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PROFESSOR: Now, what we're going
to do today is build on

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00:00:24,530 --> 00:00:28,520
what you learned in
section on Friday.

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00:00:28,520 --> 00:00:34,470
On Friday, you learned about how
supply and demand interact

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to yield equilibrium.

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00:00:36,910 --> 00:00:39,750
So the sort of fundamental
concepts we talked about with

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Adam Smith and his water-diamond
paradox of

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supply and demand interacting
to yield a

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00:00:45,120 --> 00:00:46,940
market price and quantity.

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00:00:46,940 --> 00:00:48,950
And the way we're going to build
on your understanding of

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00:00:48,950 --> 00:00:53,050
this today is talk about what
happens when you shock that

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00:00:53,050 --> 00:00:54,440
supply and demand equilibrium.

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00:00:54,440 --> 00:00:57,970
When things change, how does
that change that supply and

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00:00:57,970 --> 00:00:59,110
demand equilibrium?

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00:00:59,110 --> 00:01:00,090
And that'll help build your

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00:01:00,090 --> 00:01:02,710
understanding of what you learned.

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00:01:02,710 --> 00:01:05,950
So to review, let's go to our
basic supply and demand graph,

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00:01:05,950 --> 00:01:08,880
Figure 2-1 in the handout.

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00:01:08,880 --> 00:01:11,150
You talked in section about
the market for pork.

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00:01:11,150 --> 00:01:12,480
That's the market
Perloff uses.

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00:01:12,480 --> 00:01:15,700
Seems good as any, so we'll
continue to rely on that, the

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00:01:15,700 --> 00:01:16,880
market for pork.

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00:01:16,880 --> 00:01:22,740
And in this pork market, you
have a demand curve and a

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00:01:22,740 --> 00:01:24,620
supply curve.

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00:01:24,620 --> 00:01:29,500
Now, it's critical to remember
what these curves represent.

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00:01:29,500 --> 00:01:33,930
Once again, for this course,
ideally, you understand all

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00:01:33,930 --> 00:01:37,660
concepts on three levels,
intuitively, graphically, and

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00:01:37,660 --> 00:01:39,570
mathematically.

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00:01:39,570 --> 00:01:42,250
But the intuitive is the most
important, especially for

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00:01:42,250 --> 00:01:44,030
those of you who aren't going
to go on and do a

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00:01:44,030 --> 00:01:44,705
whole lot of economics.

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00:01:44,705 --> 00:01:47,330
For instance, where it's just
one of the few economics

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00:01:47,330 --> 00:01:50,290
courses you'll take, it's very
important for your lives and

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00:01:50,290 --> 00:01:52,420
using economics you understand
this intuitively.

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00:01:52,420 --> 00:01:54,820
So intuitively, let's talk about
what the demand curve

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00:01:54,820 --> 00:01:56,550
represents.

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00:01:56,550 --> 00:01:58,460
Can anyone tell me, what's the
demand curve represent, from

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00:01:58,460 --> 00:02:00,780
what you learned on Friday?

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00:02:00,780 --> 00:02:02,450
Can anyone just take a shot?

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00:02:02,450 --> 00:02:03,730
We're just--

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00:02:03,730 --> 00:02:04,842
yeah, go ahead.

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00:02:04,842 --> 00:02:06,420
AUDIENCE: The willingness
of consumers to

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00:02:06,420 --> 00:02:07,097
buy a certain product.

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00:02:07,097 --> 00:02:07,830
PROFESSOR: Exactly.

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00:02:07,830 --> 00:02:09,490
The willingness of consumers--

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00:02:09,490 --> 00:02:11,660
I'm going to change your words
just a bit, because words are

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00:02:11,660 --> 00:02:11,740
important here.

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00:02:11,740 --> 00:02:13,930
The willingness of
consumers to pay.

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00:02:13,930 --> 00:02:15,540
The willingness to pay.

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00:02:15,540 --> 00:02:18,260
The difference with buy is
it's really because the

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00:02:18,260 --> 00:02:19,340
different amounts.

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00:02:19,340 --> 00:02:21,580
They're going to be willing
to pay different amounts.

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00:02:21,580 --> 00:02:27,220
So it's the willingness of
consumers to pay for the good.

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00:02:27,220 --> 00:02:29,230
The willingness of consumers
to pay for the good.

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00:02:29,230 --> 00:02:34,260
So what this says is that each
point in the demand curve

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represents the price consumers
are willing to

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00:02:37,590 --> 00:02:39,240
pay for that quantity.

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And it's downward sloping.

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00:02:40,740 --> 00:02:44,110
The demand curve is downward
sloping because as the price

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goes up, consumers are willing
to buy less of a good.

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00:02:54,680 --> 00:03:00,910
So their willingness
to pay changes.

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So that's the demand curve.

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Now what about supply curve?

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What's a supply curve
represent?

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Anyone?

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Yeah?

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AUDIENCE: Pretty much
the opposite.

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00:03:10,260 --> 00:03:13,660
The willingness of producers
to produce, like, how much

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00:03:13,660 --> 00:03:15,612
they are going to charge for--

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PROFESSOR: Yeah, the willingness
of producers to

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supply the good.

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So how much they're going
to charge for a given

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quantity of the good.

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00:03:21,400 --> 00:03:26,440
And once again, that is upward
sloping because as the price

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00:03:26,440 --> 00:03:30,480
rises, they're willing
to supply more.

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So as the price rises, consumers
demand less.

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00:03:34,290 --> 00:03:38,270
As the price rises, producers
produce more.

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And equilibrium is that point
where supply equals demand.

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Equilibrium equals happiness.

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00:03:45,680 --> 00:03:50,280
It's the point where suppliers
and demanders are both happy.

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00:03:50,280 --> 00:03:57,200
They're both happy because at a
point such as e, the amount

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00:03:57,200 --> 00:04:01,370
that consumers demand at that
price is equal to the amount

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00:04:01,370 --> 00:04:04,330
suppliers are willing to
supply at that price.

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00:04:04,330 --> 00:04:05,680
So jointly happy.

91
00:04:05,680 --> 00:04:07,880
You've reached a point where
consumers want a certain

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00:04:07,880 --> 00:04:09,310
amount at a certain price.

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00:04:09,310 --> 00:04:11,890
At that price, producers say,
great, you want e, I'm happy

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00:04:11,890 --> 00:04:13,450
to produce e at that price.

95
00:04:13,450 --> 00:04:16,339
So we've reached equilibrium.

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00:04:16,339 --> 00:04:19,800
Now, let's talk about what
happens when we shock that

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00:04:19,800 --> 00:04:21,800
equilibrium.

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00:04:21,800 --> 00:04:24,340
This is the market for pork.

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00:04:24,340 --> 00:04:30,680
Imagine that the price
of beef rises.

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00:04:30,680 --> 00:04:33,060
The price of beef rises.

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00:04:33,060 --> 00:04:34,750
Can anyone give me a guess as
to what that does to the

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00:04:34,750 --> 00:04:36,900
market for pork?

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00:04:36,900 --> 00:04:37,980
The price of beef rises.

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00:04:37,980 --> 00:04:40,200
What does that do to the
market for pork.

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00:04:40,200 --> 00:04:40,515
Yeah.

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00:04:40,515 --> 00:04:41,604
AUDIENCE: It reduces
the demand.

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00:04:41,604 --> 00:04:42,380
PROFESSOR: It what?

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00:04:42,380 --> 00:04:43,750
AUDIENCE: Reduces the demand.

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00:04:43,750 --> 00:04:45,300
PROFESSOR: Why would it reduce
the demand for pork?

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00:04:45,300 --> 00:04:48,485
AUDIENCE: Because the
price [INAUDIBLE].

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00:04:48,485 --> 00:04:50,520
PROFESSOR: But I didn't say
the price of pork rises.

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00:04:50,520 --> 00:04:52,290
The price of beef rises.

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00:04:52,290 --> 00:04:54,032
And how does beef
relate to pork?

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00:04:54,032 --> 00:04:55,298
AUDIENCE: They're substitutes.

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00:04:55,298 --> 00:04:57,080
PROFESSOR: They're
substitutes.

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00:04:57,080 --> 00:04:57,820
Exactly.

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00:04:57,820 --> 00:05:01,250
So when the price of beef
prices, how does that affect

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00:05:01,250 --> 00:05:03,380
people's demand for pork?

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00:05:03,380 --> 00:05:04,610
Increases it.

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00:05:04,610 --> 00:05:05,360
Exactly.

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00:05:05,360 --> 00:05:06,580
Because they're substitutes.

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00:05:06,580 --> 00:05:08,650
What we're going to learn
critically as we go through is

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00:05:08,650 --> 00:05:11,280
what's going to determine
these demand curves

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00:05:11,280 --> 00:05:14,420
importantly is going to be
substitutability across goods.

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00:05:14,420 --> 00:05:18,500
So here we have a situation
where the substitute for pork

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00:05:18,500 --> 00:05:20,440
has gotten more expensive.

127
00:05:20,440 --> 00:05:23,940
As a result, people
want more pork.

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00:05:23,940 --> 00:05:28,070
That is a shift out in the
demand curve, or a shift up in

129
00:05:28,070 --> 00:05:29,720
the demand curve.

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00:05:29,720 --> 00:05:33,580
A shift up or out, depending on
it's out into space or up

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00:05:33,580 --> 00:05:35,800
vertically in the
demand curve.

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00:05:35,800 --> 00:05:39,960
So what happens here is that
folks shift to consuming pork,

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00:05:39,960 --> 00:05:42,450
so they want more of it.

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00:05:42,450 --> 00:05:43,950
So we're initial equilibrium--

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00:05:43,950 --> 00:05:45,040
we just made up some numbers--

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00:05:45,040 --> 00:05:50,030
we're initial equilibrium here
at 220 millions of kilograms

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00:05:50,030 --> 00:05:54,500
of pork a year and a price
of $3 a kilogram.

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00:05:54,500 --> 00:05:56,100
That was the initial
equilibrium.

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00:05:56,100 --> 00:05:57,340
That was the point where
demanders and

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00:05:57,340 --> 00:05:59,260
suppliers were happy.

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00:05:59,260 --> 00:06:03,550
Now the price of beef has
gone up, maybe because--

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00:06:03,550 --> 00:06:04,470
I don't know.

143
00:06:04,470 --> 00:06:06,900
Mad cow disease or something
like that has raised

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00:06:06,900 --> 00:06:08,980
the price of beef.

145
00:06:08,980 --> 00:06:12,210
So now people are saying,
hey, we want more pork.

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00:06:12,210 --> 00:06:14,450
That shifts the demand
curve out.

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00:06:14,450 --> 00:06:19,350
Initially, if the price stayed
at $3, if the price remained

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00:06:19,350 --> 00:06:21,530
at $3, what would happen?

149
00:06:21,530 --> 00:06:24,250
What would happen is people
would now-- and once again,

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00:06:24,250 --> 00:06:25,110
these numbers are made up.

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00:06:25,110 --> 00:06:27,700
But this is just to illustrate
an example.

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00:06:27,700 --> 00:06:32,740
People would now say, gee, at a
price of $3 and this further

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00:06:32,740 --> 00:06:35,000
out demand curve-- now I'm on
Figure 2-2, if you haven't

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00:06:35,000 --> 00:06:36,950
picked that up--

155
00:06:36,950 --> 00:06:40,580
I want 232 millions of kilograms
of pork a year--

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00:06:40,580 --> 00:06:41,570
not I, personally.

157
00:06:41,570 --> 00:06:43,400
That'd be like Homer.

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00:06:43,400 --> 00:06:47,920
Everybody wants 232 millions of
kilograms of pork a year.

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00:06:47,920 --> 00:06:49,620
I hope you guys don't get tired
of Simpsons references.

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00:06:55,080 --> 00:06:57,830
So what that says is consumers
say, gee, I want a lot more

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00:06:57,830 --> 00:06:58,670
pork at that price.

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00:06:58,670 --> 00:07:01,300
If it's going to be $3, and the
price of beef just went

163
00:07:01,300 --> 00:07:04,110
up, I'm going to want
a lot more pork.

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00:07:04,110 --> 00:07:07,750
So what you're going to have
initially is excess demand,

165
00:07:07,750 --> 00:07:11,900
because at that price of $3,
suppliers are only willing to

166
00:07:11,900 --> 00:07:16,020
supply 220 million kilograms.
They were happy, right?

167
00:07:16,020 --> 00:07:18,590
They were happy at point e1.

168
00:07:18,590 --> 00:07:21,200
When you come along, and you say
consumers now want more,

169
00:07:21,200 --> 00:07:23,980
they say, well, we're
not happy to provide

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00:07:23,980 --> 00:07:25,280
more at that price.

171
00:07:25,280 --> 00:07:27,560
If you want more, we're
going to have to

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00:07:27,560 --> 00:07:30,050
charge a higher price.

173
00:07:30,050 --> 00:07:34,810
So they say, if you want more
pork, we're going to have to

174
00:07:34,810 --> 00:07:35,750
produce more.

175
00:07:35,750 --> 00:07:39,060
So we are going to slide
up the supply curve.

176
00:07:39,060 --> 00:07:47,580
So if you start at a point like
e1, they say, gee, you

177
00:07:47,580 --> 00:07:48,580
want more pork?

178
00:07:48,580 --> 00:07:51,850
Well, we're going to have to
slide up that supply curve.

179
00:07:51,850 --> 00:07:55,100
So we're moving up the supply
curve and saying, we're going

180
00:07:55,100 --> 00:07:59,890
to have to charge you a higher
price if you want more.

181
00:07:59,890 --> 00:08:02,640
Well, as the price goes
up, consumers say,

182
00:08:02,640 --> 00:08:03,330
well, wait a second.

183
00:08:03,330 --> 00:08:07,160
If the price is going up, I
don't want quite as much more.

184
00:08:07,160 --> 00:08:11,390
And you meet at the new
equilibrium e2.

185
00:08:11,390 --> 00:08:13,835
So what happens is producers
say, gee, if you want more,

186
00:08:13,835 --> 00:08:15,970
I'm going to charge you
a higher price.

187
00:08:15,970 --> 00:08:17,540
Consumers say, well, gee, if
you're charging a higher

188
00:08:17,540 --> 00:08:21,480
price, I'm going to go back
up the demand curve.

189
00:08:21,480 --> 00:08:24,120
I don't quite want as much
at that higher price.

190
00:08:24,120 --> 00:08:26,150
And the new equilibrium is e2.

191
00:08:26,150 --> 00:08:29,050
That's where consumers and
producers are now happier with

192
00:08:29,050 --> 00:08:30,550
that outward shift
in demand curve.

193
00:08:30,550 --> 00:08:33,940
But the key point is consumers
are not getting as much as

194
00:08:33,940 --> 00:08:36,240
they originally wanted at the
original price, because the

195
00:08:36,240 --> 00:08:38,360
original price will not hold.

196
00:08:38,360 --> 00:08:39,620
The price is going to change.

197
00:08:39,620 --> 00:08:41,299
Given the price is going
to change, the

198
00:08:41,299 --> 00:08:42,890
quantity is going to change.

199
00:08:42,890 --> 00:08:45,300
And you end up with both a
higher price and a higher

200
00:08:45,300 --> 00:08:46,980
quantity for pork.

201
00:08:46,980 --> 00:08:47,640
So think about it.

202
00:08:47,640 --> 00:08:48,500
This is pretty interesting.

203
00:08:48,500 --> 00:08:51,840
The price of beef rising raised
the price of pork.

204
00:08:51,840 --> 00:08:54,020
It didn't just increase the
demand for pork, but through

205
00:08:54,020 --> 00:08:55,970
increasing the demand,
it raised the price.

206
00:08:55,970 --> 00:08:59,170
So price in one market affects
the price in another market,

207
00:08:59,170 --> 00:09:00,770
not just the quantity but the
price in another market.

208
00:09:00,770 --> 00:09:02,400
And that's our new
equilibrium.

209
00:09:02,400 --> 00:09:04,670
That's the shift in
the demand curve.

210
00:09:04,670 --> 00:09:07,390
And once again, suppliers
and demanders are happy.

211
00:09:07,390 --> 00:09:09,250
They're happy at this new
point e2, this new

212
00:09:09,250 --> 00:09:13,220
equilibrium, because given the
new demand curve, at a price

213
00:09:13,220 --> 00:09:19,382
of $3.50 a kilogram, producers
are happy to produce the 228

214
00:09:19,382 --> 00:09:23,860
million kilograms of pork a
year that consumers want.

215
00:09:23,860 --> 00:09:26,050
And at that price, that's
what consumers want.

216
00:09:26,050 --> 00:09:28,250
If they're going to say, oh,
it's $3.50, I want about 228.

217
00:09:28,250 --> 00:09:31,170
I want more than I wanted
before, because beef's gotten

218
00:09:31,170 --> 00:09:33,420
more expensive, but not as much
as I would have wanted if

219
00:09:33,420 --> 00:09:34,950
you hadn't increased
your price.

220
00:09:34,950 --> 00:09:37,000
And that's the new equilibrium
is e2.

221
00:09:37,000 --> 00:09:37,470
Yeah.

222
00:09:37,470 --> 00:09:40,525
AUDIENCE: But is it possible
that changing the price of

223
00:09:40,525 --> 00:09:42,980
pork could affect the
price of beef?

224
00:09:42,980 --> 00:09:45,310
PROFESSOR: Excellent.

225
00:09:45,310 --> 00:09:48,130
So the question is, could there
be a feedback effect

226
00:09:48,130 --> 00:09:50,440
where, basically, now the pork
market's changed, could that

227
00:09:50,440 --> 00:09:52,770
go back and affect
the beef market?

228
00:09:52,770 --> 00:09:54,640
In principle, yes.

229
00:09:54,640 --> 00:09:55,830
In practice, we're going
to make your life

230
00:09:55,830 --> 00:09:57,700
easy by saying no.

231
00:09:57,700 --> 00:09:59,180
In principle, it could.

232
00:09:59,180 --> 00:10:02,390
And that gets into something
called "general equilibrium."

233
00:10:02,390 --> 00:10:05,310
And that's way too complicated
for this course, so we are

234
00:10:05,310 --> 00:10:08,600
going to ignore those kinds of
feedback effects for now.

235
00:10:08,600 --> 00:10:11,220
That's something you can learn
about more in future courses.

236
00:10:11,220 --> 00:10:11,990
But you're right.

237
00:10:11,990 --> 00:10:16,350
In principle, it could affect
the demand for everything.

238
00:10:16,350 --> 00:10:19,600
You could imagine that as the
price of beef goes up, that

239
00:10:19,600 --> 00:10:21,020
means that, for example,
the cost of

240
00:10:21,020 --> 00:10:22,720
restaurant meals goes up.

241
00:10:22,720 --> 00:10:24,175
So I'm not going to eat at the
restaurant as much, so maybe

242
00:10:24,175 --> 00:10:25,940
I'll go to the movies more.

243
00:10:25,940 --> 00:10:27,980
So in principle, the price of
beef going up could raise the

244
00:10:27,980 --> 00:10:29,160
demand for movies.

245
00:10:29,160 --> 00:10:29,960
It's crazy.

246
00:10:29,960 --> 00:10:31,290
It's hard to know
where to stop.

247
00:10:31,290 --> 00:10:34,280
So we're going to make your life
easy by stopping at one

248
00:10:34,280 --> 00:10:35,250
level here.

249
00:10:35,250 --> 00:10:35,650
But you're right.

250
00:10:35,650 --> 00:10:38,450
In principle, there could be
these wide range of feedbacks.

251
00:10:41,460 --> 00:10:43,760
And once again, I talked in
the first lecture about

252
00:10:43,760 --> 00:10:45,260
simplifying assumptions.

253
00:10:45,260 --> 00:10:47,470
We're going to try to teach you
the basic concepts but try

254
00:10:47,470 --> 00:10:49,120
to make simplifying assumptions
that make it more

255
00:10:49,120 --> 00:10:49,730
manageable.

256
00:10:49,730 --> 00:10:51,300
That's the kind of simplifying
assumption we'll make for our

257
00:10:51,300 --> 00:10:54,310
modeling here in this course.

258
00:10:54,310 --> 00:10:56,190
So that's a shift in
the demand curve.

259
00:10:56,190 --> 00:10:56,470
Yeah.

260
00:10:56,470 --> 00:10:58,262
AUDIENCE: How do you
quantify the shifts

261
00:10:58,262 --> 00:10:59,158
in the demand curve?

262
00:10:59,158 --> 00:11:00,060
PROFESSOR: Excellent.

263
00:11:00,060 --> 00:11:02,810
And that will be exactly--

264
00:11:02,810 --> 00:11:04,453
basically, the way we're going
to learn in this course, we're

265
00:11:04,453 --> 00:11:07,490
going to do things a
couple of times.

266
00:11:07,490 --> 00:11:10,330
When we talk about producer
theory, we will teach you

267
00:11:10,330 --> 00:11:12,490
where this supply curve
comes from.

268
00:11:12,490 --> 00:11:15,370
Basically, firm
profit-maximizing decisions

269
00:11:15,370 --> 00:11:17,340
will determine the supply curve
and how much it shifts,

270
00:11:17,340 --> 00:11:19,630
and we'll teach you that when we
teach you producer theory.

271
00:11:19,630 --> 00:11:22,090
So this is sort of
a big overview.

272
00:11:22,090 --> 00:11:23,140
You're good MIT students.

273
00:11:23,140 --> 00:11:24,435
You're immediately thinking,
where the hell do these demand

274
00:11:24,435 --> 00:11:25,910
and supply curves come from?

275
00:11:25,910 --> 00:11:26,790
That's where we're
going to get to.

276
00:11:26,790 --> 00:11:28,530
That's the whole point of
consumer theory will give us

277
00:11:28,530 --> 00:11:29,585
the demand curve.

278
00:11:29,585 --> 00:11:32,320
Producer theory will give
us the supply curve.

279
00:11:32,320 --> 00:11:32,710
All right.

280
00:11:32,710 --> 00:11:34,750
Good questions.

281
00:11:34,750 --> 00:11:36,100
So now, let's talk about
a different case.

282
00:11:36,100 --> 00:11:39,230
Let's talk about a shift
in the supply curve.

283
00:11:39,230 --> 00:11:42,950
So now, let's suppose
there's a drought.

284
00:11:42,950 --> 00:11:44,840
And let's suppose it's
a drought that

285
00:11:44,840 --> 00:11:46,120
only affects pork.

286
00:11:46,120 --> 00:11:47,760
Because if the drought affected
beef, that would then

287
00:11:47,760 --> 00:11:48,940
have these other feedback
effects.

288
00:11:48,940 --> 00:11:50,910
Let's imagine there's
a pork drought.

289
00:11:50,910 --> 00:11:52,100
I don't know what that
would mean, but let's

290
00:11:52,100 --> 00:11:53,920
imagine that happened.

291
00:11:53,920 --> 00:11:56,830
So suddenly, it becomes
more expensive--

292
00:11:56,830 --> 00:11:58,520
or let's just say there's
mad pig disease.

293
00:11:58,520 --> 00:12:00,650
Let's imagine there's
mad pig disease.

294
00:12:00,650 --> 00:12:05,890
So suddenly, it becomes more
expensive to produce pork.

295
00:12:05,890 --> 00:12:07,140
Because there's fewer
pigs, it's more

296
00:12:07,140 --> 00:12:09,500
expensive to produce it.

297
00:12:09,500 --> 00:12:16,200
So what that would do is that
would cause a shift in in the

298
00:12:16,200 --> 00:12:19,330
supply curve-- inward or upward
of the supply curve.

299
00:12:22,080 --> 00:12:26,280
Suddenly, on you get the fact
that given that it's more

300
00:12:26,280 --> 00:12:31,430
expensive to produce pork,
suppliers say, well gee, to

301
00:12:31,430 --> 00:12:34,050
produce a given amount of pork,
I need to get paid a

302
00:12:34,050 --> 00:12:35,680
higher price.

303
00:12:35,680 --> 00:12:38,780
So we get, once again,
initially, if the price stayed

304
00:12:38,780 --> 00:12:41,280
constant-- so now I'm
on Figure 2-3.

305
00:12:41,280 --> 00:12:43,820
If the price stayed constant,
we would not

306
00:12:43,820 --> 00:12:45,710
begin with excess demand.

307
00:12:45,710 --> 00:12:53,350
Because if the price stayed
constant, then consumers would

308
00:12:53,350 --> 00:12:57,540
want 220 million kilograms of
pork, which is what they

309
00:12:57,540 --> 00:12:58,100
wanted before.

310
00:12:58,100 --> 00:12:59,960
Nothing's changed from
their perspective.

311
00:12:59,960 --> 00:13:02,400
But producers would say, look,
at that price, I can only now

312
00:13:02,400 --> 00:13:06,210
produce 205, because my supply
curve shifted up.

313
00:13:06,210 --> 00:13:09,390
So once again, you have to
move to a new equilibrium

314
00:13:09,390 --> 00:13:12,550
where suppliers and consumers
are happy.

315
00:13:12,550 --> 00:13:17,520
That will happen at
a point like e2.

316
00:13:17,520 --> 00:13:20,300
Because at e2, given the higher
price of producing

317
00:13:20,300 --> 00:13:24,375
pork, producers will now say,
OK, I'm happy to sell 215

318
00:13:24,375 --> 00:13:28,730
million kilograms at $3.55.

319
00:13:28,730 --> 00:13:31,070
And consumers will say, well
gee, at $3.55, I don't want

320
00:13:31,070 --> 00:13:31,970
quite as much as I
wanted before.

321
00:13:31,970 --> 00:13:33,950
I only want 215.

322
00:13:33,950 --> 00:13:35,610
And they're happy.

323
00:13:35,610 --> 00:13:37,530
Here's what's striking.

324
00:13:37,530 --> 00:13:40,160
We had two very different
phenomena.

325
00:13:40,160 --> 00:13:43,010
We had a demand shift
and a supply shift.

326
00:13:43,010 --> 00:13:47,630
Both led to the same outcome.

327
00:13:47,630 --> 00:13:49,840
I'm sorry, both led
to a higher price.

328
00:13:49,840 --> 00:13:50,770
Sorry, not the same outcome.

329
00:13:50,770 --> 00:13:51,780
Both led to a higher price.

330
00:13:51,780 --> 00:13:53,670
One led to higher demand,
to higher

331
00:13:53,670 --> 00:13:55,090
quantity sold in the market.

332
00:13:55,090 --> 00:13:57,270
So you go back to Figure 2-2.

333
00:13:57,270 --> 00:13:59,600
The price went up, and the
quantity in the market went up

334
00:13:59,600 --> 00:14:02,210
from 220 to 228.

335
00:14:02,210 --> 00:14:05,530
In Figure 2-3, when the supply
shift happened, the price also

336
00:14:05,530 --> 00:14:08,130
went up almost exactly
the same amount.

337
00:14:08,130 --> 00:14:10,940
But here, the quantity fell.

338
00:14:10,940 --> 00:14:14,250
So you can't tell from a price
increase what happened.

339
00:14:14,250 --> 00:14:16,693
If the price of pork goes up,
you can't tell me whether that

340
00:14:16,693 --> 00:14:18,310
was a demand or supply shift.

341
00:14:18,310 --> 00:14:20,710
You need to know both the price
and quantity to be able

342
00:14:20,710 --> 00:14:22,820
to tell me that.

343
00:14:22,820 --> 00:14:29,480
Both changes led to the same
outcome in terms of prices.

344
00:14:29,480 --> 00:14:30,730
Questions about that?

345
00:14:33,220 --> 00:14:34,470
Now let's make it interesting.

346
00:14:37,640 --> 00:14:39,750
So we have the supply and
demand equilibrium.

347
00:14:39,750 --> 00:14:42,010
Supply shifts, demand shifts,
you move the points.

348
00:14:42,010 --> 00:14:43,390
You guys can all do it
graphically, even if you don't

349
00:14:43,390 --> 00:14:45,970
quite get it intuitively yet.

350
00:14:45,970 --> 00:14:48,550
Now let's ask, what happens if
the government comes in and

351
00:14:48,550 --> 00:14:49,920
messes this up?

352
00:14:49,920 --> 00:14:52,040
Now, step aside to
my other hat.

353
00:14:52,040 --> 00:14:54,650
The other course I teach is
called Public Economics, which

354
00:14:54,650 --> 00:14:56,190
is all about the role of the
government in the economy.

355
00:15:02,070 --> 00:15:05,150
In this course, most of what
you'll learn is there's a

356
00:15:05,150 --> 00:15:05,860
clear role of the government
in the economy.

357
00:15:05,860 --> 00:15:08,650
It's to screw it up.

358
00:15:08,650 --> 00:15:13,570
Economics is fundamentally
a right-wing science.

359
00:15:13,570 --> 00:15:15,450
Most of my colleagues are
Democrats, but that doesn't

360
00:15:15,450 --> 00:15:18,390
change the fact that what we
teach is fundamentally very

361
00:15:18,390 --> 00:15:21,030
conservative, which is the
market knows best, and

362
00:15:21,030 --> 00:15:23,280
governments just
mess things up.

363
00:15:23,280 --> 00:15:25,420
Now, later in the semester,
we'll talk about why that

364
00:15:25,420 --> 00:15:26,670
might not be true.

365
00:15:26,670 --> 00:15:28,970
And the whole point of my other
course, 14.41, is to

366
00:15:28,970 --> 00:15:31,220
talk about why that might not be
true and where governments

367
00:15:31,220 --> 00:15:32,720
can make things worse
and better.

368
00:15:32,720 --> 00:15:34,920
But from your basic perspective,
you need to be

369
00:15:34,920 --> 00:15:37,760
indoctrinated with this
fundamental position, that the

370
00:15:37,760 --> 00:15:39,300
market gets it right.

371
00:15:39,300 --> 00:15:40,310
The market equilibrates.

372
00:15:40,310 --> 00:15:42,250
Governments mess things up.

373
00:15:42,250 --> 00:15:43,750
And that's sort of where
we'll start.

374
00:15:43,750 --> 00:15:45,490
So let's talk about the classic
example of government

375
00:15:45,490 --> 00:15:48,890
messing things up,
the minimum wage.

376
00:15:48,890 --> 00:15:50,440
You've all heard of the minimum
wage, the thing

377
00:15:50,440 --> 00:15:51,240
workers get paid more.

378
00:15:51,240 --> 00:15:52,190
That seems like a good thing.

379
00:15:52,190 --> 00:15:54,700
Well, in fact, to economists,
it's a bad thing.

380
00:15:54,700 --> 00:15:56,650
And let's talk about why.

381
00:15:56,650 --> 00:15:58,350
To many economists, at
least this initial

382
00:15:58,350 --> 00:15:59,010
analysis is a bad thing.

383
00:15:59,010 --> 00:16:01,670
We'll come back later as to why
it might not be so bad.

384
00:16:01,670 --> 00:16:04,380
To do that, let's talk about
equilibrium not in a market

385
00:16:04,380 --> 00:16:07,870
for goods, like pork,
but in a market for

386
00:16:07,870 --> 00:16:09,960
inputs, which is labor.

387
00:16:09,960 --> 00:16:12,260
Labor is an input to the
production process.

388
00:16:12,260 --> 00:16:15,440
We'll talk about this at great
length later in the semester.

389
00:16:15,440 --> 00:16:18,890
But the key thing is, just like
there's a market for pork

390
00:16:18,890 --> 00:16:20,966
where the equilibrium outcome is
the price you pay for pork

391
00:16:20,966 --> 00:16:24,670
and the amount of pork sold,
there's a market for labor.

392
00:16:24,670 --> 00:16:28,020
And in that market, things
are flipped.

393
00:16:28,020 --> 00:16:29,610
Who are the consumers now?

394
00:16:29,610 --> 00:16:33,520
Well, they're the firms.
The firms demand labor.

395
00:16:33,520 --> 00:16:34,790
Who are suppliers now?

396
00:16:34,790 --> 00:16:35,710
Well, they're you.

397
00:16:35,710 --> 00:16:36,910
They're the people.

398
00:16:36,910 --> 00:16:38,530
People supply labor.

399
00:16:38,530 --> 00:16:40,390
So now we've flipped
things on its head.

400
00:16:40,390 --> 00:16:42,620
The suppliers are the people.

401
00:16:42,620 --> 00:16:47,500
The demanders are the firms. But
the analysis is the same.

402
00:16:47,500 --> 00:16:49,630
This basic supply and demand
framework, which will turn out

403
00:16:49,630 --> 00:16:52,520
to be so powerful this semester,
can be used, even

404
00:16:52,520 --> 00:16:54,590
though we flipped the labels
of who's on what side.

405
00:16:54,590 --> 00:16:57,750
So you see in Figure 2.4, we
have a labor market with an

406
00:16:57,750 --> 00:16:59,630
upward-sloping supply curve.

407
00:16:59,630 --> 00:17:00,820
What does that mean?

408
00:17:00,820 --> 00:17:02,690
Why is the supply curve
upward-sloping?

409
00:17:02,690 --> 00:17:04,730
Because the higher your
wage, the more

410
00:17:04,730 --> 00:17:05,980
you're willing to work.

411
00:17:08,109 --> 00:17:09,900
And we have a downward-sloping
demand curve.

412
00:17:09,900 --> 00:17:11,349
Why is it downward sloping?

413
00:17:11,349 --> 00:17:13,910
Because the higher the wage,
the fewer workers the firm

414
00:17:13,910 --> 00:17:15,140
wants to hire.

415
00:17:15,140 --> 00:17:18,250
It would rather use
machines instead.

416
00:17:18,250 --> 00:17:21,790
So basically, you've got that
same supply and demand curve,

417
00:17:21,790 --> 00:17:25,760
different stories as to where
they come from, but the same

418
00:17:25,760 --> 00:17:27,839
effect in terms of determining
equilibrium.

419
00:17:27,839 --> 00:17:34,700
We get an equilibrium at w1 l*,
which is at a wage w1, l*

420
00:17:34,700 --> 00:17:38,660
workers are willing to work.

421
00:17:38,660 --> 00:17:41,470
Or l* hours are supplied
of labor.

422
00:17:41,470 --> 00:17:43,760
We think about hours
supplied, not

423
00:17:43,760 --> 00:17:45,360
necessarily number of workers.

424
00:17:45,360 --> 00:17:48,680
l* hours of labor
are supplied.

425
00:17:48,680 --> 00:17:52,510
And at that w1, l* workers are
willing to provide l* hours,

426
00:17:52,510 --> 00:17:55,240
and at that w1, firms demand
l* hours, and that's the

427
00:17:55,240 --> 00:17:57,100
equilibrium.

428
00:17:57,100 --> 00:17:59,430
Same analysis as before, just
different stories as to what's

429
00:17:59,430 --> 00:18:00,760
behind the curve.

430
00:18:00,760 --> 00:18:04,920
Now, let's say the government
rolled in and set, as in

431
00:18:04,920 --> 00:18:07,600
Figure 2-5, a minimum wage.

432
00:18:07,600 --> 00:18:11,510
The government says, look,
that wage w1 is too low--

433
00:18:11,510 --> 00:18:13,810
or w* in this graph--
is too low.

434
00:18:13,810 --> 00:18:16,820
Workers are not paid enough
in equilibrium.

435
00:18:16,820 --> 00:18:20,390
We need to make sure that they
get paid a minimum amount.

436
00:18:20,390 --> 00:18:23,400
So we are going to mandate that
workers cannot be paid

437
00:18:23,400 --> 00:18:30,015
below w lower bar, which
is critically above w*.

438
00:18:30,015 --> 00:18:31,900
Well, what happens
in that case?

439
00:18:31,900 --> 00:18:37,910
Well, in that case, at that
wage, workers are thrilled.

440
00:18:37,910 --> 00:18:39,340
They say, look at that wage.

441
00:18:39,340 --> 00:18:41,780
We are delighted to work--

442
00:18:41,780 --> 00:18:42,680
god, the numbers are--

443
00:18:42,680 --> 00:18:44,240
I'm getting old--

444
00:18:44,240 --> 00:18:48,030
ls hours.

445
00:18:48,030 --> 00:18:49,830
I have my prescription
for my bifocals.

446
00:18:49,830 --> 00:18:51,600
I've had it for, like, two
months, and I just can't quite

447
00:18:51,600 --> 00:18:53,070
take it to the mall
and get them.

448
00:18:53,070 --> 00:18:54,150
So eventually I'll get them.

449
00:18:54,150 --> 00:18:55,400
I just can't quite admit
I'm that old.

450
00:18:57,900 --> 00:18:59,140
So workers are like, great.

451
00:18:59,140 --> 00:19:02,440
At that wage, we'll supply
l sub s hours.

452
00:19:02,440 --> 00:19:04,000
That sounds great to us.

453
00:19:04,000 --> 00:19:05,450
We're all good.

454
00:19:05,450 --> 00:19:07,570
But the firm says,
wait a second.

455
00:19:07,570 --> 00:19:09,710
No, we don't want to hire l
sub s hours at that wage.

456
00:19:09,710 --> 00:19:10,690
That's way too high.

457
00:19:10,690 --> 00:19:16,020
We only want to hire at that
high wage l sub d hours.

458
00:19:16,020 --> 00:19:20,690
So suddenly, here you have
a case of excess supply.

459
00:19:20,690 --> 00:19:23,100
Not excess demand,
excess supply.

460
00:19:23,100 --> 00:19:26,750
Workers want to supply more
hours than firms want to hire.

461
00:19:26,750 --> 00:19:30,290
Now, in our previous example,
what would happen?

462
00:19:30,290 --> 00:19:33,300
What would happen is, if there's
excess supply-- well,

463
00:19:33,300 --> 00:19:34,100
let me ask you.

464
00:19:34,100 --> 00:19:36,270
If there's excess supply in
the market, how would the

465
00:19:36,270 --> 00:19:36,835
market equilibrate?

466
00:19:36,835 --> 00:19:39,530
What would happen?

467
00:19:39,530 --> 00:19:39,810
Yeah.

468
00:19:39,810 --> 00:19:41,980
AUDIENCE: It would lower
the price so that the--

469
00:19:41,980 --> 00:19:43,140
PROFESSOR: In this case,
the price is what?

470
00:19:43,140 --> 00:19:45,222
AUDIENCE: The number of--

471
00:19:45,222 --> 00:19:46,680
PROFESSOR: The wage.

472
00:19:46,680 --> 00:19:47,170
The wage.

473
00:19:47,170 --> 00:19:48,170
So exactly.

474
00:19:48,170 --> 00:19:50,970
In our previous example,
the wage would fall.

475
00:19:50,970 --> 00:19:53,740
Workers would suck it up
and get a lower wage.

476
00:19:53,740 --> 00:19:55,040
Firms would be happy to
pay a lower wage.

477
00:19:55,040 --> 00:19:57,990
You'd reach a point where
they were happy.

478
00:19:57,990 --> 00:20:00,280
You'd reach a point like e.

479
00:20:00,280 --> 00:20:02,630
But you can't now.

480
00:20:02,630 --> 00:20:04,940
You can't, because the
government said you can't pay

481
00:20:04,940 --> 00:20:06,730
less than w lower bar.

482
00:20:06,730 --> 00:20:12,380
So you end up with
excess supply.

483
00:20:12,380 --> 00:20:16,250
And we call that excess supply
"unemployment." You end up

484
00:20:16,250 --> 00:20:21,850
with unemployment, because at
that high wage, firms are not

485
00:20:21,850 --> 00:20:24,570
willing to hire as
many workers as

486
00:20:24,570 --> 00:20:25,350
are willing to work.

487
00:20:25,350 --> 00:20:28,470
And you end up in
disequilibrium.

488
00:20:28,470 --> 00:20:31,650
You end up not in equilibrium
but disequilibrium.

489
00:20:31,650 --> 00:20:34,800
Now, disequilibrium is kind of
hard to think about, because

490
00:20:34,800 --> 00:20:38,870
in some sense, this course
is all about equilibrium.

491
00:20:38,870 --> 00:20:41,410
So I'm not talking about chaos
or cats and dogs living

492
00:20:41,410 --> 00:20:42,720
together, breakdown
of social order.

493
00:20:42,720 --> 00:20:44,970
That's not what I'm
talking about.

494
00:20:44,970 --> 00:20:52,690
Disequilibrium, there is
still a market outcome.

495
00:20:52,690 --> 00:20:55,110
The market still settles
at a point.

496
00:20:55,110 --> 00:20:59,610
In this case, what happens is
the market settles at a wage

497
00:20:59,610 --> 00:21:05,770
of w lower bar because it has
to and at an amount of labor

498
00:21:05,770 --> 00:21:10,380
delivered at l sub s, that low
amount of labor delivered.

499
00:21:10,380 --> 00:21:15,310
Because when you're in
disequilibrium, the outcome of

500
00:21:15,310 --> 00:21:17,120
quantity and prices
is determined by

501
00:21:17,120 --> 00:21:19,810
the constrained party.

502
00:21:19,810 --> 00:21:20,640
That's the way I like
to think about.

503
00:21:20,640 --> 00:21:21,350
You can think about it
however you want.

504
00:21:21,350 --> 00:21:23,000
But here's the point.

505
00:21:23,000 --> 00:21:26,110
Workers can't work if firms
won't hire them.

506
00:21:26,110 --> 00:21:28,320
So if you want to say, look,
we're going to end up at w

507
00:21:28,320 --> 00:21:31,260
lower bar, how much labor is
going to be in the market?

508
00:21:31,260 --> 00:21:34,730
Well, it's up to the firms.
They get to decide.

509
00:21:34,730 --> 00:21:37,430
They're going to say, look, we
don't want more than l sub d,

510
00:21:37,430 --> 00:21:39,770
so that's how many jobs they're
going to provide.

511
00:21:39,770 --> 00:21:45,140
So the new outcome is going to
be at a wage w lower bar and

512
00:21:45,140 --> 00:21:49,490
an amount of hours l sub d.

513
00:21:49,490 --> 00:21:54,530
So basically, you end up with
this unemployment situation

514
00:21:54,530 --> 00:21:57,950
where only l sub d workers
are hired and the

515
00:21:57,950 --> 00:21:59,200
wage is w lower bar.

516
00:22:02,000 --> 00:22:04,410
Now, let me ask a question.

517
00:22:04,410 --> 00:22:09,490
What would happen if w sub lower
bar was set below w*?

518
00:22:09,490 --> 00:22:11,500
What if I'd redrawn this
diagram so w lower

519
00:22:11,500 --> 00:22:12,870
bar was below w*?

520
00:22:12,870 --> 00:22:13,767
Yeah.

521
00:22:13,767 --> 00:22:17,730
AUDIENCE: The market would
equilibrate and--

522
00:22:17,730 --> 00:22:20,260
PROFESSOR: Yeah, nothing would
happen at the end of the day.

523
00:22:20,260 --> 00:22:21,800
And here's the key point--

524
00:22:21,800 --> 00:22:23,600
very important point
to remember--

525
00:22:23,600 --> 00:22:28,510
which is that markets are very
robust. Economic markets are

526
00:22:28,510 --> 00:22:31,450
very robust. And if they can
undo the effective government

527
00:22:31,450 --> 00:22:33,140
intervention, they will.

528
00:22:33,140 --> 00:22:35,870
So if the government tries to
come and intervene in a way

529
00:22:35,870 --> 00:22:38,880
which markets can undo and get
back to where they wanted to

530
00:22:38,880 --> 00:22:39,840
be, they will.

531
00:22:39,840 --> 00:22:42,350
That original point e is where
the market wants to be.

532
00:22:42,350 --> 00:22:44,420
That was where it was happy.

533
00:22:44,420 --> 00:22:46,840
It can't get there in the
example I taught here with w

534
00:22:46,840 --> 00:22:47,880
lower bar above w*.

535
00:22:47,880 --> 00:22:50,630
But if w lower bar was below w*,
it could get there and be

536
00:22:50,630 --> 00:22:52,460
happy, so government
intervention would make no

537
00:22:52,460 --> 00:22:53,710
difference.

538
00:22:55,390 --> 00:22:58,530
That's one example of a
government intervention.

539
00:22:58,530 --> 00:22:59,540
Let's do another example.

540
00:22:59,540 --> 00:23:01,230
Then I want to talk about the
pros and cons of these

541
00:23:01,230 --> 00:23:01,960
government interventions.

542
00:23:01,960 --> 00:23:03,210
Let's do another example.

543
00:23:06,320 --> 00:23:08,970
Gas price ceilings.

544
00:23:08,970 --> 00:23:14,660
So let's consider a cap on how
much can be charged for gas.

545
00:23:14,660 --> 00:23:15,660
Seems a pretty sensible
policy.

546
00:23:15,660 --> 00:23:16,930
Gas is crazy expensive.

547
00:23:16,930 --> 00:23:18,710
We all like to drive.

548
00:23:18,710 --> 00:23:24,940
So let's consider a cap
on the price of gas.

549
00:23:24,940 --> 00:23:27,290
Imagine, for example, we're
initially in equilibrium, in

550
00:23:27,290 --> 00:23:33,680
Figure 2-6, with demand of
Q2 and a price of P1.

551
00:23:33,680 --> 00:23:36,510
We're all happy.

552
00:23:36,510 --> 00:23:40,850
Now let's imagine there's an oil
crisis, because, say, oil

553
00:23:40,850 --> 00:23:42,620
companies decide it's a good
idea to drill eight miles

554
00:23:42,620 --> 00:23:44,470
underground, and everything
explodes, and we suddenly run

555
00:23:44,470 --> 00:23:46,200
out of oil.

556
00:23:46,200 --> 00:23:50,030
So all of a sudden, there's a
constraint in the supply.

557
00:23:50,030 --> 00:23:52,730
Suddenly, there's a--

558
00:23:52,730 --> 00:23:53,440
I'm sorry, my bad.

559
00:23:53,440 --> 00:23:55,510
We're initially in equilibrium
at e1.

560
00:23:55,510 --> 00:23:56,160
My bad.

561
00:23:56,160 --> 00:24:02,110
We're initially at equilibrium
at e1, with a price of P1.

562
00:24:02,110 --> 00:24:03,880
There's a bit of mislabeling
here.

563
00:24:03,880 --> 00:24:07,910
On the vertical axis, that
upper price should be P2.

564
00:24:07,910 --> 00:24:11,050
So on the vertical axis, you see
there's P1 equals P. Then

565
00:24:11,050 --> 00:24:12,260
above it, it says P1 again.

566
00:24:12,260 --> 00:24:14,300
That should say P2.

567
00:24:14,300 --> 00:24:18,590
So we're initially in
equilibrium at point e1 with a

568
00:24:18,590 --> 00:24:22,790
price of P1 and a
quantity of Q1.

569
00:24:22,790 --> 00:24:26,830
Now oil tanks blow up
all over the world.

570
00:24:26,830 --> 00:24:28,390
Suddenly, that means there's
a restriction in

571
00:24:28,390 --> 00:24:30,360
the supply of gas.

572
00:24:30,360 --> 00:24:33,600
Suddenly, there's not as much
gas as can be produced.

573
00:24:33,600 --> 00:24:36,810
So that's an upward shift in the
supply curve, just like we

574
00:24:36,810 --> 00:24:38,940
talked about before.

575
00:24:38,940 --> 00:24:43,430
And absent any government
intervention, the supply curve

576
00:24:43,430 --> 00:24:49,150
would shift up to s2, consumers
would want less gas,

577
00:24:49,150 --> 00:24:53,040
and you'd reach a new
equilibrium at e2.

578
00:24:53,040 --> 00:24:54,475
And once again, let's talk about
equilibrium as being

579
00:24:54,475 --> 00:24:55,430
where people are happy.

580
00:24:55,430 --> 00:24:58,000
Now, you could say, well gee,
people aren't happy paying a

581
00:24:58,000 --> 00:24:58,840
higher price for gas.

582
00:24:58,840 --> 00:25:02,130
Well, that's why I'm a bit glib
using the term "happy."

583
00:25:02,130 --> 00:25:04,010
It's a point where the suppliers
and demanders are

584
00:25:04,010 --> 00:25:06,360
jointly willing to
make the deal.

585
00:25:06,360 --> 00:25:09,075
And they're willing to
make the deal at e2.

586
00:25:09,075 --> 00:25:11,350
They're willing to say, look,
given how many oil rigs have

587
00:25:11,350 --> 00:25:14,745
blown up, we are happy to
equilibrate the market now at

588
00:25:14,745 --> 00:25:16,640
a higher price and
a lower quantity.

589
00:25:16,640 --> 00:25:20,305
But then it's September, 2010.

590
00:25:20,305 --> 00:25:22,150
There's an election
two months away.

591
00:25:22,150 --> 00:25:24,540
President Obama isn't very
happy about this.

592
00:25:24,540 --> 00:25:25,950
And he says, forget it.

593
00:25:25,950 --> 00:25:30,450
We're going to cap the price at
P. We were paying P before.

594
00:25:30,450 --> 00:25:31,400
We can pay P again.

595
00:25:31,400 --> 00:25:33,610
Those stupid oil companies
can suck it up.

596
00:25:33,610 --> 00:25:35,630
They're the ones who drilled
eight miles underground.

597
00:25:35,630 --> 00:25:37,070
They're the ones who
blew everything up.

598
00:25:37,070 --> 00:25:37,850
They can suck it up.

599
00:25:37,850 --> 00:25:41,000
We're keeping the price at P.
We'll help the consumer.

600
00:25:41,000 --> 00:25:41,760
We'll keep the price.

601
00:25:41,760 --> 00:25:43,570
Well, what happens?

602
00:25:43,570 --> 00:25:49,690
What happens is that consumers
are now, great, we

603
00:25:49,690 --> 00:25:51,880
continue to want Q1.

604
00:25:51,880 --> 00:25:53,130
That's where we were before.

605
00:25:53,130 --> 00:25:54,860
We're happy.

606
00:25:54,860 --> 00:25:57,960
But producers say, well, you
know what, President, we can't

607
00:25:57,960 --> 00:26:00,690
supply that much
at that price.

608
00:26:00,690 --> 00:26:04,890
Because it costs us so much to
drill oil now that if you're

609
00:26:04,890 --> 00:26:07,710
going to force us to keep the
price at P1, we are only going

610
00:26:07,710 --> 00:26:12,090
to supply Q sub D because
we just can't

611
00:26:12,090 --> 00:26:13,300
supply at that low price.

612
00:26:13,300 --> 00:26:15,500
We're going to supply Q sub D.

613
00:26:15,500 --> 00:26:18,550
So what happens, you end
up with excess demand.

614
00:26:18,550 --> 00:26:22,970
Consumers want Q
sub D gallons.

615
00:26:22,970 --> 00:26:27,130
Producers are willing to produce
only Q sub S. And you

616
00:26:27,130 --> 00:26:30,660
end up with disequilibrium.

617
00:26:30,660 --> 00:26:33,120
And in this case, once again,
the amount sold is what the

618
00:26:33,120 --> 00:26:33,940
producers are willing to sell.

619
00:26:33,940 --> 00:26:35,530
It doesn't matter how much
consumers want if producers

620
00:26:35,530 --> 00:26:37,110
aren't willing to sell it.

621
00:26:37,110 --> 00:26:39,120
You end up with disequilibrium,
and you end up

622
00:26:39,120 --> 00:26:42,710
with much, much less
gas being sold.

623
00:26:42,710 --> 00:26:45,510
So yeah, the price stays low,
but the amount of gas being

624
00:26:45,510 --> 00:26:48,210
sold is much lower than if
the president allowed

625
00:26:48,210 --> 00:26:51,310
the price to rise.

626
00:26:51,310 --> 00:26:55,530
So that's another example of
a government intervention

627
00:26:55,530 --> 00:26:56,780
causing disequilibrium.

628
00:26:59,710 --> 00:27:01,770
Any questions about that?

629
00:27:01,770 --> 00:27:02,160
Yeah.

630
00:27:02,160 --> 00:27:05,485
AUDIENCE: In the last chapter,
we talked about, can the

631
00:27:05,485 --> 00:27:08,572
government then come in and
give a subsidy to the oil

632
00:27:08,572 --> 00:27:12,446
producers to produce
the same amount?

633
00:27:12,446 --> 00:27:14,370
PROFESSOR: Great.

634
00:27:14,370 --> 00:27:16,300
Hold that thought for 14.41.

635
00:27:16,300 --> 00:27:18,080
But that's exactly what the
government could do.

636
00:27:18,080 --> 00:27:20,130
The government has
lots of tools.

637
00:27:20,130 --> 00:27:21,710
So it can come in and say, well,
on the one hand, we'll

638
00:27:21,710 --> 00:27:22,410
set a price cap.

639
00:27:22,410 --> 00:27:24,635
But then we'll come in on the
other hand and give a subsidy

640
00:27:24,635 --> 00:27:27,290
to oil producers to make
sure they do that.

641
00:27:27,290 --> 00:27:31,320
That has two problems. One is,
not so good with the voters.

642
00:27:31,320 --> 00:27:33,370
Like, gee, we're going to give
subsidies to oil companies.

643
00:27:33,370 --> 00:27:34,930
Isn't that a great idea.

644
00:27:34,930 --> 00:27:37,240
Two is, you've got to raise the
money somehow, which means

645
00:27:37,240 --> 00:27:38,350
you've got to raise taxes.

646
00:27:38,350 --> 00:27:40,030
Also not so good with
the voters.

647
00:27:40,030 --> 00:27:43,260
So it's, in general, not a good
idea, because you screw

648
00:27:43,260 --> 00:27:46,210
it up on the one hand
to screw up again.

649
00:27:46,210 --> 00:27:47,570
Two wrongs don't make a right,
something I learned

650
00:27:47,570 --> 00:27:48,210
from an early age.

651
00:27:48,210 --> 00:27:49,830
If the government's messed up
the market on the one hand,

652
00:27:49,830 --> 00:27:52,540
it's not, generally, a good idea
to try to mess with it

653
00:27:52,540 --> 00:27:53,710
again to fix that.

654
00:27:53,710 --> 00:27:55,780
But that's exactly the kind of
stuff we'll discuss in 14.41.

655
00:27:55,780 --> 00:27:57,970
AUDIENCE: I've got a question
about that.

656
00:27:57,970 --> 00:28:01,198
Will that mean that there's
a [INAUDIBLE] because

657
00:28:01,198 --> 00:28:02,154
[INAUDIBLE]?

658
00:28:02,154 --> 00:28:04,500
PROFESSOR: Great segue into
what I want to talk about

659
00:28:04,500 --> 00:28:08,510
next, which is, what are the
costs and benefits of these

660
00:28:08,510 --> 00:28:10,620
kinds of market interventions,
of a minimum wage

661
00:28:10,620 --> 00:28:12,450
or gas price ceiling?

662
00:28:12,450 --> 00:28:14,320
Why do we do this?

663
00:28:14,320 --> 00:28:18,290
The government, these aren't
stupid people, by and large.

664
00:28:18,290 --> 00:28:20,000
Why do governments do
things like this?

665
00:28:20,000 --> 00:28:22,640
What are the costs
and benefits?

666
00:28:22,640 --> 00:28:23,940
Now, later in the semester,
we'll talk

667
00:28:23,940 --> 00:28:26,490
about welfare economics.

668
00:28:26,490 --> 00:28:28,230
By welfare, welfare
has two meanings.

669
00:28:28,230 --> 00:28:30,010
We often think of welfare as
being money distributed to

670
00:28:30,010 --> 00:28:31,270
poor people.

671
00:28:31,270 --> 00:28:31,980
That's one meaning.

672
00:28:31,980 --> 00:28:34,880
But when we say "welfare
economics," we actually mean

673
00:28:34,880 --> 00:28:36,510
the well-being of society.

674
00:28:36,510 --> 00:28:41,570
And we'll talk about the
well-being of society later on

675
00:28:41,570 --> 00:28:42,980
in the semester.

676
00:28:42,980 --> 00:28:45,880
But let's talk for a minute
about this general topic.

677
00:28:45,880 --> 00:28:48,820
And how do we think about the
kind of welfare economics of

678
00:28:48,820 --> 00:28:49,760
these restrictions?

679
00:28:49,760 --> 00:28:54,630
Well, there's two costs and
one benefit to these

680
00:28:54,630 --> 00:28:56,250
restrictions.

681
00:28:56,250 --> 00:29:00,990
The first cost is the
efficiency loss.

682
00:29:00,990 --> 00:29:07,870
So the costs of things like the
minimum wage and gas price

683
00:29:07,870 --> 00:29:13,110
ceilings, the first cost
is the efficiency loss.

684
00:29:13,110 --> 00:29:15,310
And we are going to be
much more precise.

685
00:29:15,310 --> 00:29:17,090
This lecture is sort of a chance
to be loosey-goosey

686
00:29:17,090 --> 00:29:18,730
about things that I'll then
make much more precise

687
00:29:18,730 --> 00:29:19,880
throughout the semester.

688
00:29:19,880 --> 00:29:21,720
We'll be precise about
what we mean by this

689
00:29:21,720 --> 00:29:23,370
throughout the semester.

690
00:29:23,370 --> 00:29:28,190
But the key point is, in
economics, whenever there is a

691
00:29:28,190 --> 00:29:34,830
trade that can be made that
makes both parties better off,

692
00:29:34,830 --> 00:29:38,540
and it is not made, that
is an inefficiency.

693
00:29:38,540 --> 00:29:42,310
So in economics, we define
"efficient" as when all trades

694
00:29:42,310 --> 00:29:45,780
that can make both parties
better off are made.

695
00:29:45,780 --> 00:29:49,100
And whenever anything comes
up that interferes--

696
00:29:49,100 --> 00:29:50,920
so a trade that could
make both parties

697
00:29:50,920 --> 00:29:52,690
better off is not made--

698
00:29:52,690 --> 00:29:53,810
that is inefficient.

699
00:29:53,810 --> 00:29:56,900
There is an efficiency loss.

700
00:29:56,900 --> 00:29:57,550
And think about it.

701
00:29:57,550 --> 00:29:58,690
It makes sense.

702
00:29:58,690 --> 00:30:01,160
If both parties could be better
off by a trade and

703
00:30:01,160 --> 00:30:06,240
don't let it happen, then
society is worse off.

704
00:30:06,240 --> 00:30:08,520
That's the idea of an efficiency
loss in economics.

705
00:30:08,520 --> 00:30:11,510
Economics is all about trading
to make things work more

706
00:30:11,510 --> 00:30:11,950
efficiently.

707
00:30:11,950 --> 00:30:15,570
When you don't let that happen,
you've hurt society.

708
00:30:15,570 --> 00:30:19,090
You have a welfare loss, because
you have something

709
00:30:19,090 --> 00:30:21,340
that could've made both people
better off, that would've been

710
00:30:21,340 --> 00:30:22,230
a good thing to do.

711
00:30:22,230 --> 00:30:24,500
You haven't allowed
that to happen.

712
00:30:24,500 --> 00:30:28,120
And if we think about it, in
both these examples, Figure

713
00:30:28,120 --> 00:30:32,190
2-5 and 2-6, there are trades
that would've made both

714
00:30:32,190 --> 00:30:34,240
parties better off that we're
not allowing to happen.

715
00:30:34,240 --> 00:30:39,640
So in the labor market case,
think about a wage that's

716
00:30:39,640 --> 00:30:42,440
above w* and below
w lower bar.

717
00:30:42,440 --> 00:30:44,940
So a wage in that interval.

718
00:30:44,940 --> 00:30:49,020
At that wage, workers
would be happy--

719
00:30:49,020 --> 00:30:51,990
and take unemployed workers.

720
00:30:51,990 --> 00:30:54,990
Unemployed workers would be
happy to work it a wage

721
00:30:54,990 --> 00:30:57,460
somewhat below w bar.

722
00:30:57,460 --> 00:31:00,610
Firms would be happy to hire
them at a wage somewhat below

723
00:31:00,610 --> 00:31:02,000
w lower bar.

724
00:31:02,000 --> 00:31:03,640
But it isn't happening, because
the government has

725
00:31:03,640 --> 00:31:04,730
interfered.

726
00:31:04,730 --> 00:31:06,350
That's an efficiency loss.

727
00:31:06,350 --> 00:31:09,600
Likewise, look at Figure 2-6.

728
00:31:09,600 --> 00:31:13,120
Consumers would be happy to pay
a somewhat higher price

729
00:31:13,120 --> 00:31:14,660
and get some more gas.

730
00:31:14,660 --> 00:31:18,050
Producers would be happy
to produce more

731
00:31:18,050 --> 00:31:19,340
at that higher price.

732
00:31:19,340 --> 00:31:20,790
But it's not happening.

733
00:31:20,790 --> 00:31:23,670
That's an efficiency loss.

734
00:31:23,670 --> 00:31:25,925
So an efficiency loss is
whenever there are trades that

735
00:31:25,925 --> 00:31:31,120
can make both sides better
off that don't happen.

736
00:31:31,120 --> 00:31:32,630
Once again, this is
loosey-goosey here.

737
00:31:32,630 --> 00:31:33,700
We'll make this all more
precise as the

738
00:31:33,700 --> 00:31:35,210
semester goes on.

739
00:31:35,210 --> 00:31:37,740
But it's important to get the
big picture concept of what we

740
00:31:37,740 --> 00:31:40,250
mean by efficiency in economics,
which is trades

741
00:31:40,250 --> 00:31:42,470
being made that make both
parties better off.

742
00:31:42,470 --> 00:31:46,870
The second cost here is what
we call "allocation

743
00:31:46,870 --> 00:31:57,470
inefficiency." Remember in the
first lecture, I talked about

744
00:31:57,470 --> 00:32:01,370
how prices play three
roles in the market.

745
00:32:01,370 --> 00:32:05,410
They determine what is to be
produced, they determine how

746
00:32:05,410 --> 00:32:09,920
it is to be produced, and they
determine who gets it.

747
00:32:09,920 --> 00:32:14,530
That's called "allocation."
Price plays a critical role in

748
00:32:14,530 --> 00:32:17,630
making sure that the people
who want the good

749
00:32:17,630 --> 00:32:19,270
the most get it.

750
00:32:19,270 --> 00:32:22,540
Because remember, that demand
curve is a willingness-to-pay

751
00:32:22,540 --> 00:32:25,450
curve, or a willingness-to-buy
curve.

752
00:32:25,450 --> 00:32:28,360
What that lets us know is the
further up the demand curve,

753
00:32:28,360 --> 00:32:32,350
the more people want the good.

754
00:32:32,350 --> 00:32:36,030
And we should make sure
that those people are

755
00:32:36,030 --> 00:32:38,710
allocated that good.

756
00:32:38,710 --> 00:32:42,090
So in a world of equilibrium,
we make sure that the

757
00:32:42,090 --> 00:32:43,920
allocation happens.

758
00:32:43,920 --> 00:32:46,950
Anybody who wants the good at
a price that consumers are

759
00:32:46,950 --> 00:32:48,790
willing to sell it gets it.

760
00:32:48,790 --> 00:32:53,330
Someone who doesn't want it at
that price doesn't get it.

761
00:32:53,330 --> 00:32:55,960
Equilibrium takes care of
that allocation problem.

762
00:32:55,960 --> 00:32:57,560
But in disequilibrium,
it doesn't.

763
00:32:57,560 --> 00:33:00,410
Let's consider the
gasoline example.

764
00:33:00,410 --> 00:33:04,680
Now we have a case where there
are many, many people-- in

765
00:33:04,680 --> 00:33:07,840
fact, all the folks
who lie between Qs

766
00:33:07,840 --> 00:33:09,790
and Qd on that x-axis--

767
00:33:09,790 --> 00:33:14,950
all those folks want gas
at that low price

768
00:33:14,950 --> 00:33:17,570
but can't get it.

769
00:33:17,570 --> 00:33:19,830
There's only Qs being
supplied.

770
00:33:19,830 --> 00:33:20,900
So what happens?

771
00:33:20,900 --> 00:33:22,070
Well, what happened--

772
00:33:22,070 --> 00:33:25,640
you guys weren't alive for this,
but in the 1970s, does

773
00:33:25,640 --> 00:33:27,050
anyone know what happened
when we did price

774
00:33:27,050 --> 00:33:29,590
ceilings of this type?

775
00:33:29,590 --> 00:33:30,250
Does anyone know
what happened?

776
00:33:30,250 --> 00:33:32,210
AUDIENCE: Gas shortage.

777
00:33:32,210 --> 00:33:33,610
PROFESSOR: Gas shortage.

778
00:33:33,610 --> 00:33:35,000
And how did people respond?

779
00:33:35,000 --> 00:33:36,900
How was gas allocated in
that gas shortage?

780
00:33:36,900 --> 00:33:37,870
AUDIENCE: There were lines.

781
00:33:37,870 --> 00:33:40,120
PROFESSOR: Peopled waited
in huge lines.

782
00:33:40,120 --> 00:33:42,890
Basically, we couldn't use
the price mechanism,

783
00:33:42,890 --> 00:33:43,770
so what did we do?

784
00:33:43,770 --> 00:33:46,580
We used the wait mechanism, just
like they used to do in

785
00:33:46,580 --> 00:33:50,900
Russia all the time
and still do.

786
00:33:50,900 --> 00:33:54,430
The point is the gas that's
limited-- that Qs--

787
00:33:54,430 --> 00:33:57,190
has got to get allocated
somehow.

788
00:33:57,190 --> 00:34:02,470
In the market, it gets allocated
by the price rising

789
00:34:02,470 --> 00:34:04,740
until the price is high enough
that the set of people who

790
00:34:04,740 --> 00:34:06,190
want it at that price get it.

791
00:34:06,190 --> 00:34:08,060
With this gas price ceiling,
that can't happen.

792
00:34:08,060 --> 00:34:09,370
So what happens?

793
00:34:09,370 --> 00:34:10,630
Lines for gas.

794
00:34:10,630 --> 00:34:12,540
Huge, hours-long wait.

795
00:34:12,540 --> 00:34:13,650
This is sort of inconceivable
now.

796
00:34:13,650 --> 00:34:16,460
Sometimes, you have to wait at
a gas pump, but pretty much,

797
00:34:16,460 --> 00:34:18,860
you drive up, you get your gas,
you leave. In the 1970s,

798
00:34:18,860 --> 00:34:21,679
literally, you would
wait hours--

799
00:34:21,679 --> 00:34:24,179
multiple hours-- in
line to get gas.

800
00:34:24,179 --> 00:34:26,159
That was how the gas was
allocated in the face of these

801
00:34:26,159 --> 00:34:27,409
gas price ceilings.

802
00:34:29,420 --> 00:34:29,650
Yeah.

803
00:34:29,650 --> 00:34:34,470
AUDIENCE: What about things like
the government saying you

804
00:34:34,470 --> 00:34:38,085
can't shut off someone's gas in
the winter, even if there

805
00:34:38,085 --> 00:34:40,105
was a price ceiling?

806
00:34:40,105 --> 00:34:43,659
PROFESSOR: OK, let me
come back to that.

807
00:34:43,659 --> 00:34:44,620
Hold that thought for
a couple minutes.

808
00:34:44,620 --> 00:34:45,520
I want to come back to that.

809
00:34:45,520 --> 00:34:47,570
But I want to focus on these
gas price lines and why

810
00:34:47,570 --> 00:34:49,340
they're bad.

811
00:34:49,340 --> 00:34:51,820
Well, these gas price lines
are themselves a source of

812
00:34:51,820 --> 00:34:52,420
inefficiency.

813
00:34:52,420 --> 00:34:53,611
And why?

814
00:34:53,611 --> 00:34:55,090
Why is it inefficient
to have people

815
00:34:55,090 --> 00:34:58,234
waiting in line for gas?

816
00:34:58,234 --> 00:34:58,720
Yeah.

817
00:34:58,720 --> 00:35:00,178
AUDIENCE: Because they
could be working

818
00:35:00,178 --> 00:35:01,020
or doing other things.

819
00:35:01,020 --> 00:35:02,560
PROFESSOR: They could
be working.

820
00:35:02,560 --> 00:35:06,350
They could be out making trades
that make everybody

821
00:35:06,350 --> 00:35:06,940
better off.

822
00:35:06,940 --> 00:35:08,750
Instead of being in line waiting
for gas, they could've

823
00:35:08,750 --> 00:35:11,380
been at work, working for a wage
that they were happy to

824
00:35:11,380 --> 00:35:13,450
earn and their employer
was happy to pay.

825
00:35:13,450 --> 00:35:15,070
So a trade is not being made.

826
00:35:15,070 --> 00:35:17,060
Unless they're equally happy
sitting in line waiting for

827
00:35:17,060 --> 00:35:22,470
gas, which is doubtful, a trade
is not being made, which

828
00:35:22,470 --> 00:35:24,790
makes both parties better off.

829
00:35:24,790 --> 00:35:25,400
What else?

830
00:35:25,400 --> 00:35:26,400
AUDIENCE: I have a question.

831
00:35:26,400 --> 00:35:28,400
Did the government
know about this?

832
00:35:28,400 --> 00:35:31,440
PROFESSOR: Yeah, believe
me, they did.

833
00:35:31,440 --> 00:35:33,880
But they said, well gee, we
can't let people pay those

834
00:35:33,880 --> 00:35:35,260
high prices.

835
00:35:35,260 --> 00:35:36,720
Governments face really
hard decisions like

836
00:35:36,720 --> 00:35:38,040
this all the time.

837
00:35:38,040 --> 00:35:40,350
There's another program, of
course, which is, what happens

838
00:35:40,350 --> 00:35:42,860
with people waiting
in line for gas?

839
00:35:42,860 --> 00:35:45,600
They're idling and
using up gas.

840
00:35:45,600 --> 00:35:48,920
So in fact, there was a direct
mechanical inefficiency as

841
00:35:48,920 --> 00:35:51,230
well, which is all the gas that
was wasted while people

842
00:35:51,230 --> 00:35:53,630
idled in line, waiting
to get their gas.

843
00:35:53,630 --> 00:35:55,210
So that's the kind of
inefficiency you're used to

844
00:35:55,210 --> 00:35:58,010
thinking about as engineers.

845
00:35:58,010 --> 00:36:00,430
There's a mechanical
inefficiency, but the main

846
00:36:00,430 --> 00:36:03,440
thing we care about is the
allocative inefficiency, which

847
00:36:03,440 --> 00:36:07,190
is trades are not being made
because people are sitting in

848
00:36:07,190 --> 00:36:08,640
their cars waiting for gas.

849
00:36:08,640 --> 00:36:09,325
And that's inefficiency.

850
00:36:09,325 --> 00:36:12,240
And that inefficiency arises
because we have to allocate

851
00:36:12,240 --> 00:36:14,190
the gas somehow.

852
00:36:14,190 --> 00:36:16,260
You can't get around
that problem.

853
00:36:16,260 --> 00:36:19,050
Remember, we are the
dismal science.

854
00:36:19,050 --> 00:36:21,630
We point out problems that
cannot be surmounted.

855
00:36:21,630 --> 00:36:22,780
You can't get around
that problem.

856
00:36:22,780 --> 00:36:25,170
That gas has to get
allocated somehow.

857
00:36:25,170 --> 00:36:27,480
And if you don't let the price
mechanism allocate it, some

858
00:36:27,480 --> 00:36:29,670
other, more inefficient
mechanism will arise to do so.

859
00:36:32,400 --> 00:36:33,750
Now, the trade-off, of
course, is then you

860
00:36:33,750 --> 00:36:34,450
keep the price low.

861
00:36:34,450 --> 00:36:35,770
And the government's
got to decide--

862
00:36:35,770 --> 00:36:37,440
once again, this gets into the
political economy of how the

863
00:36:37,440 --> 00:36:38,590
governments make these
decisions.

864
00:36:38,590 --> 00:36:40,520
And that's not really the
point of this course.

865
00:36:40,520 --> 00:36:42,340
But that's the kind of decision
they have to make.

866
00:36:42,340 --> 00:36:44,870
Now let's come-- and this will
touch on your question-- oh,

867
00:36:44,870 --> 00:36:46,038
do you have a question
about this?

868
00:36:46,038 --> 00:36:47,532
AUDIENCE: I have a question,
actually,

869
00:36:47,532 --> 00:36:50,022
about the minimum wage.

870
00:36:50,022 --> 00:36:53,010
So isn't it a little imbalanced,
because when

871
00:36:53,010 --> 00:36:58,488
people need work more than
companies need people--

872
00:36:58,488 --> 00:37:01,476
because, for example, there are
a lot of instances when

873
00:37:01,476 --> 00:37:05,056
companies are paying hunger
wages, a dollar a day.

874
00:37:05,056 --> 00:37:07,852
[INAUDIBLE]

875
00:37:07,852 --> 00:37:10,182
they're not happy for it.

876
00:37:10,182 --> 00:37:15,960
PROFESSOR: Yeah, basically, in
some sense, the bottom line

877
00:37:15,960 --> 00:37:18,000
is, equilibrium is where people
are going to work for

878
00:37:18,000 --> 00:37:19,670
what the company's
willing to pay.

879
00:37:19,670 --> 00:37:22,560
Now, you can say, if people
want work when the company

880
00:37:22,560 --> 00:37:23,800
wants to offer it,
that's sort of a

881
00:37:23,800 --> 00:37:25,820
difficult subjective judgment.

882
00:37:25,820 --> 00:37:27,335
But at the end of the day, if
people are willing to work for

883
00:37:27,335 --> 00:37:28,680
a dollar and the company's
willing to hire them for a

884
00:37:28,680 --> 00:37:32,730
dollar, then that's a trade
which should be made.

885
00:37:32,730 --> 00:37:36,370
Except, that's a great example
to point out--

886
00:37:36,370 --> 00:37:38,090
same person who just said
that, well then, tell me

887
00:37:38,090 --> 00:37:39,760
what's the benefit of
a minimum wage?

888
00:37:39,760 --> 00:37:42,502
AUDIENCE: [INAUDIBLE]

889
00:37:42,502 --> 00:37:46,070
PROFESSOR: It's equity, that
thing economists like to not

890
00:37:46,070 --> 00:37:48,520
think about, because
it's tricky.

891
00:37:48,520 --> 00:37:49,230
It's fairness.

892
00:37:49,230 --> 00:37:50,300
It's equity.

893
00:37:50,300 --> 00:37:54,460
It's unfair that you would
work for a dollar a day.

894
00:37:54,460 --> 00:37:56,510
And people might be exploited
and work for

895
00:37:56,510 --> 00:37:59,500
unfairly low wages.

896
00:37:59,500 --> 00:38:04,160
Likewise, it's unfair that we
pay a huge amount for gas.

897
00:38:04,160 --> 00:38:08,210
So people, we should keep the
wage high and the prices low

898
00:38:08,210 --> 00:38:10,090
to make it fair.

899
00:38:10,090 --> 00:38:12,690
And that's the pro of
the minimum wage.

900
00:38:12,690 --> 00:38:13,090
Yeah.

901
00:38:13,090 --> 00:38:16,048
AUDIENCE: I didn't quite
get [INAUDIBLE]

902
00:38:16,048 --> 00:38:19,499
it is giving a few people
a higher wage, right?

903
00:38:19,499 --> 00:38:21,964
But it's causing unemployment,
so how is that better?

904
00:38:21,964 --> 00:38:24,040
PROFESSOR: Wonderful point.

905
00:38:24,040 --> 00:38:24,890
Wonderful point.

906
00:38:24,890 --> 00:38:29,560
That's because in economics,
there's the direct effect and

907
00:38:29,560 --> 00:38:31,050
the indirect effect.

908
00:38:31,050 --> 00:38:33,440
And the direct effect is
what voters understand.

909
00:38:33,440 --> 00:38:37,050
And the indirect effect
is what we understand.

910
00:38:37,050 --> 00:38:38,850
In the case of gas, it
was easy to see.

911
00:38:38,850 --> 00:38:41,600
The question, why didn't the
government realize this?

912
00:38:41,600 --> 00:38:43,860
Everyone saw the direct effect,
which was low prices,

913
00:38:43,860 --> 00:38:46,630
and indirect effect, which
was long lines.

914
00:38:46,630 --> 00:38:48,980
With a minimum wage, it's
harder, because there's lots

915
00:38:48,980 --> 00:38:51,160
of reasons for unemployment,
not just the minimum wage.

916
00:38:51,160 --> 00:38:54,110
So the indirect effect is
a lot harder to see.

917
00:38:54,110 --> 00:38:55,650
If you're a politician, you're
saying, look, I'll raise the

918
00:38:55,650 --> 00:38:55,800
minimum wage.

919
00:38:55,800 --> 00:38:56,990
I'll make sure you're
paid more.

920
00:38:56,990 --> 00:38:58,180
Everybody goes, yay.

921
00:38:58,180 --> 00:38:59,830
And then the economist says,
well, you have to understand,

922
00:38:59,830 --> 00:39:01,190
according to this diagram,
that would lead to

923
00:39:01,190 --> 00:39:01,630
unemployment.

924
00:39:01,630 --> 00:39:02,270
People are like, whatever.

925
00:39:02,270 --> 00:39:03,630
Shut up.

926
00:39:03,630 --> 00:39:06,070
So basically, the
point is that,

927
00:39:06,070 --> 00:39:07,910
basically, yes, you're right.

928
00:39:07,910 --> 00:39:11,630
But for perceived equity,
this is the case.

929
00:39:11,630 --> 00:39:12,250
But you're right.

930
00:39:12,250 --> 00:39:12,810
There's a trade-off.

931
00:39:12,810 --> 00:39:14,530
Just like they recognize the
trade between the price and

932
00:39:14,530 --> 00:39:16,445
the lines, there's a trade-off
between the higher wage and

933
00:39:16,445 --> 00:39:17,440
the employment.

934
00:39:17,440 --> 00:39:19,320
And that comes so what we'll
talk about, empirical

935
00:39:19,320 --> 00:39:21,520
economics, which is measuring
that trade-off.

936
00:39:21,520 --> 00:39:23,130
Well, how big is
that trade-off?

937
00:39:23,130 --> 00:39:25,790
How much unemployment does a
higher minimum wage cause?

938
00:39:25,790 --> 00:39:28,570
In fact, we'll learn in about
nine lectures that it actually

939
00:39:28,570 --> 00:39:29,820
doesn't cause that much
unemployment.

940
00:39:32,370 --> 00:39:33,310
It actually doesn't.

941
00:39:33,310 --> 00:39:35,120
So maybe the trade-off
isn't that bad.

942
00:39:35,120 --> 00:39:38,750
But in principle, there's
a trade-off.

943
00:39:38,750 --> 00:39:41,500
Now, that comes to your point
about shutting people's water

944
00:39:41,500 --> 00:39:44,150
off and things like that, and
the government making sure

945
00:39:44,150 --> 00:39:46,530
that the suppliers make
sure people's water

946
00:39:46,530 --> 00:39:47,200
doesn't get shut off.

947
00:39:47,200 --> 00:39:50,460
Once again, one way to do that
is just say to the water

948
00:39:50,460 --> 00:39:52,320
company, you can't shut people's
water off, even if

949
00:39:52,320 --> 00:39:53,880
they don't pay their bills.

950
00:39:53,880 --> 00:39:55,940
Well, that's going to mean the
water company's going to lose

951
00:39:55,940 --> 00:39:57,280
money on those people.

952
00:39:57,280 --> 00:40:00,590
That'll raise the cost of
supplying water, and that will

953
00:40:00,590 --> 00:40:02,620
lead to the same kind of
problems we've talked about.

954
00:40:02,620 --> 00:40:05,045
AUDIENCE: But if a
price cap and a--

955
00:40:05,045 --> 00:40:06,950
PROFESSOR: But if the government
then says, OK, a

956
00:40:06,950 --> 00:40:08,113
price cap, and then we're
going to pay you for the

957
00:40:08,113 --> 00:40:10,770
people who don't pay, that's
kind of like the idea before.

958
00:40:10,770 --> 00:40:13,170
You can have these
countervailing interventions.

959
00:40:13,170 --> 00:40:14,590
But then it starts
to get messy.

960
00:40:14,590 --> 00:40:16,990
You've got to raise the money
to pay them, et cetera.

961
00:40:16,990 --> 00:40:19,280
So that's why equity
is so hard.

962
00:40:19,280 --> 00:40:21,670
If it's efficiency, it's easy.

963
00:40:21,670 --> 00:40:23,850
You just don't do anything.

964
00:40:23,850 --> 00:40:26,380
With equity, it gets a lot
harder, because government has

965
00:40:26,380 --> 00:40:28,410
to intervene to address equity,
and then that causes

966
00:40:28,410 --> 00:40:30,950
other problems. It causes
these equity efficiency

967
00:40:30,950 --> 00:40:32,150
trade-offs.

968
00:40:32,150 --> 00:40:34,660
And that's a lot of the
problems it raises.

969
00:40:37,690 --> 00:40:42,600
So now let's talk about one
last example to stop.

970
00:40:42,600 --> 00:40:44,660
I don't have a diagram for this
one, but let's talk about

971
00:40:44,660 --> 00:40:46,450
the great example-- it's a
real world example that

972
00:40:46,450 --> 00:40:49,690
happens a lot-- which
is water shortages.

973
00:40:49,690 --> 00:40:53,030
How many people here
from California?

974
00:40:53,030 --> 00:40:54,530
You guys know water shortages.

975
00:40:54,530 --> 00:40:55,820
You guys know about
how this works.

976
00:40:55,820 --> 00:40:57,230
You guys know the drill.

977
00:40:57,230 --> 00:41:00,500
Which is that there'll be a
drought, and the government

978
00:41:00,500 --> 00:41:03,050
will say, you can only use
x gallons per day.

979
00:41:03,050 --> 00:41:04,640
You can't water your lawn or--

980
00:41:07,950 --> 00:41:09,110
actually, let me ask
the Californians.

981
00:41:09,110 --> 00:41:12,760
So does the government monitor
your meter or just tell you?

982
00:41:12,760 --> 00:41:13,465
Is it enforced?

983
00:41:13,465 --> 00:41:14,460
AUDIENCE: Tells us.

984
00:41:14,460 --> 00:41:16,040
PROFESSOR: Just tells you.

985
00:41:16,040 --> 00:41:17,350
So the government says,
you can't do this,

986
00:41:17,350 --> 00:41:17,990
you can't do that.

987
00:41:17,990 --> 00:41:18,650
Maybe they enforce it.

988
00:41:18,650 --> 00:41:19,100
Maybe they don't.

989
00:41:19,100 --> 00:41:19,830
Whatever.

990
00:41:19,830 --> 00:41:21,870
But the government comes in and
says, look, there's not

991
00:41:21,870 --> 00:41:23,780
enough water.

992
00:41:23,780 --> 00:41:26,390
So as a result, we are going
to limit your use of water.

993
00:41:26,390 --> 00:41:26,845
Yeah.

994
00:41:26,845 --> 00:41:29,120
AUDIENCE: They also have
tiered pricing.

995
00:41:29,120 --> 00:41:30,150
PROFESSOR: OK, hold on.

996
00:41:30,150 --> 00:41:30,540
Time out.

997
00:41:30,540 --> 00:41:31,380
That's because the government
got smart.

998
00:41:31,380 --> 00:41:34,340
So let's go back 10 years ago.

999
00:41:34,340 --> 00:41:38,910
So what they'll do is they'll
come in, and they'll say, you

1000
00:41:38,910 --> 00:41:40,980
can't use as much water.

1001
00:41:40,980 --> 00:41:43,920
Now, this has two problems,
just like we talked about.

1002
00:41:43,920 --> 00:41:47,180
First of all, there are
households which would happily

1003
00:41:47,180 --> 00:41:49,970
pay more to make sure
they got to use the

1004
00:41:49,970 --> 00:41:51,560
same amount of water.

1005
00:41:51,560 --> 00:41:54,550
And those trades are
not being made.

1006
00:41:54,550 --> 00:41:56,570
The first inefficiency.

1007
00:41:56,570 --> 00:42:00,000
Moreover, it's got the problem
that you're not allocating the

1008
00:42:00,000 --> 00:42:02,170
water appropriately.

1009
00:42:02,170 --> 00:42:05,170
Some guys are just dirty and
don't like to shower.

1010
00:42:05,170 --> 00:42:07,730
Some guys are clean and care
a lot about showering.

1011
00:42:07,730 --> 00:42:10,880
I want to allocate the water
to the clean guys.

1012
00:42:10,880 --> 00:42:12,610
But the government typically
doesn't do that.

1013
00:42:12,610 --> 00:42:16,130
It just says, don't use
more than x gallons.

1014
00:42:16,130 --> 00:42:18,990
So there's an allocation
inefficiency as well, where

1015
00:42:18,990 --> 00:42:21,395
the people that value the water
the most aren't getting

1016
00:42:21,395 --> 00:42:25,530
it the most. Now, tell me
about tiered pricing.

1017
00:42:25,530 --> 00:42:30,185
AUDIENCE: So it's like if you
use 0 to 80 gallons per year

1018
00:42:30,185 --> 00:42:32,390
or per month or whatever,
you pay a certain price.

1019
00:42:32,390 --> 00:42:36,310
And then if you use
81 to 120, you pay

1020
00:42:36,310 --> 00:42:37,780
extra on those gallons.

1021
00:42:37,780 --> 00:42:41,210
And then you pay even
more down--

1022
00:42:41,210 --> 00:42:42,200
PROFESSOR: Exactly.

1023
00:42:42,200 --> 00:42:43,860
So what the government
can do--

1024
00:42:43,860 --> 00:42:48,450
the right answer is that the
government can use the price

1025
00:42:48,450 --> 00:42:51,390
mechanism to deal with
the shortage.

1026
00:42:51,390 --> 00:42:54,310
And the way it can do that is by
saying, we're going to let

1027
00:42:54,310 --> 00:42:56,400
the price increase.

1028
00:42:56,400 --> 00:43:01,150
We're going to let the price
increase, and we are going to

1029
00:43:01,150 --> 00:43:03,980
allow the price to
be a function.

1030
00:43:03,980 --> 00:43:06,120
You see us pricing, but you make
that a function of the

1031
00:43:06,120 --> 00:43:08,585
underlying conditions
and water supply.

1032
00:43:08,585 --> 00:43:11,130
So basically, you have a tiered
pricing, and if there's

1033
00:43:11,130 --> 00:43:13,320
a drought, the prices
all go up.

1034
00:43:13,320 --> 00:43:15,480
So the government sets the price
for water, and it says,

1035
00:43:15,480 --> 00:43:16,810
look, the price this
year will be higher

1036
00:43:16,810 --> 00:43:18,370
if there's a drought.

1037
00:43:18,370 --> 00:43:20,400
And what that will do is that
will make sure whoever wants

1038
00:43:20,400 --> 00:43:22,130
the water gets the water and
makes sure we allocate it to

1039
00:43:22,130 --> 00:43:24,900
the people who need
it the most.

1040
00:43:24,900 --> 00:43:29,510
Can anyone think of another
way you can do this?

1041
00:43:29,510 --> 00:43:30,940
Never really worked in reality,
but it's kind of a

1042
00:43:30,940 --> 00:43:33,830
fun way to think about it.

1043
00:43:33,830 --> 00:43:39,460
Well, imagine that what I did
is I said, every Californian

1044
00:43:39,460 --> 00:43:42,440
gets a certain amount
of water permits.

1045
00:43:42,440 --> 00:43:43,920
Every Californian gets--

1046
00:43:43,920 --> 00:43:45,580
I don't know how many gallons
of water people use.

1047
00:43:45,580 --> 00:43:45,840
I don't know.

1048
00:43:45,840 --> 00:43:52,870
You get 1,000 gallon a
year water permit.

1049
00:43:52,870 --> 00:43:54,840
How many gallons of water
people use in a year?

1050
00:43:54,840 --> 00:43:57,940
I've got no idea.

1051
00:43:57,940 --> 00:43:58,402
1,000?

1052
00:43:58,402 --> 00:44:00,170
Let's say 1,000.

1053
00:44:00,170 --> 00:44:03,120
1,000 gallon a year
water permit.

1054
00:44:03,120 --> 00:44:04,960
We're going to give you
1,000 pieces of paper.

1055
00:44:04,960 --> 00:44:08,100
Each one permits you to
use a gallon of water.

1056
00:44:08,100 --> 00:44:10,760
Now, what we're going to let you
do is trade those pieces

1057
00:44:10,760 --> 00:44:13,960
of paper with your neighbors.

1058
00:44:13,960 --> 00:44:15,470
So what we're going to do is
we're going to say, in normal

1059
00:44:15,470 --> 00:44:20,710
times, basically, there's
enough water,

1060
00:44:20,710 --> 00:44:23,030
everyone gets 1,000.

1061
00:44:23,030 --> 00:44:26,240
Then we're going to say, when
times are tight that

1062
00:44:26,240 --> 00:44:31,710
basically, you can only
use 900 gallons.

1063
00:44:31,710 --> 00:44:34,700
So what that's going to mean is
that you're going to have

1064
00:44:34,700 --> 00:44:40,370
to have permits that allow
you to use those gallons.

1065
00:44:40,370 --> 00:44:41,450
And you're going to
have to buy those

1066
00:44:41,450 --> 00:44:44,300
permits off your neighbors.

1067
00:44:44,300 --> 00:44:46,520
So basically, we can allow
neighbors to trade.

1068
00:44:46,520 --> 00:44:47,670
And the neighbor that
says, I don't care

1069
00:44:47,670 --> 00:44:49,750
about water so much--

1070
00:44:49,750 --> 00:44:51,760
so what's going to happen now
is the government's going to

1071
00:44:51,760 --> 00:44:55,956
say, this year, we only issue
900 gallon permits to each of

1072
00:44:55,956 --> 00:44:57,910
you, instead of 1,000.

1073
00:44:57,910 --> 00:44:59,650
Now, you're a clean person.

1074
00:44:59,650 --> 00:45:03,790
You say, wait a second, I wanted
to use 1,000 gallons.

1075
00:45:03,790 --> 00:45:08,040
So you go to your neighbor and
say, look, you're dirty.

1076
00:45:08,040 --> 00:45:09,700
You don't need more
than 800 gallons.

1077
00:45:09,700 --> 00:45:12,020
Sell me your extra hundred.

1078
00:45:12,020 --> 00:45:14,730
The government gave you 900.

1079
00:45:14,730 --> 00:45:15,665
I want my 1,000.

1080
00:45:15,665 --> 00:45:17,500
The government gave me 900.

1081
00:45:17,500 --> 00:45:20,210
Sell me your extra 100.

1082
00:45:20,210 --> 00:45:21,950
The neighbors says, sure.

1083
00:45:21,950 --> 00:45:25,410
And they set a price, and they
sell to you, and it works out

1084
00:45:25,410 --> 00:45:28,430
to be exactly the same outcome
as if the government had used

1085
00:45:28,430 --> 00:45:31,350
the proper pricing, because
that secondary market--

1086
00:45:31,350 --> 00:45:33,060
somebody asked about
black markets--

1087
00:45:33,060 --> 00:45:36,670
this secondary market can
evade the government

1088
00:45:36,670 --> 00:45:38,810
regulation.

1089
00:45:38,810 --> 00:45:43,370
So once again, the market
equilibrium is very robust.

1090
00:45:43,370 --> 00:45:45,030
And if you can figure out a way
to evade the government

1091
00:45:45,030 --> 00:45:46,010
regulation, you will.

1092
00:45:46,010 --> 00:45:47,820
If there's some way with
permits, if there's some way

1093
00:45:47,820 --> 00:45:50,120
to trade-- now, in reality, you
can't really trade water.

1094
00:45:50,120 --> 00:45:54,140
But if you could, then you could
use a market mechanism

1095
00:45:54,140 --> 00:45:55,460
to overcome this problem.

1096
00:45:55,460 --> 00:45:55,860
Yeah.

1097
00:45:55,860 --> 00:46:00,572
AUDIENCE: Is that what-- one of
the suggestions was for the

1098
00:46:00,572 --> 00:46:02,705
global warming type thing,
the carbon credits--

1099
00:46:02,705 --> 00:46:03,505
PROFESSOR: Exactly.

1100
00:46:03,505 --> 00:46:05,640
So global warming--

1101
00:46:05,640 --> 00:46:09,020
actually, I flew with Al Gore
over to Kyoto in 1997 and

1102
00:46:09,020 --> 00:46:10,460
negotiated the global
warming treaty.

1103
00:46:10,460 --> 00:46:12,240
So something near and
dear to my heart.

1104
00:46:12,240 --> 00:46:16,510
And with global warming, that's
exactly the solution

1105
00:46:16,510 --> 00:46:18,770
that's part of the Kyoto
protocol, the framework that

1106
00:46:18,770 --> 00:46:21,510
was set up at that meeting,
which is that basically, there

1107
00:46:21,510 --> 00:46:24,410
will be a certain limit on how
much carbon dioxide can be

1108
00:46:24,410 --> 00:46:27,080
emitted into the air.

1109
00:46:27,080 --> 00:46:29,720
But there'll be permits, and
countries can actually trade

1110
00:46:29,720 --> 00:46:31,530
across each other.

1111
00:46:31,530 --> 00:46:36,010
And the idea is, look, in the
US, it's incredibly expensive

1112
00:46:36,010 --> 00:46:38,785
to reduce the emissions we have.
Because what you have to

1113
00:46:38,785 --> 00:46:41,190
do is you have to take a
coal-fired plant and retrofit

1114
00:46:41,190 --> 00:46:43,410
it to use natural gas instead.

1115
00:46:43,410 --> 00:46:46,530
Well, in China, they haven't
built the plant yet.

1116
00:46:46,530 --> 00:46:47,430
They're building the plant.

1117
00:46:47,430 --> 00:46:48,970
And it's not that much more
expensive to build it to be

1118
00:46:48,970 --> 00:46:50,940
natural gas instead of coal.

1119
00:46:50,940 --> 00:46:53,310
So in China, it's pretty cheap
to reduce emissions.

1120
00:46:53,310 --> 00:46:54,590
You just say, OK, I was
going to build a coal.

1121
00:46:54,590 --> 00:46:55,780
I'll build a natural
gas instead.

1122
00:46:55,780 --> 00:46:56,900
It's pretty much the
same cost. I've

1123
00:46:56,900 --> 00:46:58,500
just reduced emissions.

1124
00:46:58,500 --> 00:47:05,410
So the idea is that we would
trade with China, we would

1125
00:47:05,410 --> 00:47:08,070
pollute more, China would
pollute less, but the global

1126
00:47:08,070 --> 00:47:09,800
total would be the same.

1127
00:47:09,800 --> 00:47:11,330
Now, as you hear that, you might
think that's kind of

1128
00:47:11,330 --> 00:47:12,290
controversial.

1129
00:47:12,290 --> 00:47:14,850
But in fact, it makes
total sense.

1130
00:47:14,850 --> 00:47:16,410
Just like it might be
controversial that dirty

1131
00:47:16,410 --> 00:47:18,440
neighbors are selling water
to clean neighbors.

1132
00:47:18,440 --> 00:47:21,580
You can imagine the newspaper
articles, the outrage.

1133
00:47:21,580 --> 00:47:26,420
People forced to be dirty
to make ends meet.

1134
00:47:26,420 --> 00:47:29,080
But that's not right.

1135
00:47:29,080 --> 00:47:32,445
What's right is you want to
allocate to people for whom

1136
00:47:32,445 --> 00:47:33,650
it's most efficient.

1137
00:47:33,650 --> 00:47:36,790
It is more efficient for China
to reduce emissions because

1138
00:47:36,790 --> 00:47:39,970
it's cheaper than for the
US to reduce emissions.

1139
00:47:39,970 --> 00:47:42,145
So the efficient system, we say,
here's the total amount

1140
00:47:42,145 --> 00:47:45,810
of emissions we're going to
reduce, and we're going to let

1141
00:47:45,810 --> 00:47:50,100
China do extra reduction, or
pollute less, and the US gets

1142
00:47:50,100 --> 00:47:52,550
to continue our slovenly
ways, and that's

1143
00:47:52,550 --> 00:47:53,800
the efficient outcome.

1144
00:47:56,000 --> 00:47:58,090
One last thing on this note.

1145
00:47:58,090 --> 00:47:59,890
Many of you may know who
Larry Summers is.

1146
00:47:59,890 --> 00:48:03,260
Larry Summers was actually my
thesis adviser who then went

1147
00:48:03,260 --> 00:48:05,470
on to be Secretary of the
Treasury, had a somewhat

1148
00:48:05,470 --> 00:48:07,840
failed stint as president of
Harvard and is now Obama's top

1149
00:48:07,840 --> 00:48:08,870
economic advisor.

1150
00:48:08,870 --> 00:48:11,990
Well, Larry Summers has gotten
himself in trouble two times.

1151
00:48:11,990 --> 00:48:14,450
You all know about the time
he said women are stupid.

1152
00:48:14,450 --> 00:48:16,570
But the other time he got
himself in trouble was in

1153
00:48:16,570 --> 00:48:20,350
1990, he actually signed
his name to a memo.

1154
00:48:20,350 --> 00:48:20,660
He didn't actually write it.

1155
00:48:20,660 --> 00:48:22,980
Signed his name to a memo saying
that the efficient

1156
00:48:22,980 --> 00:48:24,220
thing to do is we should
ship all our

1157
00:48:24,220 --> 00:48:26,680
garbage to poor countries.

1158
00:48:26,680 --> 00:48:29,940
And he said that's efficient
because poor countries, what

1159
00:48:29,940 --> 00:48:30,300
do they have?

1160
00:48:30,300 --> 00:48:33,030
They have lots of space
and not much money.

1161
00:48:33,030 --> 00:48:33,690
What do we have?

1162
00:48:33,690 --> 00:48:35,610
Lots of money and
not much space.

1163
00:48:35,610 --> 00:48:37,700
So the efficient thing to do is
we should take our garbage

1164
00:48:37,700 --> 00:48:41,400
and put on barges and
send it to Africa.

1165
00:48:41,400 --> 00:48:42,550
He was right.

1166
00:48:42,550 --> 00:48:44,140
That is the efficient
thing to do.

1167
00:48:44,140 --> 00:48:45,940
Africans would be better off,
because they have lots of

1168
00:48:45,940 --> 00:48:48,180
space they're not using,
and they'd be richer.

1169
00:48:48,180 --> 00:48:49,890
The US would be better off,
because we would be able to

1170
00:48:49,890 --> 00:48:51,520
get rid of our garbage, and
we're happy to pay to do it.

1171
00:48:51,520 --> 00:48:53,000
That's the trade to make
it better off.

1172
00:48:53,000 --> 00:48:56,210
And yet, it got him fired,
writing that memo.

1173
00:48:56,210 --> 00:48:58,200
That's why economics is the
dismal science, because we

1174
00:48:58,200 --> 00:49:00,530
point out things like this.

1175
00:49:00,530 --> 00:49:02,970
All right, let me stop there,
and we'll come back on

1176
00:49:02,970 --> 00:49:04,940
Wednesday and start talking
in more detail

1177
00:49:04,940 --> 00:49:06,190
about consumer demand.