Economics 1: Introduction to Economics: January 25, 2016 Lecture · 25/01/2016  · Economics:...

Economics1:IntroductiontoEconomics:January25,2016Lecture

J.BradfordDeLong<delong@econ.berkeley.edu>

EconomicModelsandLiberalEducation

January25,20168-9AMWheelerAuditorium,U.C.Berkeley

AWordorTwoonHowEconomistsThink• Stripasituationdowntoitsessentials—thatis,neglectalmosteveryaspect…

• Playwiththisgrossly-oversimplifiedworld…

• Reachconclusions…• Checkthoseconclusions…

• Iterate…

• “Avicenna”:PeterBeagle(1987):TheFolkoftheAir<http://amzn.to/1PvCcdN>.“StateofEuphoria”:DavidLodge(1975):ChangingPlaces<http://amzn.to/1nhoXXp>.IbnSina:AbūʿAlīal-ḤusaynibnʿAbdAllāhibnAl-HasanibnAliibnSīnā<http://tinyurl.com/n58rjc6>.Enkidu:Gilgamesh<http://amzn.to/1PepdkP>.FujiwaraTakako:GenjiMonogatari<http://amzn.to/1nhCkXy>.Hypatia<http://tinyurl.com/z9uyqyw>:IbnKhaldun:AbūZayd‘Abdar-RaḥmānibnMuḥammadibnKhaldūnal-Ḥaḍramī,Muquaddimah<http://amzn.to/1Sd0uhv>.Odysseus:<http://amzn.to/1nhCA94>.

EconomicModels• Movebackandforthbetween:• Verbaldescriptionsofhowpeopleact

• Quantitativeexamples

• Individual-behaviorequations

• Aggregateequations• Graphs:analyticgeometry

• Equilibriumconditionsas“wherethecurvescross”

• “Avicenna”:PeterBeagle(1987):TheFolkoftheAir<http://amzn.to/1PvCcdN>.“StateofEuphoria”:DavidLodge(1975):ChangingPlaces<http://amzn.to/1nhoXXp>.IbnSina:AbūʿAlīal-ḤusaynibnʿAbdAllāhibnAl-HasanibnAliibnSīnā<http://tinyurl.com/n58rjc6>.Enkidu:Gilgamesh<http://amzn.to/1PepdkP>.FujiwaraTakako:GenjiMonogatari<http://amzn.to/1nhCkXy>.Hypatia<http://tinyurl.com/z9uyqyw>:IbnKhaldun:AbūZayd‘Abdar-RaḥmānibnMuḥammadibnKhaldūnal-Ḥaḍramī,Muquaddimah<http://amzn.to/1Sd0uhv>.Odysseus:<http://amzn.to/1nhCA94>.

AndintheProcessHaveSomeFun• Refertoourcommoncollectivehumanculturalheritage.

• NotbecauseIamgoingtotestyouonit.

• Butbecauseourcommoncollectivehumanculturalheritageisanimportantintellectualresource.

• Liberaleducation

• “Avicenna”:PeterBeagle(1987):TheFolkoftheAir<http://amzn.to/1PvCcdN>.“StateofEuphoria”:DavidLodge(1975):ChangingPlaces<http://amzn.to/1nhoXXp>.IbnSina:AbūʿAlīal-ḤusaynibnʿAbdAllāhibnAl-HasanibnAliibnSīnā<http://tinyurl.com/n58rjc6>.Enkidu:Gilgamesh<http://amzn.to/1PepdkP>.FujiwaraTakako:GenjiMonogatari<http://amzn.to/1nhCkXy>.Hypatia<http://tinyurl.com/z9uyqyw>:IbnKhaldun:AbūZayd‘Abdar-RaḥmānibnMuḥammadibnKhaldūnal-Ḥaḍramī,Muquaddimah<http://amzn.to/1Sd0uhv>.Odysseus:<http://amzn.to/1nhCA94>.

AWordorTwoonaLiberalEducation• “Liberaleducation”≠“kindaleft-wingeducation”here

• “Liberaleducation”heremeans“appropriatetosomebodyfree”

• Someonewithcontrolovertheirownandashareofcontroloverourcommondestinies• Notsomeonetaughtaparticularskilltodoonething

• But,rather,someonewhoselifewillbespentinawiderangeofactivities

• Andwhothusneedsawiderangeofknowledge

• Aliberaleducationisaveryvaluablething

• Differenceinthenaturallog(ln)of0.6meansthatthehighernumberis1+0.6+(0.6)^2/2+(0.6)^3/(3!)+(0.6)^4/(4!)+…=1.8221timesthelesser:is82%higher.

ALiberalEducationIsaVeryValuableThing• Ata$40,000/yearaverageearningslevel…

• 82.2%x$40,000/year=$32,884/year

• Gotocollege:invest$15K/yr(tuitionandfees)+$20K/yr(earningsnotmade)for5years=$175,000

• Getanextra$32,884/yearfor40yearsifyou’rethekindofpersonwhocangraduate

• Plus:freedom,depthofexperience…

LiberalEducation:ItisNotthe“Technical”TrainingThatIstheMostValuable

• Inmyextendedfamily,threepeoplewhowere,are,orlookliketheyareheadednotforthetop1%butthetop0.1%…

• constructionandchemicalengineering—ultimatelypollutioncontrol—“smartmoney”onWallStreetmanagingtheflowoffinancingofinvestment,“theindustry”astheycallitinLA…

• LearninghowtodealsociallyasanoutsideratHarvardinthe1920s,historicalsourceanalysisinthe1980s,messingaroundinDartmouthAVinthe1990s

SoLearn!:ExtendYourBrainsinEveryDirectionYourCuriosityMovesYou

• “Avicenna”:PeterBeagle(1987):TheFolkoftheAir<http://amzn.to/1PvCcdN>.

• “StateofEuphoria”:DavidLodge(1975):ChangingPlaces<http://amzn.to/1nhoXXp>.

• IbnSina:AbūʿAlīal-ḤusaynibnʿAbdAllāhibnAl-HasanibnAliibnSīnā<http://tinyurl.com/n58rjc6>.

• Enkidu:Gilgamesh<http://amzn.to/1PepdkP>.• FujiwaraTakako:GenjiMonogatari<http://amzn.to/1nhCkXy>.• Hypatia<http://tinyurl.com/z9uyqyw>:• IbnKhaldun:AbūZayd‘Abdar-RaḥmānibnMuḥammadibnKhaldūnal-Ḥaḍramī,Muquaddimah<http://amzn.to/1Sd0uhv>.

• Odysseus:<http://amzn.to/1nhCA94>.

AWordorTwoonHowEconomistsThink• DidyouseewhatIdidthere?

ProductionPossibilities,Specialization,andtheDivisionofLabor

January25,20168-9AMWheelerAuditorium,U.C.Berkeley

SpecializationandDivisionofLaborI• Differentcapabilitiesandtalents

• Practice-makes-perfect(oratleastbetter)

• Betterifweallmanagetospecialize(tosomedegreeatleast)

SpecializationandDivisionofLaborII• Ofthesepeople,Enkiduisthebestateverything…

• DoesthatmeaneverybodyelseshouldsitbackandletEnkidudoeverything?

• Supposeeverybodyspendshalftheirtimeateachtask…

• Totalproduction:150YL,950TL

SpecializationandDivisionofLaborIII• But…Startwitheverybodyteachingyoga…

• Ifwewanttomakelattes,whoshouldwepulloffthemat?

• IbnKhaldun?• Thenwewindupwith200YL,300TL

SpecializationandDivisionofLaborIV• IfwepullEnkidufirstoffoftheyogamatandputhimontheespressomachine?

• Thenwewindupwith200YL,900TL.

• AnefficienteconomicsystemwouldpreferthatEnkidubefirstontheespressomachine

• Thatishiscomparativeadvantage

TheProductionPossibilityFrontier• IfwepullEnkidufirstoffoftheyogamatandputhimontheespressomachine?

• Thenwewindupwith200YL,900TL.

• AnefficienteconomicsystemwouldpreferthatEnkidubefirstontheespressomachine

• Thatishiscomparativeadvantage

• Andifwewantstillmorecoffee,whodoweputontheespressomachinenext?

TheProductionPossibilityFrontierII• Wenowhavearuleforhowtoallocatetasksinordertomakesocietymostproductive

• Rankpeoplebytheircomparativeefficiency—theircomparativeadvantage

• Putthosewiththegreatestcomparativeadvantagetothetask—theespressomachine,orthemat—first.

AdditionalQuestions• WhatpointonthePPFisitgoodforasocietytochoose?

• Howisitgoodforasocietytodistributethestuffthatitseconomymanagestomake?

• Whenevereconomiststalk“efficiency”talk,theyarereservingthosetwoadditionalquestionsforlater.

ProductionPossibilitiesII

January25,20168-9AMWheelerAuditorium,U.C.Berkeley

Let’sCalculateOurFullPPF• Givencapabilitiesandtalents

• Clearinwhatorderyoushouldtakepeopleoffthematandputthemontheespressomachine

• Andlet’shavemorethanfiveworkers:let’ssaythatthereare20Odysseus-likeworkers,etc.

Let’sCalculateOurFullPPFII• Ifall55workersteachingyoga…5000lessons/day

• Ifall55workerspullinglattes…25000lattes/day

• Andweknowwhatordertoputpeopleontothemat/machine

Let’sCalculateOurFullPPFIII• Puttingall10Enkidu-likeworkersonespressomachinesmovesusfrom(5000YL,0TL)to(4000YL,9000TL)

• Nowlookatthe(0YL,25000TL)point.Whodoyoupulloffthematfirst?

• Yes:Odysseus,andthoselikehim…

Let’sCalculateOurFullPPFIV• Yes:the20Odysseus-likeworkersarethefirstthatyoushouldsettoworkteachingyoga

• EventhoughtheOdysseus-likeworkersaretheworstyogateachersintheeconomy,right?

• It’sjustthatOdysseus’sbadnessatmakinglattesismuchworse,relatively,thantheirbadnessatteachingyoga…

Let’sCalculateOurFullPPFV• AndthenextclassofworkerstoputtoworkteachingyogaareFujiwara-clanworkerslikeTakako…

• AndthenextclasstoputtoworkpullinglattesaretheArabcivilservantslikeIbnKhaldun…

• WiththeAlexandrianmathematicianslikeHypatiainthemiddle…

• Andwearedone!

ModelBuilding• Butthishasbeenapain—carryingallthesenumbersandindividualsaroundinourhead

• Couldtherebeabetterwayofwritingdownallthisinformationaboutrelativeproductivitiesandnumbersinaverysmallspace?

• Thereis:anequation• Muchbetterthan:

• Havingalargetableof55individuals,eachwiththeirrelativeproductivities

• Plusanothertableofderivedcalculationsfromthatfirsttable,no?

• Butremember:ineconomics,equationsaretheresothatwecandescribeveryconciselywhatpeopleareorwouldbedoing…

TL=25000-(YL)2/1000

ThePriceMechanism

January25,20168-9AMWheelerAuditorium,U.C.Berkeley

WeHaveOurPPF• Thesmoothedequationversion—TL=25000-(YL)

2/1000

• The55-workersversion—theOdysseus,IbnKhaldun,Hypatia,FujiwaraTakako,andEnkidu-like.

• Buthowdowegetpeopletoproperlysortthemselvesintotherightjobstocreateanefficienteconomy?

HowAboutIfWePayThem?• Let’ssaythataYLcosts$10tothestudent—pays$10totheteacher…

• ThenifthepriceofaTLis$1…thennobodywillpulllattes…

• ButifthepriceofTLsgoesto$1.12…Enkidushowsup…

• Andat$1.43FujiwaraTakakoshowsup…

• Andat$2,Hypatia;and$3.34,IbnKhaldun…

• Andat$10foraTL,Odysseusandcompany…

SupplyandDemand

January25,20168-9AMWheelerAuditorium,U.C.Berkeley

TheMagicoftheMarketplace• Wedonotneedanycomplicatedbureaucraticcommand-and-controlsystemtogetthe“right”peopleworkingtheespressomachines…

• Allwehavetodoistocryouttherightprice,andpeople—peopleseekingtheirownbetterment—willarrangethemselvessothatthe“right”peopleareattheespressomachinesallbythemselves…

Let’sGraphThis!ThisIsOurSupplyCurve• Let’ssaythataYLcosts$10tothestudent—pays$10totheteacher…

• ThenifthepriceofaTLis$1…thennobodywillpulllattes…

• ButifthepriceofTLsgoesto$1.12…Enkidushowsup…

• Andat$1.43FujiwaraTakakoshowsup…

• Andat$2,Hypatia;and$3.34,IbnKhaldun…

• Andat$10foraTL,Odysseusandcompany…

ButLifeWillBeMuchEasierIfWeSimplifyAgain,andConsiderOnlySmoothSupplyCurves

• RememberourequationforthenicesmoothPPF?

• Justaswedrewourflat-and-jumpsupplycurveforourtable,thereisasmoothsupplycurvefortheequation.

• Hereitis• Ingeneral,fromhereonoutwearegoingtostartouranalyseswithsupplycurves• ButlurkingbehindsupplyistherelativeproductivityanalysisthatledtothePPF

TL=25000-(YL)2/1000

TheMagicoftheMarket• Wedonotneedanycomplicatedbureaucraticcommand-and-controlsystemtogetthe“right”peopleworkingtheespressomachines…

• Allwehavetodoistocryouttherightprice,andpeople—peopleseekingtheirownbetterment—willarrangethemselvessothatthe“right”peopleareattheespressomachinesallbythemselves…

LifeWillBeMuchEasierIfWeConsideredOnlySmoothSupplyCurves

• Butworkingwithasupplycurvewithjumpsandflatswillbeapain…

• RememberourequationforthenicesmoothPPF?

• Justaswedrewourflat-and-jumpsupplycurveforourtable,thereisasmoothsupplycurvefortheequation.

• Hereitis• Ingeneral,fromhereonoutwearegoingtostartouranalyseswithsupplycurves• ButlurkingbehindsupplyistherelativeproductivityanalysisthatledtothePPF

TL=25000-(YL)2/1000

SupplyandDemand• Andinadditiontothesupplycurve,thereisademandcurve…

• Behindthesupplycurve,therelurkedproductionpossibilitiesandotheropportunities:opportunitycost…

• Sobehindthedemandcurve,therelurksananalysisofalternativeopportunitiestobuyandhappiness,willingnesstopay…

MarketEquilibrium• Take,however,theopportunitycostofworkingattheespressomachineandthewillingnesstopayofcustomersasgiven.

• Thuswehaveoursupplyanddemandcurves

• MovetoChicagoandpizza…• Whatwouldhappenifthepriceofpizzawas,say,$4aslice?• Excesssupply:unsoldpiecesofpizza…

• Thefollowingday(orlatethatsameday)someproducerswouldcuttheirprice—andthepricewouldfall…

MarketEquilibriumII• Whatwouldhappenifthepriceofpizzawas,say,$2aslice?• Excessdemand:unhappycustomers…

• Customersinlinewouldtrytooutbidthoseaheadofthem,andthepricewouldrise…

MarketEquilibriumIII• Onlyatapriceof$3/slicewillthemarketbeinequilibrium

• Nobuyersunhappybecausetheycouldnotbuy…

• Nosellersunhappybecausetheycouldnotsell…

• Nobuyerswhowouldbewillingtopaymoreremainingattheendofthedaytobiduptheprice…

• Nosellerswhowouldbewillingtoacceptlessremainingattheendofthedaytocuttheprice…

MarketEquilibriumIV• Atmarketequilibrium,thereisnoreasonforthepricetochange…

• Andatmarketequilibrium,nobodyisunhappy…

• WeareonthePPF—therightpeopleare,inthiscase,cookingthepizza,andtheyarecookingtherightamountofit…

• And,inasense,weareattherightpointonthePPFaswell…

• Note:nobodyhastofixtheequilibriumprice:itspontaneouslyemerges…