Monday, January 30 th

Transcription

1 Monday, January 30 th Draft of Essay 1 due in labs this week Post electronic version online at Turn-It-In on Blackboard prior to lab. Submit two hard copies at the beginning of lab. Late penalties: Up to 24 hours late: 10% deduction Between 24 and 48 hours late: 25% deduction More than 48 hours late: no credit Midterm #1: February in the Testing Center Monday and Tuesday: No late fee Wednesday: $5 late fee Thursday: $7 late fee and test must be in hand by 11 am

2 Markets and Liberty - I 2 MARKETS AND LIBERTY I

3 Markets and Liberty - I 3 Outline (2 lectures) The magic of markets Gains from exchange (trade) Money Specialization Competition How markets work Demand, supply, and price adjustment The role of profits The roles of government in a market economy Government restriction of exchange

4 Markets and Liberty - I 4 The magic of the market Smith showed how freedom and a market economy work to achieve the best outcome in the face of self interest. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but to their own interest. We address ourselves, not to their humanity, but to their self-love Adam Smith, Wealth of Nations

5 Markets and Liberty - I 5 Video: Steak in New York City One way to get a steak in NY is to raise and slaughter own beef (in Central Park?). Another is to depend on the magic of the market.

6 Markets and Liberty - I 6 Video: Steak in Soviet Russia Getting steak in a command economy.

7 Markets and Liberty - I 7 The magic of the market How does the market do it? Without government direction, how does a market economy cause individuals freely pursuing only their self interest to undertake the cooperation necessary to satisfy my desire for a steak?

8 Market Economy Free exchange (trade) increases wealth the gains from exchange Three things expand the gains from exchange: Money Specialization based on comparative advantage. Competition. Prices and profits provide key guiding information.

9 Exchange Increases Wealth Both parties to an exchange are better off, because it is voluntary. [Recall auction of doughnuts.]

10 Economic Conflicts 10 Video: The Gains from Exchange Look for the gains from exchange illustrated in this McDonald s ad.

11 Exchange Increases Wealth Both parties to an exchange are better off, because it is voluntary. [Recall auction of doughnuts.] More exchange in society makes it better off economically. Restricting exchange makes the society worse off economically.

12 Market Economy Free exchange (trade) increases wealth. Three things expand the gains from exchange: Money Specialization based on comparative advantage. Competition. Prices and profits provide key guiding information.

13 Money Facilitates Exchange Money removes the need for a coincidence of wants. Anything can be used for money, as long as everyone agrees on its value. Money is one the most important inventions ever.

14 Market Economy Free exchange (trade) increases wealth. Three things expand the gains from exchange: Money Specialization based on comparative advantage. Competition. Prices and profits provide key guiding information.

15 Specialization and Exchange Key concepts Scarcity: society does not have enough resources to meet everyone s wants. Scarcity is a basic fact of life.

16 Video: Old Couple and Potato Chips Scarcity: You can t always get what you want. (Rolling Stones)

17 Specialization Key concepts Scarcity: society does not have enough resources to meet everyone s wants. Scarcity is a basic fact of life. Scarcity implies that we must make choices, and choices have costs. Opportunity cost: the value of the best foregone alternative choice.

18 Markets and Liberty - I 18 The Opportunity Cost of Going to College Tuition ($5000) 4 Years = $20,000 Books ($1000) 4 Years = $4,000 Misc expenses ($500) 4 Years = $2,000 Foregone Earnings 4 Years = $100,000 Total Opportunity Cost of College = $126,000

19 Video: Burger or Heather Every choice has a cost.

20 iclicker Question Judy wants to travel from SLC to Denver. Travel by air requires a $300 ticket and takes 2 hours. Travel by bus requires a $180 ticket and takes 10 hours. Judy values her time at $20 per hour. Which way of travel has the lower opportunity cost? A. Air [Opportunity cost by air: $300 + $40 = $340] B. Bus [Opportunity cost by bus: $180 + $200 = $380] C. We cannot tell from the information given.

21 Specialization Key concepts Scarcity: society does not have enough resources to meet everyone s wants. Scarcity is a basic fact of life. Scarcity implies that we must make choices, and choices have costs. Opportunity cost: the value of the best foregone alternative choice. Law of Comparative Advantage: People specialize in producing goods for which they have low opportunity costs and exchange those goods for other goods for which their opportunity cost is higher.

22 Example: Exchange, Specialization, and Comparative Advantage Time required to get work done Time to: Mona Lisa Clean one apartment 1 hour 2 hours Paint one apartment 1 hour 4 hours If each cleans and paints own apartment: Mona works for 2 hours, Lisa for 6 hours. Suppose Mona paints both and Lisa cleans both: Mona works for 2 hours, Lisa for 4 hours.

23 Markets and Liberty - I 23 Example - continued Opportunity Costs Cost to: Mona Lisa Clean one apartment 1 painted apt. ½ painted apt. Paint one apartment 1 cleaned apt. 2 cleaned apt. Thus, Mona is low-cost painter; Lisa is low-cost cleaner. I.e., Lisa has a comparative advantage in cleaning apartments. Could Mona and Lisa find an exchange that would give gains to both?

24 Markets and Liberty - I 24 Example - continued Opportunity Costs Cost to: Mona Lisa Clean one apartment 1 painted apt. ½ painted apt. Paint one apartment 1 cleaned apt. 2 cleaned apt. Suppose Mona paints her apartment and ¾ of Lisa s ; Lisa cleans both apartments and paints the remaining ¼ of her apartment. Mona works for 1¾ hours, Lisa for 5 hours.

25 Markets and Liberty - I 25 Example - concluded This example illustrates that both parties benefit from specialization and exchange even if one is better at everything. The key is that each party is the low opportunity cost producer of something.

26 Four Key Points Relating to the Law of Comparative Advantage (LoCA) Resources are put to best use. Even low-skill individuals benefit from the LoCA. Often, jobs will not be filled by the most productive people. Specialization according to the LoCA leads to lots of economic interdependence.

27 Market Economy Free exchange (trade) increases wealth. Three things expand the gains from exchange: Money Specialization based on comparative advantage. Competition. Prices and profits provide key guiding information.

28 Markets and Liberty - I 28 Competition Expands Gains from Exchange Competition Spurs producers to produce better products at lower costs. Benefits consumers. This leads to more exchange.

29 Video: Competition in Health Care Look for evidence that competition leads to better service at a lower price.