THE APPLICATION OF ESSENTIAL ECONOMIC PRINCIPLES IN ARMED FORCES

Transcription

1 THE APPLICATION OF ESSENTIAL ECONOMIC PRINCIPLES IN ARMED FORCES ENG. VENDULA HYNKOVÁ Abstract The paper defines the role of economics as a discipline in the area of defence. There are specified ten major economic principles (by T. Slembeck) and presented their application in department of defence. The author puts the accent on problems of defence as a public good and some other important connections. Introduction Economics is a demanding discipline, which seeks to understand many important issues in the world around us. Economics is a preparation for taking day-to-day decisions in all areas. It is about how the whole economy works and we know that economy is always one of our foremost concerns. Ten Essential Principles in Armed Forces Dr. Tilman Slembeck, professor of economics from University of St. Gallen in Switzerland, specified ten principles of economics as a discipline. The principles refer to the basic methods and concepts for economists use clarify the basic concepts that make up economists analysis. There are the following ten principles which are applied by economists, also in the area of defence: 1. Scarcity; 2. Rationality; 3. Preferences; 4. Restrictions; 5. Opportunity Cost; 6. Economic Principle; 7. Efficiency; 8. Marginal Analysis; 9. Equilibrium; 10. Game Theory. Economics is the study of choice under conditions of scarcity. When economists talk of scarcity, they refer to limited resources inputs of production (land, labour and capital), not for example to a lack of riches. People have unlimited wants, while there are and always will be limited resources. Because of scarcity, various economic decisions must be made to allocate resources efficiently. So we must make choices between different items because our resources are limited in comparison to all our wants and needs. Then the decisions are made by giving up one thing if you want to satisfy the other. Of course, each individual and nation will

2 have different values, but by having different levels of scarce resources, people and nations all form some of these values as a result of the particular scarcities with which they are faced. So, because of scarcity, people and economies must make decisions about how to allocate their scarce resources. So also for military needs there are unlimited resources. Rationality is assumed to guide our choices or decisions. People systematically compare their utilities with cost of all alternatives or options they are facing when they are deciding. Within economics of defence as a special discipline there is a problem because defence is a pure public good and we can not identify our utility and cost of defence accurately just like consumers in consumption of private goods can. Defence is used to cover all aspects of military provision, including that of war. Just only defence expenditures can cause the deterrent effect if some potential aggressor is deterred from invading the country. I think in case of need of security the utilities of defence (which is very important) are very high for all citizens in comparison with the situation without any threats. Another thing is that the consumption of defence can not be exclusive for individuals and at their own expense. The defence is paid from taxes. Each of us is equipped with given preferences that allow us to assign utilities to all options and choose the option that maximizes our utility. Our preferences are important for what will be produced or provided (public goods). In economic analysis they are shown by indifference curves. We know that different consumers put various amounts of value on marginal utility of some good to themselves. There is a problem of applying this principle to defence to answer how much security we need. Maybe some citizens can value the benefit for themselves as being zero. This is difficult to solve because of the free rider problem that describes the incentive for individuals to understate the true value that they place on a public good. Within economic analyses there are used simple models in accord with indifference theory, but the models as we know are always simplification of economic reality and we have to consider all assumptions. People face many constrains or restrictions that they cannot change themselves, and thus have to take as given. For consumers there is the income restriction. In economic theory it is called budget line which shows all combinations of commodities available to some consumer given his income and prices formed in the markets. But defence expenditures and the other state expenditures are covered

3 from state budget which is limited by budget revenues if we suppose the government calls for well-balanced state budget. Defence expenditures are approved by Parliament together with the other state expenditures. We can monitor some restrictions of state expenditures or public finance reforms in most countries by reason of almost annual budget deficits and increasing state debts. Opportunity Cost is induced by scarcity and by the need to make choices. All our choices always involve opportunity cost because deciding in favour of one option always means deciding against some other option or options. The classic economic example is with butter and guns production where Production Possibility Boundary demonstrates the idea of opportunity cost. In theoretical economy with only two goods butter and guns, a choice must be made between how much of each good to produce. As economy produces more guns (military spending) it must reduce its production of butter (food). The figure below illustrates this concept. The curve represents all possible choices that the economy can produce. The darts represent two possible choices of outputs. The point here is that every choice has an opportunity cost, you can get more of something only by giving up something else. Also notice that the curve is the limit to the production, economy cannot produce outside the curve unless there is an increase in productivity. Butter (quantity) Opportunity Cost Produce 500 items of guns and 800 items of butter. Production - Possibility Boundary Produce 700 items of guns and 400 items of butter Guns (quantity) Fig. no. 1 A production - possibility boundary Economics aims to study why we make decisions and how we allocate our resources most efficiently. So the government must also decide on its total spending for any given year, it must decide how to allocate that spending between various competing parts of public sector, such as just defence, education, health etc. Some

4 increasing spending of one sector means the reducing spending of another. The Economic Principle is the application of rationality to situations of scarcity. It is about to minimize cost with regard to a certain level of utility or maximize utility or output for a given level of cost or input. This principle enables attain efficiency and avoids wasting valuable resources. It can also be applied in armed forces. Efficiency is a basic theme in economics. This principle is most often assessed either in terms of the economic principle or the Pareto criterion. Production efficiency in economic analysis means that production is impossible to reallocate resources so as to produce more of some product without producing less of some other product. Allocative efficiency relates to the allocation of resources among the production of all goods and services that are produced and relates to the choice among alternative points on the production possibility boundary (fig. no. 1). In public sector, e. g. in armed forces, there is the demand for 3E which means: economy, efficiency and effectiveness whereas only one can be applied. Marginal Analysis use is a typical way to look at economic problems. The decisions are analyzed in terms of marginal benefits and costs. This analysis enables assess the optimum. We can use Adam Smith s proposal for defence as a pure public good with the assumption that we know the cost of providing the defence and the benefits from providing defence (security). We can get a point of intersection of combined marginal benefit of a level of military security and its cost. In figure no. 2 we measure the cost of providing defence along the vertical axis and the amount of defence (security) purchased along the horizontal axis (leaving aside the problem of measuring it). Individuals receive benefits from defence expenditures and they value the marginal benefits of increasing security. This is in accordance with the economic theory of diminishing marginal utility, so the line MB (marginal benefits) has a negative slope. The line MB represents the vertical sum of the individual benefits. In figure no. 2 we can see two lines (MB a, MB b ) which refer to two individuals or two groups of society. The line MC (marginal cost) is increasing. We also assume within the economic analysis that the more resources are devoted to a fixed factor the less the additional product will be and the increment in security for additional amounts of expenditure will fall. Then we find the point of intersection (E) of both lines. Thus we know how much defence

5 (security) we need and how much it costs. But there are many problems with this result allied to by the predefined assumptions. Cost of defence p E MB b MB E MC MB a q E Defence (Security) Fig. no. 2 Marginal analysis in armed forces Equilibrium is a fundamental notion in economic theory. In terms of equilibrium no one has an incentive to change his (her) behaviour. There are no forces tending to make any change. When quantity demanded equals quantity supplied we say that the market is in equilibrium. We suppose the market of private goods and services. For public goods there is a problem of application of this principle. This problem relates with the previous item. The last, Game Theory, is an approach to study situations of interdependence where people (states) have incentives to think and behave strategically. Game theory is a major branch of economic analysis that provides many insights into the real world behaviour of economic agents in situations where there is an actual or potential conflict of interest. This is a theory of rational behaviour in interactive decision-making problems. The game element arises because the outcome depends not only on the choices made by one player, but also on what other players choose to do at the same time or subsequently. A specific outcome is called equilibrium if no player can take actions to improve his situation (payoff) while all other players continue to follow their optimal strategies. This equilibrium is the most fundamental formulation of the concept of equilibrium. It is possible to apply this principle in armed forces. I think very well.

6 Conclusion We found out, during the history, that the market economies fulfil their functions better (better information, greater flexibility, better adaptability, decentralization of power) than any known alternative. We know that markets cope best with rival excludable goods and that the perfect competition, which is an ideal model today, produces productive efficiency. But there are several important circumstances under which markets fail to allocate scarce resources with reasonable efficiency, such as public goods (defence) which will usually not be produced at all by the free market. This is the reason why some principles are applied with certain problems (but all can be applied) in armed forces. References [1]. Lipsay, R.G., Christal, K.A. Economics. Oxford University Press, 10 th edition, UK, 2004 [2]. Schiller, R.B., The Micro economy today. McGraw-Hill, inc., 5 th printing, USA, 1991 [3]. Slembeck, T., Slembeck s Ten Principles of Economics (as a Discipline). PDF document added. Available on internet pages: < [4]. Varian, H.V., Intermediate Microeconomics a Modern Approach. First edition, Victoria Publishing, Praha, Translated by Ing. Libor Grega in Czech language