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SU ECN 203 - 3.0 Interdependent Choice and Market Coordination
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ECN 203 1st Edition Lecture 5 Outline of Last Lecture II. Quick Reviewa. Discount Rate, Present Value III. Relaxing our “Risk and Uncertainty” Assumption a. Riskb. Uncertaintiesc. On Role Models Outline of Current Lecture IV. Interdependent Choice and Market Coordinationa. Relaxing our No interdependence Assumptioni. The challengeV. The Division of Labor – Reason for Productivity VI. What Limits the Division of Labor?VII. Forms of Coordinationa. Traditional systemb. Command economy c. Liberal System of Free Marketsi. Establishing Commutative justice ii. Establishing Distributive Justice VIII. Magic of Markets IX. Role of Money in Marketsa. Characteristics of Good Medium of Moneyb. Commodity vs. Fiat Money Current Lecture1/26/153.0 - Interdependent Choice and Market Coordination- EPV1=EPV2=EPV3=…=EPVno Value, present, expected o Allows individuals to determine what to These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute. Produce & Consume Save & Invest o Ex Ante – the coordination of these decisions is perfecto Relaxing our “No Interdependence Assumption” Individual decision rule remains the same  The Challenge:- Coordinating interdependent choices to produce and consume and save and invest - If interdependence creates an additional challenge…o Why not live our lives in isolation?o Why impose the challenge of interdependence on ourselves?- According to Adam Smith humans are interdependent in our very nature.o It is inevitable – there are many of us, and the resources on earth are finite o It is necessary o It is potentially very beneficial - The Division of Labor – Reason for Productivity o Dividing up the tasks of society increases individual productivity by: Increasing dexterity  Saving time in production  Encouraging inventiveness o If every individual in society is more productive, the social product is greater. o But with the Division of Labor, at the end of the day, each individual has  A surplus of the one thing she produces, but nothing else she needs o In order to have all necessities being produces, society needs a mechanism to coordinate the exchange of individual surplus So each person ends up with a useful combination of all productso An effective coordination mechanism of the exchange of surpluses makes possible what economists refer to as: The gains from trade – this describes division of labor at the micro level o Absolute Advantage – each of us is absolutely better at something- What limits the Division of Labor?o Adam Smith made clear, the limitation on the division of the market is the extent of the market  There is a social benefit to developing infrastructure that extends the market- …because extending the market enables a finer the division of labor and in turn increases the productivity of society - Examples: posts, roads, bridges, railroads, airports, and internet connection o They are examples of community infrastructure that extend the market, facilitate the finer divisions of labor, and thus increase society’s productivity. - Forms of Coordination o Traditional system  The patterns of the division of labor are based on social definition of place and these patterns are passed down from generation to generation  The good:- Internally stable - Predictable - May be just/fair The bad:- No creativity – creative thought is a threat - Extremely fragile - Stagnant  The greatest strength, internal stability, is its greatest weakness. This derives from its rigid structure.- A rigid structure breaks down easily when it is exposed to external stresseso Command Economy or centralized system  A central authority, a dictator, who determines what is produces and consumed and what is saved and invested  The good:- Centralized planning is coordinated - May be just/fair  The bad:- Commander is not omniscient – decisions are made to her own impressions - May or may not be fair - Individuals needs are not appreciated - Motive is fear, not success – people do not like to work - Little or no choice of one’s leaders or role -- Liberal System of Free Markets o More classical sense of liberal as in valuing individual freedom o The good: Under the right condition markets can be incredibly efficient in satisfying theneeds and wants of those who have the means to make their needs The Challenge: Finding the right condition  Commutative justice is difficult to establish o Establishing Commutative Justice The Challenge- If each individual is free to choose, then she is free to manipulate the system to her advantage. She can “win” by manipulating the rules or ignore them - Cheating is good for the individual, but not for the system.- 1. How can we establish rules? o Majority vote? Minority might be exploited o Unanimous agreement? Is this even feasible?- 2. If we could decide on rules how can they be enforced?o Self gov’t (personal ethics)o By gov’t (police)o Second Challenge Achieving distributive justice: is the outcome of the market system fair to all? Even given perfect efficiency, the distribution of the fruits if the market may not be distributed fairly among individuals.  To the degree Commutative Justice fails, the market system is inefficient  Individuals with advantages can “win” with little effort and resources are wasted seeking or maintaining advantages.  For now we will assume commutative and distributive justice - The Magic of Markets o We also assume for the moment that there are no naturally occurring market advantageso Each individual starts from a roughly equivalent starting line The system will be perfectly efficient, and each individual will enjoy a benefitthat reflects his/her effort to be a productive member of society. o Challenge There are naturally occurring advantages There are bequeathed advantages - There are strong identities to acquire and keep artificial advantages - All these unearned advantages can skew the distributive outcome toward those with the advantage, and undermined the efficiency of the market system. Is there a role for gov’t or is gov’t part of the problem in markets?- The Role of Money in Markets o On Money  Evolved from barter system - Exchange of equivalents - Very inefficient for complex exchanges  General equivalent emerges –- A commodity all will exchange for any


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SU ECN 203 - 3.0 Interdependent Choice and Market Coordination

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