This course will require more thinking and less reading than other courses. My goal is to give you time to re-read materials and let them sink in. Constantly question yourself whether you really understand the concepts. Test yourself with your own examples. The problems are designed to provoke reflection on the material covered in the lectures.
It is worth starting the problems early in the week, so that you can ponder them a while before answering. Answers may not occur to you until days after you first see the problems. Give yourself time to think up answers by starting early.
Why should we spend a semester learning economics? Why is it important? And what is economics, anyway?
We all need goods and services. The goods that are essential include food, clothes, cars, and books. The services that we need include help by doctors, dentists, teachers, lawyers and barbers.
But we also want goods and services beyond our basic needs. We sometimes go to restaurants even though they are more expensive than eating at home. We pay money for entertainment, such as movies. We buy food that we like more often than food that we absolutely need. We pay for luxury items to enjoy and sometimes even impress others, such as fancy clothes or cars.
Each day billions of buying and selling decisions are made in America. Economics consists of studying those decisions. If the price of meat is doubled, will more or less meat be sold? (Less.) We will be analyzing pricing and buying behavior throughout this course.
Economics is basic to our freedom, and is very influential in determining who we elect. Countries that lack economic freedom often lack religious freedom. If we lack rights in deciding what career to go into, then we will lack rights of worship also.
How we buy and sell things is almost as important as which goods we choose. Since nearly the beginning of the world, something called “money” has been the medium for buying and selling goods and services. The “money” itself has only the value that people assign to it. It can be made of a worthless material, such as green paper.
Money is not essential to a society. When we buy food, we could offer to work in exchange. Or we could grow our own food and trade the excess of our crop for the excess of someone else’s crop. This is known as “bartering”. American Indians lived well for long time without any money. So have many societies. A great deal of bartering still occurs today. The Amish are known to barter when they need services from outsiders today.
But money makes transactions more efficient. Imagine loading up your shopping cart with groceries and then trying to barter with the owner of the store. You may not have any goods or services that the owner really wants. You may be a teacher, but he may not be interested in learning. Or you may be professional football player, and he may not be a fan. Others are willing to pay to watch you play, but this grocer is not. Both of you are then stuck, and you might as well unload your shopping cart and try another store.
Money solves this inefficiency. You accumulate dollars by doing work for someone who wants or needs it, and then use those dollars to buy the goods and services that you desire. The person or company who receives your dollars can then spend it in yet another way.
Money is, in many ways, a form of communication. Donating money to a political candidate or a charity makes a statement. Buying expensive clothes, a luxury car, or a certain houses is like free speech. We often judge the value of something by looking at its price. We expect a car that costs $30,000 to have higher quality than a car that costs $15,000. We don’t even have to look at the two cars to have a high probability of being correct in that conclusion. Sometimes the price can be misleading, of course. But often it is a good indicator.
Money can be used to obtain food for starving people and for other good deeds. Or money can promote evil, as when communist countries build armies to suppress freedom. Then money becomes necessary to combat the enemy.
When asked how much more money people want, most say they would be happy with 20-100% more money than they have. This answer is the same from the poorest to the wealthiest persons. In absolute terms, the more money someone has, the more money he wants. There are exceptions. Andrew Carnegie acquired and hoarded one of the greatest amounts of wealth in the history of the world, wrote the “Gospel of Wealth,” and then gave it all away before he died. Carnegie Hall, the first 39 branches of the New York Public Library, and Carnegie-Mellon University are the products of just a few of his gifts.
Freedom depends on the free exchange of money. Communism and other totalitarian systems consist of government control over how money is earned, saved and spent. Loss of this freedom inevitably results in the loss of freedoms of religion and speech too.
Our “economy” is our system of earning, saving and spending money on goods (like food) and services (like teaching or entertainment). “Economics” is the study of the production, distribution and consumption of goods and services. We will refine our definition of “economics” throughout the course.
“Macroeconomics” uses the Greek root “macro-“, which means “big”. Macroeconomics is the study of the big picture of economics on the national level. It includes analysis of the total money supply of dollars, the Gross National Product (total dollar value of all goods and services), and the national unemployment rate (the percentage of Americans who recently lost their job).
“Microeconomics” uses the Greek root “micro-“, which means “small”. Microeconomics is the study of individual decisions about goods and services. It includes issues like how much a barber should charge for a haircut, or how much a grocery store should charge to sell a loaf of bread. Microeconomics includes the study of your decisions in buying a good or service.
“Opportunity cost” is the value lost in order to do something. Doing a job that pays only $5 per hour when you could have taken a different job at $12 per hour has an opportunity cost of $7 per hour. Wasting three hours stuck in traffic has an opportunity cost of the money you could have been making for those three hours.
“Marginal analysis” consists of looking at an incremental change in terms of costs and benefits rather than the overall average costs and benefits. For example, if you are driving by a 7-11 the marginal cost of stopping in to buy a carton of milk is only a few minutes of your time. But if you are sitting at home, then the marginal cost of buying a carton of milk is much greater: you must get into your car and drive all the way to a grocery store, which takes much longer and consumes more gas.
“Positive” statements in economics are testable claims of fact, without any moral judgment. For example, “most people watch many hours of television a day” is a positive statement. It can be tested by doing a survey. The people are spending their time poorly, but it is a fact that they act that way. Similarly, the statement that some people smoke a pack or more of cigarettes a day is a “positive” statement. It is an observation of an activity that is hurting those who do it.
In contrast, “normative” statements are judgments about whether something is good or bad. People should not watch as much television or smoke cigarettes. That is a normative statement. People should pray more. That is also a normative statement.
Sometimes we use the word “net”, as in “net benefits.” What that means is the total benefit minus the total cost. For example, the net benefit of working at McDonalds is your salary minus your taxes and expenses in getting there and back each day.
We will also use the word “rational”, as in “rational choice.” That means the choice or decision that maximizes the net benefit. A rational action, in economic terms, would be to accept the job with the highest net benefit (salary minus taxes and expenses). You may not actually want that job for other reasons, such as working for a company that profits from addiction (e.g., a casino in Atlantic City). But those reasons would have to be translated into economic terms to be counted as part of your economically rational decision.
Finally, there is the concept of “redistribution”. That is the concept that government should try to even out the wealth in society, taking money from the rich and giving it to the poor. The process inevitably causes a loss in total societal wealth. Some visualize redistribution as a leaky bucket taking water from one pool and putting it into another, with water leaking out during the transfer. The leak in the bucket corresponds to the direct and indirect costs of the transfer, including salaries for people to do the transfer and disincentives to those affected by it.
These concepts will become clearer for you as the course progresses.
“Scarcity” is when the available good or service is not enough to satisfy everyone’s needs or wants. There is a scarcity of oil and gasoline, for example. Gas is expensive because there is not enough easily available to completely satisfy everyone’s desire for it in fueling their cars and supplying their other energy needs. Drinking water is scarce also, and more scarce in western states like Arizona and California.
Note that the economic definition of scarcity includes far more goods than the ordinary meaning of the term. Economists would say that television shows are scarce, while most of us would not ordinarily say that. Economists would say that beer is scarce, while most of us would say there is too much it. Economists would say that fatty foods are scarce, even though that sounds odd.
The reason for the broad definition of scarcity in economics is to include any good or service that can be bought and sold. If an item is so plentiful that everyone’s needs are satisfied, then there is no market to buy or sell it (e.g., air). Once a price can be put on a scarce good or service, then some will not be willing or able to afford it. Often people will not be able to obtain all of the good or service that they want. They may be better off without (e.g., fatty desserts at restaurants), though economists don’t address how we are better off with scarcity sometimes.
“The best things in life are free!” True, but even free things can be considered scarce. If the New Yankees gave away some free tickets to a World Series game, they would still be very scarce. People would wait for days in line to get a chance to grab those tickets. However, many other items of great value are not scarce. There is no scarcity of prayer, for example. It’s available to anyone at any time without charge. Exercise, in some form, is not scarce either. But many types of exercise are scarce, such as memberships in a health club.
Goods that no one wants are not scarce. For example, a new deodorant that smells like a skunk would not be a scarce good. You could charge nothing for it and supply would still far exceed demand. Toothpaste that turns your teeth yellow would not be scarce either. How about hairspray that makes your hair fall out?
Based on our definition of scarcity, we can now refine our definition of “economics”. “Economics” is the study of the purchase and sale of goods and services when there is scarcity. If there is no scarcity, then everyone has what they want. For example, there is no scarcity of air, so economics does not study the everyday uses of air. But there is a scarcity of land and oil, so we do study how they are bought and sold.
IV. Transaction Costs.
Whenever we buy something, there are incidental charges known as “transaction costs.” These are the annoying burdens of time and money that interfere with our buying what we need or want. When you buy clothes, you have to spend time finding something you like. No one is going to pay you for that time you spend. You also have transportation costs. Then, when you finally find what you want, you have to pay extra for it to fund the salary of the sales clerk at the store. You also have to pay sales taxes on the purchase.
If you buy clothes over the internet instead, then you avoid some transaction costs but also take a risk that you might not like it when it arrives. Also, you have to pay for shipping when you buy over the internet, and the shipping costs are transaction costs.
“Transaction costs” are defined as the time, effort and added expense associated with the purchase of a good or service. Look around, and you will start noticing them everywhere. Almost nothing can be bought without all sorts of middlemen tacking on extra costs. Effort is also required by you when you buy almost anything. Some entire professions are built on transaction costs. Most attorneys, for example, make their entire living as transaction costs. People hire an attorney to help them obtain what they want. Salesmen, too, live off of transaction costs.
We will be referring to transaction costs throughout this course. They are one of the most basic concepts in economics. Often transaction costs are obstacles to the efficient purchase and sale of goods.
V. Invisible Hand.
Have you ever heard of the “invisible hand”? The most famous economist of all time, the Scottish philosopher Adam Smith, coined this term in his breakthrough tome called “The Wealth of Nations.” The “invisible hand” is the unseen force that guides individuals, who are acting to help themselves, to work in ways that benefit society. For example, the businessman who keeps his store open longer each day to make more money for himself ends up helping customers who need to buy his goods late at night.
When the early Jamestown settlers were on the brink of failure because no one was working, John Smith arrived and instituted a new rule: “He who does not work, will not eat.” Each individual then began working just to feed himself. The community soon became very successful. The invisible hand is the force that guides people to do work that is needed such that others benefit.
The opposite of the “invisible hand” is government control. In dictatorships like communist Russia under Josef Stalin, the government dictates what people will and will not do. There is no “invisible hand.” The result is often disastrous. Tens of millions of people starved to death under Stalin’s rule due to the improper government planning. Stalin may have even starved them intentionally.
A force perhaps even stronger than the “invisible hand” is charity. The desire to give something of benefit to others, without demanding as much in return, is enormous. “Give and ye shall receive” is an economic lesson from the Bible. Look around, and you will notice numerous important charitable acts by others and yourself.
America’s health care system, by far the greatest in the world, was built on a foundation of charity. People and religious organizations giving time, money and expertise to care for individuals who could never afford to pay all the costs. Education, too, was developed in this country largely through charity. In recent years, both health care and education have lost their charitable identities, and the results are not encouraging. Both are weakening.
Most economics courses avoid charity entirely. When charity is mentioned, it is described as a minor add-on to the invisible hand of self-interest. But is this backwards? Is the invisible hand of self-interest actually a wrapper around a basic foundation of charity? These are thoughts to consider throughout this course.
The size and importance of charitable institutions in the world is immense. All religious institutions are charitable, as are nearly all private schools. Many hospitals are still charitable, including the Seventh-Day Adventist hospital in Hackettstown, New Jersey. On a recent trip to Orlando, I saw another Seventh-Day Adventist hospital there. Many religious organizations operate hospitals through the United States, just as they built most of our leading universities. Harvard, Yale, Princeton and Columbia, for example, were all built by charitable religious organizations.
The renowned Sloan-Kettering Cancer Center, for example, was built with the generosity of Alfred Sloan and Charles Kettering. They acquired wealth as senior executives of General Motors and ultimately donated their money to the cause of medicine. It has operated on a non-profit basis to this day.
The first private medical clinic in the United States was the Mayo Clinic, established by the Mayo family of physicians in 1889. Their sponsor was the Sisters of St. Francis, which built St. Mary’s Hospital in Rochester, Minnesota.
Likewise, the successful American colonies were initially more religious and charitable than commercial. Pennsylvania was founded on religious principles by the Quaker William Penn, who in turn established Philadelphia as the City of Brotherly Love. Within a few decades it grew to become the second most populated city in the British Empire, after London.
It was only on the solid foundation of the brick houses of hardy Quakers and their strict moral rules that the flower of free enterprise blossomed there. The same could be said for Boston, where Puritans served as the anchor.
The Virginia colony was purely commercial at first, but it only survived by turning to tobacco and slavery. It suffered so many problems that King James revoked its charter and took control less than two decades after its founding.
The colony of Georgia was subsidized by the British Parliament but was essentially charitable in nature. General James Oglethorpe established it as a haven for impoverished Brits languishing in debtors’ prison. It was, in a sense, an antithesis to a capitalistic venture, featuring nothing but those who failed in the free market. It barred liquor and slavery, reflecting its idealism.
Over 150 years ago, Alexis de Tocqueville observed that “despotism may govern without faith, but liberty cannot. … How is it possible that society should escape destruction if the moral tie is not strengthened in proportion as the political tie is relaxed?” Perhaps charity is the economic manifestation of that “moral tie,” upon which economic liberty and free enterprise rely.
We will be discussing charity at several points during the course.
Read and, if necessary, reread the above lecture. Then read “I, Pencil” by Leonard Read, and the short essays by Milton Friedman and Donald Boudreaux. If you do not have a copy, then this is available online at: http://www.econlib.org/library/Essays/rdPncl1.html
- In three sentences or less, what do you hope to learn in this course?
- Give two short examples each of “normative statements” and “positive statements.”
- Describe the transaction costs associated with going out and eating dinner at a good restaurant.
- Suppose you bought a very expensive bicycle for $900. Later, prices on those bikes fell to $400. One day you collided with a skateboarder, and your bike needed fixing. A repair shop quoted you a price of $405 for that job. Do you fix it or throw it away and buy a new one? What piece of information is irrelevant to your decision?
- Prices are both a form of communication and an incentive. Suppose you just heard that a hotel on Miami Beach costs $500 a night. What communication and incentive does that price convey?
- Suppose we quantified scarcity by defining it as the number of people who very much want a good but can’t afford it. Suppose we call that quantity “x”. Should the good with the biggest “x” be the most expensive good in the world? Discuss. What do you think is the most expensive good in the world?
- After reading “I, Pencil,” what do you think are the main reasons that the “invisible hand” is preferable to government dictating how a pencil should be made? Rank your reasons in order of importance.
- Nobel laureate Milton Friedman emphasized “cooperation without coercion” in his essay. Do you think monetary rewards are essential to ensure “cooperation without coercion”? Explain, with examples.
- Volunteer work can be more efficient and productive than hired labor. Can you explain why? Do you think volunteer work is guided by the “invisible hand”? Explain.
Extra credit (4 points each for questions 10 and 11; 6 points for question 12):
- Why do you think charitably motivated American colonies were more successful than for-profit colonies? Explain. If possible, draw an analogy with how charities were historically more successful in building schools and hospitals than for-profit companies.
- One often sees many car dealerships situated next to each other, but rarely are supermarkets located next to each other. Why is that? Can you think of other examples where companies like being next-door to their competitors?
- American produces far more corn than it can consume, yet corn is still considered an economically scarce good. Why? What is the economic argument in favor of genetically modified corn that has greater output? Can you think of an economic argument against it?