Introduction to Macroeconomics

1
Introduction to Macroeconomics

• Chapter 1
• Market Interaction
• J. Patrick Gunning
• October 25, 2015

2
Introduction (1) The Definition of Economics

• Economics the study of market interaction.
• Market Interaction an abstract image of
  interaction among purposeful, "normal human
  beings," or actors, under a given set of
  conditions.

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Introduction (3) The Definition of Market
Interaction

• Meaning of distinctly human action.
• People have definite wants.
• People have the goal of satisfying the wants.
• People possess imagination, creativity, and
  inventiveness.
• Compare normal, distinctly human beings with
• Animals.
• Robots.

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Distinctly Human Action
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Not Distinctly Human Action
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Introduction (2) Subjects Covered in This
Chapter

• The conditions of market interaction.
• Roles in market interaction.
• The pure market economy.
• Why study economics?

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First Subject The Conditions of Market
Interaction

• Three Topics in This Part
• 1. A system of private property rights.
• 2. Free enterprise.
• 3. The use of money.

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The Private Property System It Has Two
Characteristics

• 1. For every separable good or resource, there is
  an individual who is assigned by law as an owner
  of the legal right to control its use.
• 2. The owner of a legal right also has a legal
  right to exchange it.

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First Characteristic of Private Property Rights

• Every separable good or resource has an owner.

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The Assumption of Power andLoyalty to Enforcement

• A private property system implies that
  government agents (the police or the soldiers)
  have the power to block others from using a good
  or resource to which an individual has a legal
  right.
• It also implies loyalty of the police or soldiers
  to the duty of enforcement.

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Definitions

• Good a thing or behavior that can be used to
  satisfy a want directly.
• Resource a thing of behavior that can be used to
  satisfy a want indirectly by helping to produce a
  good.

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Ownership in a Complete PrivateProperty System

• To own the legal right to control a good or
  resources use means that a person can (a) cause
  it to have or not have beneficial effects either
  on himself and others and (b) cause it to have or
  not have harmful effects.
• This implies no government ownership of goods or
  resources.

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Separable and Non-separableGoods and Resources

• Separable good or resource one for which the
  benefits and harm due its control and use can
  only be felt by a single person.
• Example of a separable good a banana. Your
  eating it does not ordinarily yield benefits to
  others.

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Separable and Non-separableGoods and Resources

• Non-separable good or resource one for which the
  benefits and/or harm due to controlling its use
  can be felt by more than one person.
• Examples of non-separable goods If one person
  supplies it, others benefit
• Clean air.
• Defense against aliens.

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Ownership and Negative Externalities

• Negative externality the harm felt by one person
  resulting from the action of another person.
• Example 1 throwing the banana peel on the
  ground.
• Example 2 the pig farmers allowing waste to
  flow into the unpolluted river used for swimming
  by a neighbor.
• A complete property system means that someone
  owns the legal right to control all such actions.
  Either the perpetrator or the victim could own
  the right. Even out outsider could own it. But it
  must be owned.

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Second Characteristic of Private Property Rights

• Individuals have the legal right to exchange
  ownership rights.

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Exchangeability

• The legal rights associated with ownership of
  property are exchangeable. A person may sell
  them or give them away.
• The legal right to control and action having an
  external effect is also exchangeable.

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Exchangeability and Specialization

• The exclusive ownership and exchangeability of
  ownership rights in a private property system
  gives individuals an incentive to specialize.
• A skilled rancher has an incentive to buy a
  ranch. Knowing that he can buy a ranch gives an
  individual an incentive to become a skilled
  rancher.

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Exchangeability and Optimal Negative Externalities

• Ownership and exchangeability give individuals
  incentives to allow the externalities to continue
  only when the expected benefits are greater than
  the expected harm, in terms of money.
• The pig farmer will pollute only if her benefits
  are greater than the harm to the person who is
  damaged by the pollution.
• Note Either the farmer owns the right control
  the action that pollutes the stream or the
  swimming neighbor owns the right.

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Evolution of Private Property Rights

• Two requirements for a modern system of private
  property rights
• 1. Formalness this usually means a set of
  written laws or widely understood laws that are
  enforced by the police or military.
• 2. Equality under the law if a person subject to
  a law is interchanged with any other member of
  the community, the enforcement, judgment and
  punishment for a crime would be the same.

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Informal and Formal Private Property Rights

• Informal private property rights can exist in a
  traditional society. But rewards and punishments
  in such a society depend only roughly on ones
  contribution to the society. When such societies
  grow large, statuses are usually established.
  Families favored by the leaders are often given
  special privileges that are passed on to heirs.
  But descendants may be incompetent specialists.
  To give them rewards similar to their ancestors
  is harmful to the community long run interests.
• A more flexible system evolved in England and its
  codified principles are called the common law.

22
England as a Mother Country

• Due to its military power and policy of
  colonization, England can be regarded as the
  mother country for the property systems that
  emerged in the U.S., Canada, Australia, the
  Indian subcontinent, several countries in Africa
  and a number of others through out the world.
  Many of these countries adopted the common law
  system and its principles after they became
  independent.

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The Common Law

• Common law a set of legal rights to control
  actions that have external effects.
• The common law developed in England as a
  consequence of centuries of judgment in dispute
  resolution cases by government-appointed judges.
• The judges traveled from place to place, made
  rulings, and sent written copies of their rulings
  back to the capital city.
• Young judges could learn the principles by
  studying the rulings.

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Dispute Resolution

• Procedures under common law.
• 1. A person who believed that someone else was
  responsible for harming him would make a damage
  complaint.
• 2. A judge, appointed by the king, would decide
  whether the complaint was justified. He would
  rule on whether a damage payment should be made
  and how much it should be.
• The dog and chicken example.

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Emergence of Common Law

• Early British judgments in dispute resolution
  cases were collected and used as precedents in
  judgments for later decisions.
• Principles were established through trial and
  error.
• These principles enabled new judges to decide the
  right of first possession in most cases on the
  basis of precedent.

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Formality and Equality Under the Law

• When judgments came to be made according to
  principles rather than according to tradition and
  norms, the judgments met the standard of equality
  under the law.
• The long tradition of common law in England
  ultimately led to the formality that is necessary
  for a more complete system of private property
  rights.
• Former colonies of England formally adopted the
  British common law as part of their written
  constitutions.

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The Common Law and the Right of First Possession

• Another example of a common law judgment A
  nurtures a crop and B takes it. A makes a damage
  claim. In ruling that B should pay compensation,
  the judge establishes the legal right of A to
  benefit from his actions with respect to
  nurturing the crop.
• Note that in deciding the case, the judge is
  establishing the right of possession and even the
  right of first possession.

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Evolution of the Right of First Possession

• Two kinds of cases
• 1. Harmful externality the dog and chicken
  example, assuming that no dog had ever caused
  damage before.
• 2. Right of first possession a person produces,
  discovers or invents a good or resource.
• Judges expanded the application by considering
  increasingly complex cases.

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The Common Sense of the Common Law

• A goal of the best common law judges was to show
  that the kings law i.e., judge-made law --
  could benefit the community.
• The judge aimed to make judgments that he
  believed were in the long run community
  interest.
• He took account of future generations.

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First Possession in a Kingdom

• We can understand the importance of the right of
  first possession under common law by comparing it
  with the right of first possession in a kingdom.
• In a kingdom, the king has the right of
  possession to everything.
• Do people have an incentive to discover, invent,
  specialize and produce goods in a kingdom?
• It depends on how much the king knows and whether
  he rewards the discoverers, inventors,
  specialists and producers.
• Could the king, or any other single person, know
  the kinds of discoveries and inventions that take
  place routinely in a modern capitalist society?
• Hmmmmmmmmmmmmmmmmmm,

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Alternative Means Of Assigning The Right Of First
Possession

• Assign it to the leading government official or
  agency in the community.
• People would not produce, discover, or invent
  unless they expected a share of the benefit.
• Assign it by means of a lottery.
• Because each citizen would have an equal chance
  of receiving a share, the incentive to produce,
  discover and invent would be low.

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Right of First Possession Under Common Law

• The benefit of assigning the right of first
  possession to the producer, discoverer or
  inventor.
• If the law gives the discoverer of a good or
  resource the legal right of first possession,
  people will have a greater incentive to discover
  goods and resources. The same is true of a right
  of first possession that is given to an inventor
  or a producer.

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First Possession and Teamwork (1)

• In the eyes of common law judges, an employment
  compact supersedes what would otherwise be the
  rule of first possession.
• Under the legal right of first possession, every
  team member possesses a share of the total
  output. However, the members may agree to give up
  their rights.

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First Possession and Teamwork (2)

• Today the employment agreement is recognized in
  courts as an implicit agreement by employees to
  give up their legal rights to the output.
• The seller of a resource a component in the
  production of another product also implicitly
  gives up his legal right to share in the output.

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An Example of First Possession

• Who has the right of first possession to a book
  that you own?

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Contract Law

• Example of another common law judgment A
  nurtures the crop and gives it to B in return for
  Bs promise to pay. B does not pay. In ruling
  that B should pay compensation, the judge helps
  to establish the law of contracts.
• Besides establishing the right of first
  possession, common law established the law of
  contracts.
• Contract a promise to perform some action,
  usually in writing.
• Contract law the system of rules for determining
  whether a promise has been broken, whether the
  person who broke it should compensate the
  promissee, and what the compensation should be.

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Free Enterprise (1)

• Definition with some exceptions, individuals are
  free from coercion to enter into any kind of
  business they wish, to apply for any kind of job,
  to buy and sell, and to make binding contracts.
• Exceptions
• Slavery.
• Free enterprise a person may cause damage to a
  competitor in an effort to sell his goods or
  services to others.

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Free Enterprise (2)

• Two implications for the role of government
• 1. The government should make no laws that
  prevent or deter individuals from making business
  exchanges.
• 2. The government should use its power to stop
  others from preventing or deterring people from
  making business exchanges.
• Free enterprise means that everyone faces
  potential competition.

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Free Enterprise (3)

• Restrictions on free enterprise in history
• Restrictions on entry onto business in 17th and
  18th century Europe.
• Entrance into a particular trades was often
  limited to those whose families were already in
  the trade or who had apprenticed for many years.
• Licenses are often required today by the U.S.
  state and federal governments.

40
Evolution of Free Enterprise

• Proponents of free enterprise
• Economists who recognize its benefits.
• Opponents of free enterprise
• People who do not recognize its benefits
• People who recognize the benefits and who want
  exceptions for themselves.
• History of free enterprise begins with the
  development of economics but the conflict
  between opponents and proponents never ends.

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Functions of money

• Medium of exchange.
• Store of value.
• Unit of accounting.

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Money as a Medium (1) Barter Vs. Money Exchange

• Barter society a society in which individuals
  acquire goods directly by trading their own goods
  for those of others.
• Money economy a society in which individuals
  acquire goods indirectly by trading their goods
  for money and then their money for the goods of
  others.

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Money as a Medium (2) Barter Vs. Money Exchange

• Barter society people trade
• goods directly for other goods.
• This is direct exchange.
• Money society people trade
• goods for money and then
• trade the money for other
• goods. This is indirect exchange.

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Money as a Medium (3) Money vs. Other Media of
Exchange

• Medium of exchange an item that is wanted not
  because one plans to use it but because one plans
  to exchange with others. It is wanted not because
  of its expected value in use but because of its
  expected value in exchange.
• Money the generally accepted medium of exchange.
  This means that practically everyone will accept
  it in exchange.

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Money As a Medium (4) The Origin and
Characteristics of Money

• One theory the more marketable item becomes
  money.
• Characteristics of a marketable money durable,
  cheap to store, small in relation to their value
  in exchange, divisible, and capable of easy
  quantitative measurement.
• Whether a particular item is used as money
  depends on peoples' expectations about its
  marketability.
• As barter exchange grows and becomes more
  complex, some items are acquired mainly because
  people want to exchange them for other items. The
  people who acquire them do not plan to use them,
  although others may.
• One item eventually dominates the others in
  exchange.

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Money As a Medium (5) Modern Money Forms

• Government-issued paper money and coins.
• Transferable deposits.

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Money As a Store of Value (1)

• Money enables people to economize on their
  savings. They prefer to save marketable items
  that do not deteriorate or become obsolete.
• This is a major reason why durability is an
  important characteristic of money. Besides
  physical durability, people must believe that it
  will retain its exchange value.

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Money As a Store of Value (2)

• Historically, gold and silver coins have been
  good examples of durable money.
• Children in a market economy must learn to use
  money.

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Money As a Unit of Accounting

• Definition of capital accounting using a rate
  of interest to compare the revenue and costs that
  are expected at one time in the future with those
  that are expected at a different time.
• Examples
• Should you continue your education beyond
  undergraduate school?
• Choosing to buy a car or house.

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Roles in Market Interaction (1) Introduction

• The concept of a role
• Example 1 the role of a student. Nobody is only
  a student. But it is often useful to refer to a
  person as a student.
• Example 2 the roles of a father, mother, first
  son, grandmother in a family.

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Roles in Market Interaction (2) Introduction

• In market interaction, a person must first earn
  money. He can do this by being an employer of
  others resources or by allowing others to employ
  his resources. Thus, he becomes a producer or a
  resource supplier.
• Once the money is received, a person must choose
  whether to spend or save. Usually, he chooses to
  spend some of his money and to save some.
• Thus, he becomes a consumer and saver.

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Roles in Market Interaction (3) the Most
Fundamental Roles

• 1. Resource supplying hiring out work or other
  resources.
• 2. Producing hiring resources to produce a
  saleable good and then selling it.
• 3. Consuming using income to buy a good for the
  purpose of consuming it in the near future.
• 4. Saving setting aside some income in order to
  buy goods in the future.

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Impossibility of the Pure Market Economy

• Pure market economy an economy in which the
  private property system is complete and there is
  completely free enterprise.
• But a market economy can never be pure because
  the private property system can never be complete.

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Why a Private Property System is Always
Incomplete (1)

• The Reasons
• 1. It is physically impossible or not worthwhile
  to enforce some private property rights.
• 2. There are common property resources.
• 3. There are public goods.
• 4. Personal freedom means that no one can
  completely control another person's actions.
• 5. Governments have other goals.

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Why a Private Property System is Incomplete (2)

• It is not worthwhile to enforce some private
  property rights.
• The case of small benefits, such as rights to
  control the use of abusive and socially
  unacceptable language or actions.
• The case of high costs, such as clean air, ocean
  minerals and food, sound waves, light waves, and
  radio waves.

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Why a Private Property System is Incomplete (3)

• There are common property resources and public
  goods.
• Common property resource a resource for which
  members of a community have not established
  private property rights.
• Two characteristics of public goods
• 1. A number of people benefit simultaneously.
• 2. It is impossible to exclude beneficiaries.
• Examples dam, flood control project,
• lighthouse.

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Why a Private Property System is Incomplete (4)

• There is personal freedom.
• Personal freedom one person cannot own another
  person. In other words, slavery is prohibited
  because it would violate the principle of
  equality under the law and restrict freedom of
  enterprise.
• A person cannot sell herself into slavery even if
  she wants to do so.

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Why a Private Property System is Incomplete (5)

• Governments have other goals.
• Examples
• Redistributing wealth.
• Protecting the culture or state religion against
  foreign influence.
• Enforcing moral values.

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Why a Private Property System is Incomplete (6)

• Cultural intervention
• 1. Blocking the production and sale of particular
  goods or services that are generally unwanted
  although some individuals may want them drugs,
  prostitution, gambling, pork products.
• 2. Making government decisions subject to the
  will of the people (democracy). Elected
  representatives may pass laws that lead to market
  interventions.

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Types Of Government Intervention That Restrict
Free Enterprise

• 1. Government regulation and price setting.
• 2. Government enterprises.

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Why Study Economics

• To help evaluate arguments for and against
  intervention in market interaction.
• To know what you are defending when you say you
  are defending the capitalist system.