market, and for this particular type of competition, we can call it a perfect competition in which businesses offer identical products or services with no barrier to entry and exit. As Sok realized his profit, he could not hide it from the eyes of the other kids who were also profit-seeking individuals. Sok could not monopolize the business because the demand was too much for him to handle alone, and there was no rules or regulations stating that only Sok can provide the service. Plus, he could only watch over limited number of pairs of shoes if he did not hire other kids to work under him (and he did not). As the shoes-keeping business, which existed on the same timeline and place, offered greater incentive than standing around beeing, begging now incurred a huge opportunity cost (a huge loss of money that could have been made by entering into the tiny shoes-keeping industry). Consequently, several other kids ended up in the same business.

Before the shoes-keeping business took off! Lots of shoes in
risk of being stolen! We need Sok!

The problem arising from having to take off your shoes and the risk of losing them had given Sok a great idea to begin this little business of his. His insight, despite how young he still is and difficult conditions he is in, gave him the edge against the other kids and probably adults as well as allowing him to help solve the existing problem people had on that day. Thus, we can see that demand has created supply or in this case, it can be also said that supply has created demand because people might not have realized that they even needed this kind of service at first. However, after Sok started his little business, people welcomed him at the entrance. They smiled at him and thanked him while at the same time compensated him for his time and energy with some money. This is exactly what incentive is. Once profit had been realized, other kids with profit-seeking behavior became more and more interested. Eventually, at the entrance, we had our little shoes-keeping service industry with perfect competition operated under the free market system. The only thing that did not happen as expected based on the economic theory I have learned is that as more kids supplied the same service as Sok did, price did not fall. There were people who actually gave 2,000 riels and such. This is why development economics can be a little bit difference from the fierce business competition stated the orthodox economics. It factors in "Generosity" of the people. This is what drove up price offered by the demanders of the service, and thus, a greater satisfaction to them and a greater benefit to the suppliers.

Lucky him that Sok started all this.

So, were the kids better off? Surely they were. About 2 hours later, before I left the pagoda, I asked them about the amount they made (and still, I forgot to ask for their names... regret that!). Sok made 15,000 riels and another kid made 5,000 riels. I do not know about the rest. Well, early bird gets more worms, I guess. The initiator benefited more due to the smaller competition and more customers of his own while the followers also benefit greatly but to a lesser extent. Still, they were all much better-off that day!

Moreover, to attract more customers, they had also thought of ways to provide better quality services. Sok and the other kids neatly arranged the shoes in order, and for my patronage, Sok even put my shoes (the biggest black pairs on the right of the pink shoes) at the front (He told me that). What a nice kid! Due to this privilege he gave me, I was also more inclined to further use his service. What a great entrepreneur Sok is!

Is this the end of the money circulation in that small economy? Not really. So where will the money go next? Probably to the ice-cream seller in the right picture.

See the street vendor in the middle of the picture?

As ice-cream is really sweet and makes people feel thirsty, it is a complimentary product to drinking water products. So the next person to benefit might be the street vendor selling drinking water and beverage in the pagoda that day (The street vendor was in the picture far back).

This is just a small economy that has been improved to an extent thanks to one kid with a great entrepreneurial spirit. I salute you, kid.

I consider myself very lucky to be able to witness such an improvement in people's income, even if for a day. This shows us that the law of economics, the law of supply and demand, applies to every level of our society. I, thus, urge the development workers to start thinking economics and employ solutions to poverty that consist of 5 elements:

- Relevance
- Effectiveness
- Efficiency
- Impact
- Sustainability

The use of economics to improve life quality can meet the 5 conditions while being much less costly than the traditional solutions which do not factor in much of economic thinking.

Once again, this article could not be made possible without Sok and his friend. I still am fascinated by what I have observed, and this particular experience has reassured me of the crucial role economics plays in development and life in general.

Thank you for spending time reading this article, and I will see you again next time with an even more amazing piece of economics!

All the best.



Sources used:
http://www.kh.undp.org/content/cambodia/en/home/countryinfo/
http://www.adb.org/sites/default/files/pub/2014/basic-statistics-2014.pdf
http://en.wikipedia.org/wiki/Pchum_Ben

Market Failure: The Flaws of Capitalism and Laissez Faire Economics

SOME CHANGES MADE~!
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16-08-2014
**Some mistakes spotted as I re-read the article. I will revise them later to create a better flow, make the article more reader friendly and not causing much confusion.**

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Contents as of 29-08-2014:

My apology. As stated above, I noticed some mistakes. Well, not mistakes in a strict sense, but more like something that can potentially cause confusion. I have just realized that I really need to insert this paragraph somewhere in the text, and no where can I fit it in better than at the beginning of the article.

So let me clarify one thing. I want to make it clear to all of you of there. Long story short, capitalism is about private ownership. Free market is about the freedom in exchanging of goods and services. Simply speaking, capitalism is accumulating privately-owned wealth, while free market or laissez faire economics is about freely trading your wealth after having it converted into something tradable. The two are entwined and quite often got mixed up. While free market requires capitalism to operate effectively and efficiently, capitalism does not necessarily need free market. In fact, in extreme case, capitalism can also exist in the absence of free market (like when only monopoly exists, what is monopoly? Google it). For simplicity, the article does not differentiate much between the two. Most of the time, you will see either term used in the same paragraph. Do not freak out! Despite the difference, the consequences resulted from having both or either one of the two (capitalism or free market) freely reign an economy are quite similar. At least, that is what I think!

From my very first article, little did I write in favor government intervention or restriction on the free market system. It seems as if I am in full support of an economy with no or little government intervention. And that is not the case actually. In economics, we have something called "Market Failure". Market Failure is neither a myth nor an attempt of a government to gain more power. Market Failure is real, and it is pretty much related to Capitalism and Laissez Faire Economics.

In essence, capitalism is a key component of free market, and capitalism is to allow people to pursue their dream, prioritize their self-interest, and optimize the use of their resources to attain the best possible outcome and maximum profit. We can also say that the many individual quests to accumulate wealth, combined, have given birth to capitalism, and the economic system that allows everyone to do so, or to be accurate, that enhances the effectiveness of capitalism and directs it towards the optimal path for the mass is the one that favors free market system with little or without exertion of force or control is called Laissez Faire Economics.

Being free is good. People fight for freedom. They want to liberate themselves from all sorts of bondage. This is human nature, to be free because YOLO, you only live once. However, note that in theory, we mostly talk about economic freedom in its perfect form, we always talk about the extreme of this or that because it is just much easier to imagine and study, and much less complex to analyze as it gets rid of the myriads of other influential variables that increase uncertainty and unpredictability. The real world is not as simple, and for this reason, free market cannot and should not exist on its own. I will explain why later in the article.

Capitalism promotes free market which is believed to give birth to all sorts of great incentives for the people to work their buttS off because in capitalism, your get to reap what you sow. You speculate well, you seize the right opportunity at the right time, you invent and innovate, you add much brain power, energy and time as inputs, and the final product is yours to sell to the world. Your increased productivity drives the world economy forward. You work for yourself, but to increase your productivity, you hire people, i.e. pay them, to work for you. In that sense, everyone is better off! A single person's initiation, his spirit of entrepreneurship to create something of value from which he can derive profit, will, whether or not that is his aim, benefit the world and the society around him. Those beneficiaries are called stakeholders, and who are they? They are employees, suppliers, buyers, society in which the business operates, and also the international community as well.

As mentioned, the great thing about free market is that a single person's greed is turned into everyone's benefits. The desire to produce to earn, the desire to beat your competitors by cutting cost, reinventing the wheel, giving birth to new invention and innovation, improving existing products and services... all result in betterment of human living standard as witnessed during the last couple of centuries. Nothing, nothing but capitalism/free market will ever respond so quickly to the new demand, want or need of consumers. Why? Because the ambitious ones always seek the gap that must be filled within a market. Businessmen respond and adapt quickly to the changes in market conditions, much faster than the government ever could, because they are the frontline soldiers, they have the expertise in their own respective fields of production, they know the drill, and the most important of all, they seek profit, and capitalism gives them the enabling environment to do so.

HOWEVER, wait for it...

TOO MUCH of anything is NEVER GOOD. Too much cake will make you fat, too much nightclub will make you bad, and too much study will make you sad. Like wise, too much of free market will corrupt the economy. Capitalism is good because the complex economic system turns self-interest into collective yields. Nonetheless, this simple reasoning that justifies the use of laissez faire economics was contested. Many times. And is still going on. And on. And on.

The challenger based their opposition to the free market on the so-called Market Failure, the Flaws of Capitalism and Laissez Faire Economics. Though much is true that free market has been good (or so we think) to us for many decades, leading to double-digit economic growth for nations like China for many years, capitalism still has its engine sparked and run by profit-seeking individuals who probably do not think much of the well-being of the rest of the world. Of course, somehow, free market dictates that their actions will keep the globe spun and everyone gets a piece of the sweetness. However, the greed driven behavior will make the system implode. You will see why soon.

Capitalism/free market often does not lead to Pareto Efficiency or Pareto Optimality, an economic state where every individual well-being can no longer be optimized without causing harm in some sort of form to the others. The problem is that Capitalism/Free market will continue to drive the economy onwards even the cost to the society at large outweighs the profit to a small number of individuals, and no matter how much return certain actions will yield to the collective social welfare, capitalism fails to make them happen if the individual benefit is not there. This statement I made, I think (and if I am correct), pretty much sums up everything of the defects of capitalism. Simply put, social cost is just too great that the individual benefits yielded by an action (say a business action) is insignificant, and this leads to inefficiency or waste or huge opportunity cost.

I will give you more specific examples on the matter.

Let's us now look at market failure from a few different angles.

The first thing that comes to my mind when thinking about market failure is none other than Externalities. What are they? They are the by-products resulted before, during or after a business action that may either of beneficial or harmful effects for the people in general, not limited to the direct stakeholders. Now, let's focus on negative externalities so we can challenge the concept of free market. These are mostly unintended or perversely done so despite knowing the demerits. For instance, the severe environmental damage set in by the Chinese manufacturers in a number of regions in China, the burning forest in Indonesia leading to negative health impacts on countries like Singapore and so forth. These are all decisions made by profit-seeking individuals who may or may not have carefully studied the repercussion of their actions, and they ended up harming the communities or societies, even the ones of great distant from them.

Let's try to relate this to individual rationality and collective irrationality, the past article of this blog. I will give you an example. You see, when free market rules, individuals will exert their utmost effort to meet their own best vested interest, even in something some people consider trivial like driving. Everyone is pushing forward for the little available space on the lane so they can arrive at their destination a bit faster, and this is actually a very rational and free-market-like decision. What is the result? Traffic congestion. If the rule of getting in the line/queue was not firmly established and enforced, the result is traffic congestion. Smoking is also another example. Smoking is bad for the smokers, and well, these are individual choice knowing well that they are exchanging some of their own life span for those moments of transient pleasure. By the laws of free-market and freedom of choice, this should be okay. However, their decision introduces negative externality, smoke that is a threat to the health of the people around them. So now, we have smoke-free laws.

Talk about smoking, let us now get into de-merit goods and services. De-merit goods and services are those goods and services that despite their demand on the market, they are harmful in some way to all or certain segments of the population. Like? Like Cigarette or Alcohol or Drug. Without regulations and taxes placed on these goods, who knows what our world will turn into? These are why we have the no-drink-while-driving laws and such. It is of crucial importance to realize that certain limitation need to be in place for the market to function as it should.

How about public goods? Let us first define public goods. What are they? Well, they have 3 characteristics, but sadly, I only remember two, and googling or yahoo-ing or binging doesn't seem to help either. Actually, during my study, my prof specifically said that pure public goods are hard to come across or think of. Well, for simplicity, let's just say that public goods are the one that are non-rivalrous and non-excludable. Non-rivalrous goods are those which are not depletable. In other words, if you think of Hamburger as a public goods, then no matter how much group A consumes it, it will never exhaust the supply of Hamburger for group B. Non-excludable goods are those that everyone can consume, everyone can utilize. For instance, you cannot ban a person from enjoying the beautiful sunset or listen to free music played by some street bands. You cannot ban a person from fishing, but the more he fishes, the less fish there will be for the rest of the world. This is why we have fishing license and regulation! Come to think of it, maybe air is a pure public goods... I think.. not sure though. Don't take my words for it.

Anyway, when we talk about public goods, we are talking about the missing market that might as well be non-existent or insufficient to meet the people's demand when free market is allowed to reign a nation. What might those be? For instance, street light, national defense, highway and such. Why is that? Because of the "free-rider" problem. In other word, the moment you produces street light or something as big as national defense, you cannot exclude any citizen of a country from benefiting from it simply because he/she doesn't pay for it. National defense is for the whole nation, and if it was produced in a free-market, some people might refuse to pay for it, and this is a problem because the less you pay, the less you have to sustain the national defense. That is why we have the tax system, the tax laws that requires everyone to pay taxes. This is only made possible by an entity considered as the locomotive of the nation, the government. Not just national defense or street light, even education or health which is not a complete public goods might not be made enough to meet the demand under the free-market if the government does not intervene.

And do you think that the many transactions happening even as we speak can continue so smoothly without the laws and regulations to govern them? No. Of course not. This is partly due to the asymmetric information. In a transaction, it is not in their best interest for the sellers or sometimes also the buyers to disclose all the information (including intention and motive) they have available for the products or services. This is why we have the judicial branch to take care of things like fraudulence.

Last but not least (though there are so much more to talk about), I want to talk about income inequality. Free market is more likely to expand the gap of income than shrinking them. Free market does not stop the rich from accumulating more and more wealth (even some are doing it through the means of exploitation in various forms). Though this might sound negative, what I really meant is that free market won't stop rewarding you or reward you less for your success. It will keep doing so, and eventually, there will be a small bunch of people with great wealth and power while the majority will be in the range between middle-income and low-income. Many examples can be seen throughout the history of human kind, and like it or not, income inequality can lead to social unrest and revolution. Violent or not, the restructuring of the economic system through such means will drastically damage the economy as it upsets the balance of wealth and power once so familiar to the people. Income inequality, at its worst, can lead to what I would like to call "relative poor" portion of the population. This is a social problem. The relative poor is the one who is not exactly poor, by strict definition, but still thinks that he/she is poor when comparing to the richer few. This has a lot to do with the psychological phenomena which I am not knowledgeable enough to elaborate.

Well, this is a pretty long article, and I will end it here for the sake of saving you from boredom. This is not the end of it, and there are so much more to write. As you may have noticed, I really did not get into detail (which would only make it much longer). To sum up, what I want to convey to you, my dear reader, is that there is nothing that is good when taking to the extreme. Moderation is the key. It is easier talked than done, or in my case, written than done. When you talk about moderation, people ask "but to what extent? What is the appropriate degree of moderation?", well folks, this is a complicated question. Moderation cannot be perfectly executed because, easy answer, there is no perfection in this world, and to answer it in a bit more complicated way... the world, as we know it, is made of so many variables as the factors that influence an economy; by this rationale, in order to balance between free-market and central planning, we need to first gather data, analyse, see the pattern, see the trend, observe the reality, understand factors of production, conduct speculation, and do cross-sectoral meeting to discuss about the possible impacts of certain decisions to be made for the whole nation. One thing for sure is that a great economist must be present in order to coordinate and direct the process. A good decision can result in a leap-forward for an economy while a bad one can also result in a leap-backward or the lost of potential (huge opportunity cost) for an economy. So balancing and moderation are important, and... to be continued.

That's it for now. We will meet in our next article.

Free Market and its Self-Correcting System: A glimpse at Income Effect and Substitution Effect (Featuring Zombies)

In economics, nothing is more fun than observing words and thought of economists being animated in the real world, our everyday life. One of the earliest economic concepts I came across was none other than income effect and substitution effect, the two popular terms which every economist is so fond of. They are very simple and easy-to-digest concepts, to be honest.

Income effect basically states that the more you earn or the more income you generate, the more you consume. For example, assuming you really like cake. When you earn $1000/month, you can only buy 1 cake/week. That is the budget cap because you need to spend your money on other necessities like utilities (water, electricity, internet...), healthy food, gas for your car, etc. But once you get promoted to a much much higher position and end up earning $10,000/month? Your entire house rains cake. You might even buy a fridge solely dedicated to storing cake. You will get really fat and have a stroke from all the cake you consume.

Substitution effect, on the other hand, focuses on the change in price and change in consumption pattern, or simply put, the higher the price of a certain product, the more likely you are to consume none or less of them and switch to purchasing their substitutes, if there is any; and the reverse is also true. For example, let's say you are the same person who likes cake to the point that you can die for it, literally. Suddenly, without any warning, World War Z happens. Zombies apocalypse befalls your country (but for some unknown and inexplicable reason, it is a special type of zombies in a way that they are only attracted to cakes and bakers in your country...), and so, all the bakers in your country have been, unfortunately, turned into zombies. And for some other unknown reason, your company is still running and you still get paid $10,000/month (because I say so). Well, the crisis your country faces now is severe cake shortage (Of course, let's just ignore all the zombies that are running around. No one cares about them). Wait, I should have mentioned also that every other country puts up huge and impregnable walls, blocking the way of anyone, let alone zombies, that can inflict even the slightest injury on their bakers. So yes, you can still get the cake you love so much by importing it. If you really want to eat cake, you need to talk to the importers who will have to risk their life to import the cake from the neighboring countries. A cake now will costs you $9,000 (I am just making it up on the spot). So you see the point. You will now consume less cake simply because the domestic market price of the cake has risen up so much due to the cake zombies crisis. And that is Substitution Effect.

All the hassles it takes to get cake might then change you into a new person. You might start to develop a new liking to your new cake's substitute, probably, ice-cream. Sadly, this new favorite will not make you get any thinner than your previous cake-loving self. But at least, it has taught you something about economics, to be specific, substitution effect.

So to you, ice-cream is probably a substitute product. Just like how some people see Pepsi as a substitute to Coke or vice-versa.

With the zombies apocalypse crippling the cake market operation, it negatively affects many cake ingredients suppliers such as flour seller, sugar farmer and so forth. This might force some of them out of business, but don't lose hope because the lower demand for sugar in the cake industry will push sugar price down, NOT out of the market, yet. Instead, the economy will re-adjust itself. Lower price of sugar will enable more ice-cream makers to make cheaper ice-cream, and thus, increase the demand for ice-cream and expand ice-cream industry.

At the same time, I forgot to mention earlier that along with substitute products, we also have something called complementary products. Assuming cake is just so expensive, so unaffordable that the whole country is now starting to consume more ice-cream as a replacement and coming to like it. As ice-cream becomes more popular, there are bound to be some products that also tag along in this growth spurt. For example, cookies! Some people like to have their ice-cream with some cookies as their side dish. So when the demand for ice-cream rises, cookies business is also doing great, much better than when people were stuffing their face with cake. In this scenario, cookies represent a complementary product because the demand for cookies and the demand for ice-cream are positively correlated. In other words, when people consume more (or less) ice-cream, they also consume more (or less) cookies.

The interesting part is that even if the economy is to be extensively damaged by zombies invasion (causing unemployment, food shortage...), and everyone could barely earn enough income to survive, there are still people who see this as their opportunity to earn money, and thus, introducing a simple economic solution (without knowing it is one), the production of inferior goods.

Inferior goods are those goods that people need more when they become poorer and less when richer (its example is the entire paragraph below). Normal goods is the opposite. Normal goods are something that you consume more as you get richer and less as you get poorer. For example, movies.

Inferior goods are produced within an industry that seeks its profit from people with low income. With rising food price, due to food shortage (substitution effect) and lower income (income effect), people are now facing starvation. So to meet their desperate need for food, people will pretty much consume anything edible (so do the zombies, I guess, but they probably won't pay anyone any money), caring less about the quality of the product. This is when mass production of cheap and low-quality food is hugely rewarding, and those who realize that and dare to follow their ambition to become the richest man in town might start a business that produces inferior goods, for example, instant noodle. People are suffering from zombies attack, the economy crippled, so in time like this, when you can buy your lunch (a pack of instant noodle) for (just an example) $0.25, who wouldn't want it? Assuming the cost to make a pack of noodle is $0.1, so as long as the government doesn't decide to involve itself by, for example, reducing the price even further to, say, $0.09 for a pack of noodle rendering the business unprofitable, then the people can be saved. Believe me, there have been instances that the government did something similar to what I described and ended up starving many people to death (because with $0.09 a pack, no one would be irrational enough to continue producing instant noodle as it might not even cover the cost of doing it).

So what does this tell you about Economics? It tells you about beauty of free market that it allows resource ownership and freedom of choice. Individuals are the one to make their own decision, unlike within a centrally planned economy in which the government or some supreme ruler makes arbitrary decision for the rest of the country (we will discuss more about it in our next article).

Even without much government interference, an economy always has a self-correcting system that allows it to be quite resilient in the face of any foreseen or unforeseen crises. In economics, we have alternative choices; hence, when one door closes, one or many more open. With top-down approach, with too much intervention from the government, there were times when people suffered greatly due to economic hardship (and that is undeniable) as bad economic decisions have led to political turmoil, public outrage, rebellion, war and destruction. Of course, that doesn't mean we need no regulations. Free market is favorable but only with appropriate rules and regulations to level the playing field because sometimes, the self-correcting does not bring us to the state of recovery fast enough (I will talk more about it in our future articles as well). We need people with sufficient knowledge of economics to aid the decision makers. Likewise, we need decision makers who are, at the very least, well-trained in the basics of economics.

"Individual rationality" and "Collective irrationality"

Before we proceed any further, firstly, the definition of rationality must be defined to get rid of all the ambiguity. Rationality, in a nutshell, is all about sensible and justifiable decision. For example, jumping off a burning building is rational if there is a trampoline awaiting you on the ground, but it is not rational to jump off the building because you think you can fly. Of course, rationality is quite susceptible to subjectivity. It is mostly based on personal preference and reason. Being logical is the complete opposite. Buying a Lamborghini because you think it is edible might be irrational to the others, but to you, it is rational. Still, no matter how you look at it, from whichever corner you view it, whoever views it (you or your parent or your dog or complete strangers) it does not change the fact that it is clearly an illogical decision. So logic is a more rigorous and objective  reasoning process.

Individual rationality is basically a sensible decision/judgement/behaviour/action for a person. Collective irrationality is pretty much a collectively unsound or unreasonable decision/judgement/behaviour/action. So what I am trying to achieve here is to explain to you how individual rationality can lead to collective irrationality. In other words, concurrent/similar decisions or actions by the majority can be irrational and lead to adverse results at a macro level.

If you and all your friends suddenly decide to drive to school at the same time, well, to each of you, it is a good decision. It will be safer, and probably, you can find a girlfriend faster than those who ride a bike (like me). However, the problem is that this decision has led to traffic congestion at the school entrance, not to mention the small parking lot that has the capacity of only 5 cars. So it will probably cause lots of inconvenience for you, your friends, teachers, especially the principal (just as planned).

Likewise, what happened in the medieval warfare, some scenarios might be no different. Soldiers' morale weakened, and they deserted their base. Of course, when a soldier decided to run for his life, the others might find it irrational to stay any longer risking their life in the process. In the end, they followed each other's "rational" decision, and ultimately, the war was lost even if there was this possibility that they could have won had they hold on to their base, defending it while waiting for reinforcement. And who knows? If the enemy pursued them, with scattered force like that, their chance of survival would be much lower. This is really what we call "worse comes to worst".

A more relevant example to what happened recently is food price inflation in Cambodia. Since everyone felt insecure due to the political turmoil, the unstable condition of the country, people started stocking up their food supply, buying every single piece of meat they can find on the shelves. The result? Food price spiked. We all made a rational decision by securing food supply for the need of our own family, but at the same time, as the fear pervaded the country, the aggregate demand for food rose high, and food price soared. So we were in fact worsening the situation, creating more fear, increasing the food price, making it more scarce, and killing ourselves and everyone else (especially, the poor who is most vulnerable to the increase in food price) in the long run.

Rationality, just as mentioned in my first article, is one of the core assumption of economics. Of course, people don't always make rational decision, but highly educated people mostly do as education turns people into a more rational being who relies more on thought and reason to reach a certain decision. Since those people are the one with the most impact on the economy, rationality can be scary, especially when we deal with individual rationality which can transform into collective irrationality.

So the moral of the story is that there has to be someone who can oversee the whole process. Someone who recognizes the defect and makes rules and regulations to control and intervene with any form of rationality deemed harmful for the whole society/economy. This is why we have leader, ruler, king, government...etc. And this is why free market can lead to market failure as free market allows free movement with little or no restriction. So just so you know, free market is never the best option. In this world, the ideal free market does not exist. Absolutely, purely free market does not and should not exist. We do not have anything on the extreme, but only things in moderation.

This is still a controversial public discussion among scholars and policy makers as to how much of the free market should be allowed. Regardless, too much is never good. Moderation is almost always better.

In conclusion, rationality should never be considered as evil, but the lack of understanding of its nature and the ignorance of its harmful effect in the absence of regulation are what we all should be afraid of. That is why we should at least be aware of its inherent characteristics, so we can make a better decision for our long-term well-being.

This is an important topic connecting to free market, market failure and policy making, about which I will write later. Enjoy learning.