Capitalism Socialism *Private ownership of *Public (gov.

) ownership of the mass & production means & production *Free markets *Central planning Trade Surplus Exports > Imports Five Fundamental Questions: 1) What gets produced? 2) How much? 3) How? 4) Who gets what? 5) How do we cope with the change? Persuasion is at the heart of what constitutes the economy *The more important you are, the bigger your reward *In the free market economy, we rely on people buying and selling products The Wealth of Nations: *Dominant school at the time was mercantilism Beginning of the 16th century to end of 18th century *Dominant characteristics: 1) Bullionism (gold or silver) Nations were obsessed with accumulating as much gold and silver as possible (to regulate Trade Surplus) Imports of gold/silver > exports of gold/silver creates balance Smiths point is that they got this completely wrong *Smith is a philosopher and a humanist Deeply concerned about the way people live and the way they view each other in relation to each other * When the rate of economic growth exceeds the rate of population, the average income increases More prosperity = higher mortality rates * The sustenance of life is physical as well as spiritual Adam Smith draws a connection between a means to feel compassion in society and the ability to do so POVERTY HEALTH DEATH LIFE Smith argues that gold and silver do not = national wealth * It is the ability to produce the goods and services for a nations necessaries and conveniences of life National Wealth: resides in the skill, dexterity, and spirit of industriousness of that nations labor What Causes National Wealth? * The measure of labor productivity is the amount of output/time * The single most important cause of National Wealth is improvements in the social division of labor Smith * Limits improvement in division of labor: extent of the market Existence of opportunities for people to exchange in mutually beneficial exchanges * Causes improvement: non-interference * Bissez-faire: Let people trade freely Money is NOT National Wealth * No money barter economy (has never existed in specialized economy) aka goods exchanged directly for goods * Money as a medium of exchange Reduces transaction costs It is cheaper to go through the middle-man Chapter Seven: The Invisible Hand of the market * Two prices in connection with goods: 1) Pm = Market price of a good 2) Pn = Natural price of a good A price that is just barely high enough to cover the cost of producing a thing, it can be higher or lower than market price * Productive resources are necessary to produce things But they are scarce THINGS < WANTS * For everything that gets produced, something does NOT get produced everything we do entails cost in a world of scarcity * The cost of producing a thing reflects the value of the resources used to produce it in their next best alternative use EX: accounting professors vs. English professors The market places a very low value on intelligence and a very high value on sociability If Pm > Pn: 1) Provides people with information 2) Provides people with incentives Pm decreases and Pn increases until Pm = Pn Productive resources are relocated toward increased production of the thing Arbitrage: attempting to take advantage of an opportunity to realize greater than normal gains, and in doing so, reducing the gains to others engaging in the same action EX: Lines in a checkout grocery store * The only way you can do better than everybody else, is by knowing something they dont know * The invisible hand of the market process is constantly allocating productive resources away from less valuable uses and towards more valuable uses

Market: Some sort of institutional mechanism in which people are buying and selling things in terms of a mutually agreeable trade * Markets allocate productive resources in a way that maximizes individual well-being as the individuals themselves perceive it to best be served Markets work better than any other institutional mechanism that people have devised to answer the 5 basic economic Qs Do a good job of ensuring human freedom Smiths Distinction Between Productive and Unproductive Labor Productive Labor: That part of the labor force that is directly involved in producing the communitys means of subsistence Unproductive Labor: That part of the labor force that is directly involved in producing things other than communitys means of subsistence Smith talks about how this is important for the Arts of Civilization: they produce things that are enjoyable to society Not unproductive, just different * The problem is that those who are involved in productive labor must produce more than enough to support themselves in order to sustain unproductive workers Mathus Law: Population tends to grow arithmetically: 1, 2, 3, 4, BUT REALLY Population grows geometrically: 1, 2, 4, 8, * This is because we have a natural tendency to outdo the rate that nature can produce resources * Therefore, Mathus Law is not a law at all * Montaignes advice is to be intellectually humble; every age has taken something for granted which is false * Mathus is wrong because he did not foresee human ingenuity and the technological progress Our ability to support an enormous amount of unproductive workers CAPITAL THEORY: very murky concept Three main sources: 1) Labor 2) Land 3) Capital: produced goods that are used to produce other goods for sale * Capital and improvements in the division of labor go hand in hand with this economy * The problem is that it is hard to acquire and accumulate capital what has to happen?? GDP Two options: 1) consume it 2) save it Capital cannot exist unless SAVING is a prerequisite saving gives rise to capitalism Appreciation: Capital being used up slowly * The biggest industry that consumes far more than it saves is GOVERNMENT Problem of current consumerist economy Modern Economic Theory: Peter Heynes The Economic Way of Thinking (Bias = Libertarian) Authors are spelling out basic principles * Keynes wrote that there is some factual content to economics, but thats not all It is a method rather than a doctrine * The approach to economic involves a particular way of thinking using Methodological Individualism: In trying to understand social economic phenomenon, the individual human person is the ultimate unit of exploration * All social phenomenon result from the calculated choices and actions of individuals (The actions that people take after making calculations based on expected benefits or losses to themselves) * Cannot locate a distinct point of consciousness (mind) in society w/o disregarding the other points (people) that make up the whole thing society cannot want something Property Rights: The rules of the game that govern what you can and cannot do with things and yourself private property rights are generally acknowledged by everybody Biases of Economic Theory: Tends to favor/exclude certain systems (theories)

* Estimator is biased if it tends to give rise to systematic error also applies to hard sciences Pro-Market Bias: In terms of market progress Common Economic Fallacy: 1) Ad Hoc Ergo Prompter Hoc Fallacy 99.8% all heroin addicts drank milk as children therefore, we should ban milk Correlation is not the same thing as cause 2) Fallacy of Composition Assuming that whats true for the one is true for the whole 3) Man on the Street Fallacy Unqualified authoritative pronouncements on the economy Fundamental Principles of Economic Theory: * We live in a world of SCARCITY! The condition that makes economics possible Scarcity: The stuff that we use to satisfy is fewer in number than the wants that those goods could be used to satisfy * Scarcity DOES NOT = rarity Scarcity implies a relationship between stuff and wants The Law of Demand: When the cost of any activity increases, people tend to engage in less of the activity. There is a negative relationship between the cost of doing something, and the amount of the thing people will want to do. EX: If everyone were armed, would deaths increase or decrease? More people would use handguns to settle disputes than currently do. Marginalism: Implies that people make calculated choices on the basis of a comparison of the MBs & MCs of different courses of action * MBs are the values we expect to realize or gain as a result of engaging in some yet to be undertaken action * MCs are the values we expect to give up as a result of engaging in some yet to be undertaken action To claim that costs dont matter is to claim that there is only one good * People make calculated choices on the basis of a comparison of the MBs and MCs of different courses of action * Value the importance we attach to something as a result of our awareness that it can be used to satisfy Production Possibilities Frontier: * In order to get to point D, we must consider: 1) An economys supply of resources 2) The state of production technology 3) The state of economic organization Chapter 2: The Economic Way of Thinking: We must judge by EFFICIENCY Energy output/ energy input * Positive Statement What IS * Normative Statement What OUGHT to be Efficiency: Is a measure of how well things are working to achieve maximum benefits with minimum costs Has to do with subjective value Simply the ratio of MBs/ MCs The Relationship btw Exchange and Efficiency: THREE GAINS 1) + Sum: Gains to Winner > Losses to Loser 2) 0 Sum: Losses to Loser = Gains to Winner 3) - Sum: Losses to Loser > Gains to Winner Pursuit of Comparative Advantage: You can do something at a lower cost than someone else 1) More efficient resource, use and allocation 2) Explains the pattern of the social division of labor EX: Jane is accountant gets paid $100/hr Would take 10 hrs to paint her house George offers to paint for $10/hr in 30 hrs George has a comparative advantage * Example of Comparative Advantage to International Trade: US has CA in producing wheat, Brazil has CA in producing coffee Brazil offers 1 C for 1 W In a move from anarchy to free trade, the gains to the winners outweigh the losses to the losers

Demand for Donuts: * When price falls from $0.75 to $0.50, the demand foes not change, but rather the Qd changes A change in the goods own price does not change the demand, only the Qd * An increase in demand means at every price, Qd goes up and at every Qd, price goes up Demand curve shifts out * A decrease in demand means at every price, Qd goes down and at every Qd, price goes down Demand curve shifts in Law of Demand: When a goods price increases, people will buy less of it and when its price decreases, people will buy more of it Less of it (decrease of quantity demanded) More of it (increase of quantity demanded) * The demand for a good is the specific relationship that exists over a certain time period between a goods own price and the amount of that good that people are willing and able to buy (Qs) Demand Theory: Has to do with the side of the market that deals with (Substitutes for nearly everything) Things Held Constant: 1) Population 2) Incomes: Normal goods When income goes up, demand goes up Inferior goods When income goes up, demand goes down 3) Technology 4) Transactions Costs 5) Peoples tastes, preferences, perceptions of a goods quality 6) Expected Future Prices P: Expected future goes up, D: Now goes up P: Expected future goes down, D: now goes down 7) The Price of Other Goods Consider goods A and B One of three possible relationships: a. NO RELATIONSHIP b. SUBSTITUTES c. COMPLEMENTS Price Elasticity of Demand: * The availability of substitutes: The more substitutes = the more price elastic demand will be (Ed = higher); the fewer substitutes = the less price elastic demand will be (Ed = lower) Longer time period, the higher the price elasticity of demand Supply: A behavioral relationship between P and Qs over a certain time period * When S goes up, at every P, Qs go up and at every Qs, P goes down Supply curve shifts out and down * When S goes down, at every P, Qs go down and at every Qs, P goes up Supply curve shifts up and in Supply and Demand: How markets determine prices and how prices provide people with information and incentives that generally enable efficient coordination of a complex social division of labor Reasons Supply Curves are Upward Sloping: 1) Higher prices attract resources away from alternate resources 2) Higher prices increase the opportunity costs of not producing the thing whose price has risen, therefore, people tend to produce more of the thing * Anything that causes production costs to increase at all levels of production will CAUSE a decrease in supply Three Causes: 1) An increase in the monetary costs of productive resources 2) A decrease in productivity 3) An increase in the opportunity cost of producing something Administered Prices: Government interferes in price setting 1) A legislated maximum price is called a price ceiling 2) A legislated minimum price is called a price floor * If legislated maximum price is above market equilibrium price, it will have NO effect Price Ceiling: If price is set below market equilibrium price there will be a shortage * Scarcity entails rationing Rationing entails discrimination Price Floor: Minimum Wage At Pf, Qs > Qd (Pf = minimum price to keep the small guy in) * Competition involves people striving to fulfill the criteria that others are causing to ration the scarce goods that they own Market Efficiency: 1) Buyers and sellers must be price takers If one seller than monopoly Q* will be too low & P* too high from the standpoint of efficiency 2) Perfect Information (transparency of markets) 3) No externalities 4) The condition that all wants and values must be solvent EX: Princeton criteria is not only $ but grades and qualifications * Competition takes place between sellers; not buyers and sellers * Competition takes place between buyers; not buyers and sellers Externalities: Spill-over costs and benefits that are taken into account by neither suppliers nor demanders in market progress 1) Negative Externalities: Spill-over costs 2) Positive Externalities: Spill-over benefits

Market Failure: Market fails to provide the efficient outcome * Goods that generate negative externalities * As you pursue an activity, marginal costs (mc) increase and marginal benefits (mb) decrease Eliminating Negative Externalities: * Tax vs. Command-&-Control (four industries) 10k tax revenue distribute as 2.5k tax rebate Elastic: Price/Expenditures = opposite direction; Inelastic: Price/Expenditures same Positive Externalities Smb > Pmb at all Qs Government Intervention 1) Subsidize Demand this persuades people to buy more of the thing in question than they otherwise would => D increase 2) Subsidize Supply this occurs when payments are made to producers to offset production costs => S increase (P increase & Q decrease) Free-Rider Problem a free rider is someone who thinks they will get a good whether they pay for it or not -> this problem likely to be most evident in the case of goods that are difficult to exclude non-payers from consuming Prisoner Dilemma Problem people think they will not get the good, whether they pay for it or not *coercion works by threatening to reduce options *persuasion works by offering to increase options Principle-Agent Problem interests being served -principle is those who are being served -agent is those who are doing the serving Government Failure government intervention in the market results in less effective outcomes than non-intervention *government has power to legally coerce adults Problem: rent-seeking behavior seek to get governt to impose restrictions so they can get more benefits than they would get thru the free market ASSUMPTION: governt sees public as rationally ignorant, free-riders, and rationally apathetic 2 Cases Requiring Government Intervention 1) any business that is too big to fail, must be regulated to prevent its failure 2) anytime upside gains are privatized and losses are socialized, institutions will take on far more risk than is socially optimal MACROECONOMICS Symbols: GDP = Y Unemployment Rate = M Price Level = P %changeP = Nominal Interest Rate = i Real Interest Rate =r GDP all the goods and services that are produced in a countrys borders in a calendar year measured at current market prices *Real GDP found when the GDP deflator filters out adjustments to price changes -> GDP is best measure of economic performance but does not include everything does include some things that dont make us better off (storm cleanup) Rate of Economic Growth = %changeGDP Expansion = %change Y > 0 and either increase Slowdown = %change Y > 0 and decreasing Recession = %change Y < 0 Per Capita GDP = Y/population Unemployment Rate = M M = labor force employed / labor force *Full Employment is the desired unemployment being achieved (varies, currently 4.5% and %.5%) Frictional Unemployment people who are changing jobs

Structural Unemployment results from technological change or change in the D of L Cyclical Unemployment those who are layed off Inflation => %changeP > 0 Deflation => %changeP < 0 Interest Rate is the premium one must pay in the future to borrow Positive Time Preference = things are more valuable in the present than the future people discount future Functions of Money 1) medium of exchange 2) store of value 3) unit of account 4) standard of deferred payment *central bank controls the money supply (Fed) *Msupply increase => when Fed buys securities *Msupply decrease => when Fed sells securities Reserve Requirement: Fed controls Msupply thru forcing banks to maintain a minimum reserve Mv = velocity of money-how fast $ moves thru the economy Increase Msupply = decrease i = increase Pbond = increase Dstock = increase Pstock D(houses) increase => P(houses) Fiscal Policy refers to the governts tax and spending policies Trade Deficit = net export < 0 Net Exports = exports-imports ENCYCLICAL Socialism is based on a lie, and any economic system based on a lie cannot endure *consumerism an emphasis on having rather than being Obligations obligated to individual (human person) and society *negative rights entail obligations to not do something *positive rights entail obligations to do something Pope says supply and demand take efficiency into account, but not justice