Economics 1:  Fall  2010   J.  Bradford  DeLong,  Michael  Urbancic,  and  a   cast  of  thousands...   hAp://delong.typepad.com/econ_1_fall_2010/

Gerard Roland  Has  Found  Some  Extra   Money...

•  Please let  your  students  know  that  the  tutors   are  available  to  students  of  Econ  1,  100A,   101A,  100B,  140,  and  141.   •  The  tutors  will  start  holding  oﬃce  hours   tomorrow.  The  Smes  and  locaSons  of  their   oﬃce  hours  will  be  posted  to  the  following   page  later  today:   •  hAp://www.econ.berkeley.edu/econ/ugrad/ eac/eac.shtml

Economics of  Markets  with  Search   FricSons   •  “Sveriges  Riksbank  Prize  in  Economic  Sciences  in   Memory  of  Alfred  Nobel”  vs.  “ The  Nobel  Prize  in   Chemistry”

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Administrivia: The  Next  Month:  The   Long  March  to  the  Second  Midterm   M  Oct  11:  Choice,  Scarcity,  and   Exchange   W  Oct  13:  Markets  and  Other   AllocaSon  Procedures.  Essay  2:  two-­‐ pages  on  human  social  large-­‐scale   cooperaSon   M  Oct  18:  Working  with  Supply  and   Demand   W  Oct  20:  ProducSon  and  Equilibrium   in  the  Short  Run  and  the  Long  Run.   Problem  set  4       M  Oct  25:  General  Equilibrium  and  the   "Eﬃciency"  of  "Perfect"  CompeSSon.   W  Oct  27:  Monopoly.  Problem  set  5   M  Nov  1:  Oligopoly   W  Nov  3:  MonopolisSc  CompeSSon.   Problem  set  6   M  Nov  8:  MIDTERM  2  EXAM

Economics 1:  Fall  2010:     Choice,  Scarcity,  and  Exchange   J.  Bradford  DeLong   October  11,  2010,  12-­‐1   Wheeler  Auditorium,  U.C.  Berkeley

Ladies and  Gentlemen,  to  Your   i>Clickers...   •  About  how  much  does  use  of  markets  rather   than  command  amplify  societal  economic   producSvity?   –  A.  None   –  B.  Doubles  it   –  C.  Triples  it   –  D.  Quadruples  it   –  E.  Quintuples  it

Guessing at  Some  Numbers   •  Growth  rates  of  populaSon   –  –  –  –

HG: 0.01%/year   AS:  0.05%/year   EM:  0.2%/year   >1800:  1.0%/year

•  Growth rates  of  technological  and   organizaSonal  knowledge   –  –  –  –

HG: ????   AS:  0.01%/year   EM:  0.09%/year   IS:  2%/year

•  Growth rates  of  global  GDP   –  –  –  –

AS: 0.05%/year   EM:  0.2%/year   EIS:  1.4%/year   IS:  3.4%/year

How Much  Does  Market  OrganizaSon   MaAer?   •  We  have  a  20th  century   “natural  experiment”   •  High  Stalinist  central  planning

–  Marx’s suspicion  of  markets  as   surplus-­‐extracSon  devices   –  Hence,  the  communists  said,   we  won’t  have  any   –  We  will  reproduce  the   Rathenau-­‐Ludendorﬀ  World   War  I  Imperial  German  war   economy   –  Communes,  economies  of   scale,  GOSPLAN,  etc.

•  Eﬀect: you  throw  away  a  ﬁve-­‐ fold  ampliﬁcaSon  of   producSvity  by  eschewing  the   market

How Much  Does  Market  OrganizaSon   MaAer?   •  Eﬀect:  you  throw  away  a   ﬁve-­‐fold  ampliﬁcaSon  of   producSvity  by   eschewing  the  market...   •  Eﬀect  on  human  welfare   can  be  greater  or  smaller   (Cuba/Cambodia)...   •  Linkage  between  market   economy  and   technological   knowledge...

The Economic  Problem   •  Stuﬀ:

–  What... –  How...   –  For  whom...

•  We can’t  make  everything   •  Where  there  is  no  scarcity—or   where  we  don’t  care  that  there   is  scarcity—there  is  no   economic  problem   •  Where  there  is,  and  where  we   care,  there  is  an  economic   problem:   –  Ursula  K.  LeGuin:  Urras  and   Anarres   –  Jan  Wenner  vs.  Paul  Allen

What Do  We  Care  About?   •  We  care  about  choices   between  things  we  value   •  “Opportunity  cost”

–  What is  the  “opportunity   cost”  of  aAending  Cal?   •  Cash  cost  plus  foregone   wages  plus  foregone   valuable  experience  plus   Sed  to  Berkeley  plus  not  a   boring  job...

–  What is  the  “opportunity   cost”  of  drinking  a  cup  of   coﬀee?     •  You  can’t  spend  the  Sme   and  money  taking  yoga   lessons

Scarcity and  Choice  in  a  MulS-­‐ Person  Economy   •  Dharma  and  Greg   –  Greg  is  good  at  making   coﬀee—can  make,  say,   10  cups  a  day   •  But  inept  at  yoga—one   lesson  a  day  max

–  Dharma is  good  at   doing  (and  teaching)   yoga—can  teach  5   lessons  a  day   •  But  can  only  make  two   cups  of  coﬀee

Greg and  Dharma  in  Autarky

A Market  with  cu2  Yoga  Lessons!

What the  Market  System  Gets  Us   •  •  •

They have  specialized  in  what  they  are   most  producSve  doing   They  have  traded  via  this  insStuSon   clled    “market”   It  is  win-­‐win   –  Dharma  beneﬁts  as  long  as  the  price  of   yoga  lessons  >  cu0.40   –  Greg  beneﬁts  as  long  as  the  price  of  yoga   lessons  <  cu10

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Wealth MaximizaSon

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DistribuSon:

–  Any price  between  cu0.40  and  cu10   produces  a  wealth-­‐maximizing   producSon  outcome   –  Any  price  between  cu0.40  and  cu10   produces  an  eﬃcient  allocaSve  outcome   –  Any  price  outside  the  range  shuts  the   market—and  specializaSon—down   –  A  price  of  cu10  gives  all  the  surplus  to   Dharma   –  A  price  of  cu0.40  gives  all  the  surplus  to   Greg   –  A  price  of  cu2  makes  them  equally  well   oﬀ   •  Or  does  it?

Ladies and  Gentlemen,  to  Your   i>Clickers...   •  The  “economic  problem”:   –  A.  Is  ﬁguring  out  how  to  deal  with  the  fact  of  scarcity   in  (at  least  some  of)  the  things  we  care  about.   –  B.  Is  the  result  of  high  opportunity  costs.   –  C.  Was  solved  for  all  Sme  by  the  wave  of  technological   innovaSon  that  was  the  Industrial  RevoluSon.   –  D.  Is  that  supply  is  not  guaranteed  to  match  demand.   –  E.  Is  that  of  ﬁguring  out  what  prices  should  be  charged   in  markets

In Order  to  Coordinate...   •  ...in  an  economy  with   N  commodiSes  via   the  market,  you  have   to...   –  1.  Find  a  whiteboard   –  2.  Write  down  N   prices   –  3.  Laissez-­‐faire   –  4.  Maybe  you  don’t   have  to  write  down   the  prices

In Order  to  Coordinate...   •  ...in  an  economy  with  N   commodiSes  via  a   bureaucraSc  command-­‐ and-­‐control  hierarchy,   you  have  to...

–  1. Tell  everybody  what  to   do   –  2.  Tell  everybody  what   they  are  going  to   consume   –  3.  Check  up  to  make  sure   everybody  is  doing  what   they  are  supposed  to  be   doing

In Order  to  Coordinate...   •  ...in  an  economy  with   N  commodiSes  via   “custom,”  you  have   to...   –  1.  Already  have  solved   the  economic   problem  last   generaSon   –  2.  Keep  things  from   changing

How Important  Is  InformaSon  Flow?   •  •

With two  people—Dharma  and  Greg— these  informaSon  diﬀerences  may  not   seem  that  important   But  with  140  million  workers  and  with   100,000  diﬀerent  commodiSes?   –  Private  property  pushes  decision-­‐making   out  to  the  periphery  where  the   informaSon  already  is:  you  don’t  have  to   collect  it   –  Purchase-­‐and-­‐sale  automaScally  gives   good  incenSves:  you  don’t  have  to  check   up  on  people   –  If  you  can  get  prices  right

•

But what  if  the  market  system  has  big   fricSons?  What  if  it  is  more  producSve   to  do  pieces  of  the  division  of  labor  via   bureaucraSc  command-­‐and-­‐control?   –  Then  the  market  provides  incenSves  to   create  such  islands  within  itself—that  is   what  big  businesses  are   –  And  we  can  and  do  supplement  the   market  with  the  government   •  Wyoming  KnoA’s  Sixth  InternaSonal   Plauorm

QuesSons to  Ask  of  Any  Societal   CalculaSng  Mechanism   •

Is it  aAainable?

–  i.e., China  during  the  Great  Leap  Forward   not  aAainable   •  Peng  Dehuai’s  reprimand  of  Mao;  Hai   Jui’s  reprimand  of  Shih  Tsung

•  •  •

ProducSve eﬃciency:  will  the  right   people  be  making  the  right  things?   AllocaSve  eﬃciency:  will  anybody  say   “I  don’t  want  that,  I  want  this   instead”?   Will  it  be  fair?   –  The  cu0.40  price  allocaSon  might  be   Pareto-­‐opSmal

•  Dharma teaches  yoga   •  Dharma:  2.5  yoga  and  1  cup  of  coﬀee— and  doesn’t  want  to  teach  more  or  less   •  Greg  consumes  2.5  yoga  and  9  cups  of   coﬀee—if  he  doesn’t  like  yoga  that  much,   he  might  not  want  to  take  any  more    yoga

–  But it  doesn’t  seem  fair,  does  it?

•

That is  what  we  will  look  at  next   Sme...

Ladies and  Gentlemen,  to  Your   i>Clickers...   •  What  is  the  single  principal  reason  to  have  a  market   economy  rather  than  a  bureaucraSc-­‐command   economy?

–  A. It  is  more  producSve   –  B.  It  requires  that  a  huge  amount  less  of  eﬀort  be  spent  on   centrally  collecSng  and  processing  informaSon   –  C.  It  requires  that  a  huge  amount  less  of  eﬀort  be  spent   checking  up  on  people  to  make  sure  that  they  are  doing   what  they  are  supposed  to  be  doing   –  D.  Its  tolerance  of  independent  centers  of  social  power   makes  a  collapse  into  oppressive  dictatorship  less  likely.   –  E.  It  is  fairer

Test Your  Knowledge   •  What  is  the  “economic  problem”?   •  What  is  “opportunity  cost”?   •  What  informaSon  do  we  need  to  disseminate   in  order  for  a  market  economy  to  funcSon?   •  What  informaSon  do  we  need  to  acquire  and   process  in  order  for  a  centrally-­‐planned   bureaucraSc  economy  to  funcSon?   •  What  are  the  quesSons  we  should  ask  of  any   societal  social  calculaSng  mechanism?

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