WEBVTT 00:00:00.040 --> 00:00:02.460 The following content is provided under a Creative 00:00:02.460 --> 00:00:03.870 Commons license. 00:00:03.870 --> 00:00:06.910 Your support will help MIT OpenCourseWare continue to 00:00:06.910 --> 00:00:10.560 offer high quality educational resources for free. 00:00:10.560 --> 00:00:13.460 To make a donation or view additional materials from 00:00:13.460 --> 00:00:17.390 hundreds of MIT courses, visit MIT OpenCourseWare at 00:00:17.390 --> 00:00:18.640 ocw.mit.edu. 00:00:21.390 --> 00:00:22.570 PROFESSOR: So what I want to do today is I want to talk 00:00:22.570 --> 00:00:23.930 about what the heck this course is. 00:00:23.930 --> 00:00:25.560 What is microeconomics? 00:00:25.560 --> 00:00:28.080 What are you going to be learning in this course? 00:00:28.080 --> 00:00:30.150 And just, sort of, set us up for the semester. 00:00:30.150 --> 00:00:30.720 OK. 00:00:30.720 --> 00:00:37.400 So basically, microeconomics is all about scarcity. 00:00:37.400 --> 00:00:43.470 It's all about how individuals and firms make decisions given 00:00:43.470 --> 00:00:46.410 that we live in a world of scarcity. 00:00:46.410 --> 00:00:49.540 Scarcity is key because basically what we're going to 00:00:49.540 --> 00:00:52.860 learn about this semester in various shapes and forms is a 00:00:52.860 --> 00:00:55.480 lot of different types of constrained optimization. 00:01:01.320 --> 00:01:04.530 We're going to learn a lot about different ways that 00:01:04.530 --> 00:01:08.890 individuals make choices in a world of scarcity. 00:01:08.890 --> 00:01:10.060 OK? 00:01:10.060 --> 00:01:13.550 That is, this course is going to be about trade-offs. 00:01:13.550 --> 00:01:17.240 Given scarce resources, how the individuals and firms 00:01:17.240 --> 00:01:19.760 trade off different alternatives to make 00:01:19.760 --> 00:01:22.150 themselves as well-off as possible. 00:01:22.150 --> 00:01:24.790 That's why economics is called the dismal science. 00:01:24.790 --> 00:01:25.250 OK? 00:01:25.250 --> 00:01:27.740 It's called the dismal science because we are not about 00:01:27.740 --> 00:01:28.910 everyone have everything. 00:01:28.910 --> 00:01:30.710 We're always the people who say, no, you can't have 00:01:30.710 --> 00:01:31.090 everything. 00:01:31.090 --> 00:01:32.750 You have to make a trade-off. 00:01:32.750 --> 00:01:33.190 OK? 00:01:33.190 --> 00:01:35.040 You have to give up x to get y. 00:01:35.040 --> 00:01:36.810 And that's why people don't like us. 00:01:36.810 --> 00:01:37.380 OK? 00:01:37.380 --> 00:01:39.050 Because that's why we're called the dismal science, 00:01:39.050 --> 00:01:40.250 because we're always pointing out the 00:01:40.250 --> 00:01:41.870 trade-offs that people face. 00:01:41.870 --> 00:01:45.640 Now, some may call it dismal, but I call it fun. 00:01:45.640 --> 00:01:48.640 And that may be because of my MIT training, as I said I was 00:01:48.640 --> 00:01:50.360 an undergraduate here. 00:01:50.360 --> 00:01:53.190 In fact, MIT is the perfect place to teach microeconomics 00:01:53.190 --> 00:01:56.500 because this whole institute is about engineering solutions 00:01:56.500 --> 00:01:57.850 which are really ultimately about constrained 00:01:57.850 --> 00:01:59.060 optimization. 00:01:59.060 --> 00:02:00.790 Indeed, what's the best example in the 00:02:00.790 --> 00:02:01.600 world we have of this? 00:02:01.600 --> 00:02:03.360 It's the 270 contest. Right? 00:02:03.360 --> 00:02:06.090 You're given a pile of junk, you've got to build something 00:02:06.090 --> 00:02:07.480 that does something else. 00:02:07.480 --> 00:02:09.780 That's an exercise in constrained optimization. 00:02:09.780 --> 00:02:12.070 All engineering is really constrained optimization. 00:02:12.070 --> 00:02:13.800 How do you take the resources you're given and do the best 00:02:13.800 --> 00:02:15.280 job building something. 00:02:15.280 --> 00:02:18.650 And that's really what microeconomics is. 00:02:18.650 --> 00:02:21.900 Just like 270 is not a dismal contest, microeconomics is not 00:02:21.900 --> 00:02:23.720 to me a dismal science. 00:02:23.720 --> 00:02:26.490 You could think of this course like 270. 00:02:26.490 --> 00:02:27.775 But instead of the building robots, we're 00:02:27.775 --> 00:02:29.180 running people's lives. 00:02:29.180 --> 00:02:29.720 OK? 00:02:29.720 --> 00:02:30.650 That's, kind of, the way I like to 00:02:30.650 --> 00:02:31.230 think about this course. 00:02:31.230 --> 00:02:32.840 Instead of trying to decide how we can build something to 00:02:32.840 --> 00:02:35.140 move a ping pong ball across a table, we're trying to decide 00:02:35.140 --> 00:02:37.510 how people make their decisions to consume, and 00:02:37.510 --> 00:02:39.270 firms make their decisions to produce. 00:02:39.270 --> 00:02:41.660 That's basically what's going to go on in this class. 00:02:41.660 --> 00:02:42.140 OK? 00:02:42.140 --> 00:02:44.960 And that's why basically modern microeconomics was 00:02:44.960 --> 00:02:48.360 founded at MIT in the 1950s by Paul Samuelson. 00:02:48.360 --> 00:02:52.890 The father of modern economics was a professor here, and he 00:02:52.890 --> 00:02:54.080 basically founded the field. 00:02:54.080 --> 00:02:57.240 He basically introduced mathematics to economics. 00:02:57.240 --> 00:03:00.690 And through teaching this course, 14.01, 50, 60 years 00:03:00.690 --> 00:03:04.210 ago, actually developed the field that we now study. 00:03:04.210 --> 00:03:08.990 Now, what we're going to do in this class, is focused on two 00:03:08.990 --> 00:03:11.450 types of actors in the economy: 00:03:11.450 --> 00:03:13.330 consumers and producers. 00:03:19.910 --> 00:03:20.730 OK? 00:03:20.730 --> 00:03:25.300 And we are going to build models of how consumers and 00:03:25.300 --> 00:03:29.500 producers behave. Now, technically, a model is going 00:03:29.500 --> 00:03:33.230 to be a description of any relationship between two or 00:03:33.230 --> 00:03:35.180 more economic variables. 00:03:35.180 --> 00:03:35.950 OK? 00:03:35.950 --> 00:03:36.460 That's a model. 00:03:36.460 --> 00:03:38.090 A description of any relationship between two or 00:03:38.090 --> 00:03:40.120 more economic variables. 00:03:40.120 --> 00:03:42.430 The trick with economics, and the reason many of you will be 00:03:42.430 --> 00:03:45.870 frustrated during the semester, is that unlike the 00:03:45.870 --> 00:03:48.970 modern relationship between say energy and mass these 00:03:48.970 --> 00:03:51.600 models are never precise. 00:03:51.600 --> 00:03:55.490 They are never accurate to the 10th decimal. 00:03:55.490 --> 00:03:56.630 OK? 00:03:56.630 --> 00:03:58.950 This is not a precise, scientific 00:03:58.950 --> 00:04:00.190 relationship with modeling. 00:04:00.190 --> 00:04:03.390 We'll be making a number of simplifying assumptions that 00:04:03.390 --> 00:04:06.650 allow us to capture the main tendencies in the data. 00:04:06.650 --> 00:04:09.850 That allow us to capture the main insights into how 00:04:09.850 --> 00:04:12.000 individuals make consumption decisions and how firms make 00:04:12.000 --> 00:04:13.240 production decisions. 00:04:13.240 --> 00:04:15.390 But it's not going to be as clean and precise as the kind 00:04:15.390 --> 00:04:16.890 of proofs you're going to be doing in some of your other 00:04:16.890 --> 00:04:20.450 classes in freshman and sophomore year. 00:04:20.450 --> 00:04:21.130 OK? 00:04:21.130 --> 00:04:24.180 So basically, we have a trade off with the simplifying 00:04:24.180 --> 00:04:25.480 assumptions. 00:04:25.480 --> 00:04:28.720 On the one hand, obviously we want a model that can explain 00:04:28.720 --> 00:04:30.600 reality as much as possible. 00:04:30.600 --> 00:04:33.280 If a model can't explain reality, it's not useful. 00:04:33.280 --> 00:04:35.250 On the other hand, we need a model that's tractable, a 00:04:35.250 --> 00:04:38.810 model that I can teach you in a lecture or less. 00:04:38.810 --> 00:04:40.100 OK? 00:04:40.100 --> 00:04:45.200 And basically, what we do is we make a lot of simplifying 00:04:45.200 --> 00:04:47.730 assumptions in this class to make those models work. 00:04:47.730 --> 00:04:50.580 And yet, what we'll find is despite these assumptions, 00:04:50.580 --> 00:04:53.270 we'll come up with incredibly powerful predictions of how 00:04:53.270 --> 00:04:55.940 consumers and producers behave. 00:04:55.940 --> 00:04:58.260 So with consumers what we're going to do is, we're going to 00:04:58.260 --> 00:05:02.010 say that consumers are constrained by their limited 00:05:02.010 --> 00:05:05.030 wealth or what we'll call their budget constraint. 00:05:05.030 --> 00:05:09.930 And subject to that constraint they choose the set of goods 00:05:09.930 --> 00:05:12.250 that makes them as well off as possible. 00:05:12.250 --> 00:05:12.760 OK? 00:05:12.760 --> 00:05:15.970 That's what we're going to call utility maximization. 00:05:15.970 --> 00:05:19.000 We'll say the consumers maximize their utility, 00:05:19.000 --> 00:05:25.600 consumers are going to maximize utility subject to a 00:05:25.600 --> 00:05:26.800 budget constraint. 00:05:26.800 --> 00:05:28.680 That's going to be what we're going to develop 00:05:28.680 --> 00:05:29.460 the consumer decision. 00:05:29.460 --> 00:05:31.583 They have some utility function which is going to be 00:05:31.583 --> 00:05:33.600 a model of their preferences. 00:05:33.600 --> 00:05:35.600 OK? 00:05:35.600 --> 00:05:37.790 So I'm going to propose to take everything you love in 00:05:37.790 --> 00:05:40.220 life and write it down as a u function. 00:05:40.220 --> 00:05:40.920 OK? 00:05:40.920 --> 00:05:42.716 Then I'm going to propose you take all the resources at your 00:05:42.716 --> 00:05:44.900 disposal, write them down as a budget constraint and then I 00:05:44.900 --> 00:05:47.760 just do constrained maximization to solve for how 00:05:47.760 --> 00:05:49.580 you make decisions. 00:05:49.580 --> 00:05:53.310 Firms, on the other hand, are going to maximize profits. 00:05:55.960 --> 00:05:57.100 Pi is profits. 00:05:57.100 --> 00:05:59.200 Firms are going to maximize profits. 00:05:59.200 --> 00:06:03.360 Their goal is to make as much profit as possible, to earn as 00:06:03.360 --> 00:06:05.030 much money as possible. 00:06:05.030 --> 00:06:05.880 OK? 00:06:05.880 --> 00:06:09.960 However, that's going to be subject to both the demands of 00:06:09.960 --> 00:06:14.620 consumers, we get to firms it's a lot harder, subject to 00:06:14.620 --> 00:06:22.850 both consumer demand and input costs. 00:06:22.850 --> 00:06:25.740 So firms have to consider, consumers have to consider 00:06:25.740 --> 00:06:27.310 look what does stuff cost and what do I like, 00:06:27.310 --> 00:06:28.290 I'll make my decision. 00:06:28.290 --> 00:06:29.900 Firms is a little more complicated. 00:06:29.900 --> 00:06:32.200 They've go to consider, what do consumers want and how do I 00:06:32.200 --> 00:06:33.640 make what they want? 00:06:33.640 --> 00:06:36.895 So they've got to consider both the output side, what a 00:06:36.895 --> 00:06:39.050 consumer is going to want me to make and what's it going to 00:06:39.050 --> 00:06:40.880 cost me to produce that good? 00:06:40.880 --> 00:06:43.880 And how do I combine those to make the most profits? 00:06:43.880 --> 00:06:44.700 OK? 00:06:44.700 --> 00:06:50.650 So from these assumptions, we will be able to answer the 00:06:50.650 --> 00:06:53.790 three fundamental questions of microeconomics. 00:06:53.790 --> 00:06:54.380 OK? 00:06:54.380 --> 00:06:56.650 The three fundamental questions of microeconomics 00:06:56.650 --> 00:07:04.485 will be, what goods and services should be produced? 00:07:07.800 --> 00:07:09.440 What goods and services should be produced? 00:07:11.960 --> 00:07:13.760 How to produce those goods and services? 00:07:20.920 --> 00:07:23.250 And who gets the goods and services? 00:07:27.400 --> 00:07:30.400 What goods and services get produced? 00:07:30.400 --> 00:07:33.090 How to produce those goods and services? 00:07:33.090 --> 00:07:35.290 And who gets them? 00:07:35.290 --> 00:07:38.150 And what's amazing, we'll learn in this course, is that 00:07:38.150 --> 00:07:40.980 all three of these questions, the three fundamental 00:07:40.980 --> 00:07:44.990 questions that drive our entire economy, are all solved 00:07:44.990 --> 00:07:47.460 through the role of one key state 00:07:47.460 --> 00:07:48.825 variable, which is prices. 00:07:52.080 --> 00:07:57.820 Prices in the economy resolve all of these problems. OK? 00:07:57.820 --> 00:08:02.810 Consumers and firms will interact in a market, they'll 00:08:02.810 --> 00:08:04.800 interact in a marketplace. 00:08:04.800 --> 00:08:08.330 And out of that marketplace will emerge a set of prices, 00:08:08.330 --> 00:08:11.020 in a way we'll describe. 00:08:11.020 --> 00:08:14.460 And those prices will allow firms and consumers to make 00:08:14.460 --> 00:08:16.063 the relevant decisions. 00:08:16.063 --> 00:08:16.870 OK? 00:08:16.870 --> 00:08:19.080 So let me just give you one, and we're going to do all this 00:08:19.080 --> 00:08:20.900 rigorously throughout the semester, let me just start 00:08:20.900 --> 00:08:22.050 with one casual example. 00:08:22.050 --> 00:08:22.650 OK? 00:08:22.650 --> 00:08:25.600 Let's think about the development of the iPod. 00:08:25.600 --> 00:08:26.070 OK? 00:08:26.070 --> 00:08:29.830 Let's cast our minds way back, lo way back to the development 00:08:29.830 --> 00:08:30.760 of the iPod. 00:08:30.760 --> 00:08:31.380 OK? 00:08:31.380 --> 00:08:37.350 Now, when Apple was thinking about making the iPod, they 00:08:37.350 --> 00:08:40.750 had to ask, would consumers want this? 00:08:40.750 --> 00:08:44.430 So consumers had to decide given their limited resources, 00:08:44.430 --> 00:08:47.040 given the fact that they were buying a certain set of things 00:08:47.040 --> 00:08:49.560 would they be willing to forsake some things they were 00:08:49.560 --> 00:08:52.600 already doing to spend the money on the iPod? 00:08:52.600 --> 00:08:52.890 OK? 00:08:52.890 --> 00:08:54.110 It was a non-trivial amount of money. 00:08:54.110 --> 00:08:55.413 Would they be willing to forsake things they are 00:08:55.413 --> 00:08:56.530 already doing? 00:08:56.530 --> 00:08:57.340 OK? 00:08:57.340 --> 00:08:58.760 To spend money on the iPod. 00:08:58.760 --> 00:09:00.500 And clearly they were. 00:09:00.500 --> 00:09:03.960 Clearly, consumers were willing to spend money, to 00:09:03.960 --> 00:09:06.470 spend a lot of money, to get an iPod. 00:09:06.470 --> 00:09:08.590 They were originally what? $300 Back 00:09:08.590 --> 00:09:10.040 when $300 meant something. 00:09:10.040 --> 00:09:10.650 OK. 00:09:10.650 --> 00:09:16.760 So basically, what the firm will do is they'll say, OK, we 00:09:16.760 --> 00:09:20.800 get a signal from the consumer that they're willing to pay 00:09:20.800 --> 00:09:22.620 money to get the iPod. 00:09:22.620 --> 00:09:25.910 They're willing to pay a high price to get the iPod. 00:09:25.910 --> 00:09:28.850 Now, the firm will say, well, should we make iPods? 00:09:28.850 --> 00:09:32.000 Well, that will depend on what it cost to make them. 00:09:32.000 --> 00:09:39.100 So we have to then assess what are the inputs that we'll need 00:09:39.100 --> 00:09:40.310 to make an iPod? 00:09:40.310 --> 00:09:44.070 Well, to do that we have to look at the prices of the 00:09:44.070 --> 00:09:46.550 various inputs that we'll need, of the chip in them and 00:09:46.550 --> 00:09:49.130 the metal and all the other stuff that goes into the iPod. 00:09:49.130 --> 00:09:50.020 OK? 00:09:50.020 --> 00:09:52.610 So they can shop across different countries, to 00:09:52.610 --> 00:09:54.170 different kinds of chips, they can look at different kinds of 00:09:54.170 --> 00:09:55.560 monitors, et cetera. 00:09:55.560 --> 00:09:58.820 But, once again, what they'll do is they'll use the prices 00:09:58.820 --> 00:10:01.290 of those different inputs to decide how 00:10:01.290 --> 00:10:02.430 to produce the iPod. 00:10:02.430 --> 00:10:05.630 So whether to produce the iPod will depend on the price 00:10:05.630 --> 00:10:08.030 people are willing to pay for it. 00:10:08.030 --> 00:10:11.850 How to make the iPod will depend on the prices that 00:10:11.850 --> 00:10:15.870 firms have to pay for the chip and the casing and all the 00:10:15.870 --> 00:10:18.420 other things that go into the iPod. 00:10:18.420 --> 00:10:19.280 OK? 00:10:19.280 --> 00:10:22.400 And then finally, who's going to get the iPod? 00:10:22.400 --> 00:10:24.500 Well, they're going to make a certain amount. 00:10:24.500 --> 00:10:25.510 What decided who gets them? 00:10:25.510 --> 00:10:27.170 Well, the person who gets them are the people who are willing 00:10:27.170 --> 00:10:30.610 to pay the price that Apple decides to charge. 00:10:30.610 --> 00:10:33.140 Some people are willing to pay that price, they're going to 00:10:33.140 --> 00:10:34.940 get an iPod. 00:10:34.940 --> 00:10:37.400 Some people are not willing to pay that price, they will not 00:10:37.400 --> 00:10:38.910 get an iPod. 00:10:38.910 --> 00:10:41.460 So the price in the market will ultimately decide who 00:10:41.460 --> 00:10:44.030 gets the iPod, as well. 00:10:44.030 --> 00:10:44.710 OK? 00:10:44.710 --> 00:10:48.710 So basically, prices will determine what gets produced, 00:10:48.710 --> 00:10:50.880 how it's produced, and who gets the 00:10:50.880 --> 00:10:53.000 goods that are produced. 00:10:53.000 --> 00:10:54.280 OK? 00:10:54.280 --> 00:10:57.850 Of course, this is a very, very simplified example, as 00:10:57.850 --> 00:10:58.900 you can already tell. 00:10:58.900 --> 00:11:00.610 There are lots of cases where prices don't 00:11:00.610 --> 00:11:02.070 decide these things. 00:11:02.070 --> 00:11:06.590 So my favorite example is the fact that there are lines for 00:11:06.590 --> 00:11:10.190 hours to get tickets to see a Lady Gaga concert. 00:11:10.190 --> 00:11:11.030 OK? 00:11:11.030 --> 00:11:15.040 Now if it's really true that prices determine everything, 00:11:15.040 --> 00:11:16.740 we shouldn't see any lines. 00:11:16.740 --> 00:11:18.650 It should just be that those who are willing to pay the 00:11:18.650 --> 00:11:21.730 most to see Lady Gaga should. 00:11:21.730 --> 00:11:25.220 Those who want the most to get Lady Gaga 00:11:25.220 --> 00:11:26.120 should get the tickets. 00:11:26.120 --> 00:11:27.990 Those who aren't willing to pay shouldn't get the tickets. 00:11:27.990 --> 00:11:29.420 Why should there be a line? 00:11:29.420 --> 00:11:31.000 Not to mention the fact that people shouldn't be willing to 00:11:31.000 --> 00:11:32.660 pay anything, but that's a different issue. 00:11:32.660 --> 00:11:33.510 That's a taste issue. 00:11:33.510 --> 00:11:34.770 We'll come to taste later. 00:11:34.770 --> 00:11:35.610 OK? 00:11:35.610 --> 00:11:39.010 So basically, clearly this is not working perfectly. 00:11:39.010 --> 00:11:42.060 If the world worked in the way I just described, then what 00:11:42.060 --> 00:11:45.870 should happen is there should be essentially an auction and 00:11:45.870 --> 00:11:48.140 whoever is willing to pay the most for Lady Gaga tickets 00:11:48.140 --> 00:11:49.270 would get them. 00:11:49.270 --> 00:11:50.500 And whoever is not willing to pay wouldn't. 00:11:50.500 --> 00:11:51.560 It wouldn't involve any waiting in 00:11:51.560 --> 00:11:53.850 line or other things. 00:11:53.850 --> 00:11:56.440 Now, what's very interesting is we've actually seen an 00:11:56.440 --> 00:11:59.910 evolution from my youth to your youth towards the 00:11:59.910 --> 00:12:00.840 economic model. 00:12:00.840 --> 00:12:04.660 When I was a kid, if you wanted, so then it was Cars 00:12:04.660 --> 00:12:09.710 tickets, OK, to date myself, OK, you had to go and camp out 00:12:09.710 --> 00:12:13.050 at 3:00 in the morning outside the store where they're 00:12:13.050 --> 00:12:14.700 selling them to get the tickets. 00:12:14.700 --> 00:12:16.440 Now, of course, you don't do that anymore. 00:12:16.440 --> 00:12:19.800 Now you go on Stub Hub or Ticketmaster or these other 00:12:19.800 --> 00:12:22.870 secondary sellers and there there are prices that 00:12:22.870 --> 00:12:23.380 determine it. 00:12:23.380 --> 00:12:28.060 So how many people have waited on line to 00:12:28.060 --> 00:12:30.750 get a concert ticket? 00:12:30.750 --> 00:12:31.390 That's amazing. 00:12:31.390 --> 00:12:34.620 So if I asked this question 30 years ago, 90% of the hands 00:12:34.620 --> 00:12:35.500 would have gone up. 00:12:35.500 --> 00:12:36.100 OK? 00:12:36.100 --> 00:12:38.750 So what that means is the price mechanism has 00:12:38.750 --> 00:12:40.000 started to be used. 00:12:40.000 --> 00:12:45.240 It has replaced the line mechanism as a way to allocate 00:12:45.240 --> 00:12:45.700 those tickets. 00:12:45.700 --> 00:12:47.070 And we see prices working. 00:12:47.070 --> 00:12:47.760 That wasn't true. 00:12:47.760 --> 00:12:49.120 There wasn't StubHub. 00:12:49.120 --> 00:12:52.470 There weren't these secondary ticket sellers 30 years ago. 00:12:52.470 --> 00:12:55.640 You had to wait on line to get the tickets. 00:12:55.640 --> 00:12:58.590 Now, so that's basically, sort of, an overview about, sort of 00:12:58.590 --> 00:13:01.300 an example, of how we think about the role of prices. 00:13:01.300 --> 00:13:04.420 Now, let me draw a couple of important distinctions, terms 00:13:04.420 --> 00:13:05.970 I'm going to use this semester that I want you to be 00:13:05.970 --> 00:13:07.270 comfortable with. 00:13:07.270 --> 00:13:08.000 OK? 00:13:08.000 --> 00:13:15.580 The first distinction I want to draw is between theoretical 00:13:15.580 --> 00:13:20.345 versus empirical economics. 00:13:23.720 --> 00:13:26.680 Theoretical versus empirical economics. 00:13:26.680 --> 00:13:27.460 OK. 00:13:27.460 --> 00:13:34.940 Theoretical economics is the process of building models to 00:13:34.940 --> 00:13:36.190 explain the world. 00:13:40.070 --> 00:13:40.860 OK? 00:13:40.860 --> 00:13:44.260 Empirical economics is the process of testing those 00:13:44.260 --> 00:13:49.480 models to see how good a job they do in 00:13:49.480 --> 00:13:51.380 explaining the world. 00:13:51.380 --> 00:13:52.200 OK? 00:13:52.200 --> 00:13:54.630 We could all make up a model. 00:13:54.630 --> 00:13:54.950 OK? 00:13:54.950 --> 00:13:56.890 Anybody with math skills could make up a model. 00:13:56.890 --> 00:14:00.040 But it doesn't do any good unless it's actually doing 00:14:00.040 --> 00:14:01.600 something to explain the world. 00:14:01.600 --> 00:14:07.490 And so basically, the goal of theoretical economics is 00:14:07.490 --> 00:14:12.560 essentially to build a model that has some testable 00:14:12.560 --> 00:14:14.090 predictions. 00:14:14.090 --> 00:14:16.490 To build a model that says, look here's my simplified 00:14:16.490 --> 00:14:22.050 model of how consumers decide whether or not to buy an iPod. 00:14:22.050 --> 00:14:22.570 OK? 00:14:22.570 --> 00:14:24.830 I have a model of that, that I've built theoretically. 00:14:24.830 --> 00:14:27.410 Well, that has some testable predictions. 00:14:27.410 --> 00:14:29.320 And the role of empirical economics is to gather the 00:14:29.320 --> 00:14:33.490 data and go and test them using statistical methods. 00:14:33.490 --> 00:14:35.700 Specifically, typically regression analysis like the 00:14:35.700 --> 00:14:38.820 kind you learn about in advanced statistics. 00:14:38.820 --> 00:14:39.980 OK? 00:14:39.980 --> 00:14:44.775 So basically, what we're going to do is we're going to is 95% 00:14:44.775 --> 00:14:46.440 of this course will be about theoretical 00:14:46.440 --> 00:14:47.940 economics this semester. 00:14:47.940 --> 00:14:50.210 It will be about understanding how economists develop the 00:14:50.210 --> 00:14:53.680 models to model how consumers and firms behave. But I will 00:14:53.680 --> 00:14:57.610 try to talk somewhat about empirical economics and what 00:14:57.610 --> 00:15:00.730 data we can bring to bear to understand whether or not 00:15:00.730 --> 00:15:04.080 these models explain the world. 00:15:04.080 --> 00:15:05.230 OK? 00:15:05.230 --> 00:15:10.540 The other distinction that's very important is positive 00:15:10.540 --> 00:15:17.570 versus normative economics. 00:15:17.570 --> 00:15:21.020 Positive versus normative economics. 00:15:21.020 --> 00:15:25.950 And this is the distinction between the way things are, 00:15:25.950 --> 00:15:30.370 which is positive economics, and the way things should be 00:15:30.370 --> 00:15:31.920 which is normative economics. 00:15:31.920 --> 00:15:34.600 Distinction between the way things are and the way 00:15:34.600 --> 00:15:36.160 things should be. 00:15:36.160 --> 00:15:37.060 OK? 00:15:37.060 --> 00:15:39.660 So let's consider a great example of microeconomics at 00:15:39.660 --> 00:15:42.880 work which is auctions on eBay. 00:15:42.880 --> 00:15:44.210 OK? 00:15:44.210 --> 00:15:48.000 Auctions on eBay, economists love studying auctions on eBay 00:15:48.000 --> 00:15:51.390 because it's a textbook example of what we call a 00:15:51.390 --> 00:15:55.100 perfectly competitive market which is what we'll focus on 00:15:55.100 --> 00:15:56.670 the semester. 00:15:56.670 --> 00:15:59.060 A perfectly competitive market. 00:15:59.060 --> 00:15:59.930 OK? 00:15:59.930 --> 00:16:07.040 And by that we mean that basically that producers in 00:16:07.040 --> 00:16:09.620 this market offer up their good to a 00:16:09.620 --> 00:16:12.390 wide range of consumers. 00:16:12.390 --> 00:16:13.500 OK? 00:16:13.500 --> 00:16:15.610 A number of producers offer up their goods to a 00:16:15.610 --> 00:16:17.840 wide range of consumers. 00:16:17.840 --> 00:16:18.530 OK? 00:16:18.530 --> 00:16:22.150 And the consumers bid up the price until the person who has 00:16:22.150 --> 00:16:24.680 the highest value for the good gets it. 00:16:24.680 --> 00:16:27.350 So price serves exactly the signal it should 00:16:27.350 --> 00:16:29.240 in allocating goods. 00:16:29.240 --> 00:16:29.670 OK? 00:16:29.670 --> 00:16:32.150 So really eBay's really sort of about this third thing of 00:16:32.150 --> 00:16:33.660 who gets the good. 00:16:33.660 --> 00:16:34.360 OK? 00:16:34.360 --> 00:16:41.840 I offer my alarm clock or whatever on eBay, OK, and then 00:16:41.840 --> 00:16:42.760 people bid on that. 00:16:42.760 --> 00:16:44.880 And whoever values that the most, that rare Jon Gruber 00:16:44.880 --> 00:16:47.460 alarm clock the most, they get it. 00:16:47.460 --> 00:16:48.150 OK? 00:16:48.150 --> 00:16:50.780 So it's a perfect textbook example. 00:16:50.780 --> 00:16:51.590 OK? 00:16:51.590 --> 00:16:55.980 And basically, because on eBay the price is used, or now with 00:16:55.980 --> 00:16:59.670 also StubHub and concert tickets, the price is used to 00:16:59.670 --> 00:17:01.740 allocate the good to the person who wants 00:17:01.740 --> 00:17:03.620 it the most. OK? 00:17:03.620 --> 00:17:06.380 Now, a recent example of an auction on eBay that a lot of 00:17:06.380 --> 00:17:08.940 attention, not so recent anymore a couple years ago, 00:17:08.940 --> 00:17:12.020 someone tried to auction their kidney on eBay. 00:17:12.020 --> 00:17:12.510 OK? 00:17:12.510 --> 00:17:15.010 Someone offered their kidney for auction on eBay and said, 00:17:15.010 --> 00:17:17.349 I have two kidneys I only need one. 00:17:17.349 --> 00:17:20.200 So I'm going to auction my kidney, you pay for me to fly 00:17:20.200 --> 00:17:22.300 to wherever you need my kidney and the operation, they take 00:17:22.300 --> 00:17:23.680 it out and they give it to you. 00:17:23.680 --> 00:17:26.060 And that's the way it goes. 00:17:26.060 --> 00:17:28.500 So what happened was person offered their kidney and they 00:17:28.500 --> 00:17:30.390 said the starting price will be $25,000. 00:17:30.390 --> 00:17:31.620 They didn't do a buy it now. 00:17:31.620 --> 00:17:34.150 They said the starting price will be $25,000 and the 00:17:34.150 --> 00:17:36.860 bidding went on. 00:17:36.860 --> 00:17:41.720 The price got to $5 million before eBay shot it down. 00:17:41.720 --> 00:17:43.120 eBay shut the auction down. 00:17:43.120 --> 00:17:47.390 And eBay said no, in fact, you can't do this. 00:17:47.390 --> 00:17:50.380 Now there's two questions here. 00:17:50.380 --> 00:17:52.470 The first is, why did the price of the 00:17:52.470 --> 00:17:53.690 kidney go so high? 00:17:53.690 --> 00:17:55.950 That's the positive question. 00:17:55.950 --> 00:17:58.440 The positive question is, why did the price the kidney on 00:17:58.440 --> 00:18:00.940 eBay get so high? 00:18:00.940 --> 00:18:04.720 And here, we'll talk, and you'll learn more starting 00:18:04.720 --> 00:18:12.360 Friday, about the twin forces of supply and demand. 00:18:12.360 --> 00:18:16.640 The twin forces that drive the economy of supply and demand. 00:18:16.640 --> 00:18:17.920 And you'll talk more rigorously 00:18:17.920 --> 00:18:21.320 about these on Friday. 00:18:21.320 --> 00:18:23.290 Basically, they're what they sound like. 00:18:23.290 --> 00:18:25.670 Demand is how much someone wants something. 00:18:25.670 --> 00:18:28.900 Supply is how much of it there is to have. 00:18:28.900 --> 00:18:32.300 And the intuition here is surprising. 00:18:32.300 --> 00:18:32.990 OK? 00:18:32.990 --> 00:18:40.730 The more that there's demand for a good, the higher will be 00:18:40.730 --> 00:18:42.500 the upward pressure on prices. 00:18:42.500 --> 00:18:45.530 The more people want a good, the higher prices will go. 00:18:45.530 --> 00:18:48.430 And the less supply there is of a good, also the higher 00:18:48.430 --> 00:18:49.400 prices will go. 00:18:49.400 --> 00:18:51.310 So if everybody wants something but it's common, the 00:18:51.310 --> 00:18:52.650 price will be low. 00:18:52.650 --> 00:18:55.220 And if no one wants something but it's uncommon, the price 00:18:55.220 --> 00:18:57.240 will still be low, and vice versa. 00:18:57.240 --> 00:19:01.000 In fact, the development of the model of supply and demand 00:19:01.000 --> 00:19:04.900 framework was from Adam Smith, the, sort of, so-called first 00:19:04.900 --> 00:19:08.360 economist who wrote The Wealth of Nations in 1776 which is, 00:19:08.360 --> 00:19:10.610 sort of, viewed as the, kind of, first 00:19:10.610 --> 00:19:12.440 serious book about economics. 00:19:12.440 --> 00:19:15.400 And he posed what he called the water diamond paradox. 00:19:15.400 --> 00:19:18.500 What Smith said in that book is, look, it's clear water is 00:19:18.500 --> 00:19:19.700 the most important thing in life. 00:19:19.700 --> 00:19:21.060 We can't live without water. 00:19:21.060 --> 00:19:23.670 And diamonds are completely irrelevant to life. 00:19:23.670 --> 00:19:25.810 You can live totally fine without a diamond. 00:19:25.810 --> 00:19:27.190 And yet, the price of diamonds is 00:19:27.190 --> 00:19:29.860 astronomical and water's free. 00:19:29.860 --> 00:19:31.340 How can this be? 00:19:31.340 --> 00:19:34.620 How can it be that water which is so much more of a 00:19:34.620 --> 00:19:37.230 fundamental building block of our life is so much cheaper 00:19:37.230 --> 00:19:38.220 than diamonds which are not. 00:19:38.220 --> 00:19:41.110 And the answer, of course, is that so far you've only 00:19:41.110 --> 00:19:43.260 considered demand and not supply. 00:19:43.260 --> 00:19:43.910 Yes, it's true. 00:19:43.910 --> 00:19:45.300 The demand for water is much higher than 00:19:45.300 --> 00:19:46.200 the demand for diamonds. 00:19:46.200 --> 00:19:49.170 But the supply is even larger. 00:19:49.170 --> 00:19:52.690 So that basically, yes it's true that while water should 00:19:52.690 --> 00:19:56.530 be worth more, in fact, in the end the price of water is much 00:19:56.530 --> 00:19:59.570 lower, because of the twin forces of demand and supply. 00:19:59.570 --> 00:20:02.150 The demand is higher, but the supply is much higher. 00:20:02.150 --> 00:20:03.490 So the price ends up lower. 00:20:03.490 --> 00:20:06.320 And that was his diamond water paradox. 00:20:06.320 --> 00:20:06.760 OK? 00:20:06.760 --> 00:20:08.890 Well, in this case, it's a similar thing. 00:20:08.890 --> 00:20:12.530 What determines the demand for a kidney? 00:20:12.530 --> 00:20:14.905 What determines the demand for a kidney is going to be the 00:20:14.905 --> 00:20:16.770 fact that you die without it. 00:20:16.770 --> 00:20:17.340 OK? 00:20:17.340 --> 00:20:19.830 If you have no kidneys, you're having kidney failure. 00:20:19.830 --> 00:20:20.110 OK? 00:20:20.110 --> 00:20:20.810 You'll die without it. 00:20:20.810 --> 00:20:22.110 So basically, what will determine it is people are 00:20:22.110 --> 00:20:24.236 willing to spend all their wealth, as much money as they 00:20:24.236 --> 00:20:26.360 can have, to get a kidney OK? 00:20:26.360 --> 00:20:28.320 So the demand will be quite high. 00:20:28.320 --> 00:20:31.220 The supply will be quite low. 00:20:31.220 --> 00:20:33.940 Sadly, not many people are willing to be organ donors. 00:20:33.940 --> 00:20:35.490 More relevantly, a lot of people aren't in good 00:20:35.490 --> 00:20:37.480 situations to be organ donors. 00:20:37.480 --> 00:20:38.110 OK? 00:20:38.110 --> 00:20:41.980 As a result, the supply is much lower than the demand. 00:20:41.980 --> 00:20:44.775 So we have a situation with a high demand, a low supply and 00:20:44.775 --> 00:20:47.130 the price went through the roof. 00:20:47.130 --> 00:20:49.240 That's a positive analysis. 00:20:49.240 --> 00:20:50.310 OK? 00:20:50.310 --> 00:20:52.250 So we can understand pretty intuitively. 00:20:52.250 --> 00:20:54.750 We don't need this course to understand why 00:20:54.750 --> 00:20:56.120 the price went up. 00:20:56.120 --> 00:20:56.410 OK? 00:20:56.410 --> 00:20:59.460 It's just the twin powers of demand and supply. 00:20:59.460 --> 00:21:05.790 But what about the normative question which is, should eBay 00:21:05.790 --> 00:21:07.220 have allowed this sale to happen? 00:21:07.220 --> 00:21:09.980 EBay at $5 million cut it off and then passed the rule 00:21:09.980 --> 00:21:12.420 saying you can't auction your body parts on eBay. 00:21:12.420 --> 00:21:12.870 OK? 00:21:12.870 --> 00:21:15.180 Should they have done that? 00:21:15.180 --> 00:21:16.160 That's the normative question. 00:21:16.160 --> 00:21:20.200 That's economics gets really interesting, which is you all 00:21:20.200 --> 00:21:22.660 are smart enough to figure out why the price went up. 00:21:22.660 --> 00:21:27.070 But this is where it gets interesting is should people 00:21:27.070 --> 00:21:31.510 have been able to auction their kidney on eBay? 00:21:31.510 --> 00:21:35.200 On the one hand, many, many people in this country die for 00:21:35.200 --> 00:21:37.030 want of a body part. 00:21:37.030 --> 00:21:37.920 OK? 00:21:37.920 --> 00:21:40.090 Thousands to hundreds of thousands of people die every 00:21:40.090 --> 00:21:42.300 year waiting for a transplant. 00:21:42.300 --> 00:21:42.890 OK? 00:21:42.890 --> 00:21:47.470 If someone is incredibly rich and they want a body part, 00:21:47.470 --> 00:21:51.800 which to me a surplus because I have two kidneys, why 00:21:51.800 --> 00:21:55.180 shouldn't they be allowed to buy it from me? 00:21:55.180 --> 00:21:59.560 I'm better off because they can pay me a ton of money. 00:21:59.560 --> 00:22:02.440 They are better off because they live. 00:22:02.440 --> 00:22:04.490 So I've just described a transaction that makes both 00:22:04.490 --> 00:22:05.660 parties better off. 00:22:05.660 --> 00:22:08.540 Why shouldn't that be allowed to happen? 00:22:08.540 --> 00:22:09.790 So you tell me. 00:22:11.900 --> 00:22:13.670 Does everyone think eBay was wrong? 00:22:13.670 --> 00:22:14.399 Yeah, go ahead. 00:22:14.399 --> 00:22:15.158 AUDIENCE: Say there is another person who doesn't have as 00:22:15.158 --> 00:22:16.408 much money, and that person also dies. 00:22:25.065 --> 00:22:27.273 PROFESSOR: You mean the person who, what do you mean the 00:22:27.273 --> 00:22:27.910 person doesn't have as much- 00:22:27.910 --> 00:22:29.165 AUDIENCE: --so obviously somebody 00:22:29.165 --> 00:22:32.257 doesn't get the kidney. 00:22:35.205 --> 00:22:37.460 PROFESSOR: So in other words, what you're assuming is, let's 00:22:37.460 --> 00:22:39.550 say that if I hadn't done the auction on eBay, I would have 00:22:39.550 --> 00:22:42.300 just given my kidney away to the transplant center. 00:22:42.300 --> 00:22:43.780 Then that's one less kidney that can go to 00:22:43.780 --> 00:22:44.940 the transplant center. 00:22:44.940 --> 00:22:47.180 And that means the rich guy gets the kidney, and someone 00:22:47.180 --> 00:22:48.610 else implicitly doesn't. 00:22:48.610 --> 00:22:49.890 That's a trade-off. 00:22:49.890 --> 00:22:51.570 You've just described a trade-off. 00:22:51.570 --> 00:22:55.180 The trade-off is that basically now we've allocated 00:22:55.180 --> 00:22:57.470 the kidney away from the poor person to the rich person. 00:22:57.470 --> 00:23:00.600 Now, but why do we care about that? 00:23:00.600 --> 00:23:03.550 I mean one person dies, another person 00:23:03.550 --> 00:23:04.550 lives, why do we care? 00:23:04.550 --> 00:23:04.945 Yeah? 00:23:04.945 --> 00:23:07.085 AUDIENCE: There would be some sort of case 00:23:07.085 --> 00:23:08.664 of severity in condition. 00:23:08.664 --> 00:23:11.395 Like there might be someone who's poor who would get the 00:23:11.395 --> 00:23:14.930 kidney if it went to a transplant association because 00:23:14.930 --> 00:23:18.790 they would die in a couple of days without it. 00:23:18.790 --> 00:23:21.470 Whereas the rich person might just be able to afford it, and 00:23:21.470 --> 00:23:22.826 it might make their life more convenient. 00:23:22.826 --> 00:23:24.940 But they might not be in any more peril. 00:23:27.760 --> 00:23:28.480 PROFESSOR: They might be a collector. 00:23:28.480 --> 00:23:29.980 So basically, that's right. 00:23:29.980 --> 00:23:35.770 So one reason we might care is because we think that kidneys 00:23:35.770 --> 00:23:38.170 should be allocated on the basis of who needs 00:23:38.170 --> 00:23:39.700 it the most. OK? 00:23:39.700 --> 00:23:42.490 So a great example of this, of course, was Mickey Mantle with 00:23:42.490 --> 00:23:43.570 a liver transplant. 00:23:43.570 --> 00:23:46.410 Mickey Mantle, famous ballplayer, raging alcoholic, 00:23:46.410 --> 00:23:48.950 who had liver failure because he was basically drinking 00:23:48.950 --> 00:23:52.570 himself to death, and jumped the queue and got a liver 00:23:52.570 --> 00:23:54.530 above a bunch, a lot of people and then he kept drinking and 00:23:54.530 --> 00:23:56.610 killed himself and wasted the liver he'd gotten. 00:23:56.610 --> 00:23:57.050 OK? 00:23:57.050 --> 00:24:00.270 So basically, you can think that doesn't make sense. 00:24:00.270 --> 00:24:01.850 We should give it to people who need it the most. For who 00:24:01.850 --> 00:24:04.660 it would do the most good in terms of 00:24:04.660 --> 00:24:05.800 increasing their life. 00:24:05.800 --> 00:24:07.050 OK. 00:24:09.410 --> 00:24:11.610 So we've got the substitution point. 00:24:11.610 --> 00:24:12.080 OK. 00:24:12.080 --> 00:24:14.420 Let's come back to the substitution point though. 00:24:14.420 --> 00:24:16.300 Tell me a situation in which that's wrong. 00:24:16.300 --> 00:24:18.270 Can someone tell me a situation in which, in fact, 00:24:18.270 --> 00:24:20.020 that not a valid point. 00:24:20.020 --> 00:24:20.360 Yeah. 00:24:20.360 --> 00:24:21.779 AUDIENCE: Well, if the guy is only going to sell it. 00:24:21.779 --> 00:24:22.725 He's not going to give it away. 00:24:22.725 --> 00:24:24.617 PROFESSOR: Exactly. 00:24:24.617 --> 00:24:26.509 You're assuming that the guy who did sell 00:24:26.509 --> 00:24:27.460 would give it away. 00:24:27.460 --> 00:24:31.720 But, in fact, if it's sell it or keep it 00:24:31.720 --> 00:24:33.670 then there's no trade-off. 00:24:33.670 --> 00:24:39.430 And similar here, if it's sell it or keep it then you might 00:24:39.430 --> 00:24:41.130 as well let the rich guy get it. 00:24:41.130 --> 00:24:43.440 Or is there another argument? 00:24:43.440 --> 00:24:44.720 Is there another reason why you might not 00:24:44.720 --> 00:24:46.883 want this to happen? 00:24:46.883 --> 00:24:47.374 Yeah. 00:24:47.374 --> 00:24:49.171 AUDIENCE: It would encourage people to use illegal ways of 00:24:49.171 --> 00:24:50.421 getting kidneys. 00:24:54.610 --> 00:24:58.390 PROFESSOR: So the other reason could be that we don't trust 00:24:58.390 --> 00:25:01.950 people to make good decisions when money's involved. 00:25:01.950 --> 00:25:04.610 That we think that, gee, if it's really true I can get a 00:25:04.610 --> 00:25:07.450 couple million bucks for a kidney, I might give mine up 00:25:07.450 --> 00:25:08.920 even if I haven't really thought through the 00:25:08.920 --> 00:25:10.730 ramifications of doing so. 00:25:10.730 --> 00:25:13.970 Even if there's a risk to the surgery, if there's a risk 00:25:13.970 --> 00:25:16.300 that my other kidney will then fail then I'll be screwed. 00:25:16.300 --> 00:25:16.800 OK? 00:25:16.800 --> 00:25:23.840 So basically, we might have a paternalistic attitude that 00:25:23.840 --> 00:25:27.320 will lead us to not want to allow people to engage in this 00:25:27.320 --> 00:25:28.440 kind of risky behavior. 00:25:28.440 --> 00:25:28.873 Yeah? 00:25:28.873 --> 00:25:30.870 AUDIENCE: There may also be some legal ramifications 00:25:30.870 --> 00:25:33.574 associated with that if someone sells their kidney and 00:25:33.574 --> 00:25:37.096 then their other kidney fails, they might then blame eBay. 00:25:37.096 --> 00:25:37.554 PROFESSOR: Want it back. 00:25:37.554 --> 00:25:39.850 Like that Repo movie. 00:25:39.850 --> 00:25:42.200 That's right. 00:25:42.200 --> 00:25:45.630 There could, but let's leave the lawyers out of this, OK? 00:25:45.630 --> 00:25:46.440 I don't like lawyers. 00:25:46.440 --> 00:25:48.260 I'm going to rag on lawyers this semester. 00:25:48.260 --> 00:25:50.530 We're going leave the lawyers out of this. 00:25:50.530 --> 00:25:52.010 But, in any case, you're right. 00:25:52.010 --> 00:25:52.550 That's, sort of, a 00:25:52.550 --> 00:25:54.180 ramification of the same thing. 00:25:54.180 --> 00:25:57.330 So we've talked about the fact that there's substitution. 00:25:57.330 --> 00:25:59.340 We've talked about the fact that it's not allocated to 00:25:59.340 --> 00:26:01.580 those who need it the most. We've talked about the fact 00:26:01.580 --> 00:26:04.370 that people might be making bad decisions in doing this. 00:26:04.370 --> 00:26:08.180 But there's another factor, as well, which is we may just as 00:26:08.180 --> 00:26:11.240 a society feel it's unfair that rich people can get 00:26:11.240 --> 00:26:13.560 things poor people can't. 00:26:13.560 --> 00:26:16.660 There may be a pure equity component here. 00:26:16.660 --> 00:26:17.180 OK? 00:26:17.180 --> 00:26:20.100 Which is simply that we as a society value equality, value 00:26:20.100 --> 00:26:21.500 income inequality. 00:26:21.500 --> 00:26:24.250 And we think people should not have an extra shot at getting 00:26:24.250 --> 00:26:26.970 a resource just because they're rich. 00:26:26.970 --> 00:26:31.380 Now that is a very deep and hard concept, and we'll spend 00:26:31.380 --> 00:26:33.970 a couple lectures talking about equity towards the end 00:26:33.970 --> 00:26:34.810 of the semester. 00:26:34.810 --> 00:26:36.720 By and large, we won't consider it. 00:26:36.720 --> 00:26:37.270 OK? 00:26:37.270 --> 00:26:42.300 But it turns out to be behind much of what we'll discuss, 00:26:42.300 --> 00:26:46.660 OK, in much of what we'll discuss this semester and much 00:26:46.660 --> 00:26:49.340 of what goes on in economics. 00:26:49.340 --> 00:26:50.070 OK? 00:26:50.070 --> 00:26:52.660 Just take a look at the debate that's going on right now in 00:26:52.660 --> 00:26:56.720 terms of President Obama trying to decide whether or 00:26:56.720 --> 00:27:02.610 not to extend tax cuts to wealthy individuals in the US. 00:27:02.610 --> 00:27:06.400 Some people argue that allowing those tax cuts would 00:27:06.400 --> 00:27:07.800 promote the economy. 00:27:07.800 --> 00:27:08.400 OK? 00:27:08.400 --> 00:27:10.730 But others argue it's unfair for rich 00:27:10.730 --> 00:27:12.630 people to get tax breaks. 00:27:12.630 --> 00:27:16.450 And that fairness argument matters a lot in terms of 00:27:16.450 --> 00:27:18.010 driving the kind of economic policy 00:27:18.010 --> 00:27:22.010 decisions we need to make. 00:27:22.010 --> 00:27:25.530 So this semester, we're going to focus a lot on efficiency 00:27:25.530 --> 00:27:28.950 and optimization and how to get resources 00:27:28.950 --> 00:27:30.150 to the right place. 00:27:30.150 --> 00:27:33.220 But you have to remember behind a lot of this is deep 00:27:33.220 --> 00:27:36.200 normative issues about what should be happening, how 00:27:36.200 --> 00:27:38.440 should an economy function, and, in particular, how should 00:27:38.440 --> 00:27:39.540 we think about these kind of equity 00:27:39.540 --> 00:27:43.920 issues that are so important. 00:27:43.920 --> 00:27:45.440 OK. 00:27:45.440 --> 00:27:48.920 The last thing I want to talk about is I want to talk about 00:27:48.920 --> 00:27:52.490 why micro is not just an abstract concept for things 00:27:52.490 --> 00:27:55.300 like you might say, oh this is all pretty funny and it's like 00:27:55.300 --> 00:27:57.860 selling kidneys on eBay and tax cuts for the rich 00:27:57.860 --> 00:27:59.070 and why do I care? 00:27:59.070 --> 00:27:59.640 OK? 00:27:59.640 --> 00:28:03.470 Well, you care because literally every decision you 00:28:03.470 --> 00:28:06.790 make is made through the kind of framework we're going to 00:28:06.790 --> 00:28:08.960 think about this semester. 00:28:08.960 --> 00:28:09.490 OK? 00:28:09.490 --> 00:28:13.060 Now, different decisions may follow our models more closely 00:28:13.060 --> 00:28:14.840 and less closely. 00:28:14.840 --> 00:28:17.740 But there is not an economic decision. 00:28:17.740 --> 00:28:18.910 OK? 00:28:18.910 --> 00:28:19.970 Sorry, let me back up. 00:28:19.970 --> 00:28:21.990 There's not a decision that people have made that 00:28:21.990 --> 00:28:24.090 economists haven't tried to model. 00:28:24.090 --> 00:28:26.850 From whether to produce iPods, to how many times to 00:28:26.850 --> 00:28:28.170 have sex each week. 00:28:28.170 --> 00:28:28.640 OK? 00:28:28.640 --> 00:28:31.630 These are all things economists have tried to model 00:28:31.630 --> 00:28:33.790 with varying degrees of success. 00:28:33.790 --> 00:28:34.980 OK? 00:28:34.980 --> 00:28:37.420 Because economists think that these all come from the same 00:28:37.420 --> 00:28:41.080 decision theoretic framework that we can discuss. 00:28:41.080 --> 00:28:44.430 Let's talk about a simple example from this course. 00:28:44.430 --> 00:28:47.880 Your decision of whether or not to buy the textbook. 00:28:47.880 --> 00:28:50.780 There's a textbook and what's it cost? $140? 00:28:50.780 --> 00:28:52.540 What's it cost? 00:28:52.540 --> 00:28:54.500 Does anyone know? 00:28:54.500 --> 00:28:56.950 AUDIENCE: This line says $180. 00:28:56.950 --> 00:28:59.400 And this one says $180, but it's available for $130. 00:28:59.400 --> 00:29:00.450 PROFESSOR: $130, fine. 00:29:00.450 --> 00:29:03.340 So $130 for Professor Perloff out at Berkeley. 00:29:03.340 --> 00:29:04.050 He doesn't get it all. 00:29:04.050 --> 00:29:04.630 I wrote a textbook too. 00:29:04.630 --> 00:29:06.000 He gets a small share of it. 00:29:06.000 --> 00:29:07.740 OK. 00:29:07.740 --> 00:29:12.250 So you have to decide, now has anyone bought a used version 00:29:12.250 --> 00:29:14.067 of the fourth, well it's the fifth edition now, does 00:29:14.067 --> 00:29:16.040 anybody use a version of the fourth edition? 00:29:16.040 --> 00:29:18.440 Does anyone know what the used price is? 00:29:18.440 --> 00:29:19.660 You can be honest. I don't care. 00:29:19.660 --> 00:29:22.970 AUDIENCE: I know some people found it for like $85 or so. 00:29:22.970 --> 00:29:24.440 PROFESSOR: So $85. 00:29:24.440 --> 00:29:26.200 So you've got to decide. 00:29:26.200 --> 00:29:30.380 So let's say you can buy the previous edition, the fourth 00:29:30.380 --> 00:29:34.390 edition, for $85 or the current edition for $130. 00:29:34.390 --> 00:29:35.090 OK? 00:29:35.090 --> 00:29:37.160 You've got to make that decision. 00:29:37.160 --> 00:29:37.650 OK? 00:29:37.650 --> 00:29:39.550 How do you make that decision. 00:29:39.550 --> 00:29:41.440 Well you may think, gee I just make the decision. 00:29:41.440 --> 00:29:42.860 It's not really about microeconomics. 00:29:42.860 --> 00:29:43.920 But it is. 00:29:43.920 --> 00:29:45.540 We're going to model how you think about a 00:29:45.540 --> 00:29:46.500 decision like that. 00:29:46.500 --> 00:29:48.670 Well how do you think about a decision like that? 00:29:48.670 --> 00:29:52.900 Well, the first thing you consider is your preferences. 00:29:52.900 --> 00:29:56.280 How much are you willing to take a chance that there's new 00:29:56.280 --> 00:29:59.454 stuff in the fifth edition that you need to know? 00:29:59.454 --> 00:30:00.740 OK? 00:30:00.740 --> 00:30:02.250 If the fifth issue was identical to the fourth 00:30:02.250 --> 00:30:04.340 edition then you'd be an idiot to not just buy the used 00:30:04.340 --> 00:30:04.970 fourth edition. 00:30:04.970 --> 00:30:06.030 But it's not. 00:30:06.030 --> 00:30:07.180 Textbook writers are smart. 00:30:07.180 --> 00:30:08.460 They update their book. 00:30:08.460 --> 00:30:09.210 OK? 00:30:09.210 --> 00:30:11.670 So basically, the fifth edition is updated. 00:30:11.670 --> 00:30:12.950 There's new things in it. 00:30:12.950 --> 00:30:16.880 So you have to ask yourself, what are the odds that I need 00:30:16.880 --> 00:30:18.670 some of the new information in the fifth edition and not in 00:30:18.670 --> 00:30:19.910 the fourth edition? 00:30:19.910 --> 00:30:21.400 And in thinking about that, you're going to think about 00:30:21.400 --> 00:30:22.070 your preferences. 00:30:22.070 --> 00:30:26.090 In particular, are you very risk averse, are you afraid to 00:30:26.090 --> 00:30:27.410 take a chance? 00:30:27.410 --> 00:30:28.590 Or are you risk loving? 00:30:28.590 --> 00:30:30.410 Are you willing to take a chance? 00:30:30.410 --> 00:30:31.050 OK? 00:30:31.050 --> 00:30:32.370 That's one side of the equation. 00:30:32.370 --> 00:30:34.810 If you're someone that says, you know I will not take a 00:30:34.810 --> 00:30:35.450 chance in life. 00:30:35.450 --> 00:30:37.420 I just have to make sure I learn the most possible from 00:30:37.420 --> 00:30:38.820 this course. 00:30:38.820 --> 00:30:40.040 Then you're going to want that new edition. 00:30:40.040 --> 00:30:42.410 If you're someone that says, you know what screw it, I'll 00:30:42.410 --> 00:30:43.610 just figure it out later. 00:30:43.610 --> 00:30:44.350 I'm going to the lectures. 00:30:44.350 --> 00:30:45.490 I don't care. 00:30:45.490 --> 00:30:46.100 OK? 00:30:46.100 --> 00:30:47.830 Then you might not want it that much. 00:30:47.830 --> 00:30:49.950 So that's the first factor, is going to be your preferences 00:30:49.950 --> 00:30:51.230 and break down how much you are willing to take a risk 00:30:51.230 --> 00:30:53.230 that you need this fifth edition. 00:30:53.230 --> 00:30:55.820 The second factor is going to be your constraint: how much 00:30:55.820 --> 00:30:57.590 money you have. OK. 00:30:57.590 --> 00:31:00.430 The more money you have, the more you're willing, or more 00:31:00.430 --> 00:31:03.210 relevant perhaps your parents have, the more willing you are 00:31:03.210 --> 00:31:04.980 to go ahead and buy that new edition. 00:31:04.980 --> 00:31:08.060 The less money you have, the less willing you are. 00:31:08.060 --> 00:31:08.950 OK? 00:31:08.950 --> 00:31:11.390 So basically, it's going to depend on whether you're 00:31:11.390 --> 00:31:13.070 paying or your parents are paying, in which case what the 00:31:13.070 --> 00:31:14.680 hell you might as well buy the fifth edition. 00:31:14.680 --> 00:31:15.640 OK? 00:31:15.640 --> 00:31:20.570 And then finally, you're going to take these preferences and 00:31:20.570 --> 00:31:23.370 this constraint, your preferences and your 00:31:23.370 --> 00:31:25.510 resources, and go to the market and look at what does 00:31:25.510 --> 00:31:27.485 the market tell me the difference is. 00:31:27.485 --> 00:31:30.230 So you're going to say, here's how much I kind of care about 00:31:30.230 --> 00:31:34.180 fifth versus fourth edition, here's the resources I have, 00:31:34.180 --> 00:31:39.570 now I'll go to the market and say, aha there is a $45 00:31:39.570 --> 00:31:42.530 difference between these two editions. 00:31:42.530 --> 00:31:44.550 So now I will solve that constrained 00:31:44.550 --> 00:31:46.470 optimization problem. 00:31:46.470 --> 00:31:52.430 And I'll decide whether I want to get that book. 00:31:52.430 --> 00:31:53.730 You are going to be thinking to yourself, this is stupid. 00:31:53.730 --> 00:31:55.530 I never think about it that way. 00:31:55.530 --> 00:31:57.440 But the key point is you don't have to think about it 00:31:57.440 --> 00:31:58.740 exactly that way. 00:31:58.740 --> 00:32:01.400 There's a famous example in economics of what's called the 00:32:01.400 --> 00:32:02.440 as if principle. 00:32:02.440 --> 00:32:04.380 I don't know if kids still say this one, as if. 00:32:04.380 --> 00:32:06.130 So it's the as if principle. 00:32:06.130 --> 00:32:06.720 OK? 00:32:06.720 --> 00:32:08.545 And basically it's from Milton Friedman, the famous economist 00:32:08.545 --> 00:32:13.150 from Chicago, who said, look, when you're playing pool, 00:32:13.150 --> 00:32:17.110 technically you could compute the optimal angles of which to 00:32:17.110 --> 00:32:19.310 shoot the ball every single time to get the appropriate 00:32:19.310 --> 00:32:20.210 bounce and get the balls in. 00:32:20.210 --> 00:32:22.610 You could do the mathematics and compute it. 00:32:22.610 --> 00:32:25.870 But professional pool players are not in this class with 00:32:25.870 --> 00:32:26.710 you, I'll only say that. 00:32:26.710 --> 00:32:27.260 OK? 00:32:27.260 --> 00:32:29.710 They're not guys who are able to do that computation. 00:32:29.710 --> 00:32:33.830 They just know how to hit the ball to get the same outcome 00:32:33.830 --> 00:32:35.980 they would get if they mathematically solved for the 00:32:35.980 --> 00:32:37.900 optimal trajectory to hit the ball. 00:32:37.900 --> 00:32:39.190 OK? 00:32:39.190 --> 00:32:42.160 They behave as if they've solved the constrained 00:32:42.160 --> 00:32:44.330 optimization problem. 00:32:44.330 --> 00:32:46.650 And your decision when you buy this book, you may not think 00:32:46.650 --> 00:32:49.432 it through the very framework that I just laid out very 00:32:49.432 --> 00:32:52.380 heuristically and will lay out more rigorously this semester. 00:32:52.380 --> 00:32:53.940 But you're going to behave as if you do. 00:32:53.940 --> 00:32:55.460 Because those facts are going to be in your mind, and you'll 00:32:55.460 --> 00:32:58.700 be thinking about it when you make that decision. 00:32:58.700 --> 00:33:01.050 So while you may feel the models we learn in this course 00:33:01.050 --> 00:33:04.430 are rather abstract and don't really explain how you behave 00:33:04.430 --> 00:33:07.200 in an everyday basis, you're going to behave as if those 00:33:07.200 --> 00:33:11.290 models are really applying to you. 00:33:11.290 --> 00:33:13.340 And if you think about, over the next few days, think about 00:33:13.340 --> 00:33:14.530 the decisions you make. 00:33:14.530 --> 00:33:15.820 From should I bring an umbrella today, 00:33:15.820 --> 00:33:17.000 it looks like rain? 00:33:17.000 --> 00:33:18.080 Well, on the one hand, I might lose it. 00:33:18.080 --> 00:33:18.860 It's a pain to carry. 00:33:18.860 --> 00:33:20.770 On the other hand, how much do I care about getting wet? 00:33:20.770 --> 00:33:23.300 That's a constrained optimization decision. 00:33:23.300 --> 00:33:27.010 To should I have an extra drink at a party Friday night? 00:33:27.010 --> 00:33:30.290 On the one hand, that could have some pros and cons. 00:33:30.290 --> 00:33:30.850 OK? 00:33:30.850 --> 00:33:34.050 These are all decisions, constrained optimization 00:33:34.050 --> 00:33:35.680 decisions, you're going to make. 00:33:35.680 --> 00:33:36.440 They're going to affect your life. 00:33:36.440 --> 00:33:38.180 And what we'll learn this semester is about how you make 00:33:38.180 --> 00:33:40.390 them and how we model, how economists can use what we 00:33:40.390 --> 00:33:43.520 learn about that to understand the function of the economy. 00:33:43.520 --> 00:33:44.220 OK? 00:33:44.220 --> 00:33:46.280 So I'm going to stop there. 00:33:46.280 --> 00:33:50.130 One other announcement, there will, in general, be handouts 00:33:50.130 --> 00:33:50.660 every lecture. 00:33:50.660 --> 00:33:51.210 I'm not going to do PowerPoint. 00:33:51.210 --> 00:33:51.900 I'm going to do handouts. 00:33:51.900 --> 00:33:54.000 So when you come in every lecture, please look at the 00:33:54.000 --> 00:33:54.880 back banister. 00:33:54.880 --> 00:33:56.200 Though typically, not today. 00:33:56.200 --> 00:33:59.160 But typically, they'll be handouts that you'll need to 00:33:59.160 --> 00:34:00.900 follow along with in class. 00:34:00.900 --> 00:34:05.130 So remember, go to section on Friday, first problems that 00:34:05.130 --> 00:34:08.480 will be posted on Friday and it will be due in section the 00:34:08.480 --> 00:34:09.480 Friday after. 00:34:09.480 --> 00:34:12.220 And I'll see you all back here on Monday, next Monday.