Hi, I am Richard Mckenzie. In the previous lecture, I tried to accomplish two goals.

First, I sought to alert you to an economic reality that escapes many people. Expectations of good and bad events. The going into the future, can and will get capitalized into the value of asset prices today. I took up the issue of bad management. Bad management has consequences for the future of firms, because it can suppress the firm's profits. The suppressed profits can get capitalized into the value of the firm, today. Badly managed firms can therefore be attractive to take over targets. Take overs can lead to corrective policies or else the firms would not want to take them over. And it can lead to the min, minimization not elimination of bad management. Policies. Executives must be ever mindful, of how their bad policies can make them take over targets. Which can put their jobs, in serious jeopardy. By extension we might expect private firms, to be more efficient, than public bearuacracies. First of public bureaucracies don't make profits that can be garnered by private entrepreneurs in search of takeover targets. And most public bureaucracies when they operate poorly. Just try to take over the post office. Or for that matter try to take over your public university. Similarly, the prospects of adverse natural circumstances, whether floods, wildfires, or hillside collapses, can feed into the prices, of affected, of property. We considered the issue of people who buy property in flood prone areas. There's good reason to believe, that the prices of property inside flood planes and on the hillside, should be expected to diverge by the amount of the expected damage from floods. Everything else, equal, the greater the expected flood damage the greater the price differential between property and the flood. On a plain, and property on a hillside. When people incur the costs of flooding out, being flooded out, they can simply be paying the piper for their cheaper property. Government efforts to cover the costs of flood victims can get, can also get capitalized into the prices of flood-prone properties. Which can mean (no period) That the help can hike the wealth of people who own the property in the flood plains when the government aid is inaugurated, but it will not necessarily help the people who buy

into the flood prone areas later on. They can be expected to pay higher prices for their property, which can include the expected future recovery of flood. cost, so therefore they may not be helped at all. they get the help but they have prepaid for that help thru higher prices for the property that, properties that they have bought. Second, I alerted you to the reality that economic events have consequences, often hidden consequences that with a little thought can be traced out. Consider again the 9/11 terrorist acts. When the terrorists flew their planes into the Twin Towers, they increased the risk cost of flying, which reduced the amount of flying, which caused people to move to the highways, which caused more accidents on American highways. We can deduce that even The threat of terrorist attacks can result in greater deaths on American, highways. How? the threat of terrorist attacks can feed into the risk cost of flying, which can reduce flying. And can cause people, to dri-, can drive people, to driving. the TSA raising the alert status at airports can have a similar consequence because an increase in the alert status can lengthen the lines at the security checkpoints at airports. That can increase the risks, the time costs of airline travel which can drive people to driving again, which can lead to more deaths, on american highways. I raise the issue of Charles Shaw wine or what's called in Southern California, two buck chuck because it sells for $1.99 a bottle. two Buck Chuck can in fact lead to more drunk driving because it leads to more wine being, consumed. You can have an increase in the supply of grapes, but can lower the price of wine and increase, drunk, driving. Because the lower price of wine, can induce people to buy, more wi ne. The department of agriculture's efforts to reduce smoking by encouraging tobacco farmist to move from growing tobacco into a growing grapes and increase the supply of grapes and that can lower the their the prices of grapes and can lower the prices of wine which can have deadly effects on American highways as people drink more wine and engage in more recursive drunk driving. By indirection, I tried to get across two very important, points. One comes from, a quote by Frederick Bastiat. A nineteenth century, journalist. Who said, wrote this. There is only one difference between a bad economist and a

good one. The bad economist confines himself to the visible effect, the good economist takes into account both the good effect that can be seen and those effects that must be foreseen. Today my various examples I introduced in an informal way, the most important principle in the economic way of thinking. This principle is called The Law of. Of demand and this principle basically says that if in fact you lower the price of the good, more of it will be consumed. For example, here I have a demand which is, represents the law of demand. It basically says that at a price P1 there will be Q1. Being bought. And if you lower the price to P two, there will be more being bought. Q two, lower the price even more, and you get a larger quantity consumed. In this case Q three. Now, this is, this law of demand was very much at the heart of our discussion of Charles Shaw wine. You lower the price of wine, and you increase the amount of wine consumed. You lower the price from P1 to P3, and you increase the quantity of Charles Shaw wine consumed from Q1 to Q3 The same is true of the 9/11 terrorists. You lower the price, you raise the price of flying from P3 to P1 by increasing the risk cost of flying or by increasing the wait time, and the quantity of flying will go from Q3 to Q1, and as a result, people can move from flying into driving. There is an abundance of applications of, of this one law of demand. We can ask the question, why have Americans gotten so fat? And they have in fact gained on average about 26 pounds that is American adults have gained on average about 26 pounds since nineteen 60. Now, that may not seem like much, but when you add it up across all American adults, it's about three million additional tons that we are carrying around on our backside and around our, our waistline. Tons, and that three million tons is equal to about 37 million additional 1960 equipment. Adults who we are carrying around. Again on our backside and around our, our guts. And of course, those additional people are weighing down our automobiles and our airplanes, which can in fact be resulting in greater gasoline being consumed. The issue though is, is why, is why have Americans gained more weight? Well one explanation is that, is that extra pounds has become more socially acceptable. if you're the only heavy person in your high school class it's going to be very difficult for you to, to get dates, and you may become the

object of jokes, but if everybody else around you is heavier then it may be easier for you to get dates and people may be more reluctant to make jokes about you. What this means is that as more Americans have gained weight, the social cost of, of weight gain has gone down. As a consequence you might anticipate that the social acceptance of weight gain has in fact led to a greater quantity of, of, of pounds being packed on peoples, backside and on their guts. One might also reason, that Womens Liberation had something to do with American weight gains. How can that be? Well, I'm not against women's liberation at, at all. All I need to do is point out That when in fact you, you create more opportunities for women in the work place and you increase her wages which we've done over the last 50 years you get an increase in the price of home cooked meals, mainly because women are still responsible for home cooking. The result is that the price of home-cooked meals goes up and as a result, fewer home-cooked meals have been consumed, and that means that more out of home meals have, have, have been bought. Out of home meals are more calorie rich then home cooked meals and as a result, you can reason that with an increase in the wages of women, the real wages of women, you get a substitution for higher calorie out of home cooked. Cooking for in-home cooking. And of course what we've also seen is a decline in the real price of fast food relative to the prices of, of sit down restaurant. fast foods have become more attractive because of the relative drop in the real price of fast food besides they've become more dense. As a result, you don't have to walk as far or drive as far in order to get to a fast food restaurant. That also increase, decreases the real price of fast food which should lead to a greater consumption of the fast food restaurant. We might also reason that the decline in the real minimum wage over the last 50 or so years. It went down from a peak of about $ten an hour in 1968 to about $five and, and $0.25 an hour in 2007. That decline in the real minimum wage gave a cost advantage to businesses that use menial labor. While fast food restaurants are big user of, of, of menial labor. As a result the decline in the real minimum wage could have given fast-food restaurants a competitive cost advantage, enabling them to lower their prices relative to other restaurants and

home-cooked meals, and that in turn could have led to more people buying high-calorie fast-food. two meals. And do understand that some of the big burgers that you, that you find in fast food restaurants contain almost the equivalent of the recommended daily calorie intake of, Of american adults. A burger at hi, Ihop contains almost 1800, calories. We could also reason that, the growth in American weight is due to the downfall of communism Why? Well, the downfall of communism means that you had nearly two billion people in the former Soviet Union and in China, free to do what they wanted to do. The result is that you had an increase in income, which could cause more people to, buy more food, and to pack on the p ounds. They could also be contributing to the reduction in the prices of toys and electronic goods, which enables people to have more income available for the purchase of, of foodstuffs in this country. The growing efficiency of world trade can also be a factor contributing to weight, gain. In this lecture, I want to take up, more formally, the economic way of, of thinking. In conventional microeconomic courses, professors usually start off with the idea of scarcity being the core concept, in economics. the argument is, that we are, we live in a world, beset with limited resources. There are only so many trees, so many tons of iron ore. And so many gallons of, ,of gasoline. And for that matter, only so many gallons of, of water. But at the same time we have a unlimited number of wants. You can imagine how many things that you might want at this, this time. My guess is that many students watching this video would love to have a bigger screen television, no matter how large the screen is, people seem to want bigger flat screen. TV's, well anyway the, the notion of scarcity has several implications. The first of which is important to, to remember, we can't have everything, we must make choices, we only have so many things that we can do. Now if in fact we make choices we must incur a cost every time we make a choice. If you have only two options, A and B, and you choose A, then it follows that, that you give up B. And the cost of doing A is the value forgone, in, B. So scarcity implies, that there's a cost to everything. And economists, just love to repeat the refrain. There is no such thing, as a free lunch. There's also no such thing as free

love. Indeed, I think most of you would, will agree. Love can be some of the most expensive stuff you can buy, which is why so many people go without so often. Economists are always Looking for hidden costs in matters. And as a result we burst the bubble of everyone. When somebody says that library books can be checked out freely. We want to point out, that somebody has to pay f or the books that are, That are bought by the library. And somebody has to pay for the clerk's time, that, does the checking out. There are no free, library books. Another implication of scarcity is that perfection is not an option, because of the likely escalating costs and declining, gains. As people move toward achieving a, perfect level of environmental quality We can only imagine that the costs of achieving additional units of environmental quality goes up. Why? Because in, in moving toward greater environmental quality, we're most likely to export, exploit the cheaper means of greater environmental quality first. Which means that we only have the more expensive methods of, of improving environmental quality. Also as we move towards perfection in environmental quality the value, of the additional units of greater environmental quality is going to decline. And as the cost goes up, and the, and the quality, the benefits go down as the quality increases. There's likely to be some optimum level of environmental quality. The idea of scarcity also suggest the people, the best that people can do is, well, the best that they can do. Which is to find ways of allocating the limited resources among the unlimited wants so as to maximize value or welfare from the limited resources that are available. That is, people again seek to optimize within the constraints of cost and benefit. Now I think the. Idea of scarcity has many good dimensions of it. But I also have reservations about it. First off it sets up economists. Or some people may deduce it sets up economists and their students as, as judges of. Of how resources should be allocated. That is that's what this, this work is, is all about or economics is about is, trying to figure out ways to allocate the scarce resources among the unlimited wont's and, And we supposedly might be involved in that process. We are in something of a god-like position determined to determine which resources will be used, where the resources will be used, for what purposes they will be used

, that is what is going to be produced and who will benefit from the production and by how much. That's a very tall order, especially since it is very difficult to determine. the resources and, and, and warrant. Just consider, determining what resources are. Do you know what resources are? well, rocks on the side of the roads could be a resource, and labor can be a resource. but how many, how much labor do we have in a group of a hundred students? Well, it's not at all easy to determine Also, in the scarcity perspective of economics. there, the suggestion is that, that eliminating scarcity, is a real problem in life. If it, and if it is ever solved, we would live, happily ever after. But suppose the problem of scarcity were to be resolved. Would we really be happier? Suppose we had no want to be fulfilled. That is, we could just fulfill our every desire that we could ever imagine. Imagine being in heaven where all these desires are satisfied. What would life be like? Would it have meaning? I, I'm not so sure that it, that it would have meaning. As Heaven is normally described I suspect that Heaven would be a form of Hell. But I digress here, into speculation involving theology, which is not my area of expertise. From my perspective, the scarcity with which we must deal in economics is not the scarcity out there. The limited resources in the external world around us. But it is the scarcity inside us. In our brain. I have here a, a cast, of, a cast of my, of my brain. And this brain is about the appropriate size of the average adult. Human brain. And it actually weights about the amount that the human brain weighs. It is about three pounds in total. And this brain has maybe about a hundred billion neurons in it, and that's a lot of neurons. But you've got to realize that most of those neurons are devoted to controlling and orchestrating our various bodily of functions, that are on automatic pilot, for the most part. And then, many of those neurons are involved, in controlling our, our movement. Maybe up to 70% of our neurons are, are not accessible for making analytical decisions. And I should tell you, that men's brains are, on average, larger than women's brains. those of you who might get some glee out of knowing that men's brains are larger than women's should also know that women have more neurons than men, that is on average. And they have more connection between the

two halves of the brain. All of which can cause men and women to have slightly different abilities, for example in hearing and seeing, and to think different to say that men's brains are, are bigger than women's is not to say that they're smarter because the question is, is it better to have a more weighty brain or a brain with, with a more active neuron. Now, the problem here is that the brain is, is extraordinarily small. It has a limited capacity. But consider the, the fact that this brain must understand a terribly complex world. And there are billions of people in this world interacting with one another, there are trails of interactions and, and a trillion more reactions of people within the business world and, And broader society. There are gazillions of gigabytes of bits of information coming into our brain on a weekly, if not daily basis from the five senses that we have. The most dominant one being the sense of sight. One neuroscientist estimates that the brain has to deal with about eleven million bits of information every second of the day. Now, get that. The brain has to deal with eleven million bits of information every second of the day. And, believe it or not, the brain can only handle about 40 bits of information, per second. So, there are a lot of demands on the brains, and there's a limited, capacity. The brain, itself, must economize and on it's self in some way. And we must find ways of economizing on our limited brain power available to analytically thought. How do we do that? We devise ways of thinking that involve abstractions. If you try to understand the world by taking it, and As it comes to us and all of its complexity then we would have a brain overload immediately. We would get nowhere in understanding the world and I suspect that if you have trouble understanding the economy, it's probably because you're trying to consider too much information not too little information, and what we want to do is somehow cut through the gigabytes of information that is extraneous. We need to be able to extract from a complex reality and deal with the real world in reduced form. In what we call models of the complex world. Which are not meant to represent the real world in any descriptive way. But which can be used to draw out insights that we would otherwise miss. If we tried to deal with the real world in its full complexity, I'm sure we

would have a tough time, understanding the real world. there is a quote that I'd like to bring to your attention form Kenneth Boulding. He was a University of Colorado economist, he is now long deceased. But anyways he made a very profound statement. It is a very fundamental principle indeed that knowledge is always gained by the orderly loss of information. That is, by condensing and obstructing and indexing the great buzzing confusion of information that comes from the world around us into a form that we can appreciate and comprehend. Now let me re, repeat that. It is a very fundamental principle indeed that knowledge is always gained by the orderly laws of information. That's important. Because it suggests what we're going to be doing in this class. It, it explains why we put so much emphasis on this demand curve that I, I presented to you earlier. That is we're trying to gain knowledge by the orderly loss of information. In my next lecture I will start the development of the economic way of thinking by going to its foundation, the assumption that people are rational and are actually more rational than we know them to be. I will take up the thought experiment, assignment that I gave you at the end of the last lecture. The choice between option A and option B. I will delay consideration of that choice problem until I've gone through rationality. And the assumption's implications because some psychologists and economists see that choice outcome as evidence that people are not as rational as economists assume them to be, which suggests in their way of thinking that the economist's way of thinking is flawed in a fundamental way. Which I will argue, is not the case, at all. Many thanks for being with me.