The Economics Lesson

 Sometimes, when we don’t have change, we borrow the money from my 9 yo daugther. One time this happened, her friend was in the room, and told her, “Ask them to return it with interest”. Talk about corrputing influences…


Since my daughter still doesn’t know what “interest” is, I thought I’d fill her in. Later that day, I drew it up on a whiteboard. “Why would you put your money in a bank?”, I asked rhetorically, “Not just for safety, but also because they give you back something extra, something more than what you put in”. She was very interested (pun intended).


“What do you think the bank does with your money?”, I asked. I had her undivided attention now, “You mean they do something other than keeping it safely?”. “Yes”, I said, “they lend it to other people”. “What?”, she was alarmed, “They give my money to others?” “Not ‘give’, they ‘lend’”, I repeated. Lending implied getting it back, but she was still not thrilled with this idea.


I explained that when she deposits ₹100 in the bank, they lend, say, ₹25 to someone to buy a car. That guy has to pay back something more than ₹25. That extra amount is called “interest”, I explained. And thus the bank lends your ₹100 to others to get back say ₹100 + interest of ₹10, to make a total of ₹110.

And they pass on some of that extra ₹10 as interest to you, so you get back ₹100 + ₹4 = ₹104. (It’s a lot easier to understand the ‘principal’ and ‘interest’ number when it’s drawn in different colors, which is why a whiteboard helps). You’d think she’d be happy to get ₹4 more than what she deposited, but no. “What about the other ₹6 the bank made?”, she asked. In the same breath, she answered her own question (partly), “Do they use that to pay salaries to people who work at the bank?”.

 

“Yes”, I replied, “Part of that ₹6 goes to pay their salaries, say ₹4. That still leaves the bank with ₹2.”. “But why does a bank need to keep that ₹2? It’s not a person, so why does a bank need money?”, she asked.

 

Ah, kiddo, that question (“It’s not a person, so why does a bank need money?”) lies at the heart of what led to the unprecedeneted rise and success of capitalism, and also at the backlash against capitalism in recent years.

 

We’ll get into that when you’re a bit older.

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