Woods sum ‘05
ECP 6705-149
ECONOMICS OF BUSINESS DECISIONS
Time:
Saturday, 12:40 – 2:20. TTH.
Place:
042-1101
Term:
Summer 2005
Course Number:
ECP 6705 - 149
Course Title:
Economics of Business Decisions
Course Description Prerequisites: ECO 5115 or equivalent.
and Prerequisites: Study of the applications of economic theory to decision-making
business.
Instructor:
L.A. Woods
Office Hours:
Saturdays, before and after class
Via e-mail: lwoods@unf.edu
Phone:
[904] 620-2641
E-mail:
lwoods@unf.edu
Required Texts:
James D. Gwartney and Richard L. Stroup (1993) What Everyone
Should Know About Economics and Prosperity. Tallahassee: James
Madison Institute.
Assigned supplemental reading from a variety of sources,
including:
Michael Crichton’s official website (www.chrichton-official.com),
under ‘Other Projects’, ‘Speeches’. The following are of particular
interest in regards to the Scientific Method and legitimate research
methodologies:
“Aliens Cause Global Warming,” Caltech Michelin Lecture
(July 17, 2003);
“Why Speculate?” A Speech to the International
Leadership Forum” (April 26, 2002);
“Remarks to the Commonwealth Club” (September 15,
2003);
A Speech to the Joint Session AEI-Brookings Institution,
(January 25, 2004); and
“Ritual Abuse, Hot Air, and Missed Opportunities: Science
And the Media,” American Association for the
Advancement of Science (January 25, 1999).
While Crichton’s papers deal primarily with what are known as
the ‘hard’ sciences, the procedures are also applicable to both the
business sciences and the social sciences, as well.
Unfortunately, there is a general failure to adhere to the high
standards of the ‘scientific method’ (or even basic honesty) in
contemporary professional and academic fields: see, for example:
Julian Simon’s Hoodwinking the Nation and John Stossel’s How
I Exposed Hucksters, Cheats and Scam Artists and Became the
Scourge of the Liberal Media…Give Me A Break.
Outside Readings:
In addition to the assigned reading materials in the texts, each
student is expected to read a total of ten (10) articles in scholarly
journals over the term. Summaries, outlines, or abstracts of the
articles are to be submitted to the instructor on a weekly basis
beginning the week of June 8th. No more than four of the articles
listed below may be used for this purpose. Articles should be
selected on the basis of relevance to materials discussed in the
texts or to materials discussed in class or the lecture notes.
The following articles are suggested readings. They have been
selected to provide clarification and amplification of concepts that
are introduced in the textbooks. A student expecting to earn an
outstanding grade in the course is expected to read all or most of
these articles.
*N. Kaldor. 1972. The irrelevance of equilibrium economics.
Economic Journal, 82, 1237-1255.
*P.A. David. 1985. Clio and the economics of QWERTY.
American Economic Review: Papers and Proceedings, 75,
2, 332-337.
*W.B. Arthur. 1990. Positive feedbacks in the economy. Scientific
American, 262, 2, 92-99.
*W.B. Arthur. 1989. Competing technologies, increasing returns,
and lock-in by historical events. Economic Journal, 99, 1,
116-131.
*R.H. Coase. 1937. The nature of the firm. Economica, 4, 386-
405.
*R.H. Coase. 1960. The problem of social cost. Journal of Law
and Economics, 3, 1-44.
*H. Demsetz. 1967. Toward a theory of property rights. American
Economic Review, 57, 2, 347-359.
*E.G. Furubotn and S. Pejovich. 1972. Property rights and
economic theory: a survey of recent literature. Journal of
Economic Literature, 10, 4, 1137-1162. [A long annotated
bibliography.]
*T.L. Anderson and P.J. Hill. 1975. The evolution of property
rights: a study of the American West. Journal of Law and
Economics, 18,1, 163-180.
*T.L. Anderson and P.J. Hill. 1983. Privatizing the commons: an
improvement? Southern Economic Journal, 50, 2, 438450.
*F.A. Hayek.1945. The use of knowledge in society. American
Economic Review, 35, 4, 519-530.
*D.E. Booth. 1986. Long waves and uneven regional growth.
Southern Economic Journal, 53, 2, 448-460.
Additional
Requirements:
Each student is expected to be well informed on current economic
issues, by reading the Investor’s Business Daily (especially, the
Monday issues which go on sale on Saturday) or the Wall Street
Journal; and viewing Market Wrap on CNBC or Nightly Business
Report (PBS).
Lecture Notes:
A single copy of current lecture notes will be made available to
students.
Prefatory Review of Key Ideas in Economics
Purpose of using this book – eliminate economic ignorance! Many notions that people hold about
economics are in error, largely because they have been given the theoretical mechanics, but not the broader
rudimentary concepts that form the structural framework, e.g., the ‘law of demand’ vs. ‘incentives matter’.
It also adheres to the military’s KISS [Keep It Simple, Stupid] principle.
The authors’ open with a simple statement that incorporates one of the ‘key elements of
economics’ – “there’s no such thing as a free lunch’ (TANSTAAFL). “We realize that your time is
valuable.” (iv) Embedded in this statement is the recognition that: (i) resources, including your time, are
scarce (the ‘law of scarcity’; and (ii) they can be put to alternative uses (they have an alternative or
opportunity cost). One of the primary reasons that learning the ‘basic’ economic principles outlined in the
book is that they: “…enhance your ability to differentiate between sound arguments and economic
nonsense, i.e., separate the truth from the BS that constantly presented in the media. Often the media elite
make misleading statements such as: “Gasoline prices are at an all time high.” Which is true, if you fail to
discount prices for the influence of inflation, brought to us by the government’s ability to print (create)
money without constraint. Ask yourself, what has happened to the five-cent Hershey bar. Equally
misleading is their confusion over Revenue and Profit when reporting “Oil companies profits are up 350
percent!”, when the true metric was Gross Revenue. And, again, “Health care costs (prices) are too high in
the United States,” implying that this is a result of greedy businesses and medical professionals, without
inquiring further about WHY they are high! Without too much effort, it is possible to deduce several
reasonable reasons that account for the high costs, though not necessarily in order of importance:
(i)
the role of Medicare (government intervention):
[by setting reimbursements to doctors, hospitals and other medical
professionals
at below market clearing (equilibrium) prices, the unfunded costs are
shifted onto consumers with insurance or who pay cash. This raises the
premiums on health insurance, as well.]
(ii)
the ‘greed’ of tort lawyers (Fast Eddy Farah and John Edwards);
[skimming-off 33%, PLUS costs from the gross award, results in higher
premiums paid by doctors for mal-practice insurance, translating into
even higher bills to health insurance companies and higher premiums to
consumers. Transfer wealth from those that have to themselves.]
(iii)
a gradually aging population:
[the need for medical care increases with age, placing greater demand
on the healthcare system.] and
Murray N. Rothbard has observed: “But why are rates (health care) high and rising? The answer is
the very existence of health-care insurance, which was established or subsidized or promoted by the
government to help ease the previous burden of medical care.” (78) By this he means that there is a system
of third party payers (government or private insurers) that, “…pay, not a fixed sum, but whatever the doctor
or hospital chooses to charge.” (79) Moreover, he reports that “…medical customers…have come to think
of unlimited third-party payments as some sort of divine right….” (79) Further, he notes: “…there is
another deep flaw in the medical insurance concept. Theft is theft, and fire is fire, so that fire or theft
insurance is fairly clear-cut – the only problem being the ‘moral hazard’ of insurees succumbing to the
temptation of burning down their own unprofitable store….” (79) “…there is no way to prevent a galloping
moral hazard, as customers – their medical bills reduced to near zero – decide to go to the doctor every
week to have their blood pressure checked or their temperatures taken.” (79) Health insurance became a
commonality during WWII as wages were fixed, but benefits were not…so companies began to provide
health insurance, in lieu of pay increases.
Somewhat later in his article, Rothbard wrote:
But the roots of the current medical crisis go back much further than the 1950s and medical
insurance. Government intervention into medicine began much earlier, with a watershed in
1910 when the much celebrated Flexner Report changed the face of American medicine.
[Named after Abraham Flexner and commissioned by the Carnegie Institute for Medical
Research.]
Flexner’s report was virtually written in advance by high officials of the American
Medical Association, and its advice was quickly taken by every state in the Union.
The result: every medical school and hospital was subjected to licensing by the state,
which would turn the power to appoint licensing boards over to the state AMA. The
state was supposed to, and did, put out of business all medical schools that were
proprietary and profit-making, that admitted blacks and women, and that did not
specialize in orthodox, ‘allopatic’ medicine: particularly homeopaths, who were then
a substantial part of the medical profession, and a respectable alternative to orthodox
allopathy.
Thus through the Flexner Report, the AMA was able to use government to cartelize the
medical profession: to push the supply curve drastically to the left (literally half the
medical schools in the country were put out of business by post-Flexner state
governments), and thereby raise medical and hospital prices and doctors’ income. (80)
…the medical establishment was now able to put competing therapies (e.g., homeopathy)
out of business; to remove disliked competing groups from the supply of physicians
(blacks, women, Jews); and to replace proprietary medical schools financed by student
fees with university-based schools run by the faculty, and subsidized by foundations and
wealthy donors.
…our very real medical crisis has been the product of massive government intervention,
state and federal, throughout the century; in particular, the artificial boosting of demand
coupled with an artificial restriction of supply. The result has been accelerated high prices
and deterioration of patient care. (81)
Source: M.N. Rothbard. 1995. “Government Medical ‘Insurance,’ Making Economic Sense.
Auburn, AL: Ludwig von Mises Institute, 78-81.
[It must be noted that the AMA was pursuing what economists call ‘rent-seeking behavior.’ Rentseeking frequently involves going to government (especially the legislative or judicial branches) to
get what they are unable to obtain through free-market transactions. Zoltan J. Acs and Daniel A.
Gerlowski have defined ‘rent-seek behavior’ more narrowly: “An attempt by some interested party
to alter the allocation of rents in a contractual agreement; in general, does not create value within
the organization.” 1996. Managerial Economics and Organization. Upper Saddle River, NJ:
Prentice Hall, 448.
Another, recent example of TANSTAAFL has been borne out by the November elections in
Florida. One of the initiatives that passed overwhelmingly was to increase the ‘minimum wage’ to a ‘living
level’ as of January 1, 2005. Has anyone been to a McDonald’s since New Year’s Eve? What has happened
to the price of a Big Mac, or a Big Mac Meal? Raising the minimum wage to businesses (you know, those
GREEDY folks) has increased their cost of doing business, and they have decided to ‘share their pain’ by
passing these increases on to their customers (roughly a 30% increase in the price of a Big Mac), rather
than cutting the size of a burger or order of fries. [Keep in mind, this higher minimum wage applies to ALL
firms, not just ‘fast-food’ operations – retail outlets (Kmart, Target, Wall Mart), grocery stores (Publix,
Winn-Dixie, Albertson’s), hospitals, movie theaters, and so on…expect to pay higher prices in ALL areas to
cover these higher labor costs. Note Well: These increased costs of labor HAVE NOT BEEN
ACCOMPANIED by an increase in labor productivity!!!] The importance of this observation may be seen
the fifth “Key Element of Economics” cited by Gwartney and Stroup, below.] There are still several
adjustments that may be expected, if you understand economic processes – substitute capital (equipment)
for labor, which means fewer entry level jobs will be available for young workers reducing opportunities
for women and minorities to obtain work experience leading to BETTER jobs. Milton Friedman once stated
in an interview with Playboy (early 1970s), in regard to the ‘minimum wage question’: “It is better to be
employed at $3.50 and hour, than unemployed at $5.00 an hour.” [See: Robert L. Formaini, “Milton
Friedman – Economist as Public Intellectual,” Economic Insights, Vol. 7, No. 2; available at:
www.dallasfed.org/research/ei/ei0202.html.] Additionally, some firms may be forced to REDUCE their
labor force due to higher labor costs, resulting in higher rates of UNEMPLOYMENT… this result may be
seen clearly in a number of European nations that have heavy handed government intervention in their
economies, especially in labor markets, foe example France and Germany, which have unemployment rates
twice those in the United States. Such secondary outcomes are referred to by economists as ‘unintended
consequences’ (note: the tenth “Key Element of Economics” cited by Gwartney and Stroup, below) and
they have unintended costs.
Economic ignorance seems to stem from a concentration on the theoretical mechanics of
economics (mathematical models, et.), rather than focusing on the basic principles. This results in a tuningout of students. The key principles have been provided to people from the cradle onward, but without
simple approaches to the messages, e.g.,
Aesop’s fable of the ‘Grasshopper and the Ants’ – what is the message of the fable? Simply, it is
self-reliance and self-responsibility! Rather than accepting responsibility it is easier
(more convenient?) to seek self-absolution by passing the blame or responsibility onto
others or society as a whole, e.g., the old Flip Wilson character (Geraldine) – “The Devil
made me do it!” Place reliance on some third party to take responsibility – the
government, disregarding its inability to effectively/efficiently solve real human
problems because of its propensity to distort markets and to
create unintended consequences.
The child’s story, “Chicken Little,” has a message, too: THINK, don’t be stampeded into life(changing) threatening decisions on the basis of faulty information, no matter how loud
the message is shouted or how often! “The sky is falling! The sky is falling! Would
Turkey Lurky and Ducky Lucky and all the other barnyard critters have been better-off
had they just sat down and thought Chicken Little’s foolishness through. But, what did
they do? They followed a self-appointed false prophet (Foxy Loxy) to there doom. Are
there many ‘self-appointed false prophets’ out there? Count on it! Global warming, the
population bomb has exploded (Thomas Malthus and Paul Ehrlich) genetically modified
(GM) foods (Jeramy Rifkin), and vaccines will harm children, to name a few!
“The Little Red Hen” provides an additional example of a child’s story with a
profound message – the role of incentives and property rights (physical/ intellectual and
individual/group) in a well-ordered barnyard or society. We are always and everywhere
constrained by scarcity, whether of resources or of time. This reality means that ALL
human needs/wants cannot be satisfied at a moment in time, consequently some
individuals have more than others – an uneven distribution of looks, income, wealth,
land…. Those that have less would always like to have more. Hence laws and their
enforcement are necessary. An unspoken truth of the tale, expressed by the Little Red hen
is a property right to her and her children’s labor – ‘we worked to produce the final
product, and it is ours to use as we see fit.’ Keep in mind the Three Inalienable Rights
espoused by the Founding Fathers – ‘Life, Liberty and Pursuit of Happiness,’ remember
they were barrowed from John Locke’s ‘Life, Liberty and Property’. Contrast this with
the nonsense that everyone should have ‘equal shares’ à la Karl Marx, “From each
according to his ability, to each according to his need,” and Stalin’s re-write, “From each
according to his ability, to each according to his work’!
Gwartney & Stroup point out the fact that “political rules and policies” affect the economy –
largely as a result of the ‘law of unintended consequences’. Decisions are made and policies implemented
with utter disregard to potential future outcomes, which have probabilities that must be estimated and the
consequences calculated. Consider their admonition:
…we are a nation of economic illiterates. In a democratic setting, the
consequences of economic
illiteracy can be disastrous. People who do not understand the sources of
economic prosperity are
susceptible to schemes that conflict with the attainment of that prosperity. (v)
Ten Key Elements of Economics
1.Incentives Matter. In simple terms, if you want more of a certain activity or behavior, reward it, if you
want less, the penalize it. The ‘reward’ may be profits (sales), an ice cream cone (a child minding
his/her parents), or a kindly word (a ‘Thank you’) for a good deed done. The penalty may be a
higher tax on the activity, a spanking, or deprivation of a pleasurable activity (watching a favorite
TV program for a naughty child) or a rebuke for bad behavior. Responses are not instantaneous,
but require time for behavioral adjustments (a lagged effect). Uses market adjustment to a change
in price (buyers/sellers). A change in tax rates behaves the same way, households
must adjust their expectations and spending behaviors to both higher and lower rates. Please note
the comment (4):
….market prices will coordinate the actions of both buyers and sellers.
The example provided of ‘higher gasoline prices of the 1970s is both timely and telling. The
connection between voters and political candidates is also worthy of comment – see: Robert L.
Formaini. 2003. “James M. Buchanan – The Creation of Public Choice Theory,” Economic
Insights, 8 (2); available at:
www.dallasfed.org/research/ei/ei0302.
The insight that incentives also matter in socialist/communist societies is significant in avoiding
wishful thinking and the belief that certain economic laws may be repealed by caring politicians –
‘Let’s impose price controls’ – in the mistaken belief that there will be no consequences!
[SHORTAGES]
Gwartney & Stroup field a common notion: “…economic analysis only helps explain the actions
of self-centered, greedy materialists.” (5) By observing that “This view is false.”
2. There is No Such Thing as a Free Lunch. (or, more crudely: TANSTAAFL) TANSTAAFL was a term
coined by Milton Friedman, see: Robert L. Formaini. 2002. “Milton Friedman – Economist as
Public
Intellectual,”
Economic
Insights,
7
(2);
available
at
www.dallasfed.org/research/ei/ei0202.html. [Note: this is the same as Mankiw’s “Principle # 1
“People Face Tradeoffs”, 4-5]. The factor underpinning these statements is the so-called ‘law of
scarcity’, which gives rise to the principle of alternative (or opportunity) costs. These costs are
associated with the facts that we must contend with limited resources and unlimited wants (and,
perhaps more importantly, needs). Money spent on lighting bridges for the Super Bowl is no
longer available to add classrooms to public schools. This means that if we want more of one
item, it will be necessary to forego or give up alternative items as we transfer resources into the
production of the item desired. We must make choices between/among various alternatives
because of scarcity. This principle applies to government, as well as individuals. You may
remember this basic idea from the Production Possibilities Curve found in all Principles of
Economics texts. Of all costs, it is the costs that reflect ‘lost alternatives’ that are most frequently
ignored by individuals (if I go partying tonight, how will it affect my grade on tomorrows test?),
businesses (if we allocate investment dollars to this product, what alternative investments must be
give-up?) and government bureaucrats (if we provide public housing to this group, what services
must be foregone by other groups?) The Congress consistently ignores this principle
(TANSTAAFL)! They can always raise taxes, impose user-fees, impose price-controls, and,
thereby, distort markets, i.e., divert spending on PRIVATE sector goods and channel it into the
production of PUBLIC sector goods. This does not reflect the desires of consumers, but the wishes
of special interest groups, i.e., it represents rent-seeking behavior. (go to: Robert L. Formaini.
2003. “James M Buchanan. – The Creation of Public Choice Theory,” Economic Insights, 8 (2);
available at: www.dallasfed.org/research/ei/ei0302. ) Such costs are a critical force in directing
scarce resources to their ‘highest and best uses’ and avoiding mal-investment! See: Robert L.
Formaini. 1999. “Hayek – Social Theorist of the Century,” Economic Insights, 4 (1); also
available at: www.dallasfed.org/research/ei/ei9901; Robert L. Formaini. “Ludwig von Mises,
Economic Insights, 6 (4); available at: www.dallasfed.org/research/ei/ei0104.html. Roger W.
Garrison. 2001. Time and Money: The Macroeconomics of Capital Structure. London:
Routledge/Taylor & Francis Group, esp. Chapter 3; Ludwig von Mises, 1998. Human Action: A
Treatise on Economics. Auburn, AL: Ludwig von Mises Institute, esp. Chapter XX.
Prices provide signals to both consumers and producers: higher prices – buy less and produce
more; and lower prices – buy more and produce less [revealed in the demand/supply relationship].
In this process, increased consumer demand for a good, stimulates producers to attempt to increase
output. Output expansion requires producers to bid resources away from their use in the
production of other goods (their alternative uses). It is always necessary to remember Mises
admonition: in a free market, the consumer is king and that all production is for consumption!
Note the emphasis that Gwartney & Stroup place on the provision of so-called ‘free’ goods to an
‘individual or group’ and the opportunity costs that these ‘free’ goods impose on others. (7) They
are emphatic in their assessment:
…this merely shifts the costs; it does not reduce them. Politicians often speak of ‘free’
education’, ‘free medical care,’ or ‘free housing’. The terminology is deceptive. None
of these things are free.
Something to ponder, the Bush II administration’s proposed Medicare Prescription Drug Bill,
what are the likely opportunity costs? And, what are the potential unintended consequences? In
spite of many government attempts, none have been able to repeal the ‘Law of Scarcity’.
However, its restrictive nature has been loosened over the long haul by the activities of the
innovative actions of the ‘entrepreneur’. See: W. Michael Cox. 2001. “Schumpeter – In His Own
Words,” Economic Insights, Vol. 6, No. 3; available at: www.dallasfed.org/htm/pubs/ei/ei6_3_01.
For example, as demand for copper has grown and prices have risen, it has been displaced in many
uses by cheaper and more efficient substitutes, i.e., optical fiber and/or aluminum cable. Other
examples include the longer term shift in energy sources: wood, coal, liquid fuel stock, gaseous
fuels, to WHAT next?
3. Voluntary Exchange Promotes Economic Progress. Individuals pursuing their own self -interest entering
into exchange realize a ‘mutuality of benefits’ or voluntary exchange will not take place.
‘Exploitation’ is only possible by the use or the threat of the use of force – a theft. Exchange or
“Trade is productive; it permits each of the trading partners to get more of what they want.” (8)
G&S provide three reasons why trade (exchange) is productive, i.e., “why it increases the wealth
of people.” Specialization enables individuals and societies to expand total output.
(i) “First, trade channels goods and services to those who value them most”; manifested through a
willingness to pay! “A good or service does not have value just because it exists.” (8)
(ii) “Second, exchange permits trading partners to gain from specializing in the things they do
best,” including individuals, regions and nations resulting in lower costs for goods and
services.[The so-called ‘Law of Comparative Advantage, see: Robert L. Formaini.
“David Ricardo: Theory of Free International Trade,” Economic Insights, Vol. 9, No 2;
available at: www.dallasfed.org/researh/ei/ei0402.html.]
(iii)“Third, voluntary exchange permits us to realize gains derived from cooperative effort,
division of labor, and the adoption of large-scale production methods.” It is necessary to
contrast outcomes under situations of individual (household) production, known as
‘subsistence or self-sufficiency production’ involving small-scale production, with those
of collective effort (factory or mass production) known as ‘commercial production’. It is
wise not to equate ‘collective effort’ with the Marxist/Socialist model… Mass production
yields vastly larger output per worker at substantially lower costs [the realization of
‘scale economies’]. See: Robert L. Formaini. “Adam Smith – Capitalism’s Prophet,”
Economic Insights, Vol. 7, No.1; available at:www.dallasfed.org/research/ei/ei0201.html.
for Adam Smith’s observations on the gains from specialization of task, or, alternatively,
division of labor. He provides what has come to be known as ‘the pin factory’ case as an
example of worker specialization and improvements in output.
4. Transaction Costs Are An Obstacle to Exchange; Reducing This Obstacle Will Help Promote Economic
Progress. The source of the idea of ‘transaction costs’ is to be found in the work of Ronald Coase,
especially: 1937. “The Nature of the Firm,” Economica, 4 (November), 386-405. A primary aspect
of Coase’s conceptualization of the firm is that it is ‘a bundle of contracts’ (with suppliers, labor,
customers, share holders). For a brief overview of Coase and his contributions, see: Robert L.
Formaini and Thomas F. Siems. “Ronald Coase – The Nature of Firms and Their Costs,”
Economic Insights, Vol. 8, No. 3; available at: www.dallasfed.org/research/ei/ei0303.html.
Gwartney and Stroup note: “Voluntary exchange is productive because it promotes cooperation
and helps us get more of what we want. However, exchange is also costly. The time, effort and
other resources necessary to search out, negotiate, and conclude an exchange are called
transaction costs.” (11, emphasis added) Other transaction costs include monitoring and
enforcing behaviors, implicitly or explicitly implied in any exchange contract. The text identifies
two major sources of high transaction costs: (i) physical obstacles – oceans, rivers, marshes, and
mountains; and (ii) institutional obstacles – taxes, licensing requirements (radio, television, etc.),
government regulations, price controls, tariffs and quotas. (11) They further observe that “…high
transaction costs reduce the potential gains from trade. Conversely, reductions in transaction costs
increase the gains from trade and thereby promote economic progress.”
5. Increases in Real Income are Dependent Upon Increases in Real Output. “Higher income and standard
of living are dependent upon higher productivity and output.” (13) This relationship should be
intuitively obvious – productivity is ‘output per unit input’ (labor, capital, etc.). With increases in
productivity (more output for the same, or even fewer input), prices of goods fall, while returns to
factor owners (land, labor, etc.) rise. Gwartney and Stroup continue: “Once the linkage between
output and income is recognized, the real source of economic progress is clarified. We improve
our standard of living (income) by figuring out how to produce more output (things that people
value). Economic progress is dependent, for example, on our ability to build a better house,
computer, or video camera with the same or a lesser amount of labor and other resources.
Without increases in real output – that is, output adjusted for inflation – there can be no
increases in income and improvement in our living standard. (13, emphasis added) Gwartney and
Stroup, right point out: “Politicians often erroneously talk as if the creation of jobs is the source of
economic progress….Focusing on jobs is a potential source of confusion. More employment will
not promote economic progress, unless the employment expands output.” (14, emphasis added)
Consider the ‘economic’ rationality of, President F.D. Roosevelt’s make-work projects (WPA,
CCC, for example) in this light, especially given what Gwartney and Stroup have to say: “We do
not need more jobs, per se. Rather, we need more productive workers, more productivityenhancing machinery, and more efficient economic organization so we can produce more output
per capita.” (14, emphasis added) Productivity, then depends, according to Greg Mankiw, on:
physical capital (machinery, equipment); human capital (education, training, skills; natural
resources (availability or substitutability); and technological knowledge (invention and
innovation). (245-7)
Gwartney and Stroup continue, reporting: “Some observers argue that technology adversely affects
workers.” Such observers are reminiscent of General Ned Ludd, see:
www.albany.edu/~rs7921/quick.html. “In fact, just the opposite is true. Once you recognize that
expansion in output is the source of higher wages, the positive impact of improvements in
technology is apparent: better technology makes it possible for workers to produce more and
thus to earn more.” (14, emphasis added) There is a whole new breed of ‘luddites’ in the world
today, following in the pattern of Mary Shelley (authoress of Frankenstein), opposing numerous
technologies that increase human well-being, for example: the issue of ‘genetic engineering’ …
more and better food sources; more effective pharmaceutical products; bacteria that destroy
harmful compounds (nuclear wastes, chemical waste products); save endangered species (elm and
chestnut trees; and panda). One of the most outrageous of these Neo-Luddites is Jeramy Rifkin.
Often these neo-luddites engage in ‘terrorism’ (destroying other peoples’ property and killing
folks – e.g., the Unibomber), in the name of doing a social good. One of Joseph Schumpeter’s
primary contributions to economics was his recognition of the beneficial destructiveness of
technological change, resulting from both invention and innovation, summarized by the phrase
“the perennial gale of creative destruction.” W. Michael Cox. 2001. “Schumpeter – In His Own
Words,” Economic Insights, Vol. 6, No. 3; available at: www.dallasfed.org/htm/pubs/ei/ei6_3_01.
Gwartney and Stroup have incorporated these ideas: “Sometimes specific jobs will be
eliminated….These changes, however, merely release human resources so they can be used to
expand output in other areas….Other tasks can now be accomplished with the newly released
resources and, as a result, we are able to achieve a higher standard of living than would otherwise
be the case.” (15)
Ironically, Gwartney and Stroup’s small book was published by The James Madison Institute in
Tallahassee, Florida, but their insights consistently have been ignored by politicians and policy
makers in that city. For example, the likely ‘unintended consequences’ of state-mandated
minimum wages were ignored, and the socially undesirable outcomes (higher prices, fewer
choices, higher unemployment; fewer work opportunities for teenagers) will likely be blamed on
the greedy business community (read, greedy capitalist). They wrote in 1993: “Recognition of the
link between output and income also makes easier to see why minimum wage legislation and labor
union fail to increase overall wages of workers. A higher minimum wage will price some low-skill
workers out of the market.” [More unemployed low-skill workers.] “Therefore, their employment
will decline, reducing total output. While some individual workers may be helped, overall per
capita income will be lower because per capita output will be lower.” (15) They conclude,
emphatically: “Without high productivity per worker, there can be no high wages per
worker….Production provides the source of income.”
Associated with improved technologies, increased output, and higher wages is the need for fewer
workers, especially fewer unskilled or semi-skilled workers.
6. The Four Sources of Income Growth are (a) Improvements in Worker Skills, (b) Capital Formation, (c)
Technological Advancements, and (d) Better Economic Organization. The term ‘growth’ involves
change(s) over some period of time. (i) Skilled workers are more productive – leading to higher
levels of output. Skills are improved by both formal training (schools, apprenticeships) and on the
job learning (OJT). (ii) Additions to capital stock (new machines, software) enable workers to be
more productive. (iii) Improvements in technology (new equipment, new products) permit the
increase in output per worker per unit of time. (iv) Improvements in organizational structures, both
in the private and the public sectors support increased productivity…the shift from craft to factory
product/mass production. All four elements stimulate economic growth (increases in output).
Gwartney and Stroup cite the role of legal systems and the creation of patent
protection…”Effective economic organization will facilitate social cooperation and channel
resources toward the production of goods that people value, Conversely, economic organization
that protects wasteful practices and fails to reward the creation of wealth will retard economic
progress.” (18) All too frequently firms and individuals will pursue ‘rent-seeking’ behaviors, i.e.,
going to government to obtain what they have been unable to obtain through the free market, e.g.,
Barksdale and Netscape (US Department of Justice) vs. Gates and Microsoft.
7. Income is Compensation Derived from the Provision of Services to Others. People Earn Income by
Helping Others. “…we must not lose sight of precisely what income is. Income is simply
compensation received in exchange for productive services supplied to others. People who earn
large incomes provide others with lots of things that they value….There is a moral here. If you
want to earn a large income, you had better figure out how to help others a great deal.” (19) They
point out a common fallacy in regards to high incomes: “Some people have a tendency to think
that high-income individuals must be exploiting others… The late Sam Walton (founder of
Walmart Stores) became the richest man in the United States because he figured out how to
manage large inventories more effectively and bring discount prices on brand-name merchandise
to small town America.” (20) Currently, many ‘luddites’ oppose Walmart because: they run small,
‘mom-and-pop’ retailers out of business! But, they provide consumers with lower prices, enabling
them to buy more items that provide them with satisfaction of both wants and needs. Keep in mind
Henry Ford drove the Stanley Steamer out of business, as his mass production factories reduced
the price of automobiles from an average of $ 2,000 per vehicle to less than $ 800; yes, jobs were
lost in the Stanley Steamer plants, but were added in the factories producing Fords. In addition,
lower prices permitted lower income families to acquire an automobile.
8. Profits Direct Businesses Toward Activities that Increase Wealth. “At any given time, there is virtually
an infinite number of potential investment projects. Some will increase the value of resources and
promote economic progress. Others will reduce the value of resources and lead to economic
decline. If economic progress is going to proceed, the value-increasing projects must be
encouraged and the value-reducing projects avoided. This is precisely what profits and losses do in
a market setting.” (21) Often individuals, pursuing their own self-interest promote value-reducing
projects by recruiting government intervention in markets to assure the value-reducing projects
take precedence over value-increasing projects. Such actions reduce general, social welfare below
levels that it would have otherwise have attained. In spite of all the negative comments by critics,
“…profit is a reward that business owners earn if they produce a good that consumers value more
(as measured by their willingness to pay) than the resources required for the good’s production
(as measured by the cost of bidding the resources away from their alternative employment
possibilities). In contrast, losses are a penalty imposed on businesses that reduce the value of
resources…Losses and bankruptcies are the market’s way of bringing such wasteful activities to a
halt.” (21) Gwartney and Stroup conclude this section: “Essentially, profits and losses direct
business investment toward projects that promote economic progress and away from those that
squander scarce resources.” 23)
9. The ‘Invisible Hand’ Principle – Market Prices Bring Personal Self-Interest and the General Welfare
Into Harmony. Gwartney and Stroup quote Adam Smith’s Wealth of Nations: “Every individual is
continually exerting himself to find out the most advantageous employment for whatever capital
he can command. It is his own advantage, indeed, and not that of the society which he has in
view….He intends only his own gain, and he is in this, and in many other cases, led by an
invisible hand to promote an end which was not part of his intention.” They continue, “…the
remarkable thing about an economy based on private property and freedom of contract is that
market prices will bring the actions of self-interested individuals into harmony with the general
prosperity of a community or nation.” (24) See: Robert L. Formaini. “Adam Smith –
Capitalism’s Prophet,” Economic Insights, Vol. 7, No.1; available at:
www.dallasfed.org/research/ei/ei0201.html. Despite Adam Smith’s observations, “The invisible
hand principle is difficult for many people to grasp because there is a natural tendency to
associate order with centralized planning. If resources are going to be allocated sensibly, surely
some central authority must be in charge.” (24, emphasis added) The ancient Greeks and modern
depth psychologists (Carl G. Jung) would suggest that the cause is hubris or egocentric projection,
both of which result in disaster! More to the point, historical (empirical) evidence demonstrates
the inability of ‘central planning’ to out-perform the free market in meeting real human needs and
wants, see: the former Soviet Union and its client states in Central and Eastern Europe. All of this
had been predicted by von Mises ; [Robert L. Formaini. “Ludwig von Mises, Economic Insights, 6
(4); available at: www.dallasfed.org/research/ei/ei0104.html] and Hayek [Robert L.
Formaini. 1999. “Hayek – Social Theorist of the Century,” Economic Insights, 4 (1); also
available at: www.dallasfed.org/research/ei/ei9901] in their debates with communists/socialists
during the 1920s. Gwartney and Stroup continue, “When private property and freedom of
exchange are present, market prices will register the choices of literally millions of consumers,
producers, and resource suppliers and bring them into harmony. Prices will reflect information
about consumers preferences, costs and matters related to timing, location, and circumstances
that are well beyond the comprehension of any individual or central-planning authority. This
single summary statistic – the market price – provides producers with everything they need to
know in order to bring their actions into harmony with the actions and preferences of others
[consumers and suppliers]. The market price directs and motivates both producers and resource
suppliers to provide those things that others [consumers] value highly, relative to their costs.”
(24-5, emphasis added) For a detailed explanation, see: F.A. Hayek.1945. “The Use of Knowledge
in Society.,” American Economic Review, 35, 4, 519-530. (This is a difficult article, but well
worth the effort.)In a brief, telling statement, Gwartney and Stroup, noting that central planning is
unnecessary, write, “When the prices of these [wheat, houses, furniture] and other products
indicate that consumers value them as much or more than their production costs, producers
seeking personal gain will supply them….producers will seek out the best resource combination
and most cost-effective production methods because lower costs mean
higher profits” (25-6)
10. Ignoring Secondary Effects and Long-term Consequences is the Most Common Source of Error in
Economics. Gwartney and Stroup attribute Henry Hazlitt (Economics in One Lesson) with
pointing out the importance of ‘secondary’ and ‘long-term’ effects of human decisions. “Hazlitt’s
one lesson was, that when analyzing an economic proposal, one:
must trace not merely the immediate results but the results in the long run, not merely the
primary consequences but the secondary consequences, and not merely the effects on
some special group but the effects on everyone.(27, emphasis in the original)
Gwartney and Stroup conclude: “It is difficult to argue with this point [failure to adhere to this
warning is the most common source of economic error]. Time and again, politicians stress the
short-term benefits derived from a policy, while completely ignoring longer-term consequences.
Similarly, there seems to be an endless pleading for proposals to help specific industries, regions,
or groups without considering their impact on the broader community, including taxpayers and
consumers.” (27, emphasis added) They report sadly, ”Of course, much of this is deliberate…
When the benefits are immediate and easily visible, while the costs are less visible and mostly in
the future, it will be easier for interest groups to sell befuddled economic reasoning.” (27) They
cite: rent controls – more housing for the poor, lower returns for landlords, less construction of
rental units, increased shortages and declining quality of existing rental units… They then quote a
Swedish economist: “In many cases rent control appears to be the most efficient technique
presently known to destroy a city – except for bombing.” (28) Rent controls create
SLUMS…Next, they identify tariffs and quotas to ‘protect jobs’ as an example of ignoring long
run, secondary effects…tariffs/quotas on foreign (imported) automobiles serve to protect jobs in
Detroit and increase automobile prices, auto consumers must curtail consumption of other goods
and services, resulting in job losses in other industries…fewer foreign cars sold, exporting nations
have fewer dollars with which to purchase US manufactured goods further affecting employment
in non-automobile producing industries in the US!!!Gwartney and Stroup conclude: “Once the
secondary effects are considered, the impact on employment is clear. The restrictions do not
create jobs; they reshuffle them.” (29, emphasis added) Other examples include government
spending on favorite projects and minimum wage legislation….
Course Outline and
Schedule:
May 10
June 09 -
Introduction to the course
What is Economics? Why is all this necessary?
Gwartney and Stroup, “Introduction”, vi-v. Notice the comment on
v, “Studies indicate that we are a nation of economic illiterates.”
Gwartney and Stroup, Part I: Ten Key Elements of Economics, 129
Friedman, M. 1953. “The Methodology of Positive Economics”, in
M. Friedman, Essays in Positive Economics, pp. 3-43. Chicage:
University of Chicago Press, pp. 3-43.
*R.H. Coase. 1937. The nature of the firm. Economica, 4, 386-405
Competitive Exchange, Acs & Gerlowski, Chapter 2, pp. 34-63.
Neoclassical Theory of the Firm, Acs & Gerlowski, Chapter 3, pp.
64-87.
*N. Kaldor. 1972. The irrelevance of equilibrium economics.
Economic Journal, 82, 1237-1255.
May 19
First abstract due.
Discussion of recent trends:
-globalization (a return to free trade and David Ricardo’s Law of
Comparative Advantage)
-shift to a post-industrial society and the emergence of a
knowledge-based economy
-loss and recovery of America’s competitive advantages in the
Global Marketplace (adjustments to international
competition)
-success of ‘Capitalism’ and the decline of ‘Statism’ (Socialism)
[See: Commanding Heights at: www.pbs.org]
*W.B. Arthur. 1990. Positive feedbacks in the economy. Scientific
American, 262, 2, 92-99.
*W.B. Arthur. 1989. Competing technologies, increasing returns,
and lock-in by historical events. Economic Journal, 99, 1,
116-131.
*H. Demsetz. 1967. Toward a theory of property rights. American
Economic Review, 57, 2, 347-359.
*R.H. Coase. 1960. The problem of social cost. Journal of Law
and Economics, 3, 1-44.
June 14
FIRST QUIZ.
June 16 July 12
Gwartney and Stroup, Part II: Seven Major Sources of Economic
Progress, 30-67.
Economic Decisions in an Uncertain Economic Environment
Demand and Revenues, Supply and Costs
Assumptions of microeconomic models and market structures
*Sweezy, P.M. 1939. “Demand Under Conditions of Oligopoly”,
Journal of Political Economy, 568-573.
*Simon, J.L. 1969. “A Further Test of the Kinky Oligopoly
Demand Curve”, American Economic Review, 55, pp.
971-975.
*R.H. Coase. 1937. The nature of the firm. Economica, 4, 386-405
*R.H. Coase. 1960. The problem of social cost. Journal of Law
and Economics, 3, 1-44.
*Alchian, A.A. 1950. “Uncertainty, Evolution, and Economic
Theory”, Journal of Political Economy, 58 (3), pp. 21121.
July 14
SECOND QUIZ
July 27Aug. 02
Gwartney and Stroup, Part III: Economic Progress and the Role of
Government, 68-112.
Knowledge-based industries and the ‘new’ economics
The role of Intellectual Property Rights (IPRs) and the
transformation of markets and regulatory activities
*R.H. Coase. 1937. The nature of the firm. Economica, 4, 386-405
*P.A. David. 1985. Clio and the economics of QWERTY.
American Economic Review: Papers and Proceedings, 75,
2, 332-337.
*D.E. Booth. 1986. Long waves and uneven regional growth.
Southern Economic Journal, 53, 2, 448-460.
High Tech Industries and Location of Industry (Comparative
Advantage and Spatial Division of Labor
Kondratiev’s Long Wave and Joseph Schumpeter
*Valavanis, S. 1955. “Lösch on Location”, American Economic
Review, 45, pp. 637-644.
Aug. 04
Final Exam
Grading:
Three quizzes will comprise 86% of the final grade. Each quiz is
weighted equally. The weekly outside reading summaries will
comprise the remaining14% of the final grade. The grading scale
is as follows:
93.0 - 100.0% = A
86.0 - 92.9% = B
76.0 - 85.9% = C
69.0 - 75.9% = D
Less than 69.0 = F.
Library
Assignments:
Scholarly journals may be located in the periodical section of the
library (Third level).
Written
Communication
Requirements:
The individual article summaries will comprise one of the written
communications requirements in this course.
Oral
Communication
Requirements:
Class participation constitutes the demonstration of oral
communication skills.
Computer
Applications:
Use of the internet for data searches and data manipulation via
statistical software or a spreadsheet should be used for preparing
class and identifying materials for weekly abstracts.
International
Coverage:
Four chapters in the Acs & Gerlowski text are devoted to
international topics. Lectures and handouts will be used to augment
the international component of the course.
Environmental
Covered:
Externalities and market failure comprise major issues in Issues
discussions of efficiency and general equilibrium. The roles of
private vs. public ownership (the so-called ‘tragedy of the
commons”) and efficiency concerns are highly associated with
environmental concerns.
Ethical Issues
Covered:
Ethical issue related to illegal activity in the economy will be
discussed where appropriate. A distinction will be drawn between
legal but tough corporate policies and illegal activities, particularly
in relationship to employment, insider trading and environmental
issues.
Academic Integrity: Each student is expected to do his/her own work on assigned
activities and on quizzes. An understanding of what constitutes
plagiarism and abuse of copyright laws is expected of each student.