Presentation on theme: "Antony Davies, Ph.D. Duquesne University Click here for instructions."— Presentation transcript:
Antony Davies, Ph.D. Duquesne University Click here for instructions.
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This unit is divided into several sections. Start with the micro-lecture. Then proceed onto each section. You can click on a link below to navigate to the section where you had recently left off. Micro-Lecture Section 1: The Laws of Economics Section 2: Information and Intuition Section 3: Solutions and Error Correction Section 4: Decisions Section 5: Conclusion Unit Summary & Assignment
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THE LAWS OF ECONOMICS
Everything is scarce. Is there anything that you can consume that is not scarce? What does it mean to consume something? To consume something is to experience or use that thing. People think of consumption as being synonymous with eating but economists think of consumption more broadly: o We consume cars when we use them to travel to a destination. o We consume a sunset when we sit and look at it. o We consume perfume when we smell it. o We consume the company of another person when we spend time with that person.
Everything is scarce. Is there anything that you can consume that is not scarce? What does it mean to consume something? Something is scarce when the amount you can consume is limited. The amount may be limited for any of several reasons: o You cant afford to purchase the thing. o There isnt enough of the thing available for you to consume any. o There isnt enough time to procure and consume the thing
Every choice includes a tradeoff. What do you give up in order to get something else? A tradeoff is the that which you must forego in order to consume something else. o When you purchase a pair of shoes for $10, you forego all the other things that the $10 could have purchased instead. o When you spend an hour reading, you forego all the other activities that you could have done in that hour.
The cosmos is a non-linear place. What do you give up in order to get something else? When you consume something, you experience opposing forces. o The more you consume the thing, the more happiness you attain. o The more you consume the thing, the less variety you experience and the less happiness you attain. After working in the hot sun, a cold drink brings you happiness. A second cold drink also brings you happiness, but less happiness than did the first drink. As we consume more, happiness increases but at a decreasing rate.
The cosmos is a non-linear place. When a firm produces, it experiences opposing forces. o The more labor the firm hires, the more the workers can specialize. o The more labor the firm hires, the more internal congestion is created.congestion One worker cuts wood, paints the wood, and assembles the wood to make a birdhouse. One worker can make one birdhouse per day. One worker cuts wood. One worker paints the wood. One worker assembles the wood. Because of specialization, the three workers can make ten birdhouses per day. Because of specialization, the number of workers tripled but production increased ten-fold.
The cosmos is a non-linear place. When a firm produces, it experiences opposing forces. o The more labor the firm hires, the more the workers can specialize. o The more labor the firm hires, the more internal congestion is created.congestion One worker cuts wood. One worker paints the wood. One worker assembles the wood. The three workers can make ten birdhouses per day. With limited space and tools, thirty workers start to get in each others way. Thirty workers can make twenty birdhouses per day. Because of congestion, tripling the number of workers only doubles production.
The cosmos is a non-linear place. When a firm produces, it experiences opposing forces. o The more labor the firm hires, the more the workers can specialize. o The more labor the firm hires, the more internal congestion is created.congestion As the firm hires more workers, output increases, first at an increasing rate, but then at a decreasing rate.
People respond to incentives. In the UK, from 1985 to 1992, car travel became safer due to the introduction of safety devices in cars. But, the drivers mortality rate remained unchanged. Why? Because people respond to incentives. As cars became safer, people (on average) felt more comfortable driving longer distances. Driving longer distances increased the time spent in cars. The decrease in mortality due to safer cars was counter-balanced by the increase in mortality due to people spending more time driving.
People respond to incentives. In Africa, foreign aid often hurts developing countries. Why? When the UN gives food aid, it increases the supply of food driving the price of food down. Local farmers find it unprofitable to farm because they cannot compete with free food. With fewer local people farming, the country becomes dependent on continued food aid.
Everything is scarce. Every choice involves a tradeoff. The cosmos is a non-linear place. People respond to incentives. You want it. You cant have it. What are you going to do about it? Recall two principles you learned in the previous units…
Everything is scarce. Every choice involves a tradeoff. The cosmos is a non-linear place. People respond to incentives. Exchange is a positive-sum game. Profit happens when someone creates value for others. You want it. You cant have it. What are you going to do about it? The answer lies in community.
At its root, economics studies how people, who have mutual respect for each others life and property, come together to benefit each other. The economists focus on the profit motive can be interpreted as evidence that economics is about selfishness. But, when we understand that profit is what happens when someone provides value to another, we can interpret profit as a measure of the extent to which people have benefited their community. The answer lies in community.
INFORMATION AND INTUITION
When it comes to economics, human intuition sometimes fails because the human mind has evolved to wring maximal use out of limited information. Two mental tools humans use are anchoring and information availability. Good for making snap decisions. Bad for making thoughtful decisions.
When we see a piece of information, we evaluate subsequent information in light of the first piece of information.
Information In the newspaper, you read about a single mother working three jobs to support her family. Policy Question Should the government institute programs to help people like this? Problem We do not know how common this example is. A single piece of evidence is anecdotal – it provides no information as to the magnitude of the problem in society at large. This problem is compounded because the media has a financial incentive to present information that is atypical.
We make decisions on the basis of information that is available to us and we tend to assume that information not available to us would not contradict the information that is available. Information In the newspaper, you read that many children were injured in a school bus accident because they did not have seat belts. Policy Question Should the government require seat belts in school buses? Problem We do not know the tradeoffs for requiring seat belts. How many childrens lives would be saved by requiring seat belts? How many lives could we save by taking the money that we would have spent on installing seat belts and spending it elsewhere (e.g., malaria prevention)?
So what? Humans will sometimes make poor decisions due to anchoring and availability. In comparing the government to the free market, the relevant question is not only which structure should provide solutions. The relevant question is also which structure is able to identify and correct errors more quickly. The humans that make decisions within a government structures have the same limitations and motivations as the humans that make decisions within free market structures.
SOLUTIONS AND ERROR CORRECTION
Governments create solutions by design – a group of people come together and design a solution to a problem and then design a means for implementing the solution. To design solutions effectively requires omniscience – the people designing the solution must have complete knowledge of the needs of all the people affected by the solution and knowledge of all the costs associated with achieving the solution.
To implement designed solutions requires omnipotence – the people who are affected by the solution must be prevented from taking actions the might undermine the solution.
Suppose our problem is that children do not have enough shoes. We need to design a solution that provides free shoes to all children who need them. To design the solution, for every child, we need to answers to the following questions: Does the child need shoes? What size shoe does the child need? How costly is it to produce shoes? It seems easy to get answers to these questions – just ask. The problem is that people have an incentive not to tell the truth.
Does the child needs shoes? People who do not need shoes have an incentive to say that they need shoes because they might be able to use or sell the shoes later. What size shoe does the child need? Because the shoes are free, parents have an incentive to specify sizes that fits the children exactly. But, if the parents were to buy shoes, they would likely buy sizes slightly larger than the children need knowing that the children would be able to use the shoes for a longer time.
How costly is it to produce shoes? Because the government purchases the shoes with taxpayers money, the government has less incentive to negotiate for the best price. Knowing this, producers have the incentive to charge more for the shoes.
Even if the government had correct answers to these questions, it could not implement its solution of providing children with shoes unless the government were omnipotent. To implement the solution, the government must be able to do the following things: Acquire the shoes. Distribute the shoes. Ensure that the recipients wear the shoes. This might also appear easy, but consider that people have incentives to prevent the government from doing these things.
Acquire the shoes. The people who produce the shoes have an incentive to charge the government a high price for the shoes and to provide lower quality (and therefore less costly) shoes. Distribute the shoes. The people who distribute the shoes have an incentive to steal the shoes and sell them to others. Ensure that the recipients wear the shoes. The people who receive the shoes have an incentive to sell or trade the shoes if they would rather have something other than shoes.
Markets provide solutions by spontaneous order – people who have needs and people who can satisfy those needs seek each other. Spontaneous order requires freedom – the people seeking solutions and the people offering solutions must have the freedom to enter into agreements with each other. The only information the people need is information about themselves. The people who need a solution must know how badly they want a solution and what they are willing to give up to acquire a solution. The people who offer a solution must know how costly it is for them to provide the solution.
Suppose our problem is that children do not have enough shoes. If we allow parents the freedom to seek out and create their own solutions to this problem, then each parent must answer the following questions for himself: Does the child need shoes? What size shoe does the child need? How costly is it to produce shoes? Not only does the parent know the answers to these questions, the parent has no incentive to lie to himself.
Does the child needs shoes? The parent knows how badly his child needs shoes. He also knows how badly the child needs other things that he could buy instead of buying shoes. He has no incentive to lie to himself because he will pay for the lie by ending up with shoes when he would rather have something else, or something else when he would rather have shoes.
What size shoe does the child need? The parent knows what size shoe the child needs. Depending on how frequently the child wears shoes and how expensive the shoes are, he also knows whether it would be better to buy larger shoes that the child can wear for a longer time. How costly is it to produce shoes? Producers know that buyers have the incentive to seek out low priced shoes, so producers will compete with each other to offer shoes at the lowest possible price.
Both the government and the free market are composed of fallible and self-interested humans. Regardless of whether decisions are made by the government or by the free market, errors will occur. For example, under either system, people may erroneously make choices that result in the production of too many shoes of the wrong size. What is interesting to economists is what is required to quickly identify and correct errors.
To detect and correct errors (for example, incorrectly producing many shoes of the wrong size) requires omniscience, omnipotence, and altruism. As with constructing and implementing a solution, correcting errors requires that the government have full knowledge and the ability to control peoples behaviors. To correct solutions, the government also must be altruistic. If the people working in the government do not have the welfare of others as their primary motivation, then the government will not have the incentive to seek out and correct errors.
To detect and correct errors (for example, incorrectly producing many shoes of the wrong size) requires self-interest and natural selection. When buyers are self-interested, they will avoid buying products that are inferior and more expensive. This reduces the profits for firms that provide inferior and more expensive products and increases the profits for firms that provide better and less expensive products. As their profits decline, firms that produce inferior and more expensive products will either find ways to improve the qualities and reduce the costs of their products, or the firms will go out of business due to a lack of customers. This is natural selection. Buyers self-interest fuels natural selection. Natural selection forces firms to correct their errors.
GovernmentDesign (requires omniscience and omnipotence) MarketSpontaneous Order (requires freedom)
GovernmentDesign (requires omniscience, omnipotence, and altruism) MarketSelf-Interest and Natural Selection (requires freedom)
One can argue that there are some decisions that, for the good of society, should not be left to the free market. For example, if children wore seat belts on school buses, there would be a lesser chance of children being injured in school bus accidents. The following statements are true: Protecting children is good. Seat belts on school buses protect children. If we leave the decision as to whether or not to have seat belts on school buses to the market, then it is possible that the market might not produce buses with seat belts.
Protecting children is good. Seat belts on school buses protect children. If we leave the decision as to whether or not to have seat belts on school buses to the market, then it is possible that the market might not produce buses with seat belts. These statements appear to imply that we need the government to require school buses to have seat belts. The problem is that there is a missing statement – all choices involve tradeoffs. The correct question to ask is, What are the tradeoffs in requiring seat belts on school buses?
Let us look at how many lives we can save by spending money in several areas. For example, the United Nations estimates that spending money on HIV tests for sex workers saves one life for every $3.35 spent.
Spending money training midwives saves one life for every $8.50 we spend. Spending money on treating malaria or mitigating global warming saves one life for every $10.00 we spend.
Spending money on anti-smoking campaigns, malaria prevention, PAP smears, and colonoscopies saves one life for every $2,500 to $7,000 we spend.
Installing airbags in cars saves one life for every $720,000 we spend.
Installing seat belts on school buses is estimated to save one life for every $2.75 million we spend.
But, were talking about saving childrens lives. You cant put a price on that! If it saves just one life, no price is too much! Bring it on!
Spending $2.75 million on bus seat belts will save 1 life. Spending $2.75 million on HIV tests will save 820,000 lives. When we spend money on seat belts so as to save 1 life, we condemn to death 820,000 people whose lives we could have saved by spending the money on HIV tests instead. Everything is scarce. Every choice involves a tradeoff.
Return to the true statements: Protecting children is good. Seat belts on school buses protect children. If we leave the decision as to whether or not to have seat belts on school buses to the market, then it is possible that the market might not produce buses with seat belts. Now that you understand the tradeoffs of spending money on seat belts, you should see that the third statement is not an indictment of allowing markets to make decisions, but rather is an indictment of allowing government to make decisions.
If we allow the market to decide whether or not school buses should have seat belts, we would likely find parents less willing to pay a higher price for buses with seat belts than to pay a higher price for schools that provide treatment for malaria.
Everything is scarce, so every choice will involve tradeoffs. Who decides what tradeoffs are acceptable? Deciding by vote allows everyone an equal say. Should everyone have equal say? Should we weight each vote based on how strongly the voter feels about the tradeoffs? How do we know how strongly the voter feels? If we ask the voter how strongly he feels, he may have an incentive to lie.
Prices are much more than how much something costs. Prices signal how strongly the community feels about things. All other things equal… The more people want something, the higher the price will be. The greater the tradeoffs of bringing something to market, the higher the price will be.
Competition among producers will drive the price of a good down to reflect the producers tradeoffs for investing resources in producing the good versus producing other goods. Competition among consumers will drive the price of a good up to reflect the consumers tradeoffs for spending their money consuming the good versus spending their money consuming other goods. In the end, the free market price will give people the incentive to divert the right amount of resources to producing the good and to divert the right amount of effort to attaining and consuming the good. The result will be socially optimal.
In this unit, you learned that humans, whether acting in the capacity of government officials or in the capacity of consumers or producers in a free market, are subject to the same laws of economics. Everything is scarce. Every choice involves a tradeoff. The cosmos is a non-linear place. People respond to incentives.
Taken together, these laws imply that the benefit of (competitive) free- market solutions to government solutions is that the latter frequently ignore the reality of tradeoffs (e.g., If elected, I will increase spending on social programs and reduce your taxes.) and scarcity (e.g., If elected, I will guarantee that every person has access to the best medical care.). Because government solutions cannot respond quickly or efficiently to changing circumstances and new information, government solutions also tend to ignore the fact that the cosmos is a non-linear place and that people respond to incentives (e.g., Raising the minimum wage will not destroy jobs.).
Either individually, or in groups, look for a law the government has enacted that is intended to promote some good (e.g., public safety, improved standards of living, etc.). Keeping in mind that all things are scarce and that all choices involve tradeoffs, think about how enforcing the law alters peoples incentives.
Once you have a law to look at, complete the following tasks: 1.Appealing to incentives, can you make an argument for why the law might end up achieving the opposite of its intended purpose? Post your response onto the JPIC 220 Wiki.JPIC 220 Wiki 2.Conduct further research to see whether or not the law achieved its intended purpose. HOW TO POST ONTO WIKI 1.Click on the Wiki discussion link above. 2.Sign into Wikispaces so that you are able to post via the Sign In link. 3.Type your response in the reply box at the bottom of the page
Read the following article, which is available on the JPIC 220 ERes site at the Gumberg Library. To access these articles, click on the links below. You may be prompted to enter a password ( JPIC ). Landsburg, Steven E. "Why Prices Are Good: Smith Versus Darwin." The Armchair Economist: Economics and Everyday Life. New York: Free, Print.
Congestion occurs when workers begin to interfere with each other's abilities to work. For example, adding workers to a confined work space causes physical congestion because workers begin to have too little space to perform their functions well.