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ECON20110 Fall 2013 - Lecture 6: Perfect Competition — Transcript

by Glen Weyl · 11,736 words · 1,729 segments · language en · Watch on YouTube

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0:01okay so today is um we're going to talk
0:05about perfect competition and I'm going
0:07to begin by refreshing your memory about
0:10and extending the basic pure trade
0:14equilibrium uh talking about uh the
0:17existence of equilibrium in large
0:18economies a little bit I'll then talk
0:21about introducing production into
0:23economies and comparative
0:26advantage how trade AIDS production as
0:29well as cons assumtion and uh who wins
0:32and loses in international trade I'll
0:35talk a little bit about comparative
0:36Statics and stability uh and what's
0:39called the correspondence principle and
0:41then I'll turn to the welfare theorems
0:44and their
0:45implications and in particular I'll try
0:47to challenge some of the traditional
0:49things you may have heard about the
0:51implications of the welfare theorems why
0:54the first welfare theorem is not really
0:56PR Market as you might have learned it
0:58and why why the second welfare theorem
1:01is actually much more consistent with
1:03the spirit of uh what happened under the
1:06Soviet Union than uh the United States
1:09or the west and then I'll talk a little
1:12bit about um the role of information and
1:15how that really uh is the crucial thing
1:18in distinguishing different social
1:20systems and in particular about how
1:22information technology is changing the
1:25role of
1:26information
1:28Okay so um Tanner do you remember why
1:33trade brought benefits in a simple
1:37exchange economy that you learned about
1:39last term yeah if uh people have
1:41different uh different things different
1:44things different galance and if I have
1:46something that you want and that I want
1:48then it would be very beneficial for us
1:50to trade yeah exactly that's exactly the
1:53idea of trade in a um in an endowment
1:56economy so um if I have things that you
1:59value more you have things that I value
2:01more trade allows us to each have what
2:03we value the most this was represented
2:05in a simple Edgeworth box where um
2:10individuals have uh points at which
2:13their indifference curve are tangent any
2:15of those points would be PTO optimal but
2:18the economy could easily start start at
2:20a point that um was in between two of
2:23those curves and then they would want to
2:26trade back to somewhere that lies along
2:28that curve
2:31okay so not only uh do we know that
2:34there are gains from trade but also uh
2:38we know that any equilibrium in a
2:41trading economy is predo efficient
2:44because at any equilibrium people most
2:48both set their indifference curves
2:49between the two um Goods tangent to the
2:54price and that's exactly what's required
2:57for us to get to one of these points
2:58that lies along the contract curve that
3:00both people set their marginal rates of
3:03substitution between the two goods equal
3:04to one another right um so everyone sets
3:10these marginal rates of substitution
3:13equal um to the ratio of the prices
3:17between the two goods so really the role
3:19that the prices play in the economy is
3:21to get everyone to set these marginal
3:23rates of substitution equal which if
3:26you'll remember from when we did uh
3:28production theory was exactly what the
3:29lrange multiplier was doing in the
3:32context of the um in the context of the
3:38producer problem yeah what does the MRX
3:41stand
3:46for
3:48uh it is the
3:51marginal uh rate of
3:55substitution of of X into y
4:01it really should have been
4:02Mr S I think but I'm not completely sure
4:05why but mrss so is it like a marginal
4:07rate of exchange it's like how much on
4:09the margin I would give up of X in order
4:11to get a unit of Y what what would be
4:15the minimum amount of maximum amount of
4:18X I would be willing to give up in order
4:19to get a unit of Y on the
4:23margin okay so individuals optimization
4:27leads to social optimization in this
4:29context because every individual sets
4:32their marginal rate of substitution
4:34equal to the social marginal rate of
4:35substitution which is given by the ratio
4:37of the prices this is the Invisible Hand
4:40of the market at work um and in fact uh
4:45any Proto efficient allocation any of
4:48these points along the contract curve
4:50can be achieved by not interfering in
4:52any way in the final allocation but just
4:55moving around the initial goods and then
4:57allowing people to bargain through trade
4:58back to this point so that's called the
5:01second fundamental welfare theorem and
5:03with
5:04production uh what we're really going to
5:06do is just reiterate these same basic
5:08principles by incorporating production
5:10in so the simplest possible production
5:14economy is called the Robinson cruso
5:16economy and this is an island where the
5:19only thing to eat is coconuts and every
5:21coconut can be produced with one unit of
5:25Labor um and there's one individual or
5:29many individuals who are identical who
5:32can choose um how much to work in order
5:36to buy coconuts which they then consume
5:40and their utility function let's say is
5:42just a cob
5:44Douglas uh which is given by the
5:47consumption of coconuts they have to
5:49some power Alpha times 1 minus the
5:52amount of work they do that is the
5:54amount of leisure they get to some other
5:56power one minus
5:58Alpha now
6:00the currency in this economy is
6:01arbitrary right we could scale
6:03everything up and down and it wouldn't
6:05make a difference so let's just
6:06normalize the price of Labor the wage to
6:11$1 so a firm can produce a coconut for
6:14one unit of Labor and the firms have
6:17constant returns to scale and therefore
6:20Supply is perfectly elastic so the price
6:23must be equal to cost uh at a
6:25competitive equilibrium right and so the
6:28price the Coconuts is going to be
6:31perfectly elastic at
6:34$1 so the question is uh soel uh what is
6:39the equilibrium in the market for
6:41coconuts going to be
6:44um so we know it price is going to be $1
6:47so then what is the consumer who can
6:50choose to buy coconuts for $1 and sell
6:52his labor for
6:53$1 what is he going to
6:56do sorry did you repeat that so the
6:58consumer can sell his labor for $1 okay
7:01and we know that like he can buy
7:03coconuts for $1 so what is he going to
7:05choose to do then uh given
7:08his utility function the same amount of
7:11cocon as Leisure so split the two evenly
7:15will each just to have the same amount
7:16of like Alpha and oneus Alpha to one um
7:21well sorry sorry he'll split them by
7:23proportion alha they'll choose like
7:25Alpha coconuts and oneus Alpha Leisure
7:28exactly exactly
7:30right so um
7:33let's uh let's go through that in more
7:36detail um Ming can you uh derive his
7:41utility maximization given that his
7:43budget that his uh budget constraint is
7:47that sorry this should be 1 * the number
7:50of coconut equal to this times 1 - L but
7:54why isn't it
7:55I sorry I this is L not I this is the
8:00amount of Labor he does so it's one the
8:02budget is 1 * yeah this is one 1 * 1us
8:07uh sorry time l 1 * l l right
8:12okay so do I you can do it on the board
8:14or wherever you want to do
8:16it this is basically just to derive what
8:18sual just you know
8:23said just ask like a basic question and
8:26then according to the utility function
8:28you have that if l equals to one that
8:31means the person won't get any kind of
8:32utility whatsoever yeah exactly so if
8:34they're working all day long they're
8:36going to like be incredibly depressed
8:39cuz they need to sleep for
8:41example oh oh okay one unit oh right
8:44okay I thought one was one
8:46minut yeah this is like they have one
8:48hour in the day let's say you know or
8:51one day you know it's it's measured a
8:53day
8:55not this is the fraction of time they're
8:57working
9:03okay
9:06[Applause]
9:12oops so you want the equilibrium in the
9:15market for C and by the Ware theorem
9:18that means uh it is where the marginal
9:21rate of substitution to the ratio of the
9:22prices
9:27yeah okay I don't know what my
9:29[Music]
9:59this
10:08am I making aake no
10:25no no uh it's just one because oh wait
10:28yeah oh yeah
10:30and this has to equal to the ratio of
10:32the prices the prices of they're both
10:34equal to one right yeah
10:40so one one right Y and you know that the
10:44number of coconuts that he has is
10:46exactly the same as the L yes so you get
10:50so I just substitute this c yeah okay
11:24this right no uh so you you want to
11:28collect all the C's on side of the
11:30equation so you add Alpha so you get C *
11:341 isal to just mov it around I got
11:43this did I you just undid what you did
11:46before did yeah
11:48yeah so you want to add C * Alpha to
11:52both sides right so you get you isolate
11:55C so you get C is equal to Alpha which I
11:58don't think is what I saw solve for here
12:00which is funny let me make sure that I
12:03made the mistake and not you do you guys
12:06get do you guys get AL C is equal to
12:09Alpha oh c over L is equal to Alpha over
12:131us Alpha which is right okay good C
12:16over Alpha is equal to 1- alpha alpha
12:19over 1- Alpha which is exactly what Ming
12:22got so ming you're you're done for the
12:24you're done for the day
12:25congratulations um Okay so if each
12:29worker has one day then the question is
12:33what's the solution to Ming's equation
12:35and I just gave it but I'm going to let
12:37Evan give the answer Evan it's right
12:39over there what is it it's c 1 minus Cal
12:42Alp no but what is c equal to then oh C
12:45equals the amount c yeah but what is the
12:47value of C that he's going to
12:49choose I'm sorry could you ask what's
12:51the solution for C in this equation I
12:54just said it
12:57before sorry I must have missed it
12:59solve for C in this equation it's really
13:01easy solve for c yeah what is C oh I'm
13:04sorry do you want me to go up to the
13:05board you don't even need to look this C
13:08over 1 - c is equal to Alpha over 1us
13:11alpha alpha it's Alpha yes ding ding
13:15ding uh yes that's right okay so um now
13:22question is uh uh is anab here I think
13:27he dropped that he dropped that okay
13:29so if you did this without uh if you did
13:33this
13:34without um like going through this whole
13:36Market thing and we just maximized
13:38utility obviously this thing is going to
13:40have the same solution because basically
13:44the way that we solved it was exactly by
13:48saying that um the
13:53uh well I mean you can just take the
13:55derivative of this guy with respect to L
13:58and you get that you know this whole
14:01thing divid L *
14:05Alpha uh has to be equal to this thing /
14:091 - L * 1 - Alpha and you get exactly
14:14the same ratio of L over 1 - L is equal
14:18to Alpha over 1us Alpha right so that
14:21says that the social Optimum is exactly
14:24equal to the
14:25equilibrium um and Julian what can you
14:28explain intuitively why that's the case
14:31um so um because um everyone is so it's
14:37just the the marginal rate of
14:38substitution thing that you put up
14:41before uh so everyone um is has
14:47to U well everyone is is the same in
14:49this case yeah so um if everyone is
14:54doing what's best for themselves and
14:56it's going to be what's best for
14:57everyone in this case cuz everyone the
14:59same well but what is the role of the
15:02production here playing so like we we
15:05saw from before that everyone set their
15:06marinal rates of substitution between
15:08goods equal to the ratio of prices but
15:10what is the what is the firm by setting
15:14the ratio of the price of wages to the
15:16price of Labor equal to one what is it
15:18doing there uh so it's setting what the
15:23marginal rate of substitution should be
15:26but then it's determined by the wage
15:28rate so it's determined by the rate at
15:30which it can transform work into
15:33coconuts right because that's the other
15:35way so like one way that like what are
15:38why do we need to set all the marginal
15:39rates of substitution equal to one
15:40another it's because one way I can get
15:43an extra good is by having you have less
15:46of it right and so I need to set the
15:48rate at which you're willing to have
15:49less of it equal to the rate at which
15:51I'm willing to have more of it right
15:53here we have to set the rate in which we
15:56have less of leisure equal toate which
15:59we have more of C exactly and that's
16:01exactly what the firm does uh so um so
16:06the rate of turning labor into coconuts
16:08is the price to wage ratio and the firm
16:11always sets its ratio of price and wages
16:14to the marginal rate which it can
16:15transform uh coconuts in labor into
16:18coconuts right and the consumer has a
16:22ratio of consumption to Leisure value
16:25and it sets it equal to the same which
16:26is exactly what you would do if you were
16:28solving the problem in the centralized
16:30way right so um now we can make the
16:35worker imagine we had lots of workers
16:37that were like this we could make some
16:38better off and some worse off by moving
16:40money around um but any uh
16:44redistribution can be accomplished by
16:47just moving money around we don't
16:48actually need to change uh anything else
16:52in the economy in order to get people to
16:54be able to buy as much or as little as
16:56is possible okay so the only problems
16:59can arise
17:01here uh when equilibrium fails to exist
17:05and this can be a problem if Supply or
17:08demand are discontinuous so let me give
17:10you an example suppose that the demand
17:12is 1 -2 p and suppose that there there's
17:16a firm that can either produce one unit
17:19at
17:20um
17:23uh or zero units uh and it can produce
17:28those at a cost one so then it's pretty
17:31easy to see that there's no equilibrium
17:33right so let me just draw out a picture
17:35of this
17:46um so the demand curve looks like
17:49that and the supply is
17:53either looks like
17:56this and then looks like this
17:59right so the demand is like we talked
18:01about in the other class cutting through
18:03the area where the supply has a gap so
18:06what are we supposed to do exactly well
18:10um suppose that there are 100
18:14consumers uh and firms like this right
18:17well then what could happen is that 50
18:19of the consumers could consume uh sorry
18:2250 of the firms could produce the good
18:25and 50 of the firms would choose not to
18:27produce the good and then we would have
18:29an equilibrium at this point here so
18:32rather than just having these two points
18:34here as we get to 50 firms like that we
18:36would be filling in the little grids in
18:39between because that would be the
18:40fraction of firms that are producing
18:42right and at some point that's going to
18:44get filled in so it's going to get
18:45closer and closer to the demand and if
18:47you have you know the right uh if it
18:50turns out it's even then it will exactly
18:53be able to hit that uh equilibrium point
18:55Yeah Austin this assumes divisibility of
18:57units though it doesn't so in fact
19:00that's exactly what was causing the
19:01problem here is that the units were not
19:03divisible but what solved that was
19:06having a lot of firms so even you know
19:09the normal things you learn assume
19:11divisibility of units but you don't
19:12really need that what you really need is
19:14that there's a lot of firms in the
19:16market and it's um and the thing is that
19:18it's not reasonable to assume perfect
19:20competition unless you have a lot of
19:21firms and so I think it's very a very
19:24reasonable way to solve these problems
19:26of existence is to assume that there's a
19:28large number of of people otherwise you
19:30wouldn't want to use these perfectly
19:32competitive ideas yeah D so in this case
19:34the supply curve would just be a
19:36horizontal well it's going to get
19:38towards being a horizontal line as
19:39there's more and more firms okay
19:43exactly philli you have a question well
19:45I was just saying so basically the
19:48implications is you can only produce
19:50whole coconut for once you produce them
19:52you can cut them in half and split them
19:54among consumers right no well no no no
19:56no we're assuming you can only produce
19:58or consume whole coconuts but if there's
20:00enough people on the island even if
20:06uh sorry so yes you're right that's
20:09exactly what I'm assuming that's right
20:10pH that's right so even if you if you
20:12can only produce whole coconuts and
20:14there's but you can split them then
20:16among consumers then uh people will
20:20eventually as long as there's a large
20:22number of people you'll be able to
20:24satisfy demand because you'll be able to
20:26make enough 50 coconuts so that each one
20:29can have half of a coconut that's the
20:31idea yes yeah so if like P is5 for
20:34example if you're only receiving .5 and
20:36it cost you to make one coconut for $1
20:39then why would any I mean even know even
20:40if there are 100 firms or a thousand
20:41firms why would any of them produce at a
20:43loss yes they wouldn't produce at a loss
20:47they're only going to produce at a price
20:48of one uh and that's exactly that point
20:51and if you had the inability to divide
20:54coconuts you could end up with a similar
20:56thing imagine that consumers valued
20:59coconuts uh a whole coconut at
21:03$2 uh but didn't value a partial coconut
21:07at all you know then you could have gaps
21:09in demand but as there got to be more
21:11consumers some of them would get the
21:12coconut for $2 some of them would get it
21:15not at all so you you you would have a
21:17similar way of resolving that problem so
21:20in general anytime there's a problem of
21:22like non- divisibility it can be solved
21:25by there being a large number of people
21:27because rather than dividing things
21:29within the person you divide them across
21:32people some people getting it and some
21:33people not does that make
21:35sense okay I'm sorry it still cost them
21:39zero to prod it still cost them a dollar
21:41a dollar to produce it says to produce
21:45one or zero no they can produce either
21:47one or zero and if they produce one it
21:48costs them a dollar so sorry I think you
21:51just asked us but so price would have to
21:53be over a dollar right for per produce
21:57no they it would have to be
21:59equal to a dollar yeah yeah at at a
22:01dollar firms are indifferent between
22:03producing and not
22:04producing okay so when there's a large
22:08number of firms or consumers there's
22:09always going to be an
22:11equilibrium and the only problems for
22:13equilibrium existence really come from
22:15small numbers of consumers but that's
22:17not a very interesting thing to study in
22:19the context of perfect competition you
22:21should study that in the context of
22:23Monopoly or oligopoly models so you
22:25really don't need to worry about
22:26equilibrium existence um this is similar
22:29to what we did with uncertainty before
22:32uncertainty as well as large numbers of
22:34people can smooth out all these
22:36discontinuities and make things uh work
22:38nicely again okay so
22:44um Florence what does
22:48intuitively production the possibility
22:50of production add to the potential B
22:52benefits from
22:54trade sorry so so we were talking
22:57earlier about the benefits When just
22:59consumption um if you kind of know what
23:01people want then you can kind of produce
23:03more or less to get more of what you
23:06want and also kind of get more trade
23:09yeah that that that's that's a good
23:11point so production can be optimized to
23:14match the demands of consumers there's
23:16another potential gain that comes from
23:18trade when there's production uh Wesley
23:22uh well so some firms may have a
23:23comparative advantage of producing
23:25certain things over other things and so
23:27they'll gain by trading those things
23:29away after they produce yeah exactly so
23:32what Lesley is saying is that you know
23:35with
23:36individuals uh
23:38consuming what we basically said was
23:41that some people want certain things
23:43more than
23:44others under production instead we say
23:47some people are better at creating
23:48certain things than others are and trade
23:51now allows us to take advantage of those
23:53differences in people's abilities and
23:55not just the differences in their tastes
23:59okay so like an example of this is
24:02Imagine That Brazil is really great at
24:04growing sugar and uh so to create um one
24:10computer it costs them one ton of sugar
24:14and imagine that China is really great
24:15at building computers and not so great
24:17at growing sugar and it costs them one
24:20tenth of a ton uh of sugar to build a
24:24computer right so then we say that China
24:28has a comparative advantage in creating
24:31computers um and Brazil is a comparative
24:33advantage in Sugar even if China's more
24:36productive at Sugar as well as at uh
24:39computers overall because all that
24:40really matters is which are they
24:43relatively uh better at creating so even
24:46though China has an absolute advantage
24:47in both uh Brazil has a comparative
24:51advantage in sugar and regardless both
24:54do better if they focus on their
24:56comparative advantage um
24:58um
25:00so
25:02um let me see if graph this
25:07up okay let me draw
25:14one
25:16so this is computers and this is sugar
25:20cane and Brazil can get one computer for
25:24one ton of sugar cane so they have a
25:27production possib possibilities Frontier
25:29like this now China can get 10
25:33computers uh for one ton of sugar cane
25:36but imagine they can produce more sugar
25:37cane than can
25:38Brazil so they'll have a production
25:40possibilities set like this
25:44right but both of them could do better
25:47if Brazil produced all of the sugar
25:51because imagine they want
25:54say uh this much sugar in total well
25:58then have Brazil produce all the sugar
26:00and China produce all the um all the uh
26:07computers and they will be able to uh
26:13have okay so if they if they tried to
26:16get to here and imagine they each
26:18produced half of the
26:19sugar for that amount then you would
26:23get this amount of Computers Plus this
26:27amount of computers
26:29uh which would take us to there on the
26:33other hand if Brazil produces all the
26:35sugar and China produces all the
26:37computers we get up to that much higher
26:40point up there because basically for
26:43every unit of if we're producing one
26:46unit of sugar China had to give up 10
26:49computers for that whereas Brazil only
26:51had to give up one uh computer for that
26:55and so uh and that's more generally true
26:59regardless of the mix that they want
27:02it's always best for the first uh units
27:05of sugar to be produced by Brazil and
27:07China only to produce it if Brazil is no
27:09longer able to produce right so for
27:12example if China um can produce 100 comp
27:15China could produce 100 computers and
27:17Brazil could produce eight tons then
27:20together they could produce 80 computers
27:23and 10
27:25tons um whereas alone to get the same
27:28ratio China would have to produce only
27:3050 computers and 5 tons and Brazil would
27:34produce seven computers and one ton
27:36which is much worse uh than what they
27:39can do
27:40together um and this is very analogous
27:43to what we said about pure consumption
27:45trade everyone produces what they're
27:47best at in the same way that in P pure
27:49consumption trade everyone consumes what
27:52they most want to consume so being good
27:54at producing something is like being
27:57enjoying consuming
27:58it okay now imagine that there are two
28:03different groups of people living in
28:05Within These
28:08societies we know overall the societies
28:11will be able to produce
28:12more but imagine that um but the problem
28:17is that once they start trading the
28:19prices for things are going to end up in
28:21between where the prices were before so
28:25imagine that for example the price uh is
28:29five computers per one ton of sugar now
28:32the Chinese farmers who used to be able
28:33to get 10 computers for the one ton of
28:35sugar that they produced are going to
28:37only be able to get five tons and
28:39they're going to be worse off right yeah
28:41philli this price would be in the middle
28:44if then only if uh bra well it could
28:48only be in the middle if Brazil was
28:50producing only sugar and China was
28:51producing only computers
28:56right um
29:01that sounds right yeah I mean the
29:03problem is I've made the Technologies
29:04completely linear here so if I made the
29:06Technologies less linear then it will
29:08always be in the middle it's on one of
29:11the extremes here unless they're
29:13completely specialized that's
29:16right so then Chinese Farm
29:20owners uh will have their price cut in
29:23half while the Brazilian Factory owners
29:26will be able to get uh only one fifth as
29:29much sugar for each one of their
29:31computers so the Brazilian farmers and
29:34the Chinese producers uh are going to
29:36benefit more than these guys lose and so
29:39while there's an overall social gain
29:41there's going to be a loss to the person
29:43who's producing the thing that's more
29:45scarce within their
29:47country and that's called the staler
29:49samuelson's theorem now economists say
29:53well you could always compensate you
29:55could always redistribute to the person
29:57who who benefit harmed from the person
30:00who's benefited but that can create
30:02problems as well imagine that you had a
30:04general policy that whenever anyone was
30:06harmed by trade you would redistribute
30:08to them from the person who was
30:09benefited by trade that would encourage
30:11everyone to seek protectionism just so
30:13that they could gain uh when then the
30:17protectionism was repealed
30:19right um so in practice uh we don't
30:23compensate people fully that way and
30:25that in turn can lead to lobbying by the
30:28people who are the scarce uh factor to
30:32try to stop um free trade so in the
30:35United States uh labor is
30:39scarce uh compared to most developing
30:42countries and therefore it's uh usually
30:46the labor unions who are in favor of
30:48protectionism rather than
30:50businesses and some people have used
30:52more generally this idea of the ster
30:56samelson theorem to EXP exp Lain many
30:58political developments in history so for
31:01example in the UK in the 19th century uh
31:05labor was quite abundant there were lots
31:07of people Capital was quite abundant
31:09there were lots of machines but land was
31:11very
31:12scarce and as a result you got an
31:14alliance between capital and labor
31:16against land and that's why you had like
31:19the Liberal Party versus the
31:20conservative party in Britain in the
31:2219th century on the other hand in
31:24Germany land was quite scarce
31:28and uh Capital was pretty scarce but
31:32labor was very abundant and so you got
31:34an alliance of land and capital against
31:37labor which is why you had these
31:38conflicts between the Communists and the
31:40Nazi party or at least that's what
31:42there's a famous uh history book arguing
31:46that uh yeah explain like where in the
31:49US you see a lot of times in like the
31:51cons Republican party you get kind of
31:53the land the farmers those kind of
31:55people and the capital like businessman
31:58against labor and Democrat yeah you
32:00could you could definitely uh view it
32:03that way and there's this history
32:05Professor from you political scientist
32:07from UCLA who likes using the ster
32:09samelson theorem to think about a lot of
32:11politics those ways and you Republican s
32:13to be pretty free trade and yeah so
32:16that's uh one way of thinking about it
32:18yeah Austin um so obviously like these
32:22would these problems would be humiliated
32:24with the FL lot of movement of Labor and
32:26capital into the most productive
32:27industri
32:28are are there any you know examples of
32:31times where that's shifted massively and
32:33thus you know you see changes along
32:35those lines well I think that so anner
32:38graef who's a professor at Stanford is
32:40writing a really interesting book about
32:43um the Industrial Revolution where he's
32:45trying to argue that like really this
32:48idea that it was quote unquote
32:50capitalism or free markets that made the
32:52Industrial Revolution happen is really
32:54confused that what it was really about
32:56was like how well societies were able
32:58to like both give people welfare and
33:02help them to retrain for the new jobs
33:04because countries that didn't do that
33:07had like revolutions or like gangs of
33:10marauding people who were unemployed
33:12like uh causing chaos and so like what
33:15really made the Industrial Revolution in
33:17England succeed was the ability to
33:20cushion those who were the losers from
33:22all the unemployment caused by the
33:23Industrial
33:25Revolution so
33:28um so another a classic story about
33:32comparative advantage is based on
33:35natural
33:36endowments so for example the China
33:39Latin America trade or China Africa
33:42trade is based on the fact that China
33:44has all these uh manufacturing goods and
33:47Latin America and Africa have lots of
33:49raw materials the US Latin America trade
33:52is based on the fact that there's
33:54certain especially during certain
33:55Seasons uh for roots that can grow in
33:58Latin America that can't grow in the
34:00United States but I think in a lot of
34:03the gains from trade don't come from
34:05these natural
34:06endowments but instead from the way that
34:09countries themselves choose to
34:11specialize themselves so for example
34:13Japan produces Hardware much better than
34:17the United States does and the US
34:19produces software and it's not really
34:21obvious what natural endowment makes
34:23Japan better at hardware and what
34:25natural endowment makes us better at
34:26software it's it's really just that
34:28there's a culture of producing Hardware
34:29in Japan and a culture of producing
34:31software in the United States that's
34:33sort of grown up and got gathered its
34:35own
34:37momentum and it's probably good that we
34:39specialize because each area is better
34:41than it would be if you had a mix of the
34:42two because each you know area has
34:45gotten really good at what it does uh so
34:48that's allowed for valuable trade but
34:50there's not really any natural endowment
34:52driving that right um everyone gains by
34:55each group focusing on something this
34:57can happen in cities as well so one
34:59reason why cities uh form is that you
35:02have lots of people doing lots of
35:04different things easily able to trade
35:06with one
35:07another right everybody can be focused
35:10on one thing but then they have the
35:12ability to
35:13exchange and that's uh you know what
35:17happens at universities as well you can
35:19have people who are experts in different
35:21things but then they have the
35:22opportunity by being in the university
35:23to trade with each other whereas if they
35:25were on their own they would have to
35:26learn a little bit of everything can not
35:28be as
35:29good um another uh yeah Mike um this
35:34isn't likeed well are there cases where
35:37this kind of specialization keeps people
35:39from like having like so if Japan
35:42produces a lot of like hardware for
35:44things like uh I assume like computers
35:46CU yeah uh but then Apple does something
35:49like uh design a completely new like way
35:52of of putting together a laptop or
35:54something and then they like sell a
35:55bunch uh are there examples of that
35:57you're saying when when like integrating
35:59the hardware and the software can be
36:00important to Innovation and therefore
36:02places that are specialized might be
36:04hard is that sort of what you're
36:05suggesting um or maybe that like that
36:08kind of specializ like what if there's
36:09somebody in the US who's like really
36:10good at producing or like who has a
36:12really good Hardware idea but it would
36:15like be harder for them to do it in that
36:17culture of producing software right
36:20maybe yeah so I mean that's a case in
36:22which that that pushes against this idea
36:24that there could be these economies of
36:26scale the these things all depend on
36:27economies of scale like it's better to
36:29specialize than to diversify and that is
36:32true certainly for many things but it's
36:34not true for everything and one reason
36:36it might not be true is that people just
36:38might have creative ideas in different
36:39areas and if you force them to
36:41specialize they may be unable to
36:44manifest all their
36:45creativity um I guess my feeling is like
36:49you know it's actually there's another
36:51level of specialization which is that
36:53some areas specialize in being
36:55specialized and some areas specialized
36:56in being General
36:58you know what I mean and it's only
37:01because you like a lot of the gains from
37:04specialization come precisely because
37:06there's people who are specialized in
37:08bridging between the
37:10specializations um
37:12okay so talented individuals can uh
37:16reach a a bigger audience is another
37:19reason why trade can be useful so this
37:21is a little bit like uh compartive
37:23Advantage but it's not really an issue
37:25of you focusing on something it's
37:27exploiting natural differences in
37:29ability if you allow the absolute best
37:32people at any given thing to reach the
37:34whole world rather than just serving
37:36their country which trade allows you to
37:38do uh you can reap a lot of gains from
37:41them and there's actually lots of other
37:43stories about why trade brings benefits
37:46and many of them are connected to the
37:47logic here okay so that's the basics of
37:52trade now I want to talk about um uh
37:56comparative static of an
37:58equilibrium so what happens uh if there
38:03is a rise in um uh supply of a good uh
38:10or a subsidy given to the producers of a
38:12good Andrew what what what should we
38:14should expect to happen to price and
38:16quantity um suppose quantity would go up
38:19price would go down that's right um and
38:22this is what happens in normal supply
38:24and demand right so in particular the
38:29equilibrium if we give some increase in
38:33Supply is the increase in Supply S Plus
38:36the supply as a function of price and
38:38demand uh as a function of
38:41price so um uh Kim can you derive how
38:46much price changes when this Supply
38:49shifter increases using the implicit
38:51function theorem from this
38:55equation you can do it on on the board
38:57or whatever you PR
39:38no don't look at your
39:43computer SP P minus D Prime
39:48p d Prime SP what 1 over
39:54Prim yeah so it's one over okay so you
39:57different implicitly differentiate you
39:59get a one here right with respect to
40:02S uh oh you're saying derivative of p
40:05with respect to yeah so it's uh and then
40:09it's S Prime *
40:11dpds is equal to D Prime * dpds so you
40:16subtract this side from that side and
40:18you divide and you get 1/ D Prime of P
40:22star minus S Prime of P star
40:28um okay so we because of what Andrew
40:31said we think that this should be NE
40:33negative right that the price go down
40:36when the supply increases
40:38right um now one simple way to justify
40:42that would be if demand slopes downward
40:43this is negative and Supply slopes
40:45upward that's positive then we get that
40:47right but that's
40:50not necessary in order for this to be
40:53the case right so imagine that demand
40:57were to slope upward in
40:59price uh but not as quickly as Supply
41:03did that would still lead to the right
41:07comparative static
41:09right um and if that weren't the case uh
41:15things would be really crazy right so
41:18imagine that demand sloped upward more
41:20quickly than Supply that would mean that
41:23if we were if we had a price that was a
41:24little bit too high uh
41:27that there would actually be
41:30greater um so if the price is a little
41:33bit too high sorry if there's more
41:36demand than there is Supply we usually
41:38want to raise the price but if demand
41:41slopes upward more quickly than Supply
41:43does then raising the price makes that
41:45even
41:46worse and then if you raise the price
41:48again it makes it even worse right and
41:50it leads you to move away from that
41:52equilibrium right um on the other hand
41:56if demand doesn't SL slope up as quickly
41:58as price that difference
42:00Narrows and therefore you converge back
42:03stably to the equilibrium right so let
42:06me show you a picture of this I've
42:09reversed the axes from what they usually
42:11are here's a function of price is demand
42:14and I've graphed it so that Supply is
42:16sloping downward right so that's not the
42:17way we usually think about it but as
42:19long as demand slopes downward more
42:21quickly than price then uh Supply does
42:25if Supply increases the price still
42:27decreases like we wanted to but on the
42:30other hand if Supply slips downward more
42:31quickly than demand does then when
42:33Supply increases the price actually has
42:35to
42:36increase right and the reason why that's
42:40crazy is that you know here if the P if
42:44we have Demand Being greater than Supply
42:46we want to raise the price and that
42:49makes demand and Supply closer together
42:51but here if demand is greater than
42:53Supply and we raise the price that makes
42:55them further apart so we're getting
42:57further and further from an equilibrium
42:59as we make the adjustments that we think
43:01yeah Tanner under what situations would
43:03you get a
43:05demand uh well I mean you could get a
43:07demand curve sloping upward and a if it
43:09was a gif and good for example but Happ
43:12there doesn't that not
43:14exist not very often no so in in reality
43:18this isn't too much of a problem but the
43:20basic principle here applies not just to
43:23like competitive equilibria but also to
43:25game theoretic situation
43:27where you can have equilibria that sort
43:30of cross in the wrong way each other and
43:33those are not stable and so like one way
43:36like you might have many equilibria but
43:38many of them might be unstable and there
43:39might be only one or two stable
43:41equilibria and that allows you to refine
43:43down the set of things that you look
43:46at okay so more generally uh in any
43:50equilibrium situation you should um
43:54check to make sure that things cross in
43:56the right direction if they don't things
43:58are not stable and an equilibrium that's
44:00not stable is really just like a local
44:02minimum in a maximization problem it
44:05satisfies the first order equilibrium
44:07conditions but it doesn't satisfy the
44:08second order conditions about whether
44:10that's actually a place where you would
44:12expect things to sit so uh one of the
44:1624210 problem sets as you look at this a
44:19little bit and I might have asked you in
44:20some of your problems that's a question
44:22related to it so hopefully you guys will
44:23look into it in the context of a game
44:25theoretic situation as well
44:28okay so just um as with
44:34trade uh with production all equilibria
44:39are going to be
44:40efficient uh because now the production
44:43possibilities are also going to be
44:44tangent so before we said all the
44:46marginal rates of substitution equal to
44:48one another now all the marginal rates
44:50of transformation of different firms are
44:53going to be set equal to those marginal
44:54rates of substitution everything is
44:56going to be made tangent by the ratio of
44:59the prices yeah Phil um if the if the
45:03demand function slopes upward due to a
45:05network effect is it possible to main uh
45:10do you have stability maintained even if
45:13the curves cross in the bom Direction um
45:16those upward sloping okay so first of
45:19all Network goods are almost never a
45:21competitive market so they're almost
45:23always controlled by a monopoly and a
45:25monopolist will never choose to produce
45:27in the part of the demand curve where
45:29demand slopes upward because you can
45:30reduce the quantity so you can increase
45:33the quantity and get a higher price so
45:36he's always going to do that so you'll
45:38never end up in that part of the uh
45:41demand
45:42curve because you know Network Goods
45:45aren't controlled in the competitive
45:47market they have two large economies of
45:49scale for that to
45:53happen
45:54um Okay so so uh
45:58production is really no different from
46:01consumption and we get the same
46:03conclusion the First Fundamental welfare
46:04theorem all Market allocations are Proto
46:07optimal um again this is just another
46:10version of the Invisible Hand but these
46:13concepts of markets are not just used in
46:15standard situations that we consider to
46:17be markets but also in various
46:19non-market uh situations so uh so what
46:23are some
46:24situations uh where Market is used or
46:29could be used uh that aren't like
46:32traditional economic settings can you
46:34think of any the okay sorry so where the
46:37market can be used as an allocation
46:40mechanism in something that's not like
46:42standard economic environment okay
46:46um and like you mean environment that
46:49like isn't currently yeah you wouldn't
46:51currently think of as being a market M
46:54um okay just give me a moment
47:01okay so I'm GNA give a shot at it kind
47:04of weird um So currently there's like no
47:06Market or or IND donations CU just like
47:09doesn't it just prohibits that but if
47:11you know certain people maybe have like
47:13two lungs and you you don't need two
47:14lungs you only need one this is a fact I
47:18yeah and so certain people only need one
47:20kid it may be may make sense to trade
47:24yeah so one even more contral example is
47:27marriage so if you think about marriage
47:30or like dating or whatever you can sort
47:32of think of every you know imagine we're
47:35in a heterosexual World which I don't uh
47:39necessarily uh think think we are but
47:41imagine we're in a heterosexual World in
47:44some sense every man has some price
47:46which is like how attractive they are
47:49and there's like every woman has some
47:50price which is how attractive she is
47:53according to like many different metrics
47:55and in some sense you know there's
47:56competition you're not going to get
47:58matched to someone who's less uh good
48:02than you because you could do better
48:03than that and she's not going to get
48:06matched to someone who's less good than
48:07her because she could do better than
48:08that and through that sort of
48:11competitive Dynamics uh you get
48:13something that's very similar to a
48:15market going on there and there's some
48:17papers by Gail and chapley and Becker
48:19about that and the mechanisms that come
48:21out of those ways of running those
48:23markets have been used as suel mentioned
48:26to design uh markets for kidneys uh
48:29without using money officially but using
48:31basically competitive mechanism um and
48:34to match medical students to their
48:36schools so medical students submit a
48:39ordering of all the schools that they'd
48:41like to get into and there's a
48:42competitive process where there's prices
48:44that move around to determine whether
48:46people get in or not I don't know if
48:48anyone knows about has anyone heard
48:49about the medical match yeah is that for
48:52yeah for yeah for residents he got a
48:54Nobel Prize for that right yeah he got a
48:55Nobel Prize for that and basically the
48:57way that it works is everyone submits
48:59like this is the school I'd most like to
49:01get into this is the next one Etc and
49:03all the schools say here's the resident
49:04we' most like to get the one we next
49:06most like to get Etc and then what
49:08happens is that there's sort of like a
49:10minimum spot you need to be at on the
49:13ranking of the school in order to get in
49:16that's like the market price for that
49:18school and all those things for
49:20different schools move around until
49:22Supply equals demand so it's like a
49:24market yeah Philip um that type of
49:27system the first welfare theorem does
49:30not uh ensure that the resulting
49:32allocation is optimal enough well it
49:35does ensure that it
49:39is Paro efficient within that
49:43system so uh it makes sure that there's
49:47no way you could make everyone better
49:49off uh does that include someone lying
49:52about their preferences people
49:55or people only one side of the market
49:58will have an incentive to be truthful so
50:01the usually the students the way it's
50:03set up will have an incentive to be
50:04truthful but the hospitals won't have an
50:07incentive to be truthful they'll have an
50:09incentive to try to basically reduce the
50:12number of students they get so that they
50:13can get some students to get admitted to
50:15other places so that those so that the
50:17students they prefer get rejected from
50:19those other places and come back to
50:21them so uh it's not generally true that
50:24you there any is is there anything that
50:27determines which side that uh is has an
50:30incentive to be truthful because I've
50:31heard in students applying to like uh
50:35k12's Charter Schools like the students
50:38can sometimes do well by lying yeah so
50:41um these this mechanism is called a
50:43stable matching mechanism and there are
50:45two different types of stable matching
50:47mechanisms one is where like you try to
50:50respect the students preferences as much
50:51as possible another one is where you try
50:54to respect the hospitals preferences as
50:56much as possible and uh when you respect
51:00the students preferences as much as
51:01possible they have an incentive to be
51:02truthful but the hospitals have an
51:04incentive to gain the system and vice
51:08versa now if there's a very large number
51:10of hospitals and a very large number of
51:12students then both have an incentive to
51:14be truthful it's very much the same way
51:16that in a competitive market everyone
51:18will act as price takers if um they're
51:22all uh small relative to the market as a
51:24whole so basically
51:27if someone's preferences aren't fully
51:30respected they will have an incentive to
51:32lie
51:36yeah okay so a second uh application is
51:40the allocation of courses so this has
51:43been a recent um popular
51:47application so uh you're probably
51:51aggravated by course signups and Eric
51:53budish proposed a mechanism where you
51:56submit your preferences in courses and
51:58then you would be given some budget but
52:01then the computer would like go through
52:03and create a market equilibrium so that
52:05Supply you know equals demand and
52:08everyone gets uh the best that they can
52:11given the income they've been allocated
52:13which leads to things that are both fair
52:16and efficient efficient in the sense
52:18that no one could be better off by
52:19exchanging their courses uh without
52:22making someone else worse off and fair
52:24in the sense that nobody wishes they
52:26could be uh anybody else no one prefers
52:29anybody else's allocation Yeah Austin
52:31doesn't boo do something like this uh
52:33not exactly they do something somewhat
52:35related but not exactly the same because
52:38in Booth you have like a auction that's
52:41like a sealed bit auction at one moment
52:43and you could be left holding a bunch of
52:44fake currency that's worth nothing to
52:45you right whereas under Eric system all
52:49your currency gets used up because the
52:52prices are sort of like gradually
52:53adjusting over time and you'll never end
52:55up like
52:57just just missing all your courses by $1
53:00or something like
53:02that um
53:04okay so perhaps in the future you could
53:08run artificial markets for delegated
53:11Financial investing so uh good investing
53:15is really complicated for human beings
53:16but it's very easy for computers it's
53:18like a big optimization problem so
53:20imagine you told your the computer all
53:22the circumstances of your life your um
53:27uh you know what risks you were exposed
53:30to and rather than having money and
53:32buying mutual funds yourself you just
53:35had all your money invested in the
53:37optimal mix of financial securities for
53:39you to be holding and anytime I bought
53:41something from you it just drew down my
53:43Holdings a little bit transferred them
53:45over to you and the market in real time
53:48re-equilibrated uh the prices so that
53:50everyone could hold whatever they wanted
53:52to do that's sort of like what happens
53:54in an idealized model of a market but uh
53:57you know I think someday computers will
53:58be able to make that happen in reality
54:00yeah Philip if computers are so good at
54:03doing investing why isn't there a bunch
54:06of computer programs you can do download
54:08and have them do your Investing For
54:10You uh because I think a lot of people
54:12think they're better at investing than
54:14they are and so it's hard to convince
54:15people of that uh a lot of people do
54:18invest
54:20with like mutual funds and Etc so they
54:23do pay other people to invest because
54:25they think that other people are better
54:26at investing than other people really
54:28are I mean I think people like don't
54:29recognize the fact that it's like why do
54:31people want to have a doctor advise them
54:33about their health rather than a
54:35computer you know they think oh it's
54:37nice to have a doctor right but the
54:40doctors like have almost no data points
54:43compared to the amount that like you
54:45could have if you put all the data
54:46together
54:48so so the second fundamental welfare
54:51theorem also still holds with production
54:54so any Proto Optimum allocation can be
54:57achieved by the market you just need to
54:59redistribute the right amount of money
55:02and this leads economists to believe
55:04that we should generally try to avoid
55:05price interventions that we should try
55:07to redistribute money directly and then
55:09allow the market to operate now in
55:12practice uh this is impossible uh is
55:15Victor here
55:18Victor um anyone else want to talk about
55:21why it's impossible in practice to
55:23implement this idea behind the second
55:25fundamental welfare theorem uh Adam yeah
55:27well um in the reading it said something
55:29like uh you know uh taking like a fixed
55:33amount of money from people is more
55:36difficult because yeah if you just do a
55:38tax and it can disincentivize Behavior
55:41so you more have to tax like potential
55:43for work potential for whatever and that
55:45gets complicated yeah why is that
55:48hard um well it's hard to know not only
55:52how much they would work also like what
55:53would be their potential job their
55:56potential would be so the money has to
55:58be redistributed independent of people's
56:00actions so it doesn't discourage people
56:02from working but most people have most
56:04of their wealth in their human capital
56:06rather than in physical stuff they have
56:08and the problem is it's hard to know how
56:09much human capital people have right
56:11their wages are not a good measure um
56:14and they don't
56:17uh and they certainly don't capture the
56:19jobs that someone might get right if you
56:22require a fixed amount of money from
56:24people and imagine they say oh sorry I
56:26can't pay what are you supposed to do do
56:28you throw them into the goog or do you
56:32not do anything if you don't do anything
56:33then no one will take that threat cred
56:35it will not be credible right so what if
56:37someone is really talented but decides
56:40they want to live like a bum are you
56:41going to throw them in jail what are you
56:43going to do to make sure that they
56:44actually pay that money right or what if
56:46they want to do something like public
56:48service right now one exception to this
56:51was Henry George's land tax so Henry
56:54George argued that you should tax land
56:57because its value is observable and
56:59fixed uh and you wouldn't um do any harm
57:04by uh taxing land so this is efficient
57:08but it was never very popular in terms
57:10of distribution because a lot of people
57:12feared that there were people who were
57:14poor but who had like their
57:16grandmother's land or something like
57:18that and if you tax the land you would
57:20you know force them to give it up and
57:23that that could be uh inefficient
57:27okay so in
57:30practice um the interpretation of the
57:33second welfare theorem is a little bit
57:37different um redistribution economists
57:41usually argue should be as direct as
57:42possible taxes should fall on things
57:44like income or total consumption rather
57:47than on specific components that might
57:50Dort people's decisions so for example
57:52many economists even oppose capital
57:54gains taxation because this distorts
57:57whether I save or um and consume
58:00tomorrow or whether I consume
58:02today uh second redistribution should
58:05usually not affect the prices of goods
58:09uh programs shouldn't like subsidize
58:12rice just as the poor consume rice it's
58:14better to tax the rich and give to the
58:18poor rather than to subsidize rice which
58:19the poor consume because otherwise they
58:22consume too much rice or too much fuel
58:25Etc um and many programs in developing
58:28countries that do this sort of thing are
58:30pretty misguided they're not even
58:32particularly effective ways to
58:34distribute to the poor because the rich
58:35might actually consume more fuel than
58:37the poor do right and it causes a lot of
58:40overc consumption and it's a very
58:41expensive way to do
58:43it yeah Julian isn't the problem in poor
58:46countries though it's just hard to do
58:48that kind of redistribution because you
58:50don't have electronic records everyone
58:52everyone's not paying taxes and like
58:55yeah that's a that's a very good point
58:58I'm not sure that um that the like
59:02subsidies on Commodities does a very
59:04good job either sorting people out but
59:07one thing that might do and this is
59:09actually what my wife's dissertation is
59:10about is um in a lot of poor countries
59:13they allow people to Ste like there's
59:15laws against stealing land or selling
59:18Goods in the street but the government
59:21doesn't really enforce those against
59:22poor people uh and the reason that that
59:25works well is that no rich person wants
59:27to live on Stolen land or wants to sell
59:29their goods in the street because it
59:30puts them in a lot of Jeopardy and so
59:32that system is like a good way of
59:33targeting to the poor the um the
59:38subsidies
59:41um and even when you do want to affect
59:44the prices of particular Goods uh it's
59:47not just because they're Goods consumed
59:50by the poor or uh by the rich usually
59:54what you want to do is tax Goods that
59:58are complementary with Leisure like
1:00:02vacations and penalize Goods which are
1:00:07complimentary
1:00:09uh sorry and and uh subsidized Goods
1:00:13that uh are complimentary with working
1:00:18harder so like education causes people
1:00:20to work harder why does that make sense
1:00:23well that encourages people that
1:00:25overcomes the fact that the tax is
1:00:28discouraging people from working this
1:00:29hard so if we subsidize education people
1:00:32might earn more money in their lifetime
1:00:34and that might cause them to pay higher
1:00:36taxes which will be better for the rest
1:00:37of society and you might want to tax a
1:00:40good like heroin or maybe even make it
1:00:43illegal because a lot when people start
1:00:45taking heroin they stop working so like
1:00:48one broader reason why you can think
1:00:49that we have laws against drugs law all
1:00:52these sort of paternalistic things is
1:00:54that the government really has an
1:00:55interest in seeing not be lazy because
1:00:57if you're lazy then it doesn't earn as
1:00:59much tax revenue off of
1:01:02you okay so you guys probably learned um
1:01:07in uh
1:01:0920200 um the prom Market interpretations
1:01:12of the fundamental welfare theorems you
1:01:15know the usual rhetoric is that the
1:01:16market does everything efficiently so
1:01:18leave it alone but this isn't how these
1:01:20theorems have always been seen and many
1:01:23socialists argued something uh very
1:01:25different different uh so Tanner do you
1:01:29do you remember from the haek piece what
1:01:30socialists argued about the fundamental
1:01:33welfare they said that since uh it's
1:01:37does the efficiency doesn't matter if
1:01:38it's Cally planned or not in order to
1:01:40get the perfect distrib or the op
1:01:42distribution well the government some
1:01:45essentially plan Authority should just
1:01:47distribute uh organize the eony exactly
1:01:51so they argued that a planner can just
1:01:53implement the relevant conditions
1:01:55there's no you know that you can call
1:01:57them prices or whatever but you can also
1:01:58just say they're like range multipliers
1:02:00in some computers optimization program
1:02:03right and markets in practice suffer
1:02:05from lots of imperfections Market Powers
1:02:08externalities public goods Mistakes by
1:02:11consumers uh just like poor distribution
1:02:14of wealth and we're going to study those
1:02:15things throughout the rest of the course
1:02:17and that therefore socialism would
1:02:19really implement the true market economy
1:02:21by doing the optimization perfectly and
1:02:24that the welfare theorems are really
1:02:26warnings against stupid local deviations
1:02:29from free markets not in any way saying
1:02:32that we should uh have a private
1:02:36determination of the allocation rather
1:02:39than a centralized one I mean think of
1:02:41all the non-market applications I gave
1:02:44earlier in all those cases you were
1:02:46having some computer do some big
1:02:48computation you weren't actually having
1:02:50people interacting in a market and those
1:02:52were implementing the same thing that a
1:02:54market does right so so there's no no
1:02:56reason why we actually need to have some
1:02:58free market capitalist system so what
1:03:01that says is the welfare theorems
1:03:03actually don't favor capitalism uh in
1:03:06any significant sense so if that's not
1:03:10what's good about markets uh my what did
1:03:14uh hyek argue really was the benefit of
1:03:16markets over socialism you don't need
1:03:19like every or like the central planner
1:03:21to have all the information like you can
1:03:23just keep them in the minds of the
1:03:24consumers and they can make decisions
1:03:26exactly so this was argued by Von misus
1:03:28and and more famously by Hayek so the
1:03:31planner in order to make these decisions
1:03:34needs all of uh the information but it's
1:03:37really hard for them to get that
1:03:38information without prices so for
1:03:41example imagine that you're a planner
1:03:42and you're trying to build a
1:03:43railroad should you
1:03:46um you've got a choice there's a
1:03:48mountain coming up you could go around
1:03:49the mountain which will take more
1:03:51materials or you could go through the
1:03:54mountain which will take a lot more man
1:03:56power uh but less materials right and
1:03:59we'll also let the train get there
1:04:01faster how do you trade those things off
1:04:04well in a capitalist system you'd say
1:04:05well how much do people value their time
1:04:07what's the wage rate that's how much
1:04:09time we save how much is the you know
1:04:12cost of the materials well that depends
1:04:14on the price of the materials etc etc
1:04:16but without prices it's really hard to
1:04:17do a lot of those things how do you get
1:04:19that information without market prices
1:04:23right well you need to do some huge
1:04:25calculation you'd have to have a
1:04:26computer constantly running determining
1:04:28what the prices of everything should be
1:04:30what all the opportunity costs of things
1:04:32are and that computer would need
1:04:35information about all the different
1:04:36markets but uh in the capitalist system
1:04:39everyone only needs to think about how
1:04:41they interact with the prices that are
1:04:43relevant to them and they can bring the
1:04:45little pieces of information they have
1:04:47about the way that the market is working
1:04:49to bear on those prices and then you
1:04:52know the whole social system can compute
1:04:55all these prices in an
1:04:58equilibrium uh otherwise you'd have to
1:05:00have some gigantic computer and you'd
1:05:02have to get people to reveal all their
1:05:03information into that system right um so
1:05:08uh the market in this view is
1:05:11fundamentally an information aggregator
1:05:14um it's something that puts together all
1:05:17the information from different people in
1:05:20society to form an estimate of these
1:05:23lrange multipliers these prices so a
1:05:26classic example of this is the story
1:05:29that nobody knows how to make a pencil
1:05:31somebody knows how to mine the graphite
1:05:34and somebody else knows how to chop down
1:05:36the trees and somebody else knows how to
1:05:38cut the trees into you know the shape
1:05:40for the pencil and someone else knows
1:05:42how to attach it to the graphite etc etc
1:05:44but no one actually understands all the
1:05:46steps and what the market does is allow
1:05:48all those subdivided information to be
1:05:50aggregated up another story I really
1:05:53like about this is I how many of you
1:05:56guys have seen Skyfall the new James or
1:05:58the relatively new James Bond movie so
1:06:01uh in Skyfall Q who's like this uh The
1:06:05Tech Guy uh who's like a nerdy young guy
1:06:09uh meets with Bond and he says to him um
1:06:12you know I could do more damage by uh
1:06:15noon in sitting in my pajamas on my
1:06:17computer than you could do during a year
1:06:19in the field and then Bron says well why
1:06:22don't you fire me then and they said
1:06:24well occasionally we need to pull a
1:06:26trigger and bond says or not it's hard
1:06:29to know when you're sitting in your
1:06:31pajamas right so the point is that
1:06:34there's information that people on the
1:06:36ground can have that even the most
1:06:38brilliant centralized Authority would
1:06:39have a lot hard time
1:06:42Gathering okay so yeah go um have there
1:06:46been attempts to like maybe on go a
1:06:49small scale to like
1:06:52um I like govern interaction between
1:06:54people through like computer
1:06:56simulation like well that's exactly what
1:06:59the course allocation system was doing
1:07:02right was having people report their
1:07:04preferences and then it was just having
1:07:05the computer assign people the courses
1:07:08uh yeah D well along that lines wasn't
1:07:10there a system in the in Chile in like
1:07:12the 70s before noad overthrew them that
1:07:16try to use computers to do exactly that
1:07:19but then they were I didn't know about
1:07:20that but that's interesting there's
1:07:22there's a there's a famous paper by
1:07:24Oscar longa well which is related to
1:07:27what we're going to talk about in one
1:07:28second called the computer and the
1:07:30market uh and it's about how the
1:07:33computer might eventually replace the
1:07:34market as a way of processing
1:07:36information we'll talk about that in a
1:07:38second so if
1:07:41um market failures are the main cost of
1:07:44markets their main benefit is delegation
1:07:47if individuals have information that the
1:07:49government doesn't there's a value in
1:07:51allowing the market to function despite
1:07:52its flaws uh because it incorp op Ates
1:07:56information so for example if we knew
1:07:59everyone's potential income well we
1:08:00could just charge them that but because
1:08:02we don't have all that information we
1:08:05have to leave to people we have to leave
1:08:08some inequality in order to give people
1:08:09an incentive to work harder because we
1:08:12can't just redistribute all their income
1:08:14right so each according to his ability
1:08:17and to each according to his need is
1:08:19impossible to implement unless we know
1:08:21exactly what everybody's abilities are
1:08:23right um
1:08:26uh
1:08:28regulation uh of markets can help keep
1:08:30prices near marginal cost which we know
1:08:32is efficient but you can't impose it
1:08:34unless you know exactly what company's
1:08:36costs are um patents also raise prices
1:08:40above cost and it would be a lot better
1:08:42if we could just give companies prizes
1:08:44for however much value their thing
1:08:46created so we didn't have to have
1:08:48patents to raise their price higher but
1:08:49in order to do that we need to know how
1:08:51valuable the products were create that
1:08:53were created independent of the price
1:08:54they could get in the market
1:08:56right um another uh example is how much
1:09:01information to give consumers so it's
1:09:05really confusing for people to like use
1:09:09websites that require them to fill out
1:09:10long forms or to get a whole Deluge of
1:09:14disclosures every time you sign a credit
1:09:15card statement right you can't make any
1:09:17sense of that stuff and that wouldn't be
1:09:21necessary if we knew everything about
1:09:24what would be the best finan contract
1:09:25for you to choose then a computer could
1:09:27just assign it to you we wouldn't have
1:09:28to have you do all that processing right
1:09:30so depending on how much information is
1:09:32available to the consumer about what's
1:09:34good for them we can reduce the burden
1:09:36on them in terms of uh reading through
1:09:38all the stuff or filling out lots of
1:09:40forms right so do you have a question
1:09:43for yeah I was thinking that wasn't uh
1:09:47use of market prices actually suggested
1:09:51as a as a mechanism for determining the
1:09:54correct value of to buy out patents and
1:09:56put them in the public
1:09:58domain uh that's right so that's an
1:10:00example of how you might need the market
1:10:05uh operating at least to some extent
1:10:07because it's precisely what provides the
1:10:09information to the government to make
1:10:10the decisions so uh you know and in fact
1:10:14when we study uh benefit cost analysis
1:10:17there's going to be lots of uh analysis
1:10:20that relies on market prices in order to
1:10:23determine how much uh benefits and costs
1:10:26of things are but as we get better and
1:10:28better information we may have better
1:10:30ways of determining what those values
1:10:31are than even the market prices and in
1:10:33fact that's what I'm going to talk about
1:10:35so market distortions mean that
1:10:37centralization is going to be better
1:10:39than decentralization absent
1:10:41informational problems and as a result
1:10:45capitalism is really justified by the
1:10:47lack of fast computers and easy access
1:10:50to the relevant
1:10:52information so um what
1:10:55uh Austin do you think will happen as
1:10:59information uh becomes more and more
1:11:01public via the Internet and all the like
1:11:05reduction in privacy that's been
1:11:06happening recently well we'll be looking
1:11:08at a shift towards basically Central
1:11:10planning where you have a computer a
1:11:11bunch of algorithms that do things like
1:11:13allocate people to jobs and things like
1:11:15that and that's effectively what we've
1:11:17been seeing in the last few years so uh
1:11:20the Soviet Union lost the Cold War but
1:11:21it won the long War uh because uh and
1:11:25it's being implemented exactly through
1:11:27capitalism right because Netflix now
1:11:29tells you what movies you want to see
1:11:32Google even before you search tells you
1:11:34what information you want uh and tells
1:11:36you what ads you want and therefore what
1:11:38you want to buy uh and um in the
1:11:43internet age local knowledge is
1:11:44gradually retreating right and consumers
1:11:47actually want to give up this
1:11:49information because they want the
1:11:51computer to be able to make the best uh
1:11:53decisions for them right and this erods
1:11:55much of the case for capitalist
1:11:57institutions decision engines
1:11:58increasingly make choices for us
1:12:01um Apple has such good information about
1:12:05which apps you like just based on what
1:12:07time you spend using them that it can
1:12:09reward app developers not based on the
1:12:11price you're willing to pay but just
1:12:12based on people's use right so that's
1:12:14like an alternative to uh patents that
1:12:17Apple can basically Implement right it's
1:12:20getting increasingly easier to monitor
1:12:22ability and income uh because of
1:12:25Information Technology and genetics
1:12:28being able to predict uh how you know
1:12:31well someone will do based on things
1:12:33that are observable right consumers make
1:12:36bad decisions in financial markets and
1:12:38there's a good case for this sort of
1:12:39centralization through technology that I
1:12:41was talking about before so many of
1:12:44these changes were brought about
1:12:46precisely by the innovations that took
1:12:48place in within the market but in the
1:12:51end eroded are eroding the value of
1:12:53those markets institutions so I think in
1:12:55the end Marx was right that capitalism
1:12:58would be its own undoing but for
1:13:00completely different reasons than he s
1:13:02because he didn't think about the fact
1:13:04that it was information that was Central
1:13:05to the nature of capitalism other than
1:13:08uh you know capital or anything like
1:13:10that okay so for the rest of the course
1:13:13we're going to explore tradeoffs along
1:13:16these informational Dimensions we'll see
1:13:19ways in which individuals and markets
1:13:21misbehave and but we'll also see that
1:13:24absent the information those individuals
1:13:26in markets have it may be very hard to
1:13:28do planning and the degree of optimal
1:13:30intervention is going to be based on a
1:13:32balance between these two things um many
1:13:36interventions by the way don't really
1:13:38require governments per se as we saw
1:13:40Google and Netflix and so forth are
1:13:43acting as the central planners for large
1:13:44parts of the economy presently so it's
1:13:48not really an issue of markets versus
1:13:50government um it's an issue of whether
1:13:53resources should be allocated
1:13:55uh in a centralized or in a
1:13:56decentralized matter and these things
1:13:59are almost never 01 it's almost always
1:14:02in certain areas it's more strongly this
1:14:04way and the costs are on net in this
1:14:07direction or the other it's really a
1:14:09question of how much should who decide
1:14:11and when uh and details of the
1:14:15situations matter for those types of
1:14:16questions and the coming weeks we
1:14:18hopefully tune you into these and beat
1:14:20out of you ideological reactions to
1:14:23centralization and socialism versus
1:14:25capitalism and I think that's really
1:14:27what it means to be a communist I mean
1:14:29to be
1:14:31a and uh to leave you with what it means
1:14:36to be a communist I will uh play for you
1:14:40uh a song as you leave
1:14:53today has anyone ever heard this song
1:14:55before

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