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PROFESSOR: All right, so today
we are going to finish up our

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00:00:28,880 --> 00:00:32,080
discussion of consumer
theory and then move

10
00:00:32,080 --> 00:00:33,170
on to producer theory.

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00:00:33,170 --> 00:00:36,030
That is, we're finishing up
what's behind the demand curve

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00:00:36,030 --> 00:00:38,440
and moving on to what's behind
the supply curve.

13
00:00:38,440 --> 00:00:43,310
But before we do that, I want
to talk about an application

14
00:00:43,310 --> 00:00:46,030
of why income and substitution
effects are important.

15
00:00:46,030 --> 00:00:47,910
Income and substitution effects,
we talked about this

16
00:00:47,910 --> 00:00:49,170
imaginary budget constraint.

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00:00:49,170 --> 00:00:51,280
It seems like sort of
a vague concept.

18
00:00:51,280 --> 00:00:53,690
We talked last time about labor
supply and how you can

19
00:00:53,690 --> 00:00:55,570
get some interestingly
different answers.

20
00:00:55,570 --> 00:00:57,840
But I want to talk about an
application now, of why

21
00:00:57,840 --> 00:00:59,450
understanding income and
substitution effects can

22
00:00:59,450 --> 00:01:01,600
really help you understand
the world a bit better.

23
00:01:01,600 --> 00:01:03,820
And the application I want to
talk about today is the case

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00:01:03,820 --> 00:01:06,660
of child labor in developing
countries.

25
00:01:06,660 --> 00:01:08,810
Now this is a terrible
problem worldwide.

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00:01:08,810 --> 00:01:11,920
In developing countries in
particular, children are

27
00:01:11,920 --> 00:01:13,610
pulled out of school to work.

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00:01:13,610 --> 00:01:17,010
They then don't develop the
skills that can allow them to

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00:01:17,010 --> 00:01:21,830
earn high wages later in life
and as a result, the cycle of

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00:01:21,830 --> 00:01:24,370
impoverishment continues in
these nations, where these

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00:01:24,370 --> 00:01:26,560
children in turn have low
wage jobs and make

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00:01:26,560 --> 00:01:28,030
their kids go to work.

33
00:01:28,030 --> 00:01:30,060
And it's a major problem in
the developing world.

34
00:01:30,060 --> 00:01:31,880
And we all know that one way
to help countries out of

35
00:01:31,880 --> 00:01:34,850
poverty is to help them get
their kids to get education.

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00:01:34,850 --> 00:01:37,510
Education is the key to getting
out of poverty.

37
00:01:37,510 --> 00:01:39,185
And you can't get education
if you're working.

38
00:01:42,720 --> 00:01:44,330
I think that's a generally
recognized fact.

39
00:01:44,330 --> 00:01:46,720
A more interesting,
controversial fact is well,

40
00:01:46,720 --> 00:01:49,460
what does this imply
for the benefits or

41
00:01:49,460 --> 00:01:51,250
cost of free trade?

42
00:01:51,250 --> 00:01:54,530
We'll talk about free trade
later in the semester and

43
00:01:54,530 --> 00:01:56,335
we'll come back to this, but
basically the idea is look, if

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00:01:56,335 --> 00:02:00,510
you have free trade, then poor
countries can sell more goods

45
00:02:00,510 --> 00:02:04,470
to rich countries and that will
allow them to raise their

46
00:02:04,470 --> 00:02:05,750
standard of living.

47
00:02:05,750 --> 00:02:08,080
But many of you will point out
that that's contradictory with

48
00:02:08,080 --> 00:02:09,370
our concern over child labor.

49
00:02:09,370 --> 00:02:13,670
Which is if a poor country is
going to sell more goods to a

50
00:02:13,670 --> 00:02:16,220
rich country, then maybe kids
in that country are going to

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00:02:16,220 --> 00:02:18,930
have to work harder to
make those goods.

52
00:02:18,930 --> 00:02:20,920
And one concern people have
when they talk about free

53
00:02:20,920 --> 00:02:22,980
trade agreements is essentially
we're dooming the

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00:02:22,980 --> 00:02:26,520
children of these impoverished
countries to work harder to

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00:02:26,520 --> 00:02:28,530
make the goods that rich
countries want.

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00:02:28,530 --> 00:02:31,270
And that if these impoverished
countries weren't engaging in

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00:02:31,270 --> 00:02:33,100
making all these textiles and
all the things these rich

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00:02:33,100 --> 00:02:34,470
countries want, maybe their
kids would be getting an

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00:02:34,470 --> 00:02:36,970
education instead.

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00:02:36,970 --> 00:02:39,690
So that's a concern that's been
raised about free trade,

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00:02:39,690 --> 00:02:42,440
but in fact, what we can
understand from understanding

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income and substitution effects
is that, in fact, that

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00:02:44,890 --> 00:02:46,040
claim may not be true.

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00:02:46,040 --> 00:02:48,200
In fact, the effect
of free trade on

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00:02:48,200 --> 00:02:50,070
child labor is ambiguous.

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00:02:50,070 --> 00:02:53,060
And that's what I want to talk
through now, an application of

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why understanding income and
substitution effects matter.

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And there's a very interesting
study by two professors at

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00:02:57,930 --> 00:03:01,390
Dartmouth who studied the impact
of trade liberalization

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00:03:01,390 --> 00:03:02,700
in Vietnam.

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00:03:02,700 --> 00:03:06,400
Vietnam used to have a system
where they would not allow

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00:03:06,400 --> 00:03:09,420
domestic producers to
sell rice abroad.

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00:03:09,420 --> 00:03:13,160
Domestic rice producers had to
sell that rice only in Vietnam

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00:03:13,160 --> 00:03:15,580
and then they introduced free
trade provisions in Vietnam

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00:03:15,580 --> 00:03:18,150
which allowed them to sell
that rice abroad as well.

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00:03:18,150 --> 00:03:20,190
And one concern that was raised
is that would mean kids

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in Vietnam would have to work
harder producing rice so it

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00:03:23,005 --> 00:03:24,550
could be sold around
the world.

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00:03:24,550 --> 00:03:26,190
Let's see whether
that was true.

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Well, to think about that, let's
first think about it

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00:03:28,150 --> 00:03:28,920
theoretically.

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00:03:28,920 --> 00:03:30,170
So let's go to figure 8-1.

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00:03:33,050 --> 00:03:38,080
Figure 8-1 shows the demand for
rice, D sub V the demand

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00:03:38,080 --> 00:03:41,965
for rice in Vietnam, D sub W is
the demand for Vietnamese

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00:03:41,965 --> 00:03:43,215
rice worldwide.

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00:03:53,900 --> 00:03:57,820
D sub V is the Vietnamese demand
for Vietnamese rice, D

87
00:03:57,820 --> 00:04:02,800
sub W is the world demand for
Vietnamese rice, and S sub V

88
00:04:02,800 --> 00:04:04,430
is the supply of Vietnamese
rice.

89
00:04:04,430 --> 00:04:06,910
And we assume demand curves are
downward sloping, supply

90
00:04:06,910 --> 00:04:08,920
curves are upward sloping,
as usual.

91
00:04:08,920 --> 00:04:13,020
So if there was a worldwide
market where Vietnamese rice

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00:04:13,020 --> 00:04:15,720
farmers could sell their rice
to the entire world, then

93
00:04:15,720 --> 00:04:18,291
you'd have an equilibrium
price P sub W and an

94
00:04:18,291 --> 00:04:20,500
equilibrium quantity
of Q sub W.

95
00:04:20,500 --> 00:04:25,530
What happened was until 1989,
that was not the case.

96
00:04:25,530 --> 00:04:32,468
Before 1989, the government
imposed a quota which said

97
00:04:32,468 --> 00:04:36,880
that rice producers in Vietnam
could not sell effectively,

98
00:04:36,880 --> 00:04:38,200
could not sell outside
Vietnam.

99
00:04:38,200 --> 00:04:40,320
It wasn't quite that easy, but
you could think of it this

100
00:04:40,320 --> 00:04:42,590
way, they could not sell
outside Vietnam.

101
00:04:42,590 --> 00:04:46,460
Instead, they could only sell
the amount that Vietnamese

102
00:04:46,460 --> 00:04:50,120
citizens demanded of rice, which
meant that they sold Qv

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00:04:50,120 --> 00:04:53,910
units of rice at a price, Pv.
So there was a government

104
00:04:53,910 --> 00:04:56,210
imposition which said
effectively--

105
00:04:56,210 --> 00:04:57,660
not quite, but effectively--

106
00:04:57,660 --> 00:05:00,000
you can only sell rice in
Vietnam, so we're going to

107
00:05:00,000 --> 00:05:02,520
sell Qv at a price, Pv.

108
00:05:02,520 --> 00:05:08,840
So then what happened was
in the early 1990s, the

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00:05:08,840 --> 00:05:12,420
government weakened this quota
so that by 1997, there was no

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00:05:12,420 --> 00:05:13,420
longer a quota.

111
00:05:13,420 --> 00:05:15,620
Rice farmers were allowed to
sell wherever they want.

112
00:05:15,620 --> 00:05:22,920
So effectively, the country
moved from Qv, Pv to Qw, Pw.

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00:05:22,920 --> 00:05:26,660
Essentially, it expanded the
market for Vietnamese rice so

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00:05:26,660 --> 00:05:28,990
that they were able to sell a
larger quantity at a higher

115
00:05:28,990 --> 00:05:33,220
price on the worldwide market.

116
00:05:33,220 --> 00:05:37,500
And the difference between
Qv and Qw were exports.

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00:05:37,500 --> 00:05:40,300
So basically, the government
allowed them to export an

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00:05:40,300 --> 00:05:44,600
extra amount of rice, Qw minus
Qv, and allowed them to obtain

119
00:05:44,600 --> 00:05:47,770
a higher price for their rice.

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00:05:47,770 --> 00:05:50,633
So we'll talk later about
whether this is a good idea or

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00:05:50,633 --> 00:05:51,570
a bad idea in general.

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00:05:51,570 --> 00:05:53,450
We'll talk about free trade and
get on to free trade later

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00:05:53,450 --> 00:05:54,400
in the semester.

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00:05:54,400 --> 00:05:56,680
Hint, we like free trade
as economists.

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00:05:56,680 --> 00:05:58,390
I think most of you probably
knew that, and we'll talk

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00:05:58,390 --> 00:06:00,010
about that later in
the semester.

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00:06:00,010 --> 00:06:02,770
But now I want to focus
specifically on one question,

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00:06:02,770 --> 00:06:06,480
which is what did this
do to child labor?

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00:06:06,480 --> 00:06:14,670
Well, if we go the
next figure, if

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00:06:14,670 --> 00:06:16,420
you look for a second--

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00:06:16,420 --> 00:06:18,880
forget the shifting
supply curves.

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00:06:18,880 --> 00:06:22,400
The market for child labor is
initially at equilibrium at a

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00:06:22,400 --> 00:06:25,180
supply of child labor of S1--

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00:06:25,180 --> 00:06:30,226
that is, the higher the wage,
the more the kids will work--

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00:06:30,226 --> 00:06:32,880
and demand for child
labor of D1--

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00:06:32,880 --> 00:06:35,000
that is, the higher the wage,
the less the demand there is

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00:06:35,000 --> 00:06:36,310
for child labor.

138
00:06:36,310 --> 00:06:39,920
And we're in some initial
equilibrium where L1 kids work

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00:06:39,920 --> 00:06:41,510
at a wage, W1.

140
00:06:41,510 --> 00:06:43,540
And let me highlight an
important thing about the

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00:06:43,540 --> 00:06:45,610
supply of labor of kids.

142
00:06:45,610 --> 00:06:47,380
If the kids aren't working,
they're in school.

143
00:06:47,380 --> 00:06:49,190
The notion is not if the kids
aren't working, they're

144
00:06:49,190 --> 00:06:50,330
sitting at home.

145
00:06:50,330 --> 00:06:51,710
If the kids aren't working,
they're in school.

146
00:06:51,710 --> 00:06:55,070
So basically, the more kids are
working, the fewer kids

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00:06:55,070 --> 00:06:56,920
are in school.

148
00:06:56,920 --> 00:07:03,170
So you have this supply, S1,
and this demand, D1.

149
00:07:03,170 --> 00:07:07,370
So what free trade does is it
shifts out the demand for

150
00:07:07,370 --> 00:07:09,300
child labor.

151
00:07:09,300 --> 00:07:11,490
Because now you need to produce
more rice, you need

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00:07:11,490 --> 00:07:14,050
kids to produce it, so
it shifts out to D2.

153
00:07:19,470 --> 00:07:23,470
It's not marked in this diagram,
but you would end up,

154
00:07:23,470 --> 00:07:27,810
if you could see where D2
intersects with S1, you'd end

155
00:07:27,810 --> 00:07:32,540
up with a lot more child
labor at a higher wage.

156
00:07:37,000 --> 00:07:39,880
And that's the argument for
why free trade is bad for

157
00:07:39,880 --> 00:07:40,820
child labor.

158
00:07:40,820 --> 00:07:42,820
Because it increases demand for
child labor and therefore

159
00:07:42,820 --> 00:07:45,930
increases the amount of child
labor that's used.

160
00:07:45,930 --> 00:07:50,960
But what that argument misses is
the income effect, which is

161
00:07:50,960 --> 00:07:54,600
that the rice farmers in
Vietnam are now richer.

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00:07:54,600 --> 00:07:58,220
And one thing they'll do with
their wealth is buy their kids

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00:07:58,220 --> 00:08:00,130
more education.

164
00:08:00,130 --> 00:08:01,870
That is, think about the
utility function

165
00:08:01,870 --> 00:08:03,050
of these rice farmers.

166
00:08:03,050 --> 00:08:04,360
They don't want their
kids to work.

167
00:08:04,360 --> 00:08:05,600
They understand that
their kids are

168
00:08:05,600 --> 00:08:07,800
better off with education.

169
00:08:07,800 --> 00:08:10,310
So what would happen if
they won the lottery?

170
00:08:10,310 --> 00:08:11,960
What would happen if they won
the lottery is they'd use some

171
00:08:11,960 --> 00:08:12,986
of that money to say
hey kids, you don't

172
00:08:12,986 --> 00:08:14,130
have to work anymore.

173
00:08:14,130 --> 00:08:16,050
You get to now go to school
instead and build yourselves a

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00:08:16,050 --> 00:08:17,360
brighter future.

175
00:08:17,360 --> 00:08:20,370
Well, the higher price for rice
that exists through world

176
00:08:20,370 --> 00:08:22,330
trade is like them winning
the lottery.

177
00:08:22,330 --> 00:08:25,480
Suddenly, rice farmers are
richer because each unit they

178
00:08:25,480 --> 00:08:28,270
produce is sold at
a higher price.

179
00:08:28,270 --> 00:08:30,450
What are they going to do
with that higher wealth?

180
00:08:30,450 --> 00:08:33,010
They're going to allow their
kids to work less.

181
00:08:33,010 --> 00:08:34,996
They're going to say, we're
effectively richer because

182
00:08:34,996 --> 00:08:37,950
we're now selling our rice
at a higher price.

183
00:08:37,950 --> 00:08:40,190
As a caring parent who's richer,
I'm going to send my

184
00:08:40,190 --> 00:08:42,240
kids to school instead
of having them work.

185
00:08:42,240 --> 00:08:44,340
How do we manifest that
in this diagram?

186
00:08:44,340 --> 00:08:47,750
As an inward shift in the
supply of child labor.

187
00:08:47,750 --> 00:08:50,910
That is, children get pulled off
the market because their

188
00:08:50,910 --> 00:08:54,100
parents now say, I'm going to
send them to school instead.

189
00:08:54,100 --> 00:08:57,850
So the supply curve for child
labor shifts inwards.

190
00:08:57,850 --> 00:09:01,110
Now, how much it shifts inwards
determines what

191
00:09:01,110 --> 00:09:02,640
ultimately happens
to child labor.

192
00:09:02,640 --> 00:09:07,500
If it shifts inwards a little
bit from S1 to S2, then child

193
00:09:07,500 --> 00:09:09,970
labor on net still increases
from L1 to L2.

194
00:09:09,970 --> 00:09:13,340
That is, the demand shift
exceeds the supply shift and

195
00:09:13,340 --> 00:09:14,430
on net child labor increases.

196
00:09:14,430 --> 00:09:17,780
That is, on net, free trade
does increase child labor.

197
00:09:17,780 --> 00:09:21,900
But if supply shifts in a lot,
if parents are a lot richer

198
00:09:21,900 --> 00:09:24,060
and send their kids to school
a lot, then actually the

199
00:09:24,060 --> 00:09:28,490
supply of child labor could
fall from L1 to L3.

200
00:09:28,490 --> 00:09:30,980
You could have less child labor,
even though the demand

201
00:09:30,980 --> 00:09:32,340
for it's gone up.

202
00:09:32,340 --> 00:09:35,090
And that's because of
income effects.

203
00:09:35,090 --> 00:09:37,550
The importance of income effects
is that the families

204
00:09:37,550 --> 00:09:39,460
are now richer, so they're
pulling their

205
00:09:39,460 --> 00:09:40,850
kids out of the market.

206
00:09:40,850 --> 00:09:42,550
And they're pulling their kids
out of the market in such

207
00:09:42,550 --> 00:09:48,350
numbers that it exceeds the
excess demand for child labor.

208
00:09:48,350 --> 00:09:50,120
So once again, we see the
power of income and

209
00:09:50,120 --> 00:09:51,980
substitution effects.

210
00:09:51,980 --> 00:09:55,660
We have the standard market
operation, which is g.

211
00:09:55,660 --> 00:09:58,960
We want more rice, we need to
hire more kids to produce it.

212
00:09:58,960 --> 00:10:00,790
But we're forgetting the income
effect, which is the

213
00:10:00,790 --> 00:10:02,170
price of rice has gone up.

214
00:10:02,170 --> 00:10:04,280
Farmers are now richer, they're
now going to send

215
00:10:04,280 --> 00:10:06,040
their kids to school instead
of making them work in the

216
00:10:06,040 --> 00:10:07,870
rice paddies.

217
00:10:07,870 --> 00:10:09,870
OK?

218
00:10:09,870 --> 00:10:14,310
So that is the importance of
understanding the subtle

219
00:10:14,310 --> 00:10:18,230
argument that comes forth when
you think more completely

220
00:10:18,230 --> 00:10:20,860
about income and substitution
effects and when you don't

221
00:10:20,860 --> 00:10:23,530
stop and just say, gee,
more rice exported

222
00:10:23,530 --> 00:10:25,470
means more child labor.

223
00:10:25,470 --> 00:10:28,790
So the question is, which
of these is right?

224
00:10:28,790 --> 00:10:29,320
OK?

225
00:10:29,320 --> 00:10:30,620
Which of these is right?

226
00:10:30,620 --> 00:10:34,200
How do we know whether free
trade increases or decreases

227
00:10:34,200 --> 00:10:34,970
the demand for child labor?

228
00:10:34,970 --> 00:10:37,420
Let me first stop and ask a
question about the theory.

229
00:10:37,420 --> 00:10:40,170
People understand why an
increase in free trade can

230
00:10:40,170 --> 00:10:44,280
either lead to more kids working
or less kids working.

231
00:10:44,280 --> 00:10:45,000
Yeah?

232
00:10:45,000 --> 00:10:49,900
AUDIENCE: I'm not sure how you
would sustain that increase in

233
00:10:49,900 --> 00:10:50,880
demand for rice.

234
00:10:50,880 --> 00:10:54,065
Because if their kids won't work
anymore, how will they

235
00:10:54,065 --> 00:10:55,780
keep up that increase
in demand of

236
00:10:55,780 --> 00:10:58,740
rice, keep them wealthy?

237
00:10:58,740 --> 00:11:01,280
Well, see, here's the key point,
which is that the price

238
00:11:01,280 --> 00:11:03,070
has gone up.

239
00:11:03,070 --> 00:11:05,250
So the price has gone up, so
they don't have to increase

240
00:11:05,250 --> 00:11:06,830
the supply that much.

241
00:11:06,830 --> 00:11:10,310
So the kids could work less,
they could work more, or they

242
00:11:10,310 --> 00:11:12,030
could just not supply
that much more rice.

243
00:11:12,030 --> 00:11:14,140
But the fact that they sell
it in a worldwide market

244
00:11:14,140 --> 00:11:17,580
increases the demand so that
they're getting a higher price

245
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and that makes them wealthier.

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So now we have to ask,
what's the truth?

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What happened?

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Well, the answer is that
how do we tell this?

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Well, the way we tell this is
we can look, we can use the

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fact that the increase in the
price of rice varied across

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the country.

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In some parts of Vietnam, those
that were very close to

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the border and it was easy to
export, there was a big

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increase in the demand for rice,
a big price increase.

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In other parts of Vietnam, those
more internal where it's

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a huge transportation cost to
get to the coast and therefore

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export it, it's like
nothing happened.

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So you can actually ask, what
happened to child labor in the

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areas close to the border where
the price of rice went

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up a lot and therefore there's
a big effect of this free

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trade, versus the areas more
internal to the country where

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price of rice didn't
change much?

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And by comparing those two, you
can ask, what happened to

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child labor in those
two areas?

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What you find is that child
labor went down in the areas

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near the coast. They got so much
richer from these higher

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prices that on net, they used
fewer kids to work.

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That is, the supply shift was
larger than the demand shift.

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So actually, free trade
lowered overall

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use of child labor.

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Free trade lowered the overall
use of child labor so that

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freeing up trade was good for
kids, not bad for kids.

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We'll talk later about other
arguments about why free trade

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is good or not, but this is an
important point where you can

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get beyond a simple intuition
of, gee, more kids are going

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to work, to say wait a second.

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That's offset by the fact that
the higher worldwide prices

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led parents to allow their kids
to go to school rather

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than go to work.

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And that's an example of
the power of income and

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substitution effects.

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And the power of this theory
for understanding how you

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might not get what
seems, initially,

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an intuitive answer.

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OK, questions about that
example, how it relates to

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00:13:16,890 --> 00:13:18,090
consumer theory, income
or substitution

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00:13:18,090 --> 00:13:20,130
effects, any of that?

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OK.

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So that's where we are going
to stop on consumer theory,

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and that's where the material
for the exam will stop.

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You can't leave, but that's
where the material for the

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00:13:28,900 --> 00:13:30,480
exam stops, OK?

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So the exam will cover
everything up to

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through this point.

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The exam will be on
consumer theory.