Laws of Economics

• Everything is scarce.

Is there anything you consume that is not scarce?

What does it mean to “consume” something?

• Every choice involves an opportunity cost (tradeoff).

What do you give up in order to get something else?

Mom-Pop shops v. Big Box Retailers

Global warming v. Global warming

Laws of Economics

• Everything is scarce.

Is there anything you consume that is not scarce?

What does it mean to “consume” something?

• Every choice involves an opportunity cost (tradeoff).

What do you give up in order to get something else?

Mom-Pop shops v. Big Box Retailers

Global warming v. Global warming

Laws of Economics

• The cosmos is a non-linear place.

Opposing consumption forces: consumption & variety

Opposing production forces: specialization & congestion

• People respond to incentives.

Airplanes and car seats

Entrepreneurship and taxes

Russians and dead light bulbs

Laws of Economics

Cascade of tradeoffs due to choice and incentives…

Regulation: Require cars to have airbags so as to save lives.

The tradeoff of safety vs. time…

Airbag make cars safer thereby allowing people to drive faster yet maintain same level of safety as before.

Cost per life saved = $720,000

…presents a tradeoff of lives saved via airbags vs. lives saved via other means…

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

HIV

blo

od t

est

for

sex

wor

kers

Mid

wife

tra

inin

g in

Thi

rd W

orld

Mal

aria

tre

atm

ent

Miti

gate

glo

bal

war

min

g

Sm

okin

g ce

ssat

ion

inte

rven

tion

Mal

aria

pre

vent

ion

PA

P s

mea

r ev

ery

3ye

ars

Col

onsc

opy

ever

y 10

year

s

Hea

rt t

rans

plan

t

Airb

ags

Sea

t be

lts in

sch

ool

buse

s

Co

st

pe

r L

ife

Sa

ve

d

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

HIV

blo

od t

est

for

sex

wor

kers

Mid

wife

tra

inin

g in

Thi

rd W

orld

Mal

aria

tre

atm

ent

Miti

gate

glo

bal

war

min

g

Sm

okin

g ce

ssat

ion

inte

rven

tion

Mal

aria

pre

vent

ion

PA

P s

mea

r ev

ery

3ye

ars

Col

onsc

opy

ever

y 10

year

s

Hea

rt t

rans

plan

t

Airb

ags

Sea

t be

lts in

sch

ool

buse

s

Co

st

pe

r L

ife

Sa

ve

d

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

HIV

blo

od t

est

for

sex

wor

kers

Mid

wife

tra

inin

g in

Thi

rd W

orld

Mal

aria

tre

atm

ent

Miti

gate

glo

bal

war

min

g

Sm

okin

g ce

ssat

ion

inte

rven

tion

Mal

aria

pre

vent

ion

PA

P s

mea

r ev

ery

3ye

ars

Col

onsc

opy

ever

y 10

year

s

Hea

rt t

rans

plan

t

Airb

ags

Sea

t be

lts in

sch

ool

buse

s

Co

st

pe

r L

ife

Sa

ve

d

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

$800,000

HIV

blo

od t

est

for

sex

wor

kers

Mid

wife

tra

inin

g in

Thi

rd W

orld

Mal

aria

tre

atm

ent

Miti

gate

glo

bal

war

min

g

Sm

okin

g ce

ssat

ion

inte

rven

tion

Mal

aria

pre

vent

ion

PA

P s

mea

r ev

ery

3ye

ars

Col

onsc

opy

ever

y 10

year

s

Hea

rt t

rans

plan

t

Airb

ags

Sea

t be

lts in

sch

ool

buse

s

Co

st

pe

r L

ife

Sa

ve

d

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

HIV

blo

od t

est

for

sex

wor

kers

Mid

wife

tra

inin

g in

Thi

rd W

orld

Mal

aria

tre

atm

ent

Miti

gate

glo

bal

war

min

g

Sm

okin

g ce

ssat

ion

inte

rven

tion

Mal

aria

pre

vent

ion

PA

P s

mea

r ev

ery

3ye

ars

Col

onsc

opy

ever

y 10

year

s

Hea

rt t

rans

plan

t

Airb

ags

Sea

t be

lts in

sch

ool

buse

s

Co

st

pe

r L

ife

Sa

ve

d

Laws of Economics

Cascade of tradeoffs and mitigation due to incentives…

Regulate safety: The tradeoff of safety vs. time presents a tradeoff of lives saved via airbags vs. lives saved via other means…

Each 1 life saved via heart transplant costs 15,700 lives that could have been saved via malaria treatment.…which, in turn, presents a tradeoff of lives saved vs. impact on the environment, etc., etc.

Laws of Economics

Given that everything is scarce, every choice will involve a tradeoff.

Who decides what tradeoffs are acceptable?

Deciding by vote allows everyone an equal say.

Should everyone have equal say?

Should we weight each vote based on how strongly the voter feels about the tradeoff?

How do we know how strongly the voter feels?

Voter has incentive to lie!

Laws of Economics

Prices are much more than “how much something costs.”

Prices signal how strongly the community feels about things.

All other things equal…

• The more people want something, the higher the price.

• The greater the opportunity cost of bringing something to market, the higher the price.

Economic Models

20.000135 0.0011 0.000024

stopping distance (feet)

velocity (mph)

mass (lbs)

d m v v

d

v

m

Economic Models

60 ft.d

1,750 lbs.m

50 mphv

Economic Models

60 ft.d

1,750 lbs.m

50 mphv

2

2

0.000135 0.0011 0.000024

1,750 lbs.

50 mph

1750 0.000135 0.0011 50 0.000024 50 201 ft.

d m v v

m

v

d

Economic Models

Criticism: Ignoring factors that impact model results

• Is the driver cautious?

• Does the driver have good reaction time?

Criticism: Issues that invalidate the model

• The car isn’t moving.

• The car has no mass.

Economic Models

The point of the economic model is to strip away:

• Irrelevant information (e.g., the color of the car),

• Relevant but individual specific information (e.g., the reaction time of the driver), and

• Relevant but negligible information (e.g., the mass of the driver).

The Players and the Goals

In this experiment, there are WORKERS and FIRMS.

WORKERS sell labor to the FIRMS.

FIRMS make stuff and sell stuff to the WORKERS.

The Players and the Goals

Two types of worker

• Red workers (know how to make Red stuff)

• Blue workers (know how to make Blue stuff)

Each worker’s goal: Maximize utility

Three things make you happy: Red Stuff, Blue Stuff, and Leisure

The Players and the Goals

Two types of firm

• Red firms make and sell Red stuff

• Blue firms make and sell Blue stuff

Each firm’s goal: Maximize profit

Profit = Ending $ – Starting $

Phases of Play

1. Labor market round

2. Leisure round

3. Production round

4. Goods market round

5. Utility and profit round

Phases of Play

1.Labor market round

= 1 hour of Blue labor

= 1 hour of Red labor

= 1 dollar

Labor

$

Labor

Phases of Play

1.Labor market round

Red workers sell some of their labor to Red firms for $.

Labor

$

Phases of Play

1.Labor market round

Blue workers sell some of their labor to Blue firms for $.

Labor

$

Leisure

Phases of Play

2. Leisure round

Red workers turn in their unsold

labor for leisure.

UnsoldLabor

Leisure

Phases of Play

2. Leisure round

Blue workers turn in their unsold

labor for leisure.

UnsoldLabor

Phases of Play

3. Production round Firms turn Labor into STUFF!

Labor

Labor

Stuff

Stuff

Phases of Play

4. Goods market round

= 1 unit of Blue stuff

= 1 unit of Red stuff

= 1 dollar

Stuff

$

Stuff

Phases of Play

4. Goods market round

Red workers buy Red stuff and Blue stuff.

Stuff

Stuff

$

Phases of Play

4. Goods market round

Blue workers buy Red stuff and Blue stuff.

Stuff

Stuff

$

Phases of Play

5. Utility and profits round

Utility = (Red Stuff + 1) (Blue Stuff + 1) (Leisure + 1)

Phases of Play

5. Utility and profits round

Profit = Ending $ – Starting $

Ready to begin…

Labor Market Round

Red workers sell some of your labor to Red firms for $.

Blue workers sell some of your labor to Blue firms for $.

= Labor

Utility = (Red Stuff + 1) (Blue Stuff + 1) (Leisure + 1)

Leisure

Leisure

Leisure Round

1. Red workers return unsold labor for Leisure.

2. Report your Leisure to moderator.

3. Write down how much Leisure you have.

1. Blue workers return unsold labor for Leisure.

2. Report your Leisure to moderator.

3. Write down how much Leisure you have.

Labor Stuff

Labor Stuff

Production Round

1. Red firms report hired labor to moderator.2. Report remaining money to moderator.

1. Blue firms report hired labor to moderator.2. Report remaining money to moderator.

Goods Market Round

Red workers buy Red stuff and Blue stuff.

Blue workers buy Red stuff and Blue stuff.

= Stuff

Utility = (Red Stuff + 1) (Blue Stuff + 1) (Leisure + 1)

Utility and Profit Round

1. Red workers report red stuff purchased to moderator.

2. Report blue stuff purchased to moderator.

1. Blue workers report red stuff purchased to moderator.

2. Report blue stuff purchased to moderator.

1. Red firms report unsold red stuff to moderator.

2. Report remaining money to moderator.

1. Blue firms report unsold blue stuff to moderator.

2. Report remaining money to moderator.

New Rules

The discovery of the nature of redness enables Red Firms to produce the same amount of Red Stuff using the one-third the amount of Red Labor.

Labor Stuff

Stuff

Stuff

Questions

What will be the effect (if any) on the price of red stuff?

What will be the effect (if any) on the price of blue stuff?

What will be the effect (if any) on the red wage rate?

What will be the effect (if any) on the blue wage rate?

What will be the effect (if any) on red worker employment?

What will be the effect (if any) on blue worker employment?

What will be the effect (if any) on red firm profits?

What will be the effect (if any) on blue firm profits?

Will the red workers be better or worse off?

Will the blue workers be better or worse off?

Ready to begin…

Labor Market Round

Red workers sell some of your labor to Red firms for $.

Blue workers sell some of your labor to Blue firms for $.

= Labor

Utility = (Red Stuff + 1) (Blue Stuff + 1) (Leisure + 1)

Leisure

Leisure

Leisure Round

1. Red workers return unsold labor for Leisure.

2. Report your Leisure to moderator.

3. Write down how much Leisure you have.

1. Blue workers return unsold labor for Leisure.

2. Report your Leisure to moderator.

3. Write down how much Leisure you have.

Labor

Labor Stuff

Production Round

1. Red firms report hired labor to moderator.2. Report remaining money to moderator.3. Triple your quantity of red stuff.

1. Blue firms report hired labor to moderator.2. Report remaining money to moderator.

Stuff

Stuff

Stuff

Goods Market Round

Red workers buy Red stuff and Blue stuff.

Blue workers buy Red stuff and Blue stuff.

= Stuff

Utility = (Red Stuff + 1) (Blue Stuff + 1) (Leisure + 1)

Utility and Profit Round

1. Red workers report red stuff purchased to moderator.

2. Report blue stuff purchased to moderator.

1. Blue workers report red stuff purchased to moderator.

2. Report blue stuff purchased to moderator.

1. Red firms report unsold red stuff to moderator.

2. Report remaining money to moderator.

1. Blue firms report unsold blue stuff to moderator.

2. Report remaining money to moderator.

Results…

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

Red Wage Rate Blue Wage Rate Price of Red Stuff Price of Blue Stuff

Round 1 Round 2

0

20

40

60

80

100

120

140

160

Avg Red Utility Avg Blue Utility

Round 1 Round 2

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

Red Employment Rate Blue Employment Rate

Round 1 Round 2

-$150

-$100

-$50

$0

$50

$100

Red Profits (total) Blue Profits (total)

Round 1 Round 2

units of red stuff consumed by the red player

units of red stuff consumed by the blue player

units of blue stuff consumed by the red player

units of blue stuff consumed by the blue player

u

R

B

R

B

R

R

R

B

B

L

nits of labor sold by the red player

units of labor sold by the blue player

units of labor endowed to the red player

units of labor endowed to the blue player

price per unit of red stuff

pri

B

R

B

R

B

L

E

E

P

P

ce per unit of blue stuff

wage per unit of red labor

wage per unit of blue labor

number of red workers

number of blue workers

number of red firms

number of blue firms

output of red indust

R

B

R

B

R

B

W

W

N

N

F

F

R

ry

output of blue industryB

Utility functions

1 1 1

1 1 1

Constraints

Utility maximizing consumption

1 2

3

1 2

3

2 1

3

R R R R R

B B B B B

R R R R B R

B B R B B B

R R R BR

R

R R R BR

B

R R R BR

R

U R B E L

U R B E L

W L P R P B

W L P R P B

W E P PR

P

W E P PB

P

W E P PL

W

1 2

3

1 2

3

2 1

3

B B R BB

R

B B R BB

B

B B R BB

B

W E P PR

P

W E P PB

P

W E P PL

W