Then I’ll broaden the lens to discuss situations in which unregulated markets may run into issues, including monopoly and lack of competition; pollution and environmental harms; lack of sufficient support for new technology, innovation, and infrastructure; persistent or rising levels of poverty and inequality; and dysfunctional insurance markets. 92
Note: Good examples of market failure
What should be produced by a society? • How should it be produced? • Who gets to consume what is produced? These three questions are fundamental to every economic system and indeed every society: capitalist or socialist or communist, low-, middle-, or high-income. 118
Division of labor allows a firm to take advantage of economies of scale. “Economies of scale” is the jargon for saying that, in certain cases, a larger firm can produce at a lower average cost than a smaller firm. A tiny factory that produces only one hundred cars a year will have much larger production costs per car than a factory making ten thousand cars, which can take advantage of specialization and assembly line production. 211
Note: Economies of Scale
The overwhelming majority of Americans have never grown food, caught game, raised meat, ground grain into flour, or even fashioned flour into bread. Faced with the challenge of clothing themselves or building their own homes, they would be hopelessly untrained and unprepared. Even to make minor repairs in the machines that surround them, they must call on other members of the community, whose job it is to fix cars or repair plumbing. Paradoxically, perhaps, the richer the nation, the more apparent is the inability of its average inhabitants to survive unaided and alone. 224
Note: While it isn’t an argument against Libertarianism, it does a good job of refuting the idea that we are all islands in and of ourselves, that the idea of Margerate Thatcher’s “There is no such thing as a society” is ridiculous. It i possible from this, we could extrude the idea that while we may not nessesarily owe anyone something by force, we are all connected in a society in which everyone is depending upon everyone else who works in some way. Even the wealthy man who seemingly needs nothing from a common laboror, can use his pencil to write only because of the incredible nexus of connections of common workers whose labor makes that possible. It isn’t enough to show the wealthy man owes them anything more, because he has paid for his pencil and the workers have been paid, but it does show we are a society that are dependant on each other. The pencil example above is a good one. You can’t even use a pencil without the help of perhaps 100, or 1000 people.
Let’s take a deeper look at how markets work together in the economy as a whole. We’re going to start with a circular flow diagram, which pictures the economy in terms of flows of goods, services, and payments between two groups, households and firms, through three markets: goods, labor, and financial capital. 270
It’s important not to confuse the terms “demand” and “quantity demanded” as economists use them. “Quantity demanded” refers to the specific amount of a good that is desired at each given price. In 2009, about 120 million bags of coffee were sold at a price of $1.15 per pound. “Demand” refers to the relationship between price and quantity demanded. It refers to how much is desired at any possible price or at every price. As the price of coffee rises, the quantity of coffee demanded will decline. In terms of our graph, quantity demanded is a point, but demand is the curve. 323
What if income rises for society as a whole? If everyone had more money, there would be greater quantities demanded for most goods across the board at pretty much every price. • What if a society has a population boom? If you have more people demanding goods, that equates to higher quantities demanded at every price. • What about tastes and fads? Certain things become more or less popular all across a society—such as people consuming more chicken and fish and less beef. In that example, the quantities of chicken and fish go up and the quantity of beef demanded goes down at any given price. The demand for chicken and fish rises, and the demand for beef declines. • What about a change in the price of a substitute good? In the previous scenario, if most people think chicken is the best substitute for beef, its price goes up, and in response, people move away from chicken and demand more beef. Conversely, if the price of chicken goes way, way down, people buy more chicken, and the demand for beef goes down. 331
Just as there’s often confusion between “demand” and “quantity demanded,” there’s a parallel confusion between “supply” and “quantity supplied.” Quantity supplied refers to the specific amount produced at a given price. Supply refers to how much is produced at every price. Quantity supplied is a point, and supply is a curve. 346
Think about demand, think about supply. Start at equilibrium; think about what would happen if demand or supply shifted. Think about what new price and quantity would result at the new equilibrium. Supply and demand is a framework for discussing how prices and quantities are determined in markets and why those market prices and quantities are going to change. Understand this, and you’re on your way to a solid grasp of the basics of economics. 382
Disagreements about price and quantity in a market are impossible to avoid. Suppliers will always say if they just had a little more money, they could create new jobs, build new factories, hire more people. 405
Let’s start by considering some alternatives to rent control. One could give money directly to the poor by raising welfare payments, or by giving housing vouchers. This kind of demand-side help is more targeted than price controls, going straight to those who need it. On the supply side, a government could subsidize the construction of low-cost housing or adjust zoning laws to allow and encourage the construction of more low-cost housing. Either of these actions should result in a higher equilibrium quantity of affordable housing without causing shortages or surpluses. 453
Instead of implementing price floors, a government could subsidize buyers of food through food stamps, school lunch programs, and so forth. Encouraging demand should help farmers sell more of their product. On the supply side, the government could supplement the income of farmers whose farms are below a certain size, thus targeting the assistance to those in need. Both of these choices avoid the problems of accumulating surpluses of farm products at home or dumping the surpluses on developing nations abroad. 458
Note: A good rebuttle to the common argument used by Libertarians about demand aide subsidy. Joe and Jeremy both used it for health care and college.
Economists also believe in taking all the costs—not just the budgetary costs, but also the opportunity costs—into account. Rent control, for example, benefits some people because they get lower housing costs, but others suffer because they can’t find an apartment, and some construction businesses suffer because they can’t turn a profit. Similarly, when a government keeps crop prices high, the farmers producing those crops benefit, but poor and middle-class families face a higher price for basic food necessities such as milk or bread, 465
Note: Remember to think of everything in terms of opportunity cost and total cost. Unseen costs. Argue against those too.
Goods with inelastic demand have an elasticity of less than 1. In a situation of inelastic demand, the percentage change in quantity demanded is smaller than the percentage change in price; for example, a 10 percent rise in price might cause the quantity demanded to fall by 5 percent. Goods that are highly inelastic are often ones for which it is difficult to substitute a less expensive good; if you have a cold, you can choose the generic cough medicine over the name brand, but a diabetic can’t cut back on insulin use just because the price goes up. Demand for insulin is inelastic. Demand for cigarettes from smokers who are well and truly hooked is inelastic. Goods with elastic demand have an elasticity of greater than 1. In terms of the formula, the percentage change in quantity demanded is greater than the percentage change in price. Here, a 10 percent rise in price might cause a 20 or 30 percent fall in the quantity demanded. The quantity demanded is highly stretchy; it moves a lot in response to changes in price. A classic example is orange juice. If the price of orange juice goes way up, people can easily substitute other drinks and vitamin C pills. Demand for orange juice is elastic. Demand for cigarettes from teenage smokers, who are not yet well and truly hooked, may well be elastic. Goods with unitary elasticity of demand have an elasticity equal to 1. When the percentage change in the quantity of a good demanded is exactly equal to the percentage rise in its price, we say it has unitary elasticity. This means that if the price goes up 10 percent, the quantity demanded falls 10 percent. Goods with inelastic supply have an elasticity of less than 1. Here, a given percentage change in price will bring a smaller percentage change in the quantity supplied, so a 10 percent rise in price might cause a 5 percent rise in supply. A classic example of a completely inelastic supply is the paintings of Pablo Picasso: no matter how much the price goes up, we aren’t getting any more of them! But in general, in any industry where it’s difficult for firms to expand their supply of raw materials or skilled labor quickly, those firms will produce goods with an inelastic supply. Goods with elastic supply have an elasticity of greater than 1. In this situation, a given percentage change in price will bring a larger percentage change in the quantity supplied, so a 10 percent rise in price might cause a 20 percent rise in the quantity supplied. These are products for which it’s pretty easy for a firm to ramp up production very quickly, perhaps because they were running below capacity. Goods with unitary elasticity of supply have an elasticity equal to 1. In this situation, a given percentage change in price would cause an equal percentage change in the quantity supplied, so a 10 percent rise in the price would bring a 10 percent rise in the quantity supplied. 487
Goods with elastic demand have an elasticity of greater than 1. In terms of the formula, the percentage change in quantity demanded is greater than the percentage change in price. Here, a 10 percent rise in price might cause a 20 or 30 percent fall in the quantity demanded. The quantity demanded is highly stretchy; it moves a lot in response to changes in price. A classic example is orange juice. If the price of orange juice goes way up, people can easily substitute other drinks and vitamin C pills. Demand for orange juice is elastic. Demand for cigarettes from teenage smokers, who are not yet well and truly hooked, may well be elastic. 491
Goods with unitary elasticity of demand have an elasticity equal to 1. When the percentage change in the quantity of a good demanded is exactly equal to the percentage rise in its price, we say it has unitary elasticity. This means that if the price goes up 10 percent, the quantity demanded falls 10 percent. 496
Raising price brings in more revenue if demand is inelastic, but not if demand is elastic. Imagine a band on tour booked to play an indoor arena that has 15,000 seats. To keep this example simple, assume that the band keeps all the money it gets from ticket sales and pays all the costs for its appearance, such as travel and lodging and equipment and so on—fixed costs that are the same no matter how many people are in the audience. Let’s also assume, for simplicity, that all the tickets are the same price. The band knows that if it raises the price of tickets, it will sell fewer tickets. The band has to decide whether to set a high price and sell fewer tickets or a lower price and sell more tickets. So how does the band maximize its revenue—that is, the ticket price times the quantity of tickets sold? 516
Demand and supply are often inelastic in the short run and elastic in the long run. Think about demand for gasoline. In the short run, if the price of gasoline goes up, what can you really do? You pay because your options are limited in the short term—combining errands into single trips, doing a little more walking or bicycling for short distances, and so on. For the most part, your demand will be inelastic in the short run. In the long run, if the price of gasoline stays high, you have more options. When your car needs replacing, you can buy a more fuel-efficient model. You can organize a carpool at your office. You can get yourself in shape and ride that bike regularly. You might consider moving nearer to where you work or taking a job that’s closer to home. 531
In the short run, the response of quantity supplied to price might be fairly inelastic, but over time, as firms have a chance to adjust, supply can become quite elastic indeed. In this way, elasticity explains why the prices in an economy tend to jump up and down a lot in the short run—because demand and supply are both somewhat inelastic. But in the long run, both quantities adjust, and prices become more stable, although of course not fixed in place. 537
When demand is inelastic, increases in the cost of production can be passed along to consumers, but when demand is elastic, increases in the cost of production have to be carried by the producers. 540
Note: Excellent Point on cost of production and costs passed onto consumers. Could apply to taxation as well. If taxes go up, we’re always told that simply gets passed to us through the companies anyway. But that’s not nessearily true if demand is elastic and we can go elsewhere. Thats only true if demand is inelastic. Elasticity of demand is one of the most useful tools we’ve seen in a long time to describe how costs between firms and producers are kept or passed along, or another way, if how willing people are to go with or without something determines where the cost of a policy or input cost gets transmitted to.
Coffee shops use coffee beans, but they don’t control the world market price of coffee. If the cost of coffee rises, can they pass the cost on to consumers in the form of higher prices? Well, is the demand for coffee elastic or inelastic? Can buyers get a less expensive caffeine fix, such as tea? Or can buyers cut out the cost of skilled barista labor and make coffee at home for less money? Unfortunately for the coffee shop, the answer to both questions is “yes.” As a result, demand for those coffee drinks is elastic, and only a modest portion of the increase in coffee prices can be passed to consumers. Let’s return to the example from the start of the chapter: What is the result of raising the tax on cigarettes? A tax, like the cost of ingredients, is an input cost. It’s a price that’s charged to the producer as it makes the product. Now, on some level, smoking is a choice; it’s certainly not a necessity any more than a double-shot extra-foam cappuccino. But for many people, smoking is also an addiction with few substitutes. We’d expect the demand for that group to be inelastic, and in fact, the evidence is that increasing the price of cigarettes by 10 percent will lead to a mere 3 percent reduction in the quantity of cigarettes smoked. As a result, if society increases taxes on companies that make cigarettes, the companies can pass most of these taxes along to consumers in the form of higher prices. 545
Note: Excellent examples of elastic and inelastic demand, and how taxation effects the costs bourn by consumers. these two exaples emcompass most templates as well. It also underscores the reality of choice, whether someone “can” choose to stop doing something vs whether or not they actually will. Yes, smoking is a choice, but it’s so hard to quit that realistically, people actually can’t.
The concept of elasticity stretches to cover many other situations. For example, we can ask whether trimming Social Security payments will encourage older people to work rather than retire. In terms of elasticity, the question is “What is the percentage change in hours worked that would result from a certain percentage change in Social Security payments?” Or it is sometimes stated that cutting income taxes will encourage people to work more. These are questions about elasticity—about how quantities respond to changes in price. 560
Note: Illuminates how the idea of elasticity effects almost all of economics.
When you don’t feel well equipped to rummage through old economics journals in search of statistical estimates of elasticities, it can be intimidating to try to guess what the result of any particular policy might be—whether it’s a sin tax on alcohol or an incentive to buy a hybrid car. But if you think about the basic concepts of whether demand and supply are likely to be elastic or inelastic in any given situation, you’ll have a strategy for making a defensible prediction. 573
Note: The overall thesis on how this can be used for policy debate.
But there’s one major distinction: In goods markets, firms are the suppliers and households and individuals are the demanders. But in the labor market, household and individuals are the suppliers and firms are the demanders. 583
Knowing what we know about price floors, we would expect a national minimum wage to lead to a decreased demand for labor; that is, in response to a higher minimum wage, fewer employers would offer jobs for unskilled or low-skilled labor. Meanwhile, more people would be willing to supply this labor. Indeed, there’s some evidence that in the United States, a 10 percent rise in the minimum wage can lead to 1 or 2 percent more unemployment for low-skilled workers. But that effect is quite small, and in other studies, the effect of a higher minimum wage on employment is indistinguishable from zero. This pattern suggests that in the United States, the minimum wage has not been much above the equilibrium wage in recent decades. 623
Note: Apsolutely wonderful way of thinking about how the minimum wage effects hiring and consequently unemployment in the economy. We can even allow them the point that a higher minimum wage reduces the number of jobs employers are willing to increase. However, it’s a matter of degree. If a large increase in the minimum wage results in a drop in employment, if that drop is miniscule, then it can be justified on the grounds that those being hired are doing so much better that the demand they will infuse into the economy will make up for the modest loss in jobs due to the wage, be expanded production in response to the increased demand. We can even go get our previous weapon of elasticity. Since a 10% increase in the “price of labor” that is the wage, results in an only 2% reduction in the amount of “product supplied” that is, jobs offered, we can say that quanity supplied of low skilled jobs are inelastic, and so the cost is bourn by the producers, not the consumers. They can’t choose to hire less because they need those workers at whatever price, unless the price increase (wage increase) is profound.
Here’s an insight for opponents of a higher minimum wage to mull over: Let’s say a 20 percent rise in the minimum wage leads to 4 percent fewer jobs for low-skilled workers (as some of the evidence suggests). But this also implies that a higher minimum wage leads to a pay raise for 96 percent of low-skilled workers. Many people in low-skill jobs don’t have full-time, year-round jobs. So perhaps these workers work 4 percent fewer hours in a year, but they get 20 percent higher pay for the hours they do work. In this scenario, even if the minimum wage reduces the number of jobs or the number of hours available, raising it could still make the vast majority of low-skilled workers better off, as they’d work fewer hours at a higher wage. 630
Note: The argument laid out, after we had already envisioned it.
Asking whether unions are “good” or “bad” for the economy will oversimplify the question. Unions clearly can coexist with high-income market-based economies; for example, many European countries have very high levels of unionization compared with the United States. The percentage of the workforce that is unionized in the United States has fallen from about 33 percent in the 1950s to about 13 percent in the 2000s. In the United Kingdom and Italy, for example, about 40 percent of the workforce belongs to a labor union. In some Scandinavian countries, unionization is closer to 70 or 80 percent. While these countries have their economic issues—as does every economy—there’s no denying their standards of living are quite high by world standards. And as the size of unions diminishes in the United States, we have to wonder whether a potentially valuable voice for labor interests isn’t being muted or lost. 658
Note: Good example to point out how the question of Unions is simply too complicated to reduce to “good” or “bad” for the economy. Examples also include how some countries with Unions do quite well.
In some scenarios, however, markets can reinforce discrimination. If customers of a certain firm are bigoted and don’t want to deal with workers from a certain ethnic group or don’t think workers of a certain gender should perform a certain job, they might take their business to a firm that shares their prejudice. Or perhaps some workers are bigoted, and if forced to work with members of the undesired group, they will have low morale and productivity. In these cases, a profit-maximizing firm—even if management is not personally bigoted—will have an economic incentive to perpetuate discrimination in hiring to keep both productivity and sales high. 676
Note: Though not a refutation of Friedman’s argument against equal pay for equal work, it’s a great reframe of how in some examples, the very market he supports can promote discrimination. Sure, some employers who discriminate might leave a great resource available to a non discriminatory employer who will recognize and sieze the oppurtunity. But likewise, some firms might have customers who support and reinforce just the opposite, where customers in the south only wants to deal with men, or whites, there could be an incentive for a firm to hire only these workers, and the market forces themselves do just the opposite of weeding out discrimination.
Sometimes “investment” refers to purchasing financial instruments such as stocks and bonds. Other times it refers to businesses buying physical capital, such as machinery or a factory. When you talk about the former, you’re talking about investors as suppliers of financial capital seeking a maximum return for minimum risk. When you talk about the latter, you’re actually discussing firms as demanders of financial capital, which they turn into physical investment assets. So “investment” can refer to either supply or demand—no wonder it’s confusing! To sidestep this confusion, I will refer to “financial investment” when I mean supply of financial capital and “physical capital investment” when I mean the demand for financial capital that is used to build assets. 713
Demand for financial capital comes from people who want funds now and are willing to pay a rate of return in exchange. With lower interest rates, a higher quantity of financial capital is demanded; for example, if someone wants to buy a car, they are more likely to buy when the interest rate on their car loan is low than when it is high. Similarly, firms are more likely to undertake physical capital investment in plants and equipment when they can borrow the money at a low rate of interest. 729
Note: Fundamental way interest rates effect the economy, and explains most of monetary policy as it relates to how by effecting interest rates, it effects investment, demand, and capital.
So how do you calculate the worth of a loan in the present compared with what it costs to repay the loan in the future? Economists use the concept of present discounted value, which is a way of taking costs or benefits that occur at different points in time and comparing them directly. Present discounted value is the amount that a future payment is worth in the present, if it were to be received immediately. To put it in practical terms, what is $100 to be received a year from now worth in the present? Assume, for the sake of the argument, that the interest rate in your bank account is 10 percent. So you pull out your handy-dandy calculator and determine that if you were given $90.91 right now and invested it for a year at 10 percent, you would have $100 a year from now. Thus, the present value of $100 a year from now would be $90.91. 743
In some industries, market competition isn’t likely to work well. Instead, it leads to a situation in which all firms can suffer enormous and unsustainable losses. 1146
Note: Already a great opening. Don’t frame it in terms of the consumer, they do not care about the consumer, for whom, it is always his fault. Frame it in terms of how it benefits the business. This is the only language they will understand.
By 1900, half the railroad tracks built by private firms were being operated by the bankruptcy courts. As a result, for most of the twentieth century, the U.S. government regulated the railroads—and, later, for similar reasons, the airlines. 1152
Note: Good example of how competition of heavy infrastructure based firms can drive prices down below the price nessesary to produce more infrastructure.
Competition doesn’t work very well among public utilities, either. Why not? Try to imagine a city with four separate water companies; that’s four sets of pipes, one for each company, under every building in the city. It’s not viable. 1154
Note: Perfect, cogent, and succinct refutation of the Libertarian idea of private common utilities, for a very practical reason. Instead of using the road intersections and courts, which is good enough but not airtight, you have an example that is simply impossible to punt to the private sector for purely practical reasons.
Imagine four times the number of electrical lines running down your street, or four times the number of railroad lines crisscrossing a city. Many water and electrical companies are technically privately owned, but they are closely regulated by the government. 1155
Note: Great example of the reason public goods need to be under the purvue of the Government. One we hadn’t thought of before.
These regulated industries share a common underlying characteristic: they rely upon networks of some kind. The cost of building the overall network tends to be high, whereas the cost of running it tends to be low. If you leave these big companies alone, you’ll tend to end up with a monopoly. Alternatively, two or more such firms in competition, once their infrastructure is in place, may compete each other into ruin—or to a merger, in which case there’s a monopoly again. This situation is referred to as “natural monopoly,” because the way in which the good is produced, with high fixed costs of building the network and low costs of delivering services afterward, can so easily lead to a monopoly outcome. 1157
Note: Another great example, with reasoning aside of government protection, for how monopolies can be the natural evolution of network or infrastructure based industries.
No option for regulating these kinds of industries is perfect, but some are better than others. 1162
Note: Cedes the point that it’s not perfect, but that doesn’t mean it isn’t better than nothing. Good practical way to put it.
An alternative to cost-plus regulation is called price-cap regulation. Under this system, the regulator (that is, the government) sets a price that the regulated firm can charge, extending several years into the future. For example, a regulator for an electrical company might set the rates that can be charged to consumers for the next three years. If the electrical company can cut costs, its profits rise, because it doesn’t have to lower its prices for several years to come. When the price cap expires, the regulator resets it according to the new costs, and the cycle starts again. Both the firm and the consumers can benefit. 1169
Note: Good argument and practical reasons for a reasonable type of regulation. Would be interesting to see some of the arguments against it.
The forces of competition can encourage innovation and efficiency and benefit consumers. But in certain well-defined circumstances, when competition can’t or won’t work well, government has a useful role as a referee of economic competition. Government is also a logical arbiter of safety standards, financial honesty, and information disclosure. The real challenge when the outcomes of market forces seem undesirable is to identify the specific underlying problem and design the policy response accordingly. Is the problem a monopoly, a cartel, a restrictive business practice, a natural monopoly, a regulated industry that doesn’t need regulation anymore, or low-income people needing access to a certain service? Rather than locking yourself into a mental box—either vehemently for or against regulation—it’s often wise to take a case-by-case approach. Regulation works poorly when it assumes that government can simply dictate the outcome; regulation is more likely to work well when it respects the power of incentives and market forces. 1209
Note: An excellent summary of regulation in a general sense, fair and balanced for any reasonable person. Anyone completely unwilling to accept an argument like this, that is idealogically locked against any form of regulation, has divorced themselves from logical discussion. It also helps us to understand that regulation works best in a case by case scenerio, which leaves us less vunerable to attack using arguments to regulate everything. It also invites the opponent to agree to certain forms of regulation. Divorce yourself from the situation, such as credit cards or Libertarianism, and look at the situation rationally. It also provides quick and easy examples of why we would want to regulate certain things. Monopolies, low-income needing a service, and so on.
The idea of a free market is based in part on the notion that buyers and sellers will act in their own best interests. However, when a market transaction adversely affects a third party—one who didn’t choose to be involved in the transaction—the argument that free markets will benefit all parties does not hold as well. 1225
Note: Good way to articulate that externalaties are a perfect example of a subversion of the free market, inclicting negative consequences onto a party not consenting to the transaction.
between your neighbor and the band didn’t take you into account. Pollution is the most important example of a negative externality. In an unfettered market transaction, the firm looks only at the private costs of production of a good. Social costs, the costs of production that the firm doesn’t pay for, don’t figure into the calculation. If a firm doesn’t have to pay anything to dump its garbage, it’s likely to generate a lot of garbage. But if firms have to pay for garbage disposal, you can be sure they’ll find ways to reduce their waste. Similarly, public policies concerning pollution seek to make those who create pollution face its costs and take them into account. 1230
Note: Perhaps one of the best parts of the book so far. Firms care only for private costs of production. They do not take into account social costs, which all of us bear. In this way, an unregulated economy is exactly the opposite of free. Instead of socialism, you get a sort of opposite, instead of subsidizing people through a form of welfare, you’re subsidizing the cost of production for a firm by bearing costs, social costs, of their production while not receiving the corresponding profit.
For those allergic to the word “tax,” it can instead be called a pollution “charge.” 1248
Note: Haha, a good way to say it.
it encourages firms to keep seeking ways to reduce pollution—rather than cutting pollution to just a hair below the legal limit. 1250
Note: Incentivizing pollution control. Working with market forces to achieve a socially desirable outcome instead of using an iron hammer.
A number of prominent climate scientists clearly believe that our present level of carbon emissions raises a risk of severe worldwide environmental damage. The probability and size of this risk is hard to measure, but when faced with a real possibility of a severe risk, it’s often worth taking out some insurance. 1266
Note: A very fair and balanced way to approach it.
The argument for absolutely zero pollution is neither viable nor intellectually serious. 1277
Note: Articulate – Remember this. One of the best ways to phrase something we can remember. Anyone who denies any possible intervention into market fundamentalism, any form of regulation or market failure, is not being intellectually serious.
These examples help to illustrate the reason why a free market may produce too little scientific research and innovation: there is no guarantee that an unfettered market will reward the inventor. Imagine a company that’s planning to invest a lot of money in research and development on a new invention. If the project fails, the company will have lower net profits than its competitors, and maybe it will even suffer losses and be driven out of business. The other possibility is the project succeeds; in that case, in a completely unregulated free market, competitors can just steal the idea. The innovating company will incur the development expenses but no special gain in revenues. It will still have lower net profits than all its competitors and may still be driven out of business. Heads, I lose; tails, you win. 1286
Note: Best argument yet for the government role of public research and development, which refutation of why the free market would not serve to reward people for their work.
Public goods share two key characteristics: they are nonrivalrous and nonexcludable. “Nonrivalrous” means that the good itself is not diminished as more people use it. When you have a private good, such as a slice of pizza, if Max eats the pizza, Michelle can’t. Compare that to, say, national defense. Max being protected by the armed forces doesn’t diminish the amount of protection Michelle receives. “Nonexcludable” means a seller cannot exclude those who did not pay from using the good. That slice of pizza is excludable; you don’t buy it, you don’t get to eat it. But if someone doesn’t wish to be protected by the armed forces, there’s no realistic way to exclude them. 1378
Note: Very good summary of the public good in general. The concept of Non Rivalrous and nonexcludable is reviwed in easy to understand terms, and in a way that can be applied to collective action for everyone’s benefit.
The free-rider problem is important to economic analysis. For the most part, economics argues that producers and consumers following their own self-interest offer many benefits for society. But in a situation of public goods, if everyone follows individual narrow self-interest, the result is actually worse for everyone. 1402
Note: The concenpt of the free rider problem is the most fundamental objection to privitization of public goods, as well as one of the most fundamantal refutations of ethical egoism, in that the pursuit of self interest always leads to collectivelly good outcomes.
is actually worse for everyone. How can public goods be provided 1404
The government uses taxes to require citizens to pay for a public good—whether each individual citizen would want that quantity of that good or not. This applies to goods the government provides directly (such as a standing army or a court system) or indirectly, via private contractors (as with road and building construction). When we say that government supplies a public good, we’re actually saying that the government collects the money to pay for the good; it’s an open question whether public workers or the private sector provides the good. Taxes overcome the free-rider problem by force: if you don’t pay your taxes for the public good, you go to jail. These benefits and costs are part of an implicit social contract. If members of society don’t find a way to come together to provide public goods—through either political or social mechanisms—they all lose out. 1408
Note: Good presentation on public goods in summary, and why they are benificial. Addresses taxation and force, which is the only thing of concern to many people. Someday, when that is overcome, everything is solved. But it also explains how many public goods can still be provided through private enterprise, hired by government and publicly funded.
What is the man supposed to eat while you’re teaching him to fish? 1477
Note: Clever point about assistance. While training in new skills, someone has to eat in the meantime. Some form of temporary assistance will always be needed.
In fact, behavior that is rational for individuals at the microeconomic level can lead to unexpected results when everyone in a group acts that way. Imagine you’re in a stadium among a big crowd watching a concert. You want a better view of the antics onstage, so you stand up. Then some others stand up for a better view, and eventually everyone is standing up. Everyone acted rationally from a microeconomic, individual point of view, but the end, macroeconomic result was that no one saw any better than they did before. (But now they are all standing for the entirety of the game, and thus less comfortable) 1835
Note: Level 10 – God – After years, and an entire book on the subject, this example provides the most compelling and useful outright refuation of Ethical Egoism, and that Libertarian Philososphy of collective serf interests, of all time. Anyone would understand. Literally, the best example we’ve ever seen. And here of alll places.
The four goals of macroeconomic policy are: (1) economic growth, (2) low unemployment, (3) low inflation, and (4) a sustainable balance of trade. 1841
Note: Four Goals of Macroeconomic Policy
Many other things affect people’s standard of living and their happiness but cannot be measured as things that are bought and sold. For example, if everyone worked ten hours a week less or had an extra two weeks of vacation every year, but output remained the same, GDP would not show any overall gain. Greater or lesser pollution levels don’t show up directly in GDP measures. Traffic congestion or length of commute doesn’t show up as something bought and sold, except indirectly, such as in gasoline or cups of takeout coffee consumed. Negative events, such as a natural disaster, can lead to the rebuilding of a large part of a city, which makes short-term GDP look positive, but the locals have clearly suffered a lower standard of living. The costs of preventing crime count as part of GDP, but the costs of the actual crimes in terms of loss and violence are not part of GDP. The fact that people have longer life expectancies and are living healthier for longer doesn’t show up in any direct way in GDP, although their spending on health care services is counted. 1884
Note: Problems with GDp
The starting and ending points of recessions are not defined by any U.S. government agency; rather, they’re defined by a committee of academic economists at a nonprofit research institution called the National Bureau of Economic Research (NBER). 1909
The underlying cause of long-term economic growth is a rise in productivity growth—that is, higher output per hour worked or higher output per worker. The three big drivers of productivity growth are an increase in physical capital, that is, more capital equipment for workers to use on the job; more human capital, meaning workers who have more experience or better education; and better technology, that is, more efficient ways of producing things. 1977
Note: Growth and education, all of the things they contribute to growth, especially technology and certainly human ability and proficiency, are based on education.
When economists break down the determinants of economic growth for an economy such as the United States, a common finding is that about one-fourth of long-term economic growth can be explained by growth in human capital, such as more education and more experience. 1984
Note: Direct refutation of the idea that education isn’t a leading contributor of growth
Aggregate supply will shift if there is a change in what an economy is capable of producing. The two main causes of aggregate supply shift are technological growth and a sharp change in the conditions of production that affect many firms across the economy. 2324
consumption plus investment plus government spending plus exports minus imports. 2332
Factories had been shuttered, but the machinery, the equipment, and the potential hadn’t disappeared. Technologies present during the 1920s were not uninvented in the 1930s. Thus, Keynes argued that the Great Depression—and many ordinary recessions as well—was not caused by a drop in potential supply as measured by labor, physical capital, and technology. Instead, Keynes argued, economies entered recessions because of a lack of demand in the economy as a whole, which led to inadequate incentives for firms to produce. Thus, he argued, a greater amount of aggregate demand could lift an economy out of recession. 2350
Note: Great summary of Keynes law of demand
There is a plausible pragmatic compromise between a Say’s law approach focused on aggregate supply and a Keynes’s law approach focused on aggregate demand: Keynesian statements about the importance of aggregate demand are more relevant for short-run policy, and neoclassical statements about the importance of aggregate supply are more important in the long run. This is probably the majority view among modern economists. 2360
In the long run, the size of an economy is determined by aggregate supply: that is, the number of workers, the skill and education levels of those workers, the level of physical capital investment, the prevailing production technologies, and the market environment in which these factors interact. But in the short run, aggregate demand may vary. For example, when firms are pessimistic or uncertain about the economic future, they put off some investment projects. Then, when they think the economy’s doing better, they may embark on their backlog of projects all at once. Also, big fluctuations in investment patterns can be tied to a nation’s financial system. In the Great Depression, for example, many businesses and households were unable to repay their loans, and banks went bankrupt as a result. 2363
If wages throughout the economy are sticky and don’t adjust immediately to changes in the economy, these short-run drops in aggregate demand can also lead to unemployment. When demand for products diminishes—that is, when there’s a recession—firms don’t immediately cut workers’ pay. They are more likely to stop hiring workers or to lay off a subset of existing workers, which leads to unemployment and a pattern of aggregate demand that doesn’t match the slow, long-term growth of aggregate supply. 2372
irrational pressures. Keynes argued that investment was affected by “animal spirits,” 2442
people’s lives and careers. Thus, Keynesian economists tend to support active 2448
Note: good, keep
likely to emphasize getting rid of or redesigning rules and regulations 2459
Note: keep p
a long-term trend. At least not yet! In short, the idea 2511
as the estate tax, don’t account for much of federal revenue. 2521
Countercyclical fiscal policy can be implemented in two ways: automatic and discretionary. Automatic stabilizers are government fiscal policies that, without any need for legislation, automatically stimulate aggregate demand when the economy is declining and automatically hold down aggregate demand when the economy is expanding. To understand how this happens automatically, imagine first that the economy is growing rapidly. Aggregate demand is very high; it’s at or above potential GDP, and we’re worried about inflation. What would be the appropriate countercyclical fiscal policy in this situation? One option is to increase taxes to take some of the buying power out of the economy. But this happens automatically to some extent because taxes are, more or less, a percentage of what people earn. As income rises, taxes therefore automatically rise. Indeed, the U.S. individual income tax is structured around tax brackets so as people earn more income, the taxes paid out of each additional dollar gradually rise. The same process works in reverse, of course. In a shrinking economy, the taxes that people owe automatically decline because taxes are a share of income. This helps prevent aggregate demand from shrinking as much as it otherwise would. Thus, taxes are an automatic countercyclical fiscal policy, or an automatic stabilizer. On the spending side, when the economy grows, what countercyclical policy do we want to apply, and what actually happens? As a booming economy approaches potential GDP, the goal of countercyclical fiscal policy is to prevent demand from growing too fast and tipping the economy into inflation. But when the economy is doing well, fewer people need government support programs such as welfare, Medicaid, and unemployment benefits. As a result, in good economic times, spending from the government in these kinds of categories automatically declines, which acts as the desired automatic stabilizer. The same works in reverse. In a shrinking economy or a recession, more people are unemployed and need government assistance. At such times, government spending on programs that help the unemployed and the poor tends to rise, boosting aggregate demand (or at least keeping it from shrinking too much), which is exactly the countercyclical fiscal policy one would want. 2602
Note: All of this is an excellent summary of automatic counter cyclical fiscal policy, and useful for review.
As a counterexample, consider the extremely large budget deficits of 2009 and 2010. President George W. Bush’s last proposed budget, which applied to fiscal year 2009, projected that the tax revenues for 2009 would be 18 percent of GDP. But when the recession hit, tax revenues for 2009 turned out to be just 14.8 percent of GDP. A portion of this drop was due to tax cuts passed in 2009 under the incoming administration of President Obama, but most of it was due to the recession turning out to be far harsher than expected. This unexpected drop in tax collections was an automatic stabilizer that helped to cushion the blow of the recession. 2624
Note: Tax revenue and economic growth.
I’ll just say that the Federal Reserve’s decision to increase or reduce interest rates offers an alternative policy for the short-term management of aggregate demand. Reduced interest rates help stimulate aggregate demand; increased interest rates hold down aggregate demand. Also, the Federal Reserve can often react more quickly than Congress; interest rate changes are more or less instantaneous compared with the tortuous budget process. So some economists hold that the Federal Reserve and the automatic fiscal stabilizers can mostly handle the short-term issues, while discretionary fiscal policy should be reserved for extreme cases and the long term. 2665
Note: Direct way to quickly address Chris on how the government affects aggregate demand.
While the conservative rhetoric tends to emphasize the “private” aspect, implying that this plan gives the individual more choices, if you listen carefully, many of those plans would either require or strongly encourage people to put in more money than they’re putting in now. 2771
Economists, therefore, do not define money by its form but as whatever object performs three functions in an economy: as a medium of exchange, a store of value, and a unit of account. 2802
The great advantage of money is that it avoids the need for barter, the trading of one good or service for another. Barter is an inadequate mechanism for coordinating the wide range of trades that happen in a modern, advanced economy with a highly specialized division of labor. In an economy without money, an exchange between two people requires what economists call a double coincidence of wants, a situation in which each person wants a good or service that the other person can provide. For example, if an accountant wants a pair of shoes, the accountant has to find someone who has a pair of shoes in the correct size and is willing to exchange the shoes for accounting services. If you wandered around looking for trades for everything you wanted in a modern economy, with thousands upon thousands of different jobs and millions of different goods, it would be extraordinarily difficult—and exhausting. Money circumvents this problem. By extension, it allows a far broader division of labor, degree of specialization, and amount of exchange. Money is a kind of lubrication to help the engine of economic exchange work smoothly. 2821
Note: For any loony Libertarian that would paint themselves into the corner of claiming we don’t need a system of money, but could somehow rely on some strange barter system. Unlikely, but I’m sure they are out there. Where does money come from in a libertarian economy?
Article I, Section 8 of the U.S. Constitution gives Congress the power to coin money and to regulate its value. In 1913, Congress created the Federal Reserve Bank, colloquially called the Fed, and delegated these powers to it. 2885
Note: That pretty much buries any notion right there that the government “can’t” or “shouldn’t” have control over the money supply. It also drives a steak I to
Monetary policy is the expansion or contraction of the money supply. Its purpose is to encourage or discourage aggregate demand. 2902
Note: So there’s your answer right there, on how the government effects aggregate demand.
The Fed, or any central bank, has three traditional tools for working within the web of banking and money to expand or contract the money supply: reserve requirements, the discount rate, and open market operations. It also has one newly minted tool developed in response to the 2007–2009 recession, called quantitative easing. 2903
Note: 4 tools of the Central bank
The reserve requirement is the percentage of their deposits banks may not loan out. Every bank is required to keep some of its deposits on reserve at the central bank; in effect, they have to deposit that money with the central bank. When the reserve requirement gets higher, each individual bank has less money to lend out. If each individual bank has less money to lend out, the quantity of loans available in the economy diminishes, and aggregate demand shrinks. 2906
Note: Tool 1-If Chris ever wanted to ask again how policy effects aggregate demand
The discount rate is another way that the Federal Reserve can encourage or discourage lending. 2915
How does the discount rate affect bank behavior? If the central bank raises the discount rate, this will encourage banks to keep money on hand, not to venture too close to the reserve requirement, because if they do need to borrow to make up the reserve, it will cost them more. To keep that little cushion around the reserve requirement, banks will loan a little bit less, reducing the amount of money in the economy as a whole. Conversely, if the central bank reduces the discount rate, banks will be less concerned about skirting close to the reserve requirement, because if they do miscalculate, borrowing the difference isn’t that costly. They can lend more money, thus increasing the supply of money in the entire economy. 2922
Open market operations occur when a central bank buys or sells bonds with the goal of decreasing or increasing the money supply. 2931
Decisions about buying and selling bonds through open market operations are made by the Federal Open Market Committee (FOMC) at the Federal Reserve. The FOMC is made up of twelve members, including all seven members of the Fed’s Board of Governors, plus five representatives from bank districts all around the country. Thus, decisions about open market operations are made not just by government appointees; there is also input from people who are actually involved in banking all around the country. 2944
Note: So Chris and Jon and the countless others constantly moaning and groaning and pissing and crying and just going on and on and on about “The Government” devaluing the dollar by increasing the money supply, part of the FOMC is in fact made up of private bankers on behalf of the private sector.
The other approach to quantitative easing is for the Fed to purchase longer-term financial securities. In 2009 and 2010 the Fed purchased U.S. Treasury bonds and, in addition, more than $1 trillion in financial securities backed by payments from home mortgages. This approach to quantitative easing seems to have helped stabilize financial markets in 2009 and 2010, but how it will work in the longer term—when the Fed eventually decides to stop purchasing such securities or to sell some of the securities it holds—remains uncertain. 2952
Note: Quantitative Easing in Practice
Remember, banks create money through the web of loans. One bank makes a loan; it’s deposited in another bank, where it provides the basis for an additional loan, and so on. The tools of monetary policy all work because they make banks either more or less eager to lend—or, to put it a little differently, more or less able to lend. To nail down this point, let’s talk about how monetary policy influences lending, aggregate demand, and interest rates. 2956
Note: Very good one paragraph summary of how factional reserve banking and basic monetary policy works
If the Fed wants the money supply to be larger, it has four options: It can lower the reserve requirement, lower the discount rate, buy bonds from the banks, or buy financial securities related to borrowing. All these steps can be referred to as expansionary, or loose, monetary policy. They all tend to reduce interest rates and encourage lending. In terms of our aggregate supply and aggregate demand model, they increase the quantity of aggregate demand in the economy. 2959
Note: Very good description of expansionary monetary policy, good summary for debates right here
News reports about the Federal Reserve often refer to the Fed raising or lowering interest rates. At this point, however, you should understand that the Fed doesn’t have dictatorial powers to say, “We declare that interest rates must rise” or “We declare that interest rates must fall.” Instead, the Fed uses its policy tools to affect the supply of funds that banks are willing and able to lend. 2967
Note: Good summery right here of Federal Reserve and interest rates
Through its open market operations, the Fed actually targets one specific interest rate, called the “federal funds rate.” The federal funds rate is the interest rate at which banks make short-term overnight loans to other banks. As this interest rate goes up or down, other interest rates—such as the rate on your car loan or home loan—move up or down more or less in sync with it. 2971
Note: Different interest rates
Part of the Fed’s job, therefore, is to be ready for situations that might lead to fluctuations in the demand for cash. 2986
Note: The FED does more than just the things Ron Paul bitches about. Like insuring there is enough cash on hand for certain situations and making certain the goddamn system doesn’t go bizzerk
The FDIC provides deposit insurance for about 8,000 banks in the United States. Even if a bank goes broke, and the executives of the bank lose their jobs, and the bank vanishes, deposit insurance and the federal government still guarantee that depositors will get their money up to $250,000. This 3000
Note: Nice to have some damn insurance
central bank such as the Fed also has a role as a lender of last resort. That is, when a financial system is potentially endangered by a major financial crash, the central bank provides short-term loans so the financial system won’t explode or implode. Financial panics can build on themselves and create an avalanche, as seen in well-known movies such as Mary Poppins and It’s a Wonderful Life. 3012
Note: Another think to be thankful of having the FED for
We don’t have bank runs anymore. People know their bank deposits are safe, thanks to deposit insurance. 3016
Note: People Like Jon and Jeremy have never lived in a world without this insurance, and don’t appreciate how important it is or nice go have it.
Central banks have both the power and the responsibility to conduct monetary policy and to participate in the soundness and safety of the banking system. 3025
Note: There’s the importance of the FED in one sentence.
further. Tighter monetary policy can fight inflation by raising interest rates 3048
Note: good summary
so high—than is deflation. Deflation occurs when the rate of inflation 3059
and as a result, even the most aggressive possible open market 3071
Note: keep this. fundamentals of deflation and money it policy
in the late 1990s or the buildup in the U.S. housing 3092
Note: keep. bubble.
In the U.S. stock market in the late 1990s, for example, 3096
Note: Best exclamation that is very simple what a bubble means
the time lag problem is that monetary policy involves a chain 3113
Note: Keep this. 3 problems with monetary policy in fighting a recession
string, it folds up and doesn’t move. When a central bank 3128
the freedom to make tough decisions fairly quickly multiple times in 3143
Efforts to estimate the costs of factors suggest that they could add up to 40 percent to the price of a good when it crosses a national border. In short, the costs of crossing national borders are still important, and for better or worse, we are not yet close to a borderless world. 3235
Thus, when people think about investing in other countries, they’re thinking, “Do I expect the exchange rate in that other country to get stronger or weaker?” That behavior sets up a cycle of self-fulfilling expectations. If people think a country’s currency is going to strengthen, they’re going to invest in that country. As they invest, the greater demand for that currency strengthens it. But this self-fulfilling cycle of expectation—that a currency will rise, leading to a currency that actually rises, leading to additional expectations for a rising currency, and then further actual rise—can’t go on forever. In the case of the goods market, we call this kind of behavior a bubble, and the exchange rate markets are full of small and larger bubbles expanding and popping all the time. At some point, the exchange rate will eventual return toward PPP. 3435
Note: Great explanation of a bubble in general, a belief is rising prices of a commodity that becomes self fulfilling, until the price is so high demand drops off
The first goal might be to keep the currency somewhat stable. It’s sometimes proposed that a nation should depreciate (that is, weaken) its currency to help its exporters become more competitive and create more jobs in exporting industries. While underlying economic factors will sometimes cause a currency to depreciate, a depreciating currency is not a road to sustained economic growth. 3450
Note: Good offsetting goal of depreciation
For example, imagine that a country suffers a negative economic shock of some kind, and so its exchange rate starts falling. If that country wants to keep its exchange rate up, it will need a contractionary monetary policy to make interest rates high, and make its exchange rate and currency more attractive. But that contractionary monetary policy will take the negative shock the economy has already experienced and make it worse. Faced with that trade-off, most countries will try to help their domestic economy, rather than stabilize their exchange rate. 3459
Note: Very Useful. Keep in mind that monetar policy not only effects the amount of dollars in an economy, but also the value of the money, and the exchange rate of he economy relative to other currencies, attacting or discouraging foreign investment or domostic investement abroad. These are all things that need to be kept in mind. Anytime someone like Jon or Jeremy bitches about the FED printing money, keep in mind they have no way to know, they have no idea how all of these things are actually connected, there is no way they read into it to this depth, beyond Ron Paul’s talking points through a biased lens. The key is to keep track of everything. Chris might have a better idea, but even he doubtfully looks much into it ast what is convenient to him.
If the government tries to fix the currency at an unrealistic level, high or low, it’s going to create imbalances and financial stress. If the government tries to keep the currency too strong, over time that country will have weak exports and huge trade deficits over a sustained period. If the government keeps the currency too weak, it will have large trade surpluses and a continual outflow of investment capital. 3475
Note: Good, summary of weak and strong exchange rates. One of the disadvantages of having a strong currency over the long term. People bitching about a “weak” dollar don’t understand that it’s not always a bad thing, especially on short terms. There are two sides to every coin. Next time someone like Jeremy, Jon, or even Chad bitches about a weak dollar, ask them “relative to what?” The idea of strong and weak don’t have any intrinsic meaning by themselves. Again, ask questions, before you jump right in. If they say relative to other countries dollars, explain how this can be an advantage over the short term, and a continually strong currency results in undesired effects. All these things need to be taken on balance.
As the money floods into these economies and then floods out, the economies can experience sharp movements in exchange rates. As foreign financial investment floods into an economy, lots and lots of people want to buy that currency, and the currency gets stronger in a hurry. When that financial investment pulls out, everyone’s trying to sell the currency, which drives the exchange rate way down. For example, the Argentinean peso was worth about one U.S. dollar on January 1, 2002. Only six months later, after the international financial capital flooded out, it was worth twenty-eight cents. It is common in these crises for the value of a country’s currency to fall by half or even more. Remember, exchange markets can be affected by self-fulfilling expectations. 3521
Note: A good summary of some reasons behind raising and declining exchange reates, and currentcy values. Good summery of what fuels a financial bubble as well. Exchange rates can fuel a large influx of investment driving down the value of the currency, and vice versa. This is a useful and brief summary of how supply and deman of capital can be affected.
For one thing, the International Monetary Fund is empowered to give loans to countries that are experiencing a financial crash in order to soften the blow. The IMF is an international institution, officially an agency of the United Nations founded in 1945 to encourage stable exchange rates. When a country is in a financial crisis, the IMF stands ready to make loans—not just temporary or short-term loans, but long-term loans that can help countries adjust to these changes. 3539
Perhaps the best kind of government control—which worked to some extent for Chile in the 1980s—is to worry less about money leaving and worry more about what kind of money arrives in the first place. Broadly speaking, foreign investment can be divided into two types: direct investment, when a foreign capital buys a firm or a factory—something solid—and portfolio investment, when foreign investment capital buys a financial instrument such as a bond. Direct investment is less likely to flee the country in a hurry, because it’s hard to sell a factory on the spur of the moment, and direct investors are more likely to seek a long-term payoff. Thus, if a small or medium-size country is going to try to impose controls on foreign investment, encouraging direct investment is probably the best route. 3556
Countries can also reduce their risks of a financial crash through better regulation of their banking and financial systems. 3561
How vulnerable is the United States to an international financial crash? The situation in the United States is quite different from that in many smaller economies, in part because the U.S. economy can borrow in its own currency, so its banking system is less vulnerable to being whipsawed by fluctuating exchange rates. Indeed, if the exchange rate of the U.S. dollar does fall, it reduces the cost of the debts that U.S. companies owe to foreign investors. 3576