I. Science & "Realism" (the desirability of abstract models, of the "orderly loss of information"--maps, physics, etc.; purpose of scientific models is to explain and predict certain classes of behavior, science as "persuasion").

II. Logical Pitfalls in Persuasive Argumentation:
    a. attacking the person, rather than the idea (ad hominem): "Mr. X is a commie sympathizer, what could he know about health care?"  (irrelevant to the benefits and costs of the health care program being considered)
    b. appeal to the masses (ad populum): "As honest hard-working Americans, we are all entitled to comprehensive health care!"  (irrelevant to the benefits and costs of the health care program being considered)
    c. failure to hold other things constant (ceteris paribus): "In 1933 cars were inexpensive, yet few were purchased, while in 1949 cars were much more expensive and more were bought--hence demand curves slope upward!" (biological versus economic "experiments"--literal controls versus statistical control)
    d. correlations and timing of events do not necessarily imply causation (post hoc, ergo propter hoc): "Farmers are exploiting consumers by raising prices of beef causing the price at the checkout counter to rise!" (causation, as here, could go the other way in spite of order of events; there may be no causation--e.g. skirt lengths and recessions; or a third variable may cause both--e.g. eating more, yet getting thinner, could both be due to increase in exercise.  Don't get tricked by such arguments!)
    e. fallacy of composition: "stand up to get a better view at CU football game," "arrive early to campus to get a better parking spot," "better off with more money in checking account," "study harder to get a better grade (curved class)" (Don't get tricked!)
    f. failure to look at secondary impacts ("Law of Unintended Consequences"): minimum wages, rent controls, tariffs, etc.--this is, doubtlessly, the most important logical problem in understanding economic arguments!  (This is a "biggie!"--most important single source of getting tricked!)

III. "Normative" versus "Positive" Economics (ethical issues are more critical to economics than to, say, chemistry where one need not worry about whether oxygen and hydrogen "want" to combine to form water!)
    a. Normative Economics: "What should be..." "What ought to have happened..." (ethical issues, typically involving the distribution among people of the benefits and costs of policy actions--e.g. "We should raise the minimum wage."; normative statements are "non-scientific" in the sense that no matter what information is brought to bear on the topic, it need not change a position for or against it)
    b. Positive Economics: "What is the impact of A on B...," "What will happen if..." (scientific statements of the "if A, then B" variety--i.e., statements that are potentially refutable; e.g. "If we raise the minimum wage, the black teenage unemployment rate will rise substantially."  Over time, with the advance of scientific knowledge, agreement grows on positive issues)

IV. Why Economists Disagree (firstly, there is not that much disagreement, vis-a-vis disagreements between economists and other people; also, desire to present "opposing" viewpoints exaggerates apparent disagreement, e.g. "gold-bugs")
    a. Most disagreement is over normative issues (flat tax versus progressive tax example)
    b. Scientific advance gradually eliminates disagreement over positive issues (e.g. globalization).

I. Scarcity--everything we want is not freely available from nature!  (many ways to express this:)
    a. must give up something to get more of other things (trade-offs are inevitable)
    b. it takes resources (inputs) to get things ==> other things could have been made
    c. stems from relatively unlimited wants, with limited resources
    d. in market settings, goods have positive prices
    e. for public policies as well as private decisions, there can be no benefits without costs (always hunt for those!)
    f. Note: "scarcity" is not the same as "poverty" (poverty, defined as fixed consumption level of virtually any amount, need not always be with us; scarcity will be! Also, goods are "equally scarce" for both rich and poor, in that the same amount of other goods must be given up to get them regardless of income...but what those goods given up mean to the people involved does differ!)
    g. NEVER say "need" or "can't afford" (in the usual contexts these words are inappropriate, and lead to sloppy logic! Substitute "want" or "don't want" at the prices and income you face)

II. Choosing Among Alternatives (made necessary by the fact of scarcity)
    a. wise choices are choices that have more "advantages" than "disadvantages"
    b. "advantages" can be called "benefits;" "disadvantages" can be called "costs" (not necessarily or merely $--and dollars have different benefits and costs to different people!)
    c. most choices are of the "a little more or a little less" variety, rather than of the "all or nothing" variety ==> it is marginal benefits and costs that matter! (e.g. study, food, water, etc.; marginal benefits fall as one does more of any activity)
    d. choices with benefits greater than costs are referred to by economists as being "efficient." (welfare enhancing, giving us more of things we value, making us better off)
    e. rational individuals always take actions with B>C (i.e. are efficient), though both benefits and costs are subjective (e.g. cost of Yale to Jodie Foster, athletes leaving school, smart people have lower costs of school, etc.)
    f. what about collective decisions where benefits aren't greater than costs for everyone? ("Pareto-efficiency"--B>C for everyone, "Kaldor-efficiency"--B>C overall, but not for everyone, raising distributional issues, and the inevitability of making decisions despite the fact that we can never know we're doing the right thing, if even one person has uncompensated C>B--but note that the market must result in Pareto-efficient outcomes, since exchange is voluntary!)

III. Opportunity Cost (foregone benefits from the action/choice taken)
    a. all activities have costs (school, date, consumer decisions, producer decision--because of the fact of scarcity again!; marginal costs rise with quantity), hence all activities are economic decisions.
    b. it is the full costs that matter--don't focus on only a portion of them (e.g. President Carter's assertion that "the bicycle is obviously the most efficient means of transportation," nostalgia for the past, "energy efficient" appliances, etc.)
    c. costs, reiterating, are--like benefits--subjective [NOTE: "prices" (data) are not equal to "costs" (what is given up)]
    d. costs stem from current decisions, all costs are in the future! ("sunk" costs are irrelevant to current decisions, e.g. Vietnam, "can't afford to take the loss" on stock or motorcycle purchase--already took it!)

I. While economics is relevant to all wise decisions, three (or four) basic decisions are of particular interest:
    a. WHAT to produce? (all societies must answer this question in some way).
    b. HOW to produce? ( " ).
    c. FOR WHOM to produce? ( " ).
    d. (WHEN to produce?)--this will receive a bit more emphasis in this class than is usual. ( " )
    e. There are many ways to answer these questions: tradition, force, religion, dictator's preferences, more general government planning (politics), voting (e.g. Boulder's cigarette ban, numerous California propositions), etc.
    f. We shall emphasize the "Market" solution (characterizes most of U.S. economy and is of growing importance world-wide).

II. What is "The Market"?
    a. Institutional arrangement under which privately-owned inputs (labor, capital, "land," and entrepreneurship) are organized voluntarily to produce what people want.
    b. Suppliers and demanders, each attempting to make themselves as well off as possible, interacting at market prices that coordinate their individual decisions.
    c. Features, good and bad, of the market:
        i. MAIN: market exchanges are voluntary, hence both parties must be made better off!
        ii. property rights matter--must "care" how inputs are used (renting versus owning, etc.)
        iii. to maximize profit, producers must produce what people want (don't have to buy).
        iv. to maximize profit, costs of production must be minimized (but this is good!--frees up resources for more total goods)
        v. not only does voluntary exchange of existing goods increase wealth, but the prospect of exchange encourages productive specialization, further increasing wealth! (e.g. night teaching to buy rather than make wine; lecture and car wash, numerical example to show comparative advantage).
        vi. potentially bad features: externalities (positive and negative), public goods, monopoly, and inappropriate income distributions (rewards go to those productive at things people want)--the role of government.
        vii. finally, nothing about the market "elevates" preferences (e.g. rap versus classical, broccoli versus Haagen-Daz Exxtra).

I. The Law of Demand: Other Things Equal, People Will Buy More at Lower Prices!
    a. Why? Mainly the existence of substitutes (other goods that also can satisfy basic human wants, such as food, shelter, prestige, etc.). Also, "income effects" of a price change (if a price falls, with the same money income, your "real" income has gone up--important when we get to labor supply later).
    b. Demand is a flow concept (has a time dimension--per week, per month, per year, etc.).
    c. Demand may be depicted as:
        i. a schedule of price-quantity numbers (messy and presumes specific knowledge)
        ii. a function (e.g. Qd = 100 - 5P) (also messy, complicated and specific)
        iii. a GRAPH (downward-sloping, discuss movements along versus shifts, memory device:
                   Dx = D( Px | "P Y N T E" )
    d. Another View: demand is "marginal willingness to pay"--not "idle wishes." (looking at it from other axis)

II. More on Demand: What "Other Things" Are We Holding Constant? (PYNTE, memory device)
    a. "P"--Prices of other goods (independent goods, complements, and substitutes).
        i. "Substitutes" are alternatives to the good in question--coffee and tea; pizza and hamburgers, Coke and Pepsi, cars and bikes, etc. If the price of a substitute good goes up, more will be demanded of the good of interest at every price (the demand curve will shift rightward).
        ii. "Complements" are goods that "go together"--toast and butter, eggs and bacon, cars and tires, bikes and bike paths, etc. If the price of a complement good goes up, less will be demanded of the good in question at every price (the demand curve will shift leftward). Ambiguous cases--are apples and oranges substitutes?  (could be only used in fruit cocktail!)
        iii. "Independent Goods" are unrelated, in that changes in the price of one will have only negligible effects on the other--bikes and pencils, salt and t- shirts, etc. Changes in the prices of independent goods can be ignored, since the demand curve of the good in question is not effected. This greatly simplifies economics!
    b. "Y"--Income (inferior goods, normal goods, and superior goods)
        i. "Inferior" goods (not necessarily "shoddy" in construction!) are goods that we buy smaller quantities of when our incomes rise (and conversely)--rice, beans, shoe repair services, bus trips, etc. (demand shifts leftward)
        ii. "Normal" goods are, as name suggests, goods that we buy more of as incomes rise (housing, clothing, broadly-defined food, etc.), but not more than in proportion to the income increase. (demand shifts rightward, but less than in proportion to the income change)
        iii. "Superior" goods (not necessarily "better" goods!) are goods whose demand increases by a larger percentage than the percentage increase in income causing that demand increase, say a 15% increase in demand for lobster arising from a 10% increase in income--foreign vacations, caviar, yachts, etc. NOTE: the share of expenditure devoted to such goods rises as income increases; spending more on them means spending relatively less on other goods, whose share must fall.
    c. "N"--Numbers of people in the market--more people, more demand; rightward shift.
    d. "T"--Tastes (preference changes favoring or disfavoring demands for goods--fads, new goods, possible advertizing effects, snob or bandwagon effects, seasonal or demographic effects, etc.). Fundamental Issues: How important are taste changes relative to price or income changes to changes in observed demands? Can we control for these other factors in arriving at price and income effects?
    e. "E"--Expectations about future prices affect current demands--if substantial price rises are expected in the future, current demand goes up (driving, we shall see, current prices up!) as with, say, oil in the '70s or Colombian coffee frost's impact on current demands. If you expect prices of a good to fall in the future, e.g. on Pentium I- powered computers, you will demand fewer units of the good now.

III. Changes in "PYNTE" (above) shift the demand curve and this is called a "change in demand." Only a change in price causes movements along the demand curve and this is called a "change in quantity demanded." (GRAPH--know this distinction; if you are confused about this, you will really mess up the first test!)

I. The Law of Supply: Other Things Equal, People Will Supply More at Higher Prices
    a. Why? As with demand, rational people will want to do anything with B > C--indeed the last unit of a good they supply will be at the point where MB = MC. But what happens when the price rises? (MB > MC at the old output level ==> they will want to produce more than before). Also as with demand, the notion of substitutes is important--if the price of one good rises it is more attractive to supply than are other goods the firm could have supplied (e.g. SUVs vs.sedans, agricultural products, study time if you are paid by parents to study one course and not others, generalized entrance and exit in a longer time frame).
    b. Supply, like demand, is a flow concept and requires a time dimension (e.g. per year) that is consistent with that of demand (this is important and we shall return to it--supply is much more responsive to price the longer the time period chosen).
    c. Supply, like demand, can be depicted by schedules, algebraic formulae, or curves (we again choose the latter as being more convenient and requiring less specific information)
    d. Like demand, we can clarify supply more fully with a memory device:

    e. Alternative view: supply can be thought of as "marginal willingness to accept."

II. More On Supply: What Are We Holding Constant? (PESTO memory device)
    a. "P"--Prices of other goods: the higher the price of other goods, the less will be supplied of the good in question at any given price. The good under consideration becomes relatively less profitable (e.g. grade compensation revisited). (the supply curve will shift, called generally a "change in supply," in this case to the left, hence a "decrease in supply").
    b. "E"--Expectations of price change, as with demand, affect supplier behavior now: if prices are expected to rise significantly in the future, less will be supplied now (supply shifts to the left, a "decrease in supply"); if prices are expected to fall in the future, more will be supplied now (supply will shift to the right, an "increase in supply"). This behavior, as with demand, will cause current prices to change as we shall see.
    c. "S"--Supplier input price increases raise the cost of supplying any given quantity (in particular the original quantity), hence suppliers will only be willing to supply the same amount if they receive a higher price (supply shifts upward--a decrease in supply!--which is the same as a leftward shift; everything would "look right" if price were on the horizontal axis, but like our non-metric system we got it wrong initially and it's hard to change!). Hence, wage increases, oil price hikes, ingredient price rises, and the like all decrease supply.
    d. "T"--the "3 T's" (technology, taxes, time). Technological advances must--holding quality constant--lower costs (or they would not be adopted!), hence such advances must increase supply, shifting down the curve. Taxes on producers "act like" an increase in input prices (shifting the supply curve up or leftward, decreasing supply), although we will find that they have quite different implications for efficiency vis-a-vis a resource price increase. Time increases allow existing and potential producers greater flexibility in adjusting to changed conditions--shifting "short run" supply curves out or in as firms enter or leave the industry in the "long run." (we shall return to the topic of "time periods" in detail a bit later in our treatment of the firm)
    e. "O"--Other factors, such as rainfall, random production machine failures, frost, and so on.  This is a "catch-all" category, analogous to "tastes" for demand.

III. Changes in "PESTO" shift the supply curve and this is called a "change in supply." Only a change in price causes movements along the supply curve and this is called a "change in quantity supplied." (GRAPH--know this distinction!)

IV. Market Equilibrium--like the two halves of a pair of scissors, demand and supply considered in isolation are not too exciting, but bringing them together yields a powerful tool to understand how the world works!
    a. Superimposing D and S generally results in a point of intersection.

        i. forces present at prices above the intersection.
        ii. forces present at prices below the intersection.
        iii. the coordinating function of market prices (while demanders always want lower prices and suppliers always want higher prices, at the market- clearing price, what they will actually do is consistent, in that all planned transactions can be carried out).
        iv. the efficiency implications of the market outcome, when demand = MB to society and supply = MC to society for more of the good.
        v. life at the intersection--assume we are always there ("instantaneous adjustment"), unless prevented from getting there by government restrictions--until you get to macroeconomics. The intersection and the "WHAT," "HOW," "FOR WHOM," and "WHEN" decisions.

        a. The Minimum Wage Revisited (unemployment, disemployment, small wage gains of many "winners," large wage losses of few "losers," discrimination, cycles of poverty, cost-of-living implications seen as leftward supply shifts by producers of goods using now-more-expensive labor, overall efficiency and equity evaluation--remember the issue is not one of changing your opinion about this policy, but rather having a fuller understanding of the mix of positive and normative underpinnings of your opinion--"thinking better" is what economics is all about!  Extreme cases are instructive:  Why be cheap?  Why not have a minimum wage of $1,000/hour; we could all be millionaires!--see any problems with that?)
        b. Agricultural Price Supports (government purchases required or paying people not to produce [taxes], higher consumer prices, storage costs, inhibiting flow of resources out of agriculture, overall efficiency--less total goods--and equity--poor farmers helped?-- evaluation)

II. "Price Ceilings"--legal maximum prices (can't go above, hence "ceilings")

       a. Rent Controls Revisited (fewer units immediately available--removed from market, condo conversion, reduced maintenance, greater quantity demanded, rationing mechanism required--first-come, first- served (long queues) or seller preferences or ration coupons, black markets (key fees, "furnished" required, etc.), long run results, increased
immobility, OK for "short-term shortages," efficiency--less housing--and equity--poor renters helped?--evaluation; demand-side voucher alternative)
       b. Venezuela anecdote (governmental policies prevented output prices from rising for "essential" goods, while allowing input prices to rise, since they are someone's income!)
       c. Water "shortages" in the Western U.S.--below market agricultural prices and above market urban prices (property rights assignment? allow exchange? the "equi-marginal principle"--what price should be used in deciding whether to build a dam or canal?)
       d. Illegal goods (sex, booze, and drugs--GRAPH, discuss enforcement costs, increases in potency and intensity of use of drugs and alcohol, rise in uncertainty in product quality and performance--overdoses, violence in turf wars, etc.)

I. Public Goods Defined: Public goods are "non-rivalrous" and "non-excludable" in consumption (e.g. light from lighthouse, clean air, national defense, endangered species--mixed goods difficulty, many parks, etc.)
    a. Optimal amount to supply (where MB = MC, but sometimes difficult to know ["free rider"]; note that the appropriate aggregation is vertical rather than the more usual horizontal summation--GRAPH)
    b. Private market fails to provide the right amount! (Hint: role of incentives!)
    c. Graves point about non-optimality of the obvious government parallel to the private market provision, due to "input market failure" resulting from inability to "buy" such goods individually (hot off the press research!).  Critical insight: we work to get generate the income to get the goods we want!  If we cannot, individually, get any more of the goods that we care about (e.g. species preservation, carbon dioxide abatement, clean air, etc.) when we generate income, we will not generate that income.  The marginal benefits are negligible, while the leisure opportunity cost is large.  (Discuss the GRAPH again, indicating that the demands are understated).

II. Externalities Defined: Externalities are positive or negative uncompensated physical spillovers.
    a. Negative externalities (e.g. pollution from steel plant) result in too much being produced.  GRAPH.
    b. Positive externalities (e.g. education) result in too little being produced.  GRAPH.
    c. Solution to this problem of "missing markets": internalize the externality through taxes or subsidies.

I. Demand and Supply in Action: Single curve shifts (nothing ambiguous--always start with an initial situation!)
        a. Demand Increase (shift out, right or up) ==> P_e up; Q_e up (GRAPH)
(vitamin E taste change, wine & income, tea when there is a frost-induced coffee price increase, "nice" locations and income, expected sugar price rise in 1953, Buff football tickets after several winning seasons, etc. NOTE: all increases in demand will lead to increases in quantity supplied)
        b. Demand Decrease (shift in, left or down) ==> P_e down; Q_e down (GRAPH)
(red meat, LPs, baseball after the strike, "bad" locations, paper in an electronic-video world, market for big autos when gas price increases, expected lower 486 computer prices next year, etc. NOTE: all decreases in demand will lead to decreases in quantity supplied)
        c. Supply Increase (shift out, right or down) ==> P_e down; Q_e up (GRAPH)
(oil discovery, favorable weather on crops, baby-boomers and female labor force participation in 1970's leading to wage stagnation, POSLTs or unwed mothers with changing mores, tequila and NAFTA, etc. NOTE: all increases in supply will lead to increases in quantity demanded)
        iv. Supply Decrease (shift in, left or up) ==> P_e up; Q_e down (GRAPH)
(OPEC cartel quantity restrictions, cost increases due to minimum wage hike, frosts or floods, drug busts and implications, tax on volume rather than "100 proof gallon"--NOTE: all decreases in supply will lead to decreases in quantity demanded)

II. Demand and Supply in Action: "Linked Markets" (single shifts in each--GRAPHS)
    a. Substitutes in Consumption (virus attacks broccoli--what happens to the price and quantity of brussel sprouts? wrinkle-free natural-looking fabric invented--what happens to equilibrium price and quantity of cotton?)
    b. Complements in Consumption (virus attacks coffee--what happens to the price and quantity of cream? greater health benefits of exercise revealed--what happens to the equilibrium price and quantity of sports fluid replacement drinks?)
    c. Complements in Production (Boulder leads a national movement toward vegetarianism--what happens to the price and quantity of leather coats in the long run? New, warm but non-scratchy fabric competes with wool--what happens to the price and quantity of legs of lamb in the long run?)
    d. Substitutes in Production ("housing" is produced with land and capital--what would happen in uncontrolled cases when land prices rise moving toward a city's center--or toward the ocean--or toward C.U.'s campus?--this is why cities "look" the way they do!, price of oil rises due to OPEC--what happens to the price and quantity of coal?)

III. Demand and Supply in Action: Single Market but Both Curves Shift (note: the change in either equilibrium price or quantity will be ambiguous--impossible to say without further quantitative information about which shifts more--GRAPHS)
    a. Demand and Supply Both Increase--Q_e increases, but P_e is ambiguous
(e.g. very short-run impact of drug legalization, computer chip cost breakthrough at the same time a "user-friendly" computer program is released that utilizes it)
    b. Demand Increases While Supply Decreases--P_e increases, but Q_e is ambiguous
(e.g. frost in coffee growing areas at same time new information "clears" coffee as a cause of cancer, homes in unpolluted areas of L.A. after sudden population increase, a "pure" inflation--note Q_e is the same; it is only relative price changes that have the effects we are talking about here)
    c. Demand Decreases While Supply Increases--P_e decreases, but Q_e is ambiguous
(e.g. sturdy, shippable tomato that tastes like cardboard, the "baby M" surrogate mother case as an example of the impact of a change in property rights)
    d. Demand and Supply Both Decrease--Q_e decreases, but P_e is ambiguous
(e.g. paper headlines report that poultry inspectors have found salmonella in chickens, requiring that some be destroyed, stepped up drug efforts with more resources devoted to both capture and media advertisements focusing on undesirable effects stemming from drug use)

I. Consumer Surplus: the net benefit consumers get from being able to buy all they want at a market price, versus do without the good entirely.  Infra-marginal units must have been worth more than they cost, the last worth about what it costs--that's why it's the last!  (Graph--area under the demand curve and above the price paid)

II. Producer Surplus: the net benefit producers get from being able to sell all they want at a market price, versus not selling the good at all.  Infra-marginal units must have cost less to produce than they can be sold for; the last unit sold is last because the added benefit of selling it just equals the marginal cost of producing it!  (Graph--area above the supply curve and below the price received).

III. Tax Incidence--Who nominally pays a tax has no bearing on its actual "incidence" (who really pays it--GRAPH of producer-pays case and consumer-pays case, showing gross price and net price are identical in either case).  Understand the impact of a tax using consumer and producer surplus (efficiency--deadweight or welfare loss--and equity--transfers from producers and purchasers of the taxed good to others--policy implications)

IV. The "Water-Diamonds Paradox" Resolved by Marginal Analysis
    a. The Paradox--water though vital to human existence has a low price ("economic value"), while diamonds, mere baubles, have a high price ("economic value").  This troubled early philosophers and they thought there was something wrong with economists' notions of value!
    b. But market prices settle where marginal benefits of more (to consumers) = marginal costs of more (to producers)!
    c. At the market price consumers and producers can demand or supply as much as they want--generating, in the case of water, huge amounts of consumer surplus.
    d. Conclusion: with the proper notion of value, the paradox evaporates--there is vast total value of water and much smaller total value of diamonds, but the marginal values (which determine price) are, sensibly, quite different.  And, it is the marginal values that are relevant for societal decisions about whether to produce more of a good, e.g. water.  (Remaining important issue: "Economists know the price of everything and the value of nothing!"--philosophy; what "should" we value?)

V. Another Reason Some People Don't Like the Market Outcome: The Role of Time and Profit (This is also useful as a lead-in to the notion of elasticity of supply)
    a. The Market or Momentary Period--too short to alter any inputs, hence output is also fixed (supply vertical, for perishable goods and often "steep" for durables)
    b. The Short-Run Period--sufficiently long that some inputs can be varied, but sufficiently short that some other inputs cannot be varied (these are called "fixed inputs")
    c. The Long-Run Period--sufficiently long that all inputs can be varied (NOTE: this is a "planning horizon" in that we are never actually producing with all inputs variable--but at any point we can plan to have--and ultimately get--any number of plants of any size we want). The idea is that in the long run we can have any particular short run, but at any point in the process we are always in some short run!
    d. An Initial Equilibrium--the market for fish, long stable, is in equilibrium in each of the above time senses. The price in the market period is just that price that is consistent with the short-run market-clearing (supply = demand), and the rate of return to fishing is just as high--but no higher--than it is in other areas of production in the economy.
    e. Now, Demand Increases (health concerns, Friday religious requirements, whatever)
The problem: people are wanting more fish at the same price, but in the momentary period, and (to a substantially lesser extent) the short-run period they get price increases, without much increase in quantity. Only in the long-run are their desires satisfied ("Consumer is King") but the earlier periods "look like" price gouging/unfair! Yet, without the incentives provided by those price increases (raising profitability of increasing production of fish) the long-run desirable result would not occur! So initially we see a transfer of consumer surplus to producers that raises the profitability of fish; only later are the profits competed away as new firms enter, supplying the consumer with what they wanted--more fish at about the same price. (GRAPHS--consider the dynamics of other initial shifts). Again, the market outcome has efficiency and equity implications--but to get the former, the latter may be compromised (alternatives?: central planning, price controls, etc., have their own problems!). It is the seeking of profit that drives the dynamic movement of the market system! Note that problems with other systems (in addition to immediate rationing difficulties) get more severe over time--people get further and further from what they want and new goods don't get introduced (poor incentives in other systems)

I. "Elasticity"--Why Complicate Matters With This Concept?
    a. Units-free (doesn't matter whether one chooses oz, lb, or ton or inches, yards, miles, or quart, gallon, or drum, etc--the number will always be the same)
    b. Responsiveness is made comparable across goods (e.g. can say "salt responds less to a given percentage price change--we will use "Ch" to represent "change"--than is the case for automobiles. It is hard to even consider how to discuss comparability of salt and cars without this concept!)
    c. In the case of demand own-price, elasticity lets you know what happens to total revenue (TR)--which is the same thing as total expenditure to the consumer--when price is changed (e.g. drug policy, farm policy, mass transit, practical business decisions--musicians or gym workers go on strike and get wage increases; you must pay them out of revenue--do you raise prices or lower them?)
    d. Helps you understand firm behavior (the important difference it makes whether the firm is a "price taker" (or approximately so) or a "price maker")

II. Elasticity Versus Slope: What is the Difference?
    a. Slope definition: ChY/ChX, where Y is the dependent variable (usually "quantity demanded," or "demand," or "quantity supplied," or "supply") and X is the independent variable (usually "own-price" or something in PYNTE or PEST)-- although it really could be the relationship between any two causative variables, e.g. ChCrop yield/ChRainfall or ChWeight/ChIceCream). NOTE: Since we follow tradition by putting quantity on the horizontal axis, rather than price which is the independent variable, the own-price slope is actually inverted (GRAPH--valuable!)
    b. Elasticity definition: %ChY/%ChX, where Y is again the dependent variable and X is the variable causing the change. Note that the only difference between slope and elasticity is that you are using percentage changes instead of raw number changes!
    c. You can understand elasticities if you can calculate a "percentage change"--How do you do that? First, to calculate a percentage you must know where you started from--it is meaningful, for example, to say price fell $1 and you bought 2 more of something; but you can't know anything about elasticity from these numbers! If price had initially been fairly low, say $3, the dollar reduction would be "big" (33%), but if the price were $20 a dollar price reduction would only be a 5% reduction. Similarly, "2 more" is a big percentage increase if you were originally buying 4, but only a small percentage increase if you were buying 100 of the items under consideration originally. Hence, you need to know the so-called "base" amounts, in order to calculate a percentage, hence an elasticity. Two "bases" of particular interest:
        i. initial prices and quantities (point elasticity):

        ii. average prices and quantities (arc elasticity):

I. "Own-Price Elasticity" (è)--assume this is the one, if asked about the "elasticity of demand"
    a. Definition: è  = %ChQd_x/%ChP_x, where Qd_x is quantity demanded of X and P_x is price of X.
    b. Price elasticity and total revenue (arrow-length memory device, extreme cases):
        i. inelastic demand (è < 1)--price increases => TR increases (and conversely)
        ii. elastic demand (è > 1)--price increases => TR decreases (and conversely)
        iii. unitary elastic demand (è = 1)--price changes => TR unchanged
        iv. GRAPH of linear demand and (beneath) TR, to clarify linear case
    c. Determinants of price elasticity
        i. degree of substitutability (definition of commodity, e.g. "food")
        ii. importance in budget (limiting case--equals unity if all one good)
        iii. time frame (more time, more elastic, e.g. oil, -.2 vs. -1.0)
    d. Examples: U.S.: furniture 1.26; motor vehicles 1.14; professional services 1.09; gas, electricity and water .92; beverages (all types) .78; clothing .64; tobacco .61; books, mags, and newspapers .34; food .12. OTHER: Tanzania food .77 (their income is 3.3 % that of U.S. and 62% of their budget goes to food as compared to only 12% in U.S.; India similar)

II. "Income Elasticity" (µ) --understanding more fully behavior cross-sectionally and over time
    a. Definition: µ = %ChQd_x/%ChY, where Qd_x is demand for X and Y is income
    b. Income elasticity and expenditure shares (1 is "watershed" case):
        i. "superior" goods (µ > 1)--expenditure shares increase as income increases
            (ocean cruises, custom clothing, international travel, jewelry, art)
        ii. "normal" goods (0 <µ < 1)--expenditure shares fall as income increases
            (food, clothing, furniture, reading material)
        iii. "inferior" goods (µ < 0)--expenditure shares fall dramatically with income
            (small motorcycles, potatoes, rice--replaced as income rises)
        iv. GRAPH demand and Engel, noting axis tangent intersects, -shape often.
    c. Determinants of income elasticity
        i. necessities have lower income elasticities than "luxuries"
        ii. BUT, what is a "necessity" or a "luxury" depends on income!
    d. Examples: U.S.: airline travel 5.82; movies 3.41; electricity 1.94; restaurant meals 1.61; gasoline and oil 1.36; shoes .94; alcoholic beverages .62; furniture .53; clothing .51; telephone .32; food .14. OTHER: India food .75, while U.S. .14.

III. "Cross-Price Elasticity" (Ë)--understanding relationships among goods in an economy
    a. Definition: Ë = %ChQd_x1/%ChP_x2 , where X₁ and X₂ are two different goods
    b. Cross-price elasticity and relations among goods:
        i. "substitutes" (Ë > 0)--the goods are alternatives to one another
            (coal and oil, coffee and tea, cookies and cakes)
        ii. "complements" (Ë < 0)--the goods go together
            (coffee and cream, cars and tires, peanut butter and jelly)
        iii. "independent goods" (Ë = 0)--the goods are unrelated
        iv. GRAPH demand shift (mention irrelevance of Maslow's "hierarchy"-- implications for price, income, cross-price elasticities)

I. The Price Elasticity of Supply (é)--Responsiveness Along a Supply Curve
    a. Definition:  é = %ChQs_x/%ChP_x, where Qs_x is quantity supplied of X and P_x is price of X.
    b. Short-Run price elasticity of supply in typical cases:
        i. first, elastic supply (é > 1)--price increases => relatively more supply
        ii. then, unit elastic supply (é = 1)--price changes => same relative change
        iii. finally, inelastic supply (é < 1)--price increases => smaller change
        iv. GRAPH of typical supply curve, noting tangent-axis intersection--and the (relevant) extreme cases
    c. Determinants of price elasticity of supply
        i. relative fixity of inputs; substitutability of inputs, hence outputs, in multi- output firms (e.g. supply of ground beef more elastic than supply of beef; or growing wheat versus corn, or goods produced world-wide versus merely domestic)
        ii. whether price-taker or price-maker in input markets (size of industry)
        iii. time frame (always "in" some SR; but LR supply very elastic, e.g. apartments)

II. Shifts in Supply Curve Due to Changes in "PESTO"--Shift Responsiveness
    a. Note: if it doesn't affect marginal cost, it won't affect SR supply!
(sunk costs irrelevant to "more-or-less" decisions, examples)
    b. If other output prices change, input substitutability determines how much supply shifts
    c. Changes in variable input prices affect marginal cost, but only in proportion to share of the input in total variable costs (e.g. wages rise by 20%, but if labor costs are 50% variable costs, marginal cost only rises by 10%)
    d. Expectational effects depend on size and certainty of expected future prices
    e. Technology effects cannot be known ahead--if we really know the future, why wait?
    f. Taxes rotate or shift, depending on their nature.

III. Employing Elasticity: Manipulating the Curves and Policy Implications
    a. Demand and Supply curve shifts and rotations: implications for elasticity
    b. What happens to price or quantity when D or S changes, depending on elasticity
    c. Policy implications of elasticity when S or D shifts:
        i. drugs--demand inelasticity, revenue-crime implications, equity, prison crowding and cost, demand-side approach as an alternative.
        ii. abortion--elasticity (D&S) and implications for price, quantity; equity
        iii. agriculture--inelasticity with respect to both price and income, tech advance
        iv. rent controls--temptations of SR inelasticity; long run elasticity; possible value in cases of temporary demand increases, when equity overshadows efficiency; demand-side alternatives.
        v. minimum wage--elasticity and "low-skilled labor's share" of output
        vi. tax revenue--naive approach of multiplying old Q by tax rate
        vii. educational choice--discussion and voucher alternative.
    d. Knowing technique is not a substitute for thinking! (Beer example)

I. Trade when there is Absolute Advantage is very easy and intuitive; clearly, if one person or country is better at one producing one good while another person or country is better at some other good, specialization is in order (Florida orange/Michigan Christmas tree example). But the more important point is that, even if one person or country is better at everything, trade still benefits both parties!

II. How can this be?
    a. Comparative Advantage: A country has a comparative advantage (or comparative disadvantage) in a good or service if it can produce the good or service at a lower (higher) opportunity cost than its trading partner. That is, when one country gives up relatively less of other goods to get more of a particular good, it has a comparative advantage in the latter. [e.g. Suppose England, with given resources, can produce either one bicycle or three bolts of cloth, while the U.S. can, with the same resources, produce either two bicycles or four bolts of cloth. Even though England is "worse" at producing both goods, it is relatively less bad at cloth (only must give up a third of a bicycle to get a bolt of cloth, while in the U.S. a half of a bicycle must be given up). Hence, England should specialize in cloth, trading it for bicycles from the U.S.--even though output per worker is higher in the U.S. for both goods!
    b. Details: In the absence of trade a bolt of cloth in England would sell for a price equal to a third (4/12's) of the price of a bicycle, while in the U.S. a bolt of cloth would sell for a price equal to a half (6/12's) of the price of a bicycle. At any post-trade world price ratio between these (which would actually result!), say a bolt of cloth selling for a price equal to 5/12's of a bicycle, both parties are better off specializing and trading with the other. For every bolt of cloth the English give up (to trade), they now get more bicycles than if they had given up production of cloth directly to get bicycles (getting 5/12's instead of 4/12's). For every bolt of cloth the Americans give up (by no longer producing), they can produce 1/2 of a bicycle--but the bicycle is "worth more" now than before--selling for 12/5's rather than 12/6's!. Hence both countries gain from trade--they can each consume more in total by specializing in the production of goods they are relatively best at (in addition to decreased costs, each country has greater competition and more diversity of products with free trade).

III. A Parable: Two Technologies for Producing Automobiles (from The Armchair Economist, by Steven Landsburg)
    a. One technology: manufacture them in Detroit (well-know technology, won't discuss).
    b. Second technology: grow them in Iowa (seeds are raw material from which cars are ultimately constructed; seeds grow into wheat which is harvested, loaded into ships and sailed Westward in the Pacific Ocean; after a few months the ships reappear with Toyotas in them)
    c. Why would we want to favor American auto producers in Detroit over American auto producers in Iowa? (a ban on "imported" autos really bans Iowa-grown cars!)
    d. The share of automobiles produced each way in American will be determined by when the marginal costs are the same (minimizing total costs).
    e. Note: protecting Detroit harms farmers, but also hurts general car consumer!

IV. Silliness: "ABC," Bal-of-Trade concerns, meaninglessness of bi-lateral imbalances.

V. Review of two equal-sized countries' production possibilities frontiers, for case where complete specialization will not occur (two bowed-out PPFs). Select a couple of "reasonable" consumption points for each country in the absence of trade. Show how trade results in a "world price" lying between, in slope, that of either country's domestic price. Essentially, allowing trade increases the total world production feasibility set--and recall that more production is more income! See how both countries benefit (as with the exchange of a sweater between two students).

VI. Look at the preceding set-up now as a supply and demand equilibrium. The initial (non-trade) point on the production possibility frontier corresponds to an initial supply and demand equilibrium without trade (DRAW). Discuss how any other point on the frontier, before trade, must be inferior to the initial point (given consumer preferences), showing the loss in welfare in each market at any other point (DRAW).

VII. Now allow trade (as in I. above), but look at it from the supply and demand perspective. Show, first, that the goods that the U.S. now exports (those for which we have a comparative advantage in production) give rise to a net gain to Americans (that is, the loss to consumers from paying higher prices for the smaller amount of goods now staying within the country is smaller than the gain to producers from being able to sell at the higher world price) (DRAW). Show, next, that the goods that the U.S. now imports (those for which we have a comparative disadvantage in production) also give rise to a net gain to Americans (that is, the loss to producers receiving the lower world price is smaller than the gain to consumers from being able to buy at the now lower world price. NOTE: these net gains are due primarily to the ability to substitute in both production and consumption away from high-cost goods toward low-cost goods. NOTE further that exactly the same process is going on from the perspective of the other country--trade is not a zero-sum game! Hence, trade increases the income of all countries trading and results in greater world income (equals output).

VIII. Arguments against trade: 1) lax environmental standards result in unfair competition (so what? Every country has different preferences for environmental and other goods--people who care less about pollution are better off specializing in goods whose production involves pollution; also, as these countries incomes rise--partly due to trade--they will demand greater environmental quality as well); 2) unfair labor practices (ditto--when the U.S. was poor we had little in the way of either environmental or labor laws) NOTE: would you think it appropriate if India would not allow U.S.goods into their country as long as we continued our "barbarous" practice of eating cattle flesh?; 3) national defense goods (discuss--possible for certain minor goods); 4) infant industries argument (seldom applied properly and the tariffs never go away). FINAL NOTE: If you really care about the health and well-being of, say, the Vietnamese you should only buy goods made in that country! (This will raise the demand for Vietnamese labor as many firms move into the country to be able to sell goods from there--incomes will rise, hence environmental/labor standards will automatically be raised!). The best-conducted studies, incidentally, suggest that foreign multinationals operate more like their origin nation than their host nation--in particular they offer more training to workers, they pay higher wages than local firms, and their labor/environmental standards are higher than locals.

I. Psychological Underpinnings of Demand: Preferences and "Utility"
    a. Preference assumptions
        i. comparability of bundles
        ii. transitivity among bundles
        iii. assigning "utility" to bundles
        iv. utility increasing at a decreasing rate--Law of Diminishing M.U.
    b. Demand revisited--The Rational Rule of Economic Life (MU_A/P_A = MU_B/P_B = ...)
    c. Can people really do this? (cognitive ability, inevitability of hard choices)
        i. improve with age, experience (grade school kids, teachers)
        ii. animal experiments--are we "dumber" than rats?
    d. Return to consumer surplus and paradox of value (M.U. emphasis)
    e. Rationale for income transfers? (can't make interpersonal comparisons)

II. Introduction to the Firm  (Chapter 11,12)
    a. What? (an artificial construct that transforms inputs (ideally, low value) into outputs (ideally, high value)
    b. Why? (production could all occur in the home, but economies of scale (mainly); knowledge coordination; risk-bearing; ease of resource accumulation; "MAPS" for existence of cities--not "mere accident" where founder stopped)
    c. Types of firm organization and pros and cons of each
        i. sole proprietorship (small and numerous; your own boss; but unlimited liability and death of company at death of proprietor)
        ii. partnership (mostly small, still numerous; "principle-agent" problems; still unlimited liability; partners replaced on death provides some continuity)
        iii. corporations (mostly large, smaller in number--but produce the vast majority of our output; limited liability; more "principle-agent" problems, access to capital via bonds or stocks; indefinite life)
    d. Goals of all firms: Maximize Profit  = Total Revenue (TR) - Total Cost (TC)
        i. treatment of those seeking profit in the media (they repent or they are killed)
        ii. seeking profit is "good"; getting profit is a normative issue about which people differ
        iii. "profitability" depends on the return to capital (not sales!)
        iv. total revenue, TR, is pretty straightforward (price x quantity)--costs not!
    e. Since inputs have positive prices, outputs have positive costs (scarcity!)
        i. explicit costs vs. implicit costs (labor example in proprietorship)
        ii. accounting costs vs. opportunity costs (corporation example--return to capital)
        iii. fixed and variable inputs => fixed and variable costs (not emphasized in this course--the various average cost curves are of limited interest for our main concern)
        iv. in the short-run, by definition, some inputs are fixed => eventual crowding => added output from constant increments of input (e.g. labor) ultimately becomes smaller (talk of agriculture, burger joint, factory)--"The Law of Diminishing Marginal Product" (like Law of Diminishing M.U., but better since it is an observable economic variable!)
        v. diminishing marginal product => increasing marginal cost! (main point!)

I. Clarifying the Relationship Between Marginal Cost and Marginal Product (true for any input, since marginal cost will be equated):

             MC = ChTC/ChQ = ChTVC/ChQ = wChL/ChQ = w/(ChQ/ChL) = w/MP_L (for any input)

II. Constructing the Cost Curves:
    a. Average Fixed Cost--this is just total fixed cost (constant with respect to output changes, by definition) divided by quantity produced (GRAPH AFC = TFC/Q; the graph falls indefinitely, approaching the quantity axis)
    b. Average Variable Cost--this is just total variable cost at each output level divided by quantity produced. Due to specialization and division of labor only later followed by crowding, this curve will first fall, then rise (GRAPH AVC = TVC/Q; it first falls (as average product rises), then rises (as average product rises)).  As with the marginal curves,

                    AVC = TVC/Q = wL/Q = w/(Q/L) = w/AP (taking, for simplicity, labor to be the only variable input)

    c. Average Total Cost--this is the vertical sum of the preceding curves, hence it first falls (for a longer time than the AVC, since AFC is always falling), then rises in a manner similar to the AVC curve (GRAPH ATC = TC/Q)
    d. Marginal Cost in Relation to AVC and ATC--this crucial curve, while first falling and then rising, must pass through the minimums of both of the AVC and ATC curves! (GRAPH and intuition; grade-point analogy)

III. Numerical example for further clarification (simple, labor only variable input, case):

    Labor     Wage     Q     MP_L     TFC     TVC     TC        MC         ATC
        0         $10         0     -         $100         $0     $100         -         infinite
        1         $10         2     2         $100        $10    $110     $5.00     $55.00
        2         $10         5     3         $100        $20    $120     $3.33     $24.00
        3         $10         9     4         $100        $30    $130     $2.50     $14.44
        4         $10        12    3         $100        $40    $140     $3.33     $11.67
        5         $10        14    2         $100        $50    $150     $5.00     $10.71
        6         $10        15    1         $100        $60    $160     $10.00   $10.67
        7         $10      15.5    .5       $100        $70    $170     $20.00   $10.97
        8         $10      15.7    .2       $100        $80    $180     $50.00   $11.47

(NOTE: AFC always falls; MC first falls, then rises; MC < ATC ATC is falling, while MC > ATC ATC rising; when MP_L is rising MC is falling and conversely)

IV. Why Go Through All These Curves?
    a. The Marginal Cost (MC) is to be compared to Marginal Revenue (MR) to see if a firm is doing "as well as possible" (maximum profit)--that is, if MC < MR at the current output level you will earn higher profits if you produce more, while if MC > MR at the current output level you will earn higher profits if you produce less. If MR (in the example) were $5 you would make the most money producing 14 units (why not 2?), while if MR were $20 you would make the most money producing 15.5 units.
    b. The Average Cost (ATC) is compared to Average Revenue (P) to see what profit you are earning at your current output level, since multiplying these by quantity yields Total Cost and Total Revenue and Profit, equals TR - TC.

I. Rational Competitive Firm Behavior: Produce Any Good With MB > MC
    a. Why? (maximizes profit)
    b. What are "marginal benefits" to firm?
        i. for price-takers, price, is the marginal benefit of selling more
        ii. for price-makers, marginal revenue, is the marginal benefit of selling more
                (GRAPH the two cases; review elasticity relationships in this context)
    c. What are "marginal costs" to firm (review--same points, but what is marginal?)?
        i. the variable costs that change when output changes are SR marginal costs
        ii. implicit vs. explicit marginal costs
        iii. social vs. private marginal costs (change firm incentives when they differ)
        iv. marginal costs are the minimum costs of producing additional output (assume "technical" efficiency--interested in economic efficiency, typewriter ex.)
        v. MYTH: "A good business decision-maker will never sell a product for less than its production costs." (sunk costs are sunk--irrelevant! Vietnam war deaths, poker)

II. Are Firms "Commonly" Price Takers or Price Makers?
    a. firm-type continuum (from P.C. to monopoly as extremes)
    b. role of scientific abstraction revisited--"as if" price takers?
    c. some markets really are competitive (agriculture, stocks)
    d. international trade => price taking (international price plus travel costs)
    e. models "more realistic" (M.C.) have implications that differ little from P.C.
    f. we shall consider the extreme case of monopoly--only difference is that marginal revenue is no longer the same as price, since the price-maker must lower price to sell more (there is a "loss" to subtract from the benefit of greater sales at the new, lower price--GRAPH).

III. For the Price Taker "Supply" is the Marginal Cost Curve! (technically, "most" of MC curve)
    a. MYTH: "The prices of most goods are unnecessarily inflated by at least 25 percent as a result of the high rate of profit of producers." (role of fixed costs--must be covered in LR--but marginal decisions are what matter. NOTE: It is profit as a percent of capital and not as a percent of sales that matters! e.g. grocery stores versus furniture store--which has higher "rate of profit?")

IV. The Competitive Market of comprised of many price takers in the Short-Run and in the Long-run
    a. Short-run market efficiency and equity.  (GRAPH)  SR market supply is horizontal sum of individual firms' supply (demand analogy).
    b. Long-run market efficiency and equity--"Consumer Sovereignty" (GRAPH)  LR much more elastic in competitive case (firm can be any size; entry and exit).

I. Monopoly: Single Seller of Good for Which There Is No Close Substitute
    a. Common? No
    b. Bases for a monopoly (must be barriers to entry, if profitable!)
        i. "natural" monopoly (large scale economies relative to market demand)
        ii. resource-based monopoly (e.g. owning 90% of world's bauxite, DeBeers)
        iii. legislated monopoly (franchise--can be competitive; patents--optimal length?; government--post office, etc; cartels in other countries--legally enforceable contracts)
    c. Monopolies pick a single price-quantity point--hence don't have a supply curve in the usual sense (GRAPH)
    d. Why monopolies are unpopular--Efficiency and Equity Implications (GRAPH)
    e. Long-run is very like the Short-run, without regulation (discuss?)

II. Monopolistic Competition (Many sellers, each selling a similar, but differentiated, product, as for example is commonly observed in retail trade.  Just know that this industrial structure is "like" perfect competition, except that there is product differentiation within each "product group"; the slightly higher consumer prices in this type of market are what we pay to have product variety)

III. Oligopoly (Few sellers, each selling either a homogeneous or a differentiated product.  Just know that in this industrial structure it is impossible to know--without additional assumptions!--what your demand curve is, since it will depend on the reactions of other rivalrous firms.  There are many specific assumptions that can be made about those reactions, and oligopoly will be discussed in much greater detail in higher level courses in economics.)

I. What is "Price Discrimination" by a price maker?
    a. DEF: charging a different price to a different person or for different quantities, when there is not a cost difference (or, perhaps more rarely, charging the same price when there is a cost difference).
    b. Why would you want to "price discriminate?" (can make more profit, by taking advantage of different demand elasticities!)
    c. When can price-making firms price discriminate?
        i. there must be different demands (by different people or for different amounts)
        ii. must be able to prevent resale
    d. Who price discriminates (i.e. who can know or guess at demand differences and prevent resale)?
        i. mostly producers of services--can't resell (doctors, dentists, massages, car repair, etc.--watch the info you give!)
       ii. international trade (customs prevents resale--usually lower price in lower income country, if used by the low income people)
      iii. local discounts (ski tickets sold in grocery stores in Boulder)
      iv. store coupons (sorts people on basis of value of time--time intensive coupons)
      v. age or student discounts (but remember demands must differ!)
      vi. air travel (higher rates unless stay over Saturday night discriminates against business customers)
      vii. "all or nothing" prices (cover charge, cheap beer, "1 for $1, 3 for $2")
      viii. block pricing ($3/unit for first 10 units, then $2/unit for next 10 units, etc)
    e. If you can price discriminate, you want to set marginal revenue in each market segment equal to the common marginal cost (GRAPH various cases)
    f. "Perfect Price Discrimination" (make all buyers pay exactly what each unit is worth to them)--Efficiency and Equity Implications? (efficiency lost due to being a price maker is--ironically--regained; but the equity implications become much more severe as all consumer surplus is "scooped" up by the price discriminator!)

II. What are "Cartels?"
    a. DEF: a cartel is a group of firms colluding in their price and output decisions to make greater total profits than would be possible if they did not engage in such collusive behavior (in extreme case, they act as a multi-plant monopoly, producing so that marginal cost is identical in all firms and that cost is equated to marginal revenue--or, if price discriminators, to the marginal revenues of each buyer)
    b. Welfare implications: both efficiency and equity worsened when compared to competitive case
    c. NOTE: cartels (e.g. OPEC) cannot merely raise prices--they must (Law of Demand) decide on a mechanism by which quantity is to be restricted (problem!).
    d. Cartel instability: because any individual member of the cartel may have very low marginal costs of production, each has an incentive to "cheat" on the agreed price (this is why I do not worry about student "study collusion"--the incentive to cheat is too large!)
    e. Over time, the preceding problems become worse as new non-cartel producers add to supply and as quantity demanded falls with greater time to adjust.

I. Our Three Basic Economic Questions Revisited and Reviewed:
    a. "WHAT?" to produce (interaction of S&D in output markets)
    b. "HOW?" to produce (firms pick least cost combinations of inputs, given the prices they must pay for those inputs, determined by input market S&D)
    c. "FOR WHOM?" to produce--we now turn to the determinants of who gets the output (remember income and output are the same!)

II. "FOR WHOM?" (we will look at the "systematic" answer, but consider others)
    a. Issues of "fairness" (most judge outcomes as fair if the "rules of the game" are fair;
equal opportunity--generally accepted--versus equal outcome--controversial)
    b. The trivial, but important, cause: your income is determined by the value of the inputs that you supply times the quantity of them that you supply.
(i.e. Y = P_LxLabor + P_KxCapital + P_NRxNat. Res.("Land") + P_ExEntrep.)
    c. Analogous to output markets, competitive market input prices are determined by the interaction of the many suppliers of inputs (households) and demanders of inputs (producers); these prices are then taken as given by individual decisionmakers.  GRAPH market and wage determination, where market demand is now from firms and market supply is now from households.

III. What Determines the Demand for Inputs by Firms?
    a. As always, hire more when MB is greater than or equal to MC (MC is just price of input--but what is MB?)
    b. MB to a firm of hiring more is just the added output (MP) times what that output is worth to the firm (either price or marginal revenue, depending on whether the firm is a price-taker or price-maker)
    c. Hence, demand for inputs is just the value of marginal product--downward sloping due to the Law of Diminishing Marginal Product!
    d. IMPLICATION: anything that either increases the price of a product (greater demand) or the productivity of inputs (technological advance) will increase firm demand for an input.  Controversy: the wages in a poor country paid by, e.g., a multinational may not necessarily correspond (in the short-run) to worker productivity, if there is a large supply of labor in the country of the skill category being employed (but capital will move, unless inhibited by bad governmental policy, to eventually drive up the wages).  Another implication is that the wages in slow productivity growth sectors will rise along with those in the high productivity growth sectors if the same skill categories are employed in both (labor movement between sectors will guarantee this equalization).
    d. NOTE: demand for inputs is derived from demand for outputs (e.g. Famous Ball-player vs. world's best ping pong player, Corn Laws, Boulder rents, implications of trade in goods, etc.)

I. What determines the supplies of various inputs by households?
    a. As always, supply more when MB is greater than or equal to MC (MB is the gain in income, MC depends on the input)
    b. Labor supply to the market depends on the net impact of income and substitution effects on the demand for leisure (very steep, possibly backward-bending), but the supply to any one firm, region, occupation, etc. will be much more elastic!  (review controversy of wages paid in developing countries).
    c. Capital inputs have upward-sloping SR supply curves, since they are the output of firms, hence have upward-sloping MC because of Law of Diminishing MP!
    d. "Land" inputs have either upward-sloping supply curves (e.g. intertemporal use of oil) or are fixed in supply (e.g. physical land) and earn "economic rents." (efficiency...quasi-rents in short-run)
    e. Entrepreneurship, a risky proposition, occurs more if returns to risk-bearing increase (hence upward-sloping supply).

II. The Dynamic Interconnectedness of Output and Input Markets: Incentives Revisited!
    a. Changes in demands and supplies => changes in the rewards (incomes) that motivate resources to move from declining to expanding industries (promotes progress). (poi, sushi example)

I. Compensating Differentials
    a. Job traits and wage compensation (e.g. the garbage truck guy and the librarian)
    b. Is there a "free lunch" in amenities?
        i. equilibrium when places vary in "niceness" (R & W equilibrated by movement)
        ii. geographers versus economists in measuring "quality of life"
        iii. benefits of being "different" in your preferences (elderly, other diffs)

II. Unions
    a. In decline nationwide (both as % of labor force and, recently, absolute numbers)
    b. Issues:
        i. elasticity of demand for union workers (substitutes, minimum wage support)
        ii. long-run implications of free trade--recall derived demands for inputs!
        iii. do they make a difference? (industry sorting problem, "gains"--who gets?)

III. Returns to Education--Human "Capital" or Sorting?
    a. The evidence: large, and growing, return to higher education
    b. The human capital argument--an investment, like any other (+ consumption benefits)
    c. The sorting argument--educational credentials as cheap signals of intelligence
    d. The twins study

IV. Discrimination
    a. Def: "discrimination" is said to occur when equally productive people do not receive equal compensation for their efforts.
    b. Discrimination is not the same as prejudice (can have either without the other)
    c. Statistical discrimination (Mary, Jane, and Mike; "credentials" signals)
    d. Equality of opportunity vs. equality of outcome (horse races, fairness)
    e. NOTE: the competitive market system makes discriminators pay for their actions!

V. Comparable Worth
    a. Recalling that input demands are derived from demands for outputs (e.g. Michael Jordan vs. "best table tennis player"), comparable worth policies will inhibit labor movement into production of things we most value, rightly or wrongly (e.g. rewarding artists or philosophers because they are "noble" callings gives us less of what we really want--the market rewards according to the value of MP_L!)

I.  Interest rates--What?--the "price" of current consumption in terms of foregone future consumption.
    a. Only 4 out of 750 investors got 10 easy questions about bonds correct in a recent survey, most not getting even half right.
    b. Where are interest rates determined?  Equilibrium in the loanable funds market as representing time preference (supply) vs productivity (demand); price of current consumption also turns out to be the "rental price of a dollar."  We will speak of "the" interest rate, despite the huge variety of rates for different risk and term categories--because the returns to all assets tend to move together.  This latter observation stems from human greed; everyone would like to possess the highest-returning asset.  That desire drives up the price of such assets until their returns are typical of other assets.  Discuss.

II. Assets--What?--durable goods providing service flows in financial or non-financial form.
    a. Assets as streams of returns (machines, home services, car services, bond income)
    b. Compounding and the Rule of 70 (discuss the growth in value of various assets).
    b. The "$1 per year forever" Graves bond...what is it worth now?  Why?
    b. Discounting generally--what's any stream of returns worth now? (flipside of compounding)
    d. Appreciating or depreciating assets over time (is the now-"closer" stream bigger or smaller?)
    e. Stock values as NPV's of market guesses of discounted future "profitability" (value of capital)
    f. Silly advice (e.g. "pay cash for stove, refrigerator and dishwasher or you'll end up paying 3 times as much in interest"--this ignores the opportunity cost of money.  Ricardian Equivalence.)
    g. Human capital investment, criminal activity, and credit card debt: responses to different rates of time preference? (must generally consider when costs and benefits occur, and some people are not good with "deferred gratification," having high internal rates of time discount)
    h. inflated or real values? (won't alter any decisions, done properly)

    There are many commonly noted reasons for the failure of the private market system to deliver the proper amount of various goods for a society. Prominent among these are monopoly (where too little is produced in the private sector, since MR < P), public goods (where zero is produced by the private sector since they are non-rivalrous and, especially, non-excludable), and positive or negative externalities (where too little or too much is produced, respectively, because decisionmakers don't take account of all the costs or benefits). The existence of private market failure would suggest a role for government intervention to correct the resource misallocation (break up monopoly, provide public goods, internalize externalities, etc).
    But will government do better? As with the private market, incentives affect what the actual outcome will be. What are the incentives that government decision-makers face? Below are some reasons to expect that a private market failure does not guarantee that government intervention will improve things:
1) Single-Agency Bias Toward "Too Much" (e.g. OSHA, DOE, EPA--have a mandate to "do their thing" not to ask whether B>C or not)
2) Budget Maximization as a Goal (power and prestige in Washington relate to budget)
3) Shorter Time Horizons than Private Sector Firms (2,4, or, at most, 6 year election horizons suggest a preference for policies that give benefits now, costs later; persistent deficits)
4) Special Interests at Odds With the General Interest (power of the PAC in particular)
5) Non-Profit Maximization Goals of Administrators (offices, subordinates, excess procurement costs, etc.--but, see the "Valuing Public Goods" paper)
6) Logrolling (e.g. vote for my dam, I'll vote for your airport; especially problematic with federal cost sharing; analogy with dessert when check split evenly)
7) Politics and Administration are Inextricably Intertwined (e.g. feasibility and expected return may be less important than "praiseworthiness" and electoral appeal; generally the problem is that votes are maximized in politics, not profits)
8) Efficiency Is Difficult to Measure (output being difficult to measure results in costs being taken as a proxy or "customer's served")
9) Large Organization Control Problems (not unique to government, but govt is big)
10) Limitations on Executive Authority (e.g. Civil Service rigidities prevent flexible responses--altering what is produced or cutting costs)
11) Pleasing Everybody May Mean Pleasing Nobody (e.g. work shoe manufacturer with 22% market share may do fine, but politics requires doing other shoes they might not be good at, to get the majority votes to keep the budget intact)
12) "Marginal" Votes Being What Matters May Imply Undue Weight To Particular Groups (e.g. Sierra Club "delivering" CA in exchange for support of a bill that might have C > B => get organized if you do want to "make a difference;" again see "Valuing Public Goods" paper)
13) Ultimately inability to fail, unlike private sector (e.g. congressional testimony)
14) Rational Voter Ignorance Allows the Preceding Problems to Persist (it is clearly irrational to vote, apart from losing the moral right to complain when things get progressively worse due to the preceding problems!)

Possible Recommendations: Real political competition (not "compromise," which looks like political price-fixing), contract enforcement of political promises ("read my lips, no new taxes"--sue 'em if they violate the contract!; see also "Real Government Reform," either paper or both), real salaries, salary bonuses for moving toward budget balance or expenditure cuts, perhaps term limits, etc.--create incentives for them to produce what we want!

During your EC1000 class, the economic way of thinking has been applied to many individual decisions--decisions that economists assume are made rationally, that is, made so as to make the decisionmaker as well off as possible. The decisions made are rendered consistent by the market prices that all decisionmakers face. To understand better the economic way of thinking, it is useful to consider common examples of "dumb thinking." The following are merely a sampling of the poor thinking that exists in the "real world:"

1. "My profits as a percentage of sales are only 1.5%, hence I..." (profit as a percentage of sales is a meaningless number--it is only profits as a percentage of capital invested that has any bearing on whether one is doing well or badly; an industry with a 50% profit on sales may well be less profitable than an industry with 2% of sales profit if the latter has high volume and little capital invested).

2. "I have a cost advantage because I own the land my business is on and don't have to pay rent." (the opportunity cost--the only relevant cost--is the same whether you own or rent; of course, you are wealthier if you own, but your costs aren't lower. Same for homes--whether paid for or not it costs you to occupy them, middlemen provide costly services, etc.).  Same point for those claiming to have "cut out the middleman and able to pass those savings on to you"--presumably the middleman was performing some valuable service that must now be paid for by those "cutting them out!"

3. "In a trade, if somebody 'wins' somebody else must 'lose.'" (trade is not like poker where winners imply losers; in voluntary transactions all parties must be made better off or they would not trade. "Exploitation" of poor countries is about fairness of distribution of benefits).

4. "You can't have too much of a good thing!" (it is marginal values--values that depend on how much you have--that matter; totally clean air or water implies zero production which implies zero people! We may want to reintroduce the wolf to a state, but we don't want so many that our loved ones are being gobbled up. The science of economics versus the religion of environmentalists--economics is about rational choice, religion about "rules" which are implicit denial of choice.)

5. "We are worse off if government runs deficits." (We may be better off! The issue is whether government is doing things with B > C; financing--whether by taxes, inflation, or bonds--is an equity issue; who should pay for something may be less important than whether it is worth paying for by anybody!)

6. "I didn't feel too bad when the stock price fell--it was "paper profits" anyway." (any change in stock value, whether a rise or fall, is a change in your real wealth. If you had sold before it went down, you could have bought many welfare-enhancing things that you cannot buy afterwards and vice versa).

7. "Greedy landlords drive up the price of land, hence rents for housing in popular places." (causation is reversed--high demands to locate in desirable areas drives up land rents. Another variant on this is the "high cost of free agent basketball players caused us to raise ticket prices"--it is the ability to raise ticket prices, to receive TV revenue, and so on, that enables competitive bidding for the players to result in such high salaries. Always remember that input demands are derived from the demands for the outputs they produce--otherwise an equally skilled table tennis player would be paid as much as a NBA All-Star!).

8. "Using dollars in benefit-cost analysis is crass, base, and inhumane; such comparisons should not be allowed!" (the dollars themselves mean nothing--it is the real effects that matter and dollars only provide a convenient unit of account for the many effects.  See, however, "Valuing Public Goods" paper for very real benefit-cost problems.)

9. "Market prices fail to capture rightly the intrinsic value of many things!" (in most contexts, the notion of intrinsic value makes no sense--if gas prices rise rapidly, the value of a gas-guzzling auto will fall dramatically because it is less desirable to people regardless of any notion of "intrinsic" value on might place on it. Similarly, gold is no more "intrinsically" valuable than is paper money--supply and demand merely yields a different price. Note also that intrinsic value is inconsistent with the vital concept of marginal values being the appropriate notion of value for decisions about having more or less of things).

10. "But people (or I) need ...." (generally when people used the word "need," especially in wealthy countries where even the poor live much better than most of the world's people, a more appropriate substitute would be "want"; while it is true that we literally need a certain amount of water or food each day, the context is usually more of an "I need the new Beatles CD"--always ask at what price do you need it?.... Saying "need" tends to imply vertical demand curves which, like unicorns, are possible but unobserved in the real world)

11. "It is unfair, because people (or I) can't afford ...." (generally when people say somebody "can't afford" something a more appropriate substitute would be "don't want" at the prices and income they face; while your parents probably literally could not afford a Learjet--in the sense that with their entire incomes they could not make the payments on it--they almost certainly could afford a Ferrari Testarossa (if they chose to live in a tent and eat poorly, perhaps); Saying "I can't afford the new Eagles CD" is very unlikely to be true since giving up just two or three lunches would do it!)

12. "We can't compete with foreign producers of anything with their cheap labor!" (first, this fails to consider why wages are low in the first place--wages are low in places where labor is not very productive (often due to lack of capital); total productivity is what matters, just like it is total costs that are important and not any one cost category; also every country must have a relative cost advantage, so even countries with very high average costs benefit from trade by specializing in goods that they are relatively best at producing)

13. "We would be so much better off if we switched to more efficient energy sources--after all, the sun is free!" (efficiency relates to full opportunity costs, not any one component)

14. "If a job is worth doing, it is worth doing right!"  (Silly...a job is worth doing up to the point where marginal benefits equal marginal costs, as seen by the decision-maker.  It is the case, however, that how the decision-maker views costs and benefits--for example those from studying economics!--is related to "maturity!"  :)

The preceding are merely examples. Apart from externalities, public goods, and monopoly, it is easy to show that voluntary exchange at market-determined prices maximizes the "Wealth of Nations," as Adam Smith put it. That is, given our limited resources, market economies give us the most of the goods we care about. This implies that interventions in market outcomes--unless correcting one of the market failures mentioned--must have costs greater than benefits (i.e. must be inefficient). In the policy arena then, remember that all benefits of any policy or program come with costs--there is no "free lunch" in benefits, even though it may appear to be so to individuals favored by the policy! This fact is sometimes called the "Law of Unintended Consequences." Always try to think about what those unintended consequences are:  Some examples from our course: 1) minimum wage--higher wages for, and more total income going to, most low-skilled workers, but unintended consequences of some disemployment and discrimination, lower total income (recall that income and output are identical and nothing about minimum wage legislation increases output), higher prices of goods using low-skilled labor, etc. 2) rent controls--lower rents in the short run for most (low income) renters, but unintended consequences of housing discrimination, deterioration of housing stock, much smaller long-run low-income housing stock, increased immobility, etc. 3) farm subsidies--rationalized as helping poor farmers (but most benefits in fact go to the rich, since poor farmers eat most of their food), with unintended consequences of high storage costs, spoilage, tax increases, and increased food costs. 4) protectionism--help and hurt some, but tariffs, quotas and the like do great net harm to a nation's consumers.  There are many, many examples of this sort in the future that you will find yourself in...try to think better!  Good luck...it is not easy, particularly when one is emotionally involved with a particular issue.