William Rainey Harper College
ECO 211
Microeconomics: An Introduction to Economic Efficiency

2a

GET AHEAD !

Outline ~/~ Must Know

TOPICS:

  • Econ. Systems
  • Capitalism and efficiency
  • Comparative advantage and the gains from trade

READING

  • Ch. 2 ALL
  • Comparative Advantage: pp. 474-482
  • Petition of the Candlemakers, 1845: p. 493

VIDEO LECTURES

Class Rules:

  • Can be added to and changed. Please give me your suggestions.
  • No cell phone use (not even as a calculator)
  • Always use name tents with your first name on both sides

Meme:

Video:

Former Lecture Outlines

Must Know / Outcomes:

 

Outline

Pure Capitalism and the Market System: The Market and the 5 Es

I. Economic Systems (pp. 33-34)

 

TYPE OF SYSTEM
WHO OWNS?
WHO DECIDES?

Pure Capitalism:

private ownership
the market system

Command Economy:

government ownership
centralized (or gov't) decision-making

Mixed Economy

some private and some government
some private and some government

II. Capitalist Ideology

A. Basic Characteristics:

CLASS:

TEXTBOOK:

1. private property
2. freedom of enterprise and choice
3. role of self interest
4. competition
5. markets and prices
6. limited role for government
1. private property
2. freedom of enterprise and choice
3. role of self interest
4. competition
5. markets and prices
6. technology and capital goods
7. specialization
8. use of money
active, but limited government

B. private property

  • provides an incentive for economic growth
  • Paul Solman Video: Private Property (and Pilgrims too)

    OPTIONAL: http://www.npr.org/templates/story/story.php?storyId=1565953

    China Considers Private Property Rights on National Public Radio

    All Things Considered, December 22, 2003 · In Beijing, legislators propose an amendment to the Chinese constitution guaranteeing private property rights. The move has great symbolic importance in a country that is nominally communist, but whose people have been buying property and trading stocks for years as the result of economic reforms by Deng Xiaoping. NPR's Rob Gifford reports.

C. markets and prices

  • prices GUIDE resources
    [pickups driving to Florida with plywood]
  • prices RATION goods and services
    [high prices after a hurricane encourage people to conserve]
  • markets and prices affect allocative efficiency

    Quick Quiz:

    TO DECIDE HOW TO USE ITS LIMITED RESOURCES TO SATISFY HUMAN WANTS PURE CAPITALISM RELIES ON:
    A. CENTRAL PLANNING
    B. FREE TRADE
    C. A PRICE SYSTEM
    D. FULL EMPLOYMENT

D. role of self interest

  • Introduction: would you rather have government or private business . . . . ? WHY?
    • gas station near a desert

 

  • Self interest is a powerful force and IF THERE IS COMPETITION IN AN ECONOMY it will result in improving the social good as if there is some "INVISIBLE HAND" guiding their decisions.
    • "greed" and productive efficiency
    • "greed" and allocative efficiency
    • "greed" and economic growth

E. freedom of enterprise and choice

  • definitions
    • Freedom of enterprise means that entrepreneurs and businesses have the freedom to obtain and use resources, to produce products of their choice, and to sell these products in the markets of their choice.

     

    • Freedom of choice means:
      • Owners of property and money resources can use resources as they choose.
      • Workers can choose the training, occupations, and job of their choice.
      • Consumers are free to spend their income in such a way as to best satisfy their wants (consumer sovereignty).

       

  • provides the means for "greedy" people to help the economy achieve allocative and productive efficiency and economic growth

F. competition = capitalism

  • what is competition?
    • 1. Large numbers of sellers mean that no single producer or seller can control the price or market supply.

      2. Large number of buyers means that no single consumer or employer can control the price or market demand.

      3. Depending upon market conditions, producers can enter or leave industry easily.

  • competition is the "invisible hand"
    • plywood after a hurricane
    • monopolies and inefficiency

G. limited role for government

  • What IS the economic role for government? (chapter 5)
  • Economic goals: 5 Es
  • Problems with capitalism:
    • at times even market economies achieve allocative INefficiency:
      • overproduction (too much produced) of goods with negative externalities
      • underproduction (too little produced) of goods with positive externalities
      • tendency for business to increase monopoly power and produce less to increase profits
    • macroeconomic instability (periods of high unemployment and periods of high inflation)
    • no mechanism to guarantee equity

     

III. The Market System at Work

A. The Market and the 5Es
1. Economic Growth
a. Define
b. Economic Growth and the characteristics of Capitalism
(1) private property
(2) self interest
(3) freedom of enterprise and choice

c. market economies tend to have faster growth rates than do command economies

2. Allocative Efficiency: Producing what consumers want

a. The role of self interest in capitalism provides INCENTIVES to be allocatively efficient.
  • more profits = produce more
  • losses = produce less

b. Capitalism's use of the market (supply and demand - Ch. 3) provides a MEANS to achieve allocative efficiency

  • consumer sovereignty and "dollar votes"

c. Capitalism tends to achieves allocative efficiency

3. Productive Efficiency: Producing at a minimum cost

a. The role of self interest in capitalism provides INCENTIVES to be productively efficient.
(1) profits = total revenues - total cost
(2) minimizing costs means more profits
(3) minimizing costs is productive efficiency

b. Capitalism tends to achieve productive efficiency

4. Equity

  • Capitalism does not have a mechanism to assure EQUITY. This may be a role of government (ch. 5)

5. Full Employment

  • Economists disagree over whether capitalism will guarantee FULL EMPLOYMENT.
  • studied in macroeconomics

B. Summary:

1. The move toward capitalism has resulted in high rates of ECONOMIC GROWTH in many countries. Profits, private property, and freedom of enterprise and choice promote growth

2. The price mechanism (supply and demand) and the role of self interest provides for an ALLOCATIVELY EFFICIENT use of resources

3. Capitalism provides the incentives (profit) for a PRODUCTIVELY EFFICIENT use of resources

4. Capitalism does not have a mechanism to assure EQUITY. This may be a role of government

 5. Economists disagree over whether capitalism will guarantee FULL EMPLOYMENT.

  • Some say yes, and if there is unemployment it is usually caused by government interference
  • Some say no, and at times government involvement is needed to move the economy towards full employment


Pure Capitalism and the Market System:
The Market and the 5 Es

Characteristics of a Market Economy (Capitalism)

A. private property
B. markets and prices
C. role of self interest: incentives
D. freedom of enterprise and choice
E. competition
1. large numbers
2. free entry and exit
3. produce standardized products

F. limited role for government

The Market and the 5Es

1. Economic Growth
Capitalist economies tend to have more rapid rates of growth

2. Allocative Efficiency: Producing what consumers want

a. Capitalism and incentives and means
(1) more profits = produce more

(2) losses = produce less

(3) consumer sovereignty and "dollar votes"

b. Capitalism tends to achieves allocative efficiency

3. Productive Efficiency: Producing at a minimum cost

a. Capitalism and incentives
(1) profits = total revenues - total cost

(2) minimizing costs means more profits

b. Capitalism tends to achieve productive efficiency

4. Equity

There is no characteristic of capitalism which will guarantee equity

Often, the government gets involved to help achieve equity

5. Full Employment

Economists disagree over whether capitalism will result in full employment
  • Some say yes, and if there is unemployment it is usually caused by government interference
  • Some say no, and at times government involvement is needed to move the economy towards full employment

 

VI. Capitalism and the Five Fundamental Questions

A. Introduction
1. The five fundamental questions must be answered by all economic systems.

2. The five fundamental questions are:

a. What goods and services will to be produced?
b. How will the goods and services be produced?
c. Who will get the output?
d. How will the system accommodate change?
e. How will the system promote progress?

B. What will be produced? (Allocative Efficiency)

1. In order to be profitable, businesses must respond to consumers' (individuals, other businesses, and the government) wants and desires.

2. Consumer Sovereignty and "dollar votes"

 

C. How will the goods and services be produced? (Productive Efficiency)

1. The market system encourages and rewards those producers who are achieving least-cost production.

2. The most productively efficient technique will be the one that produces a given amount of output with the smallest input of limited resources.

D. Who will get the output? (Equity)

1. determined by how the income is distributed

2. Products go to those who are willing and able to pay for them.

3. The productivity of the resources, the relative supply of particular resources, and the ownership of the resources will determine the income of individuals and households.

4. The resulting distribution of income may not be the most equitable (fair).

E. How will the system accommodate change?

1. Markets are dynamic - what is efficient today may not be efficient tomorrow as tastes, technology, and resource supplies change.

2. Prices help signal those changes and the market will respond. This guiding function of prices is essential to a well-functioning market system.

3. In the absence of such signals, government or some similar institution would have to decide where resources are allocated, but without knowing what people in society want. the result would most likely be allocatively inefficient.

F. How will the system promote progress?

1. The market system promotes technological improvements and capital accumulation (economic growth).

2. An entrepreneur or firm that introduces a popular new product will be rewarded with increased revenue and profits. (allocative efficiency)

3. New technologies that reduce production costs, and thus product price, will spread throughout the industry as a result of competition. (economic growth)

4. Creative destruction occurs when new products and production methods destroy the market positions of firms that are not able or willing to adjust. NOTE: this is good for society.

VII. The Circular Flow Model of Capitalism

III. The Economic Basis for Specialization and Exchange -- Trade

A. Pre-quiz (yellow page)- Do you think like an economist?
B. Why we specialize and exchange?
1. What would life be like if YOU were self-sufficient?

2. Trade: advantages and disadvantages

a. advantage:
  • larger total output / higher living standards
  • lower prices

b. disadvantage:

  • less independence / more interdependence

3. The basis for specialization and exchange

a. differences in resource endowments
b. differences in preferences
c. differences in productivity (MORE BELOW)
1) define productivity
2) define absolute advantage
3) a good lawyer trades with a good mechanic

d. differences in opportunity costs (MORE BELOW)

1) define opportunity cost
2) define comparative advantage
3) The
lawyer/mechanic argument revised

C. Differences in Productivity: Absolute Advantage

1. production possibilities: self sufficiency
2. specialization
3. trading possibilities: more total output

D. Differences in Opportunity Costs: Comparative Advantage

1. production possibilities: self sufficiency
2. specialization
a. comparative advantage
b. calculating opportunity costs

3. trading possibilities: more total output

"Specialization according to comparative advantage results in a more efficient allocation of the world's resources, and larger outputs ...." (McConnell and Brue 2005, p. 361)

4. trade with increasing costs
a. review: law of increasing costs
b. result: specialization is less than 100%

5. terms of trade

a. definition
b. minimum and maximum terms of trade
c. actual terms of trade

 

 

To watch 5 minute video:

  • Click on: http://www.learner.org/resources/series86.html
  • Scroll down to:
    • 10. Developing Countries - How these nations have been helped or hurt by the rapid growth since WWII. Case studies: comparing South Korea and Sri Lanka; aid vs. trade in Tanzania.
  • Click on (A free registration may be required)
  • Then slide the timer to minute 7:45 for the eight minute South Korea vs. Sri Lanka case study

Available online at:

  • Click on: http://www.learner.org/resources/series86.html
  • Scroll down to:
    • 11. Economies in Transition: Transforming former Communist countries into market economies. Case studies: state industries vs. private entrepreneurs in Russia; the success of Poland’s “shock therapy.”
  • Click on (A free registration is required for first time users)
  • Then slide the timer to minute 27:25 for the eight minute the success of Poland’s “shock therapy case study

Entrepreneurs Emerge As Cuba Loosens Control
National Public Radio (NPR), Morning Edition, September 20, 2011

"Since Cuba's communist government loosened its grip on the economy, thousands of small private businesses have sprung up. It's a new frontier for budding capitalists, but competition is fierce and advertising is still tightly restricted."

http://www.npr.org/2011/09/20/140501399/entrepreneurs-emerge-as-cuba-loosens-control

OPTIONAL: A View of Venezuelan Nationalization

Go to: http://www.npr.org/templates/story/story.php?storyId=6849640

Click on: "Listen"

Weekend Edition Saturday, January 13, 2007 - In the global economy where more and more capital is held in private hands or by publicly-traded companies, the South American nation of Venezuela seems to be bucking the trend.

This week, as he assumed power for a second six-year term, President Hugo Chavez announced that Venezuela will nationalize firms in two major sectors of the economy — telecommunications and electricity. [NOTE: "nationalize" means that the government is going to take over these businesses.]

And some companies in those sectors have shareholders in the United States, including Verizon, which owns a large stake in the Venezuelan telecom giant, CANTV.

Economist Moises Naim, a former minister of trade and industry in Venezuela (and now editor of Foreign Policy magazine, reviews the implications of Chavez's plan with Scott Simon.

SUMMARY

  • Industries to be nationalized:
    • Telecommunications (telephone)
    • Electricity
  • How they will be nationalized is unknown.
    • Will the government just take them over?, or
    • Will the owners be paid?
  • Why are they doing it?
    • "Political move" toward "socialism"
    • Previous nationalization had poor results
    • Should foreigners own these industries in Venezuela?
    • Would local or state ownership be better? (probably not)
    • Research shows that ownership affect efficiency - state ownership is less efficient

note the important role of INCENTIVES

OPTIONAL: http://www.npr.org/templates/story/story.php?storyId=1565953

China Considers Private Property Rights on National Public Radio

All Things Considered, December 22, 2003 · In Beijing, legislators propose an amendment to the Chinese constitution guaranteeing private property rights. The move has great symbolic importance in a country that is nominally communist, but whose people have been buying property and trading stocks for years as the result of economic reforms by Deng Xiaoping. NPR's Rob Gifford reports.

SUMMARY

  • "private sector will drive the economy forward" therfore property rights must be protected
  • private property already exists
  • doesn't necessary imply political reform (still communist)- just economic reform