1 00:00:00,040 --> 00:00:02,460 The following content is provided under a Creative 2 00:00:02,460 --> 00:00:03,870 Commons license. 3 00:00:03,870 --> 00:00:06,910 Your support will help MIT OpenCourseWare continue to 4 00:00:06,910 --> 00:00:10,560 offer high quality educational resources for free. 5 00:00:10,560 --> 00:00:13,460 To make a donation or view additional materials from 6 00:00:13,460 --> 00:00:17,390 hundreds of MIT courses, visit MIT OpenCourseWare at 7 00:00:17,390 --> 00:00:18,640 ocw.mit.edu. 8 00:00:21,390 --> 00:00:22,570 PROFESSOR: So what I want to do today is I want to talk 9 00:00:22,570 --> 00:00:23,930 about what the heck this course is. 10 00:00:23,930 --> 00:00:25,560 What is microeconomics? 11 00:00:25,560 --> 00:00:28,080 What are you going to be learning in this course? 12 00:00:28,080 --> 00:00:30,150 And just, sort of, set us up for the semester. 13 00:00:30,150 --> 00:00:30,720 OK. 14 00:00:30,720 --> 00:00:37,400 So basically, microeconomics is all about scarcity. 15 00:00:37,400 --> 00:00:43,470 It's all about how individuals and firms make decisions given 16 00:00:43,470 --> 00:00:46,410 that we live in a world of scarcity. 17 00:00:46,410 --> 00:00:49,540 Scarcity is key because basically what we're going to 18 00:00:49,540 --> 00:00:52,860 learn about this semester in various shapes and forms is a 19 00:00:52,860 --> 00:00:55,480 lot of different types of constrained optimization. 20 00:01:01,320 --> 00:01:04,530 We're going to learn a lot about different ways that 21 00:01:04,530 --> 00:01:08,890 individuals make choices in a world of scarcity. 22 00:01:08,890 --> 00:01:10,060 OK? 23 00:01:10,060 --> 00:01:13,550 That is, this course is going to be about trade-offs. 24 00:01:13,550 --> 00:01:17,240 Given scarce resources, how the individuals and firms 25 00:01:17,240 --> 00:01:19,760 trade off different alternatives to make 26 00:01:19,760 --> 00:01:22,150 themselves as well-off as possible. 27 00:01:22,150 --> 00:01:24,790 That's why economics is called the dismal science. 28 00:01:24,790 --> 00:01:25,250 OK? 29 00:01:25,250 --> 00:01:27,740 It's called the dismal science because we are not about 30 00:01:27,740 --> 00:01:28,910 everyone have everything. 31 00:01:28,910 --> 00:01:30,710 We're always the people who say, no, you can't have 32 00:01:30,710 --> 00:01:31,090 everything. 33 00:01:31,090 --> 00:01:32,750 You have to make a trade-off. 34 00:01:32,750 --> 00:01:33,190 OK? 35 00:01:33,190 --> 00:01:35,040 You have to give up x to get y. 36 00:01:35,040 --> 00:01:36,810 And that's why people don't like us. 37 00:01:36,810 --> 00:01:37,380 OK? 38 00:01:37,380 --> 00:01:39,050 Because that's why we're called the dismal science, 39 00:01:39,050 --> 00:01:40,250 because we're always pointing out the 40 00:01:40,250 --> 00:01:41,870 trade-offs that people face. 41 00:01:41,870 --> 00:01:45,640 Now, some may call it dismal, but I call it fun. 42 00:01:45,640 --> 00:01:48,640 And that may be because of my MIT training, as I said I was 43 00:01:48,640 --> 00:01:50,360 an undergraduate here. 44 00:01:50,360 --> 00:01:53,190 In fact, MIT is the perfect place to teach microeconomics 45 00:01:53,190 --> 00:01:56,500 because this whole institute is about engineering solutions 46 00:01:56,500 --> 00:01:57,850 which are really ultimately about constrained 47 00:01:57,850 --> 00:01:59,060 optimization. 48 00:01:59,060 --> 00:02:00,790 Indeed, what's the best example in the 49 00:02:00,790 --> 00:02:01,600 world we have of this? 50 00:02:01,600 --> 00:02:03,360 It's the 270 contest. Right? 51 00:02:03,360 --> 00:02:06,090 You're given a pile of junk, you've got to build something 52 00:02:06,090 --> 00:02:07,480 that does something else. 53 00:02:07,480 --> 00:02:09,780 That's an exercise in constrained optimization. 54 00:02:09,780 --> 00:02:12,070 All engineering is really constrained optimization. 55 00:02:12,070 --> 00:02:13,800 How do you take the resources you're given and do the best 56 00:02:13,800 --> 00:02:15,280 job building something. 57 00:02:15,280 --> 00:02:18,650 And that's really what microeconomics is. 58 00:02:18,650 --> 00:02:21,900 Just like 270 is not a dismal contest, microeconomics is not 59 00:02:21,900 --> 00:02:23,720 to me a dismal science. 60 00:02:23,720 --> 00:02:26,490 You could think of this course like 270. 61 00:02:26,490 --> 00:02:27,775 But instead of the building robots, we're 62 00:02:27,775 --> 00:02:29,180 running people's lives. 63 00:02:29,180 --> 00:02:29,720 OK? 64 00:02:29,720 --> 00:02:30,650 That's, kind of, the way I like to 65 00:02:30,650 --> 00:02:31,230 think about this course. 66 00:02:31,230 --> 00:02:32,840 Instead of trying to decide how we can build something to 67 00:02:32,840 --> 00:02:35,140 move a ping pong ball across a table, we're trying to decide 68 00:02:35,140 --> 00:02:37,510 how people make their decisions to consume, and 69 00:02:37,510 --> 00:02:39,270 firms make their decisions to produce. 70 00:02:39,270 --> 00:02:41,660 That's basically what's going to go on in this class. 71 00:02:41,660 --> 00:02:42,140 OK? 72 00:02:42,140 --> 00:02:44,960 And that's why basically modern microeconomics was 73 00:02:44,960 --> 00:02:48,360 founded at MIT in the 1950s by Paul Samuelson. 74 00:02:48,360 --> 00:02:52,890 The father of modern economics was a professor here, and he 75 00:02:52,890 --> 00:02:54,080 basically founded the field. 76 00:02:54,080 --> 00:02:57,240 He basically introduced mathematics to economics. 77 00:02:57,240 --> 00:03:00,690 And through teaching this course, 14.01, 50, 60 years 78 00:03:00,690 --> 00:03:04,210 ago, actually developed the field that we now study. 79 00:03:04,210 --> 00:03:08,990 Now, what we're going to do in this class, is focused on two 80 00:03:08,990 --> 00:03:11,450 types of actors in the economy: 81 00:03:11,450 --> 00:03:13,330 consumers and producers. 82 00:03:19,910 --> 00:03:20,730 OK? 83 00:03:20,730 --> 00:03:25,300 And we are going to build models of how consumers and 84 00:03:25,300 --> 00:03:29,500 producers behave. Now, technically, a model is going 85 00:03:29,500 --> 00:03:33,230 to be a description of any relationship between two or 86 00:03:33,230 --> 00:03:35,180 more economic variables. 87 00:03:35,180 --> 00:03:35,950 OK? 88 00:03:35,950 --> 00:03:36,460 That's a model. 89 00:03:36,460 --> 00:03:38,090 A description of any relationship between two or 90 00:03:38,090 --> 00:03:40,120 more economic variables. 91 00:03:40,120 --> 00:03:42,430 The trick with economics, and the reason many of you will be 92 00:03:42,430 --> 00:03:45,870 frustrated during the semester, is that unlike the 93 00:03:45,870 --> 00:03:48,970 modern relationship between say energy and mass these 94 00:03:48,970 --> 00:03:51,600 models are never precise. 95 00:03:51,600 --> 00:03:55,490 They are never accurate to the 10th decimal. 96 00:03:55,490 --> 00:03:56,630 OK? 97 00:03:56,630 --> 00:03:58,950 This is not a precise, scientific 98 00:03:58,950 --> 00:04:00,190 relationship with modeling. 99 00:04:00,190 --> 00:04:03,390 We'll be making a number of simplifying assumptions that 100 00:04:03,390 --> 00:04:06,650 allow us to capture the main tendencies in the data. 101 00:04:06,650 --> 00:04:09,850 That allow us to capture the main insights into how 102 00:04:09,850 --> 00:04:12,000 individuals make consumption decisions and how firms make 103 00:04:12,000 --> 00:04:13,240 production decisions. 104 00:04:13,240 --> 00:04:15,390 But it's not going to be as clean and precise as the kind 105 00:04:15,390 --> 00:04:16,890 of proofs you're going to be doing in some of your other 106 00:04:16,890 --> 00:04:20,450 classes in freshman and sophomore year. 107 00:04:20,450 --> 00:04:21,130 OK? 108 00:04:21,130 --> 00:04:24,180 So basically, we have a trade off with the simplifying 109 00:04:24,180 --> 00:04:25,480 assumptions. 110 00:04:25,480 --> 00:04:28,720 On the one hand, obviously we want a model that can explain 111 00:04:28,720 --> 00:04:30,600 reality as much as possible. 112 00:04:30,600 --> 00:04:33,280 If a model can't explain reality, it's not useful. 113 00:04:33,280 --> 00:04:35,250 On the other hand, we need a model that's tractable, a 114 00:04:35,250 --> 00:04:38,810 model that I can teach you in a lecture or less. 115 00:04:38,810 --> 00:04:40,100 OK? 116 00:04:40,100 --> 00:04:45,200 And basically, what we do is we make a lot of simplifying 117 00:04:45,200 --> 00:04:47,730 assumptions in this class to make those models work. 118 00:04:47,730 --> 00:04:50,580 And yet, what we'll find is despite these assumptions, 119 00:04:50,580 --> 00:04:53,270 we'll come up with incredibly powerful predictions of how 120 00:04:53,270 --> 00:04:55,940 consumers and producers behave. 121 00:04:55,940 --> 00:04:58,260 So with consumers what we're going to do is, we're going to 122 00:04:58,260 --> 00:05:02,010 say that consumers are constrained by their limited 123 00:05:02,010 --> 00:05:05,030 wealth or what we'll call their budget constraint. 124 00:05:05,030 --> 00:05:09,930 And subject to that constraint they choose the set of goods 125 00:05:09,930 --> 00:05:12,250 that makes them as well off as possible. 126 00:05:12,250 --> 00:05:12,760 OK? 127 00:05:12,760 --> 00:05:15,970 That's what we're going to call utility maximization. 128 00:05:15,970 --> 00:05:19,000 We'll say the consumers maximize their utility, 129 00:05:19,000 --> 00:05:25,600 consumers are going to maximize utility subject to a 130 00:05:25,600 --> 00:05:26,800 budget constraint. 131 00:05:26,800 --> 00:05:28,680 That's going to be what we're going to develop 132 00:05:28,680 --> 00:05:29,460 the consumer decision. 133 00:05:29,460 --> 00:05:31,583 They have some utility function which is going to be 134 00:05:31,583 --> 00:05:33,600 a model of their preferences. 135 00:05:33,600 --> 00:05:35,600 OK? 136 00:05:35,600 --> 00:05:37,790 So I'm going to propose to take everything you love in 137 00:05:37,790 --> 00:05:40,220 life and write it down as a u function. 138 00:05:40,220 --> 00:05:40,920 OK? 139 00:05:40,920 --> 00:05:42,716 Then I'm going to propose you take all the resources at your 140 00:05:42,716 --> 00:05:44,900 disposal, write them down as a budget constraint and then I 141 00:05:44,900 --> 00:05:47,760 just do constrained maximization to solve for how 142 00:05:47,760 --> 00:05:49,580 you make decisions. 143 00:05:49,580 --> 00:05:53,310 Firms, on the other hand, are going to maximize profits. 144 00:05:55,960 --> 00:05:57,100 Pi is profits. 145 00:05:57,100 --> 00:05:59,200 Firms are going to maximize profits. 146 00:05:59,200 --> 00:06:03,360 Their goal is to make as much profit as possible, to earn as 147 00:06:03,360 --> 00:06:05,030 much money as possible. 148 00:06:05,030 --> 00:06:05,880 OK? 149 00:06:05,880 --> 00:06:09,960 However, that's going to be subject to both the demands of 150 00:06:09,960 --> 00:06:14,620 consumers, we get to firms it's a lot harder, subject to 151 00:06:14,620 --> 00:06:22,850 both consumer demand and input costs. 152 00:06:22,850 --> 00:06:25,740 So firms have to consider, consumers have to consider 153 00:06:25,740 --> 00:06:27,310 look what does stuff cost and what do I like, 154 00:06:27,310 --> 00:06:28,290 I'll make my decision. 155 00:06:28,290 --> 00:06:29,900 Firms is a little more complicated. 156 00:06:29,900 --> 00:06:32,200 They've go to consider, what do consumers want and how do I 157 00:06:32,200 --> 00:06:33,640 make what they want? 158 00:06:33,640 --> 00:06:36,895 So they've got to consider both the output side, what a 159 00:06:36,895 --> 00:06:39,050 consumer is going to want me to make and what's it going to 160 00:06:39,050 --> 00:06:40,880 cost me to produce that good? 161 00:06:40,880 --> 00:06:43,880 And how do I combine those to make the most profits? 162 00:06:43,880 --> 00:06:44,700 OK? 163 00:06:44,700 --> 00:06:50,650 So from these assumptions, we will be able to answer the 164 00:06:50,650 --> 00:06:53,790 three fundamental questions of microeconomics. 165 00:06:53,790 --> 00:06:54,380 OK? 166 00:06:54,380 --> 00:06:56,650 The three fundamental questions of microeconomics 167 00:06:56,650 --> 00:07:04,485 will be, what goods and services should be produced? 168 00:07:07,800 --> 00:07:09,440 What goods and services should be produced? 169 00:07:11,960 --> 00:07:13,760 How to produce those goods and services? 170 00:07:20,920 --> 00:07:23,250 And who gets the goods and services? 171 00:07:27,400 --> 00:07:30,400 What goods and services get produced? 172 00:07:30,400 --> 00:07:33,090 How to produce those goods and services? 173 00:07:33,090 --> 00:07:35,290 And who gets them? 174 00:07:35,290 --> 00:07:38,150 And what's amazing, we'll learn in this course, is that 175 00:07:38,150 --> 00:07:40,980 all three of these questions, the three fundamental 176 00:07:40,980 --> 00:07:44,990 questions that drive our entire economy, are all solved 177 00:07:44,990 --> 00:07:47,460 through the role of one key state 178 00:07:47,460 --> 00:07:48,825 variable, which is prices. 179 00:07:52,080 --> 00:07:57,820 Prices in the economy resolve all of these problems. OK? 180 00:07:57,820 --> 00:08:02,810 Consumers and firms will interact in a market, they'll 181 00:08:02,810 --> 00:08:04,800 interact in a marketplace. 182 00:08:04,800 --> 00:08:08,330 And out of that marketplace will emerge a set of prices, 183 00:08:08,330 --> 00:08:11,020 in a way we'll describe. 184 00:08:11,020 --> 00:08:14,460 And those prices will allow firms and consumers to make 185 00:08:14,460 --> 00:08:16,063 the relevant decisions. 186 00:08:16,063 --> 00:08:16,870 OK? 187 00:08:16,870 --> 00:08:19,080 So let me just give you one, and we're going to do all this 188 00:08:19,080 --> 00:08:20,900 rigorously throughout the semester, let me just start 189 00:08:20,900 --> 00:08:22,050 with one casual example. 190 00:08:22,050 --> 00:08:22,650 OK? 191 00:08:22,650 --> 00:08:25,600 Let's think about the development of the iPod. 192 00:08:25,600 --> 00:08:26,070 OK? 193 00:08:26,070 --> 00:08:29,830 Let's cast our minds way back, lo way back to the development 194 00:08:29,830 --> 00:08:30,760 of the iPod. 195 00:08:30,760 --> 00:08:31,380 OK? 196 00:08:31,380 --> 00:08:37,350 Now, when Apple was thinking about making the iPod, they 197 00:08:37,350 --> 00:08:40,750 had to ask, would consumers want this? 198 00:08:40,750 --> 00:08:44,430 So consumers had to decide given their limited resources, 199 00:08:44,430 --> 00:08:47,040 given the fact that they were buying a certain set of things 200 00:08:47,040 --> 00:08:49,560 would they be willing to forsake some things they were 201 00:08:49,560 --> 00:08:52,600 already doing to spend the money on the iPod? 202 00:08:52,600 --> 00:08:52,890 OK? 203 00:08:52,890 --> 00:08:54,110 It was a non-trivial amount of money. 204 00:08:54,110 --> 00:08:55,413 Would they be willing to forsake things they are 205 00:08:55,413 --> 00:08:56,530 already doing? 206 00:08:56,530 --> 00:08:57,340 OK? 207 00:08:57,340 --> 00:08:58,760 To spend money on the iPod. 208 00:08:58,760 --> 00:09:00,500 And clearly they were. 209 00:09:00,500 --> 00:09:03,960 Clearly, consumers were willing to spend money, to 210 00:09:03,960 --> 00:09:06,470 spend a lot of money, to get an iPod. 211 00:09:06,470 --> 00:09:08,590 They were originally what? $300 Back 212 00:09:08,590 --> 00:09:10,040 when $300 meant something. 213 00:09:10,040 --> 00:09:10,650 OK. 214 00:09:10,650 --> 00:09:16,760 So basically, what the firm will do is they'll say, OK, we 215 00:09:16,760 --> 00:09:20,800 get a signal from the consumer that they're willing to pay 216 00:09:20,800 --> 00:09:22,620 money to get the iPod. 217 00:09:22,620 --> 00:09:25,910 They're willing to pay a high price to get the iPod. 218 00:09:25,910 --> 00:09:28,850 Now, the firm will say, well, should we make iPods? 219 00:09:28,850 --> 00:09:32,000 Well, that will depend on what it cost to make them. 220 00:09:32,000 --> 00:09:39,100 So we have to then assess what are the inputs that we'll need 221 00:09:39,100 --> 00:09:40,310 to make an iPod? 222 00:09:40,310 --> 00:09:44,070 Well, to do that we have to look at the prices of the 223 00:09:44,070 --> 00:09:46,550 various inputs that we'll need, of the chip in them and 224 00:09:46,550 --> 00:09:49,130 the metal and all the other stuff that goes into the iPod. 225 00:09:49,130 --> 00:09:50,020 OK? 226 00:09:50,020 --> 00:09:52,610 So they can shop across different countries, to 227 00:09:52,610 --> 00:09:54,170 different kinds of chips, they can look at different kinds of 228 00:09:54,170 --> 00:09:55,560 monitors, et cetera. 229 00:09:55,560 --> 00:09:58,820 But, once again, what they'll do is they'll use the prices 230 00:09:58,820 --> 00:10:01,290 of those different inputs to decide how 231 00:10:01,290 --> 00:10:02,430 to produce the iPod. 232 00:10:02,430 --> 00:10:05,630 So whether to produce the iPod will depend on the price 233 00:10:05,630 --> 00:10:08,030 people are willing to pay for it. 234 00:10:08,030 --> 00:10:11,850 How to make the iPod will depend on the prices that 235 00:10:11,850 --> 00:10:15,870 firms have to pay for the chip and the casing and all the 236 00:10:15,870 --> 00:10:18,420 other things that go into the iPod. 237 00:10:18,420 --> 00:10:19,280 OK? 238 00:10:19,280 --> 00:10:22,400 And then finally, who's going to get the iPod? 239 00:10:22,400 --> 00:10:24,500 Well, they're going to make a certain amount. 240 00:10:24,500 --> 00:10:25,510 What decided who gets them? 241 00:10:25,510 --> 00:10:27,170 Well, the person who gets them are the people who are willing 242 00:10:27,170 --> 00:10:30,610 to pay the price that Apple decides to charge. 243 00:10:30,610 --> 00:10:33,140 Some people are willing to pay that price, they're going to 244 00:10:33,140 --> 00:10:34,940 get an iPod. 245 00:10:34,940 --> 00:10:37,400 Some people are not willing to pay that price, they will not 246 00:10:37,400 --> 00:10:38,910 get an iPod. 247 00:10:38,910 --> 00:10:41,460 So the price in the market will ultimately decide who 248 00:10:41,460 --> 00:10:44,030 gets the iPod, as well. 249 00:10:44,030 --> 00:10:44,710 OK? 250 00:10:44,710 --> 00:10:48,710 So basically, prices will determine what gets produced, 251 00:10:48,710 --> 00:10:50,880 how it's produced, and who gets the 252 00:10:50,880 --> 00:10:53,000 goods that are produced. 253 00:10:53,000 --> 00:10:54,280 OK? 254 00:10:54,280 --> 00:10:57,850 Of course, this is a very, very simplified example, as 255 00:10:57,850 --> 00:10:58,900 you can already tell. 256 00:10:58,900 --> 00:11:00,610 There are lots of cases where prices don't 257 00:11:00,610 --> 00:11:02,070 decide these things. 258 00:11:02,070 --> 00:11:06,590 So my favorite example is the fact that there are lines for 259 00:11:06,590 --> 00:11:10,190 hours to get tickets to see a Lady Gaga concert. 260 00:11:10,190 --> 00:11:11,030 OK? 261 00:11:11,030 --> 00:11:15,040 Now if it's really true that prices determine everything, 262 00:11:15,040 --> 00:11:16,740 we shouldn't see any lines. 263 00:11:16,740 --> 00:11:18,650 It should just be that those who are willing to pay the 264 00:11:18,650 --> 00:11:21,730 most to see Lady Gaga should. 265 00:11:21,730 --> 00:11:25,220 Those who want the most to get Lady Gaga 266 00:11:25,220 --> 00:11:26,120 should get the tickets. 267 00:11:26,120 --> 00:11:27,990 Those who aren't willing to pay shouldn't get the tickets. 268 00:11:27,990 --> 00:11:29,420 Why should there be a line? 269 00:11:29,420 --> 00:11:31,000 Not to mention the fact that people shouldn't be willing to 270 00:11:31,000 --> 00:11:32,660 pay anything, but that's a different issue. 271 00:11:32,660 --> 00:11:33,510 That's a taste issue. 272 00:11:33,510 --> 00:11:34,770 We'll come to taste later. 273 00:11:34,770 --> 00:11:35,610 OK? 274 00:11:35,610 --> 00:11:39,010 So basically, clearly this is not working perfectly. 275 00:11:39,010 --> 00:11:42,060 If the world worked in the way I just described, then what 276 00:11:42,060 --> 00:11:45,870 should happen is there should be essentially an auction and 277 00:11:45,870 --> 00:11:48,140 whoever is willing to pay the most for Lady Gaga tickets 278 00:11:48,140 --> 00:11:49,270 would get them. 279 00:11:49,270 --> 00:11:50,500 And whoever is not willing to pay wouldn't. 280 00:11:50,500 --> 00:11:51,560 It wouldn't involve any waiting in 281 00:11:51,560 --> 00:11:53,850 line or other things. 282 00:11:53,850 --> 00:11:56,440 Now, what's very interesting is we've actually seen an 283 00:11:56,440 --> 00:11:59,910 evolution from my youth to your youth towards the 284 00:11:59,910 --> 00:12:00,840 economic model. 285 00:12:00,840 --> 00:12:04,660 When I was a kid, if you wanted, so then it was Cars 286 00:12:04,660 --> 00:12:09,710 tickets, OK, to date myself, OK, you had to go and camp out 287 00:12:09,710 --> 00:12:13,050 at 3:00 in the morning outside the store where they're 288 00:12:13,050 --> 00:12:14,700 selling them to get the tickets. 289 00:12:14,700 --> 00:12:16,440 Now, of course, you don't do that anymore. 290 00:12:16,440 --> 00:12:19,800 Now you go on Stub Hub or Ticketmaster or these other 291 00:12:19,800 --> 00:12:22,870 secondary sellers and there there are prices that 292 00:12:22,870 --> 00:12:23,380 determine it. 293 00:12:23,380 --> 00:12:28,060 So how many people have waited on line to 294 00:12:28,060 --> 00:12:30,750 get a concert ticket? 295 00:12:30,750 --> 00:12:31,390 That's amazing. 296 00:12:31,390 --> 00:12:34,620 So if I asked this question 30 years ago, 90% of the hands 297 00:12:34,620 --> 00:12:35,500 would have gone up. 298 00:12:35,500 --> 00:12:36,100 OK? 299 00:12:36,100 --> 00:12:38,750 So what that means is the price mechanism has 300 00:12:38,750 --> 00:12:40,000 started to be used. 301 00:12:40,000 --> 00:12:45,240 It has replaced the line mechanism as a way to allocate 302 00:12:45,240 --> 00:12:45,700 those tickets. 303 00:12:45,700 --> 00:12:47,070 And we see prices working. 304 00:12:47,070 --> 00:12:47,760 That wasn't true. 305 00:12:47,760 --> 00:12:49,120 There wasn't StubHub. 306 00:12:49,120 --> 00:12:52,470 There weren't these secondary ticket sellers 30 years ago. 307 00:12:52,470 --> 00:12:55,640 You had to wait on line to get the tickets. 308 00:12:55,640 --> 00:12:58,590 Now, so that's basically, sort of, an overview about, sort of 309 00:12:58,590 --> 00:13:01,300 an example, of how we think about the role of prices. 310 00:13:01,300 --> 00:13:04,420 Now, let me draw a couple of important distinctions, terms 311 00:13:04,420 --> 00:13:05,970 I'm going to use this semester that I want you to be 312 00:13:05,970 --> 00:13:07,270 comfortable with. 313 00:13:07,270 --> 00:13:08,000 OK? 314 00:13:08,000 --> 00:13:15,580 The first distinction I want to draw is between theoretical 315 00:13:15,580 --> 00:13:20,345 versus empirical economics. 316 00:13:23,720 --> 00:13:26,680 Theoretical versus empirical economics. 317 00:13:26,680 --> 00:13:27,460 OK. 318 00:13:27,460 --> 00:13:34,940 Theoretical economics is the process of building models to 319 00:13:34,940 --> 00:13:36,190 explain the world. 320 00:13:40,070 --> 00:13:40,860 OK? 321 00:13:40,860 --> 00:13:44,260 Empirical economics is the process of testing those 322 00:13:44,260 --> 00:13:49,480 models to see how good a job they do in 323 00:13:49,480 --> 00:13:51,380 explaining the world. 324 00:13:51,380 --> 00:13:52,200 OK? 325 00:13:52,200 --> 00:13:54,630 We could all make up a model. 326 00:13:54,630 --> 00:13:54,950 OK? 327 00:13:54,950 --> 00:13:56,890 Anybody with math skills could make up a model. 328 00:13:56,890 --> 00:14:00,040 But it doesn't do any good unless it's actually doing 329 00:14:00,040 --> 00:14:01,600 something to explain the world. 330 00:14:01,600 --> 00:14:07,490 And so basically, the goal of theoretical economics is 331 00:14:07,490 --> 00:14:12,560 essentially to build a model that has some testable 332 00:14:12,560 --> 00:14:14,090 predictions. 333 00:14:14,090 --> 00:14:16,490 To build a model that says, look here's my simplified 334 00:14:16,490 --> 00:14:22,050 model of how consumers decide whether or not to buy an iPod. 335 00:14:22,050 --> 00:14:22,570 OK? 336 00:14:22,570 --> 00:14:24,830 I have a model of that, that I've built theoretically. 337 00:14:24,830 --> 00:14:27,410 Well, that has some testable predictions. 338 00:14:27,410 --> 00:14:29,320 And the role of empirical economics is to gather the 339 00:14:29,320 --> 00:14:33,490 data and go and test them using statistical methods. 340 00:14:33,490 --> 00:14:35,700 Specifically, typically regression analysis like the 341 00:14:35,700 --> 00:14:38,820 kind you learn about in advanced statistics. 342 00:14:38,820 --> 00:14:39,980 OK? 343 00:14:39,980 --> 00:14:44,775 So basically, what we're going to do is we're going to is 95% 344 00:14:44,775 --> 00:14:46,440 of this course will be about theoretical 345 00:14:46,440 --> 00:14:47,940 economics this semester. 346 00:14:47,940 --> 00:14:50,210 It will be about understanding how economists develop the 347 00:14:50,210 --> 00:14:53,680 models to model how consumers and firms behave. But I will 348 00:14:53,680 --> 00:14:57,610 try to talk somewhat about empirical economics and what 349 00:14:57,610 --> 00:15:00,730 data we can bring to bear to understand whether or not 350 00:15:00,730 --> 00:15:04,080 these models explain the world. 351 00:15:04,080 --> 00:15:05,230 OK? 352 00:15:05,230 --> 00:15:10,540 The other distinction that's very important is positive 353 00:15:10,540 --> 00:15:17,570 versus normative economics. 354 00:15:17,570 --> 00:15:21,020 Positive versus normative economics. 355 00:15:21,020 --> 00:15:25,950 And this is the distinction between the way things are, 356 00:15:25,950 --> 00:15:30,370 which is positive economics, and the way things should be 357 00:15:30,370 --> 00:15:31,920 which is normative economics. 358 00:15:31,920 --> 00:15:34,600 Distinction between the way things are and the way 359 00:15:34,600 --> 00:15:36,160 things should be. 360 00:15:36,160 --> 00:15:37,060 OK? 361 00:15:37,060 --> 00:15:39,660 So let's consider a great example of microeconomics at 362 00:15:39,660 --> 00:15:42,880 work which is auctions on eBay. 363 00:15:42,880 --> 00:15:44,210 OK? 364 00:15:44,210 --> 00:15:48,000 Auctions on eBay, economists love studying auctions on eBay 365 00:15:48,000 --> 00:15:51,390 because it's a textbook example of what we call a 366 00:15:51,390 --> 00:15:55,100 perfectly competitive market which is what we'll focus on 367 00:15:55,100 --> 00:15:56,670 the semester. 368 00:15:56,670 --> 00:15:59,060 A perfectly competitive market. 369 00:15:59,060 --> 00:15:59,930 OK? 370 00:15:59,930 --> 00:16:07,040 And by that we mean that basically that producers in 371 00:16:07,040 --> 00:16:09,620 this market offer up their good to a 372 00:16:09,620 --> 00:16:12,390 wide range of consumers. 373 00:16:12,390 --> 00:16:13,500 OK? 374 00:16:13,500 --> 00:16:15,610 A number of producers offer up their goods to a 375 00:16:15,610 --> 00:16:17,840 wide range of consumers. 376 00:16:17,840 --> 00:16:18,530 OK? 377 00:16:18,530 --> 00:16:22,150 And the consumers bid up the price until the person who has 378 00:16:22,150 --> 00:16:24,680 the highest value for the good gets it. 379 00:16:24,680 --> 00:16:27,350 So price serves exactly the signal it should 380 00:16:27,350 --> 00:16:29,240 in allocating goods. 381 00:16:29,240 --> 00:16:29,670 OK? 382 00:16:29,670 --> 00:16:32,150 So really eBay's really sort of about this third thing of 383 00:16:32,150 --> 00:16:33,660 who gets the good. 384 00:16:33,660 --> 00:16:34,360 OK? 385 00:16:34,360 --> 00:16:41,840 I offer my alarm clock or whatever on eBay, OK, and then 386 00:16:41,840 --> 00:16:42,760 people bid on that. 387 00:16:42,760 --> 00:16:44,880 And whoever values that the most, that rare Jon Gruber 388 00:16:44,880 --> 00:16:47,460 alarm clock the most, they get it. 389 00:16:47,460 --> 00:16:48,150 OK? 390 00:16:48,150 --> 00:16:50,780 So it's a perfect textbook example. 391 00:16:50,780 --> 00:16:51,590 OK? 392 00:16:51,590 --> 00:16:55,980 And basically, because on eBay the price is used, or now with 393 00:16:55,980 --> 00:16:59,670 also StubHub and concert tickets, the price is used to 394 00:16:59,670 --> 00:17:01,740 allocate the good to the person who wants 395 00:17:01,740 --> 00:17:03,620 it the most. OK? 396 00:17:03,620 --> 00:17:06,380 Now, a recent example of an auction on eBay that a lot of 397 00:17:06,380 --> 00:17:08,940 attention, not so recent anymore a couple years ago, 398 00:17:08,940 --> 00:17:12,020 someone tried to auction their kidney on eBay. 399 00:17:12,020 --> 00:17:12,510 OK? 400 00:17:12,510 --> 00:17:15,010 Someone offered their kidney for auction on eBay and said, 401 00:17:15,010 --> 00:17:17,349 I have two kidneys I only need one. 402 00:17:17,349 --> 00:17:20,200 So I'm going to auction my kidney, you pay for me to fly 403 00:17:20,200 --> 00:17:22,300 to wherever you need my kidney and the operation, they take 404 00:17:22,300 --> 00:17:23,680 it out and they give it to you. 405 00:17:23,680 --> 00:17:26,060 And that's the way it goes. 406 00:17:26,060 --> 00:17:28,500 So what happened was person offered their kidney and they 407 00:17:28,500 --> 00:17:30,390 said the starting price will be $25,000. 408 00:17:30,390 --> 00:17:31,620 They didn't do a buy it now. 409 00:17:31,620 --> 00:17:34,150 They said the starting price will be $25,000 and the 410 00:17:34,150 --> 00:17:36,860 bidding went on. 411 00:17:36,860 --> 00:17:41,720 The price got to $5 million before eBay shot it down. 412 00:17:41,720 --> 00:17:43,120 eBay shut the auction down. 413 00:17:43,120 --> 00:17:47,390 And eBay said no, in fact, you can't do this. 414 00:17:47,390 --> 00:17:50,380 Now there's two questions here. 415 00:17:50,380 --> 00:17:52,470 The first is, why did the price of the 416 00:17:52,470 --> 00:17:53,690 kidney go so high? 417 00:17:53,690 --> 00:17:55,950 That's the positive question. 418 00:17:55,950 --> 00:17:58,440 The positive question is, why did the price the kidney on 419 00:17:58,440 --> 00:18:00,940 eBay get so high? 420 00:18:00,940 --> 00:18:04,720 And here, we'll talk, and you'll learn more starting 421 00:18:04,720 --> 00:18:12,360 Friday, about the twin forces of supply and demand. 422 00:18:12,360 --> 00:18:16,640 The twin forces that drive the economy of supply and demand. 423 00:18:16,640 --> 00:18:17,920 And you'll talk more rigorously 424 00:18:17,920 --> 00:18:21,320 about these on Friday. 425 00:18:21,320 --> 00:18:23,290 Basically, they're what they sound like. 426 00:18:23,290 --> 00:18:25,670 Demand is how much someone wants something. 427 00:18:25,670 --> 00:18:28,900 Supply is how much of it there is to have. 428 00:18:28,900 --> 00:18:32,300 And the intuition here is surprising. 429 00:18:32,300 --> 00:18:32,990 OK? 430 00:18:32,990 --> 00:18:40,730 The more that there's demand for a good, the higher will be 431 00:18:40,730 --> 00:18:42,500 the upward pressure on prices. 432 00:18:42,500 --> 00:18:45,530 The more people want a good, the higher prices will go. 433 00:18:45,530 --> 00:18:48,430 And the less supply there is of a good, also the higher 434 00:18:48,430 --> 00:18:49,400 prices will go. 435 00:18:49,400 --> 00:18:51,310 So if everybody wants something but it's common, the 436 00:18:51,310 --> 00:18:52,650 price will be low. 437 00:18:52,650 --> 00:18:55,220 And if no one wants something but it's uncommon, the price 438 00:18:55,220 --> 00:18:57,240 will still be low, and vice versa. 439 00:18:57,240 --> 00:19:01,000 In fact, the development of the model of supply and demand 440 00:19:01,000 --> 00:19:04,900 framework was from Adam Smith, the, sort of, so-called first 441 00:19:04,900 --> 00:19:08,360 economist who wrote The Wealth of Nations in 1776 which is, 442 00:19:08,360 --> 00:19:10,610 sort of, viewed as the, kind of, first 443 00:19:10,610 --> 00:19:12,440 serious book about economics. 444 00:19:12,440 --> 00:19:15,400 And he posed what he called the water diamond paradox. 445 00:19:15,400 --> 00:19:18,500 What Smith said in that book is, look, it's clear water is 446 00:19:18,500 --> 00:19:19,700 the most important thing in life. 447 00:19:19,700 --> 00:19:21,060 We can't live without water. 448 00:19:21,060 --> 00:19:23,670 And diamonds are completely irrelevant to life. 449 00:19:23,670 --> 00:19:25,810 You can live totally fine without a diamond. 450 00:19:25,810 --> 00:19:27,190 And yet, the price of diamonds is 451 00:19:27,190 --> 00:19:29,860 astronomical and water's free. 452 00:19:29,860 --> 00:19:31,340 How can this be? 453 00:19:31,340 --> 00:19:34,620 How can it be that water which is so much more of a 454 00:19:34,620 --> 00:19:37,230 fundamental building block of our life is so much cheaper 455 00:19:37,230 --> 00:19:38,220 than diamonds which are not. 456 00:19:38,220 --> 00:19:41,110 And the answer, of course, is that so far you've only 457 00:19:41,110 --> 00:19:43,260 considered demand and not supply. 458 00:19:43,260 --> 00:19:43,910 Yes, it's true. 459 00:19:43,910 --> 00:19:45,300 The demand for water is much higher than 460 00:19:45,300 --> 00:19:46,200 the demand for diamonds. 461 00:19:46,200 --> 00:19:49,170 But the supply is even larger. 462 00:19:49,170 --> 00:19:52,690 So that basically, yes it's true that while water should 463 00:19:52,690 --> 00:19:56,530 be worth more, in fact, in the end the price of water is much 464 00:19:56,530 --> 00:19:59,570 lower, because of the twin forces of demand and supply. 465 00:19:59,570 --> 00:20:02,150 The demand is higher, but the supply is much higher. 466 00:20:02,150 --> 00:20:03,490 So the price ends up lower. 467 00:20:03,490 --> 00:20:06,320 And that was his diamond water paradox. 468 00:20:06,320 --> 00:20:06,760 OK? 469 00:20:06,760 --> 00:20:08,890 Well, in this case, it's a similar thing. 470 00:20:08,890 --> 00:20:12,530 What determines the demand for a kidney? 471 00:20:12,530 --> 00:20:14,905 What determines the demand for a kidney is going to be the 472 00:20:14,905 --> 00:20:16,770 fact that you die without it. 473 00:20:16,770 --> 00:20:17,340 OK? 474 00:20:17,340 --> 00:20:19,830 If you have no kidneys, you're having kidney failure. 475 00:20:19,830 --> 00:20:20,110 OK? 476 00:20:20,110 --> 00:20:20,810 You'll die without it. 477 00:20:20,810 --> 00:20:22,110 So basically, what will determine it is people are 478 00:20:22,110 --> 00:20:24,236 willing to spend all their wealth, as much money as they 479 00:20:24,236 --> 00:20:26,360 can have, to get a kidney OK? 480 00:20:26,360 --> 00:20:28,320 So the demand will be quite high. 481 00:20:28,320 --> 00:20:31,220 The supply will be quite low. 482 00:20:31,220 --> 00:20:33,940 Sadly, not many people are willing to be organ donors. 483 00:20:33,940 --> 00:20:35,490 More relevantly, a lot of people aren't in good 484 00:20:35,490 --> 00:20:37,480 situations to be organ donors. 485 00:20:37,480 --> 00:20:38,110 OK? 486 00:20:38,110 --> 00:20:41,980 As a result, the supply is much lower than the demand. 487 00:20:41,980 --> 00:20:44,775 So we have a situation with a high demand, a low supply and 488 00:20:44,775 --> 00:20:47,130 the price went through the roof. 489 00:20:47,130 --> 00:20:49,240 That's a positive analysis. 490 00:20:49,240 --> 00:20:50,310 OK? 491 00:20:50,310 --> 00:20:52,250 So we can understand pretty intuitively. 492 00:20:52,250 --> 00:20:54,750 We don't need this course to understand why 493 00:20:54,750 --> 00:20:56,120 the price went up. 494 00:20:56,120 --> 00:20:56,410 OK? 495 00:20:56,410 --> 00:20:59,460 It's just the twin powers of demand and supply. 496 00:20:59,460 --> 00:21:05,790 But what about the normative question which is, should eBay 497 00:21:05,790 --> 00:21:07,220 have allowed this sale to happen? 498 00:21:07,220 --> 00:21:09,980 EBay at $5 million cut it off and then passed the rule 499 00:21:09,980 --> 00:21:12,420 saying you can't auction your body parts on eBay. 500 00:21:12,420 --> 00:21:12,870 OK? 501 00:21:12,870 --> 00:21:15,180 Should they have done that? 502 00:21:15,180 --> 00:21:16,160 That's the normative question. 503 00:21:16,160 --> 00:21:20,200 That's economics gets really interesting, which is you all 504 00:21:20,200 --> 00:21:22,660 are smart enough to figure out why the price went up. 505 00:21:22,660 --> 00:21:27,070 But this is where it gets interesting is should people 506 00:21:27,070 --> 00:21:31,510 have been able to auction their kidney on eBay? 507 00:21:31,510 --> 00:21:35,200 On the one hand, many, many people in this country die for 508 00:21:35,200 --> 00:21:37,030 want of a body part. 509 00:21:37,030 --> 00:21:37,920 OK? 510 00:21:37,920 --> 00:21:40,090 Thousands to hundreds of thousands of people die every 511 00:21:40,090 --> 00:21:42,300 year waiting for a transplant. 512 00:21:42,300 --> 00:21:42,890 OK? 513 00:21:42,890 --> 00:21:47,470 If someone is incredibly rich and they want a body part, 514 00:21:47,470 --> 00:21:51,800 which to me a surplus because I have two kidneys, why 515 00:21:51,800 --> 00:21:55,180 shouldn't they be allowed to buy it from me? 516 00:21:55,180 --> 00:21:59,560 I'm better off because they can pay me a ton of money. 517 00:21:59,560 --> 00:22:02,440 They are better off because they live. 518 00:22:02,440 --> 00:22:04,490 So I've just described a transaction that makes both 519 00:22:04,490 --> 00:22:05,660 parties better off. 520 00:22:05,660 --> 00:22:08,540 Why shouldn't that be allowed to happen? 521 00:22:08,540 --> 00:22:09,790 So you tell me. 522 00:22:11,900 --> 00:22:13,670 Does everyone think eBay was wrong? 523 00:22:13,670 --> 00:22:14,399 Yeah, go ahead. 524 00:22:14,399 --> 00:22:15,158 AUDIENCE: Say there is another person who doesn't have as 525 00:22:15,158 --> 00:22:16,408 much money, and that person also dies. 526 00:22:25,065 --> 00:22:27,273 PROFESSOR: You mean the person who, what do you mean the 527 00:22:27,273 --> 00:22:27,910 person doesn't have as much- 528 00:22:27,910 --> 00:22:29,165 AUDIENCE: --so obviously somebody 529 00:22:29,165 --> 00:22:32,257 doesn't get the kidney. 530 00:22:35,205 --> 00:22:37,460 PROFESSOR: So in other words, what you're assuming is, let's 531 00:22:37,460 --> 00:22:39,550 say that if I hadn't done the auction on eBay, I would have 532 00:22:39,550 --> 00:22:42,300 just given my kidney away to the transplant center. 533 00:22:42,300 --> 00:22:43,780 Then that's one less kidney that can go to 534 00:22:43,780 --> 00:22:44,940 the transplant center. 535 00:22:44,940 --> 00:22:47,180 And that means the rich guy gets the kidney, and someone 536 00:22:47,180 --> 00:22:48,610 else implicitly doesn't. 537 00:22:48,610 --> 00:22:49,890 That's a trade-off. 538 00:22:49,890 --> 00:22:51,570 You've just described a trade-off. 539 00:22:51,570 --> 00:22:55,180 The trade-off is that basically now we've allocated 540 00:22:55,180 --> 00:22:57,470 the kidney away from the poor person to the rich person. 541 00:22:57,470 --> 00:23:00,600 Now, but why do we care about that? 542 00:23:00,600 --> 00:23:03,550 I mean one person dies, another person 543 00:23:03,550 --> 00:23:04,550 lives, why do we care? 544 00:23:04,550 --> 00:23:04,945 Yeah? 545 00:23:04,945 --> 00:23:07,085 AUDIENCE: There would be some sort of case 546 00:23:07,085 --> 00:23:08,664 of severity in condition. 547 00:23:08,664 --> 00:23:11,395 Like there might be someone who's poor who would get the 548 00:23:11,395 --> 00:23:14,930 kidney if it went to a transplant association because 549 00:23:14,930 --> 00:23:18,790 they would die in a couple of days without it. 550 00:23:18,790 --> 00:23:21,470 Whereas the rich person might just be able to afford it, and 551 00:23:21,470 --> 00:23:22,826 it might make their life more convenient. 552 00:23:22,826 --> 00:23:24,940 But they might not be in any more peril. 553 00:23:27,760 --> 00:23:28,480 PROFESSOR: They might be a collector. 554 00:23:28,480 --> 00:23:29,980 So basically, that's right. 555 00:23:29,980 --> 00:23:35,770 So one reason we might care is because we think that kidneys 556 00:23:35,770 --> 00:23:38,170 should be allocated on the basis of who needs 557 00:23:38,170 --> 00:23:39,700 it the most. OK? 558 00:23:39,700 --> 00:23:42,490 So a great example of this, of course, was Mickey Mantle with 559 00:23:42,490 --> 00:23:43,570 a liver transplant. 560 00:23:43,570 --> 00:23:46,410 Mickey Mantle, famous ballplayer, raging alcoholic, 561 00:23:46,410 --> 00:23:48,950 who had liver failure because he was basically drinking 562 00:23:48,950 --> 00:23:52,570 himself to death, and jumped the queue and got a liver 563 00:23:52,570 --> 00:23:54,530 above a bunch, a lot of people and then he kept drinking and 564 00:23:54,530 --> 00:23:56,610 killed himself and wasted the liver he'd gotten. 565 00:23:56,610 --> 00:23:57,050 OK? 566 00:23:57,050 --> 00:24:00,270 So basically, you can think that doesn't make sense. 567 00:24:00,270 --> 00:24:01,850 We should give it to people who need it the most. For who 568 00:24:01,850 --> 00:24:04,660 it would do the most good in terms of 569 00:24:04,660 --> 00:24:05,800 increasing their life. 570 00:24:05,800 --> 00:24:07,050 OK. 571 00:24:09,410 --> 00:24:11,610 So we've got the substitution point. 572 00:24:11,610 --> 00:24:12,080 OK. 573 00:24:12,080 --> 00:24:14,420 Let's come back to the substitution point though. 574 00:24:14,420 --> 00:24:16,300 Tell me a situation in which that's wrong. 575 00:24:16,300 --> 00:24:18,270 Can someone tell me a situation in which, in fact, 576 00:24:18,270 --> 00:24:20,020 that not a valid point. 577 00:24:20,020 --> 00:24:20,360 Yeah. 578 00:24:20,360 --> 00:24:21,779 AUDIENCE: Well, if the guy is only going to sell it. 579 00:24:21,779 --> 00:24:22,725 He's not going to give it away. 580 00:24:22,725 --> 00:24:24,617 PROFESSOR: Exactly. 581 00:24:24,617 --> 00:24:26,509 You're assuming that the guy who did sell 582 00:24:26,509 --> 00:24:27,460 would give it away. 583 00:24:27,460 --> 00:24:31,720 But, in fact, if it's sell it or keep it 584 00:24:31,720 --> 00:24:33,670 then there's no trade-off. 585 00:24:33,670 --> 00:24:39,430 And similar here, if it's sell it or keep it then you might 586 00:24:39,430 --> 00:24:41,130 as well let the rich guy get it. 587 00:24:41,130 --> 00:24:43,440 Or is there another argument? 588 00:24:43,440 --> 00:24:44,720 Is there another reason why you might not 589 00:24:44,720 --> 00:24:46,883 want this to happen? 590 00:24:46,883 --> 00:24:47,374 Yeah. 591 00:24:47,374 --> 00:24:49,171 AUDIENCE: It would encourage people to use illegal ways of 592 00:24:49,171 --> 00:24:50,421 getting kidneys. 593 00:24:54,610 --> 00:24:58,390 PROFESSOR: So the other reason could be that we don't trust 594 00:24:58,390 --> 00:25:01,950 people to make good decisions when money's involved. 595 00:25:01,950 --> 00:25:04,610 That we think that, gee, if it's really true I can get a 596 00:25:04,610 --> 00:25:07,450 couple million bucks for a kidney, I might give mine up 597 00:25:07,450 --> 00:25:08,920 even if I haven't really thought through the 598 00:25:08,920 --> 00:25:10,730 ramifications of doing so. 599 00:25:10,730 --> 00:25:13,970 Even if there's a risk to the surgery, if there's a risk 600 00:25:13,970 --> 00:25:16,300 that my other kidney will then fail then I'll be screwed. 601 00:25:16,300 --> 00:25:16,800 OK? 602 00:25:16,800 --> 00:25:23,840 So basically, we might have a paternalistic attitude that 603 00:25:23,840 --> 00:25:27,320 will lead us to not want to allow people to engage in this 604 00:25:27,320 --> 00:25:28,440 kind of risky behavior. 605 00:25:28,440 --> 00:25:28,873 Yeah? 606 00:25:28,873 --> 00:25:30,870 AUDIENCE: There may also be some legal ramifications 607 00:25:30,870 --> 00:25:33,574 associated with that if someone sells their kidney and 608 00:25:33,574 --> 00:25:37,096 then their other kidney fails, they might then blame eBay. 609 00:25:37,096 --> 00:25:37,554 PROFESSOR: Want it back. 610 00:25:37,554 --> 00:25:39,850 Like that Repo movie. 611 00:25:39,850 --> 00:25:42,200 That's right. 612 00:25:42,200 --> 00:25:45,630 There could, but let's leave the lawyers out of this, OK? 613 00:25:45,630 --> 00:25:46,440 I don't like lawyers. 614 00:25:46,440 --> 00:25:48,260 I'm going to rag on lawyers this semester. 615 00:25:48,260 --> 00:25:50,530 We're going leave the lawyers out of this. 616 00:25:50,530 --> 00:25:52,010 But, in any case, you're right. 617 00:25:52,010 --> 00:25:52,550 That's, sort of, a 618 00:25:52,550 --> 00:25:54,180 ramification of the same thing. 619 00:25:54,180 --> 00:25:57,330 So we've talked about the fact that there's substitution. 620 00:25:57,330 --> 00:25:59,340 We've talked about the fact that it's not allocated to 621 00:25:59,340 --> 00:26:01,580 those who need it the most. We've talked about the fact 622 00:26:01,580 --> 00:26:04,370 that people might be making bad decisions in doing this. 623 00:26:04,370 --> 00:26:08,180 But there's another factor, as well, which is we may just as 624 00:26:08,180 --> 00:26:11,240 a society feel it's unfair that rich people can get 625 00:26:11,240 --> 00:26:13,560 things poor people can't. 626 00:26:13,560 --> 00:26:16,660 There may be a pure equity component here. 627 00:26:16,660 --> 00:26:17,180 OK? 628 00:26:17,180 --> 00:26:20,100 Which is simply that we as a society value equality, value 629 00:26:20,100 --> 00:26:21,500 income inequality. 630 00:26:21,500 --> 00:26:24,250 And we think people should not have an extra shot at getting 631 00:26:24,250 --> 00:26:26,970 a resource just because they're rich. 632 00:26:26,970 --> 00:26:31,380 Now that is a very deep and hard concept, and we'll spend 633 00:26:31,380 --> 00:26:33,970 a couple lectures talking about equity towards the end 634 00:26:33,970 --> 00:26:34,810 of the semester. 635 00:26:34,810 --> 00:26:36,720 By and large, we won't consider it. 636 00:26:36,720 --> 00:26:37,270 OK? 637 00:26:37,270 --> 00:26:42,300 But it turns out to be behind much of what we'll discuss, 638 00:26:42,300 --> 00:26:46,660 OK, in much of what we'll discuss this semester and much 639 00:26:46,660 --> 00:26:49,340 of what goes on in economics. 640 00:26:49,340 --> 00:26:50,070 OK? 641 00:26:50,070 --> 00:26:52,660 Just take a look at the debate that's going on right now in 642 00:26:52,660 --> 00:26:56,720 terms of President Obama trying to decide whether or 643 00:26:56,720 --> 00:27:02,610 not to extend tax cuts to wealthy individuals in the US. 644 00:27:02,610 --> 00:27:06,400 Some people argue that allowing those tax cuts would 645 00:27:06,400 --> 00:27:07,800 promote the economy. 646 00:27:07,800 --> 00:27:08,400 OK? 647 00:27:08,400 --> 00:27:10,730 But others argue it's unfair for rich 648 00:27:10,730 --> 00:27:12,630 people to get tax breaks. 649 00:27:12,630 --> 00:27:16,450 And that fairness argument matters a lot in terms of 650 00:27:16,450 --> 00:27:18,010 driving the kind of economic policy 651 00:27:18,010 --> 00:27:22,010 decisions we need to make. 652 00:27:22,010 --> 00:27:25,530 So this semester, we're going to focus a lot on efficiency 653 00:27:25,530 --> 00:27:28,950 and optimization and how to get resources 654 00:27:28,950 --> 00:27:30,150 to the right place. 655 00:27:30,150 --> 00:27:33,220 But you have to remember behind a lot of this is deep 656 00:27:33,220 --> 00:27:36,200 normative issues about what should be happening, how 657 00:27:36,200 --> 00:27:38,440 should an economy function, and, in particular, how should 658 00:27:38,440 --> 00:27:39,540 we think about these kind of equity 659 00:27:39,540 --> 00:27:43,920 issues that are so important. 660 00:27:43,920 --> 00:27:45,440 OK. 661 00:27:45,440 --> 00:27:48,920 The last thing I want to talk about is I want to talk about 662 00:27:48,920 --> 00:27:52,490 why micro is not just an abstract concept for things 663 00:27:52,490 --> 00:27:55,300 like you might say, oh this is all pretty funny and it's like 664 00:27:55,300 --> 00:27:57,860 selling kidneys on eBay and tax cuts for the rich 665 00:27:57,860 --> 00:27:59,070 and why do I care? 666 00:27:59,070 --> 00:27:59,640 OK? 667 00:27:59,640 --> 00:28:03,470 Well, you care because literally every decision you 668 00:28:03,470 --> 00:28:06,790 make is made through the kind of framework we're going to 669 00:28:06,790 --> 00:28:08,960 think about this semester. 670 00:28:08,960 --> 00:28:09,490 OK? 671 00:28:09,490 --> 00:28:13,060 Now, different decisions may follow our models more closely 672 00:28:13,060 --> 00:28:14,840 and less closely. 673 00:28:14,840 --> 00:28:17,740 But there is not an economic decision. 674 00:28:17,740 --> 00:28:18,910 OK? 675 00:28:18,910 --> 00:28:19,970 Sorry, let me back up. 676 00:28:19,970 --> 00:28:21,990 There's not a decision that people have made that 677 00:28:21,990 --> 00:28:24,090 economists haven't tried to model. 678 00:28:24,090 --> 00:28:26,850 From whether to produce iPods, to how many times to 679 00:28:26,850 --> 00:28:28,170 have sex each week. 680 00:28:28,170 --> 00:28:28,640 OK? 681 00:28:28,640 --> 00:28:31,630 These are all things economists have tried to model 682 00:28:31,630 --> 00:28:33,790 with varying degrees of success. 683 00:28:33,790 --> 00:28:34,980 OK? 684 00:28:34,980 --> 00:28:37,420 Because economists think that these all come from the same 685 00:28:37,420 --> 00:28:41,080 decision theoretic framework that we can discuss. 686 00:28:41,080 --> 00:28:44,430 Let's talk about a simple example from this course. 687 00:28:44,430 --> 00:28:47,880 Your decision of whether or not to buy the textbook. 688 00:28:47,880 --> 00:28:50,780 There's a textbook and what's it cost? $140? 689 00:28:50,780 --> 00:28:52,540 What's it cost? 690 00:28:52,540 --> 00:28:54,500 Does anyone know? 691 00:28:54,500 --> 00:28:56,950 AUDIENCE: This line says $180. 692 00:28:56,950 --> 00:28:59,400 And this one says $180, but it's available for $130. 693 00:28:59,400 --> 00:29:00,450 PROFESSOR: $130, fine. 694 00:29:00,450 --> 00:29:03,340 So $130 for Professor Perloff out at Berkeley. 695 00:29:03,340 --> 00:29:04,050 He doesn't get it all. 696 00:29:04,050 --> 00:29:04,630 I wrote a textbook too. 697 00:29:04,630 --> 00:29:06,000 He gets a small share of it. 698 00:29:06,000 --> 00:29:07,740 OK. 699 00:29:07,740 --> 00:29:12,250 So you have to decide, now has anyone bought a used version 700 00:29:12,250 --> 00:29:14,067 of the fourth, well it's the fifth edition now, does 701 00:29:14,067 --> 00:29:16,040 anybody use a version of the fourth edition? 702 00:29:16,040 --> 00:29:18,440 Does anyone know what the used price is? 703 00:29:18,440 --> 00:29:19,660 You can be honest. I don't care. 704 00:29:19,660 --> 00:29:22,970 AUDIENCE: I know some people found it for like $85 or so. 705 00:29:22,970 --> 00:29:24,440 PROFESSOR: So $85. 706 00:29:24,440 --> 00:29:26,200 So you've got to decide. 707 00:29:26,200 --> 00:29:30,380 So let's say you can buy the previous edition, the fourth 708 00:29:30,380 --> 00:29:34,390 edition, for $85 or the current edition for $130. 709 00:29:34,390 --> 00:29:35,090 OK? 710 00:29:35,090 --> 00:29:37,160 You've got to make that decision. 711 00:29:37,160 --> 00:29:37,650 OK? 712 00:29:37,650 --> 00:29:39,550 How do you make that decision. 713 00:29:39,550 --> 00:29:41,440 Well you may think, gee I just make the decision. 714 00:29:41,440 --> 00:29:42,860 It's not really about microeconomics. 715 00:29:42,860 --> 00:29:43,920 But it is. 716 00:29:43,920 --> 00:29:45,540 We're going to model how you think about a 717 00:29:45,540 --> 00:29:46,500 decision like that. 718 00:29:46,500 --> 00:29:48,670 Well how do you think about a decision like that? 719 00:29:48,670 --> 00:29:52,900 Well, the first thing you consider is your preferences. 720 00:29:52,900 --> 00:29:56,280 How much are you willing to take a chance that there's new 721 00:29:56,280 --> 00:29:59,454 stuff in the fifth edition that you need to know? 722 00:29:59,454 --> 00:30:00,740 OK? 723 00:30:00,740 --> 00:30:02,250 If the fifth issue was identical to the fourth 724 00:30:02,250 --> 00:30:04,340 edition then you'd be an idiot to not just buy the used 725 00:30:04,340 --> 00:30:04,970 fourth edition. 726 00:30:04,970 --> 00:30:06,030 But it's not. 727 00:30:06,030 --> 00:30:07,180 Textbook writers are smart. 728 00:30:07,180 --> 00:30:08,460 They update their book. 729 00:30:08,460 --> 00:30:09,210 OK? 730 00:30:09,210 --> 00:30:11,670 So basically, the fifth edition is updated. 731 00:30:11,670 --> 00:30:12,950 There's new things in it. 732 00:30:12,950 --> 00:30:16,880 So you have to ask yourself, what are the odds that I need 733 00:30:16,880 --> 00:30:18,670 some of the new information in the fifth edition and not in 734 00:30:18,670 --> 00:30:19,910 the fourth edition? 735 00:30:19,910 --> 00:30:21,400 And in thinking about that, you're going to think about 736 00:30:21,400 --> 00:30:22,070 your preferences. 737 00:30:22,070 --> 00:30:26,090 In particular, are you very risk averse, are you afraid to 738 00:30:26,090 --> 00:30:27,410 take a chance? 739 00:30:27,410 --> 00:30:28,590 Or are you risk loving? 740 00:30:28,590 --> 00:30:30,410 Are you willing to take a chance? 741 00:30:30,410 --> 00:30:31,050 OK? 742 00:30:31,050 --> 00:30:32,370 That's one side of the equation. 743 00:30:32,370 --> 00:30:34,810 If you're someone that says, you know I will not take a 744 00:30:34,810 --> 00:30:35,450 chance in life. 745 00:30:35,450 --> 00:30:37,420 I just have to make sure I learn the most possible from 746 00:30:37,420 --> 00:30:38,820 this course. 747 00:30:38,820 --> 00:30:40,040 Then you're going to want that new edition. 748 00:30:40,040 --> 00:30:42,410 If you're someone that says, you know what screw it, I'll 749 00:30:42,410 --> 00:30:43,610 just figure it out later. 750 00:30:43,610 --> 00:30:44,350 I'm going to the lectures. 751 00:30:44,350 --> 00:30:45,490 I don't care. 752 00:30:45,490 --> 00:30:46,100 OK? 753 00:30:46,100 --> 00:30:47,830 Then you might not want it that much. 754 00:30:47,830 --> 00:30:49,950 So that's the first factor, is going to be your preferences 755 00:30:49,950 --> 00:30:51,230 and break down how much you are willing to take a risk 756 00:30:51,230 --> 00:30:53,230 that you need this fifth edition. 757 00:30:53,230 --> 00:30:55,820 The second factor is going to be your constraint: how much 758 00:30:55,820 --> 00:30:57,590 money you have. OK. 759 00:30:57,590 --> 00:31:00,430 The more money you have, the more you're willing, or more 760 00:31:00,430 --> 00:31:03,210 relevant perhaps your parents have, the more willing you are 761 00:31:03,210 --> 00:31:04,980 to go ahead and buy that new edition. 762 00:31:04,980 --> 00:31:08,060 The less money you have, the less willing you are. 763 00:31:08,060 --> 00:31:08,950 OK? 764 00:31:08,950 --> 00:31:11,390 So basically, it's going to depend on whether you're 765 00:31:11,390 --> 00:31:13,070 paying or your parents are paying, in which case what the 766 00:31:13,070 --> 00:31:14,680 hell you might as well buy the fifth edition. 767 00:31:14,680 --> 00:31:15,640 OK? 768 00:31:15,640 --> 00:31:20,570 And then finally, you're going to take these preferences and 769 00:31:20,570 --> 00:31:23,370 this constraint, your preferences and your 770 00:31:23,370 --> 00:31:25,510 resources, and go to the market and look at what does 771 00:31:25,510 --> 00:31:27,485 the market tell me the difference is. 772 00:31:27,485 --> 00:31:30,230 So you're going to say, here's how much I kind of care about 773 00:31:30,230 --> 00:31:34,180 fifth versus fourth edition, here's the resources I have, 774 00:31:34,180 --> 00:31:39,570 now I'll go to the market and say, aha there is a $45 775 00:31:39,570 --> 00:31:42,530 difference between these two editions. 776 00:31:42,530 --> 00:31:44,550 So now I will solve that constrained 777 00:31:44,550 --> 00:31:46,470 optimization problem. 778 00:31:46,470 --> 00:31:52,430 And I'll decide whether I want to get that book. 779 00:31:52,430 --> 00:31:53,730 You are going to be thinking to yourself, this is stupid. 780 00:31:53,730 --> 00:31:55,530 I never think about it that way. 781 00:31:55,530 --> 00:31:57,440 But the key point is you don't have to think about it 782 00:31:57,440 --> 00:31:58,740 exactly that way. 783 00:31:58,740 --> 00:32:01,400 There's a famous example in economics of what's called the 784 00:32:01,400 --> 00:32:02,440 as if principle. 785 00:32:02,440 --> 00:32:04,380 I don't know if kids still say this one, as if. 786 00:32:04,380 --> 00:32:06,130 So it's the as if principle. 787 00:32:06,130 --> 00:32:06,720 OK? 788 00:32:06,720 --> 00:32:08,545 And basically it's from Milton Friedman, the famous economist 789 00:32:08,545 --> 00:32:13,150 from Chicago, who said, look, when you're playing pool, 790 00:32:13,150 --> 00:32:17,110 technically you could compute the optimal angles of which to 791 00:32:17,110 --> 00:32:19,310 shoot the ball every single time to get the appropriate 792 00:32:19,310 --> 00:32:20,210 bounce and get the balls in. 793 00:32:20,210 --> 00:32:22,610 You could do the mathematics and compute it. 794 00:32:22,610 --> 00:32:25,870 But professional pool players are not in this class with 795 00:32:25,870 --> 00:32:26,710 you, I'll only say that. 796 00:32:26,710 --> 00:32:27,260 OK? 797 00:32:27,260 --> 00:32:29,710 They're not guys who are able to do that computation. 798 00:32:29,710 --> 00:32:33,830 They just know how to hit the ball to get the same outcome 799 00:32:33,830 --> 00:32:35,980 they would get if they mathematically solved for the 800 00:32:35,980 --> 00:32:37,900 optimal trajectory to hit the ball. 801 00:32:37,900 --> 00:32:39,190 OK? 802 00:32:39,190 --> 00:32:42,160 They behave as if they've solved the constrained 803 00:32:42,160 --> 00:32:44,330 optimization problem. 804 00:32:44,330 --> 00:32:46,650 And your decision when you buy this book, you may not think 805 00:32:46,650 --> 00:32:49,432 it through the very framework that I just laid out very 806 00:32:49,432 --> 00:32:52,380 heuristically and will lay out more rigorously this semester. 807 00:32:52,380 --> 00:32:53,940 But you're going to behave as if you do. 808 00:32:53,940 --> 00:32:55,460 Because those facts are going to be in your mind, and you'll 809 00:32:55,460 --> 00:32:58,700 be thinking about it when you make that decision. 810 00:32:58,700 --> 00:33:01,050 So while you may feel the models we learn in this course 811 00:33:01,050 --> 00:33:04,430 are rather abstract and don't really explain how you behave 812 00:33:04,430 --> 00:33:07,200 in an everyday basis, you're going to behave as if those 813 00:33:07,200 --> 00:33:11,290 models are really applying to you. 814 00:33:11,290 --> 00:33:13,340 And if you think about, over the next few days, think about 815 00:33:13,340 --> 00:33:14,530 the decisions you make. 816 00:33:14,530 --> 00:33:15,820 From should I bring an umbrella today, 817 00:33:15,820 --> 00:33:17,000 it looks like rain? 818 00:33:17,000 --> 00:33:18,080 Well, on the one hand, I might lose it. 819 00:33:18,080 --> 00:33:18,860 It's a pain to carry. 820 00:33:18,860 --> 00:33:20,770 On the other hand, how much do I care about getting wet? 821 00:33:20,770 --> 00:33:23,300 That's a constrained optimization decision. 822 00:33:23,300 --> 00:33:27,010 To should I have an extra drink at a party Friday night? 823 00:33:27,010 --> 00:33:30,290 On the one hand, that could have some pros and cons. 824 00:33:30,290 --> 00:33:30,850 OK? 825 00:33:30,850 --> 00:33:34,050 These are all decisions, constrained optimization 826 00:33:34,050 --> 00:33:35,680 decisions, you're going to make. 827 00:33:35,680 --> 00:33:36,440 They're going to affect your life. 828 00:33:36,440 --> 00:33:38,180 And what we'll learn this semester is about how you make 829 00:33:38,180 --> 00:33:40,390 them and how we model, how economists can use what we 830 00:33:40,390 --> 00:33:43,520 learn about that to understand the function of the economy. 831 00:33:43,520 --> 00:33:44,220 OK? 832 00:33:44,220 --> 00:33:46,280 So I'm going to stop there. 833 00:33:46,280 --> 00:33:50,130 One other announcement, there will, in general, be handouts 834 00:33:50,130 --> 00:33:50,660 every lecture. 835 00:33:50,660 --> 00:33:51,210 I'm not going to do PowerPoint. 836 00:33:51,210 --> 00:33:51,900 I'm going to do handouts. 837 00:33:51,900 --> 00:33:54,000 So when you come in every lecture, please look at the 838 00:33:54,000 --> 00:33:54,880 back banister. 839 00:33:54,880 --> 00:33:56,200 Though typically, not today. 840 00:33:56,200 --> 00:33:59,160 But typically, they'll be handouts that you'll need to 841 00:33:59,160 --> 00:34:00,900 follow along with in class. 842 00:34:00,900 --> 00:34:05,130 So remember, go to section on Friday, first problems that 843 00:34:05,130 --> 00:34:08,480 will be posted on Friday and it will be due in section the 844 00:34:08,480 --> 00:34:09,480 Friday after. 845 00:34:09,480 --> 00:34:12,220 And I'll see you all back here on Monday, next Monday.