MacroEconomics

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Economical Jargon Absolute Advantage o If one person, firm, or country can produce more of something with the same amount of effort and resources, they have an absolute advantage over other producers Adverse Selection o A situation in which one party lacks information while negotiating an agreement. Asymmetric Information o When someone knows more information than someone else Autarky o A situation in which a country is economically self-sufficient Average Tax rate o The fraction of total income paid in taxes Binding o A price control that affects the equilibrium outcome Business Cycle o Boom and Bust; the long-run pattern of economic growth and recession Cap and trade system o A system where the government caps the overall level of acceptable pollution, and then allows this pollution property to be bought and traded Capitalism o An economic system in which the means of production are owned privately and operated for profit Central Planning Economy

o Basically, a command economy Command and control regulations o Regulations that tell companies exactly what to do Command Economy o When a government controls all aspects of economic activity (as in communism) Communism o An economic system with common ownership of the means of production Comparative Advantage o Identifies which activities a country (person or firm) is most efficient at doing; It is used to show how countries can gain more from specializing then trading than making everything by their respective selves. Complementary goods o Something youll need in compliment with one good. For example, computer and software. If the price of one rises or falls, it will affect the other good, therefore, they are compliment goods. (other examples include e-books and kindle, condiments and hotdogs, etc.) Consumer Surplus o The difference between what a consumer would be willing to pay for a good or service and what the consumer actually has to pay; it measures total economic benefit of a sale Deadweight Loss o Economic welfare lost as the result of an artificial price change (such as price ceilings and price floors) Economic Surplus o The sum of consumer and producer surplus Elasticity o A measure of the responsiveness of one variable to another Price Elasticity measures how much the quantity of supply(or demand) a good changes if its price changes. If the percentage change in quantity is more than the percentage change in price, the good is price elastic; if it is less, the good is inelastic Cross-elasticity shows how the demand for one good changes when the price of another good changes (compliments and substitutes)

Endogenous o If price changes within the model movement along the demand curve Excise Tax o Constant amount on every good, despite the price of the good. Exogenous o If anything outside of the model (i.e. substitutes, population, preference) changes demand curve shifts External Costs o The additional cost to third parties arising from negative externalities Externalities o An economic side-effect; a byproduct of an action or product Free market o A market with established property, contract, and liability rules, and no additional government intervention in voluntary transaction GDP o Otherwise known as Gross Domestic Product; this is the measure of economic activity and wealth in a country. General Equilibrium o Economic perfection; when demand and supply are in balance for each and every good and service in the economy Government o They play large roles in command economies They decide price levels, oversee the allocation of scarce resources and run the most important part of the economy Grim Inelastic

o When the supply or demand for something is insensitive to changes in another variable, such as price. Inferior goods o Products that are less in demand as consumers get richer Inflation o less bang for your buck erodes the purchasing power of a unit currency Intellectual property o The ideas, designs, or processes that contribute to the availability of goods and services, along with the research and creativity behind them Invisible hand o Term by Adam Smith o The ability of the free market to allocate factors of production, goods and services to their most valuable use. o If everybody acts from self-interest, then the economy will work more efficiently, and more productively o An invisible hand guides the actions of individuals to combine for the common good Macroeconomics o The big picture: analyzing economy-wide phenomena such as growth, inflation, and unemployment Marginal o The difference made by one extra unit of something. Marginal benefit o The additional benefit a buyer gets from consuming an additional unit of the product Marginal Benefit of Abatement o The benefit of reducing pollution by a unit Marginal Cost

o The additional cost to the seller of supplying another unit of a product Marginal cost of abatement o The cost of reducing pollution by a unit Marginal Price o How much extra a consumer must pay to buy one extra unit Marginal product of labor o How much extra output a firm would get by employing an extra worker, or if an existing worker puts in an extra hour on the job Marginal revenue o The extra revenue earned by selling one more unit of something Marginal Tax rate o The tax paid on the last dollar of income earned Market Economy o Economy in which decisions are based on supply and demand and the prices of goods and services are determined in a free price system. o Markets use price as a signal to efficiently allocate scarce resources o They are five times richer than their command economy counterparts Market Failure o When a market left to itself does not allocate resources efficiently o Sources of failure: The abuse of market power (monopoly/monopsony) Externalities when the market does not take into account the impact of an economic activity on outsiders Public goods

Asymmetric information or uncertainty Microeconomics o The study of the individual pieces that together make an economy. Microeconomics considers issues such as how households reach decisions about consumption and saving, how firms set a price for their output, whether privatization improves efficiency, whether a particular market has enough competition in it and how the market for labor works. Mixed Economy o A market economy in which both private firms and government firms take part in economic activity Monopoly o When the production of a good or service with no close substitutes is carried out by a single firm with the market power to decide the price of its output Monopsony o A market is dominated by a single buyer. A monopsonist has the market power to set the price of whatever it is buying Moral Hazard o A situation in which people who are protected from risk behave differently than they would behave if they were instead fully exposed to the risk Normal goods o Demand increases as consumers have more to spend Opportunity Cost o The true cost of something is what you give up to get it. o Loss of opportunities and time as a result of doing something else Patents o Grants an inventor temporary monopoly over the idea, to stop it from being stolen by imitators who have not borne any of the development risk and costs. This gives people incentives for innovations o Patents create inefficiency because of the lack of competition to produce and sell the product Payroll Tax o A tax on earnings

Per unit tax o A tax of a specific amount on each unit of a product sold Price Ceiling o A maximum price set by the government that sellers can charge for a particular product or service Price Elasticity o A measure of the responsiveness of demand to a change in price. o If demand changes by more than the price has changed, the good is priceelastic. o If demand changes by less than the price, it is price-inelastic. Price Floor o A minimum price set by the government that sellers can charge for a particular product or service Private Insurance o Insurance offered by companies that insures against specific risks Producer Surplus o Amount producer receives for a good; the minimum amount they are willing to sell it for Productive Base o The economys stock of capital assets and institutions Production Possibilities Frontier (PPF) o A graph showing the maximum attainable combinations of two goods that an economy can produce using its available productive resources and its available technology Profit o = Revenue Cost Progressive Tax

o A tax in which lower-income people pay a smaller fraction of their incomes than higher-income people Property Rights o The right to determine how a resource is used Property Rules o The rules that define what constitutes ownership Public goods o Things that can be consumed by everybody in a society, or nobody at all. They have three characteristics: Non-rival one person consuming them does not stop another person consuming them Non-excludable If one person can consume them, it is impossible to stop another person consuming them Non-rejectable people cannot choose not to consume them even if they wanted to o Ex: Air National defense system judiciary Public Insurance o Insurance provided directly by government Ration o The procedure used to distribute a product where there is a shortage of it Regressive Tax o A tax in which lower-income people pay a larger fraction of their incomes than higher-income people Revenue

o = Price * Quantity Scarcity o Supplies of the factors of production are infinite o Market forces operating through the price mechanism usually offer the most efficient way to allocate scarce resources. o Scarcity simply means that the needs and wants exceed the resources available to meet them Securities o Financial contracts, such as bonds and shares, that grant the owner a stake in an asset Shadow Price o The true economic price of an activity Social Benefit o The total benefit, includes both the benefit to those purchasing the product and the additional benefit as a result of the positive externality Social Cost o The total cost of production, which includes both the producers cost and the additional cost due to negative externalities Subsidy o A payment the government gives sellers over and above what they would otherwise earn in the market Substitute goods o Goods for which an increase or fall in demand for one leads to a fall or increase in demand for the other o Good that can be bought in substitute for another good Sustainable development/growth o When a population leaves at least as much of a productive base as it inherited from the previous generation Tariff

o Tax on goods produced abroad imposed by the government of the country to which they are exported Tax Incidence o How the burden of a tax is distributed between buyers and sellers Total Expenditure o The amount consumers spend on a product, the price of the product times the quantity they purchase Total Revenue o The amount companies get from selling a product, the price of the product times the quantity that is sold Weak Ties o They connect people to a wide variety of people and subsequently a large information base. Welfare o The well being of an individual or society Macroeconomics Elasticity o Price Elasticity of Supply How quantity supplied of a good changes as the price of a good changes o Price elasticity of demand is smaller when the quantity demanded is bigger because the more people buying, the less tolerant they are of price increases. o The demand curves downward slope suggests that at the maximum quantity demanded, the price is at its minimum point. o The relationship between the price elasticity of demand and the slope of the demand curve are inversely related because we graph demand as a price function of quantity o Demand is price elastic if the price elasticity of demand is greater than 1; Price inelastic if the price elasticity of demand is less than 1 Government o Government Correct Markets

To compensate for negative externalities such as pollution and congestion, the government introduces taxes and/or subsidies This way, the people feel the cost to society. You want to tax the polluter, but you want to subsidize the inventor for their invention that is benefitting society Tax is then used by the government to help reduce the negative externality If the full social cost of products or services generating negative externalities were figured into the price, fewer of those products and services would be consumed If the full social benefit of activities generative positive externalities were figured into the price producers received, more of these activities would occur Government corrects the under-provision of a product or service with positive externalities pay those who produce it a subsidy A subsidy can be used to increase the equilibrium quantity of vaccines to the efficient quantity, eliminating dwl of a positive externality Tax incentives are offered to motivate the individuals (tax reduction) Public goods are provided by the government directly and financed by everyone through taxes Governments should provide public goods up to the point where the marginal benefit to society no longer exceeds the marginal cost to society o Governments Create Markets Established private property rights Sets Contracts rules Creates liability rules Enforces these things Private Property It encourages work and investment (If I do something great, I am entitled to it; no one else can take it from me without compensation) It encourages people to move scarce resources to where they are most wanted or can be best used. Encourages maintenance and conservation Intellectual property rights

Extends for only a limited period of time (patents and copyrights) Apply only to new creations or inventions and not to general knowledge or discoveries Are limited by a doctrine known as fair use Property rights will become more contentious as markets become increasingly global. Contracts are useful because People might not keep promises Might think buyers and sellers have reached an agreement, but each had a different idea of what was to be bought/sold One party might not fulfill conditions of the contract causing losses to the other party. Compensation is necessary Party that wants to get out of agreement is usually compensated Government provides public insurance Providers of insurance face moral hazard because people who are protected from certain risks are more willing to take riskier actions Asymmetric Information Government requires disclosure of information (i.e. side effects and health risks) Government certifies that certain buyers/sellers are reliable Protecting trustworthy brands Creating uniform standards Creating minimum standards o Government Intervention If the government is concerned that people cannot afford a good and want to intervene in prices, they would impose a price ceiling By imposing a price ceiling, there will be more demanded than supply available, so it would cause a shortage. Governments might intervene when there are: Monopolies (Theyd impose anti-trust laws)

Externalities (Usually tax the people) Lack of information/asymmetric information Want more equality A tax on an elastic good will be disproportionately paid for by the producer Government intervention can cause deadweight loss (price ceiling/floor) The price ceiling decreases the price below the equilibrium, causing movement along the supply curve: quantity supplied decreases. The lower price causes a movement along the demand curve so the quantity demanded increases. Deadweight loss of taxes will depend on: Elasticity Size of the tax To minimize deadweight loss, you should tax goods with inelastic demand and avoid taxing elastic goods. Government intervention can be flawed, and can often impose even greater costs on an economy than market failures High tax rates would discourage people and companies from undertaking economic activities that would, without tax, have been profitable A market economy can function only if there is an adequate legal system and enforceable property rights. Government overrides the market by setting price ceilings and floors on certain items or activities in order to achieve particular societal goals; may result in shortages or surplus The government bans certain trades because: Paternalism (Its for the peoples best interest because they may not know what they are getting their selves into or cannot stop[in the case of drugs]) Large negative externalities Moral repugnance Violation of democratic ideals Banning a trade does not stop the trade from occurring, usually results in the trade ending up in the black market

Markets o Market economies are 5 times richer than centrally planned economies o Market equilibrium is the point where quantity supplied and quantity demanded are equal o Markets clear everything that is produced is bought, no shortages or surplus o Total economic surplus is maximized o To make markets better, the government should leave them alone. Markets work best and make us more prosperous when government does not intervene in any way o Allow everyone to pursue their individual interests so that everyone will be better off o Allow you to obtain goods you otherwise would not have access to (weak ties) o A competitive market equilibrium leaves no side deals o Market as win-win Create the most surplus denominated in money Dont leave anyone worse off when you open up a market Dont use markets all the time because of these hidden assumptions No general equilibrium Competitive Needs lots of buyers and lots of seller and prices are tight One where no one holds economic power Can buy from many different people for the same deal Surplus o Market Efficiency As the quantity of a good consumed increases, the marginal benefit of consuming an additional unit of that good decreases, so the maximum price a buyer is willing to pay for that unit decreases (When you get chocolate bars, you become less satisfied as you keep consuming more, and youll have less of a desire for it)

The maximum price a buyer is willing to pay to get an additional unit of a product is a measure of the marginal benefit the buyer gets from consuming it Marginal benefit of consumption decreases as quantity increases As the quantity of a product supplied increases, the marginal cost of supplying an additional unit of that product increases Sellers will keep supplying as long as the price is at least as great as their marginal cost. Marginal benefit larger than the market price paid = Consumer surplus Price producer gets from supplying an additional unit of product is larger than his marginal cost of producing it = Producer surplus Market is efficient when it satisfies one of the following: The product is purchased by those buyers who value it the most as measured by their marginal benefit The product is produced at the lowest possible cost The marginal benefit of those buying the product is equal to the marginal cost of those producing the product It is impossible to make some market participants better off without making other worse off The efficiency of a market takes the distribution of income, resources, tastes, abilities, and other attributes among potential buyers and sellers on which demand and supply are based as given When the consumption or production of a product result in externalities, the equilibrium outcome is inefficient

People o Adam Smith The founder of Economics as we know it He emphasized the role of specialization, technical progress, and capital investment as the main engines of economic growth. Stressed Invisible Hand The way in which self-interest pursued in free markets leads to the most efficient use of economic resources and makes everybody better off in the process o Friedrich Hayek He won the Nobel Prize in 1974 He studied the business cycle, and believed that booms and busts were caused by government intervention, not the market

Business cycle originated from expanded credit creation by banks, followed by firms and people making mistaken capital investments in producing things for which the market turns out to be smaller than expected. He predicted the Great Depression Anticipated the demise of command economies that sought to suppress price signals He argued that market economies were very much more efficient than central planning economies o Karl Marx Thought market economy was just devices that mask surplus values in the labor class Slaves;: very necessary for the people to get rich Says that most everyone is equal We can all make whatever contracts and propositions we make Thats the way it looks but that isnt the way it is When capitalist I very rich and contractors are very poor, they are unable to make equal exchanges o Milton Friedman A fierce advocate of free markets Argues that the problems of inflation and short-run unemployment would be solved if the Federal Reserve had to increase the money supply at a constant rate Supply and Demand Curves o Factors that result in exogenous shifts in the curve Supply: Changes in: Price of goods Technology Prices of Substitutes and Compliments

Number of suppliers Demand: Changes in: Income Population size Preferences Price of a substitute or compliment o A monopoly will sell their goods where the demand curve is Unit Elastic This is where revenue is at its maximum o Along the elastic part of the curve, revenue is increasing up until the unit elastic point, and then starts decreasing on the inelastic part of the curve The road to serfdom o People are being controlled and being made into this slave by government o What people need to be is free o If you have all these government restrictions, it restricts people from achieving their true potential, they cant buy what they want to buy they cant sell what they want to sell o Just dont want government to intervene in the market, let the market guide changes and make decisions for people Tax o On inelastic goods, if we were to raise the price, there wouldnt be much of a shift in the quantity demanded. This is why we are able to pass taxes onto consumers. o On the other hand, with elastic commodities, passing on tax to the consumer will result in a large change in quantity. Producers do not want this, so they bear the tax on these elastic goods. o By controlling whether or not tax is passed onto the consumer, we can minimize deadweight loss o Tax something and the equilibrium quantity is lower o There is a suggestion to have a progressive tax rather than a flat tax for more equity Miscellaneous o Private insurance insure against specific risks o

MicroEconomics

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Book Concepts
Key Concepts for Midterm!!

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Dasgupta Macroeconomic History o Gerald Diamond talks about why some are rich, poor o Use GDP as measuring rod o Use up resources o Polarized world: rich and poor, virtuous and vicious cycle (poor get poorer) o Productivity o Institutions account for differences in Becky and Destas lives Trust And Communities o Trust: agreement of conditions o Nash equilibrium (game theory) best interest to keep trust, have to know it is in the other persons best interest to keep their word as well o mutual trust makes the best outcome o All or Nothing: if one person makes a mistake youre out of agreement o Graduated sanctions: ok if you make a mistake o Government Enforcing Trust Rule of law o Mutual Enforcement o R: rate at which each party discounts the future benefits of cooperation, trust o Smaller r longer relationship can last o Tipping point: where R is too high for relationship to continue o Local commons:

Private good versus public goods: private goods are excludable and can be used up, public goods, you can benefit without taking away from someone else Use money so you can have a relationship with someone that doesnt have a commodity you want, but you can still trade Property rights Weak Networks: you dont need to know people personally to engage in trade or agreements Strong Network: if you have a large family, rely on personal connections for trust and exchange Everyone has a price, so even if youre in a tight community, there is a point at which someone wont want to be in a deal People have inherent sense of justice and fairness

Markets o Examining a single markets supply and demand curve o each market isnt representative of the entire market; you ned to look at the market as a whole o Efficiency: thebest allocation of goods and services that all parties are satisfied with Pareto efficiecy: cant make one person better without making another person worse The world o Market Failures: Free Riding problem: Monopolies: single producer Asymmetry of information Slumps in the economy result from the self-reinforcement of an economic slowdown Science and Technology as institutions o Knowledge two categories: Episteme(speculative, theoretical, or abstract knowledge) and Technology Techne ( art or practical knowledge) o Science is a behavior in the community enforced by norms o Difference is that science is nonpecuniary and only produces further research o Technology generates money by creating goods and services

Households and Firms o Household is the consumers and consumption o INSURANCE: makes sure nobody is left with nothing o Firms deal with producers and suppliers who make goods for households and market o limited liability: if something goes wrong, the corp is ok o Borrowing Saving and Investing enable households to keep going Sustainable Economic Development o Natural capital has value and is arbitrarily allocated o Expansion of free trade stratified rich and poor countries o poor countries willing to exploit their natural resources o The firms are willing to exploit the poor countries o the present value is viewed as greater than future value o people dont think about the effect and negative externalities associated with not protecting the natural resources o global climate changes costs are under-estimated o GDP increasing although natural resources decreasing o Shadow prices: the SOCIAL productivity of capital assets o Sustainable Development is leaving the same productive base as you inherited from past generation o Productive base includes human capital institutions, natural resources o Preferences help make choices between goods o institutions, laws and society allows for mobility o growth of mobility

o diminished corruption protects markets and allows them to thrive Friedman Friedman Introduction o Adam smith and capitalism o free competitive markets o he likes capitalism The power of the Market o Voluntary exchange is a necessary condition for both prosperity and freedom o Smith recognized that the prices that emerged from voluntary transactions between buyers and sellers (in a free market) could coordinate the activity of millions of people, each seeking his own interest, in such a way to make everyone better off o Prices have three functions in organizing economic activity: Transmit information Always searching for the best prices If the price of something goes up, it will affect everything in the chain (i.e. the wood to make a pencil) Incentive to use as little as possible to make as much as possible as cheaply and efficiently as possible Income is determined by revenue cost, so the producer wants to minimize costs and maximize revenue to generate the highest profit Determine who gets how much of each product (distribution of wealth) o A societys Values, culture, social conventions all developed through voluntary exchange, spontaneous cooperation, the evolution of a complex structure through trial and error, acceptance and rejection o Duty of Government Protection of individuals in the society from coercion whether it comes from outside or from fellow citizens Facilitating voluntary exchanges Erecting and maintaining certain public works and institutions (paid through via tax and tolls even though they may have externalities)

Protect the non-responsible people (children and madmen) o Constitution drawn up as a means to prevent power granted to government from corruption (but it does not say everything) The Tyranny of Controls o Free trade would promote material welfare as well as foster peace and harmony among nations and spur domestic competition o There has always been tariffs that inhibit free trade o Exports are the price we pay to get imports o If one country could sell things for less than we could, with free international trade, our communities would be flooded with that countrys goods and we would be able to sell them nothing o Unfair competition due to foreign governments subsidizing their producers, enabling them to sell in the US below cost o The price of the dollar, if determined freely, serves the same function as all other prices. It transmit information and provides an incentive to act on that information because it affects the incomes that participants in the market receives o Foreign exchange rates reflect internal policies o Arguments for tariffs National security Cannot solely be dependent Infant industry temporary tariff is put in place to shelter the potential industry in its infancy and enable it to grow to maturity However, tariffs are seldom removes after being imposed beggar-thy-neighbor A country that is a major producer of a product, or that can join with a small number of other producers that together control a major share of production may be able to take advantage of its monopoly position by raising prices The free trade would be fine is all other countries practiced free trade but that so long as they do not, the United States cannot afford to. Transactions only take place only when all parties believe that they will benefit from it

A monopoly can seldom be established within a country without overt and covert government assistance in the form of a tariff or some other device When states take control in detail the economic activities of its citizens, the state may prosper and produce impressive monuments; privileged classes may enjoy a full measure of material comforts, but ordinary citizens are instruments to be used for the states purposes, receiving no more than necessary to keep them docile and reasonably productive Minorities pave the way for imitators to follow and increase social and economic progress for the masses An essential part of economic freedom is to choose how to use out income: how much to spend on ourselves and on what items; how much to save and in what form; how much to give away and to whom We are forced to conform to the wishes of the majority Cannot buy anything we want (see banned trade) Essential part of economic freedom to use the resources we possess in accordance with out own values Cannot just jump into any occupation we want without first getting a license or permit from a government official Freedom to own property Freedom cannot be absolute, but there is an urgent need today is to eliminate restrictions, not add to them The Anatomy of Crisis o The Great Depression persuaded the public that capitalism was an unstable system destined to suffer ever more serious crises o The public believed that the government had to paly a more active role; it had to intervene to offset the instability generated by unregulated private enterprises; it had to serve as a balance wheel to promote stability and assure security o Was a catalyst for the rapid growth of government, and particularly central government o The Friedmans argue that the depression was a failure of government in money management o A run on a bank is an attempt by many of its depositors to withdraw their deposits in cash, all at the same time

o When you deposit money into the bank, the bank takes some of the money and puts them in a vault as reserves and lends the rest to someone else, charging the borrower interest, or uses it to buy an interest-bearing security o When a bank is on the verge of collapse, individual banks try to get cash to meet the demands by pressing their borrowers to repay loans and refusing to renew loans or extend additional ones. The borrowers will have nowhere to turn, so banks fail and businesses fail o open market operations the purchase or sale of government bonds became the main way in which the System added to or subtracted from the amount of money in the economy o The Federal Deposit Insurance Corporation was established in 1934 to guarantee deposits against loss up to a maximum. This means that they would pay you the money you have deposited back in the event that banks fail up to a certain amount o The System had to power to prevent monetary collapse and knew how to use that power, but despite insistence by the New York Federal Reserve Bank, the System did not engage in large-scale open market purchases. o Had the Federal Reserve System followed the rules of the gold standard, it should have reacted to the inflow of gold by increasing the quantity of money. Instead it actually let the quantity of money decline o As a result of the Great Depression, the public believed that the government needed more power to counteract the alleged inherent instability of the free market o The System blames all problems on external influences beyond its control and takes credit for any and all favorable occurrences. It thereby continues to promote the myth that the private economy is unstable, while its behavior continues to document the reality that government is today the major source of economic instability

Discussion Questions

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Dasgupta: Preface o How different do you think the lives of Becky and Desta are? Given the information in the Preface, they could be very different or very similar o How would you go about explaining why the lives of Becky and Desta are different? They could be different because they live in different countries, they have differing amounts of disposable income, they are different ages, etc. o How would an economist go about explaining why the lives of Becky and Desta are different? An economist would explain the difference in terms of what factors contribute to that difference o What are the costs and benefits of thinking like an economist? Costs include a perhaps limited view, but the benefits would include a deep understanding of the economic point. o What kind of person would start an analysis by asking: "What are the costs and benefits of thinking like an economist A person who understands that there are limitations to every point of view. Prologue o Why does Becky's household live outside of Chicago and earn money by having the father work all day outside of the house doing transactions processing rather than, say, living 100 miles further west and growing corn in DeKalb County? It is because he has specialized skills that are in high demand. o How different would Becky's life be if her father (and mother) were corngrowing farmers in DeKalb County? They would probably make much less money, and the work would be much more physically demanding. However, they would not be as hard pressed as Destas family. o Why did they choose to become suburban Chicago yuppies?

As much as one is able to choose these things, they chose to live in the suburbs because it offered them a certain standard of living that they wanted. Although they could have lived in rural America, they would not have the same luxuries. o Why does Desta's household live in rural Ethiopia and grow their own corn rather than, say, living in Addis Ababa and earn money by having the father work all day outside of the house doing transactions processing? The father does not have the skills necessary to be a lawyer. Perhaps if he had the opportunity to higher education he might have been able to do that. o How different would Desta's life be if her father were an Addis Ababa lawyer? Destas life would be very different. She would likely live in the city with modern conveniences and luxuries that she does not currently have. o Why did they choose to become rural Ethiopian subsistence farmers? In this case it seems that there was very little choice involved. Farming demands all of ones time and thus limits the opportunities to explore any existing forms of education. Macroeconomic History o In the long sweep of human history, is Becky very lucky, lucky, unlucky, or very unlucky? Lucky o In the long sweep of human history, is Desta very lucky, lucky, unlucky, or very unlucky? Unlucky o How much richer is the world today than it was in the long centuries from 5000 BC to 1800? It is about 6.66times richer. o How much richer are the world's rich today than the world's poor today? It is about 54.29 times richer. o What would count as an explanation of this divergence across space and time--that is, what kinds of things would count as "causes" and make you happy that you understood what was going on? People in rich countries have better equipment to work with, are better educated, have longer life spans, and more effective institutions like governments free of corruption.

o How many useful "hierarchies of causation" can you imagine here? different natural resources being able to have a stable source of income versus one based on agriculture, which is highly volatile being able to invest having great education Government institutions that protect and reward innovation and intellectual property rights --> development of new technology, science advancements that increase productivity, etc. government that is not corrupt (reduces inefficiency) reliance on rule of law (so people with weak ties can engage in transactions) versus dependence on strong ties (can only feel safe engaging in transactions with people you or your family personally know and can trust), being able to enforce those laws versus having to rely on social scorning and stuff

Trusts o About what fraction of our wealth is the result of--or, perhaps, is enabled by--our collective ability to engage in a very large distribution of labor (rather than requiring that each extended household be close to selfsufficient)? Nearly all of it. o What are the possible ways of creating the "trust" needed for a smallscale--within the village or within the herding band, say--distribution of labor? External enforcement comes from tribal chieftains, village/clan elders, and warlords who enforce agreements and rule on disputes. Mutual enforcements come in the form of the community threatening to impose certain sanctions on people breaking agreements; this could include sabotage or ostracism from that society. o What are the possible ways of creating the "trust" needed for a large-scale division of labor? External enforcement comes in the form of laws and contracts. o What, in the world we see around us, turn out to be the most important ways of creating the "trust" needed to maintain a large-scale division of labor? I think they are laws(consequences), and social contracts(benefits).

Communities o Suppose that we have the norm (or the strategy) that a failure to share in any case leads to the end of the sharing relationship forever. How much of a large-scale social distribution of labor can be supported by tied engagements of this type? While it seems possible that this is something that could be done, it would be unwise, given that any breach of an agreement would effectively shut down an economy. o What are the advantages to having an economic network built out of "weak ties"? They connect people to a wide variety of people and subsequently a large information base. o What are the difficulties in creating and maintaining an economic network built out of "weak ties"? The problem of maintaining an economic network built out of weak ties is that there is very little loyalty binding people together and therefore ensuring the maintenance of contracts. Markets o How is having access to an ideal market the same as or different from having an economic network of ties (strong or weak) extending over the entire world? Having an ideal market will create and build these ties amongst people around the world. Strong and weak ties will be made through the transactions that carry out in market; as everyone searches for the best deals, familiarity between consumers and producers are likely to ensure. o In what sense is what Dasgupta calls an "ideal market" ideal? A lot of assumptions are made. For instance, we assume that the market for good X does not affect the market for other goods. We also assume that all households are price takers o Why did Friedrich von Hayek deserve his Nobel Prize? He deserved his Nobel Prize because he recognized the impossibility of a completely centrally planned economy because of the infinite amount of information that would be needed and the improbability of gaining accurate information. o How can a central planner nevertheless add value for society, even though Friedrich von Hayek did deserve his Nobel Prize?

He can do this by applying things like taxes, subsidies, and regulations (such as trust breaking) o Why should we worry about each of the four kinds of market failure that Dasgupta sees: distributional, free-riding, market power, and macroeconomic? Science and Technology as Institutions o Given that knowledge is non-rival--if I teach it to you, I don't have any less of it than I did before--what justification could there possibly be for charging people for access to knowledge and its uses? It provides and incentive for those in the business of pursuing knowledge to continue doing so. o If people weren't allowed to charge others for access to knowledge and its uses, would there be any reason to think that society would be putting a properly-large share of our resources into creating and disseminating knowledge? The reason would be to educate the people so that progress into the future can continue to be made. However, if people were not compensated for this, then there would be no incentive to do so. Not being allowed to charge for knowledge is ultimately unsustainable. o Why can contests and the rule of priority be good ways to spur the creation and dissemination of knowledge? They provide adequate incentives for scientists to works diligently to try and produce groundbreaking ideas and discoveries. o How well do contests and the rule of priority fit with a private-property market economy? Households and Firms o Where have all the women gone? Large differences in the number of men and women in a population may be attributed to male bias in terms of the allocation of resources. Males are typically better fed and more likely to live past infancy. There is evidence of female infanticide as well as simply comparatively underfed females. o Why do we think that Africa's population is likely to grow much faster than India's population over the next fifty years?

Africas population is likely to grow faster than Indias because they have a system in which the responsibility of raising children is spread among many, which lowers the cost to the parents, which could lead them to have more children. o How does Desta's household react to the fact that GEICO does not sell insurance policies in their neighborhood? Because they do not have adequate insurance policies, they cannot take the kinds of profitable risks that have helped make the US for example, very wealthy. The iddir they are part of is not adequate. o How does Becky's family react to the fact that they can borrow from Umpqua Bank and invest in the Vanguard Funds--rather than having to deal with the local moneylender? They can better borrow, save, and invest, which will shift consumption towards the future. o Why does Becky's world have large-scale firms? They have the ability to invest heavily. o Why does Becky's world have joint-stock limited-liability companies? So that a firm can invest and grow while being able to absorb any risk o Why does Becky's world have tradable financial assets? Beckys world has many luxury goods that can be bought and sold for a price Sustainable Economic Development o Why are we destroying our fisheries? Why are we rapidly using up our atmosphere's capacity to absorb carbon dioxide without substantial increases in temperature? Why is such a large chunk of our population potentially short of fresh water? There are two main reasons. One is that we are impatient and are looking for immediate gratification in the sense that we arent concerned with future repercussions. Also, we think that with our advancing technology we will be able to eventually curb this problem. o Why have we been able to successfully capture and use 40% of the photosynthesis on earth without already severely disrupting our planet? We already have severely disrupted the planet. o How have we managed to become so much more numerous and rich since 1800 without rapidly-rising prices of pretty much all natural resources?

Certain technologies make the use of those resources much more efficient to harvest. Also, such resources can now be shipped around the world. Social Welfare and Democratic Government o What are T.H. Marshalls three revolutions? Civil liberties in the 18th century Political liberties in the 19th century Socio-economic liberties in the 20th century o Why is each of them important? Marshalls three-way classification of freedom basically says that the enjoyment of civil liberties, the ability to participate in the political sphere, and access to commodities are necessary if people are to flourish o How does a government based on T.H. Marshalls three revolutions tend to promote a prosperous market economy? It gives individuals freedom to choose and make their own choices on the things that they want to do and the products that they want to buy o Does a prosperous market economy tend to promote T.H. Marshalls Three Revolutionsand if it does, does it promote them all? Epilogue o What distinction does Dasgupta draw between problems and challenges? Dasgupta describes Destas life as filled with problems and Beckys life as filled with challenged. The problems hinges Destas ability to survive and she has to overcome many problems in her life. Beckys life is filled with challenges as she is more or less financially well off. These challenges may get in her way and lower o Which--problems or challenges--is better suited for analysis with the tools of economics? o What, after finishing this book, do you now think the most important tools of economics are? o Adam Smith:

"The difference of natural talents in different men is, in reality, much less than we are aware of; and the very different genius which appears to distinguish men of different professions, when grown up to maturity, is not upon many occasions so much the cause as the effect of the division of labour. The difference between the most dissimilar characters, between a philosopher and a common street porter, for example, seems to arise not so much from nature as from habit, custom, and education. When they came into the world, and for the first six or eight years of their existence, they were perhaps very much alike, and neither their parents nor playfellows could perceive any remarkable difference. About that age, or soon after, they come to be employed in very different occupations. The difference of talents comes then to be taken notice of, and widens by degrees, till at last the vanity of the philosopher is willing to acknowledge scarce any resemblance. But without the disposition to truck, barter, and exchange, every man must have procured to himself every necessary and conveniency of life which he wanted. All must have had the same duties to perform, and the same work to do, and there could have been no such difference of employment as could alone give occasion to any great difference of talents. As it is this disposition which forms that difference of talents, so remarkable among men of different professions, so it is this same disposition which renders that difference useful. Many tribes of animals acknowledged to be all of the same species derive from nature a much more remarkable distinction of genius, than what, antecedent to custom and education, appears to take place among men. By nature a philosopher is not in genius and disposition half so different from a street porter, as a mastiff is from a greyhound, or a greyhound from a spaniel, or this last from a shepherd's dog. Those different tribes of animals, however, though all of the same species, are of scarce any use to one another. The strength of the mastiff is not, in the least, supported either by the swiftness of the greyhound, or by the sagacity of the spaniel, or by the docility of the shepherd's dog. The effects of those different geniuses and talents, for want of the power or disposition to barter and exchange, cannot be brought into a common stock, and do not in the least contribute to the better

accommodation and conveniency of the species. Each animal is still obliged to support and defend itself, separately and independently, and derives no sort of advantage from that variety of talents with which nature has distinguished its fellows. Among men, on the contrary, the most dissimilar geniuses are of use to one another; the different produces of their respective talents, by the general disposition to truck, barter, and exchange, being brought, as it were, into a common stock, where every man may purchase whatever part of the produce of other men's talents he has occasion for." o Friedman: Forward o Why have Milton Friedman and Rose Director Friedman written this book? The Friedmans wrote this book because they believed that our freedom was in decline. o What do they hope will happen after people read the book? They hope that after reading this book, people will have a better understanding of the comparative advantages of a free market and will shift towards that direction once again. Introduction o Who do the Friedmans think are the real founders of America? Smith and Jefferson are the real founders. Smith believes that the uniform, constant and uninterrupted effort of every man to better his condition, the principle from which public and national, as well as private opulence is originally derived has been powerful enough to maintain the natural progress of things toward improvement in spite of government control and of the greatest errors of administration. o What is the "road to serfdom"? Why do the Friedmans think in 1980 that America is on the road to serfdom? The Road to Serfdom is a book written by Fedrich Hayek that said People are being controlled and being made into this slave by government What people need to be is free

If you have all these government restrictions, it restricts people from achieving their true potential, they cant buy what they want to buy they cant sell what they want to sell Just dont want government to intervene in the market, let the market guide changes and make decisions for people The Friedmans thought that America was on the road to serfdom because of all the government regulation and restrictions being implemented. o What is the "new class" that the Friedmans see growing? What kind of a threat is it to freedom? The new class are the people who recognize the dangers of big government and are dissatisfied with the policies. There is a major change in public opinion and we need to change public opinion towards greater reliance on individual initiative and voluntary cooperation and away from collectivism The power of the market o What are the large-scale ways that societies can organize production, exchange, and distribution? Chain of commands down the hierarchy (command economy) There needs to be some voluntary cooperation involved as well o How should PED be organized if we want to maximize prosperity? PED refers to production, exchange, and distribution. Price signals are one form in which we may maximize prosperity o How should PED be organized if we want to maximize freedom? To maximize freedom, we should just let the market just organize itself and not let the government intervene. This way, people would be able to make their own choices in the things that they want to purchase or sell, thus maximizing freedom. o How many people need to cooperate to make--efficiently make--a pencil? Many people (thousands upon thousands) are needed to make a pencil. They dont necessarily cooperate with one another however. They act upon their own interests an work much like an assembly line of production to make a pencil. o How do all the people making the pencil know that I want one? Price and quantity bought are used as signals to let producers know how many to make.

o Why does Milton Friedman hate Republican presidents Richard Nixon and Gerald Ford so much? o Karl Marx said that the most important thing to know about a market economy is that it is a powerful, subtle, and clever mechanism for transferring value from the working class that creates to the rich that consume it. Why would the Friedmans disagree? The Friedmans believe the market system is a way to allocate resources efficiently. They feel that when a market is competitive and at equilibrium, the amount of surplus is at its maximum, and where demand and supply meet, the amount of resources is distributed equally and is not a method of favoring the rich over the poor. o What do the Friedmans think the government should do? Duty of Government Protection of individuals in the society from coercion whether it comes from outside or from fellow citizens Facilitating voluntary exchanges Erecting and maintaining certain public works and institutions (paid through via tax and tolls even though they may have externalities) Protect the insane The tyranny of controls o Why aren't tariffs a way to make a country rich? They hinder the economic process by interfering with trade. The additional cost of the product will lower demand. Foreign exchange rates have not been determined in a free market. Government central banks have intervened on a grand scale in order to influence the price of their currencies. The government has not been able to prevent the basic underlying economic forces from ultimately having their effect on exchange rates. Small disturbances have accumulated into large ones, and ultimately a foreign exchange rate crisis has occurred and in turn, tariffs dont help make a country rich. o What are the valid arguments that the Friedmans see for tariffs? Tariffs are set in place so that a country isnt solely dependent on another country for a good/commodity. If war were to ever occur, then there would be a loss of access to this good.

o Apple Computer and Toyota Motors do not allocate goods and services within their organizations with the market system--they use internal corporate central planning. How do the Friedmans explain the fact that large successful corporations are large islands of command-and-control central planning within the market system, and yet are well? These corporations dont have to deal with the whole of the market. The companies control much less in the market, and its easier for the company to give commands within their selves. If central planning were used for the whole market system, it would be more chaotic to attempt to control everything. o Why do the Friedmans think that we "intellectuals"--especially here in Berkeley--like communism? We live in an interdependent society where freedom cannot be absolute so there are some restrictions on our freedom. It is important to eliminate those restrictions, and that is what people like the ones in Berkeley believe in, eliminating restrictions of freedom and providing equality to all. The anatomy of crisis o Why is it very, very important for the Friedmans that they prove that the Great Depression was the result of the failure of a government agency--the Federal Reserve--and not the failure of the market system? Because if this is not proved, then the government will be given more power and more regulations will come into place and take away peoples freedoms o What do the Friedmans say is the proper monetary framework for a wellfunctioning market economy? Would Ron Paul agree? No government intervention o What links do the Friedmans see between the coming of the Great Depression and the triumph of what they call "left-wing economics" after World War II? Because of the fallacy that the depression was a result of market failure, the public believed that the government needed more power, and this led to a more centrally planned economy, in other words, into a more left-wing economic society. Because the government participated heavily in the economy during world war II, at the end of the war, the US came out as the most prosperous economy of the world.

Friedman (for after the first midterm) Cradle to grave o What is Franklin Delano Roosevelt's "New Deal"? o What did the Great Depression convince the public of? o What did World War II--especially the victories of the Russian Red Army against the Nazis on the eastern front--convince the public of? o Why don't the lessons of World War II generalize to peacetime economies? o How do the Friedmans think a country's welfare and social insurance systems should be run? o What do they think are the biggest things wrong with the U.S.'s welfare and social insurance systems as they stood in 1980? o The Friedmans predict in 1980 that the next decade or so will see the admitted failure of and dismantling of social democracy in Britain and Sweden. Were they right? Why? Created equal o What is the difference between "equality of opportunity" and "equality of result"? o Which should we care most about? o How good is capitalism at generating equality of opportunity? o How good is capitalism at generating equality of result? What's wrong with our schools? o What do the Friedmans think is wrong with the public schools? o What do the Friedmans think is wrong with the public colleges? o How do they want to try to make K-12 education better? o How do they want to try to make public colleges better? Who protects the consumer? o Are consumers really helped or hurt by agencies like the Food and Drug Administration? o Who really protects the consumer? Who protects the worker? o Are workers really helped or hurt by unions? o Who really protects the worker? The cure for inflation o Why is inflation a bad thing? o Why is trying too hard to maintain full employment a bad thing?

o What is the right way to run a market economy to avoid inflation? Would Ron Paul agree? o What is the right way to run a market economy to avoid unnecessary high unemployment? Would Ron Paul agree? The tide is turning o What is the "special interest state"? o Why do the Friedmans think that Fabian Socialism and New Deal Liberalism are unstable--that countries cannot remain there but will instead slide down the road to serfdom? Why do the Friedmans think that they will in the long run succeed in constructing what I would call a libertarian utopia?