February 27, 2010
Take a clean sheet of paper
and write your name and id
number.
Quizzes without both these
cannot be graded.
Indicate the letter of the correct
answer:
Ordinary citizens in the West in
medieval times tended to see
economics in terms of:
a) Marxism
b) Moral economy
c) Liberalism
A mercantilist wants the state to regulate
the economy and international trade in
order to:
a) Create fair prices
b) Create a trade deficit
c) Create a trade surplus
A follower of Adam Smith would argue
that:
a) The state should not heavily regulate the
market
b) Markets are bad
c) Karl Marx was right
The basis for trade is the operation of
market mechanisms.
Liberals and mercantilists again have
different ideas about the place of markets:
 Liberals: markets should generally be left
alone; if they are, they will create wealth
through the spurring of productivity and
the reduction if inefficiencies.


While markets are useful, their free operation
assumes that everyone will benefit from all
transactions and that the free flow of goods and
the elimination of inefficiencies will not hinder
the security of states.
That is not the case. Free markets can damage
countries by creating trade deficits, destroying
industries, displacing workers, holding the
population hostage to the supply of goods
from outside the country
Markets generally are good for creating wealth
in an overall sense and in creating efficiency.
Efficiency = maximize output and minimize
waste
Operate through the interaction of buyers and
sellers. These have complementary needs that
allow them to engage in transactions that allow
both to be better off than they were before
(though the gain to each party is not always
equal).


Exchanges are possible when there is an
overlap between the highest price a buyer will
pay for a good and the lowest price a seller will
accept for a good. No overlap = no exchange.
If the overlap is large, then there is room for
negotiation as each side attempts to get the best
deal without losing the opportunity to make an
exchange.

In a more general sense, prices are set not
by individuals engaging in separate
negotiations, but by all buyers and sellers
interacting. The point at which many
buyers and sellers agree are determined
importantly by how many sellers there
are and how many goods they are
willing to part with, and how many
buyers there are and how many goods
they are willing to buy.



This is a dynamic process, as the number of
goods available for sale and the willingness of
buyers to buy them interact on one another in
the form of supply and demand curves.
Supply curve: curve representing the dynamic
situation in which the higher the price, the
more product suppliers are willing to sell.
Demand curve: curve representing the
dynamic in which the lower the price, the more
product buyers are willing to purchase.


Equilibrium price: the point at which the
supply and demand curves cross, thus creating
a situation in which the market is cleared of
goods
X axis: Amount of Goods; Y axis: Price


On the individual level, markets exist because
individuals are not able to supply all the goods
and services they need to survive, or at least
could not do so efficiently. Someone who had
to grow his own food, make his own clothes,
build his own house, etc., would never be able
to discharge all those tasks well or with a
minimum amount of labor and time.
A division of labor that entails people
specializing and then trading their products
tends to benefit everyone.



According to this logic, it is the desire to maximize
utility across individuals that results in increases in
standards of living and efficiency due to
competition among buyers and sellers and
interactions between the two groups.
Demand for goods, indicated by rising prices,
stimulates the production of more goods, while
competition leads to lower prices. Falling prices
allow people to buy more things and signal to
producers to stop producing so much, but more
buying will drive up prices.
No government or other outside agent is necessary
for this to occur.
The same is true of international markets
and international trade. Exchanges take
place on the international market because it
benefits everyone to specialize in the types
of goods they create and then trade what
one produces for things they do not
produce. Again, liberals argue that nothing
outside this mechanism is need in order for
everyone to get what they need and enjoy a
rising standard of living


While the logic of a division of labor is similar
on the international stage as on the domestic, it
does operate a bit differently.
On the individual level, a division of labor is
efficient because it is better for particular
individuals to specialize the in production of
goods due to the loss of productivity that
comes from switching from one activity to
another and the inability to develop high levels
of expertise.


Internationally, the efficiencies that come from
a division of labor and the resulting
possibilities for trade are conceptualized in
other concepts:
Absolute advantage: a country is better off
concentrating on producing and exporting
product A (and importing product B) because
it produces product a at a lower cost than
another country.

Example: Taiwan can engage in trade in
flatscreen tv’s and should concentrate on their
manufacture because it can produce them at a
lower price than other countries. As a result, it
may import car batteries because it does not
produce enough of them due to its
concentration on flatscreen tv’s.


However, a country need not have an absolute
advantage in order to trade. Indeed, if that
were the case, trade volumes would be small
and few countries would engage in trade.
Instead, a country can engage in trade if it
enjoys merely a comparative advantage.
Having a comparative advantage does not
mean you produce a good at a lower cost than
another country. The US trades with the PRC,
and in almost all cases, the PRC has a lower
cost of production than the US


In the case of comparative advantage, a
country is better of concentrating on producing
a product and exporting it to a partner when it
can create a good at a lower opportunity cost
than the other country.
Opportunity cost: the cost incurred when the
decision to select one option means foregoing
the gains that could be realized by selecting
another option


General example of opportunity cost: The
opportunity costs of studying may entail
forgoing the pleasure of going out drinking
with your friends.
Economic example: the opportunity costs of
manufacturing good A rather than Good B is
the absence of the amount of good B that could
be created with the labor and capital expended
in creating good A.



Say the US is more efficient in producing boats
than it is in producing computers.
Taiwan is more efficient in producing computers
than it is boats.
The opportunity cost in the US is
Produce 1 boat costs 2 computers
 The opportunity cost for Taiwan is:
 Produce 1 boat costs 3 computers.


We see that in terms of boats, the US has a lower
opportunity cost than Taiwan, and for computers,
Taiwan has a lower opportunity cost than the US



It is more efficient for US to concentrate on
boats and export them to Taiwan, and for
Taiwan to concentrate on computers and
export them to the US, even though:
For US, 1 boat costs 20 units of labor and
capital
For Taiwan, 1 boat costs 15 units of labor and
capital

This is because if both sides specialize and
trade:



The US will have the same number of boats it would
have had if trade had not occurred, and will have
more computers;
Taiwan will have the same number of computers it
would have had if trade had not occurred, but more
boats.
Thus, the standard of living for both countries
will rise.

However, while both countries collectively
would benefit, that does not mean everyone
benefits:




Workers and industries that are favored will benefit,
those who do not will pay a prices in the loss of jobs
and business
Costs to country of unemployment, retraining
Dissatisfaction among those who lose jobs and
opportunities
Loss of manufacturing base
These negative effects can lead to government
intervention even if the government does not
generally follow mercantilist principles
Sometimes intervention is necessary to correct
market problems:
 Existence of monopolies or oligopolies
 Combat corruption
 Enforce contracts

To pursue political goals


Sanctions: attempt to influence the behavior of other
countries by limiting or prohibiting economic
interactions
Pursue autarky: protect national security by
pursuing a situation in which the nation becomes
self-sufficient in the production of necessary goods.


Protectionism: shielding domestic industries
from international competition by prohibiting
or discouraging imports
Reasons:





Protect industries vital to security
Protect infant industries
Protect classes of workers
Respond to industry lobbying
Defend against predators seeking to create
monopolies

Means of pursuing protectionism:
Tariffs: a tax on imported goods
 Quotas: a ceiling on the amount of a kind of good
that can be imported
 Subsidies: money given to an industry to allow it to
lower its prices.
 Regulations: restrict distribution of goods, high
quality standards, labor or environmental standards







Benefit particular industries and workers
Put other industries and workers at a
disadvantage due to domestic competition or
foreign retaliation
Higher prices for consumers
Loss of comparative advantage
Shield inefficient industries
Stabilize economy, shield important industries,
maintain manufacturing base.