Transcript Slide 1

Modern Principles
Microeconomics
See the Invisible Hand
Understand Your World
Tyler Cowen and Alex Tabarrok
The Romance
 Roses in February in Chicago.
Quite incredible. Where do the
Roses come from? Not from
nearby greenhouses!
Bloemenveiling photo by Wilfried Overwater.
Markets are Cooperative
 A rose is a truly international product.
 The market for roses links romantic Americans with
South American flower growers, Dutch clocks, Finnish
cell phones, Colombian coffee (to keep the pilots
awake) and much more.
 Hundreds of thousands of people from Ecuador to
Chicago cooperated to bring the rose to our
handsome young man and they did so voluntarily, on
the basis of self interest, and without central direction
- this is the invisible hand in action.
Markets are Creative
 When oil was cheap roses were grown in heated
greenhouses in NY and PA.
 A rising price of oil in the 1970s was a signal to
entrepreneurs to look for ways to use less oil so they
could reduce the costs of growing roses.
 Entrepreneurs discovered that transporting millions of
roses thousands of miles was cheaper and greener (!)
than growing them locally so rose production moved to
Ecuador, Colombia, Kenya, Thailand and other
countries with warmer climates.
Markets are Connected
 Markets are connected in a
complex web.
 When one price changes
every other price responds
as entrepreneurs
recalculate and reconfigure
to help solve the “great
economic problem” of
producing as many
valuable goods as possible
from our limited resources.
Map of the World Wide Web
(Barrett Lyon OPTE Project)
Modern Principles: The Rose
 The rose is a symbol of
worldwide cooperation.
 The story of the rose
demonstrates the power of
trade and the creativity of
entrepreneurs as they respond
to the dual role of prices as
signals and incentives.
 The rose illustrates the invisible
hand – how markets generate
cooperation and coordination
around the world.
The Role of Prices
A Price is a Signal
Wrapped Up
in an Incentive
Understanding the Price System
Understanding the Price System
With Price Controls
1. Shortages
2. Reductions in
product quality.
3. Wasteful lines and
other search costs
4. Loss of gains from
trade
5. Misallocation of
resources
Understanding the Price System
with Price Controls
Reading the Price Signals
 In January news
organizations reported that
cold weather was increasing
the price of oil and related
products such as gasoline.
 At the same time the WSJ
reported that the February
futures price of oil—the price
for oil to be delivered one
month in the future--was
falling because of
expectations of warmer
weather.
Cold Temps Drive Higher
Prices At Pump
WHIOTV, Jan 13, 2010
OIL FUTURES: Crude Falls As
Temperatures Rise
The Wall Street Journal, Jan 12, 2010
The Use of Information in Markets
VS
Roll, Richard. 1984. Orange Juice and Weather. American Economic Review, 74, 5, 861-880.
From “The Use of Information in Markets” to
Information Markets or Hayek to Hanson
Friedrich Hayek
Robin Hanson
Iowa Electronic Market
2008 Presidential Candidates
One “Obama share” pays $1 if Obama wins. Nothing otherwise.
One “McCain share” pays $1 if McCain wins. Nothing otherwise.
Prices
On
August 8, 2008
$0.63
$.37
Prediction Markets are Now Widespread
Prediction Markets
(click)
• Prediction markets are about harnessing the amazing
ability of markets to aggregate and summarize
information.
• Prediction markets are not miraculous but they do tend to
outperform other prediction mechanisms such as expert
opinion or polls.
Seeing the “Invisible Hand”
throughout
Principles of Economics
The True Importance
of the
P=MC Condition of Profit Maximization
How to Minimize the Total Costs of Corn
Production Across Two Farms
Farm Two
Farm One
MC1
$
Increase
in Costs
Savings
C = A-B
$
Decrease
in Costs
MC2
$200th unit
C
A
B
0
25
Quantity
(Bushels of Corn)
Cost of Producing
200th Unit
175 200
Quantity
(Bushels of Corn)
To Minimize Total Costs Set MC1=MC2
Farm Two
Farm One
MC1
$
$
MC2
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
Pat Sets P =MC1 , Alex sets P =MC2
A Much More Difficult Problem
as a result MC1=MC2
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
$2.50
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
Pat Sets P =MC1 , Alex sets P =MC2
as a result MC1=MC2
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
Pat Sets P =MC1 , Alex sets P =MC2
as a result MC1=MC2
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
Pat Sets P =MC1 , Alex sets P =MC2
as a result MC1=MC2
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
The True Importance of the P=MC Condition
is P=MC1=MC2 …=MCN
Alex’s Farm
Pat’s Farm
MC1
$
$
MC2
Price of
Corn
$2.50
0
40
Quantity
(Bushels of Corn)
160
Quantity
(Bushels of Corn)
Seeing the Invisible Hand
• Emphasize worldwide cooperation and coordination
(roses, pencils, snickers!).
• Teach the price system (not just single markets).
• The dual role of prices as signals and as incentives.
• The “use of information” in prices illustrated with
information markets.
• The minimization of the total costs of production as a
result of profit maximization.
– A product of human action but not of human design!
Modern Principles
Microeconomics
See the Invisible Hand
Understand Your World
Tyler Cowen and Alex Tabarrok