Money

Pink Floyd, from The Dark Side of the Moon

Money, get away
Get a good job with more pay and you're O.K.
Money it's a gas
Grab that cash with both hands and make a stash
New car, caviar, four star daydream,
Think I'll buy me a football team
Money get back
I'm alright Jack keep your hands off my stack.
Money it's a hit
Don't give me that do goody good bullshit
I'm in the hi-fidelity first class travelling set
And I think I need a Lear jet
Money it's a crime
Share it fairly, but don't take a slice of my pie
Money so they say
Is the root of all evil today
But if you ask for a rise it's no surprise 
That they're giving none away

Logistical matters:

All clear on homework? Negotiate with TAs about homework, not with me.

Review matters:

Get on top of distinction among total costs, average costs, marginal costs:

Let's say you decided to produce 3 widgets: 

What are your total costs at that point? 
What is your average cost at that point?
What is the marginal cost at that point?

Let's say you decided to produce 4 widgets.

What are your total costs at that point?
What is your average cost at that point?
What is your marginal cost at that point?

Another example of sunk costs:

Tom and Susie are talking about the stock of a company called Techton, which has recently fallen to about $2.00 a share from a high of $8.00 a share.

Susie says, "OK, the price has fallen, but I still don't think it's a good deal. If it falls to $1.50 a share I might buy it."

Tom says, "Yeah, I agree with you. But you know I bought it at $7.00 a share so I feel like I need to hang on to it until it comes back up."

What's wrong with Tom's reasoning?

He has already lost $5.00 a share.

His investment in the stock is a sunk cost.

It might or might not come back up.

If he agrees with Susie that it's real value is $1.50 a share he should sell it now and buy it if and when it drops to that price.

Chapter 3: Comparative Advantage and International Trade.

This chapter is hard. Pay attention.

Main theme--specialization increases overall productivity.

We will do first half today, focusing on two individuals, Susan and Tom--a 2-person economy.

On Wednesday we will generalize to economies as a whole--trade among nations.

Examples: 

The "jack of all trades" that your textbook author employed while in the Peace Corps in Nepal didn't specialize in anything and was poor. 

A Harvard-employed economist hires someone else to mow his lawn (even though he could do it in less time than the student he hires) because the opportunity cost to him is higher. 

Adam Smith's description of a pin factory. 

Why I don't update my own web-pages.

Each person should specialize in the activity in which they have a comparative advantage.

The way to think about comparative advantage is through relative opportunity cost.

The way to think about relative opportunity costs is with a graph.

Start with a "one-person" economy.

Let's focus on Figure 3.1 on p. 56, Susan's Production Possibilities.

In order to get an additional pound of nuts, Susan must give up 2 pound of coffee. In order to get an additional pound of coffee, Susan must give up 2 pounds of nuts.

That's true at every point along the line--it has a constant slope.

The slope of a straight line is the change in the vertical distance divided by the change in the horizontal different, or "the rise over the run"

In this case, the slope of the line is negative 1/2.

Note that Susan can choose to work less than was assumed in Figure 3.1, in which case she would have to make do with less coffee and nuts. But under the conditions stated (she is working 8 hours a day, and we hold other factors, like technology fixed), any points to the right of the straight line are "unattainable" --see Figure 3.2.

Now consider Tom's production possibilities curve (Figure 3.3).

Note that Tom is kind of a slacker, less productive than Susan at both activities.

The slope of this line is different.

The opportunity cost to Tom of picking coffee--in terms of nuts--is smaller--one pound of nuts for one of coffee, instead of, for Susan, two pounds of nuts for one of coffee.

Bottom line: Tom is absolutely less efficient than Susan, but he is COMPARATIVELY more efficient at picking coffee and less efficient at picking nuts.

This point is illustrated in Figure 3.4.

Now, move to a "two-person economy"

Add Susan's and Tom's productive potential for picking coffee and nuts.

Remember Susan and Tom. As individuals, they divide their time between picking coffee and picking nuts. Susan is more productive at both tasks. So she has an ABSOLUTE ADVANTAGE.

But Susan has a comparative advantage picking nuts, and Tom has a comparative advantage picking coffee. Why don't they each do what they do best, even without trade? They could, but they both want to eat both coffee and nuts....

That's where trade comes in--it allows them both to specialize in what they do best, and thereby makes them better off. Look at Figure 3.5 in the text.

Now, let's do a review that sets you up for a homework question:

6. Larry and Harry are on a desert island where they have unlimited raw materials for beer and pizza, but their quantities are unlimited. What's scarce is labor. They are each willing to work only 10 hours per day.

Following table specifies how much beer and pizza Harry and Larry can produce per hour:

A. Draw the daily production possibilities curves for Harry and Larry.

(multiply each amount by 10 hours to see the maximum each could produce).

B. Who has an absolute advantage in making pizza?

Duh, Larry.

C. Who has a comparative advantage in making pizza?

Harry's ratio of pizza to beer is .2/1, Or, 1 pizza costs him the opportunity of making 5 beers.

Do this mentally, or solve for x in the following equation: .2/1=1/x

.2x=1, so x=5

Larry's is 1.5/5

Larry's ratio of pizza to beer is 1.5/.5

So let's ask 1.5/.5=1/x

1.5x=.5

x=.5/1.5

=1/3

Making one pizza costs him the opportunity of 1/3 of a beer.

Larry has a comparative advantage as well. But note how this would change if Larry's productivity with beer were 10 per hour.

Specialization--sometimes goods or services that one country produces are cheaper not because that country is more productive, but simply because it is cheaper.

Like, let's say you have to dig ditches by hand in Atlanta in 1830. If you hire a wage earner to do it, you have to pay them $.50 a day. But if you make a slave do it (during the part of the year that they are not tending cotton) it only costs $.25 a day. The opportunity cost of the slave's time is lower. Does this mean it is more efficient to have the slave dig ditches? No, just less costly.

Likewise, the reason Indonesian workers make most of the sneakers we wear in the U.S. is not that they are really any more efficient at this. Their wages are just lower...and one reason their wages might be lower is that they don't have the right to unionize; nor do they have much power over their government....

"Anti-sweatshop" campaigns try to put restrictions on purchases of imported goods--not to from from companies (or countries) that don't enforce minimum standards of worker rights and safety.

Specialization can increase risk.

Especially if you specialize in something that might become obsolete, or that might decline in value over time, or that is hard to "take with you" when you go.

Like, Honduras has a comparative advantage in producing bananas, and the U.S. in producing computer technology. So should Honduras specialize in bananas? Ummm, if they do, they will be a) completely dependent on another country for technology and b) unlikely to develop the skills and capabilities of their workforce and c) dependent on increased demand for bananas for any future growth. But people can only eat so many bananas, whereas their demand for computer technology seems insatiable....

Another good example is the traditional gender division of labor.

Oh, let men specialize in earning money and women specialize in taking care of family members.

This doesn't imply that men have an absolute advantage or are any smarter or harder working than women in general. It just implies that women have a comparative advantage in taking care of kids, which is obviously true for kids that are breast-feeding.

But women who specialize in raising kids are extremely vulnerable to the economic effects of non-marriage or divorce--they can't sell their "output" on the market, and taking time out of paid employment lowers their lifetime earnings...so they become economically dependent on their husbands...and even if they don't experience a divorce, they may be so intimidated by the thought of what would happen to them if they DID experience one that they are easily bullied....

There's more on these themes in The Invisible Heart, especially the first and the last chapters.

I want to turn now to another "down side" of specialization--what it does to human capabilities.

As Frank and Bernanke, put it (p. 64).

...one of Karl Marx's central themes was that the fragmentation of workplace tasks often exacts a heavy psychological toll on workers. Thus, he wrote, "All means for the development of production...mutilate the laborer into a fragment of a man, degrade him to the level of an appendage of a machine, destroy every remnant of charm in his work and turn it into hated toil..."

Charlie Chaplin's 1936 film Modern Times offers a classic interpretation.