What do you get if you cross one economic action with another economic action?
Sorry — this isn’t a joke! What you might get is a third economic action which has exactly the same effect on what everyone owns, owes and is owed as the two original actions combined. Let’s look at a simple example.
This shows two “transfer tangible asset” actions:
Alice gives Bob an apple. (It doesn’t matter whether it’s part of a transaction where he gives her something in return).
Bob then gives the apple to Charlotte. (Again, it doesn’t matter if he gets anything in return).
What effect do those two actions have on what everyone owns, owes and is owed?
Alice owns one less apple.
After action 1, Bob owns one more apple. But after action 2, he owns one less apple, leaving him exactly where he started.
Charlotte owns one more apple.
So to summarise, the only changes are that Alice owns one less apple and Charlotte owns one more apple. What does that sound like?
It’s exactly the same result as if Alice gave the apple to Charlotte directly!
If you’re familiar with vectors from maths or physics, you probably know about adding two vectors together to get a “resultant” vector. It’s the same sort of idea.
All the combinations
So we can combine two “transfer tangible asset” actions into a single action. What other combinations of actions are equivalent to a single action?
Two obvious combinations are two “transfer debt asset” actions and two “transfer liability” actions. But there are others. It’s also possible to combine either a “create debt” or “write off debt” action with either a “transfer debt asset” or “transfer liability”.
Finally we can combine a “create debt” action with a “write off debt” action. This last one is actually equivalent to doing nothing at all.
In the diagrams below, the actions are numbered in the order they occur. Sometimes the second action is on the left, so that all of the diagrams (apart from the last) have all their arrows pointing from left-to-right. Remember that action arrows always point from the person whose raw net worth1 ↓ to the person whose RNW ↑ — and that gaining a liability makes your RNW ↓, while losing a liability makes your RNW ↑.
Transfer tangible asset ×2
Alice transfers an apple to Bob, who transfers it to Charlotte.
The result is the same as Alice transferring an apple directly to Charlotte.
Transfer debt asset ×2
Alice transfers an IOU for one apple to Bob, who transfers it to Charlotte.
The result is the same as Alice transferring the IOU directly to Charlotte.
Transfer liability ×2
Bob agrees with Charlotte to becomes the debtor of a debt she currently owes. Then Alice agrees with Bob to become the debtor of the debt he now owes.
The result is the same as Alice agreeing with Charlotte to become the debtor of the debt she owes.
Create debt + transfer debt asset
Alice agrees to owe a new debt to Bob. Then Bob transfers the IOU to Charlotte.
The result is the same as Alice agreeing to owe a new debt to Charlotte.
Create debt + transfer liability
Bob agrees to owe a new debt to Charlotte. Then Alice agrees with Bob to become the debtor of the debt he now owes.
The result is the same as Alice agreeing to owe a new debt to Charlotte.
Transfer debt asset + write off debt
Alice transfers an IOU for one apple (owed by Charlotte) to Bob. Then Bob agrees that Charlotte no longer owes the debt.
The result is the same as Alice agreeing that Charlotte no longer owes the debt.
Transfer liability + write off debt
Bob agrees with Charlotte to becomes the debtor of a debt she currently owes (to Alice). Then Alice agrees that Bob no longer owes the debt.
The result is the same as Alice agreeing that Charlotte no longer owes the debt.
Create debt + write off debt
Alice agrees to owe a new debt to Charlotte. Then Charlotte agrees that Alice no longer owes the debt.
The result is the same as nobody doing anything at all. The two actions completely cancel each other out.
Spot the pattern!
Apart from the last diagram above, notice how the tip of the arrow pointing to Bob is the same colour as the base of the arrow pointing away from him. That shows the two actions cancelling each other out from his perspective.
And in the last diagram, Alice and Charlotte each have one arrow pointing towards them and one arrow pointing away from them, and the ends of the arrows nearest the same person are the same colour. That shows the two actions cancelling each other out from both of their perspectives — neither person has a change to what they own, are owed or owe, and the result is the same as if neither action had occurred.
How does this help?
Economic actions are so simple to work with, because they’re so intutive, and we’ve seen that they are easy to combine too. The more we think about the economy as economic actions, instead of more complex transactions, the easier economics is to understand.
Next week, we’ll use what we’ve seen in this article to “see the bigger picture” in a third way. After each transaction, we’ll use these “resultant” actions to simplify all of the actions up to that point.
Someone’s raw net worth (RNW) is what they own plus what they’re owed minus what they owe (i.e. their assets minus their liabilities). It is a “heterogeneous” sum/difference, which just means that things of different types are added and subtracted, not monetary “values” which have been assigned to them.