Economics Lecture One

Economics Lectures - [1 - 2 - 3 - 4 - 5 - 6 - 7 - 8 - 9 - 10 - 11 - 12 - 13 - 14]

This course requires thinking more than reading or writing. The assignments will be short and the homework "problem sets" will be intriguing. You will have time to read and reread the materials, and think about them, in order to fully understand the concepts. Repeatedly ask yourself and others questions, and ask questions in class. Test yourself with your own examples. You may have to read and think about a concept in economics many times before you really understand it. But once you understand these concepts, you can use them your entire life. Many of my students have told me that economics is the best course they ever took from me, and I teach many other topics.

Start working on the problems early in the week, so that you can ponder them a while before answering. Answers may not occur to you at first. It may be days after you read a problem, and while you're doing something completely different, when a light bulb turns on in your mind and you think, "Eureka" (I solved it!). Give yourself plenty of time for that to happen, by starting early on the problems. They are not difficult if you start early.

Why should we even spend time on an economics course? Why is it important? How should we define "economics", the term itself?

It is often helpful to think about and improve the definition of an important word, as a way of increasing your understanding of it. Finding and improving definitions of the words "faith" and "forgiveness" are helpful exercises. Let's work on identifying and improving the definition of the word "economics".

The Merriam Webster's Collegiate Dictionary (1994) defines "economics" to mean:

"a social science concerned chiefly with description and analysis of the production, distribution, and consumption of goods and services"

That definition has several terms that cry out definitions of their own, such as "social science" and "goods and services," You might acquire a habit of having a dictionary handy to look up words when you need to, and even when you think you know the meaning in order to see how the dictionary defines it.

Perhaps we can improve on that definition of economics. But let's first try to define what "goods and services" are, because they are found in the definition of "economics". At first glance, "goods and services" are the things and activities that someone is willing to purchase. Maybe you are not willing to pay for them, but someone is. Essential goods include food, clothes, cars, and books. We all pay in some way for those. The services that we need include help by doctors, dentists, teachers and barbers. A "good" is a tangible "thing"; a "service" is an activity.

The meaning of "goods and services" extends beyond our basic needs. We do not need to go to a restaurant or a Yankees baseball game, or see a movie. We do not need to buy ice cream in order to survive. Sometimes people buy things like fancy clothes or cars in order to impress others.

So the meaning of "goods and services" goes far beyond what people need, and includes anything they want, and that some people are willing to pay for. Note that not everything people want is something they are willing to pay for. We all want air in order to breathe, but we are not willing to pay for air. "Air" is not a "good or service." We all want friendship too, but that's not something that can be purchased. We all want the Yankees to win the World Series (well, not all of us do!), but we cannot directly buy that either. At most we can buy tickets in exchange for the Yankees' playing a game and trying to win the World Series. That "service" by the Yankees is a form of entertainment, like a music rock concert or a movie.

Now we are ready to define economics. We do not have to use the vague term "social science" as Merriam Webster's dictionary did. Our definition can simply be this:

Economics is the study of the flow of goods and services.

Synonyms for "the flow" in this context include "market", "transactions", "making, buying, selling and consuming," and what Merriam Webster's dictionary said above: "production, distribution, and consumption."

Your first question on the homework will be to try to improve on my definition of economics indented shortly above, and briefly explain why you think your version is an improvement.

Each day there are billions of buying and selling transactions in the world. Think about how often, each day, someone in your family buys or sells something. Economics tries to understand those transactions, and what improvements are possible.

Most American families buy meat several times a week. If the price of meat is doubled, will more or less meat be sold? (Less.) We will be analyzing that type of change in purchases based on a change in price.

How we buy and sell things is almost as important as which goods we choose. Since nearly the beginning of the world, something called “money” has been the medium for buying and selling goods and services. The “money” itself has only the value that people assign to it. It can be made of a worthless material, such as green paper.

Money is not essential to a society. When we buy food, we could offer to work in exchange. Or we could grow our own food and trade the excess of our crop for the excess of someone else’s crop. This is known as “bartering”. American Indians lived well for long time without any money. So have many societies. A great deal of bartering still occurs today. The Amish are known to barter when they need services from outsiders today.

But money makes transactions more efficient. Imagine loading up your shopping cart with groceries and then trying to barter with the owner of the store. You may not have any goods or services that the owner really wants. You may be a teacher, but he may not be interested in learning. Or you may be a professional football player, and he may not be a fan. Others are willing to pay to watch you play, but this grocer is not. Both of you are then stuck, and you might as well unload your shopping cart and try another store.

Money solves this inefficiency. You accumulate dollars by doing work for someone who wants or needs it, and then use those dollars to buy the goods and services that you desire. The person or company who receives your dollars can then spend it in yet another way.

Money is, in many ways, a form of communication. Donating money to a political candidate or a charity makes a statement. Buying expensive clothes, a luxury car, or a certain houses is like free speech. We often judge the value of something by looking at its price. We expect a car that costs $30,000 to have higher quality than a car that costs $15,000. We don’t even have to look at the two cars to have a high probability of being correct in that conclusion. Sometimes the price can be misleading, of course. But often it is a good indicator.

Money can be used to obtain food for starving people and for other good deeds. Or money can promote evil, as when communist countries build armies to suppress freedom. Then money becomes necessary to combat the enemy.

When asked how much more money people want, most say they would be happy with 20-100% more money than they have. This answer is the same from the poorest to the wealthiest persons. In absolute terms, the more money someone has, the more money he wants. There are exceptions. Andrew Carnegie acquired and hoarded one of the greatest amounts of wealth in the history of the world, wrote the “Gospel of Wealth,” and then gave it all away before he died. Carnegie Hall, the first 39 branches of the New York Public Library, and Carnegie-Mellon University are the products of just a few of his gifts.

Freedom depends on the free exchange of money. Communism and other totalitarian systems consist of government control over how money is earned, saved and spent. Loss of this freedom inevitably results in the loss of freedoms of religion and speech too.

Economics is basic to our freedom, and is very influential in determining whom we elect. Countries that lack economic freedom often lack religious freedom. If we lack rights in deciding what career to go into, then we will lack rights of worship also.

While many associate economics with money, economics has powerful insights that go far beyond money. Economics has teachings about the nature of time, marginal value, utility, and many other concepts that we will discuss throughout this course. One concept in particular, the "Coase theorem" (developed in 1960), is an economic insight that is powerful far beyond issues of money.

Economics will help you with your own purchasing decisions, planning for savings, choosing a career, and making business decisions. But it can help you with far more also, such as using your talents to their fullest potential, minimizing wastes of your time, not allowing yourself to become addicted to bad habits.

Several key concepts will be introduced and discussed in this course that illustrate both a powerful economic meaning and a broader "life lesson." Here are two examples in the form of Latin phrases:

• "caveat emptor," which has an economic meaning of "let the buyer beware" but is also useful in cautioning against participating in anything harmful such as drugs or pornography
• "carpe diem," which means "seize the day" and not waste a good opportunity. The present time is worth far more than time in the future, when it is unknown what will be possible or even if the world will still exist as it does today. The same principle of "carpe diem" can be seen in the Parable of the Talents (Mt 25:14-30) and the Parable of the Fig Tree (Luke 13:6-9) (the master gives the fig tree one more year to bear fruit, or else he'll chop it down)

Economics is also special in that it is concerned exclusively with the future rather than the past. For example, the price a good is sold for does not depend on how much it cost in the past, but how much someone will pay for it now or in the future. This is a difficult aspect of economics for students to accept, as other subjects (e.g., history) are primarily about the past rather than the future.

Our “economy” is our system of earning, saving and spending money on goods (like food) and services (like teaching or entertainment).

“Macroeconomics” uses the Greek root “macro-“, which means “big”. Macroeconomics is the study of the big picture of economics on the national level. It includes analysis of the total money supply of dollars, the Gross National Product (total dollar value of all goods and services), and the national unemployment rate (the percentage of Americans who recently lost their job).

“Microeconomics” uses the Greek root “micro-“, which means “small”. Microeconomics is the study of individual decisions about goods and services. It includes issues like how much a barber should charge for a haircut, or how much a grocery store should charge to sell a loaf of bread. Microeconomics includes the study of your decisions in buying a good or service.

“Net benefits” are total benefits minus total costs.

“Opportunity cost” is the value lost in order to do something. Doing a job that pays only $5 per hour when you could have taken a different job at $12 per hour has an opportunity cost of $7 per hour. Wasting three hours stuck in traffic has an opportunity cost of the money you could have been making for those three hours.

“Marginal analysis” consists of looking at an incremental change in terms of costs and benefits rather than the overall average costs and benefits. For example, if you are driving by a 7-11 the marginal cost of stopping in to buy a carton of milk is only a few minutes of your time. But if you are sitting at home, then the marginal cost of buying a carton of milk is much greater: you must get into your car and drive all the way to a grocery store, which takes much longer and consumes more gas.

“Positive” statements in economics are testable claims of fact, without any moral judgment. For example, “most people watch many hours of television a day” is a positive statement. It can be tested by doing a survey. The people are spending their time poorly, but it is a fact that they act that way. The remark that “fish live in trees” is also a positive statement. The statement is false, but it is still a positive statement. (Thanks to Tim S. for making this insightful point on conservapedia.com).

In contrast, “normative” statements are judgments about whether something is good or bad. People should not watch as much television or smoke cigarettes. That is a normative statement. People should pray more. That is also a normative statement.

Sometimes we use the word “net”, as in “net benefits.” What that means is the total benefit minus the total cost. For example, the net benefit of working at McDonald's is your salary minus your taxes and expenses in getting there and back each day.

We will also use the word “rational”, as in “rational choice.” That means the choice or decision that maximizes the net benefit. A rational action, in economic terms, would be to accept the job with the highest net benefit (salary minus taxes and expenses). You may not actually want that job for other reasons, such as working for a company that profits from addiction (e.g., a casino in Atlantic City). But those reasons would have to be translated into economic terms to be counted as part of your economically rational decision.

Finally, there is the concept of “redistribution”. That is the concept that government should try to even out the wealth in society, taking money from the rich and giving it to the poor. The process inevitably causes a loss in total societal wealth. Some visualize redistribution as a leaky bucket taking water from one pool and putting it into another, with water leaking out during the transfer. The leak in the bucket corresponds to the direct and indirect costs of the transfer, including salaries for people to do the transfer and disincentives to those affected by it.

These concepts will become clearer for you as the course progresses.

“Scarcity” is when the available good or service is not enough to satisfy everyone’s needs or wants. There is a scarcity of oil and gasoline, for example. Gas is expensive because there is not enough easily available to completely satisfy everyone’s desire for it in fueling their cars and supplying their other energy needs. Drinking water is scarce also in some areas of the world. Drinking water is more scarce in western states like Arizona and California than in northeastern states like New Jersey, where there are many wells.

Note that the economic definition of scarcity includes nearly all types of goods and services. Economists would say that television shows are scarce, while most of us would not ordinarily say that. Economists would say that junk food is scarce, while most of us would say there is too much it. Economists would say that fatty foods are scarce, even though that sounds odd.

The reason for the broad definition of scarcity in economics is to include any good or service that can be bought and sold. If an item is so plentiful that everyone’s needs are fully satisfied, then there is no market to buy or sell it (e.g., air). Once a price can be put on a scarce good or service, then some will not be willing to pay for it. Often people will not be able to obtain all of the good or service that they want. They may be better off without (e.g., fatty desserts at restaurants), though economists don’t address how we are better off because of scarcity sometimes.

“The best things in life are free!” True, but even free things can be considered scarce. If the New Yankees gave away some free tickets to a World Series game, they would still be very scarce. People would wait for days in line to get a chance to grab those tickets. However, many other items of great value are not scarce. There is no scarcity of prayer, for example. It’s available to anyone at any time without charge. Exercise, in some form, is not scarce either. But many types of exercise are scarce, such as memberships in a health club.

Goods that no one wants are not scarce. For example, a new deodorant that smells like a skunk would not be a scarce good. You could charge nothing for it and supply would still far exceed demand. Toothpaste that turns your teeth yellow would not be scarce either. How about hairspray that makes your hair fall out?

Based on our definition of scarcity, we can now refine our definition of “economics”. “Economics” is the study of scarcity, especially as it relates to goods and services. If there is no scarcity, then everyone has what they want. For example, there is no scarcity of air, so economics does not study the everyday uses of air. But there is a scarcity of land and oil, so we do study how they are bought and sold, along with everything else that is bought and sold.

Can you define “scarcity” now in just four words? Here we go: scarcity consists of “wants greater than means.”

Whenever we buy something, there are incidental charges known as “transaction costs.” These are the annoying burdens of time and money that interfere with our buying what we need or want. When you buy clothes, you have to spend time finding something you like. No one is going to pay you for that time you spend. You also have transportation costs. Then, when you finally find what you want, you have to pay extra for it to fund the salary of the sales clerk at the store. You also have to pay sales taxes on the purchase.

If you buy clothes over the internet instead, then you avoid some transaction costs but also take a risk that you might not like it when it arrives. Also, you have to pay for shipping when you buy over the internet, and the shipping costs are transaction costs.

“Transaction costs” are defined as the time, effort and added expense associated with the purchase of a good or service. Look around, and you will start noticing them everywhere. Almost nothing can be bought without all sorts of middlemen tacking on extra costs. Effort is also required by you when you buy almost anything. Some entire professions are built on transaction costs. Most attorneys, for example, make their entire living as transaction costs. People hire an attorney to help them obtain what they want. Salesmen, too, live off of transaction costs.

We will be referring to transaction costs throughout this course. They are one of the most basic concepts in economics. Often transaction costs are obstacles to the efficient purchase and sale of goods.

Have you ever heard of the “invisible hand”? The most famous economist of all time, the Scottish philosopher Adam Smith, coined this term in his breakthrough tome called “The Wealth of Nations.” The “invisible hand” is the unseen force that guides individuals, who are acting to help themselves, to work in ways that benefit society. For example, the businessman who keeps his store open longer each day to make more money for himself ends up helping customers who need to buy his goods late at night.

When the early Jamestown settlers were on the brink of failure because no one was working, John Smith arrived and instituted a new rule: “He who does not work, will not eat.” Each individual then began working just to feed himself. The community soon became very successful. The invisible hand is the force that guides people to do work that is needed such that others benefit.

The opposite of the “invisible hand” is government control. In dictatorships like communist Russia under Josef Stalin, the government dictates what people will and will not do. There is no “invisible hand.” The result is often disastrous. Tens of millions of people starved to death under Stalin’s rule due to the improper government planning. Stalin may have even starved them intentionally.

A force perhaps even stronger than the “invisible hand” is charity. The desire to give something of benefit to others, without demanding as much in return, is enormous. “Give and ye shall receive” is an economic lesson from the Bible. Look around, and you will notice numerous important charitable acts by others and yourself.

America’s health care system, by far the greatest in the world, was built on a foundation of charity. People and religious organizations giving time, money and expertise to care for individuals who could never afford to pay all the costs. Education, too, was developed in this country largely through charity. In recent years, both health care and education have lost their charitable identities, and the results are not encouraging. Both are weakening.

Most economics courses avoid charity entirely. When charity is mentioned, it is described as a minor add-on to the invisible hand of self-interest. But is this backwards? Is the invisible hand of self-interest actually a wrapper around a basic foundation of charity? These are thoughts to consider throughout this course.

The size and importance of charitable institutions in the world is immense. All religious institutions are charitable, as are nearly all private schools. Many hospitals are still charitable, including the Seventh-Day Adventist hospital in Hackettstown, New Jersey. On a recent trip to Orlando, I saw another Seventh-Day Adventist hospital there. Many religious organizations operate hospitals through the United States, just as they built most of our leading universities. Harvard, Yale, Princeton and Columbia, for example, were all built by charitable religious organizations.

The renowned Sloan-Kettering Cancer Center, for example, was built with the generosity of Alfred Sloan and Charles Kettering. They acquired wealth as senior executives of General Motors and ultimately donated their money to the cause of medicine. It has operated on a non-profit basis to this day.

The first private medical clinic in the United States was the Mayo Clinic, established by the Mayo family of physicians in 1889. Their sponsor was the Sisters of St. Francis, which built St. Mary’s Hospital in Rochester, Minnesota.

Likewise, the successful American colonies were initially more religious and charitable than commercial. Pennsylvania was founded on religious principles by the Quaker William Penn, who in turn established Philadelphia as the City of Brotherly Love. Within a few decades it grew to become the second most populated city in the British Empire, after London.

It was only on the solid foundation of the brick houses of hardy Quakers and their strict moral rules that the flower of free enterprise blossomed there. The same could be said for Boston, where Puritans served as the anchor.

The Virginia colony was purely commercial at first, but it only survived by turning to tobacco and slavery. It suffered so many problems that King James revoked its charter and took control less than two decades after its founding.

The colony of Georgia was subsidized by the British Parliament but was essentially charitable in nature. General James Oglethorpe established it as a haven for impoverished Brits languishing in debtors' prison. It was, in a sense, an antithesis to a capitalistic venture, featuring nothing but those who failed in the free market. It barred liquor and slavery, reflecting its idealism.

Over 150 years ago, Alexis de Tocqueville observed that “despotism may govern without faith, but liberty cannot. ... How is it possible that society should escape destruction if the moral tie is not strengthened in proportion as the political tie is relaxed?” Perhaps charity is the economic manifestation of that “moral tie,” upon which economic liberty and free enterprise rely.

We will be discussing charity at several points during the course.

I am a lead pencil—the ordinary wooden pencil familiar to all boys and girls and adults who can read and write. ... I am a mystery— more so than a tree or a sunset or even a flash of lightning. But, sadly, I am taken for granted by those who use me, as if I were a mere incident and without background. ...

I, Pencil, am a complex combination of miracles: a tree, zinc, copper, graphite, and so on. But to these miracles which manifest themselves in Nature an even more extraordinary miracle has been added: the configuration of creative human energies—millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human master-minding! ...

For, if one is aware that these know-hows will naturally, yes, automatically, arrange themselves into creative and productive patterns in response to human necessity and demand—that is, in the absence of governmental or any other coercive master-minding—then one will possess an absolutely essential ingredient for freedom: a faith in free people. Freedom is impossible without this faith. ...

The lesson I have to teach is this: Leave all creative energies uninhibited. Merely organize society to act in harmony with this lesson. Let society’s legal apparatus remove all obstacles the best it can. Permit these creative know-hows freely to flow. Have faith that free men and women will respond to the Invisible Hand. This faith will be confirmed. I, Pencil, seemingly simple though I am, offer the miracle of my creation as testimony that this is a practical faith, as practical as the sun, the rain, a cedar tree, the good earth.

(the full essay by Leonard E. Read is available from FEE at http://www.fee.org/publications/the-freeman/article.asp?aid=3308

Read and reread the above lecture. Complete the homework assignments at the level in which you choose to enroll in this course. You can change your mind later and shift from "honors" to "regular" or "regular" to "honors" if you like. Each week the "regular" portion will be about 6 or 7 questions, which all students should complete. The honors portion will be additional questions that the students enrolled in honors should complete.

Regular

1. Please suggest an improvement to our definition of economics, and in one or two sentences say why you think you've improved it.

2. In three sentences or less, what do you hope to learn in this course?

3. Imagine it is lunchtime and your family has two options: eat dinner at home, or go out to dinner at McDonald's. Does one of these options have more transaction costs than the other? Identify which option incurs more transaction costs, and identify two or more specific transaction costs. Which option is cheaper for your family, and why?

4. Define the concept of "scarcity" in your own words, and give an example of how an increase in scarcity for a good or service increases its price. That good or service could be a World Series ticket (a good) or a famous autograph (a service), or anything else you can think of.

5. What do you think are the main reasons that the “invisible hand” is preferable to government dictating how a pencil should be made? Rank your reasons in order of importance.

6. There are many parables by Jesus that use familiar concepts of money and economics as an example in order to make a deeper, more profound spiritual point. Pick one and discuss it.

Honors

Write an essay totaling about 250 words (rough approximation only) on one or more of the following topics:

7. "Money is a good servant, but a poor master." Please explain.

8. Improve on the lecture's definition of scarcity.

9. Does the U.S. Constitution protect private property? Explain how, with a specific reference or two.

10. "There is no such thing as a free lunch!" Discuss the concept of (economic) scarcity in the context of that saying.

11. "A bird in the hand is worth two in the bush." Explain that thought in economic terms.

12. The account of the multiplication of the loaves by Jesus is unique in the way it is included in all four Gospels, and is even mentioned twice in Mark. Read the account, as in Matthew 14:13-21. After reading that, do you think scarcity does inherently exist?

• Libertarian thinking
• Adam Smith