BCOR Study Guide Modules 1-4 (Midterm 1) PDF

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BCOR 1015 Midterm 1 summary review (Modules 1-4)...

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Scarcity        

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Scarcity: the condition that results because there are more human needs and wants than there are resources to meet them; human wants and needs are infinite, resources are finite Scarcity forces three choices: what should we produce? By whom should it be produces? For whom should it be produced? o We should use economic rationality to make these choices Goods produce externalities which are potentially bad things that result from consumption and production Opportunity Costs: selection of one option and implicitly forgoing every other possible option (second best) Trade off: the sacrifice of one good in order to gain another good Tradeoffs: some things will be left undone (housing) Knowledge problem: do experts have enough information to decide what is and is not needed/wanted Prices convey supple and demand o When there is too little of a good or service, then its price goes up, providing an incentive to produce more o When there is too much, then its price goes down, providing an incentive to produce less o The coordination of these price signals organizes production RECAP: the market solution to the scarcity problem o Scarcity is viewed as part of the human condition  People will always want more than can be produced  All societies must decide what shall be produced, by whom, and for whom o Markets answer these questions in a “bottom up” fashion  They decentralize decision making, thereby relying on price signals  This allows resources to be use efficiently  But this solution could be compromised if the planners disrupt the signaling process RECAP: Socialism and Scarcity o Scarcity often does not result from the human condition; it can result from our social organization o Technology and capacity exists to solve the scarcity problem  Resources are not necessarily scarce, but they may be waster o “Real value” (in a socialist sense) is created when labor power is applied to resources  for this reason, we need to focus on the people doing the work Surplus value: o Remember: wealth is created when labor power is applied to resources  Socialists call “value” or “real value” o Profits are created in the market when something is sold – the “exchange value” o Profits can only be created if the value that labor created is the “real value” is less than the “exchange value” o Surplus value = exchange value – real value Surplus value and exploitation

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o This means that workers create more value than they receive for their work  Profits can only be created if the real value that labor creates is less than the exchange value o More starkly, to obtain profit capitalists must restrict labors earnings to less than they are worth and, as such, restricts workers’ ability to consume  This leads to exploitation and scarcity Surplus value and underconsumption o To compete, capitalists do two things:  Reduce wages (thereby restricting consumption)  Push up productivity (thereby creating more goods and services) o These tactics flood markets (overproduction) with things that workers cannot afford to pay (underconsumption) Surplus value and artificial needs  Capitalists are production things that are not necessary, thereby shifting resources and labor away from more useful items  In doing so, capitalism creates scarcity Socialism and Scarcity” o Scarcity can be alleviated through technological innovation and societal coordination – it is not an inevitable human condition o Value (as opposed to market prices) derives from the application of labor to resource in the transformation to products and services (labor theory of value) o High profit margins are not necessarily an indication that something is scarce and in need of additional production Opposing World (Human Nature) Views: o Socialist default perspective:  Finite needs vs available goods (“satiety” is evidence in some traditions/cultures)  “Scarcity” can be real but is also manufactured by capitalisms deus ex machina of success envy  “Tradeoffs” are not the main issue when addressing basic human needs  freedom in the marketplace and its prices foster individual prerogative and information destructive to society and the conservation of resources  information and innovation must be directed, in part, from top down  some property rights should remain vague or societal o Capitalist Default Perspective  Infinite desires vs finite “goods” (“nonsatiation” for “things we like” is normal)  Enduring scarcity in capital, natural resources, and labor for production and consumption  Tradeoffs in sacrificing one good for another due to opportunity costs  Freedom in the marketplace and its prices foster individual prerogative and information beneficial to society and the conservation of resources  Information and innovation are best directed from bottom up  Define and enforce individual property rights (where possible) Socialist reactions to Capitalism:

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o capitalism overproduces goods desired by the affluent rather than “needs” needed by the poor – this is what prices tell them to do  This can amplify “boom times” leading to even greater inequality  Important caveat: it would be unfair to say that socialist/communist systems are always anti-market price Rent controls: rent controls cap prices for apartments which allows people to pay less for their lodging. However, it reduces developers’ incentives to build additional living spaces. o Socialist agree partly: housing is a human right. Under Capitalism, private property trumps human life.

Fairness and Equity 

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When we decide something is fair we take into account: o How benefits are allocated: Equity (merit) vs. equality (sameness) o Opportunity: This should be equally available to all. Summary: o Equality is the quality of being the same in status, quantity, and value while fairness is the quality of being unbiased and impartial. o Equality is giving individuals who have the same task the same compensation while fairness is giving individuals the same choices or chances no matter their status in life. Equity vs Equality o Equity represents fairness, or what may be termed as the equality of outcomes. This involves factoring in aspects of the system that have put particular groups at a disadvantage. Summary: o Equality denotes that everyone is at the same level, whereas equity in business parlance denotes the ownership of the shares of a company. o Equity refers to the qualities of justness, fairness, impartiality and even handedness, while equality is about equal sharing and exact division. o Equality equals quantity, whereas equity equals quality. Fairness: o Proportionality: Getting an allocation personally valued at least as highly as a proportional share of the entire cake (i.e. 1/N across all aspects of the cake) o Note this is not necessarily the same as that proportional share, particularly when you value some parts of the cake (e.g., edges) more than others o Envy-free: Getting pieces where there is no incentive to re-trade with any other recipient (each likes theirs as much any one else’s) o Equitability: Getting pieces validating the beliefs that all have achieved the same realized subjective value (where subjective total cake values are normalized to a constant). Why not Socialism o Cohen talks about “equality” (while we have talked more about “fairness” so far today) o Three forms of equality of opportunity o Three corresponding forms of obstacles to opportunity o Egalitarian Principles– Merriam Webster o 1:a belief in human equality especially with respect to social, political, and economic affairs o 2: a social philosophy advocating the removal of inequalities among people Equality of Opportunity and related labels o 1. Formal and informal social customs may limit the life chances of people  Obstacles such as race, gender, or the Indian caste system  Society may try to correct through legislation such as civil rights, marriage equality o 2. Unchosen social advantages might limit equality

Obstacles such as poverty might limit access to education and health care Society may try to correct through programs such as head start or Medicaid o 3. Differences in “Native talent”, preferences, choices, luck may result in unequal outcomes  genuine choices and preferences are no problem for socialist equality  regrettable choices may not be allowable, depending on whether you believe in free will, but it should not produce large differences unless it synergistically combines with the third  option luck: some people have better or worse outcomes, based largely on chance which is dubious if the resulting inequality is large o Socialist equality attempts to correct for all three sources of inequality o Bourgeois equality  Formal and informal social customs may limit the life chances of people (ex jim crow racism) o Left Liberal  Unchosen social disadvantages might limit equality (ex poverty might limit access to education and health care)  Left-liberals seek to correct these social disadvantages through redistributive spending on things like health care and schools o Socialist equality  Native talent has not been chosen and so the individual is not responsible  Notice that socialism is usually justified as o Increasing human happiness o Being of greater morality o But less as a means of maximizing economic growth Cohen: two principals underlying the camping trip o Egalitarian principles: socialist equality of opportunity o Community principle: socialist focus on community  Communal reciprocity: cooperation for its own sake (motivation is for greater good)  Market reciprocity: cooperation because it serves you to do so (motivation is greed and fear) Is Socialism feasible?? No, because.. o Limited by human nature: are we sufficiently generous and cooperative? o Limited by social technology or “how to really make it work” Reminders of Hayek: one reason why the camping trip can readily do without market exchange is that the information that campers need to plan their activities is modest in extent and comparatively easy to obtain and to aggregate Capitalism and Freedom o “payment in accordance with product” o differences in endowments, preferences, choices, luck may result in unequal outcomes – unequal distribution of income  

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o the ethical principle that would directly justify the distribution of income in a free market society is, “to each according to what he and the instruments he owns produces” Ethical fairness of payment for product o The most far reaching criticism has come from the Marxists:  Labor is exploited  Payment is accordance with product and need  Do not recognize any contribution by the owners of the capital to process of production Friedman: preferences lead to inequality o Differences in pay are “equalizing differences” that offset undesirable qualities of the job  By trading work preferences for money people can create optimal arrangements that improive their life satisfaction  Pay differences create equality, when equality is understood broadly  People should not be constrained from making these choices o Differences of money income offset differences in other characteristics of the occupation or trade. Friedman: luck leads to inequality  If these gains from risk-taking are confiscated, then this is morally the same as forbidding risk o Here is why Friedman questions socialism:  Luck is an equalizing difference; some people would prefer the risk in order to earn more money o There are moral and practical reasons why inequality due to luck should be allowed Friedman: personal endowments lead to inequality o Most people see this as merit and do not find it equitable  Most of his argument is only to show that inherited talent is no different in principle than inherited wealth Friedman: inheritance leads to inequality o Inheritance is okay Friedman: redistribution o However, he does provide an objection to redistribution, “if someone has extra money, then other people (or the state) must use coercion to redistribute the money”  Ethical objection: “two wrongs don’t make a right”  Practical objection: “this would make a civilized world possible” o Friedmans suggestion:  personal income tax; flat tax about a certain amount of income  No corporate tax but corporate income attributed to stockholders who pay tax on the distribution Two perspectives on fairness: o Socialism and Capitalism are distinct economic responses, but they are also moral responses o The two perspectives have different ethical views and different objectives

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Socialism  Allocation: emphasis on equality or sameness  Emphasis: human happiness and community Capitalism:  Allocation: emphasis on equity or merit  Emphasis: human freedom, individualism, and economic growth  Very concerned with morality, but views it from the perspective of individual freedom; it is ethically dubious to use coercion  Places greater emphasis on economic growth  Less direct emphasis on human happiness

Liberty and Externalities 

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(Hebling) Externalities: Prices do not capture all costs o Externalities pose fundamental economic policy problems when individuals, households, and firms do not internalize the indirect costs of, or the benefits from, their economis transactions o Resulting wedges between social and private costs or returns lead to inefficient market outcomes Characteristics of a market economy o Private property o Freedom of choice o Pursuit of self-interest o Competition o Markets and prices o Limited government Advantages of market economy o Efficient allocation of resources o Production of the most desired goods and services o Encourages innovation o Accumulation of capital o Freedom to succeed or fail o Free to agree to disagree – reduces societal strains Market failures – “a broken invisible hand” o Occur when the pursuit of a private interest does not lead to an efficient use of resources o Externalities are overproduced o Public goods are underproduced o Monopoly or lack of competition o Lack of information Externalities occur when the consumption of a good causes a benefit or a harmful effect on people not directly involved in the transaction o A “spillover” cost or benefit that is not reflected in the market price o Private costs & external costs = social/total cost o Private benefits & external benefits = social/total benefit With positive externalities the social benefit > private benefit o Remember: social benefit = private benefit + external benefit Negative externalities occur when the consumption or production of a good causes a harmful effect to people not directly involved in the transaction that caused the effect o With a negative externality the Social cost > private cost Hardin: the tragedy of the Commons

There is a class of human problems which can be called “no technical solution problem” The ToC analogy is a rebuttal to Adam Smith’s invisible hand and hardin refers to “the tragedy of freedom in a commons” o Only way to win individually is to lose as a whole  Hardin was referring to population growth Common resources – externalities o Results in inefficient allocation of natural resources because no one owns the resource or no on has a clear incentive to protect the resource o Some would say the tragedy of “unmanaged” resources Externalities – government solutions o Market based regulatory response: required outcome but method left to individual/company  Internalize the externalities  Carbon tax o Regulations – required outcome and required approach, fines o Government ownership – protect and regulate Solutions – transaction costs o If transaction costs are reasonably low, then the affected parties negotiate tolerably efficient solutions without government intervention o If transaction costs are too high, then need a cost benefits analysis to see if the benefits justify the costs Externalities – private solutions o New products o Bargaining o Programs with financial incentives o Industry solutions – cooperation, certificates Public Goods o A free market economy will under produce public goods o Another examples of an inefficient allocation of resources: a market failure o Public goods can be consumed by everyone; they are “non-excludable” Okun: Equality and Efficiency o Democracy and capitalism are both american goals that are sometimes in conflict o How does American society promote equality?  Distribution of “entitlements/rights” that are kept out of the marketplace  Rights to equal justice, exercise of free speech and religion, to vote, etc  Distributed universally, equally and free of charge to all adult citizens o Efficiency is deliberately compromised by laws that bestow these rights o How does capitalism survive in a democracy?  In order to trade in a market economy, law defines a right to private property  Government regulation is required to maintain and enforce private property rights o Key learning points:  Liberty or freedom on an individual basis may conflict with the freedom of other individuals and/or the needs of the large society  The operation of the free market has contributed to the overall wealth of the country and the world  In some circumstances, the operation of the free market results in an inefficient allocation of resources, which is called a market failure o o

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Overproduction of externalities, underproduction of public goods, tragedy of the commons and other market failures can be addressed by government and private solutions Government and private solutions have their own costs and limitations Certain rights may be considered to be out of the realm or domain of the market

Trade: Gains and Losses 

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Feudalism o A legal and military system that was designed around land-owning nobles o Both society and the economy were largely agrarian with little trade, goods produced only for consumption, and no money in wide use Feudalism to Mercantilism o Mercantilists assumed amount of wealth in world was static and therefore nations wanted to ensure they accumulated as much of this wealth as possible o The goal was to increase a nations wealth by imposing government regulation over all the nations commercial interests o National strength was maximized by limiting imports and maximizing exports o The government used regulations, subsidies, tariffs, and military force to protect the franchises/corporations from domestic and foreign competition Mercantilism to Free Trade o Mercantilists viewed agriculture as important and promoted agriculture as a way to reduce the need to import foods o Since it is impossible to every country or nation-state to have a surplus of exports, the basis of mercantilism ensured it was doomed for eventual failure o Over time free market advocated or “free traders” attributed economic growth, wealth creation and nation prosperity to trade without restrictions Adam Smith concepts: foreign trade, self-interest, division of labor, pricing and value of labor o Critique of mercantilism – shifted emphasis from  Centralized to decentralized institutions  Monopolies to competitive market  Autarky to international interdependence through an expanding division of labor o Comparative advantage: if a foreign country can provide the product for cheaper than we can make it, buy it from them with some part of the produce of our own industry, employed in a way which we have some advantage o Consumer demand – market forces  Maximize the welfare of the consumer by providing goods and services according to the market forces of supple and demand o Moral concerns about free trade:  The contraception of economic resources by monopolistic corporations (ineffective management sheltered from competition; uneq...