Class 2 January 2


Economics 110 Class #2 Theoretical Market Capitalism Part I

Handout (Chapter 2 in the Rosser text is very technical. You are not responsible for the technical economics.)


1. Nature of People: Economic Man (Handout)

a. rational, self-interested maximizer ( the profit motive )

2. Individualism --- the individual is seen as the center of society (preference over the state)

3. Social Darwinism --- life as a competitive struggle in which the most fit survive and prosper

a. great wealth is admired

b. poverty is seen as a moral failing

4. Equality of Opportunity – meritocracy

5. The Protestant Ethic --- hard work, thrift, but seek personal economic gain

a. wealth to be invested, not used for conspicuous consumption


1. Private Property -- buy or sell, use, profit from, change (encourages accumulation of wealth)

2 . Free Enterprise – right to engage in any type of economic activity

Freedom = free of government restrictions

3. Free Competitive Markets – the what, how, and for whom are determined by the interactions of buyers and sellers. Competition means to no one buyer or seller can influence the decisions.

a . Competition encourages innovation to lower costs or improve products

b. Competition creates variety for consumers

The Invisible Hand

1. History (introduce Adam Smith) – Review Allocative Efficiency

2. Goal: Consumer Sovereignty

3. Do with a change in tastes (no graphs)

4. Do with a change in relative scarcity (oil) (no graphs)

5. Price --- information function and incentives function

6. Self-interest leads to behaviors in society’s interest

Laissez Faire (Market Failure)

1. Rules (contract, tort, corporation, private property rights) – make and enforce

2. Competition (quote of Adam Smith) -- called anti-trust laws

3. Information (cigarettes, movies, TV, gasoline prices, etc.)

a. problems of asymmetric information (health care)

b. principal – agent problem (corporation)

4. Public Goods – define

5. Externalities

a. Negative --- pollution

b. Positive --- R&D, Baseball Stadium

6. Merit Goods

7. Redistribution?

Public Choice

1. Rational Abstention

2. Rational Ignorance

3. Special Interest Effect

4. Bureaucracy

Full Employment

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

B. Flu analogy

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

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

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

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,