Tuesday, May 24, 2005

Introductory econ lecture #2 

You'll find one of these each day MTWR the next three weeks.

Because we have students without textbooks, I didn't cover as much as I'd've liked today. We spent time on the textbook issue, playing out the game as we saw it and concluding -- later found correct -- that the bookstores intentionally were understocking because of textbook buys through online and off-campus brick-and-mortar stores.

We then spent a good deal of time on efficiency. I love Dwight Lee's* description:

This emphasis on efficiency seems strange, if not reprehensible, to many people. They are convinced that economists are so narrowly focused on efficiency that they ignore the truly important things in life. Who but someone lacking completely in a sense of what makes life meaningful doesn�t recognize that pollution is bad because it harms the environment? We should get rid of it whether or not it is efficient.

This criticism is unwarranted, though understandable. Efficiency is a tricky concept. Once it is understood what economists mean when they refer to efficiency, it becomes clear that it is a much broader, and more desirable, goal than many people realize.

We differentiate between technical and economic efficiency, where the former talks of outputs and inputs and the latter talks of values. While we can always seek more technical efficiency in, say, gas engines, we end long before that giving up the chase, because thinking marginally means that's a bad idea.

Sure, new engines might convert more of the energy in gasoline into motion, but doing so would require diverting resources away from producing other things of value. Long before technical efficiency was maximized, the marginal cost of improving that efficiency would exceed the marginal value. This would reduce economic efficiency because it requires sacrificing more value (marginal cost) than is realized (marginal value).

Fortunately, market prices provide the information and motivation required to achieve economic efficiency. For example, engine producers increase profits by improving the technical efficiency of engines until the marginal revenue from the improvement declines to the marginal cost. Since marginal revenue tends to reflect how much consumers value additional improvement, and the marginal cost reflects the value of the goods and services sacrificed to make additional improvement (since input prices reflect their value in alternative uses), engine producers increase their profits by improving engines only as long as they add more value than is sacrificed. That�s not technically efficient, but it is economically efficient because it increases the total value realized from scarce resources.

We illustrated this with a film clip from Along Came Polly, where Jennifer Aniston convinces Ben Stiller to stop spending time putting throw pillows on and taking them off his bed. Ben says he spends 56 minutes a month doing this. While it makes his bed look nicer, less nice and 56 additional minutes to, say, spend snuggling with Aniston might have more value. They end up knifing all the pillows. The scene immediately following has Aniston finding her keys with an electronic finder given to her by Stiller. He wouldn't use it because he's neat -- but it's the substitution of technology to allow Aniston to continue her level of messiness. Substituting money for neatness can be efficient.

We then went to talk about comparative advantage. One of economics' fundamental insights is that markets allow for people to specialize according to their comparative advantage and then exchange goods to get to consumption policies they couldn't under autarky. (There's your word of the day. You're welcome.) And what is wonderful about the process is that it does not require any design: there are incentives for people to find it by dint of their own self-interest. When it happens, both sides can gain from trade. Here's an example.

I closed with this point, offered by Heyne in a set of notes to a different text, but quite applicable here.
We all realize that demand [for a good] depends upon people's preferences. But so does supply. Technological or physical facts don't supply anything. It is the decisions of people that make goods available.

Supply curves slope upward for the same reason that demand curves slope downward: a higher cost for any activity encourages the finding of substitutes. When potential suppliers are offered a higher price, the cost of not supplying, by pursuing alternative opportunities, increases. And alternative opportunities are pursued to a lesser extent.

Tomorrow we'll talk about supply and demand.

*-there are a whole set of Dwight's pieces on FEE that he did for The Freeman that were economic primers. Readers using these lectures as a tutorial will do well to search for others on that site.