Transcript Document

Introduction to Macroeconomics
Chapter 1
Market Interaction
J. Patrick Gunning
July 20, 2015
Introduction (1): The Definition of
Economics
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Economics: the study of market interaction.
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Market Interaction: an abstract image of
interaction among purposeful, "normal human
beings," or actors, under a given set of conditions.
Introduction (3): The Definition of
Market Interaction
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Meaning of distinctly human action.
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People have definite wants.
People have the goal of satisfying the wants.
People possess imagination, creativity, and
inventiveness.
Compare normal, distinctly human beings with:
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Animals.
Robots.
Distinctly Human Action
Not Distinctly Human Action
Introduction (2): Subjects Covered in
This Chapter
 The
conditions of market interaction.
 Roles in market interaction.
 The pure market economy.
 Why study economics?
First Subject: The Conditions of
Market Interaction
Three Topics in This Part
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1. A system of private property rights.
2. Free enterprise.
3. The use of money.
The Private Property System: It Has
Two Characteristics
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1. For every separable good or resource, there is an
individual who is assigned by law as an owner of
the legal right to control its use.
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2. The owner of a legal right also has a legal right
to exchange it.
First Characteristic of
Private Property Rights
 Every
separable good or resource has an owner.
The Assumption of Power and
Loyalty to Enforcement
 A private
property system implies that
government agents (the police or the
soldiers) have the power to block
others from using a good or resource
to which an individual has a legal
right.
 It also implies loyalty of the police or
soldiers to the duty of enforcement.
Definitions
 Good:
a thing or behavior that can be used to
satisfy a want directly.
 Resource: a thing of behavior that can be used to
satisfy a want indirectly by helping to produce a
good.
Ownership in a Complete Private
Property System
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To own the legal right to control a good or
resource’s use means that a person can (a) cause it
to have or not have beneficial effects either on
himself and others and (b) cause it to have or not
have harmful effects.
This implies no government ownership of goods or
resources.
Separable and Non-separable
Goods and Resources
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Separable good or resource: one for which the benefits
and harm due its control and use can only be felt by a
single person.

Example of a separable good: a banana. Your eating it
does not ordinarily yield benefits to others.
Separable and Non-separable
Goods and Resources

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Non-separable good or resource: one for which the benefits
and/or harm due to controlling its use can be felt by more
than one person.
Examples of non-separable goods: If one person supplies it,
others benefit:
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Clean air.
Defense against aliens.
Ownership and Negative Externalities

Negative externality: the harm felt by one person resulting
from the action of another person.
Example 1: throwing the banana peel on the ground.
 Example 2: the pig farmer’s allowing waste to flow into the
unpolluted river used for swimming by a neighbor.
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A complete property system means that someone owns the
legal right to control all such actions. Either the
perpetrator or the victim could own the right. Even out
outsider could own it. But it must be owned.
Second Characteristic of
Private Property Rights
 Individuals
have the legal right to exchange
ownership rights.
Exchangeability
 The
legal rights associated with ownership of
property are exchangeable. A person may sell
them or give them away.
 The legal right to control and action having an
external effect is also exchangeable.
Exchangeability and Specialization
 The
exclusive ownership and exchangeability of
ownership rights in a private property system gives
individuals an incentive to specialize.
 A skilled
rancher has an incentive to buy a ranch.
Knowing that he can buy a ranch gives an individual an
incentive to become a skilled rancher.
Exchangeability and Optimal Negative
Externalities

Ownership and exchangeability give individuals
incentives to allow the externalities to continue only when
the expected benefits are greater than the expected harm,
in terms of money.
The pig farmer will pollute only if her benefits are greater than
the harm to the person who is damaged by the pollution.
 Note: Either the farmer owns the right control the action that
pollutes the stream or the swimming neighbor owns the right.
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Evolution of Private Property Rights
 Two
requirements for a modern system of private
property rights:
 1.
Formalness: this usually means a set of written laws
or widely understood laws that are enforced by the
police or military.
 2. Equality under the law: if a person subject to a law is
interchanged with any other member of the community,
the enforcement, judgment and punishment for a crime
would be the same.
Informal and Formal
Private Property Rights
Informal private property rights can exist in a traditional
society. But rewards and punishments in such a society
depend only roughly on one’s contribution to the society.
When such societies grow large, statuses are usually
established. Families favored by the leaders are often
given special privileges that are passed on to heirs. But
descendants may be incompetent specialists. To give them
rewards similar to their ancestors is harmful to the
community long run interests.
 A more flexible system evolved in England and its
codified principles are called the common law.
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England as a Mother Country
 Due
to its military power and policy of
colonization, England can be regarded as the
mother country for the property systems that
emerged in the U.S., Canada, Australia, the Indian
subcontinent, several countries in Africa and a
number of others through out the world. Many of
these countries adopted the common law system
and its principles after they became independent.
The Common Law
Common law: a set of legal rights to control actions that
have external effects.
 The common law developed in England as a consequence
of centuries of judgment in dispute resolution cases by
government-appointed judges.
 The judges traveled from place to place, made rulings, and
sent written copies of their rulings back to the capital city.
 Young judges could learn the principles by studying the
rulings.

Dispute Resolution
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Procedures under common law.
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1. A person who believed that someone else was responsible for
harming him would make a damage complaint.
2. A judge, appointed by the king, would decide whether the
complaint was justified. He would rule on whether a damage
payment should be made and how much it should be.
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The dog and chicken example.
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Emergence of Common Law
 Early
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British judgments in dispute resolution cases
were collected and used as precedents in
judgments for later decisions.
Principles were established through trial and error.
These principles enabled new judges to decide the
right of first possession in most cases on the basis
of precedent.
Formality and Equality Under the Law
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When judgments came to be made according to principles
rather than according to tradition and norms, the
judgments met the standard of equality under the law.
The long tradition of common law in England ultimately
led to the formality that is necessary for a more complete
system of private property rights.
Former colonies of England formally adopted the British
common law as part of their written constitutions.
The Common Law and the
Right of First Possession
 Another
example of a common law judgment: A
nurtures a crop and B takes it. A makes a damage
claim. In ruling that B should pay compensation,
the judge establishes the legal right of A to benefit
from his actions with respect to nurturing the crop.
 Note that in deciding the case, the judge is
establishing the right of possession and even the
right of first possession.
Evolution of the Right of
First Possession
 Two
kinds of cases:
 1. Harmful externality: the dog and chicken
example, assuming that no dog had ever caused
damage before.
 2. Right of first possession: a person produces,
discovers or invents a good or resource.
 Judges expanded the application by considering
increasingly complex cases.
The Common Sense of the Common Law
 A goal
of the best common law judges was to show
that the “king’s law” – i.e., judge-made law -could benefit the community.
 The judge aimed to make judgments that he
believed were in the “long run community
interest.”
 He took account of future generations.
First Possession in a Kingdom
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We can understand the importance of the right of first possession
under common law by comparing it with the right of first possession
in a kingdom.
In a kingdom, the king has the right of possession to everything.
Do people have an incentive to discover, invent, specialize and
produce goods in a kingdom?
It depends on how much the king knows and whether he rewards the
discoverers, inventors, specialists and producers.
Could the king, or any other single person, know the kinds of
discoveries and inventions that take place routinely in a modern
capitalist society?
Hmmmmmmmmmmmmmmmmmm,
Alternative Means Of Assigning The
Right Of First Possession
 Assign
it to the leading government official or
agency in the community.
 People
would not produce, discover, or invent unless
they expected a share of the benefit.
 Assign
it by means of a lottery.
 Because
each citizen would have an equal chance of
receiving a share, the incentive to produce, discover
and invent would be low.
Right of First Possession
Under Common Law
 The
benefit of assigning the right of first
possession to the producer, discoverer or inventor.
 If the law gives the discoverer of a good or
resource the legal right of first possession, people
will have a greater incentive to discover goods and
resources. The same is true of a right of first
possession that is given to an inventor or a
producer.
First Possession and Teamwork (1)
 In
the eyes of common law judges, an employment
compact supersedes what would otherwise be the
rule of first possession.
 Under the legal right of first possession, every
team member possesses a share of the total output.
However, the members may agree to give up their
rights.
First Possession and Teamwork (2)
 Today
the employment agreement is recognized in
courts as an implicit agreement by employees to
give up their legal rights to the output.
 The seller of a resource – a component in the
production of another product also implicitly gives
up his legal right to share in the output.
An Example of First Possession
 Who
has the right of first possession to a book that
you own?
Contract Law
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Example of another common law judgment: A nurtures the crop and
gives it to B in return for B’s promise to pay. B does not pay. In
ruling that B should pay compensation, the judge helps to establish
the law of contracts.
Besides establishing the right of first possession, common law
established the law of contracts.
Contract: a promise to perform some action, usually in writing.
Contract law: the system of rules for determining whether a promise
has been broken, whether the person who broke it should
compensate the promissee, and what the compensation should be.
Free Enterprise (1)
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Definition: with some exceptions, individuals are
free from coercion to enter into any kind of
business they wish, to apply for any kind of job, to
buy and sell, and to make binding contracts.
Exceptions:
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Slavery.
Free enterprise – a person may cause damage to a
competitor in an effort to sell his goods or services to
others.
Free Enterprise (2)
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Two implications for the role of government:
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1. The government should make no laws that prevent or
deter individuals from making business exchanges.
2. The government should use its power to stop others
from preventing or deterring people from making
business exchanges.
Free enterprise means that everyone faces potential
competition.
Free Enterprise (3)
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Restrictions on free enterprise in history:
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Restrictions on entry onto business in 17th and 18th
century Europe.
Entrance into a particular trades was often limited to
those whose families were already in the trade or who
had apprenticed for many years.
Licenses are often required today by the U.S. state
and federal governments.
Evolution of Free Enterprise
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Proponents of free enterprise:
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Opponents of free enterprise:
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Economists who recognize its benefits.
People who do not recognize its benefits
People who recognize the benefits and who want exceptions for
themselves.
History of free enterprise begins with the development of
economics; but the conflict between opponents and
proponents never ends.
Functions of money
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Medium of exchange.
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Store of value.
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Unit of accounting.
Money as a Medium (1): Barter Vs.
Money Exchange
 Barter
society: a society in which individuals
acquire goods directly by trading their own goods
for those of others.
 Money economy: a society in which individuals
acquire goods indirectly by trading their goods for
money and then their money for the goods of
others.
Money as a Medium (2): Barter Vs.
Money Exchange
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Barter society: people trade
goods directly for other goods.
This is direct exchange.
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Money society: people trade
goods for money and then
trade the money for other
goods. This is indirect exchange.
Money as a Medium (3): Money vs. Other
Media of Exchange
 Medium
of exchange: an item that is wanted not
because one plans to use it but because one plans
to exchange with others. It is wanted not because
of its expected value in use but because of its
expected value in exchange.
 Money: the generally accepted medium of
exchange. This means that practically everyone
will accept it in exchange.
Money As a Medium (4): The Origin
and Characteristics of Money
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One theory: the more marketable item becomes money.
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Characteristics of a marketable money: durable, cheap to store,
small in relation to their value in exchange, divisible, and
capable of easy quantitative measurement.
Whether a particular item is used as money depends on peoples'
expectations about its marketability.
As barter exchange grows and becomes more complex, some
items are acquired mainly because people want to exchange them
for other items. The people who acquire them do not plan to use
them, although others may.
One item eventually dominates the others in exchange.
Money As a Medium (5): Modern
Money Forms
 Government-issued
 Transferable
paper money and coins.
deposits.
Money As a Store of Value (1)
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Money enables people to economize
on their savings. They prefer to save
marketable items that do not
deteriorate or become obsolete.
This is a major reason why durability
is an important characteristic of
money. Besides physical durability,
people must believe that it will retain
its exchange value.
Money As a Store of Value (2)
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Historically, gold and silver coins
have been good examples of
durable money.
Children in a market economy
must learn to use money.
Money As a Unit of Accounting
 Definition
of capital accounting : using a rate of
interest to compare the revenue and costs that are
expected at one time in the future with those that
are expected at a different time.
 Examples:
 Should
you continue your education beyond
undergraduate school?
 Choosing to buy a car or house.
Roles in Market Interaction (1):
Introduction
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The concept of a role:
Example 1: the role of a student. Nobody is only a
student. But it is often useful to refer to a person as
a student.
Example 2: the roles of a father, mother, first son,
grandmother in a family.
Roles in Market Interaction (2):
Introduction
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In market interaction, a person must first earn
money. He can do this by being an employer
of others’ resources or by allowing others to
employ his resources. Thus, he becomes a
producer or a resource supplier.
Once the money is received, a person must
choose whether to spend or save. Usually, he
chooses to spend some of his money and to
save some.
Thus, he becomes a consumer and saver.
Roles in Market Interaction (3): the
Most Fundamental Roles
 1.
Resource supplying: hiring out work or other
resources.
 2. Producing: hiring resources to produce a
saleable good and then selling it.
 3. Consuming: using income to buy a good for the
purpose of consuming it in the near future.
 4. Saving: setting aside some income in order to
buy goods in the future.
Impossibility of the Pure Market
Economy
 Pure
market economy: an economy in which the
private property system is complete and there is
completely free enterprise.
 But
a market economy can never be pure because
the private property system can never be complete.
Why a Private Property System is
Always Incomplete (1)
The Reasons
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1. It is physically impossible or not worthwhile to enforce
some private property rights.
2. There are common property resources.
3. There are public goods.
4. Personal freedom means that no one can completely
control another person's actions.
5. Governments have other goals.
Why a Private Property System is
Incomplete (2)
 It
is not worthwhile to enforce some private
property rights.
 The case of small benefits, such as rights to control
the use of abusive and socially unacceptable
language or actions.
 The case of high costs, such as clean air, ocean
minerals and food, sound waves, light waves, and
radio waves.
Why a Private Property System is
Incomplete (3)
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There are common property resources and
public goods.
Common property resource – a resource for
which members of a community have not
established private property rights.
Two characteristics of public goods:
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1. A number of people benefit simultaneously.
2. It is impossible to exclude beneficiaries.
Examples: dam, flood control project,
lighthouse.
Why a Private Property System is
Incomplete (4)
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There is personal freedom.
Personal freedom: one person cannot own another
person. In other words, slavery is prohibited
because it would violate the principle of equality
under the law and restrict freedom of enterprise.
A person cannot sell herself into slavery even if
she wants to do so.
Why a Private Property System is
Incomplete (5)
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Governments have other goals.
Examples:
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Redistributing wealth.
Protecting the culture or state religion against foreign
influence.
Enforcing moral values.
Why a Private Property System is
Incomplete (6)
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Cultural intervention:
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1. Blocking the production and sale of particular goods
or services that are generally unwanted although some
individuals may want them – drugs, prostitution,
gambling, pork products.
2. Making government decisions subject to the will of
the people (democracy). Elected representatives may
pass laws that lead to market interventions.
Types Of Government Intervention That
Restrict Free Enterprise
 1.
Government regulation and price setting.
 2.
Government enterprises.
Why Study Economics
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To help evaluate arguments for and against
intervention in market interaction.
To know what you are defending when you say
you are defending the capitalist system.