Hi, I’m Saul Levmore and I teach law or
really economics and law at the University
of Chicago.
It’s my good luck to be her to introduce
you to the subject of economics.
Well, what is economics?
Let’s play a game of free association.
I say “economics,” you say whatever comes
to mind.
Economics—money.
Economics—Wall Street, housing bubble, prices,
incentives.
Ohh, if you said incentives, that’s pretty
sophisticated.
I think it’s easy to see why economics is
relevant.
Economics is everywhere.
Economics is why buildings go up; economics
is why cookies cost $3.00.
Economics is about getting the seat you want
on the plane.
Economics is, yeah, it’s about making money,
but it’s about human behavior in general.
Economics is to the real world around you
as meteorology is to the weather, it’s interpreting
all the phenomena and figuring out if there’s
anything we can do about that.
How could that not be relevant to every one
of us?
That’s a lot of what we’re going to talk
about today.
Economics is, formally at least, the study
of the allocation of scarce resources.
You don’t have enough of something, a lot
of people want it, who gets it, how do they
get it, what do they give for it, how do you
get people to make more of the thing.
All of that is economics.
I’ll say it again; economics is about the
allocation of scarce resources.
Economics is also about puzzles.
Economics likes to assume, just to make its
job easier, that people are rational.
You know, what is a rational person?
The rational man is the guy who sees that
the price of wheat rises; he gets up earlier
in the morning and grows more wheat on his
farm.
Economics is the guy who buys more of something
when the price drops.
That’s the rational man.
The rational man loves to download stuff from
iTunes when iTunes price goes down, but the
rational man also creates more music in his
garage and sells it when he gets paid more
by people who download it from iTunes.
One guy wants the price low; one guy wants
the price high.
They’re using incentives to communicate
with one another.
So economics is about exchanges, economics
is about prices, therefore it’s about money
and it’s about incentives.
Once you have those four things down, you’re
beginning to put the package together.
I said that economics was about puzzles.
Economics is also about puzzles.
And these puzzles are even deep mysteries,
have a lot to do with how economics got started
in the first place.
Kings would be really confused about some
things.
They would issue new coins, the coins would
go out into the realm and the coins would
disappear.
Where were these coins going?
Peter the Great, I just read the other day,
beheaded some 1,000 people for hoarding coins.
And he could never figure out why when he
issued silver coins, people would hide them
or bury them in the fields.
Why didn’t they want to use these coins?
What was so great about holding them?
Well, that’s the mystery that economics
was out to solve.
Peter the Great hired advisors and he wanted
to figure these things out.
How come countries traded some things and
not others?
England and Portugal were sending wine and
cheese back and forth, but some things never
seemed to travel.
Why was that?
Well out of these puzzles came the study of
economics.
And the people who advised these Kings can
be thought of as the first economists.
And economists have continued to like puzzles
ever since.
Think about sovereigns in our own time.
Think about something the government does
and wonder why the government does it.
So a fire breaks out.
You can imagine one world where ten competing
fire departments, you’d look them up on
the internet and you’d say, “Oh, how much
to put out my fire?”
And people would race around for prices to
put out fires.
That’s not the way it works.
Instead, the government is in charge of firefighting.
Economists are very interested in that, you
know, why is the government in charge of firefighting
and not growing wheat?
Why doesn’t competition make firefighting
work better or do governments somehow compete
to see who’s better at putting out fires?
Of course, there is a little bit of competition
there because if the government does a bad
job putting out fires or plowing the streets
in the wintertime, then voters will throw
them out of office and bring in new politicians.
Still, that’s not exactly using prices,
that’s using votes rather than prices.
And our job today is to understand the use
of prices.
Two of the things we are going to focus on
today are prices and the form of competition.
And let me say a little bit about them before
we get there.
Prices and competition or its opposite, monopolies,
are two central tools in the study of economics.
Prices are these things that tell people how
much something costs, how much they have to
sacrifice to buy it, how important it is to
make more of the thing.
We’re going to see a lot of prices today.
By form of competition, I mean, the people
who make these things, are they competing
with other firms to make it or are they the
only one out there making it.
A perfect competitor, economists like to say,
is somebody who is out there trying to sell
you something or make something, and though
lots and lots of other people are trying to
make the same thing, competing to make it
better or at a lower price or whatever it
is.
When they’re the only one out there, we
call them a monopolist.
So the monopoly is a form of producing goods.
A perfect competitor, economists like to say,
is somebody who is out there trying to sell
you something or make something, and though
lots and lots of other people are trying to
make the same thing, competing to make it
better or at a lower price or whatever it
is.
The monopolist is somebody who for some reason
or another has the market to itself.
And we’re going to spend a good deal of
our time today understanding what’s so interesting
about monopolies.
Why governments care about them.
Why governments even sometimes like monopolies.
And why you and I might not like them so much.
So the monopoly is a form of producing goods.
A perfect competitor, economists like to say,
is somebody who is out there trying to sell
you something or make something, and though
lots and lots of other people are trying to
make the same thing, competing to make it
better or at a lower price or whatever it
is.
The monopolist is somebody who for some reason
or another has the market to itself.
But probably 10 or 20 such tools, but we’re
going to have time for two of them today and
many applications of those tools.
Now you can even think of the government as
a kind of monopoly.
It’s sometimes that we say that the government
has a monopoly on power, you know, they’re
the only one who gets to have an army in most
countries.
But as we’ve already seen with the firefighting
example, really the government allocates to
itself the right to be a monopoly about many
things.
The government has a monopoly on making laws;
it has a monopoly on fighting fires, on being
the police.
It’s a form of monopoly, but one that’s
more influenced by votes than by prices.
But there are many, many, many other monopolies
out there that the government allows.
Think about the streets in your city.
Well, if you had competition for producing
and sending people water or electricity, you’d
have 10, 15 companies digging up the street
all the time laying pipes, putting in water,
sending the electricity and the water to your
house.
Nobody wants to tolerate that.
So instead, most governments say, let’s
make that a monopoly.
Either we will own it or we will some way
or another hire a firm to do that.
We’ll give only one firm the license to
dig up the streets and put in the pipes.
And then either other firms can compete to
sell you water at your house or probably that
one monopolist will sell water at your house.
So the government doesn’t want many people
digging up the street.
On the other hand, it might recognize that
there’s a problem with having only one supplier
of water to you.
We’re going to focus on that one supplier
in a few minutes and in any event, we already
know to call that a traditional monopolist.
While we’re talking about the government
as a monopoly, notice that the government
doesn’t charge you for firefighting.
It’s a curious thing that economists are
interested in.
The government charges you for water, but
when it puts out a fire in your house, it
doesn’t charge you.
It might even have rules requiring you to
have fire extinguishers or in big buildings,
sprinkler systems.
Still, if the Trump Tower burns down and the
government comes and saves it before it’s
burned to a crisp, the government doesn’t
say to Donald Trump, “Oh now you owe us
a certain amount of money for saving your
building.”
We might begin to wonder why that is.
This is the sort of thing that economists
are interested in.
Here’s another monopoly for you and another
example of where we use markets sometimes
but not other times.
Think about the college you go to.
The first time you met that college, it was
an intense competitor.
Many colleges were probably competing for
you to be a student there or certainly for
your application fee.
And you in turn were competing with many other
applicants for seats in the college.
It was a very, very active market.
Suddenly, it changed.
You’re admitted to a college, you matriculate
there, you show up, you need a dorm room,
very, very, very few colleges say, “Oh,
the third floor dorm rooms are better than
the second floor dorm rooms.
Let’s raise the price a little bit on the
third floor.”
No, no… suddenly, it’s as if there was
no market at all.
Colleges tend to hate prices.
Colleges act as if there is no market at all.
A course is overcrowded?
They might tell you, you can take another
time, they might add a section to the course.
They might hire another teacher, they might
stuff the room full of chairs, but the last
thing they do is say, “Okay, everybody who
wants to pay $189, please come in and sit
in the first row.”
Why is that?
That’s another good example of where sometimes
we love markets and sometimes the players
in the market, like the college in my example,
**** the market and says, “No, no, no.
There’s a reason why we should be some sort
of community without a market.”
Probably they gain something by this and they
lose something by this.
And again, that’s the sort of thing that
economists are very interested in understanding.
And I hope you will be too.
In economics, the best way to understand big
puzzles is to break them down into little
puzzles.
Little puzzles are not so easy, but big puzzles,
as we’ll see, are really beautiful.
They’re beautiful to solve by putting together
these tools, we can learn from the smaller
puzzles.
The key way we’re going to solve these puzzles
today and in economics more generally, is
by always thinking about these markets.
Where does a market exist?
What are prices doing?
What’s competition doing?
Do we have a monopolist or do we have a lot
of competitors running around?
These are the tools that we’re going to
looking to use to solve problems.
We want to understand the recent financial
crisis that hit the world.
We want to understand housing bubbles.
We’re going to start with prices.
We’re going to start with competition and
then we’re going to understand the role
of the government.
So, let’s start with prices.
When I say prices are special, I mean prices
do everything.
Prices tell oil companies when to dig deeper
for oil.
Prices tell me when to fly.
Prices tell me when to fill my car with gas.
Prices tell me whether to go to a restaurant
early or go to the restaurant late.
And in fact, when the restaurant doesn’t
offer price differentials, I’m a little
disappointed.
Sometimes on a rainy day I think, “Boy,
I bet there’s nobody going out to the restaurant
now.
I wish the restaurant would drop the price
and then I’d be more eager to go to the
restaurant.
So sometimes we have prices and sometimes
we don’t, but when we have them, they’re
a little bit like magic.
Now, this magic can be a little puzzling.
And indeed, prices have puzzled economists
for hundreds, if not thousands of years.
You know, why do things cost what they do?
You know, say I eat a chocolate chip cookie.
Why does that cookie cost a dollar or eighty
cents or three dollars, or whatever the range
it might be?
Why does it cost that amount?
Well, first let’s see the puzzle associated
with it.
You might be inclined to say, well, a really
good cookie costs more.
People really like it.
You’re forgetting that I said scarcity was
important before, but that’s okay.
Well, you might say, the more important the
thing is, the more it costs.
If I say, a house costs $300,000 and a cookie
costs $1.00, why does the house cost more
than the cookie?
You’re initial response might be, well,
people need houses more.
The cookie’s a luxury.
Therefore, the house costs more.
But that’s not really a successful way to
think about it.
Think of the following classic example, air.
Air is basically free.
Take a nice big gulp of it as one advertisement
used to say.
The air is free.
And then things like a diamond are classically
super expensive.
Economists used to say, “Why is a diamond
more expensive than a breath of air?”
Well, you already know the answer.
The answer, you should say, is scarcity.
There are very, very few diamonds.
You have to dig deep in the ground to get
the diamond.
Transport it thousands of mile, polish it,
cut it, do this, do that.
It’s a lot of work, it’s very hard to
get them, there aren’t many of them.
Diamonds are even more valuable than aisle
seats on airplanes.
Diamonds are expensive.
They’re scarce.
Air, it’s available.
You just breathe it in.
Even where it’s not available, it’s available.
If you go scuba diving, you just up at the
surface, you capture some air in a tank, tanks
are relatively cheap, you go underwater, you
can breathe.
It costs you just a few dollars.
We know the answer to that now.
A thousand years ago, that might have been
a puzzle, but if I say, why is a diamond more
expensive than air… more expensive than
a gulp of air?
It’s obvious that scarcity is the thing
that’s really doing the job.
Now, let’s go back to cookies and houses
now.
That’s a little bit more complicated.
Let’s do cookies first.
I love a good cookie.
Imagine that I would pay $10 for a really
fantastic, juicy, chocolate chip cookie.
My kids always say, there’s no such thing
as a juicy pastry.
But that’s wrong.
A really good cookie is juicy and worth $10.
Now, I’ve never paid $10 for a cookie, even
though I would.
So I go to the bakery, even my favorite bakery
and I walk in and I say, “Oh, how much are
those fantastic cookies?”
The baker knows that I would pay $10 for the
cookie.
He can see it all over my face.
But he says, “Well, that cookie is $3.00.”
Well why doesn’t he charge me $10?
I mean, he might check out my face when I
walk in and charge $10, but of course, if
he did that, I would revert to Todd’s strategy.
I would just go out to the sidewalk, I would
wait there.
I would wait for somebody else to go into
the bakery and buy the cookie for $3.00 and
they’d come out and I’d give them $3.05
or something for the cookie.
So, sometimes we say, the baker is unable
to price discriminate among people.
The baker has to sell the cookies at one price
because otherwise people will go in and arbitrage
the cookies, there will be a market made as
Todd tried to make a market for aisle and
middle seats.
Well, that doesn’t answer the question of
why the cookie costs $3.00.
So imagine the cookie sells for $5.00.
The baker sees there’s some people who really
want the cookie.
The baker starts raising his price and charging
$5.00.
What’s the next thing that will happen?
Well other people will see, you could make
a lot of money running a bakery.
Just gather together chocolate chips, rent
an oven, get some flour, get the other ingredients
necessary for making chocolate chip cookies
and you’ll start making cookies and the
price will start dropping as more and more
people offer cookies.
They’ll undercut one another $4.50, $4.00,
$3.99.
Until the price goes down to, well… to the
amount that it will cost that marginal bakery
to produce that chocolate chip cookie.
So prices are inputs are signaling the baker
how to make the cookies, the price of the
cookie is signaling me about buying the cookie.
And my desire for the cookie is bringing new
competitors into the industry.
In the long run, the price of that cookie
will be the cost of combining the inputs.
It’ll be based on the cost of supply in
the cookie.
In the short run, if there’s a lot of demand
for the cookie the price might rise.
If suddenly a hundred people, like me, rush
into the store and say we all want the cookie,
maybe the baker can raise the price a little
bit in order to allocate the cookies that
are there.
But if that keeps happening, new bakers will
enter the industry; bakeries will be popping
up all up and down the street and cookies
will drop to $3.00, which is the cost of producing
them.
Let’s compare it to that house.
Say you have a house selling for $300,000.
What does that mean?
It means that builders trying to put together
windows and bricks and doors and roofs and
subzero refrigerators or whatever goes into
the house, they put all those things together
and maybe there’s great demand for housing,
maybe incomes have risen, maybe a war has
come to an end.
Maybe somebody can sell that house for $500,000.
If so, new building contractors will come
in, just like bakers came into that previous
market.
They’ll start selling more houses, they’ll
build houses; they’ll work overtime.
And they’ll build houses and build houses
and the price for housing will drop, again,
until an equilibrium, we say, that marginal
builder can produce a house just like that
for $300,000.
The price won’t drop any further because,
by assumption, no builder can show up and
put together those inputs for less than $300,000.
One builder might be better at building them
than another builder.
In that case, maybe that builder can really
build a house for $280,000 and make a $20,000
profit.
But once we run out of such builders, we’re
left with the typical builder who can put
the house together for $300,000.
So in the long run, the answer to the question
of, gee, why is that house more expensive
than that cookie?
The answer to that is a little boring, but
it’s not scarcity.
The answer to that is that, in the long run,
that’s the cost of the inputs of putting
those things together . It just costs more
for the earth, in a sense, to produce the
house than to produce the cookie, based somewhat
on the scarcity of those inputs, but in the
long run because new competitors can come
in; the key variable is the sum of the cost
of all those inputs.
Once again, prices are messengers.
Prices are little messengers that run back
and forth.
When the price of the house went up to $500,000,
it was as if messengers went out and said
to builders, “quick, work overtime; build
more houses.”
They said to the brick kilns, produce more
bricks.
When the price started dropping, imagine a
lot of empty houses all over the place, messengers
will run around and say, “Houses are not
selling for $300,000 or less because there’s
a glut of houses.”
Builders won’t get up in the morning to
build houses.
No need to pound that hammer if you’re not
going to get paid for it.
The same thing for the baker, the prices run
back and forth telling the bakeries when to
produce more cookies, when to produce fewer
cookies, when to open new stores and so forth.
Prices are messengers.
That’s a good thing to know.
CHAPTER HEADING: Demand
Economists like to use the word, “demand,”
to refer to the consumer side of the transaction.
How much do people want the cookie?
How much do people want the new houses?
Prices are probably the best way of measuring
the intensity with which people prefer something.
And again, prices are a way of calibrating
demand.
The more people would pay, the more the good
was in demand.
What we saw though was, in the long run, for
competing objects like cookies in a bakery,
houses on the housing market, in the long
run, it was the cost of supplying them that
mattered the most.
But there are exceptions to this.
You know, imagine, you know, a trendy fashionable
handbag.
The cost of a designer putting together this
handbag might really be $40.
But the handbag might sell for 10 times that.
Now that’s kind of an exceptional market
and it’s worth thinking about what’s going
on there.
There are knock offs, of course, and the very
same designer can produce more handbags.
But in the short run, the designer seems to
figure out that selling this handbag for $400,
way above the cost of the inputs, that is,
the cost of the assembly of the handbag, somehow
triggers the market.
The higher price, in this sense, seems to
attract people to the good for a while because
it’s a fashion trend or a signal to them
that this is a hot item to buy.
There are people who want to carry this handbag
because it’s unique or there are people
who are maybe who are even signaling, “Look,
I can afford a $400 handbag.”
Well, that’s not going to last long, right?
We don’t see a fashion trend like that lasting
very long because in the long run, people
will produce competing bags or that designer
will produce more of the bag or there will
be knock offs that will be so good that nobody
can tell them apart.
Same thing with sneakers.
You know, I have boring running shoes and
even more boring shoes.
And I pay, you know, maybe $80 for them.
All around me, I see colorful, trendy footwear
that’s actually cheaper to assemble, canvas
and a rope practically, but they cost much
more money than that?
Again, why is that?
Well, that’s the demand side.
That there’s a short-term fashion trend,
in a way, where people really want the thing,
thousands of it are made, they need to be
allocated, they’re allocated by the price
mechanism.
The higher price, in this sense, seems to
attract people to the good for a while because
it’s a fashion trend or a signal to them
that this is a hot item to buy.
Again, that doesn’t last long.
We’ll learn more about this later on in
the lecture when we turn to housing bubbles.
There could be a bubble for something like
sneakers.
The price could go way, way, way up before
more sneakers flood the market or the fashion
goes out.
I don’t think you will ever find a bubble
for chocolate chip cookies.
Now that is basically based on the cost of
assembling the cookie, and many, many other
people can enter the industry and produce
the cookie and drive the price down.
It’s hard to imagine a sustainable bubble
for cookies.
Handbags, some kinds of housing, certainly
sneakers, they can be sold for a period of
time at above the cost of putting them together.
And it’s something that we need to keep
track of.
A long time ago, before you were born, there
was no internet.
I know that’s hard to believe, but trust
me, I was there and it’s true.
And in the world before the internet, prices
weren’t just little messengers; I think
it’s fair to say that prices were everything.
There were classified ads in the newspapers
and they were all about price.
You know, wanted, 2006 Audi, $4,000.
Everything was associated with a price.
Billboards were about prices.
McDonalds’ ads were about prices.
Prices are, after all, key information.
They are those messengers that I keep talking
about.
But there’s an interesting development in
the internet world, which is that as we have
more and more information about goods, my
observation is that more of the information
is about non-price attributes of goods.
So for example, if you go on Amazon and you
want to buy a book, I mean, the price is there.
It’ll give you the retail price and they’ll
tell you what a good price you can get from
Amazon.
But probably 95 percent of the information
is reviews from readers or the condition of
the book, if it’s a used book.
There’s a great deal of information that’s
being provided that’s not about prices.
I think that’s a function of the internet.
It’s much cheaper to convey information
now than it was 100 years ago.
And as a result, we have not just prices,
but a great amount of non-price information.
And this might also be a result of affluence.
You know, once upon a time, I might have said,
“Ohh, I want to go on vacation and stay
in a hotel.
How much is a hotel on the English seaside?”
And then I would get an answer.
Now, oh now, well do you want air conditioning?
Do you want a big room, a little room, how
many square feet do you want?
I mean, there’s a lot of information that
goes into this.
And this is probably a function of an affluent
society where people don’t just want a hotel
room in England, they want a particular location,
they want a kind of room, the right ambiance,
and a lobby and all of that information is
being provided with 360 degree accuracy on
the internet.
So it may be that we are moving to a period
where although prices are messengers, there
are many, many more messengers out there and
it’s these non-price attributes, as economists
would call them.
CHAPTER HEADING: Arbitrage - Creating a market
A couple of Thanksgivings ago, I was sitting
on a packed airplane.
I was lucky enough to have an aisle seat.
Sitting next to me was a really nice, tall,
very tall student named Todd, and we chatted
a little bit.
And he asked me what I did for a living and
I told him.
And as soon as I told him that, he said, probably
correctly, “Oh, well I guess you’re comfortable
talking about money.
“Listen, how about trading seats with me
for $50.”
I was a little bit startled.
And Todd said, “You know, I’m a really
big guy, I’m six-foot-eight, these middle
seats cramp me.
I really, really want an aisle seat.
So every time I get on a plane I’m in a
middle seat, I try to bargain with the person
next to me to get the aisle seat so I can
stretch out my legs.
Fifty bucks?”
I said, “Sure.”
I don’t really mind the middle seat that
much, and besides, maybe the guy in the window
seat was interesting like Todd.
Let me ask Todd to tell me more about his
bargaining for these seats.
And he said, “Actually, now that you mention
it, I’ve probably asked people 12 or 15
times to sell their seat to me for $50, and
you’re the first person that’s ever did
it.”
Well, actually one time, he said, about two
years ago, he was really frustrated but nobody
had ever accepted his offer and he said to
the person.
“Okay, I’ll give you $300 for that aisle
seat right now.”
And as if commanded to do so, the person on
the aisle said, “$300?
Sure.”
Now think about Todd a little bit and the
study of economics.
We saw that economics was about the allocation
of scarce resources.
It’s the study of how we allocate scarce
resources.
Well, the scarce resource is the aisle seats.
There are fewer aisle seats than people who
want them.
It’s scarce, at least on that airplane.
Now also, there’s no market.
Todd wishes there had been a big market out
there where you got on the plane or you got
on your computer and saw which seats were
available and which seat you want and you
could bid for your seat.
Todd apparently was willing to pay $50 to
get an aisle seat, but at least so far, no
airline is saying, “oh, you can move to
the aisle seat if you give me $47.80.
So Todd was trying to create the market on
his own.
Of course, it’s a complicated market, in
a sense; he had to create two markets.
He had to sell his middle seat, and buy an
aisle seat.
Now people do that on Wall Street and they
make hundreds of millions of dollars.
On Wall Street, we call it arbitrage.
They look for things that they think are mispriced
where you can make money by selling one thing
and buying another thing and maybe doing them
backwards and forwards many, many times in
a day.
That’s in a way what Todd was trying to
do, except he didn’t have a well-developed
market.
Todd wished there had been these markets,
but he said he had to make them.
He was trying to arbitrage middle seats and
aisle seats.
Todd’s not the only one who really wants
an aisle seat.
And it makes you wonder how airlines allocate
these seats.
Some airlines do it by first come, first served.
When I buy a seat to travel, I get on and
I click and it offers me to change seats and
it shows me the available seats, but there’s
no way for me to trade with people who acquired
seats before I did.
Some airlines do it with a queue.
Southwest Airlines, for example.
If you get up early in the morning or you
have an automatic program, app, and you check
in and you’re on of the first ones to check
in, you get a good number, you’re at the
front of the row, front of the line and then
you can get whatever seat you want.
Some airline sell you seats in the sense that
I guess Todd could buy a Business Class seat
or a First Class Seat by paying much, much
more money.
So there are many ways that we allocate things,
prices are only one of them.
But prices are special.
Economists would say that prices are a means
of showing your intensity of preference.
If you really want an aisle seat, you pay
$50 for it.
If you really want an aisle seat, you might
pay $120 for it.
Similarly, if you don’t care, you might
sell, you might sell to the low price or the
high price.
Prices can be thought of… now pay attention
to this.
Prices can be thought of as little messengers
that run back and forth between people who
want things and people who can supply them.
When I click on the website and I say, “Oh,
I want this seat.”
The seller, that is the airline now knows,
“Oh there’s somebody out there that really
wants that seat and might pay more for it.”
And similarly when the airline lowers the
seat on the plane or raises the seat on the
plane, it’s signaling me how many of those
seats it has and it’s trying to figure out
whether I want that seat.
When I flew on Thanksgiving, I paid a lot
of money for the seat.
When I fly on a Sunday morning in the middle
of February, the prices of the seat are much
lower.
Right?
The airline’s programs sees when there’s
more and more demand for seats on the airplane.
When there’s more demand, prices start rising
because it wants to allocate the scarcer source
and I don’t just mean the aisle seats, I
mean all the seats.
It wants to allocate that scarcer resource
so that people who will pay the most for it,
‘cause that’s how the airline will make
more money.
And similarly, when the program sees that
the airline is about to fly half empty, it
drops the price precipitously in order to
attract people who are only willing to fly
at a lower price.
CHAPTER HEADING : Non-competitive markets
So we’ve been talking about cookies and
about houses and they are sold in competitive
markets.
Again, by competitive markets, I don’t mean
anything complicated.
Just that there are many buyers and sellers
running around trying to service one another,
get the business, buy the thing at a lower
price and all of that.
Those markets are the foundation of economics;
economists spend a lot of time on competitive
markets.
But not everything is sold on a competitive
market and maybe less so than ever.
For example, non-profits occupy the healthcare
field.
Non-profits are important in education.
Non-profits are important for supplying goods
to poor people and so forth.
Governments are not competitive firms.
They’re either monopolists or something
else.
Governments supply a lot.
They supply a national defense and firefighting
and national parks and schools and this and
that.
And then they are also monopolists.
Monopolists again are single sellers, traditionally.
They have a market all to themselves.
Think about all the monopolists that we know.
IPads are sold on monopoly markets because
Apple has patents on critical aspects of the
iPad.
Now you might say, well, an iPad has competitors
of other tablets or PCs more generally.
But there are a lot of people who really want
what the iPad can offer them.
So to some degree, Apple has a monopoly on
selling iPads.
To some degree it’s a competitor selling
in the PC market or selling in the tablet
market.
Many goods are like that.
Say a new animated film comes out.
I want to go see the movie.
The maker of the movie has a copyright on
that movie and can decide in what movie theaters
that will be sold, which is to say, viewed.
And in a sense has some control over the price
the movie is shown.
They can offer the movies as direct download;
they can offer the movie in hardcore form
or whatever you like.
Well, again, is that a perfect market?
Is that a monopolist?
It’s somewhere in between.
I don’t have to go to the movie.
I might be just as happy to go to another
movie or go to a concert or a baseball game.
But to a degree, people who want to see that
movie are stuck getting it from that supplier
of the movie, which has a monopoly over the
copyright.
Professional football games have that kind
of monopoly.
Again, no one has that monopoly on a chocolate
chip cookie.
The chocolate chip cookie is a commodity practically.
Nobody has that commodity on an ingot of steel.
You can produce that, it’s a commodity;
it’s all over the place.
It’s like water and air.
So there are many things, healthcare, government
services, firefighting, iPads, a bridge over
the Mississippi River connecting Iowa to Illinois.
That’s a pretty effective monopoly because
no one’s going to get permission to build
eight bridges right next to each other and
compete.
So again, what we might think of as a situational
monopoly over there.
We’re going to spend some time now moving
to monopolies as probably the best example
of these non-competition forms of selling
things.
And we’re going to see many lessons out
of that, but we’re going to keep track of
prices as we do it.
So again, to review where we are; prices come
largely from costs, they also come from supply
and demand.
As we’re about to see, that’s remarkably
so for monopolists where the demand is going
to play an important feature in the price
the monopolist charges.
Let’s examine those prices and messenger
systems a little bit more carefully by thinking
at the same time of an example where the airline
is now not a competitor, where many, many
airlines are flying, but let’s now begin
to introduce the idea of the monopolist.
That is the seller who does not face competition,
but is the only one selling these seats.
CHAPTER SUBHEADING: Big Air; airline as monopolist
Let’s try an example together.
Imagine that Todd was flying on a plane and
to make the example as simple as possible,
imagine the plane was owned by an airline
called Big Air, for lack of a better name,
and that Big Air was the only carrier flying
between the two cities Todd and I were traveling.
Say it was Boston to LaGuardia Airport in
New York.
So I have a chart here, of course I made it
up, but it’s a pretty realistic chart in
a way.
And it shows that as Big Air charges more
and more for a seat on the airline; any seat
now, I’m done with aisle seats for a while.
As Big Air chargers more for a seat on the
airline, fewer people will want to travel
on Big Air.
Either they won’t travel to New York or
they’ll drive, take the train, walk, donkey,
what have you.
But let’s have a look at it.
If they charge $50 a seat, 10,000 people will
want to fly to New York that day.
Wow!
If they charge $5,000 a seat, basically, no
one wants to go.
Ten spoiled snobs will fly.
And there you go on the bottom, $5,000, 10
seats.
Big Air will collect $50,000 for those of
you who are math challenged, that’s $5,000
times 10, just count the zeroes, see four
zeroes.
Put the four zeroes on the right.
And then in the more realistic range, at a
price of $300, we see that 2,000 people will
demand seats, that is, want to accept the
offer to travel from Boston to New York on
Big Air at that price on that day.
And so, if it sells 2,000 tickets at $300
each, Big Air will collect $600,000 in revenue.
I haven’t said anything about their costs
yet.
If it raises the price more to $500, well
it gets a lot of people, 1,000 of those 2,000
people will still want to pay for the seat
and they’ll pay $500, but of course, 1,000
people then will not fly.
So I’ve constructed the example so that
Big Air takes in the most money when it charges
$300.
And again, you might be thinking, well what
about $270, or $320.
I’ve excluded all of that to make the example
as easy as possible.
It’s not free for Big Air to fly to New
York.
It has costs.
And as we known, these costs are very, very
important in figuring out when to fly, how
to fly, and what to charge.
So here, I’ve reviewed the information that
you have already in the first two columns
and then I’ve put in some information about
costs in the third and the fourth column.
Now, think of Big Air just charging $50, that
sort of crazy low price, 10,000 people wanting
to travel.
We know that Big Air would have taken in $500,000
in revenue.
That was in our previous slide.
Well what does it cost Big Air to fly 10,000
people?
And I’ve put in some huge number.
You know, imagine that it costs and average
of $300 a person, which would be $3 million
to fly so many people.
Why does it cost more, rather than less per
seat when it wants to fly more and more people?
Well, to a degree, when you start increasing
the number of seats, that is, when you increase
production or output, as we call it.
To a degree, costs drop.
You know, think about the pilot flying the
plane.
If you only have one passenger on the plane
and you’ve got to pay the pilot, say $1,000
a day to fly the plane, then that $1,000 is
bourn entirely by the customer sitting in
seat 1A.
You put 10 customers on the plane, same pilot;
the pilot’s salary can now be spread among
10 customers.
So that’s relatively fixed cost of the pilot,
that fixed cost drops or becomes a less important
price as we have more and more customers.
That would explain why, when we have a price
of $5,000 with only 10 people flying, the
average cost of flying is, say, $3,000 in
the last line of the example.
And that’s because there’s a pilot, there’s
an airplane, there’s a ticket counter, there’s
buying landing rights at LaGuardia, there
are many fixed costs that now are divided
among 10 people; 10 rich people.
And then for the average cost of flying each
of those persons is very, very high.
As you can see, working your way up from the
bottom of the chart.
When Big Air increases the number of passengers
from 10 to 1,000, by dropping the price from
$5,000 to $500, it gets what we sometimes
call, economy to scale, it’s able to spread
the pilot cost and the airplane costs and
the landing costs and all those things I mentioned
among more and more people, and so the average
cost of sending someone to New York drops,
in this case from $3,000 too $200.
Notice it stays there for a while and then
it rises once they go to 10,000 seats.
And why might that be?
Well, they’ve probably run out of landing
rights at LaGuardia.
I mean, where would you land 10,000 people
a day more than the system now holds.
I can’t even imagine.
They might buy away landing rights from other
airlines at LaGuardia.
They might fancifully suggest to the mayor
of New York that Central Park needs **** and
we put landing strips in Central Park and
unload people there all day.
It’s very hard to imagine how you could
fly so many people so quickly every day from
one city to another.
And so I’ve imagined that the prices would
rise a great deal.
This is realistic for most things we make.
That is, in the beginning, the price drops
as you increase output and then eventually
the price rises.
Sometimes we say that the marginal costs rises
over time.
Well now if we put these two trucks together,
we can see how Big Air would make the most
amount of money.
That’s usually its job.
We say that firms are trying to maximize profits.
Again, we imagine the firm's a rational player
that has a goal, and in this case its goal
is to make as much money as possible.
Well, look at the example.
When it charges $50 and those 10,000 people
fly and land in Central Park, Big Air loses
money.
It spends $3 Million, but we saw that it takes
in revenue of only $50 a seat times 10,000
is $500,000.
It loses $2.5 million.
Big Air never wants to do that.
What about $300 a seat.
Well that’s pretty good for Big Air.
If prices of seats are $300, 2,000 people
show up to the airport, that’s $600,000
in revenue and then by our assumption from
the previous side, it costs Big Air $200 per
seat to fly these people there for a total
of $400,000 in costs.
And as you can see, it yields a $200,000 profit.
Big Air can even do better if it charges $500
a seat, even though it only costs Big Air
$200 to fly the person, by raising the price
to $500, it loses half it’s customers, loses
1,000 people.
Flies just 1,000 people, collects $500,000,
$500 a seat times 1,000 seats.
And its costs are $200,000.
And so we can see that here is where it maximizes
its profits hauling in $300,000 in net profit.
So we’re thinking a little bit about exactly
how that happened and what might be good or
bad about it.
And so I really want to focus your attention
on it.
Think about Big Air’s price structure there.
It was able to supply the seat for $200.
And yet it figured out that it should charge
$500.
Let’s look at it first from Big Air’s
point of view, and then from the 1,001st customer’s
point of view.
From Big Air’s point of view, when it dropped
the price… if it tries to drop the price
from $500 to $300, in a way, you might think,
well how can that be a bad thing?
They’re going to take in 1,000 more customers
who are willing to pay $300 a seat for the
privilege of flying, when it only costs Big
Air $200 a seat to supply the airplane and
seats.
So of course, you’d think Big Air would
make more money by lower the price to $300.
Indeed, any price that can charge above $200,
it can make money.
Costs me $200 to make the seat, I charge you
$212; I chalk up another $12 in profit.
But Big Air in this example is a monopolist.
Big Air is the only one flying, and so Big
Air sees and says to itself, well wait a minute.
If we drop the price from $500 to $300 in
order to capture those extra people, we’re
giving up charging $500 to the first 1,000
people we flew.
After all, we have to charge everybody the
same price in this example, like my cookie
guy at the beginning of the lecture.
So is it worth it to Big Air?
No.
Because when it drops the price from $500
to $300, it loses $200 a seat from the first
1,000 people.
And it’s not worth losing $200,000 from
those more intense, desired inframarginal
customers, if you will, in order to make $100,000
from the new 1,000 people who will pay $300
a seat when it costs $200 to fly them.
So Big Air instead chooses, no.
We will restrict output, we say, and fly at
$500 a seat selling then… selling just 1,000
seats rather than 2,000 seats.
From a social point of view, think about it
from the outside or even from the government’s
point of view or the citizenry point of view.
This is really a shame.
After all, the cost of the resources of flying
somebody to New York is apparent $200.
And there are people out there willing to
spend more than $200.
Think of it as a resource, ecology thing.
The costs of the resources on earth are such
that for $200 you could fly another person
from point A to point B. And that somebody
out there willing to spend $300 for it, that
person has a intense preference compared to
the actual cost of doing it, but we deny them
the flights.
We say, “No, no.
Because I am a monopolist and I can make more
money at $500, I don’t want t sell it to
you at $300.
Economists call this a deadweight loss.
They say, boy, that’s a shame.
There should be somebody, there is somebody
willing to supply the seat at a tad over $200,
even $300 in our example and that if somebody
wants to pay $300 for it and yet we’re not
matching them up.
Now you’ve already seen that if this was
a competition, if there were 10 airlines out
there flying, of course another airline like
my cookie maker would jump right in there
and say, “Oh, come here, come here.
We’ll fly you to New York.
Give us $300… we can fly you for $200.
It’s a great deal.”
But again, because Big Air is a monopolist,
it’s the only one flying this route and
the demand structure; the prices are, as we’ve
seen, Big Air will choose to restrict output
to sell only 1,000 at $500 a seat.
We’re not quite telling you the truth in
this example.
Think, as I said, about that 1,001st customer.
There is a customer there who sees that she’s
willing to pay $300.
Sees the price at $500.
It’s as if she wants to whisper to the President
of Big Air and say, “Okay, okay look.
I understand that you don’t want to lower
the price because then you’ve got to lower
it to everybody else and you’ll make less
money, but how about if I don’t tell anybody.
Just sell me a seat for $300, I really want
it badly; give me a seat for $300.
It only costs you $200 to supply it, and then
instead of making $300,000, you’ll make
$300,000 plus the $200 profit… the $100
profit on selling me the seat.”
Well, I guess if Big Air could trust her not
to tell anybody about this and not to resell
the seat to somebody else, Big Air would do
it.
But the important part **** is that we see
that this deadweight loss leaves customers
unhappy, if you will.
Unsatisfied.
There are, again, 1,000 people willing to
pay at least what it costs to supply that
seat and they’re not getting their seat.
Now, in the real world.
Big Air does a little bit of each.
Anybody that has flown an airline knows that
sometimes the person next to you has paid
much more or much less the seat for you.
Anyone in the real world knows that Big Air,
in fact, can do a little bit of this.
They can have it both ways.
If you're flying on an airline and you talk
to the person next to you, you might find
that they paid much more than you paid for
your seat or much less than you paid for your
seat.
Big Air does not quite have to charge everybody
the same for its chocolate chip cookie, if
you will.
There is an ability for it to control arbitrage.
Now in this case, it does it by saying, “ Your
ticket is non-refundable and non-transferable.”
You can’t sell it back to us and just buy
another ticket when the prices drop.
And similarly, you can’t just go to the
airport and trade it with other people.
They may do this maybe hiding behind a false
claim about security or identification or
something.
I mean, it’s not entirely obvious why we
let them do that.
But for the time being they can do that and
this allows them to discriminate in a way.
That’s not meant as a terribly bad word
here, it’s a word economists use to differentiate
among customers.
They are able to take the people who want
to pay a lot of money and charge them a little
bit more and take the people who want to pay
closer to $200 and charge them less.
So in real life, Big Air discriminates among
customers.
And we will return to that in a minute.
But in our example, we are assuming no ability
to discriminate.
It’s like the chocolate chip cookie of the
house; you need to charge everybody the same
amount perhaps because people could exchange
tickets or something.
And again, in that example we’ve now seen
something pretty important.
That the thing economists and governments
don’t like about monopolies is this problem,
and I’m going to call it a problem, that
even though there are people who would pay
more for the seat then it costs to supply
it, they don’t get a seat.
It’s Big Air’s restricting of the seats
from 2,000 to 1,000 in order to make more
money, in order to make $300,000 rather than
$200,000 that is the source of this problem.
And that problem is called by economists,
deadweight loss.
Again, referring to the idea that I would
pay more for the seat than it costs to plan
it, produce it, and yet Big Air is not offering
me the seat.
If you were a couple of steps ahead of me,
you may be wondering if I’ve overestimated
the deadweight loss.
After all, what happens to those people who
wanted to pay more money than it costs to
produce the seat, but were denied by Big Air?
Well, I might drive to New York, I might fly
through Milwaukee to New York, I might go
do something else that day, but whatever else
it does with my $300, I am after all spending
that money somewhere else.
Now think about the average transaction when
you spend $300.
Someone might offer, you know, a Notebook
computer to you for $300 and you might think,
oh great, I actually would have paid $375
for it, but the market, amazing as it is,
is offering this for $300 and you buy it.
Well that extra $75 you would have paid $375,
the market it offering it to you for $300,
that extra bit is the opposite of deadweight
loss.
Like, just as Big Air denied you something
even though you would have paid more than
it cost to make it, here’s an example of
where they don’t extract for you the real
cost of this Notebook computer.
You have $75 of consumer surplus, economists
call it.
You could just think of it as benefit from
living in a civilization or benefit from living
in a market where you are not always the person
who pays just the edgy price that the market
is selling the thing at.
Almost every day when you buy something, you
would have paid a little or a lot more for
it than the person charged you and that’s
a lot of surpluses that you are gaining and
it’s the advantage of living in a civilization.
It’s the advantages of living in a market.
And it is exactly the flip of a coin of the
deadweight loss.
So my first choice of how to spend the $300
might have been to fly to New York on Big
Air and I was willing to pay $300, say, and
they could have supplied it for $200 and they
didn’t give me the seat, I lost $100 in
surplus.
But I probably took that $300 and went somewhere
else and got maybe $70 of surplus or $20 of
surplus.
Not more than $100 of surplus or that would
have been my first choice of the thing to
do rather than to fly to New York on Big Air.
But for everyone who is denied a market here
because of monopolists, that person does have
that money to spend somewhere else and they
get some surplus somewhere else.
And so this example does overstate the deadweight
loss and that’s probably something we should
keep in mind.
But again, the key idea is, is that the monopolist
looks at the market, figures out the demand,
maximizes its price always by remembering
that if it lowers the price, it has to lower
it to all the customers in the examples we’ve
seen.
I’ve already said that in real life, Big
Air does not charge the same amount for each
seat.
But it’s a little bit more clever and it
does differentiate among customers on a plane.
So for example, I might pay $300 for the seat;
the person next to me might have wanted to
get that seat very early and might have paid
$400 for it.
And then it might be somebody who really didn’t
care when she traveled, she waited till the
last minute, there were empty seats, Big Air,
Expedia, Travelocity or somebody offered that
seat at a much lower price.
So Big Air has discriminated among or differentiated
among consumers.
You’ve probably also figured out by now
that that decreases rather than increases
the deadweight loss.
After all, it make it more likely that Big
Air is selling seats that it can make for
$200 to people who are willing to pay more
than $200 for them because it’s already
sold seats to the $500 people and then it’s
able to lower the price without people conducting
arbitrage and trading the seats.
So price discrimination by a monopolist allows
it to make more money, also decreases the
deadweight loss though it might get us a little
nervous for other reasons.
After all, the monopolist is already going
to make much, much more money and there might
be people who don’t like that or they might
worry that the monopolist is setting markets
up on purpose in order to price discriminate.
The important thing though is to see that
it’s decreasing the deadweight loss.
CHAPTER HEADING: Monopolies and government;
strange bedfellows or partners in profit?﻿
Notice that the monopolist doesn’t necessarily
get to keep all this money; the more clever
the monopolist, the more clever the government.
Imagine a very clever monopolist in the computer
world.
The monopolist sees that more people want
to travel on Thanksgiving; it raises the price
of seats.
Nobody wants to travel on Sunday afternoon;
it lowers the price of seats.
It can get much more sophisticated.
It might see from my frequent flyer number
that I’m somebody who really likes to travel
at certain times of day and when I log on
to get a seat, it might charge me more for
a seat at that time.
Programs do this already.
As the plane fills up, as it sees who I am,
it knows more about me.
The more information it has about me, the
more it can see inside my brain, the more
it knows to charge me more in certain situations.
The monopolist can get good at differentiating
among us, perhaps almost perfectly, so that
as we show up, it knows exactly our reservation
price, which is to say, the amount we would
pay and any higher price, we won’t travel.
I guess a good government could take this
money away if it wanted to.
A government might say, “Well, to the extent
that we are giving you the monopoly, after
all, we’re the one that’s deciding how
many planes can land in LaGuardia.
Instead of selling all those landing rights
to Big Air, the government could have set
things up so that Big Air would have competed
with American Airline, United Air Lines and
so forth.
So if the government gives or allows Big Air
this monopoly, the government might say, well
we want to tax away a good deal of that money,
or price it away in order to use the money
for a public works or to build La Guardia,
to expand the runway or what have you.
Well, it’s easy to see how the government
does that.
The government might auction off landing rights.
The government might say, well, we’re willing
to sell the rights to fly 10 planes a day
to LaGuardia, let’s see how much you all
will pay for it.
And they would have a competition among the
airlines and the airlines know how much they
can price discriminate and therefore they
know whether they’ll make that $600,000
or $300,000 or much more than than if they
can discriminate.
And if they can make a million dollars by
charging everybody their reservation price,
then they might bid $800,000 for the right
to land at LaGuardia.
So when you see a monopoly price discriminate,
don’t immediately think that the monopoly
is making all that money, there might be somebody,
and especially the government that’s able
to extract a good deal of that profit through
an auction or a taxing scheme.
The reason why I put the example that way
is I wanted to introduce the idea that for
a monopoly to thrive, it needs to have a way
of preventing competitors from entering the
market.
Sometimes we say that monopolies thrive where
there are barriers to entry.
There has to be something that keeps the competitors
out.
In the cookie case, nothing kept out new bakeries.
And so as soon as the price of cookies started
rising, more people entered the market and
started producing those wonderful chocolate
chip cookies.
In the case of Big Air, it’s the landing
rights at LaGuardia that are the barrier to
entry.
If the government doesn’t have any more
to offer or whoever the port authority who
owns LaGuardia only sells off a certain amount,
that’s a barrier to entry that prevents
other firms from entering.
IPad has patents.
Movies have copyrights.
The bridge over the Mississippi has the situation
of a monopoly by licensing.
Lawyers have some licenses, doctors have some
licenses.
Everywhere we look where there’s some monopoly
power there are some barriers to entry.
And do you see what all these examples have
in common?
It’s that the government, the law, plays
a very, very big role in either creating or
sustaining these barriers to entry.
Indeed, we might say that while it’s true
that monopolies thrive because of barriers
to entry, that’s what keeps the competitors
out.
The barriers to entry themselves either require
government complicity or come about because
of government complicity.
We don’t need to review too much, but let’s
just remember where we are.
We’ve seen that a price discriminating monopolist
can charge people different prices on the
airplane or anywhere else; $500 to this one
$400 for that one, $300 for that one.
It can make even more money that way, though
it might have to give some of the money back
if the original monopoly is auctioned off
to it.
But let’s not lose site of the basic idea
that the run of the mill monopolist, which
can only charge everybody the same price or
they’ll exchange cookies on the sidewalk,
if you will.
That monopolist does need, when it raises
price to sell to fewer people.
That’s what’s creating the deadweight
loss of people who want to pay more than it
costs to produce the thing, but the thing
is not being sold to them.
So, the next time you’re hanging around
with friends, you’re eating pizza, you’re
doing whatever, and somebody says, “What’s
wrong with a monopolist?”
I hope you know the answer.
You take a deep breath and you say, “Well,
there’s this thing called deadweight loss
and…” and then you’re off and running
and you’ve got the picture down.
We can do better than that, but that’s a
great first answer.
Another thing we saw is that most monopolies
come into being or is sustained with the help
of government.
The government gives the right to build across
the Mississippi.
The government gives a patent.
The Constitution tells the government to give
patents.
I’m not complaining about the government
giving patents.
It might be a good way to get innovation out
of people.
But nevertheless, the patent is the right
to be a monopolist.
A copyright is a right to be a monopolist.
A license is often the right to be a monopolist.
A developer’s right to build a skyscraper
might be the right to be the only one to be
able to sell off a space at a given location
or near a given train stop.
The government is intimately involved with
monopolies.
And I don’t just mean patents and copyrights
in our Constitution.
Think about the post office, for example.
Well once upon a time, there was a Constitution
and it gave our government the right to create
currency, to set up a post office, but almost
every other country has the same government-sponsored
monopoly.
Why?
Well it might be a little bit like digging
up the streets putting in cables and pipes.
We don’t really need 10 different couriers
carrying things around door to door.
We don’t want everybody to have the right
to put a little slot in your doorway to get
things in there.
So the government had a monopoly on delivering
the mails.
Maybe it was a good idea; maybe it was a bad
idea.
What became of it?
Well, as we know, that monopoly has become
less and less valuable.
Indeed, the monopoly on the postal service
is a guaranteed way to lose billions of dollars
a year.
No one’s using the postal service.
A part of it is that monopolies are also associated
with a little kind of laziness, or lack of
innovation.
After all, if you’re a monopoly, you might
be able to make a lot of money sending people
to LaGuardia, but after a while, you probably
stop caring about the snacks you’re serving
on board.
I mean, after all, what else are they going
to do?
They’re going to need you to fly to LaGuardia.
It’s a long time before somebody’s able
to break down your monopoly and build a high
speed bullet train or find another way to
get people quickly from point A to point B.
Same thing with the post office, the world
changed.
Fax machines were invented.
Fed Ex came about.
These can all be seen as responses to a monopoly,
in this case a government owned monopoly,
but it could have been any monopoly, but got
a little slow.
And so we often associate monopolies with
the failure to innovate and we associate the
breaking down of monopoly with the extra profit
that spurs innovation.
Would I rather compete with a monopolist or
a chocolate chip cookie maker?
Well, if I can think of a way to break over
that barrier to entry, the monopolist is charging
a very high price; it’s much easier to get
into that market and make a lot of money in
the shadow of the monopoly and to knock down
that Goliath.
The government does not own federal Express,
and Federal Express in a way, is very profitable,
in part because it’s in the shadow of the
government’s monopoly.
Nobody else is allowed to deliver mail to
your front door.
Nobody else can send what we call First Class
mail that way.
Federal Express itself is a little bit of
a mystery, I mean, think about the development
of the fax machine and then email.
You know, once email was invented, why in
the world would anybody send a fax?
I have to say, I find that mystifying and
I think economics offers no great answer to
that, that as we get technology after technology
from birds to mail to stage coach to cars
to one and on and on, Fed Ex, fax machines,
email, texting and so forth, and a little
bit of the previous technology stays in effect,
the monopolies are a little bit broken, but
the government does try to get involved with
each monopoly as it goes on.
It’ll be interesting to see what happens
to the fax machine and email eventually in
this context.
It’ll be interesting to see where the fax
machine is 10 years from now.
Now it’s not just monopolies that suffer
from this problem of innovation.
So I don’t mean to blame everything on them.
If you think of the great American industrial
enterprises of the 18th and the 19th century,
they’re all gone.
The great railroads are no longer here, the
great water companies and power companies,
the great mining companies, they’re just
a shadow of their former selves, and now we’re
accustomed to thinking about Google or Microsoft
and Facebook as the up and coming very large
company.
A chip maker is likely to be the biggest company
now, whereas 50 years ago it might have been
a coal company.
And it’s not because they were monopolies
necessarily, just that large firms might have
trouble adjusting to new technologies, to
innovation and so forth.
Monopolies, however, seem to have the biggest
problem of all.
On the other hand, there are some firms that
survive over a long period of time.
You know, think about the university you are
in now.
Universities that were great 100 years ago
are by and large, the universities that are
great today.
So there’s an industry that seems to have
kept up with the times or have been protected
by other means.
So I don’t mean to say that every great
enterprise is bound to doom, but it is interesting
that the ones that remain alive are intense
competition.
These universities are competing for you,
competing for government grants, competing
for donors; they are really in a very competitive
industry.
And I think it tells us something, that they’re
still around whereas the great industrial
firms of the 18th century are gone.
In our modern world, Big Air has a funny business.
It knows that it needs the government to sustain
its monopoly; it needs those landing rights
at LaGuardia not to be sold to other airlines.
And so, Big Air’s most important business
might not be serving airline snacks, it might
not be training pilots, it might not be learning
about metal fatigue.
It might actually be about learning how to
get along with government.
After all, an important part of its business
is retaining its monopoly, getting those landing
rights at the best available prices, and maintain
them against competition.
Big Air is in the business of seeking help
from the government.
It’s not something we like to say in a capitalist
society, but it is something that’s true.
At the same time, the government, which is
to say our politicians, finds itself in the
business of wanting to do business with Big
Air.
Think about the typical government official.
The government official needs to get reelected.
They need campaign financing, they need money.
Big Air is a natural for contributing to campaigns.
Big Air wants its monopoly, the government
politicians want money to run campaigns, this
is a match made in heaven, or at least in
the skies.
And so Big Air… we need to think about that
part of the monopoly’s business that involved
getting favors or rights out of the government.
Sometimes in economics, we call this “rent
seeking.”
The idea refers to the fact that businesses
need to spend resources in order to get in
the position where they have the monopoly
power.
There is this rent they want, the monopoly
profit, they want that extra money that can
only come by being a monopolist, but they
have to spend money to get there.
And as we are about to see, the extreme case,
they might spend so much money to get that
monopolist, that they’re really not much
of a monopolist at all.
And let’s see how that might happen.
Now in middle school, they taught you; they
taught me too, that governments are perfect.
That the government knows that it needs to
do what’s good for the citizenry, if the
government does a bad job, the voters will
kick the government out of office and get
themselves some new politicians.
Well, in that world, the government will decide
where it wants monopolies.
It might decide, oh, having only one firm
land at LaGuardia is a good idea or we need
to encourage inventors, let’s have patents.
Post office is a good thing.
In other areas it might decide a monopoly
is a bad thing.
The government might do what is in the best
interest of the economy, which is to say,
the citizens at large.
But you know we’re not in middle school
anymore.
And now we know that government politicians
have their own incentives.
And part of their incentives is to get more
money and campaign donations.
Part of their job is to look for jobs for
themselves and their relatives after they
are out of office.
In this kind of world, the government cannot
necessarily be relied on to do what’s good
for its citizens.
And so it’s a good idea for us to keep track
of what’s in it for Big Air, what’s in
it for the government and see how the two
work together.
Think about this.
Someone sitting in the White House, runs for
reelection, might spend these days, a billion
dollars getting reelected; a billion dollars.
President Obama will probably spend about
one billion dollars on his reelection.
And his opponents will probably spend about
the same amount competing for the right to
run against him and then running against him.
That’s two billion dollars in resources
spent on the voters.
It’s very unlikely that a big part of that
two billion dollars is getting us information
that we cannot otherwise get from newspapers
and other sources.
So that’s a kind of waste.
That is, people competing for our votes or
competing for attention might compete with
one another in a kind of arms race where they
spend and spend and spend in order to outdo
one another and actually there’s a lot of
waste involved.
The same thing is true on the other side.
When Big Air and its competitors compete to
get these landing rights at LaGuardia or somebody
competes for the right to build a bridge across
the Mississippi river.
They too might compete with each other and
they might compete so much as to throw the
baby out with the bathwater.
And that’s what we want to turn to next,
to see how rent seeking can be destructive.
This rent seeking idea is not entirely something
new to us.
Think about a typical election.
Partly because they want to get reelected
and partly because they’re in power, and
so there are many donors who want to send
them money in order to get in the good graces
of the government.
At the same time, their opponents compete
in a primary in order to figure out who will
run against the incumbent, and then they too
have to run a campaign in November.
That too can add up to about a billion dollars
these days.
So we have two billion dollars spent every
Presidential election cycle on just one job.
Now an optimist might say that that two billion
dollars goes to informing voters, reminding
them when election day is, by the way it’s
the first Tuesday after the first Monday in
November, don’t forget.
And maybe telling them where the White House
is and what our foreign policy is and so forth.
But most of us think that’s ridiculous.
Most of it is spent on advertisements meant
to appeal to our emotions.
They’re not providing us with information
that we cannot get from other sources.
So we’re wasting a good part of the two
billion dollars in a kind of arms race between
politicians.
Similarly on the other side of the transaction,
donors or monopolists or would be monopolists
are wasting money rent seeking or competing
in order to get this monopoly.
Five contractors might bid against one another
with lunches, jobs for politician’s relatives
and other thing… and worse maybe, all in
order to get a government contract.
And that’s a topic I want to turn to now
and see how it’s possible that rent seeking
can be so destructive.
CHAPTER SUBHEADING: The pay all auction
Politicians spending on a campaign, would-be
monopolists spending for the right to get
the monopoly and countries going to war can
all be thought of in one economic model.
Economists sometimes call this a pay all auction.
And think of the following metaphor.
Imagine an auction in which I bid $10, you
bid $12, she bids $14, going, going, gone,
she gets it.
We call that a standard auction or if you
want to be fancy, an English auction.
It goes to the highest bidder, the highest
bidder pays the amount bid and the highest
bidder then gets that amount.
There are many other kinds of auctions.
In a pay all auction, I bid $10, you bid $12,
she bids $14, maybe I bid $16, then I get
it for $16, but she has to pay $14 and you
have to pay the $12.
That is, it’s pay all.
Everybody needs to pay the amount of his or
her highest bid.
Now you can see right away why this is a popular
way to think about war.
Because if two countries go to war, they spend
a lot of money buying tanks and planes and
they spend a lot of money killing off their
young, and as they invest more and more in
the war, it’s not as if you get these resources
back when the war is over and you lose or
win.
So everybody has to spend the amount that
they’ve spent and they can’t get that
money back.
And as the war drags on, it becomes attractable
having spent a trillion dollars on a war whereas,
oh a little bit more you can outlast the opponent
maybe and beat them and get something for
your whole trillion dollars.
That’s why economists like this idea of
a pay all auction model.
Same thing with a campaign, you spend a lot
of money on your campaign, I run against you
and I spend a lot of money running against
you, one of us wins, none of us gets our money
back.
It’s not like a standard auction where if
you lose, at least you don’t have to pay.
So I use the expression, “pay all auction”
to refer to this idea that in some auctions,
you pay and I pay, one of us wins, but nobody
gets their money back.
It’s like going to war.
You use tanks, you kill people, I use tanks,
I kill people.
One of us wins, but we don’t get our money
back.
In a standard auction, if you bid more for
a house than I did, you pay to get the house,
but I at least get my money back.
A campaign, a war, these seem more like the
pay all auction.
Imagine that big Air values those landing
rights at LaGuardia at $300.
Big Air would pay up to $300 to get those
landing rights, it needs to spend month on
taking politicians to lunch, on giving money
to campaigns, who knows what else, in order
to secure that right.
Big Air starts out by maybe spending $100
hoping to be the highest bidder.
Perhaps American Airlines comes in and bids
$200.
And maybe United Airlines comes and bids $250.
Well think about Big Air’s position now.
It values the rights at $300, it’s already
spent $100, isn’t getting that back.
The highest bid is $350.
It might as well add another $260 to its bid
because that way it will outbid the highest
bidder and it might get the rights even though
it might not want to spend all that money
in the first place if it can start all over
again.
Well if you add all that amount of money,
you get a number much bigger than $300.
So a great amount of money can be spent on
wining and dining politicians and other uses
of resources, maybe even more than the amount
of money than it’s worth to any single competitor.
And again, that’s what we mean by saying
that rent seeking can be very, very wasteful.
So now, if you’re sitting around eating
pizza and somebody says to you, “What’s
wrong with monopoly?”
You’ll have a very sophisticated answer.
You’re first move is, again, to say, “Well,
let me first explain deadweight loss to you.”
But then you can say, “It’s not just deadweight
loss; the deadweight loss problem is exacerbated
by rent seeking.”
Because the deadweight loss, once Big Air
has the monopoly and sells the seats, it sells
too few seats at to high a price, but then
there’s also the loss of Big Air spending
money on wining and dining politicians in
order to get the landing rights at LaGuardia.
The deadweight loss from the rent seeking
might even be bigger than the deadweight loss
from not selling seats to people who are willing
to pay more than the cost of producing them.
Let’s imagine Big Air participating in an
auction in order to get its monopoly in the
first place.
We already know that Big Air can make a lot
of money if it’s the only one flying from
Boston to LaGuardia, but it has to acquire
those landing rights.
And imagine that the government is auctioning
off those landing rights.
So one airline can fly the route.
Big Air is willing to pay up to $300 for it,
let’s imagine.
But maybe American Airlines is willing to
pay $300 as well.
And maybe United is also willing to pay $300.
They can all see they could make a lot of
money being the monopolist here.
Now the government puts it out to bid.
Of course, it might not do that explicitly;
it might be, let’s see who can curry favor
with the politicians.
In that case, the money will really be wasted.
Big Air might jump into the fray and spend
$100 wining and dining and trying to pay off
politicians, but United is not far behind
and it bids $200.
And then perhaps American Airlines goes for
broke and bids $250, it’ll only make $50
if it gets the contract… if it gets the
landing rights because it’s going to make
$300 and has now spent $250.
But from the point of view of Big Air, which
has already invested, you might say, $100,
it pays to invest another $250.
That is, even though it would have spent $350
altogether and lose money on the deal, right
now it’s going to lose $100 and have nothing
to show for it.
So it might be willing to throw in another
$250 to make the $300.
Well following that logic, we can see that
if Big Air does that and actually gets the
landing rights, Big Air will have spent $350
in order to make $300 and American Airlines
would have wasted money and United Airlines
will have wasted money and the over all rent
seeking can be quite large.
So now, when you’re sitting around having
pizza and somebody says to you, “Ah, what’s
wrong with a monopoly anyway?”
You’re really ready to go.
You start off again with deadweight loss and
you show how people who might be willing to
pay $300 for an airline seat or $500 for an
airline seat might be denied that seat even
though the airline can produce it for $200
because the airline has raised price and cut
back on output in order to maximize its profits.
There’s the first piece of deadweight loss.
But now that deadweight loss might be doubled
or something by the other part of the transaction
in that Big Air and it is competitors seeking
to be this monopolist in the first place might
waste a lot of money wining and dining politicians
or doing other things in order to get the
monopoly in the first place.
I guess the problem could be even worse, it
could be trouble.
Politicians might change things; maybe the
government knows that really, the best way
to run LaGuardia is to have three competing
airlines.
But in its quest to get all this wining and
dining and campaign contributions, the government
might inefficiently set up LaGuardia only
to handle one airline in order to get rent
seeking from the airlines.
So you see how monopolies and the structure
of government begin to fit together.
The monopolist gets to make more money once
it’s a monopoly, but in order to be a monopoly,
it often needs the government’s help.
And in turn, the government might sometimes
need the monopoly in order to fuel the politicians
and their preferences.
This is the very unhappy side of monopoly.
Moreover, in our world, the most important
items are no longer heavy items that are hard
to transport, but they’re services where
healthcare and legal services and accounting
and computer services and the like.
And these seem to be offered in the worldwide
market.
So we think about the monopoly problems associated
with them, but we’re more likely to think
that there are network effects, meaning a
good solution in one place can spread out
and expand to other places.
CHAPTER HEADING: Putting it all together;
The seamless web that is economics
I hope you’re beginning to see what a seamless
web is, this thing we call Economics.
We started out with prices and the prices
were the little messengers that ran back and
forth coordinating supply and demand.
We saw that competition is what happened in
the market to create these exchanges.
Then we introduced the idea of a monopolist.
The monopolist had a market to himself.
He was the only one selling the thing and
he could sell the item at a higher price by
cutting back on the output.
Albeit by creating deadweight loss so that
there were people who’s demand was unsatisfied
even though they wanted to pay a price that
the earth could supply the good for.
That was the bad side of monopoly.
We also saw that there might be a good side
to monopoly.
The government might want monopolies to create
incentives for innovators.
The government might want a monopoly to spread
the letters around through the postal service.
The government in the beginning was seen as
the good player that tried to figure out where
monopolies were good and where monopolies
were bad.
Then we introduced complexity and saw, well,
the government might not be such a good player.
The government might like some monopolies
and have in interest in this rent seeking,
in this play by the monopolists to get in
position where they could charge these high
prices and keep up barriers to entry that
would keep out lower priced competitors.
In that case, the government is not the solution,
but part of the problem.
So we had sort of a complex mix where everything
you see in government, in monopoly, in competition
and prices begins to interact with one another.
I told you a little bit of time ago.
I said earlier that in economics, the big
questions could be decomposed into little
questions.
And maybe now it’s time to work our way
back up to some big questions.
Let’s think about the recent housing bubble
we experienced.
I think we all have the same picture which
is housing prices were going up and up.
People were borrowing more and more money
on these houses.
Bank perhaps were too free to lend money giving
people mortgages on houses that might have
not been so valuable.
And eventually the housing market collapsed.
People were left holding houses that really
weren’t worth the amount of money they had
borrowed.
People were walking away from the mortgages.
Banks were in trouble, there was colossal
financial failure.
Big Wall Street firms were in trouble.
The government thought it had to step in and
so forth.
How could such a housing bubble occur ? If
economics is so good, if these prices are
these clever little messengers I’ve described,
why didn’t these messengers do their job?
Why didn’t they run back and forth and say,
“Whoa!
The price is just too high, don’t buy housing.
Don’t construct more.”
Instead, we had people all over the country
building houses even though houses are now
decaying empty in Nevada and California and
Florida and elsewhere.
Something went wrong, and maybe economists
are to blame.
First let me defend economists.
You might say, how can economists not see
the housing bubble?
I’m afraid the answer to that is like saying,
how can meteorologists not predict the weather
next July 4th or how could physicists not
know where I’ll be standing in two weeks?
It’s true that every motion I make between
now and two weeks from now is easily described
by the laws of physics.
There’s gravity and motion and mass times
velocity and each step is very, very easy.
But how they all come together and how in
two weeks I’ll be standing wherever I am
seems like a problem way beyond any of today’s
physicists or psychologists, and the same
with meteorology.
We might be very good at predicting weather
eight hours from now, 24 hours from now, but
predicting the weather three days from now
turns out to be a massively difficult task.
But, economists are no better at predicting
future fads than meteorologists are at predicting
the weather next year or physicists are at
predicting where I will be in two weeks.
That’s the way it is in some parts of economics.
Economists are very, very good at knowing
if the price of wheat goes up now, here’s
what will happen tomorrow.
And they’re very good at some long-term
forecasting too.
But knowing what will happen in the long run
in the housing market turns out to be very
complicated.
One reason it’s complicated is that people
are not just buying houses to live in them;
they’re buying houses as an investment.
They’re buying houses because they’re
afraid that if they don’t buy the house
the house will go up on value and they won’t
be able to afford the same house later on.
They are, in a sense, speculating in housing
even as they’re also living in it.
It’s very tricky to figure out people’s
speculation because it’s about the psychology
of everyone thinking prices are going up,
I better buy, buy, buy now.
And that’s what we mean by a bubble.
We mean that people are afraid to stay out
of the market because they’re afraid prices
will rise.
So they buy the item in question or they see
everyone else making money and they think,
I’ll make money too.
But then the price ends up having little to
do with their actual demand for the product
that is their actual preference for it.
And certainly has very little to do with the
actual cost of the assembly and the inputs.
I’ve already promised that we’ll never
see a bubble in chocolate chip cookies.
I think you can see why.
It’s unlikely that anybody will need to
speculate in it.
Why would you ever speculate in a chocolate
chip cookie?
If you really like cookies and you’re afraid
the prices will go up and up and up, well,
buying the cookie now won’t do any good.
It’s just going to get stale and you’ll
just count on more bakers entering into the
market, baking new cookies later on.
You’ll know that you can always buy them
based on the price of the inputs.
I doubt there will very be a bubble in rental
prices for housing even.
Again, it’s a short-term market.
People are not speculating in it.
They can live in a place and then wait and
then a year later rent somewhere else.
So bubbles occur more in things that are being
held for their speculative value.
You might invest in art.
Art could have a bubble.
And housing can have a bubble as well.
The bubbles are most like to arise where people
are speculating on the future and where there
are fads.
People just don’t know whether a given artist
will be popular in the future.
They might buy, buy, buy thinking it will
go up.
They might buy housing thinking people will
like this kind of housing or that housing
will be too expensive for them to afford in
the future.
It’s very unlikely to happen in short-term
markets, in markets of things that go stale.
It’s much more likely to happen in things
that involved fads or fashions and it could
happen even in commodities.
People might buy silver or coal fearful that
the price will go up and not sure that new
miners can bring the coal out of the ground
at a reasonable price.
Some people have faith that governments can
intervene and control these bubbles.
You know, in the housing case, the government
did not see the bubble coming any more than
the private market saw the bubble coming.
So there’s a lot of disagreement among economists
about whether the government is part of the
problem or part of the solution in bubbles.
Again though, that’s something you need
to study in the future because we can’t
afford too many bubbles in your lifetime.
Well you know, only because people think why
didn’t economists tell us that housing was
overpriced?
And then we would have cut back on mortgages
or something.
Whenever we have a bubble that bursts or a
recession or a Great Depression, it’s natural
for people to blame economists.
It’s like, if you have bad weather, blame
the weather forecaster for not telling you
about it in advance.
So maybe economists should have seen the housing
bubble.
Maybe if prices were these great little messengers
running around, as I insist.
Maybe economists should have seen those prices
doing their job and they should have said,
“Oh, oh, housing is too expensive,” and
encourage the government not to let banks
lend so much money or not to support mortgages
as much and maybe we could have softened the
recent great recession.
Do you remember Todd, on the airplane?
I suggested to Todd that he really needs to
think more about prices and how monopolies
are put together.
He really faced a monopoly.
He wanted an aisle seat; he was a polite guy
sitting in the middle.
He turned to the person next to him and offered
him $50 for the seat.
But that aisle seat holder, in a sense, was
a monopolist knowing that he was the only
one that Todd could bargain with to sell the
seat.
And sure enough, the monopolist cut back on
out put and raised price, only two out of
13 sold their seats to Todd and on apparently
at $300.
Well I think you now know what to advise Todd.
You should do what I told him.
I told Todd, when you get on an airplane the
next time and you see you’re in the middle
seat, immediately talk to four or five people
who have aisle seats in the vicinity near
where you are about to go and say to the four
of them.
“Okay, I’m a tall guy.
I really want an aisle seat.
I have been known to pay $20 or even up to
$40 for an aisle seat.
Anyone of you want to do it?”
That will create some competition among those
four people and rather than being one monopolist
who can sell the seat, there will be four
people who do that.
Well once you see that idea, you can see that
staying away from a monopoly is a way to get
a lower price.
And sure enough, that’s what Todd does.
I’m happy to report that Todd is now a consultant
who does a great deal of travel, probably
gets to fly first class, but when he flies
coach, eh says he often makes this offer to
four or five people in the aisle and regularly
pays $40 for his seat.
So breaking the monopoly was a way for Todd
to lower the price.
I don’t think Todd’s strategy or I should
say, my strategy for Todd is going to work
very long, and maybe you see why.
Over time airlines will gather more and more
information about us and they’ll realize
that somebody is selling a seat to Todd for
$40 when that $40 could have been the airline’s
money.
So the airline should be selling Todd the
aisle seat for $40 or maybe even working out
exchanges among seats.
Think how good the airline could be about
this.
It knows who’s in every seat, it knows a
lot about their seating preferences and it
can gather information from past sales and
past flights about how much people will pay
for aisle seats on given flights.
I suspect that within a year or two, the airline
will be offering trades that it will be itself
a market maker arbitrager of seats on planes.
That should remind you in a way of other companies
that capitalize on information they have in
the internet age and use them to create markets.
So for example, when you go to supermarket
check out, that barcode inform is being recorded
by the supermarket.
Now it’s, you know, a little bit pathetic.
They say, “Oh, 30 percent off on bananas
for you because I see you like bananas.”
But think about all the information they have
and all the things they can do with it.
They might be able to raise prices for you
on some things; they might know that more
people buy things on rainy days and sunny
days.
They might make specific recommendations for
you.
In the long run it’s probably great.
There is nothing I would like more than a
seller to know everything about me and know
all my preferences.
I could walk in the store and rather than
going up and down the isles, the seller could
just roll up a basket of goods and say, here’s
what you want and here’s our price.
That would be fantastic.
That’s probably the direction we’re heading
in, all jokes aside is that is that the more
information the airline has about me the more
information the supermarket has about me,
the less it will be about price and the more
it will be about assembling things that meet
my preferences with price just one attribute
to work out at the end.
Sixty years ago most people thought monopolies
were just down right bad.
They had figured out deadweight loss, and
they didn’t like the fact that monopolies
restricted output in order to raise prices
and deny people things they otherwise would
have bought.
About 20 years ago, people thought monopolies
were doubly bad because added to the deadweight
loss was the rent seeking insight we’ve
seen.
And they thought… people thought, not only
are monopolies bad because of deadweight loss,
but there’s extra loss created by the monopolies
competing to be monopolies in the first place
by wasting money on politicians or on advertising
or on other things that might give them this
monopoly position.
In the internet age, things have turned around
a little bit.
We begin to appreciate the good sides of a
monopoly as well.
First of all, we live in a global world.
It’s harder to be a monopolist of most good
because goods can be transported from other
countries.
You don’t just need a monopoly in Washington
or in your state capitol; you need a worldwide
monopoly unless the good is very, very heavy
to transport.
And so there’s more competition from abroad.
If we see window seven having a great market
share, we immediately think, “Um, I wonder
if there will be competition from China?”
Whereas, 50 years ago, people would have seen
a typewriter come out and they would have
thought, oh this is a really bad monopoly
because it will be very expensive to bring
in Italian typewriters.
So in a global world, we’re less concerned
about traditional monopolies, perhaps a little
bit more interested in intellectual property
and those kinds of monopolies, and we’re
looking to see where the new competition might
come from.
By now you know that I’m going to go back
to my central theme of prices.
Think about prices in the global economy.
How do we know where to get things from?
Why is iPad outsourced to China?
Again, it’s prices that are traveling the
globe.
Apple wants a component, it tries to figure
out who can make that most cheaply, the component
can be made most cheaply in one location,
people will pay more for the iPad at another
location, the prices race back and forth faster
than the iPad.
And eventually the iPad finds its way from
the maker to the end user.
The prices are therefore a way to think about
countries and their role in the world economy.
Think in this case about your future where
India and China are the growing economic powers
of the day.
And think how different those economies are
and how they rely on monopoly rent seeking
and prices.
It’s a good example for us of things that
we’ve learned.
Now, take the case of China first.
China is not outwardly a capitalist economy,
though it has a lot of capitalism in it.
It brilliantly uses local governments in competition
with one another.
So local government officials want to be promoted,
they want to make it to the Central Committee;
they want to get more payments.
They do this by showing that in their region
of the country, standards of living are rising;
people are safer, there aren’t a lot of
deaths from earthquakes or industrial accidents
and so forth.
Competition among local governments seems
to be the key of what makes China work.
Prices help China interact with the rest of
the world, but within China, power relationships
and competition seems to be what makes it
work.
It’s a top down economy in a way where people
at the grassroots are operating in order to
advance in power and wealth.
India is a very, very different kind of economy.
In the Indian economy the government famously
has trouble producing infrastructure.
There are many cities in India where upper
middle class people and certainly wealthy
people are paying for health, education, even
water in the private market.
There’s nominally a government supplied
system, but then there’s a very now, well-developed
grassroots system where entrepreneurs step
in where government fails and entrepreneurs
offer this.
In that kind of system, prices play a key
role.
If I want water and I want clean water, I
go see who provides the water best.
In China if I want water and the water’s
bad, I hold the strike and I complain and
then the media pick up on it and the local
government official is embarrassed and says,
“Oh, people here have unrest.”
Unrest is a terrible thing and before the
local official can be slapped out of position
by the Central Party, the local official has
an incentive to supply water better and improve
the infrastructure.
India, prices and markets.
China, power, rent seeking, monopoly, competition
among these monopolies, the government comparing
them one to another.
We don’t know which works better.
China takes your breath away if you’re an
economist.
If you’re an economist in my generation,
you were brought up thinking that central
planning fails, only markets can do the job,
and only prices as messengers running around,
that’s the only way to make the world go
faster.
And now suddenly we find that our major economic
competitor is really only using prices modestly
instead are using non-priced things including
power structures and promotions to fuel the
economy.
And they’re not bad at it.
There are roads in China and factories and
railroads and gas supplies, it’s fantastic.
And bridges go up and buildings go up quickly.
And they’re not going up quickly because
the little prices are going around as messengers.
They’re going up quickly because a very
clever government that has thought about rent
seeking and thought about how to eliminate
corruption and wining and dining has tried
to figure out how to get people to compete
that the buildings there will go up faster,
better and safer than the building over there.
It’s a very, very impressive feat and it’s
a big challenge for economics in your generation.
Look at the distance we’ve traveled together
today.
We started with airplane seats and chocolate
chip cookies and houses and we found our way
to landing rights at LaGuardia and to tulips
in the Netherlands and to skyscrapers going
up and to India and China and back again to
airlines and all over the place.
That’s what the great thing about economics
is.
Economics is a set of tools that helps you
understand, interpret and improve the world
around you.
It’s unbelievably exciting.
In **** Law, economics helped me make law
from a dry subject where one memorized a bunch
of rules, found in a dusty treatous[ph] into
a live thing where you could use law to change
people’s behavior.
Economics is everywhere around us, it’s
easy to access and it comes with a set of
tools that you get better and better at using.
It’s unbelievably exciting.
Economics is now a tool for you.
Economics is now a way that you’re going
to improve the world around you.
Economics is the way that you’re going to
understand your cell phone carrier and why
taxis cost what they do and why drinking straws
are free, why they supply them with some drinks
and not others.
You’re going to understand travel better
and the world better and foreign affairs better.
Use prices, think about monopolies, use theories
about how people compete and how they act
to change human behavior.
It’s a bunch of tools to put in your hand
to understand the world around you.
Go learn more about it.
Go understand the world about you and go make
it a better place.
Thank you very much and good luck.
