Economics 110 Class #3 Theoretical Capitalism – Part II


Economics 110 Class #3 Theoretical Capitalism – Part II

1. Review points from Part I

2. Full Employment

A. Do Say’s Law --- prices fall. Wages fall. Real Interest Rates fall.

B. Flu analogy

3. Distribution of Income

A. wages paid according to contribution to revenues (produce more or produce goods or

servies of higher value)

1. explain using athletes and entertainers

B. Profits --- economic profit of zero (explain what this means)

1. explain how competition drives profits down to the amount that can be received in the

best alternative

4. International Trade (favor openness)

A. Law of Comparative Advantage (Ricardo) -- Specialization and Division of Labor

1. explain using lawyer – secretary example

B. What determines comparative advantage --- relative factor endowments and factor


C. U.S. comparative advantage?

D. Not everyone within the country benefits

E. Helps to preserve competition

F. McDonald’s Theory of War

5. Economic Growth

A. Result from incentive to increase one’s personal wealth in a world of competition (Bill

Gates etc.)

B. Specialization and division of labor increase productivity

C. Profits are used for investment spending (define this)

D. Investment spending is financed by savings . Incentive to save to accumulate.

1. Banks etc.

allocate the savings to the best uses (where the returns are the highest)

E. Incentive to invest in human capital (define this)

F. Now, relating growth to the proper set of institutions – especially private property rights

6. Criticisms of Market Capitalism

A. Tends to have lack of competition at times (electricity)

B. Economic insecurity --- old age, disease, unemployment

C. Negative Externalities (pollution, worker safety, product safety)

D. Can tend to recessions (1990; 2001)

E. Inequality (recent history). Also poverty. Leads to inequality in political power.

F. Rent seeking behaviors (review public choice)

G. Emphasis on pecuniary values (Me Generation!) --- study of selfish behavior and study of


1. Can lead to corruption without an effective government to monitor (Enron, Worldcom,