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UMass Amherst ECON 103 - Class 4 Problems with markets Fall 2014

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Slide 1Slide 2Where we are goingDo we have the right institutions to link desire to supply?If markets are so great,Slide 6Slide 7Slide 8Bank formsSlide 10Slide 11Slide 12Slide 13Slide 14As much as a quarter of the American labor force guards stuffSlide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Slide 31Slide 32Slide 33Slide 34Slide 35Slide 36Class 4Problems with marketsTransactions costs, bargaining, and the PPFWhere we are going•Markets can promote good outcomes, but we often don’t use them•Transactions costs: the cost of making market exchanges: contracts, negotiating, and policing the exchange of property rights•Good social institutions lower transactions costs, facilitating division of labor through markets•Markets discourage caring work•Markets miss the benefits of complementary production where PPF is upward slopingDo we have the right institutions to link desire to supply?Central question in evaluating whether capitalism is a good system.Do markets lead producers to make the stuff that people want, and not make the stuff that people value less than the real cost?1/14/19 06:42 AMThe Amherst farmers’ market works wellBecause people are honest there!If markets are so great, Why do we have families?Why friends?Why do we give medals instead of cash bonuses?Why don't we sell grades?We have nonmarket systems because –Markets can be expensive (transactions costs)–Markets can promote bad behaviour (to take advantage of inadequate policing!)If markets are so great . . .why don’t we use them more?Relatively little economic activity is through markets.More is by command: in families, businesses, governments . . . Institutions that don’t rely on self interest, and need policingDid you pay your parents for dinner?1. Of course! And they make sure to cook what I want so that I’ll come back.2. Never!3. No; but I did the dishes for free. And I laughed at my dad’s old jokes.We shun markets because of Transactions CostsCosts of conducting exchanges and protecting propertyThis includes the cost of waiting on line to pay!Bank formsPolicing transactions is expensive3 million cashiers; 1.5 million bookkeepers; a million lawyers and a million security guards. Unproductive; they protect markets.09:29 AM1/14/19 06:42 AMNot all work hardGood Social Policy Can Lower Transactions CostsEncourage honestyPromote literacy Establish good infrastructure honest judiciary and policelegitimacy through justice 09:29 AM1/14/19 06:42 AMSelfishness leads to bad behavior.How much to spend guarding?09:29 AM1/14/19 06:42 AMHonest communities manage with fewer security guards and accountantsTransactions costs lower productivity.In an honest society, fewer workers are wasted policing transactions. Businesses can concentrate on becoming efficient and producing desirable products. Why don’t we become honest?Transactions costs makes puppy sadThey should make you sad because they raise the cost of everything we buy or sell.As much as a quarter of the American labor force guards stuffThis includes supervisors, guards, prisoners, and the military.They protect property rights and enforce contracts. They produce nothing.1/14/19 06:42 AMProblem 2:Markets discourage non-market workThey discourage community work, volunteer work, and care for those who can’t buy care.If we rely on markets . . . Who will care for children?the disabled?the elderly?the environment?09:29 AM1/14/19 06:42 AMAnd who will care for the kittens?09:29 AM1/14/19 06:42 AMOrthodox economists assume markets perfectly match desires to productionOrthodox neoclassical theory has 3 elements:PreferencesFactor endowmentsTechnologyBy discounting institutions, neoclassical economists explain everything with 3 thingsAssumes no transactions costs.Preferences DemandTechnology + factor endowments SupplyNeoclassical story ends with supply and demand. No place for institutions, politics, history, or conflict!09:29 AM1/14/19 06:42 AMTransactions costs change everythingCreates gap between price of supply and demand. There are things we want that don’t happen because of transactions problemsSize of gap depends on social conditions, honesty, and institutions.Bargaining and threats matter. 09:29 AM1/14/19 06:42 AM06:42:13 AMProblems with markets III:Upward sloping Production Possibilities FrontierProduction possibility frontier: maximum output given (physical) constraints. You could grow poppies or roses.More poppies, fewer roses.More roses, fewer poppies. More roses less heroin land is used for poppies06:42:13 AMRosesPoppiesUnattainable: Too little landInefficient: You can have moreProduction Possibility Frontier Afghan Farmers06:42:13 AMMoving along the line you get more poppies by shifting resources away from producing roses.The price of poppies is the roses you don’t produce.The opportunity cost of roses is the poppies you don’t produce – and vice versa.Consider the sex-sleep dilemma and the Production Possibility FrontierPPF: neoclassical idea technology + factor endowment determine supply.09:29 AM1/14/19 06:42 AMCrucial assumptions slip in hereSex and sleep are substitutes not complements.People are always on the efficient frontier.Both assumptions are wrong.09:29 AM1/14/19 06:42 AMFirst: Production Possibility Frontiers for substitutes and complementsSubstitutes: Producing one does not help you produce the other but it takes resources away.Examples: Limited land to produce rye or wheat.wheatryeUse the land for rye, or use it for wheat. Growing one does not help you grow the other.09:29 AM1/14/19 06:42 AMProduction Possibility Frontiers with more efficiencyYou are more productive and the PPF goes out.wheatryeMore productive in both09:29 AM1/14/19 06:42 AMProduction Possibility Frontiers with more efficiencyMaybe you have weather that is good for wheat but not rye. PPF goes out for only wheat.wheatryeMore productive in Wheat09:29 AM1/14/19 06:42 AMProduction Possibility Frontiers with less efficiencyBad weather and you are less productive in both. The PPF comes in.wheatryeLess productive in bothPPF for complements where one helps you do the other.The bees that fertilize your apple grove also make honey. More apples and more honey.honeyApplesMore apples, more bees, more honey. Curve is positively sloped for production complements. The curve may bend back because there may be a limit to production with some fixed inputs.Sex and sleep can be


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