Free Market Institute of the Pacific

Exploring Business, Economics, and Freedom

A Useful Tool for Students

I was recently asked by a young man for some tips on how he could discuss issues of the day with his buddies. It seems they had been arguing about the US economy, the federal government’s stimulus legislation, and why the economy was still going downhill despite the massive federal spending. He searched the internet and found only academic articles with fairly high-level explanations of diminishing return and other facets of the puzzle.

He wanted a simple I introduced him to one of the basic “models” used in introductions to economics...the “island” model. The “island” and “village” models have long been used to help illustrate to new students some basic concepts of economics.

For his subject matter, the very basic “island” model was I’ll repeat the illustration here just for fun (it is fun sometimes to go back to the basics):

Two men are washed up on the shore of a deserted island in the south seas. The island has abundant coconut trees and the surrounding water is full of fish. It turns out one of the men is a talented fisherman...and the other is skilled at climbing trees and knocking down coconuts.

Neither man can survive long on just one food source, so they naturally strike up a mutually beneficial arrangement. The fisherman catches half a dozen fish each day, and the climber gathers half a dozen fresh coconuts. In this way each gets a fish and a coconut for three meals each day. Their basic nutritional needs are met and they can survive efficiently. This gives them time and energy to build and improve a shelter, make tools, and do what is necessary to make their lives as bearable as possible.

They are participants in a basic free market. Each works voluntarily, as work makes survival possible, and trades voluntarily as this trade makes life better.

There is a problem however. A nearby island is inhabited by head-hunters. Our two men fear these savages may someday canoe to their island, find them, and kill them. So they hide their camp carefully, disguise signs of their passing, and keep their eyes on the water between the islands.

One day, another ship is wrecked offshore and a third man makes his way to the beach. Amazingly, this man is carrying a sidearm and a few dozen rounds of ammunition all of which survive the trip. Our two original islanders welcome him and explain their situation.

A deal is struck; the new man will serve as security and will focus his energies on preparing defensive measures, watching the water, and preparing for a head-hunter invasion. The other men can now devote more time and energy to fishing and coconut gathering, and they each now have a new production goal; 9 fish and 9 coconuts each day.

The new man represents government. At this stage of the equation, he has value to the free market, the other two men, as he makes their lives a bit more secure so they can sleep better and spend more time in productive work. So good.

But it doesn’t end there: some time afterwards another ship is wrecked off-shore and a fourth man makes it to their camp. The number three resident makes a deal with the newcomer. He easily convinces the fourth man that he is needed to help with security. The problem, he explains, is that he has begun to mistrust the two workers. He fears they may take his sidearm when he is asleep and demand he take over some of their camp chores. He suspects they are grumbling behind his back due to his receiving full rations without taking part in camp work and food gathering.

He wants the fourth man to join him in an neither can be caught unawares. When the two announce that the new man will be taking on “administrative” duties, and that production of food must go up another 3 fish and 3 coconuts per day, the two workers are understandably in disagreement with the plan.

However...the “government” has authority in the form of the sidearm and this disagreement is pushed aside.

For the first time, the two workers are coerced to work longer than ever, even to the point of getting tired, careless, and risking physical injury. If they hadn’t been grumbling before, they will be now. They begin to question their work ethic...what if a fifth person arrives on the island and that person befriends the “government” men and joins them. The two workers simply won’t be able to keep why, they ask each other, are they bothering?. As it is, on days they come up short, they go without normal rations...not the two in government. Pretty soon they will start hiding fish and coconuts in order to save themselves...friction will grow...production will go down...and violence may even ensue.

Now, let’s relate this to our young student’s question. What’s happened?

At first, a free market was created. Then a government was created and taxes, in the form of 3 fish and 3 coconuts per day, were required to operate the government. The island went from two workers, to three...of which one was a government worker. Production went up partly due to the two workers being freed of an issue, and partly due to their working more hours.

Finally, the government grew. Taxes were doubled...a fourth job was “created”...but had to be paid for by additional labor and sacrifice from the free market sector of the island’s economy.

The free market is now at the breaking point. If a fifth person enters the picture, and government “creates” a job for that person, the system will crumble. The later arrivals will have to use force to obtain food...or give up and join the free market in order to increase production. Simply taxing workers will no longer suffice.

Now let’s relate that to the “stimulus” package...a substantial taxation aimed at creating more government jobs. At this point of the story, the young man understood...I did not need to carry it any further. He could now tell his friends a story which would illustrate, simply and clearly, what is actually happening in the real world. And he could do so in a way not complicated by political opinions or media rhetoric. They could discuss and debate what might happen on the island...and then relate that to a larger economic format.

If you didn’t have such a story you do. It’s wonderful how a clear and understable scenario can be helpful in cutting through the fog of hype and getting to core issues.