Scarcity, Efficiency, Scarcity, Efficiency, and Growthand Growth

Econ Dept, UMR

Presents

StarringStarring

The 3 Basic Questions, andThe 3 Basic Questions, and The Production Possibilities The Production Possibilities

ModelModel

FeaturingFeaturing

The Invisible Hand Argument for The Invisible Hand Argument for coping with scarcitycoping with scarcity

Three Basic QuestionsThree Basic Questions Efficiency Efficiency Production Possibilities ModelProduction Possibilities Model Marginal Opportunity CostMarginal Opportunity Cost

Part IPart I

The Invisible Hand Argument for The Invisible Hand Argument for coping with scarcitycoping with scarcity

Three Basic QuestionsThree Basic Questions Efficiency Efficiency

Scarcity and Economic Scarcity and Economic QuestionsQuestions Scarcity - relationship between Scarcity - relationship between

limited resources and unlimited limited resources and unlimited wants. Not all human wants can wants. Not all human wants can be satisfied with goods or services.be satisfied with goods or services.

Resources - The inputs used to Resources - The inputs used to make goods we want. Resources make goods we want. Resources are limited and this leads to are limited and this leads to scarcityscarcity

ResourcesWants

Scarcity ‑ relationship Scarcity ‑ relationship between limited resources between limited resources and unlimited wants. Not and unlimited wants. Not all human wants can be all human wants can be satisfiedsatisfied

L: labor

K: capital

l: land

Resources ‑ The inputs Resources ‑ The inputs that are used to make that are used to make things we wantthings we want L: Labor-skilled and unskilled, also L: Labor-skilled and unskilled, also

includes entrepreneurial abilityincludes entrepreneurial ability K: Capital-tools, machines, human K: Capital-tools, machines, human

capital (education)capital (education) l: Land-natural resources, even l: Land-natural resources, even

waterwater

Scarcity implies the Scarcity implies the necessity of Choicenecessity of Choice

We can’t have everything we want We can’t have everything we want thus we must make choicesthus we must make choices

Three Basic QuestionsThree Basic Questions What (and how much)What (and how much) HowHow For WhomFor Whom

Basic Economic Questions Basic Economic Questions dealing with Scarcity dealing with Scarcity What do we want, and how much What do we want, and how much

of each do we want?of each do we want? How shall we get what we want?How shall we get what we want? Who shall enjoy what we have? Who shall enjoy what we have?

What do we want, and What do we want, and how much of each do we how much of each do we want?want? I want, We wantI want, We want

a chicken in every pota chicken in every pot a car in my garagea car in my garage a garagea garage peace and quietpeace and quiet a lot of funa lot of fun a good booka good book and so on, and so on, and on,and on, and on,and on, and on,and on, and on, and on, and on,and on,

and onand on

How shall we get what we How shall we get what we want?want? Who will be the teachers? The Who will be the teachers? The

nurses and doctors? Who will raise nurses and doctors? Who will raise our kids? How will we provide for our kids? How will we provide for our old age? for the education of our our old age? for the education of our children?children?

What technologies should we use? What technologies should we use? Do we import, or do we produce Do we import, or do we produce ourselves?ourselves?

What about the conflict between What about the conflict between production techniques and production techniques and environmental goals?environmental goals?

Who shall enjoy what we Who shall enjoy what we have?have? Those who are meritorious? or, who Those who are meritorious? or, who work hard? or, who inherit?, or who work hard? or, who inherit?, or who are “pure blooded”? or who are the are “pure blooded”? or who are the chosen few? or who are educated?chosen few? or who are educated?

Is there a necessary link between Is there a necessary link between what we get and what we contribute? what we get and what we contribute? Should there be such a link?Should there be such a link?

Should some things be available to Should some things be available to all?all? basic medical service, food and shelterbasic medical service, food and shelter basic education, telephone, postal servicebasic education, telephone, postal service internet accessinternet access one trip to Disneyland, or a national park one trip to Disneyland, or a national park

per year per familyper year per family

How should these questions be How should these questions be answered?answered?How are these questions answered?How are these questions answered?

Economists have ideas about both.Economists have ideas about both. How should they be answered?How should they be answered?

Efficiently, say economistsEfficiently, say economists Equitably, say othersEquitably, say others Normative economicsNormative economics

How are they answered?How are they answered? Increasingly through markets, Increasingly through markets,

moderated with government regulationmoderated with government regulation A “mixed” economyA “mixed” economy Positive economicsPositive economics

EfficiencyEfficiency TheThe criterion used by economists criterion used by economists Common sense of the term is “lack Common sense of the term is “lack

of waste” but we use a definition of waste” but we use a definition more precisemore precise

Efficiency: The inability to make Efficiency: The inability to make someone better off without making someone better off without making someone else worse offsomeone else worse off

A change is efficient if the gainers A change is efficient if the gainers could potentially compensate the could potentially compensate the losers and still come out aheadlosers and still come out ahead

Why Efficiency Makes Why Efficiency Makes SenseSense

The fact of scarcity implies we can’t The fact of scarcity implies we can’t have everything we want, so what have everything we want, so what we select should take into account we select should take into account what it costswhat it costs

Efficiency means getting the most Efficiency means getting the most value from our limited resourcesvalue from our limited resources

What we want should be What we want should be accomplished at minimum accomplished at minimum opportunity costopportunity cost

Efficiency and/or EquityEfficiency and/or Equity Efficiency is the preview of economists, Efficiency is the preview of economists,

Equity is for all of us to judgeEquity is for all of us to judge Equity does not necessarily mean Equity does not necessarily mean

equalityequality Equality of opportunity is fair (equitable) for Equality of opportunity is fair (equitable) for

most of usmost of us Equality of income is probably not fair Equality of income is probably not fair

(inequitable) for most of us(inequitable) for most of us If a change if efficient If a change if efficient andand equitable, it equitable, it

probably has already occurredprobably has already occurred Most policy debate is about change that Most policy debate is about change that

involves a tradeoff between these two involves a tradeoff between these two objectivesobjectives

Measurement of Efficient Measurement of Efficient ChangesChanges Review of definition: A change is efficient if Review of definition: A change is efficient if the gainers can compensate the losers and the gainers can compensate the losers and have something lefthave something left

Gains are measured by the maximum Gains are measured by the maximum persons who gain are willing to pay (WTP) persons who gain are willing to pay (WTP) for their gainfor their gain

Losses are measured by the minimum Losses are measured by the minimum people who lose are willing to accept (WTA) people who lose are willing to accept (WTA) in compensation for their lossin compensation for their loss

An efficient change requires An efficient change requires WTP > WTP > WTA WTA Notice an efficient change doesn’t require Notice an efficient change doesn’t require

losers be compensated, just that they losers be compensated, just that they potentially could be compensatedpotentially could be compensated

How do we get what we How do we get what we want Efficiently?want Efficiently?

Cooperation is more efficient that Cooperation is more efficient that self-sufficiency, so how do we self-sufficiency, so how do we insure cooperation?insure cooperation?

Cooperation and the Nature of ManCooperation and the Nature of Man Man as a benevolent actorMan as a benevolent actor Man as a self interested actorMan as a self interested actor The economist view is that man is The economist view is that man is

motivated primarily by self interestmotivated primarily by self interest

Self Interest and EfficiencySelf Interest and Efficiency Thomas Hobbs (1588-1679) Thomas Hobbs (1588-1679) LeviathanLeviathan, 1651, 1651

“No arts, no letters, no society, and which is worst of all, continual fear and danger of violent death, and the life of man solitary, poor, nasty, brutish, and short.”

advocated the submission to an absolute monarch to avoid the inevitable conflict and chaos resulting from the uncontrolled pursuit of self interest

Adam Smith (1723-90) Wealth of Nations, 1776 The Invisible Hand Argument Policy of laissez faire French “allow to act”

commonly taken to mean minimum government

The Invisible Hand The Invisible Hand ArgumentArgument A wonderful thing if trueA wonderful thing if true By allowing each person to pursue By allowing each person to pursue

their own interest, the general their own interest, the general interest will be promotedinterest will be promoted

Smith saw self interest leading to a Smith saw self interest leading to a desirable outcome--the wealth of the desirable outcome--the wealth of the nationnation

Hobbs saw self interest leading to a Hobbs saw self interest leading to a life that was nasty, brutish, and shortlife that was nasty, brutish, and short

Basic tenets of the Smith Basic tenets of the Smith argumentargument The principle human motive is self The principle human motive is self

interestinterest The invisible hand of competition The invisible hand of competition

automatically transforms the self automatically transforms the self interest of many into the common interest of many into the common goodgood

Therefore, the best government Therefore, the best government policy for the growth of a nation’s policy for the growth of a nation’s wealth is that policy which governs wealth is that policy which governs least (least (laissez fairelaissez faire))

Criticisms of Smith’s Criticisms of Smith’s SyllogismSyllogism

Without government oversight, markets Without government oversight, markets tend to be less competitive and tend to be less competitive and monopoly power replaces competitionmonopoly power replaces competition

Even with competition, market fail whenEven with competition, market fail when there are significant external effectsthere are significant external effects things we want do not have characteristics things we want do not have characteristics

of rivalry and excludabilityof rivalry and excludability significant information externalities existsignificant information externalities exist

Laissez faireLaissez faire produces an intolerable produces an intolerable degree of inequalitydegree of inequality

Competition vs. Monopoly Competition vs. Monopoly PowerPower

We will look at the inefficiencies of We will look at the inefficiencies of monopoly power in chapters 9 and 10monopoly power in chapters 9 and 10

Essentially the argument is that Essentially the argument is that monopoly power skews the gains monopoly power skews the gains from trade to the advantage of the from trade to the advantage of the party with the power. Their gain is party with the power. Their gain is less than the loss to the other party less than the loss to the other party thus monopoly power is inefficientthus monopoly power is inefficient

Market failures with Market failures with competition--external effects competition--external effects (Ch. 8)(Ch. 8) Society gains when trade takes Society gains when trade takes

place due to the self interest of the place due to the self interest of the buyer and seller. Buyer gains, seller buyer and seller. Buyer gains, seller gains, therefore society gains. gains, therefore society gains.

But some trade have effects on But some trade have effects on others not taken into account by the others not taken into account by the self interest of the buyer and sellerself interest of the buyer and seller

Thus competitive markets may not Thus competitive markets may not generate the efficient level of tradegenerate the efficient level of trade

Market failures with Market failures with competition--goods with competition--goods with nonrivalry and non-nonrivalry and non-excludability characteristics excludability characteristics (Ch. 8)(Ch. 8) Some things we want are nonrival--they Some things we want are nonrival--they

may be enjoyed by more than the buyer may be enjoyed by more than the buyer without cost to the buyer, e.g., clean airwithout cost to the buyer, e.g., clean air

In such cases, who wants to be the In such cases, who wants to be the buyer--Let Bill buy, and I’ll enjoybuyer--Let Bill buy, and I’ll enjoy

Some things we want are Some things we want are nonexcludable--people can not easily be nonexcludable--people can not easily be denied access, e.g., salmondenied access, e.g., salmon

In such cases, there tends to be over In such cases, there tends to be over use--I better get mine before Betty gets use--I better get mine before Betty gets hershers

Market failures with Market failures with competition--information competition--information asymmetry asymmetry (Ch. 8)(Ch. 8) Smith’s argument supposes pursuit of Smith’s argument supposes pursuit of

self interest is efficient because buyer self interest is efficient because buyer and seller are equally informedand seller are equally informed

When one side or the other knows When one side or the other knows more about the trade there is more about the trade there is information asymmetry that may lead information asymmetry that may lead to inefficiencyto inefficiency

Government has a role in providing Government has a role in providing sufficient information so self interest sufficient information so self interest action is informed self interestaction is informed self interest

The End The End

Continue to Part 2