Just like in nature, the market has its own Laws of Motion. On the most fundamental level they are supply and demand and risk and reward. If the market represents the "invisible hand," then these concepts are it's tendons and muscle.

The most basic, and probably most well understood of the two, is supply and demand.



The price of a product (Px) is determined at the point where supply (S) and demand (Dx) meet. Q represents quantity sold. The point where it all meets is equilibrium.

Yeah, I know. I just lost some of the non-nerds. Let me translate.

Something that has little supply and very high demand sells for a high price in the market (a new gaming console on eBay, for example). Something with very high supply and low demand sells for a low price in the market (SUVs during an oil boom). An example of a product where this is easily seen would be laser pointers -- in the mid 90s, they were hundreds of dollars in Sharper Image magazines. Now, you can buy them at a gas station for $4.95. Supply has been greatly increased through mass production.

This concept also applies to labor. Skilled positions make more than unskilled positions. For example, doctors make more than tile setters. If there were somehow only one person in the world who knew how to set tile, they'd likely be highly paid.

The next concept that's important to understand is the relationship between Risk and Reward.

For the purposes of most discussions, you can assume this relationship is linear. Truthfully, it's not perfectly linear. There is a slight bend on the left before approaching the 'expected' linear path. The goal of investing, for instance, is to find the point where reward is maximized without taking on any additional risk. In the stock market, this is most often defined as the 80% stocks, 20% bond portfolio. You can theoretically achieve a higher return by being 100% into stocks, but it comes with a disproportionate amount of risk. If I can find a graphic, I'll add one.

At its most basic level though, the higher the risk the larger the reward. A penny stock is not likely to go anywhere, but if it does, you can quickly double your investment. Loaning money to an "at risk borrower" allows the bank to charge a higher interest rate than they would otherwise, increasing the potential reward to make up for the added risk associated with potential loan default.

This concept also applies to labor. A fisherman going after Alaskan king crab makes more per hour than the fisherman going after salmon. A doctor spends years undergoing expensive and elaborate training with no guarantee of making the grade while a tile setter picks it up after a little bit of on-the-job experience. A founder of a company likely quits his day job and takes no pay in order to focus on building the company, while the contractor has the safety of other work and a steady pay check.

I guess you could say an example of disproportionate risk might be professional wrestling vs. soap opera acting. I'd suspect your chances of making Hulk Hogan money are pretty similar in both fields, but Hulk Hogan had to get his ass beat every day for the majority of his life ;)

The point of all this is...

In labor markets, risk dictates reward relative to the supply and demand of that position.

Let's put it all together in an easy to understand example.

A musician makes little because the supply outweighs the demand. The risk is that they'll spend a good portion of their lives as a 'starving artist' because of it. If they make it mainstream though, the reward is very large (both financially and personally, I'm sure). If there were only one musician in the world, there would still be a demand for music. And that one musician would be around to reap the rewards of that demand.

We'll discuss the political implications of these things later, but for now, that should help build at least a basic foundation for understanding our economy's underpinnings.

* for the sake of accuracy and completeness, there are occasional outliers and a direct comparison to the laws of motion may upset my physics-minded friends. For example, someone who plays the lotto only once and wins -- the risk was $1, the reward was much more. Or, in the case of supply and demand, a bubble is created when supply out weighs demand but prices still remain high. The thing is, in both examples folks usually end up going broke, sooo ;)