A two person closed economy

A Two Person Closed Economy

Illustration of key macroeconomic principles Property boom, benefits from trade and

inflation

On a lonely island in the middle of nowhere

Lived two men

Robinson Crusoe (RC) and Man Friday (MF)

RC owned the only piece of arable land on the island

And MF owned the only orchard there

Every year, RC gave MF some grains and MF gave RC some fruits & vegetables

It worked well for years but one fine day, RC developed an appreciation for

fresh fruits and vegetables which were a rarity for him unlike MF

Sadly MF had no use for grains mid-

season. RC and MF sat together and agreed on a

monetary measure to facilitate mid-

season transactions

They gathered all the pebbles of a rare kind on the island (100) and

split them equally between them. The pebbles were to be used as the money

for exchange.

50 50

Now RC freely took fruits & vegetables

from MF around the year

They exchanged goods worth 40

pebbles each year

RC being the smart Alex he was,

figured that he may purchase a small

portion of the orchard for the 10 pebbles that were

always in spare

So he bought a tenth of the

orchard from MF for 10 pebbles

MF was very happy that year for he had

20 pebbles in reserve after

buying all the grain he needed.

RC too was full of

joy for he now owned a little more than what he had.

Next year MF discovered that his

reserve has depleted to 12

pebbles only as RC bought lesser fruits

& vegetables

MF requested RC for a tenth of his arable land for

which RC demanded 12 pebbles – MF readily agreed

RC was very happy as he had 20

pebbles in reserve now and owned assets worth 120

pebbles.

MF too was quite happy as he now had 16 pebbles in reserve in addition to assets equal to

RC.

Next year, RC approached MF

with a proposal to buy a further tenth

of his orchard. MF realizing his folly last time, demanded 20

pebbles this time, which RC readily

agreed to.

Now RC was very happy that he owned assets

worth 220 pebbles.

MF was also overflowing with

joy for he now had 36 pebbles in

reserve in addition to assets slightly

less than RC.

BLACK SWAN – HELICOPTER MONEY

A tsunami struck the island that year. Fortunately both the arable land and orchard remained safe.

MF while gaping in awe at the damage to the trees on the seaside on which Tsunami struck discovered to his amazement 30 rare pebbles of the same kind

he and RC were using as money.

MF with his coffers over-flowing with pebbles ran to RC

and offered to purchase a further tenth of the arable

land

RC with no great want of pebbles

casually asked for 30 pebbles to

which MF surprisingly (to RC)

agreed

RC was very happy now for he had assets valued at

300 pebbles along with 30 pebbles in

reserve

MF too was overjoyed as he

also had similarly valued assets with

36 pebbles in reserve

And so the

On that isolated Island continued

After a few years, both RC and MF owned half of

arable land and half of orchard - assets

valued at 500 pebbles each

Their trend analysis also suggested that assets will continue

to rise at 20% in value.

They also owned 65 pebbles each – all

in reserve.

In the meantime, RC with no great

aptitude for maintaining an

orchard saw the production of fruit & vegetables in his owned part come

down to half

Elsewhere food-grain yields halved

in MF owned arable land for MF did not

know how to properly maintain

the right mix of manures in the soil.

RC suffering from lack of fruits &

vegetables in his diet and MF from

lack of grains started trading again with their

pebbles.

The prices they settled at now was 3x higher than the

initial price.

They could only afford to trade half

the initial trade volumes now.

Since there was no scope for further

improvement, they learnt to keep them satisfied with 75% of the grains and

fruits & vegetables now.

Yet each of them was content that he owns assets valued

at 500 pebbles growing at 20%. And he owns 65 pebbles, up from

50. And he sells goods worth 60 pebbles annually, up from

40 pebbles.

Lessons Trade improves specialization Means of production should be managed by people

best qualified to do so Price rise does not equate with rise in value Helicopter money may stimulate investment and

consumption temporarily but cannot be a substitute for greater specialization and technological improvement /innovation

It is important to decide whether to live well or to live seemingly well, both may not necessarily be the same depending on perspectives

Hope You Enjoyed It!

Coming Soon! Part 2 – RC and MF decide to relive their life