Continuation of Lecture 2
Checking Out
•
Supermarket Model -- gather all of your purchases into your cart and
selecting which line (in front of store) to pay for purchases
•
Department Store Model -- pay for purchases in the ‘department’
where the goods are located
•
Snake Line Model -- Enter a single line and when at head of line go to
first available clerk
1.
2.
What do the stores have in common?
Why do certain stores adopt one method and not the other?
7) Resources should be used
efficiently to achieve society’s goals
• Efficiency -- the inability to improve one person’s well being
without hurting someone else (Pareto Optimality)
 If we are inefficient in our use of resources, we are wasting them.
We could increase well-being (produce more) by reallocating them.
• Why would you want to deny someone additional welfare if it
didn’t hurt anyone else’s welfare?
 This is a normative (value) statement in contrast to positive
statements (statements of fact). What can economists say about
other goals for society such as fairness or equity in the distribution
of society’s wealth?
8) Markets usually lead to efficiency
• This statement is often taken to mean that society (a collective
decision perhaps taken by government) should not interfere with
individual choice. A positive statement leading to a normative
conclusion.
• But markets can fail to achieve an efficient result-- for example,
congestion on the highways.
9) When markets are not efficient,
government intervention can lead to
improvement in social welfare
• Yet there isn’t a guarantee that governments will improve upon
the market outcome. Rather they hold out the possibility to
improve upon the efficiency of the outcomes of individual
choice.
• Important to remember -- it is not that individuals make ‘bad’
choices; rather the market has failed to coordinate their
decisions
How is equity related to
efficiency?
• There is a tradeoff between equity and
efficiency
– As markets become more efficient, they are
perceived as less equitable.
• Markets generate inequality in earnings
– Markets reward winners and punish losers
• Losing firms exit from the market
• In labor markets, the most able/talented are hired; others
accept low wage jobs or are unemployed
Equity
• What is equity?
– Equity is a value judgment that means
different things to different people
– Equity in the distribution of income often
means that income was earned fairly
Equity and Equality
• Equity is not the same thing as Equality
– A equal distribution of income means that all units
have exactly the same income.
– Some people may define an equitable distribution
of income as one in which all incomes are equal,
but most Americans would not!!!
– To most Americans, incomes in an equitable
distribution of income would vary according to
individuals contributions to the market.
• Most Americans believe the story of the Little Red Hen
represents equity!
Are markets moral?
• If markets generate distributions of
income that are unequal, are markets
moral?
– Markets are neither moral or immoral.
– Markets are amoral.
• They are simply the interactions among
individuals
• They move toward equilibrium and
• They promise efficient use of resources.
Are markets moral, cont.
•
The issue of morality enters the
discussion of markets in two ways:
1. Did the market participants behavior
morally?
•
Was there a level playing field?
– Did firms collude? Fix prices? Restrict supply?
– Were individuals given equal opportunity to prepare
themselves for market activity?
Are markets moral, cont.
2. How did society react to the situation of
the losers?
•
Were the losers supported in ways consistent
with their dignity as human beings? (alternate
definition of equity)
– Examine redistributive policies
» Tax policies
» Social insurance and public welfare
Is the market moral, cont.
• Additional reading
– Chapter 21, “Taxes, Social Insurance and Income
Distribution”
– Rebecca Blank and William McGurn, Is the Market
Moral? A Dialogue on Religion, Economics, and
Justice. The Brookings Institution, 2003.
– National Conference of Catholic Bishops,
Economic Justice for All: Pastoral Letter on
Catholic Social Teaching and the US Economy,
1986.
Summary: Nine Principles
1)
Resources are scarce
2)
Every Choice has an Opportunity Cost
3)
Choices are made at the margin
4)
Individuals seek their self interest
5)
There are gains from trade
6)
Markets move toward equilibrium
7)
Resources should be used efficiently
8)
Markets usually lead to efficiency
9)
When markets don’t achieve efficiency, government intervention can improve
social welfare
Trade-Offs and Trading
Lecture 3
In Lecture 3
• Models
• Trade-Offs (Production Possibility Frontiers and
Opportunity Cost)
• Implication for Trading and Production (Specialization
and Comparative Advantage)
To Understand the Complex
World, We Construct a
Simplified Model
• Models are abstractions of reality, capturing what is believed to
be the important relationships
• Expressed in words, graphs, or mathematical equations
• Will imply a path of causation and relationship between
variables
• Holding Everything Else Constant
David Ricardo (1772-1823)
• Credited with creation of the
ideas of absolute and
comparative advantage to
understand trade
• Examined taxation and
government spending
• Was successful in his own
investing
What Can I Produce?
Wine
•
I could produce only Wool
(specialization in Wool)
•
I could produce only Wine
(specialization in Wine)
•
Or combinations of both (efficient
combinations)
•
Why is the production possibility
frontier (PPF) bowed outward?
Not Feasible
Feasible but Inefficient
Wool
A Word About Slopes
Y
•
Let Y = f(X) denoted by the red line
•
From the initial point (Xo,Yo)
Consider a change in X = X and
consequently a change in Y = Y
Yo
The ratio Y/X is the slope of the
blue line drawn through the two
points (Arc Method)
Y
•
X
Xo
X
For small (marginal) changes in X,
the slope of the line tangent to the
function represents the slope of the
function (Point Method)
Opportunity Cost
Slope=Wine/Wool
Wine
A
B
W0
W1
Wool
•The slope of the PPF tells us how much
Wine we would have to give up to get
more Wool -- Opportunity Cost of Wool
•Assume we are producing small
amounts of Wool (W0). The slope of the
red tangency tells us the Opportunity
Cost of Wool (how much Wine we have
to give up). The relatively flat slope
indicates small sacrifices of wine are
required to obtain additional units of wool.
•Now assume we have produced more
Wool (W1). The relatively tangency line
tells us that larger amounts of wine must
be sacrificed to obtain more wool than
W1.
•The Opportunity Cost of Wool in terms of
Wine has risen as we move along the
PPF from A to B
•The bowing out of the PPF reflects
increasing opportunity costs
Alternative PPFs
Wine
Increasing Opportunity Costs
Constant Opportunity Costs
Decreasing Opportunity Costs
Wool
Economic Growth
Wine
Why would the PPF shift outward?
-- more resources: land, labor, capital, and
human capital
-- technological progress
Initial PPF
Wool
Production and Consumption
Assume that there are Constant Opportunity
Costs in Wool and Wine Production in two
Countries
Wine
Britain is currently producing both wool and
wine without trade (current production levels
are marked)
Consider a potential trading partner’s PPF,
Portugal and their current production (neither
country has an absolute advantage)
Will trade between Britain and Portugal
improve the well being in both countries?
Wool
Specialization and Trading
Wine
Line Parallel to
Portugal’s PPF
implies same
opportunity cost
Assume Britain decides to specialize in Wool and use
some of their surplus wool to purchase wine from Portugal - is this possible?
If Portugal reduces its wool production by the same amount
that Britain has increased
Will the gain in their wine production exceed the loss in
wine production in Britain?
If Portugal trades their increased wine production for
Britain’s increased wool production then Portugal continues
to be able to consume exactly what it did prior to the
specialization and trading but Britain can increase its wine
consumption and still consume the same amount of wool -they are better off.
Wool
Efficiency
While Portugal has not gain, Britain has and so
there has been a gain in efficiency. On this figure,
how can we show wine and wool consumption that
would represent both countries being made better
off?
Wine
Draw quadrants through each countries initial
consumption points
The areas in the ‘northeast’ quadrants represent
where both countries would be better off
Less aggressive trading terms with Portugal would
allow both countries to be made better off.
Wool
Why do these trading patterns emerge (Portugal
trades wine for wool)? Countries specialize in
activities they have a comparative advantage -relatively lower opportunity cost of producing.
Adjustment Costs
What is happening in both Britain and Portugal?
In Britain, workers who used to work in the vineyards are working in
wool. In Portugal, workers in the woolen industry will migrate to the
vineyards.
Is there a cost to this adjustment? There is a one time adjustment
costs as workers have to find employment in other sectors of the
economy but the benefits of trade are on going. How can a
democratic society make these adjustments and impose these
costs on some in order to reap the gains?
Additional Reading
In handouts folder on web site, read the
New York Times op-ed by Senator
Schumer and Paul Craig Roberts and the
speech by Ben Bernanke (Chair of the
Fed) on globalization
The Story over Time
• Woolen manufacturing is more likely to benefit from
technical progress compared to wine production
• Consequently the PPF of the country specializing in
wool will shift out faster than the country specializing
in wine
• Britain became wealthier while Portugal became
relatively poorer
Trade and Specialization
As individuals and countries specialize,
they will trade for goods and services they
do not produce. Consequently they will
become dependent upon others for their
consumption. Is this good or bad for
countries? Can they trust each other?
On the Homefront
Market Production
(Income)
In 1950, women made less in the paid market but were
more productive in home production. What would the
PPFs for males and females look like? Does this suggest
that women would specialize in home production while
males went to work? What gave women their
comparative advantage?
Male
Over the last decades of the 1900s, discrimination against
women in the labor force lessened (let us assume that our
couple would earn the same amount if they devoted their
entire time to market work). Would women stop cleaning
homes?
Female
(today)
Female
(1950)
Home
Production
While women would have an absolute advantage over
men, we would expect men to continue to devote
themselves exclusively to market work (not to engage in
home production). Women may engage in more market
work using the extra income to hire someone to clean the
home or do two shifts (at the home and at the office).
Sharing the home production is not consistent with the
theory of comparative advantage and specialization.
Assignment for Next Lecture
• Do Homework 2 on ‘Homework Assignment’
by Wednesday at 5 pm
• Read Chapter 3
• Topics Next Time
– Concept of Demand and Supply