Class Summary 12/12/11

Profit and Losses


Profit: the difference between your total revenues and total cost--essentially, whatever is leftover
Interest: a price that comes from supply and demand; it emerges from the market of loanable funds

• A positive price we're willing to pay to obtain an unearned good now

In order to ensure profits, wages and rents are contracts that eliminate uncertainty. Economic profits are different than accounting profits because the former takes implicit and explicit costs into consideration. Economic profits are how much richer you are now as opposed to doing the next best things. Profits can be a potential cost for entrepreneurial activity. The necessary condition for profits is that we live in a world of uncertainty. Sometimes you don't know how to cut yourself in on the profits.

Losses are essentially making people pay for sucking at whatever it is that they're doing. Eliminating losses costs everyone because:

1. Allocation of resources would be all wrong and destructive
2. Eliminates feedback loops
3. Insulating people from losses causes them to take more risks.

Class Summary 12/9/11

Profit, Losses, and Entrepreneurs


We know very little about private entrepreneurs even though many of them have done a lot to improve our lives. Society as a whole also doesn't usually celebrate the making of profits. We celebrate giving them away. For example, Bill Gates is more highly regarded for his donations and charities than he is for being so wealthy. Money will always be the motivator. Even if you love what you do for a living, pay is still important. For instance, the polio vaccine probably wouldn't exist if it were created based on the developers' altruism. The scientists behind the cure created it because they knew it would make them money. Taking money out of the equation ensures that the good won't be there.

The costs of factors of production--land, labor, and capital--matter for entrepreneurs. Explicit and implicit costs are important. Even if you're using your own resources to develop your idea, you're still paying for things by way of opportunity costs.

Profitability = Rental Rate + Appreciation Rate - Interest Cost

Class Summary 12/7/11

More on Taxation


Because taxes cause a reduction in the quantity supplied, they don't generate the estimated or needed revenue that warranted their creation. We also lose $400 billion per year through opportunity costs involved with doing our taxes. The economic incidence of a tax is completely separate from the legal incidence of a tax. This means that a tax placed on a firm may actually end up costing the consumer more money because the cost to the firm has to come from somewhere. There's a specific type of tax--a payroll tax--that we say firms and workers split. This isn't true because all this tells us is who has to write the check, it says nothing about who actually pays. Because corporations are people, raising an employer's cost will actually cost the worker. The relative elasticity of supply and demand determines who pays.

Good tax policies apply taxes to goods where there's an inelastic demand for them. This way, there's no dead weight lost because buyers and sellers don't change their behavior. You don't want to implement regressive taxes, or taxes that place the most burden on the poor. The same theory about taxation can be applied to subsidies.

Class Summary 12/5/11

Illegality and Taxation


Making drugs illegal doesn't eradicate them, it just makes the supply curve steeper. This is because suppliers still bear the cost of transporting drugs, but the costs of the risks involved with doing so are much higher. Risk factors of distribution also increase the potency of the drugs. If you're going to risk making drugs, you might as well make them stronger because the danger and repercussions are the same regardless of how effective the drugs are. As these drug producers decide to grow/make more, the supply becomes more and more elastic.

Excise Taxes: the sellers have to write the check to the government --> the legal liability just refers to who is writing the check

Raising taxes isn't costly, but the act of doing so is costly. The price of the good also doesn't increase by the amount of tax that's placed upon it. Taxes get in the way of exchanges because they cause supply and demand (depending on the type of tax) curves to shift in. It's the value of the forgone transactions due to taxes that cost everyone money. Even the IRS is costly--11 billion dollars per year are spent to run it. People at the IRS aren't creating anything of value. Essentially, they are a dead weight to society. This dead weight loss is separate from tax fraud, which is encouraged by the complexity of the US tax code.

Class Summary 12/2/11

Price Floors


One of the most common price floors that we see is minimum wage. Policymakers who believe that raising minimum wage helps the poor are incorrect for several reasons.

1. Minimum wage doesn't assist the poor because less than 50% of people who hold jobs that pay minimum wage are below the poverty line. The majority of people with MW jobs work less than 20 hours per week.
2. It's worse for everyone when the demand for labor is elastic.
3. Raising minimum wage makes it harder for people to get jobs as well as making it more difficult for people who are currently employed to keep their jobs. This is because the increased labor costs have to come from some other section of the pie.

Minimum wage generally causes a surplus of labor. Just because there's a surplus doesn't mean that something isn't scare, however. There are still opportunity costs to get a good even when it's scarce. Rarity and scarcity are also two different things. It's possible that something that's rare isn't valued, and thus it isn't scarce.

Class Summary 11/30/11

Rent Control


Price ceilings are destructive because they prevent markets from functioning correctly. Rent controls set the price ceiling for possible renters. This causes quantity of apartments supplied to fall, and the quantity demanded of possible spaces to rent to rise. This price ceiling is binding because it results in a shortage. Rent controls cause a new equilibrium price to emerge that is not market-clearing, which isn't good.

Consequences of Rent Controls:

1. There is a reduced availability of apartments, and they're more difficult to obtain.
2. Lower quality apartments are in abundance because landlords have no incentive to improve spaces due to the overabundance of potential renters.
1. By reducing quality, you are effectively reducing quantity.
3. A black market for rental spaces emerges.
4. Apartments can be misallocated since the people who value them the most don't necessarily get them.
5. Rent controls have impacts on other markets.
6. An unfair burden is placed on the landlords.
7. Discrimination and other insidious costs emerge since rentees can afford to be pickier.
8. Monitoring and enforcing the law itself is costly.
1. Over the long-run, supply curves will shift inward.
2. It's destructive because police officers aren't contributing anything else to society--opportunity costs and the broken window fallacy.
3. Even if the police are doing a good job, taxes must be raised, which is costly.

Class Summary 11/28/11

Some Properties of Equilibrium


Decentralized markets are much better off because they allow for experimentation. Government planning doesn't allow for any experimentation, which explains why many government programs fail or are otherwise ineffective. The only way to survive in a complex world is to decentralize decisions. Competition makes us richer because it's unproductive to to tell people to meet goals without any financial incentives.

Four possible problems with centralized planning:

1. It's impossible to determine who is the right or wrong seller without the price system to tell us.
2. Suppose a central planner manages to get the seller right, the allocation problems are immense. How do you determine who values a good the most without prices?
3. It's impossible to determine how much should be supplied without prices.
4. If the quantity supplied is too high, it effectively makes us all poorer.

Class Summary 11/23/11

How Markets Use Knowledge

Say, for example, that new demanders in the titanium market seek 6 billion pounds of titanium at a price of $20/lb. This will cause a shortage of titanium. There are three relevant parties in this situation:

1. Existing users of titanium
2. Suppliers of titanium
3. New users of titanium

In order to deal with the shortage, there cannot be a czar of titanium. A central allocator would have to ask the existing users to use less, the supplier to supply more, and the new users to lessen their demand for titanium. This simply isn't practical because no person has the knowledge needed in order to suggest any of this. A titanium czar would need to know a myriad of things that he or she couldn't possibly ever know. It's likely that even the market participants, of whom these requests are asked of, don't know the answers. The price system does what a czar would want to do.

Class Summary 11/18/11

The Price System


Advantages of using the price system:

1. It expands upon people's ability to act on their interests.
2. You don't have to assertively ask people to order themselves by need.
3. People can evaluate which uses of a good they value most.
4. It forces consumers to think about the value that other people place on a particular good.
5. Not using the price system bankrupts us.
1. Without prices, people have to rely on brotherhood, which never works.
6. The more important the good or service is, the more important it is that it's left to the market.

Money

• Changes the nature of transactions
• Cuts out the information problem of transaction costs
• Solves the "double coincidence of wants" problem
• When people want to trade more, some form of money emerges
• Money is divisible

Class Summary 11/16/11

Rationing Mechanisms


How do you allocate scarce goods to people?

1. Need --> determining need is extremely costly
2. Queue --> the length of the line can signal the price, and sometimes makes the price higher because of opportunity costs
3. Lottery --> lotteries are very easy to rig
4. Equal Shares --> essentially communism; it's difficult to cut up goods & value decreases in distribution
5. Might makes right --> planning is difficult and inefficient
6. Merit --> who decides merit? No one has the capacity to do so, and you don't necessarily want them to. Rewarding merit isn't efficient.

Evaluation of Rationing Mechanisms

• Where does competition come from?
• Competition derives from scarcity.
• What is the nature of competition--destructive or constructive?
• The price system is constructive; rational criteria above are destructive.
• The world is richer when you allow for constructive competition.
• What are incentives for producers to make/deliver more?
• Other considerations?
• You're assuming the goods exist.
• We tend to reward dishonesty in today's society (i.e. making yourself look poorer to be more eligible for college scholarships)

Class Summary 11/14/11

Supply
All of the relevant costs for producers are opportunity costs. There are times when the price of something is too low to warrant the production of it because a profit cannot be made. The general gist of supply is that it costs more to make more.

Supply curves tell us:

1. Marginal cost - every point on the curve is the marginal opportunity cost of producing that particular item
2. Total cost
3. Total revenues
4. Producer surplus - total revenues minus total costs

The law of supply has exceptions, unlike the law of demand that is unchanging. A caveat is found in the theory of labor supply. There is some point of income where you would actually work less. For example, if your salary was a million dollars a minute, you would probably only work for about five minutes per day. Apart from a few exceptions, supply curves generally slope up. This is because of diminishing returns in production, and the fact that you need more resources in order to make more products.

What changes supply?

1. Price of inputs
2. Expectations (even expectations about factor prices)
3. Technological improvements
4. Changes in other markets

Price elasticity of supply: percent change in quanitity supplied
                                            percent change in price of good
This determines how much more is produced when price increases. Market supply curves are flatter than individual supply curves. Average costs determine entry and/or exit into/out of a particular market. Again, don't factor in sunk costs!

Class Summary 11/11/11

Supply and Demand


Is there such a thing as "perfect inelasticity"? No! At some point, you won't be able to buy a particular good because the price is too high. There's a substitute for everything, although it might not be completely desirable.

We use income elasticity of demand to determine whether goods are normal or inferior. We use cross price elasticity of demand to tell us when goods are substitutes and complements.

Law of Supply: when the price of a good rises, suppliers will make more of it (there are exceptions)
Quantity Supplied: the number of goods you are willing and able to produce

For something to be a cost, it has to be tied to an action. There is a difference between "How much does a college education cost?" and "How much does it cost to obtain a college education?" because you're taking the opportunity costs and sacrificed opportunities into consideration. Costs have to be costs to someone.

Class Summary 11/9/11

Elasticity


Own price elasticity of demand:             % change in quantity demanded            
                                                      % change in [whatever you're interested in]

Demand is said to be inelastic when people are not very sensitive to the change in price of a particular good. Demand is said to elastic when people are very sensitive to changes in price of a certain good.

What impacts elasticity?

1. Time
1. Short run vs. long run
2. Budget
1. Some goods make up very small portions of your budget so their price change doesn't affect you very much.
3. Substitutes
1. Price elasticity for your health is very low (basically 0) because your health is important to you, and there are no substitutes. 

Someone said, "If the price of salt doubled, I would still consume the same amount of salt. Doesn't this refute the law of demand?"

• NO! Your demand for salt is inelastic because there are no substitutes for salt.
• The law of demand tells us that at some ridiculously high price you'll consume less of a good.
• The more narrowly a good is defined, the more substitutes it has.

Firms are incredibly interested in how elastic their consumer's demand for their good is. Firms can make money by lowering costs of goods because they get more costumers incentivized by lower prices or they can raise prices if costumers are loyal and make more money that way.

Class Summary 11/7/11

From Individual to Market Demand


There is a difference between demand and quantity demanded! It is possible for your demand to remain constant, while your quantity demanded fluctuates. It's also possible for the price of a good to remain constant, yet you want more or less of it.

Things that impact your quantity demanded:

1. Income changes
2. Prices of other things change
3. Expectations change
4. Tastes change
5. Number of participants in the market change

Normal Goods: when income increases, your quantity demanded also increases --> you buy more or better quality versions of these goods

Inferior Goods: when your income increases, your quantity demanded decreases

Substitute Goods: when the price of substitute goods increase, your demand for the original good increases

Complementary Goods: if the price of complementary goods goes up, the demand for the paired goods goes down --> treat these goods as the original good

Expectations: expectations about the future price of goods affect how much you consume. Also, expectations about the price of substitutes affect how much you consume.

Class Summary 11/4/11

Supply and Demand


Rachel's Demand Schedule for Burritos


Price             Quantity of Burritos
$0                               12    (<--not infinite when cost is $0 because there are still costs to consumption)
$0.75                          10
$1.50                          8
$2.25                          6
$3.00                          4
$3.75                          2
$4.50                          0

This chart tells us about: 1) marginal values 2) total expenditures 3) total value & 4) buyers' net gains --> consumer surplus

• Marginal values and total values solve the water-diamond paradox
• Total value = the sum of all burrito consumption
• Marginal value is $3.50 of burritos, but the total value of the burritos is $14.25
• Total expenditures + total value = 4 burritos = $12

There is no correct way to consume something. As price rises, you're going to give up the uses of burritos that are of less value to you. Prices force you to prioritize your wants, and think about the values of everybody else. The demand curve is price related to the number of whatever is consumed. Demand curves are always downward sloping.

Why do we behave in this way?

1. Wealth effects--you're poorer when prices go up, and this causes you to consume less.
2. Substitution availability--your purchasing power is higher when your real income increases, and you're going to look for other things besides just burritos to purchase.
3. Diminishing marginal utility--each unit that you purchase of a good gives you less satisfaction than the previous one. You wouldn't be willing to pay for the next burrito because it brings you less pleasure.

Class Summary 11/2/11

Transaction Costs, Middlemen, and Demand

Transaction Costs; anything that prevents beneficial exchanges and trade

Middleman: someone who has a comparative advantage in lowering transaction costs for producers and sellers

• They get a bad rap, but are extremely common. For example, Wegmans is the ultimate middleman.
• The price is generally higher when you buy from the middleman because you're paying for the convenience, not just the product itself.
• People get rich when they lower transaction costs.

Demand

Exchange can occur in small groups, but we have a world of 7 billion people so that's just not realistic. Firstly, there's a problem regarding information. It's impossible to understand what people want in bigger groups. Secondly, there's a transactions cost problem--there's no way to overcome the immense distance.

Price: information; signals to buyers about what is scarce, and a signal to sellers about what you value

• they steer knowledge in a way that causes order to occur
• prices come from markets--markets are the ether

Markets: any group of potential buyers and sellers

• there are physical, virtual, and betting markets
• any decentralized, unorganized interaction between buyers and sellers
• cause money and non-monetary prices to emerge (usually both in most markets)
• because goal of markets is to produce order--meaning there's stuff on the shelves

Buyers are demanders. In the goods market, households are buyers, and in the factor market the firms are the buyers. Sellers are suppliers. In the goods market, firms are sellers, and in the factor market the households are suppliers.

There's no such thing as perfect competition. In order for markets to work, buyers' and sellers' transactions can't have spillover repercussions on others.

Demand: not an all or nothing concept; a relationship between the amount you wish to obtain and the sacrifices you must make to get it (marginal value)

Quantity Demanded: a plan, a number; amount of a good that buyers are WILLING and ABLE to consume at a particular price

• For example: say you want a Maserati, but you don't have a quantity demand for it because you can't afford it

Law of Demand: other things equal, the quantity demanded of a good falls when price rises (including all three of types of prices)

Class Summary 10/31/11

Trade and Debt


Trade is always perfectly balanced, even when dealing with debts. For example, China can purchase United States' debt bonds. A foreign purchase of debt is only bad if a tax payer bailout occurs. Many people don't agree with this, and view it as China "taking over" America. Why would saving/investing be virtuous when it's done within the country, but bad when "foreigners" do it? Political borders don't have any meaning when it comes to the benefits of trade.

The majority of trade occurs between high-powered manufacturing firms. This is because trade lessens transportation (pollution), and less resources are used (not every country has to grow all crops--> specialization). Every 10% increase in someone's income has a  20% benefit to the environment.

Smithian Notion

1. Specialization frees of time
2. Specialization allows you to apply specific knowledge and capital that you otherwise could not
3. Specialization allows you to expand the market

Ricardian Notion

1. Specialization and trade lower cost (opportunity cost)

Class Summary 10/28/11

Trade and Jobs (continued)


Absolute advantage and comparative advantage determine whether or not jobs are shipped overseas. This equation helps asses the situation:

                Wages                        
Marginal Product of Labor

For example:  China- $8/hour                America- $30/hour
                                   4 units                                 20 units

China can produce something for $2/unit, and the United States can produce the same something for $1.50/unit. America has a comparative advantage at producing that particular unit over China. The United States also has the absolute advantage at producing this specific unit over China. Obviously the jobs should remain in America, right? Not necessarily because we don't know the opportunity cost of those American employees working those jobs as opposed to the opportunity cost of the Chinese workers. Perhaps the American workers currently employed in that manufacturing job could be curing cancer if they didn't spend the majority of their time in a factory. The opportunity costs might be higher than the production costs.

China can often produce something much more cheaply than America can. Some people advocate for tariffs being established on Chinese goods. Raising tariffs on Chinese products would hurt American manufacturing rather than help it. This is because imports from China are usually inputs into other American products that are already produced in a America.

Trade surpluses don't create jobs, and trade deficits don't take jobs away. People who say they do ignore:

1. We pay for our imports with our exports.
2. Specialization makes us wealthier because, on net, employment increases.

Trade deficits do, however, affect capital account balance. For example, Prof. Rizzo buys $10 worth of toys from China, and a Chinese person buys $5 worth of classes from him. If that Chinese person doesn't spend that $5 in America, it makes us wealthier. This is because reducing the number of bills in circulation raises the value of existing American currency.

Class Summary 10/26/11

Trade and Jobs


Today's technology caters to the higher educated, higher skilled people. People have to keep changing their specialties in order to keep up with technological innovation. Trade improves such technology. Some would argue that the "cost" of trade is jobs, however, jobs are constantly lost and new ones are consistently created. Every year, about four million jobs are lost and four million jobs are created. Despite trade, the number of jobs eradicated and gained reach an equilibrium. Trade doesn't cost us jobs, but rather creates new and different ones.

The logic behind the job churn/turnover is that those who lose their jobs were the first to benefit from trade in the first place. Trade doesn't kill jobs. Technology actually kills jobs by a factor of forty over trade. New jobs are dependent on technological innovation. Capital and labor are compliments to improvements.

Trade Surplus:  less imports, more exports
Trade Deficit: more imports, less exports

People that assert that "America doesn't make things anymore" are full of shit. US manufacturing produces more than they ever have before. Not only that, but more things are produced with less employees. There has been almost no innovation within the healthcare and higher education sectors. Those jobs are generally "safe". Society will always need medicine and training for new skills. Employees in the two aforementioned job categories are paid less than employees in more at-risk job markets. This is because salary is directly correlated with job safety.

Class Summary 10/24/11

Comparative Advantage


The ability to produce something with less of a societal cost as compared to the next guy.


Another hypothetical situation: Rochester and Cornell students can create wine and cameras. Rochester students are able to create 10 bottles of wine per year and 5 cameras per year, while Cornell students can only create 3 bottles of wine per year and 4 cameras.

+Rochester students have an absolute advantage in making wine over Cornell students.
+Rochester students have an absolute advantage in making cameras over Cornell students.

Two questions arise:

1. Who is more efficient?
2. What is sacrificed?

Rochester                                                                                  Cornell

Cameras: 5 cameras "cost" 10 wines                                          4 cameras "cost" 3 wines

               1 camera = 2 wines                                                     1 camera = 3/4 wine

Wine:     10 wines "cost" 5 cameras                                           3 wines "cost" 4 cameras

              1 wine = .5 cameras                                                     1 wine = 4/3 cameras

+Rochester has a comparative advantage in producing wine over Cornell.

BUT no producer can have comparative advantage at producing everything.

+Cornell has a comparative advantage in producing cameras over Rochester.

Suppose Rochester ONLY produced wine, and Cornell ONLY produced cameras:

Initially Rochester has 10 wines and 0 cameras, and Cornell has 0 wines and 4 cameras. If Rochester trades Cornell 3 wines for 3 cameras, it has 7 wines and 3 cameras in the end. Cornell has 3 wines and 1 camera. Both parties increased their PPF slope, and are therefore richer as the result of the trade.

If you decide to specialize and trade, it makes us richer. This is because it uses less of the earth's resources, and you get more outputs for the same amount of inputs. Each party pays for their imports with their exports.

1. Self-sufficiency is the road to poverty.
2. What a country ends up producing is what it's relatively better at.
3. Policies that restrict trade make people poorer.