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Why I Love Economics

I was one of those lucky students who loved my chosen subject at University; Economics. (Whilst on this subject my advice to anyone going to University is to always choose a subject you love rather than one which you think will enhance your career prospects – unless the subject is Media Studies – we all enjoy watching TV. I am not worried about Media students writing in to complain as they only do texting!)

One of the subjects which I really enjoyed covering was Marxist Economics. If you have not studied Marxism, I would really recommend it. I disagree with the conclusions, but the analysis tools are seriously first rate. One of the main thoughts in Marxism was about the accumulation of wealth. To generate wealth, like developing the best work boots for flat feet, labor has to be exploited.

This argument which is now about 150 years old is still compellingly relevant. Other ways of explaining this have come to pass and are more widely accepted because they seem less ‘offensive’ or stark. However, the truth remains exactly that.

Whatever field you are in, your pay or level of remuneration will ultimately depend on two things. The value you can add to your employer and your bargaining power. If an organization decides to pay someone £1m a year, it will because they believe that the employee will add considerably more value than that and their bargaining power will get them to that level of pay.

The development of the trade union movement can be explained as thus. The bargaining power of individuals was a lot less than that of a group and they were engaged in ensuring that more of the value ‘created’ would go to their members rather than to the employer.

The interesting thing to note from Marxist Economics was that they believe that it was in the interests of capitalism to maintain high levels of unemployment. The rationale for this being that the bargaining power of individuals is not that strong when there is mass unemployment. Statistically this does hold true.

What is the relevance of this to the Entrepreneur?

Firstly, many entrepreneurs fall into the trap of paying too much money for ‘talent’. They feel that because of the insecurity of working for a start up, they have to offer a higher salary. Secondly, they also think that as a small business they are in a weaker bargaining position.

A further point is that salaries should only be offered at a level which means that the employee is adding value to at least three times the level of their salary. In sales, it is common to expect a sales person to generate sales at a level which is at least ten times their salary.

If a sales person generates £1m of sales that would probably equate to around £300,000 of gross profit – and therefore a salary of £100,000 would still hold this equation.

However, many cystic acne home remedy startups feel compelled to offer very attractive sales packages. And here another bit of economics comes in handy. You have to remember your marginal cost. Revenue is not the same as profit. There are many deals I know of where the better a sales person does, the greater a loss the company will suffer.

I was working for a startup in 2000. I was a good sales person and was one of the company’s top earners. However, the company fired me (a story for another time) and the real reason was that they wanted to replace the first set of sales people with another set who were on very different packages.

Anyway – back to the main point of the blog. Always remember that wealth creation is based on being able to sell at a greater price than you pay – and that is also true of labor.