Day 2: Introduction to the Economic Way of Thinking (Chapter 1 and 2)
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).
Day 3: Scarcity, Choice, and Opportunity Costs (Chapters 2&3)
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)
(FIRST GRAPH: Production Possibilities Frontier to
illustrate
Scarcity, Trade-Offs, Macroeconomic Problems)
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!)
(SECOND GRAPH: Marginal Benefits, Marginal Costs, and Rational Choice)
Day 4: Basic Choices and Market Answers (Chapter 3 and 4)
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).
Day 5: Demand (Chapter 4)
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!)
Day 6: Supply and Market Equilibrium (Chapter 4)
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:
Sx = S( Px | "P E S T O")
(GRAPH--showing "movement along" supply curve, called
"change in quantity supplied")
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.
(GRAPH of supply and demand curves)
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.
Day 7: Using the Demand and Supply (Chapter 5 and
7)
(Shortages, Surpluses, Price Controls Revisited)
==> EXCESS SUPPLY (surplus)
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")
==> EXCESS DEMAND (shortage)
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.)
Day 8: The Supply and Demand--Public Goods and Externalities (Chapter 7, 8, portions of 19)
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.
Day 9: Supply and Demand in Action (Chapter 5)
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) ==> Pe up; Qe
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) ==> Pe down; Qe
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) ==> Pe down; Qe
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) ==> Pe up; Qe
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--Qe
increases, but Pe 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--Pe
increases, but Qe 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 Qe
is the same; it is only relative price changes that
have
the effects we are talking about here)
c. Demand Decreases While Supply
Increases--Pe
decreases, but Qe 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--Qe
decreases, but Pe 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)
Day 10: Demand and Supply:
Consumer Surplus, Producer Surplus, Tax Incidence,
Welfare Impacts (Chapter 7)
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)
Day 11: Elasticity: A Measure of "Responsiveness" In Addition to Slope (Chapter 6)
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):
%ChY/%ChX = (ChY/Y0)/(ChX/X0)
(advantages:
simplicity, intuition)
= (ChY/ChX)x(X0/Y0)
(GRAPH--linear
case)
ii. average prices and quantities (arc elasticity):
%ChY/%ChX = [ChY/(Y0+Y1)/2]/[ChX/(X0+X1)/2]
= [ChY/(Y0+Y1)]/[ChX/(X0+X1)],
since the 2's cancel
= (ChY/ChX)x[(X0+X1)/(Y0+Y1)]
(discuss GRAPH)
Day 12: Elasticity: The Three Demand Elasticities of Concern (Chapter 6)
I. "Own-Price Elasticity" (è)--assume this is
the
one, if asked about the "elasticity of demand"
a. Definition: è = %ChQdx/%ChPx,
where Qdx is quantity demanded of X and Px 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 = %ChQdx/%ChY,
where Qdx 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 = %ChQdx1/%ChPx2
, 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)
Day 13: The Elasticity of Supply: Price and Other (Chapter 6)
I. The Price Elasticity of Supply
(é)--Responsiveness
Along
a Supply Curve
a. Definition: é = %ChQsx/%ChPx,
where Qsx is quantity supplied of X and Px 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)
Day 14: Trade and Comparative Advantage (Chapter 31, portions)
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.
Day 15: Rationality Revisited
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 (MUA/PA = MUB/PB
= ...)
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)
(THE PRECEDING IS THE MATERIAL FOR THE FIRST MIDTERM)
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!)
Day 16: The Production Function and the Cost Function (Chapter 12)
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/MPL (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 MPL
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 MPL 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.
Day 17: Firm Behavior (Price Takers) (Chapter 13)
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).
Day 18: Firm Behavior (Price Makers) (Chapter 16, a little of 14 & 15)
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.)
Day 19: Firm Behavior (Price Discrimination & Cartels) (Chapter 16)
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.
Day 20: Input Markets and Income Distribution: Firm Demands for Inputs (Chapter 17)
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 = PLxLabor + PKxCapital
+ PNRxNat. Res.("Land") + PExEntrep.)
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.)
Day 21: Input Markets and Income Distribution: Supply of Inputs by Households (Chapter 17)
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)
Day 22: Input Market Topics (Chapter 17, portions of 18)
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 MPL!)
Day 23: Assets: Discounting, Compounding, and the Role of Time in Economics (Class notes, portions of Chapter 11)
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)
Day 24: Public Choice: Will Government Do "Better?" (portions of Chapter 9)
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!
Remaining Time: REVIEW--Some Commonly Encountered Economic Myths
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.