Economics 101: Types of assets

(Disclaimer: I know nothing about economics.)

In the last post, I defined assets as anything that can be owned. Interestingly, this concept needs examples to be fully understood. In this post I will provide some examples.

Cars, houses, food, clothes etc. are obvious examples. These are all tangible objects you can hold in your hands. A vacation package to Hawaii is less tangible but no one will have problems accepting it as an asset. Let’s move quickly to the non-obvious.

A loan is an asset. Let me explain why. If you give out a $1,000 loan to your friend Bob at a 10% interest rate, you now own the right to receive $1,000 + interest back from Bob. This right is an asset, and therefore, you can do things with it that you can do with other assets. For example, you can sell it. Whoever buys it will get the right to receive $1,000 + interest from Bob. What value should the asset be priced at? That depends on many things including how reliable Bob is, what interest rate are the banks giving out loans for, and how good of a deal you can negotiate in your trade.

Similarly, many other contracts you sign with people can be considered an asset. A share of a stock is another slightly non-trivial kind of asset. If you own 1% of the shares of a company, you essentially own 1% of the company. Once again, you can exchange this asset with other kinds of assets and the price will depend on many factors including how valuable the company itself is.

The idea of treating contracts as assets has been used extensively in recent years in the form of something called derivatives. Derivatives are assets that are derived from other assets. For example, now that we have seen that a share of a stock is an asset, one can define a new asset called a “call option” which is the right to buy a share at a certain price at a specific future date. A call option is a derivative that’s derived from a stock. Being an asset, this contract can be bought and sold in exchange of other assets and its price is determined by several different market parameters interacting in complex ways. Similarly, for any kind of asset, you can sell the promise to buy or sell the asset at a future date at a specified price and that will be an asset of its own.

Next, we turn our attention to a unique kind of asset: money. Money is simply an asset whose role is to make trades easier to execute. Any object that a large community has collectively agreed to value can be considered money. Imagine you live in a society where money has not been invented yet. If you own lots of horses and you need some rice, in order to exchange horses for rice you will need to find someone who has extra rice and is in need of horses. Or if you are good at sales, you can sell your horses for rice to someone who doesn’t care for horses using the following sales pitch: “Why don’t you take my horses, give me your rice, and then sell these horses to someone else who has the thing you want? And since horses are in demand these days, selling them shouldn’t be a problem.”

This might work if horses were truly in demand (or if you were excellent at sales). This is where money comes in. This is what distinguishes money from other kinds of assets. There is some sort of probabilistic guarantee that money will always be in demand in the sense that anyone you talk to will be willing to accept your money in exchange for something else. How such a guarantee comes into existence is an interesting issue that will require a blogpost of its own. But for now, we will use this as our working definition for money: an asset that a large community has collectively agreed to value.

Finally, another interesting and often ignored asset is time. Everyone owns a certain amount of time and the thing that distinguishes time from other kinds of assets is the property that you cannot choose to not spend it. In fact, it is constantly being spent at a rate of one second per second and you can only choose what you are going to spend it on. Unlike money, for example, you cannot save it in a bank.

Once again, being an asset, it can be exchanged for other assets. The most explicit way of doing that is to take up a contractual job that pays you an hourly wage. But more indirectly, you are always converting time into other kinds of assets. If you spend four years at university getting a degree in computer science that later lands you a $100k job, you have in some way converted those four years into some sort of wealth.

At this high a level of abstraction, things become confusing and it’s not always clear exactly what trade is being executed, but I think there is a certain advantage in thinking of everything as an asset and every activity as a trade. Hopefully this will become clearer in a future post.

Economics 101: A Basic Model

(Disclaimer: I know nothing about Economics.)

From the point of view of economics, the world consists of:

  1. A set of people.
  2. A set of assets.
  3. A set of ownerships between people and assets.

#2 and #3 deserve some explanation. #1 should be clear to you if you are not an alien.

What is an asset? I want to make the definition very general and say that anything that can be owned is an asset. So, a pair of shoes is an asset, an iPhone is an asset, and so is a car. Time is also an asset, although a more subtle one. I will come back to this later and provide some more non-trivial examples of assets.

An ownership is just a pair consisting of one person and one asset. Given a set of ownerships, each person will be a part of several pairs and the set of assets in those pairs will be the assets owned by that person. A society where there is a mechanism to enforce ownerships will be amenable to various laws of economics. What do I mean by enforcing ownership? That the set of ownerships remains unchanged unless two people decide, by mutual consent, to exchange a few assets that they own. An exchange of assets is usually called a trade.

If a person combines a few of the assets he owns to create a new asset, the new asset is automatically considered to be owned by him. So if you have the ingredients for making ketchup and you use your time, which is an asset owned by you, to make ketchup, the ketchup will be considered to be owned by you.

The meaning of consent needs clarification. It’s one of the trickiest things to define and I am not going to claim that I have the most satisfactory definition. Use of physical force is clearly not consent. It’s robbery. But how about using mental tricks? It seems clear that if you drug someone and steal their wallet, they did not consent to give you their wallet. However, what if you use advanced marketing tricks to convince them to empty half their wallet for a weight-reduction armwear that clearly doesn’t work? That sounds like consent.

I am going to completely sidestep the task of defining consent by just stating its desired property. I will say that any trade that ends up increasing the perceived utility of both parties was carried out by mutual consent. That is, both parties involved in the trade should think that the trade improved their lives.  As long as this happens, we will say that the trade happened with mutual consent. Note that this definition fits the examples discussed above. In case of physical force, the party on whom the physical force was applied definitely doesn’t think they are better off now. But in case of using marketing tricks, the person who bought the weight-reduction armwear does believe the purchase to be progress. In fact, that’s the point of marketing: to convince the customers that buying the product will make them richer, happier, sexier, and healthier.

With these definitions in place, if we assume that every individual has sufficient resources (intelligence and information) to figure out what’s good for them in the long term, then we get a simple and elegant model of governance: just make sure that all trades are carried out by mutual consent. The assumption that each individual knows what’s good for them is essentially saying that the perceived utility is always the same as the correct utility, and if that’s true, every trade must improve the correct utilities of both parties involved.