1 00:00:00,000 --> 00:00:02,420 [SQUEAKING] 2 00:00:02,420 --> 00:00:04,356 [RUSTLING] 3 00:00:04,356 --> 00:00:11,630 [CLICKING] 4 00:00:11,630 --> 00:00:13,680 JONATHAN GRUBER: This is 14.01. 5 00:00:13,680 --> 00:00:19,250 I'm John Gruber, and this is microeconomics. 6 00:00:19,250 --> 00:00:21,500 Today, I want to cover three things. 7 00:00:21,500 --> 00:00:23,840 I want to talk about the course details. 8 00:00:23,840 --> 00:00:25,910 I want to talk about what is microeconomics. 9 00:00:25,910 --> 00:00:29,120 And then I'll start the substance of the course 10 00:00:29,120 --> 00:00:31,447 by talking about supply and demand. 11 00:00:31,447 --> 00:00:33,530 Couple of the points about the course-- the course 12 00:00:33,530 --> 00:00:36,710 will have a distinct sort of policy angle to it. 13 00:00:36,710 --> 00:00:40,680 I sort of do economic policy, government policy is my thing. 14 00:00:40,680 --> 00:00:42,890 So I think it's what makes economics exciting 15 00:00:42,890 --> 00:00:45,080 and it sort of offers, I think, an interesting angle 16 00:00:45,080 --> 00:00:47,480 to understand why we're learning what we're learning. 17 00:00:47,480 --> 00:00:48,980 I think sometimes in an intro class, 18 00:00:48,980 --> 00:00:50,813 it's sort of hard to understand why the heck 19 00:00:50,813 --> 00:00:52,700 you're doing things. 20 00:00:52,700 --> 00:00:54,690 However, that's just sort of a slight flavor. 21 00:00:54,690 --> 00:00:55,730 If you're really more interested in this, 22 00:00:55,730 --> 00:00:57,463 I teach a whole course called 1441. 23 00:00:57,463 --> 00:00:59,005 I'm not teaching it this year, but it 24 00:00:59,005 --> 00:01:02,000 will be taught by a visitor in the spring, Kristin Butcher 25 00:01:02,000 --> 00:01:02,860 from Wellesley. 26 00:01:02,860 --> 00:01:04,190 And I'll be teaching next year. 27 00:01:04,190 --> 00:01:06,527 That dives much more into these policy issues. 28 00:01:06,527 --> 00:01:09,110 So I'm going to use government policy as sort of an organizing 29 00:01:09,110 --> 00:01:12,500 theme, but it won't be the dominant theme of the class. 30 00:01:12,500 --> 00:01:15,297 Finally, three points about my teaching style. 31 00:01:15,297 --> 00:01:16,880 I don't write everything on the board. 32 00:01:16,880 --> 00:01:18,255 We're not in high school anymore. 33 00:01:18,255 --> 00:01:21,140 You're actually responsible for what I say, not what I write. 34 00:01:21,140 --> 00:01:24,170 Partly that's because my handwriting is brutal, 35 00:01:24,170 --> 00:01:26,840 as you can tell already. 36 00:01:26,840 --> 00:01:29,240 So what that means is, please, please do not 37 00:01:29,240 --> 00:01:32,090 be afraid to ask me what the hell I just wrote on the board. 38 00:01:32,090 --> 00:01:33,380 There's no shame in that. 39 00:01:33,380 --> 00:01:34,830 Don't just lean to your neighbors, and say, 40 00:01:34,830 --> 00:01:35,840 what the hell did he just write in the board. 41 00:01:35,840 --> 00:01:37,423 Ask, me, because if you can't read it, 42 00:01:37,423 --> 00:01:40,380 I'm sure someone else can't read it, so feel free to ask. 43 00:01:40,380 --> 00:01:42,740 And in general, please feel free to engage 44 00:01:42,740 --> 00:01:44,360 with questions in this class. 45 00:01:44,360 --> 00:01:47,570 The other point of my teaching style is I talk way too fast. 46 00:01:47,570 --> 00:01:49,820 And the longer I go-- there's a mathematical function, 47 00:01:49,820 --> 00:01:51,737 which is the longer I go without interruption, 48 00:01:51,737 --> 00:01:54,710 the faster I speak, until I just spin off. 49 00:01:54,710 --> 00:01:57,740 So basically, please ask questions. 50 00:01:57,740 --> 00:01:59,300 If anything is not clear, or you just 51 00:01:59,300 --> 00:02:02,030 want to ask questions about some related tangent 52 00:02:02,030 --> 00:02:04,125 or whatever, please feel free to do so. 53 00:02:04,125 --> 00:02:06,500 You might think, how would that work in a class this big? 54 00:02:06,500 --> 00:02:08,252 There's always way too few questions, even 55 00:02:08,252 --> 00:02:08,960 a class this big. 56 00:02:08,960 --> 00:02:11,672 So never be afraid that it will slow me down or whatever. 57 00:02:11,672 --> 00:02:12,380 Ask me questions. 58 00:02:12,380 --> 00:02:14,687 We have plenty of time on the class. 59 00:02:14,687 --> 00:02:16,520 And you'll be doing your classmates a favor, 60 00:02:16,520 --> 00:02:18,650 because it'll slow me down. 61 00:02:18,650 --> 00:02:21,380 Finally, last point, I have this terrible tendency 62 00:02:21,380 --> 00:02:24,260 to use the term "guys" in a gender neutral way. 63 00:02:24,260 --> 00:02:26,270 So this class, I like to see, looks 64 00:02:26,270 --> 00:02:28,720 like it's a fairly healthy representation 65 00:02:28,720 --> 00:02:29,750 both males and females. 66 00:02:29,750 --> 00:02:31,250 When I say "guys," I don't mean men. 67 00:02:31,250 --> 00:02:32,090 I mean people. 68 00:02:32,090 --> 00:02:33,090 I mean people. 69 00:02:33,090 --> 00:02:35,180 So women, don't take it personally. 70 00:02:35,180 --> 00:02:36,373 "Guys" means economic agent. 71 00:02:36,373 --> 00:02:37,040 It means people. 72 00:02:37,040 --> 00:02:37,902 It doesn't mean men. 73 00:02:37,902 --> 00:02:39,360 Just the way-- just a bad tendency. 74 00:02:39,360 --> 00:02:41,720 It drives my wife crazy, but I've decided better 75 00:02:41,720 --> 00:02:45,200 to just apologize up front than try to fix it throughout, 76 00:02:45,200 --> 00:02:47,870 which is impossible. 77 00:02:47,870 --> 00:02:51,620 So let's talk about what is microeconomics. 78 00:02:51,620 --> 00:02:55,190 So fundamentally, microeconomics-- how people 79 00:02:55,190 --> 00:02:56,960 took AP high school Econ? 80 00:03:00,690 --> 00:03:04,017 How many people-- for how many people 81 00:03:04,017 --> 00:03:05,100 was it taught really well? 82 00:03:07,860 --> 00:03:08,805 That's about right. 83 00:03:08,805 --> 00:03:10,680 That's why I did my high school online class. 84 00:03:10,680 --> 00:03:13,970 That's the answer I wanted to hear. 85 00:03:13,970 --> 00:03:15,880 So tell your friends still in high school who 86 00:03:15,880 --> 00:03:17,880 are taking high school Econ, if your high school 87 00:03:17,880 --> 00:03:19,800 teacher isn't great, tell them to go on EdX 88 00:03:19,800 --> 00:03:21,540 and take the class. 89 00:03:21,540 --> 00:03:24,750 And help out your friends still in high school. 90 00:03:24,750 --> 00:03:27,320 So what is microeconomics? 91 00:03:27,320 --> 00:03:29,370 Microeconomics is the study of how 92 00:03:29,370 --> 00:03:32,160 individuals and firms make decisions 93 00:03:32,160 --> 00:03:33,120 in a world of scarcity. 94 00:03:36,710 --> 00:03:41,270 Scarcity is what drives microeconomics. 95 00:03:41,270 --> 00:03:43,250 Basically, what microeconomics is 96 00:03:43,250 --> 00:03:52,770 is a series of constrained optimization exercises, 97 00:03:52,770 --> 00:03:57,030 where economic agents, be they firms or individuals, 98 00:03:57,030 --> 00:04:00,240 try to make themselves as well off as possible 99 00:04:00,240 --> 00:04:02,140 given their constraints. 100 00:04:02,140 --> 00:04:02,640 Yeah. 101 00:04:02,640 --> 00:04:04,740 AUDIENCE: Will this cover irrationality? 102 00:04:04,740 --> 00:04:08,232 JONATHAN GRUBER: I will, but not as much as I should. 103 00:04:08,232 --> 00:04:09,690 Essentially, we have another course 104 00:04:09,690 --> 00:04:12,690 in the department called 1413, Behavioral Economics, which 105 00:04:12,690 --> 00:04:13,950 gets into that much more. 106 00:04:13,950 --> 00:04:16,560 I will sprinkle it throughout, but not 107 00:04:16,560 --> 00:04:18,430 as much as I actually believe in it. 108 00:04:18,430 --> 00:04:20,430 In other words, the way we think about economics 109 00:04:20,430 --> 00:04:22,282 is it's best to sort of get the basics down 110 00:04:22,282 --> 00:04:24,240 before you start worrying about the deviations. 111 00:04:24,240 --> 00:04:25,657 Find it's better to climb the tree 112 00:04:25,657 --> 00:04:28,680 before you start going out in the branches. 113 00:04:28,680 --> 00:04:32,130 So basically, what this course is then about 114 00:04:32,130 --> 00:04:35,420 is it's about trade-offs. 115 00:04:35,420 --> 00:04:37,760 It's about given that you're constrained, 116 00:04:37,760 --> 00:04:41,450 how do you trade off things to make yourself as well off 117 00:04:41,450 --> 00:04:43,250 as possible? 118 00:04:43,250 --> 00:04:47,025 And behind this notion of trade-offs is going to be-- 119 00:04:47,025 --> 00:04:49,400 I'll say about 100 times this is the most important thing 120 00:04:49,400 --> 00:04:51,030 in the course, so just ignore that. 121 00:04:51,030 --> 00:04:52,160 But this is one of the most important things. 122 00:04:52,160 --> 00:04:53,120 I'll say "one of the most important" things 123 00:04:53,120 --> 00:04:55,535 in the course, is the notion of opportunity cost. 124 00:04:58,080 --> 00:05:01,320 Opportunity cost is a very important concept 125 00:05:01,320 --> 00:05:05,530 that we teach, sort of the first concept we teach, 126 00:05:05,530 --> 00:05:10,230 which is that every action or every inaction 127 00:05:10,230 --> 00:05:12,660 has a cost in that you could've been doing something 128 00:05:12,660 --> 00:05:14,670 else instead. 129 00:05:14,670 --> 00:05:19,680 So if you buy a shirt, you could have bought pants. 130 00:05:19,680 --> 00:05:21,870 If you stayed at home and watched TV, 131 00:05:21,870 --> 00:05:24,180 you could have been out working. 132 00:05:24,180 --> 00:05:26,670 Everything you do has a next best alternative 133 00:05:26,670 --> 00:05:28,470 you could have done instead. 134 00:05:28,470 --> 00:05:31,630 And that is called the "opportunity cost." 135 00:05:31,630 --> 00:05:35,230 And that's a critical concept in economics, 136 00:05:35,230 --> 00:05:36,790 and that is why, in some sense, we 137 00:05:36,790 --> 00:05:40,292 are referred to casually as the "dismal science." 138 00:05:40,292 --> 00:05:42,250 Economics is referred to as the dismal science. 139 00:05:42,250 --> 00:05:44,920 First of all, I'm flattered we're considered a science. 140 00:05:44,920 --> 00:05:46,480 But it's called the "dismal science" 141 00:05:46,480 --> 00:05:49,573 because our whole point is that nothing is free. 142 00:05:49,573 --> 00:05:50,740 There is always a trade-off. 143 00:05:50,740 --> 00:05:52,198 There's always an opportunity cost. 144 00:05:52,198 --> 00:05:56,290 Anything you do, you could be doing something else instead. 145 00:05:56,290 --> 00:05:57,670 And your constrained optimization 146 00:05:57,670 --> 00:05:59,890 means you're going to have to pass up one thing 147 00:05:59,890 --> 00:06:01,330 to do another. 148 00:06:01,330 --> 00:06:03,820 Now, some may call it "dismal," but as a former MIT 149 00:06:03,820 --> 00:06:05,680 undergraduate, I call it "fun." 150 00:06:05,680 --> 00:06:07,810 And this is why I think MIT is the perfect place 151 00:06:07,810 --> 00:06:11,452 to be teaching economics, because MIT engineering is 152 00:06:11,452 --> 00:06:12,910 all about constrained optimization. 153 00:06:12,910 --> 00:06:14,355 That's what engineering is. 154 00:06:14,355 --> 00:06:15,730 And economics is just the engine. 155 00:06:15,730 --> 00:06:20,860 It's just the principles you learn in engineering 156 00:06:20,860 --> 00:06:22,890 applied in different contexts. 157 00:06:22,890 --> 00:06:25,540 So if we think about the 2.007 contests-- that still 158 00:06:25,540 --> 00:06:28,210 exist with the robots, 2.007? 159 00:06:28,210 --> 00:06:30,432 Yeah, the 2.007 contests, those, as you know, 160 00:06:30,432 --> 00:06:32,890 are contests where you're given a limited set of materials. 161 00:06:32,890 --> 00:06:34,990 And you have to build a robot that does some task, 162 00:06:34,990 --> 00:06:38,020 like pushing ping-pong balls off a table or something like that. 163 00:06:38,020 --> 00:06:39,800 That's just constraint optimization. 164 00:06:39,800 --> 00:06:42,050 It's got nothing to do with economics, 165 00:06:42,050 --> 00:06:43,930 but it's constrained optimization. 166 00:06:43,930 --> 00:06:50,560 So just think of microeconomics as like engineering, 167 00:06:50,560 --> 00:06:52,800 but actually interesting. 168 00:06:52,800 --> 00:06:54,550 So think of microeconomics as engineering, 169 00:06:54,550 --> 00:06:56,000 but instead of building something 170 00:06:56,000 --> 00:06:58,750 to push a ping-pong ball off tables, you actually 171 00:06:58,750 --> 00:07:01,030 build people's lives, and businesses, 172 00:07:01,030 --> 00:07:04,233 and understand the decisions that drive our economy. 173 00:07:04,233 --> 00:07:05,650 So same principles you could think 174 00:07:05,650 --> 00:07:08,410 of for your engineering classes, but applied to people's lives. 175 00:07:08,410 --> 00:07:10,827 And that's why, in fact, modern economics was born in this 176 00:07:10,827 --> 00:07:15,970 room, this room or 26.100 by Paul Samuelson in the 1940s 177 00:07:15,970 --> 00:07:19,630 and '50s, who wrote the fundamental textbook that gave 178 00:07:19,630 --> 00:07:21,250 birth to modern economics. 179 00:07:21,250 --> 00:07:23,680 Because he was here and applied the kind of engineering 180 00:07:23,680 --> 00:07:26,080 principles of MIT to actually develop 181 00:07:26,080 --> 00:07:27,580 the field of modern economics. 182 00:07:27,580 --> 00:07:29,470 What we'll learn today was developed at MIT, 183 00:07:29,470 --> 00:07:31,820 so it's a great place to be learning it. 184 00:07:31,820 --> 00:07:36,040 Now, with that as background-- any questions about that, 185 00:07:36,040 --> 00:07:39,560 about what is microeconomics? 186 00:07:39,560 --> 00:07:41,780 With that as background, let's turn 187 00:07:41,780 --> 00:07:45,920 to our first model we'll talk about this semester, which 188 00:07:45,920 --> 00:07:47,330 is the supply and demand model. 189 00:07:54,630 --> 00:07:57,750 Supply and demand-- now, the way we're 190 00:07:57,750 --> 00:08:02,800 going to proceed in this course is going to drive you crazy, 191 00:08:02,800 --> 00:08:05,500 because we're going to proceed by teaching, 192 00:08:05,500 --> 00:08:07,210 as the very first question pointed out, 193 00:08:07,210 --> 00:08:10,930 by teaching very simplified models. 194 00:08:10,930 --> 00:08:13,210 We're going to essentially-- what is a model? 195 00:08:13,210 --> 00:08:14,800 A model is technically a description 196 00:08:14,800 --> 00:08:17,830 between any two or more economic variables or any two or more 197 00:08:17,830 --> 00:08:19,960 variables. 198 00:08:19,960 --> 00:08:23,530 But unlike the models used in all your other classes, 199 00:08:23,530 --> 00:08:26,115 these aren't laws, by and large, they're models. 200 00:08:26,115 --> 00:08:28,240 So we don't have a relation between energy and mass 201 00:08:28,240 --> 00:08:29,282 which you can write down. 202 00:08:29,282 --> 00:08:30,790 It's a law and you're done. 203 00:08:30,790 --> 00:08:35,260 We have models which are never 100% true, but always 204 00:08:35,260 --> 00:08:37,299 pretty true, "pretty" being somewhere 205 00:08:37,299 --> 00:08:40,900 between 10% and 95% true. 206 00:08:40,900 --> 00:08:44,650 So basically, the idea is to make a trade-off. 207 00:08:44,650 --> 00:08:46,750 We want to write down in our models 208 00:08:46,750 --> 00:08:49,480 a set of simplifying assumptions that 209 00:08:49,480 --> 00:08:53,050 allow us, with a relatively small set of steps, 210 00:08:53,050 --> 00:08:56,790 to capture relatively broad phenomena. 211 00:08:56,790 --> 00:08:58,800 So it's essentially a trade-off. 212 00:08:58,800 --> 00:09:00,690 On the one hand, we'd like a model 213 00:09:00,690 --> 00:09:03,480 that captures as well as possible the phenomena 214 00:09:03,480 --> 00:09:07,470 in the real world, like E equals Mc squared. 215 00:09:07,470 --> 00:09:12,230 But we want to do so in the most tractable possible way 216 00:09:12,230 --> 00:09:14,150 so that we can teach it from first principles, 217 00:09:14,150 --> 00:09:20,930 and don't need an arrow to teach every single insight we have. 218 00:09:20,930 --> 00:09:23,600 So basically in economics, we tend 219 00:09:23,600 --> 00:09:28,007 to resolve that by erring on the side of tractability. 220 00:09:28,007 --> 00:09:29,840 That is why I can teach you the entire field 221 00:09:29,840 --> 00:09:31,862 of microeconomics-- which is really sort of-- 222 00:09:31,862 --> 00:09:33,320 macro is kind of a fun application. 223 00:09:33,320 --> 00:09:34,507 Micro is really economics. 224 00:09:34,507 --> 00:09:36,590 I can teach you the entire field of microeconomics 225 00:09:36,590 --> 00:09:38,150 in the semester, because I'm going 226 00:09:38,150 --> 00:09:40,730 to make a whole huge set of simplifying assumptions 227 00:09:40,730 --> 00:09:43,160 to make things tractable. 228 00:09:43,160 --> 00:09:45,710 But the key thing is that you will 229 00:09:45,710 --> 00:09:48,650 be amazed at what these models will be able to do. 230 00:09:48,650 --> 00:09:51,065 With a fairly simple set of models, 231 00:09:51,065 --> 00:09:52,940 we will be able to offer insights and explain 232 00:09:52,940 --> 00:09:55,340 a whole huge variety of phenomena, 233 00:09:55,340 --> 00:09:57,980 never perfectly, but always pretty well, 234 00:09:57,980 --> 00:10:00,260 generally pretty well. 235 00:10:00,260 --> 00:10:01,940 And so that is essentially the trade-off 236 00:10:01,940 --> 00:10:04,950 we're going to try to do this semester. 237 00:10:04,950 --> 00:10:06,860 So the line I like is the statistician 238 00:10:06,860 --> 00:10:11,810 George Box said that all models are wrong, but some are useful. 239 00:10:11,810 --> 00:10:15,230 Now obviously, it doesn't apply to models in the hard sciences, 240 00:10:15,230 --> 00:10:17,830 but in the social sciences, that's true. 241 00:10:17,830 --> 00:10:19,420 And basically, I'm going to write down 242 00:10:19,420 --> 00:10:21,160 a set of models like that. 243 00:10:21,160 --> 00:10:24,070 Now, with every model I write down, I'm going to try-- 244 00:10:24,070 --> 00:10:27,630 my goal is to have you understand it at three levels. 245 00:10:27,630 --> 00:10:29,420 The first and most important level 246 00:10:29,420 --> 00:10:32,750 is the intuitive level, the level 247 00:10:32,750 --> 00:10:34,340 which you sort of understand. 248 00:10:34,340 --> 00:10:36,213 I call it "passing the Mom Test." 249 00:10:36,213 --> 00:10:38,630 You can go home and explain it to your mom at Thanksgiving 250 00:10:38,630 --> 00:10:40,910 or at the end of semester. 251 00:10:40,910 --> 00:10:44,032 No offense to dads, just called it "the Mom Test." 252 00:10:44,032 --> 00:10:45,740 So basically, that's the intuitive level. 253 00:10:45,740 --> 00:10:48,590 You really understand it in a way that you could explain it. 254 00:10:48,590 --> 00:10:50,703 The second is graphical. 255 00:10:50,703 --> 00:10:52,370 We were going to do-- most of our models 256 00:10:52,370 --> 00:10:55,490 here were developed in a graphical framework using 257 00:10:55,490 --> 00:11:00,250 x/y graphs that really in economics, we think delivers 258 00:11:00,250 --> 00:11:02,020 a lot of shorthand power. 259 00:11:02,020 --> 00:11:04,478 And the third is mathematical. 260 00:11:04,478 --> 00:11:06,520 The mathematical is probably the least important, 261 00:11:06,520 --> 00:11:08,510 but it's the easiest to test you on. 262 00:11:08,510 --> 00:11:14,200 So we're going to need to know things mathematically as well. 263 00:11:14,200 --> 00:11:18,430 So let's start by considering the supply and demand 264 00:11:18,430 --> 00:11:22,000 model by using the famous example 265 00:11:22,000 --> 00:11:23,920 brought up by Adam Smith. 266 00:11:23,920 --> 00:11:26,463 Adam Smith is sort of considered the father of economics. 267 00:11:26,463 --> 00:11:28,630 If Paul Samuelson is the father of modern economics, 268 00:11:28,630 --> 00:11:30,550 Adam Smith is the father of all economics. 269 00:11:30,550 --> 00:11:33,700 His 1776 book, The Wealth of Nations 270 00:11:33,700 --> 00:11:36,100 did an incredible job of actually laying out 271 00:11:36,100 --> 00:11:39,070 the entire core of the economics field-- 272 00:11:39,070 --> 00:11:41,750 no math, just words, but he just nailed it. 273 00:11:41,750 --> 00:11:45,400 And one of his most famous examples 274 00:11:45,400 --> 00:11:48,340 was the water diamond paradox. 275 00:11:48,340 --> 00:11:50,110 He said, think about water and diamonds. 276 00:11:50,110 --> 00:11:51,193 He said, start with water. 277 00:11:51,193 --> 00:11:53,110 Nothing is more important for life than water. 278 00:11:53,110 --> 00:11:54,860 It's the building block of all of life. 279 00:11:54,860 --> 00:11:56,910 Even when we look for life on other planets, 280 00:11:56,910 --> 00:11:59,080 we always start by looking for water. 281 00:11:59,080 --> 00:12:01,450 Now think of diamonds, one of the more frivolous things 282 00:12:01,450 --> 00:12:04,990 you can buy, certainly irrelevant to leading 283 00:12:04,990 --> 00:12:09,010 a successful or happy or productive life, or any life. 284 00:12:09,010 --> 00:12:12,550 Yet for most of us, water's free and diamonds 285 00:12:12,550 --> 00:12:14,800 are super expensive. 286 00:12:14,800 --> 00:12:17,140 How can this be, Adam Smith asked. 287 00:12:17,140 --> 00:12:20,560 Well, the answer he posed is that what I first described 288 00:12:20,560 --> 00:12:21,940 was just demand. 289 00:12:21,940 --> 00:12:23,800 That is, we demand lots of water. 290 00:12:23,800 --> 00:12:25,590 We demand fewer diamonds. 291 00:12:25,590 --> 00:12:29,860 But we have to match that with the concept of supply. 292 00:12:29,860 --> 00:12:32,870 And the supply of water is almost infinite, 293 00:12:32,870 --> 00:12:35,110 while the supply of diamonds-- maybe not naturally, 294 00:12:35,110 --> 00:12:38,480 maybe it's through decisions of various businesses-- 295 00:12:38,480 --> 00:12:41,410 but it's somewhat limited. 296 00:12:41,410 --> 00:12:45,700 So basically what he developed is 297 00:12:45,700 --> 00:12:48,000 what we call the "supply and demand scissors"-- 298 00:12:48,000 --> 00:12:51,730 that you can't just think of supply or demand in isolation. 299 00:12:51,730 --> 00:12:53,680 You have to put them together if you 300 00:12:53,680 --> 00:12:56,920 want to explain the real world phenomena we see, like the fact 301 00:12:56,920 --> 00:13:01,150 that water is cheap and diamonds are expensive. 302 00:13:01,150 --> 00:13:02,663 So let's just about an example. 303 00:13:02,663 --> 00:13:04,330 So there's one graph that was handed out 304 00:13:04,330 --> 00:13:07,570 in the back, which is, let's talk 305 00:13:07,570 --> 00:13:08,695 about the market for roses. 306 00:13:13,270 --> 00:13:18,580 So in the market for roses, we have a demand curve 307 00:13:18,580 --> 00:13:19,503 and a supply curve. 308 00:13:19,503 --> 00:13:21,670 So what we have here-- this is the kind of x/y graph 309 00:13:21,670 --> 00:13:24,310 we're going to look at all throughout the semester. 310 00:13:24,310 --> 00:13:28,880 On the x-axis is the quantity of roses. 311 00:13:28,880 --> 00:13:32,610 On the y-axis is the price of roses. 312 00:13:32,610 --> 00:13:36,580 The blue, downward-sloping line is the demand curve. 313 00:13:36,580 --> 00:13:39,550 Now, what I'm going to do here, I'm just giving you a overview. 314 00:13:39,550 --> 00:13:42,720 We are going, over the next five or six lectures, dive 315 00:13:42,720 --> 00:13:45,180 into where this demand curve comes from. 316 00:13:45,180 --> 00:13:47,388 We'll go to first principles and build it back up. 317 00:13:47,388 --> 00:13:48,930 But for now, what we know of a demand 318 00:13:48,930 --> 00:13:53,040 curve is it simply represents the relationship 319 00:13:53,040 --> 00:13:57,620 between the price of a good and how much people want it. 320 00:13:57,620 --> 00:14:00,440 Therefore, we assume it is downward sloping. 321 00:14:00,440 --> 00:14:03,500 At higher prices, people want less of the good. 322 00:14:03,500 --> 00:14:05,660 And we'll derive where that comes from shortly, 323 00:14:05,660 --> 00:14:07,110 starting next lecture. 324 00:14:07,110 --> 00:14:09,550 But for now, I think it's pretty intuitive 325 00:14:09,550 --> 00:14:11,450 that if the price of roses is higher, 326 00:14:11,450 --> 00:14:12,710 people want fewer of them. 327 00:14:12,710 --> 00:14:15,650 And that's why it's downward sloping. 328 00:14:15,650 --> 00:14:17,960 Basically, as the price of roses goes up, 329 00:14:17,960 --> 00:14:20,750 people want fewer roses. 330 00:14:20,750 --> 00:14:24,030 The yellow curve is the supply curve. 331 00:14:24,030 --> 00:14:25,780 Now, after we've derived the demand curve, 332 00:14:25,780 --> 00:14:27,877 we'll then go and spend about 12 lectures 333 00:14:27,877 --> 00:14:28,960 deriving the supply curve. 334 00:14:28,960 --> 00:14:29,793 That's a bit harder. 335 00:14:29,793 --> 00:14:31,835 But once again, we'll start from first principles 336 00:14:31,835 --> 00:14:32,860 and build it up. 337 00:14:32,860 --> 00:14:35,050 For now, you just need to know that's how much firms 338 00:14:35,050 --> 00:14:37,510 are willing to supply, given the price. 339 00:14:37,510 --> 00:14:40,180 So basically, as the price goes up, 340 00:14:40,180 --> 00:14:43,210 firms want to produce more roses. 341 00:14:43,210 --> 00:14:45,290 The higher price means you make more money, 342 00:14:45,290 --> 00:14:47,560 so you want to produce more of them. 343 00:14:47,560 --> 00:14:49,960 This is slightly less intuitive than demand, 344 00:14:49,960 --> 00:14:52,195 but we'll derive it and explain how it can be. 345 00:14:52,195 --> 00:14:54,070 But for now, just go with the basic intuition 346 00:14:54,070 --> 00:14:55,985 that if you're making something, and you can sell it 347 00:14:55,985 --> 00:14:57,360 in the market for a higher price, 348 00:14:57,360 --> 00:14:59,390 you're going to want to make more of it. 349 00:14:59,390 --> 00:15:02,780 And that leads to the upward sloping supply curve. 350 00:15:02,780 --> 00:15:07,180 Where the points meet is the market equilibrium. 351 00:15:07,180 --> 00:15:10,870 Where supply and demand meets is the market equilibrium. 352 00:15:10,870 --> 00:15:15,910 And that is the point where both consumers and producers are 353 00:15:15,910 --> 00:15:19,430 happy to make a transaction. 354 00:15:19,430 --> 00:15:23,180 Consumers are happy because on their demand curve 355 00:15:23,180 --> 00:15:27,770 is the $3 and 600 roses. 356 00:15:27,770 --> 00:15:32,667 That is, they are willing to buy 600 roses at $3. 357 00:15:32,667 --> 00:15:34,500 Producers are happy, because on their supply 358 00:15:34,500 --> 00:15:36,150 curve is the same point. 359 00:15:36,150 --> 00:15:40,110 They are willing to supply 600 roses at $3. 360 00:15:40,110 --> 00:15:43,020 That is the one point where consumers are happy 361 00:15:43,020 --> 00:15:44,490 and producers are happy. 362 00:15:44,490 --> 00:15:45,930 Therefore, it's the equilibrium-- 363 00:15:45,930 --> 00:15:49,762 highly non-technical, but that's the basic intuition. 364 00:15:49,762 --> 00:15:51,720 The point at which they're both willing to make 365 00:15:51,720 --> 00:15:52,890 that transaction, the point at which they're 366 00:15:52,890 --> 00:15:54,810 both satisfied with that transaction, 367 00:15:54,810 --> 00:15:57,630 is the equilibrium, which in this case is $3 per 368 00:15:57,630 --> 00:16:00,120 rose and 600 roses. 369 00:16:00,120 --> 00:16:02,008 Now, this raises lots of questions. 370 00:16:02,008 --> 00:16:03,300 Where did the curves come from? 371 00:16:03,300 --> 00:16:05,880 How does equilibrium get achieved? 372 00:16:05,880 --> 00:16:07,290 Why the heck do we give roses? 373 00:16:07,290 --> 00:16:08,700 These are a bunch of questions. 374 00:16:08,700 --> 00:16:11,880 We will come to all these questions 375 00:16:11,880 --> 00:16:14,220 over the next set of lectures. 376 00:16:14,220 --> 00:16:15,750 But the basic thing is to understand 377 00:16:15,750 --> 00:16:19,875 this intuition of Adam Smith's supply and demand model. 378 00:16:19,875 --> 00:16:20,750 Questions about that? 379 00:16:24,910 --> 00:16:31,035 Now, this model also raises another important distinction 380 00:16:31,035 --> 00:16:32,410 that we'll focus on this semester 381 00:16:32,410 --> 00:16:34,000 and is easy to get mixed up. 382 00:16:34,000 --> 00:16:35,770 So I want you to, if you're ever unclear, 383 00:16:35,770 --> 00:16:37,240 I want you to ask me about it. 384 00:16:37,240 --> 00:16:43,080 And that's the distinction between positive 385 00:16:43,080 --> 00:16:50,280 versus normative analyses-- positive versus normative. 386 00:16:50,280 --> 00:16:55,550 Positive analysis is the study of the way things are, 387 00:16:55,550 --> 00:16:57,970 while normative analyses is the study 388 00:16:57,970 --> 00:17:00,050 of the way things should be. 389 00:17:00,050 --> 00:17:02,810 A positive analysis is the study of the way things are, 390 00:17:02,810 --> 00:17:04,880 while normative analysis is the study 391 00:17:04,880 --> 00:17:08,040 of the way things should be. 392 00:17:08,040 --> 00:17:14,160 Let me give you a great example, which is eBay auctions. 393 00:17:14,160 --> 00:17:15,950 Auctions are a terrific example. 394 00:17:15,950 --> 00:17:17,410 They're like the textbook example 395 00:17:17,410 --> 00:17:18,660 of a competitive market. 396 00:17:18,660 --> 00:17:19,920 You can see it in your head-- 397 00:17:19,920 --> 00:17:22,640 demand comes as a bunch of people going on and bidding. 398 00:17:22,640 --> 00:17:24,599 People who want it more bid more, 399 00:17:24,599 --> 00:17:26,460 so you actually get a demand curve. 400 00:17:26,460 --> 00:17:29,400 The higher the price, the fewer people you're getting to bid. 401 00:17:29,400 --> 00:17:34,210 Supply is how many units of it are for sale on eBay. 402 00:17:34,210 --> 00:17:37,120 You bid until those two meet. 403 00:17:37,120 --> 00:17:39,340 And then you have a market equilibrium 404 00:17:39,340 --> 00:17:42,490 at that bidded price. 405 00:17:42,490 --> 00:17:46,450 Now, one example of an eBay auction 406 00:17:46,450 --> 00:17:49,190 that got a lot of attention a number of years ago, 407 00:17:49,190 --> 00:17:51,610 early in the days of eBay, was someone 408 00:17:51,610 --> 00:17:53,292 offered their kidney for auction. 409 00:17:53,292 --> 00:17:54,750 They said, look, I got two kidneys. 410 00:17:54,750 --> 00:17:55,675 You only need one to live. 411 00:17:55,675 --> 00:17:57,550 There are people out there who need a kidney. 412 00:17:57,550 --> 00:18:01,330 I'm putting my kidney on eBay for auction. 413 00:18:01,330 --> 00:18:03,160 And what happened, bidding went nuts. 414 00:18:03,160 --> 00:18:04,960 It started at $25,000. 415 00:18:04,960 --> 00:18:08,130 It climbed to $5 million before the auction was shut down, 416 00:18:08,130 --> 00:18:09,820 and eBay decided they wouldn't allow 417 00:18:09,820 --> 00:18:15,150 you to sell your body on eBay, bodily parts on eBay. 418 00:18:15,150 --> 00:18:18,310 So this raises two questions. 419 00:18:18,310 --> 00:18:20,820 The first is the positive question, 420 00:18:20,820 --> 00:18:23,542 why did the price go so high? 421 00:18:23,542 --> 00:18:24,750 So what's the answer to that? 422 00:18:24,750 --> 00:18:26,692 What's the answer to the positive question? 423 00:18:26,692 --> 00:18:29,195 AUDIENCE: Somebody wanted a kidney. 424 00:18:29,195 --> 00:18:31,320 JONATHAN GRUBER: Good answer, but let's raise hands 425 00:18:31,320 --> 00:18:32,040 and give answers. 426 00:18:32,040 --> 00:18:32,940 That's part of it. 427 00:18:32,940 --> 00:18:34,004 Yeah. 428 00:18:34,004 --> 00:18:34,830 AUDIENCE: Low supply, high demand. 429 00:18:34,830 --> 00:18:36,538 JONATHAN GRUBER: Low supply, high demand. 430 00:18:36,538 --> 00:18:38,978 Demand is incredibly high, because I'd die without it. 431 00:18:38,978 --> 00:18:40,770 Supply is low, because like not a lot of us 432 00:18:40,770 --> 00:18:42,145 are willing to sell their kidneys 433 00:18:42,145 --> 00:18:47,490 on eBay So low supply, high demand led to a high price-- 434 00:18:47,490 --> 00:18:48,820 Adam Smith at work. 435 00:18:48,820 --> 00:18:52,200 That's the positive analysis. 436 00:18:52,200 --> 00:18:55,990 But then there's the normative question, which is, 437 00:18:55,990 --> 00:18:59,130 should you be allowed to sell your kidneys on eBay? 438 00:18:59,130 --> 00:19:00,380 That's the normative question. 439 00:19:00,380 --> 00:19:03,280 The positive question is, what happens if you do? 440 00:19:03,280 --> 00:19:06,150 The normative question is, should you? 441 00:19:06,150 --> 00:19:11,000 Now, the standard economics answer to start 442 00:19:11,000 --> 00:19:13,820 would be, of course you should. 443 00:19:13,820 --> 00:19:16,370 We're in a world where thousands of people 444 00:19:16,370 --> 00:19:19,310 die every year because there's a waiting list for a kidney 445 00:19:19,310 --> 00:19:22,385 transplant. 446 00:19:22,385 --> 00:19:24,760 and these are people who would happily pay a lot of money 447 00:19:24,760 --> 00:19:27,580 to stay alive, I presume. 448 00:19:27,580 --> 00:19:30,880 Meanwhile, there's hundreds of millions 449 00:19:30,880 --> 00:19:35,610 of people walking around with two kidneys who only need one. 450 00:19:35,610 --> 00:19:38,980 And many of these people are poor. 451 00:19:38,980 --> 00:19:41,500 And lives could be changed by being paid $1 million 452 00:19:41,500 --> 00:19:45,292 for their kidney, and might be happy to take the risk that one 453 00:19:45,292 --> 00:19:47,250 kidney will be fine, as it is for most everyone 454 00:19:47,250 --> 00:19:49,230 for most of their life, in return 455 00:19:49,230 --> 00:19:52,650 for having a life-changing payment from a stranger. 456 00:19:52,650 --> 00:19:53,700 So economists say, look-- 457 00:19:53,700 --> 00:19:57,240 here's a transaction that makes both parties better off. 458 00:19:57,240 --> 00:20:00,150 The person who gets the kidney gets to stay alive, 459 00:20:00,150 --> 00:20:03,180 and they are willing to pay a huge amount for that. 460 00:20:03,180 --> 00:20:05,880 The person who sells the kidney in most probability 461 00:20:05,880 --> 00:20:07,723 is fine, because almost all of us 462 00:20:07,723 --> 00:20:09,640 can make it through life fine with one kidney, 463 00:20:09,640 --> 00:20:11,940 and create a life-changing amount of money that 464 00:20:11,940 --> 00:20:16,650 could allow them to pursue their dreams in various ways. 465 00:20:16,650 --> 00:20:19,350 So that's the standard argument, would be, 466 00:20:19,350 --> 00:20:23,700 yeah, you should be able to sell your kidneys on eBay. 467 00:20:23,700 --> 00:20:26,070 So the question is, why not? 468 00:20:26,070 --> 00:20:28,420 Why would we want to stop this transaction? 469 00:20:28,420 --> 00:20:31,020 What are the counter-arguments to that? 470 00:20:31,020 --> 00:20:31,950 Let's raise our hands. 471 00:20:31,950 --> 00:20:33,170 Yeah. 472 00:20:33,170 --> 00:20:35,400 AUDIENCE: Potentially, I think maybe the issue is 473 00:20:35,400 --> 00:20:37,850 because on eBay, there's no way to regulate it 474 00:20:37,850 --> 00:20:39,810 or you don't necessarily know. 475 00:20:39,810 --> 00:20:41,942 People could be like selling fake kidneys, per se. 476 00:20:41,942 --> 00:20:42,900 JONATHAN GRUBER: Right. 477 00:20:42,900 --> 00:20:45,030 So the first type of problem comes out 478 00:20:45,030 --> 00:20:48,000 of the category we call "market failures." 479 00:20:52,460 --> 00:20:55,730 Market failures are reasons why the market doesn't 480 00:20:55,730 --> 00:20:57,260 work in the wonderful way economists 481 00:20:57,260 --> 00:20:59,370 like to think it should. 482 00:20:59,370 --> 00:21:01,710 So for example, this answer puts up 483 00:21:01,710 --> 00:21:04,570 there could be the problem of fraud. 484 00:21:08,040 --> 00:21:10,890 People might not be able to tell if they're 485 00:21:10,890 --> 00:21:14,010 getting a legit kidney or not. 486 00:21:14,010 --> 00:21:17,092 There could be the example of imperfect information. 487 00:21:19,750 --> 00:21:21,640 Do you know what the odds are that you 488 00:21:21,640 --> 00:21:24,270 can spend the rest of your life with only one kidney? 489 00:21:24,270 --> 00:21:26,370 I don't either. 490 00:21:26,370 --> 00:21:30,080 We ought to know that before we start selling our kidneys. 491 00:21:30,080 --> 00:21:31,820 There could be imperfect information. 492 00:21:34,590 --> 00:21:38,780 This is one type of problem, which is the market, 493 00:21:38,780 --> 00:21:42,390 maybe the market may fail. 494 00:21:42,390 --> 00:21:42,940 Yeah. 495 00:21:42,940 --> 00:21:45,510 AUDIENCE: Well, the current system also 496 00:21:45,510 --> 00:21:49,590 holds people who are poor and have a failed kidney-- 497 00:21:49,590 --> 00:21:53,590 and which are people who would be completely screwed otherwise 498 00:21:53,590 --> 00:21:55,290 in the [INAUDIBLE] system. 499 00:21:55,290 --> 00:21:57,030 JONATHAN GRUBER: A second problem 500 00:21:57,030 --> 00:21:59,850 is what we call "equity" or "fairness." 501 00:22:02,730 --> 00:22:07,440 Equity or fairness, which is we would end up with a world 502 00:22:07,440 --> 00:22:10,470 where only rich people would get kidneys. 503 00:22:10,470 --> 00:22:13,560 Currently, there's a bunch of voluntary donors and people 504 00:22:13,560 --> 00:22:16,800 who are in accidents who have kidneys left over. 505 00:22:16,800 --> 00:22:18,750 And those go to people on the basis of where 506 00:22:18,750 --> 00:22:19,440 they are on a waiting list. 507 00:22:19,440 --> 00:22:20,400 It's actually a prioritized waiting list. 508 00:22:20,400 --> 00:22:21,480 It's kind of a cool-- 509 00:22:21,480 --> 00:22:24,480 one of my colleagues, Nikhil Agarwal, if you think about-- 510 00:22:24,480 --> 00:22:27,390 I'll talk a lot this semester about the imperialistic view 511 00:22:27,390 --> 00:22:29,880 of economics, all the cool things we can study. 512 00:22:29,880 --> 00:22:32,280 So he actually uses economic models 513 00:22:32,280 --> 00:22:36,360 to study the optimal way to allocate organs to individuals. 514 00:22:36,360 --> 00:22:39,600 now it's just done based on a waiting list, 515 00:22:39,600 --> 00:22:42,240 but it may be that someone further down the waiting 516 00:22:42,240 --> 00:22:44,010 list needs it more than someone higher up the waiting list 517 00:22:44,010 --> 00:22:45,220 because they're more critical or whatever. 518 00:22:45,220 --> 00:22:47,053 So there's various optimal ways to allocate. 519 00:22:47,053 --> 00:22:48,803 But certainly, the optimal way to allocate 520 00:22:48,803 --> 00:22:50,580 wouldn't be the rich guy gets it first. 521 00:22:50,580 --> 00:22:53,610 That would be unlikely to be what society would necessarily 522 00:22:53,610 --> 00:22:54,410 want. 523 00:22:54,410 --> 00:22:56,890 So there's an equity concern with that. 524 00:22:56,890 --> 00:22:58,410 What else? 525 00:22:58,410 --> 00:23:00,102 What other-- yeah. 526 00:23:00,102 --> 00:23:02,520 AUDIENCE: In that situation, since you 527 00:23:02,520 --> 00:23:04,680 know you can make money off of selling kidneys, 528 00:23:04,680 --> 00:23:07,420 and you take advantage of people, it's very bad, 529 00:23:07,420 --> 00:23:09,113 the black market for kidneys. 530 00:23:09,113 --> 00:23:11,280 JONATHAN GRUBER: Right, so there's sort of a third-- 531 00:23:11,280 --> 00:23:12,697 it's related to fraud, but there's 532 00:23:12,697 --> 00:23:14,490 sort of a third class of failures 533 00:23:14,490 --> 00:23:18,300 that gets into the question about behavioral economics 534 00:23:18,300 --> 00:23:23,682 that was raised earlier, which we could just call behavioral-- 535 00:23:23,682 --> 00:23:25,140 it's called "behavioral economics," 536 00:23:25,140 --> 00:23:28,680 for want of a better term, which is essentially, 537 00:23:28,680 --> 00:23:31,200 people don't always make decisions 538 00:23:31,200 --> 00:23:33,900 in the perfectly rational, logical way we will model them 539 00:23:33,900 --> 00:23:36,140 as doing so this semester. 540 00:23:36,140 --> 00:23:37,490 People make mistakes. 541 00:23:37,490 --> 00:23:38,700 That's a word we hate using in economics. 542 00:23:38,700 --> 00:23:39,783 We hate saying "mistakes." 543 00:23:39,783 --> 00:23:42,110 Ooh, boo, mistakes-- nobody makes mistakes. 544 00:23:42,110 --> 00:23:43,610 We're all perfectly economic beings. 545 00:23:43,610 --> 00:23:45,290 But we know that's not true. 546 00:23:45,290 --> 00:23:47,723 Increasingly over the past several decades, 547 00:23:47,723 --> 00:23:49,640 economists have started incorporating insights 548 00:23:49,640 --> 00:23:53,812 from psychology into our models, to not just say 549 00:23:53,812 --> 00:23:55,770 people make mistakes, that their lackadaisical, 550 00:23:55,770 --> 00:23:59,190 but to rigorously model the nature of those mistakes 551 00:23:59,190 --> 00:24:02,070 and understand how mistakes can actually 552 00:24:02,070 --> 00:24:06,300 happen due to various cognitive biases and other things. 553 00:24:06,300 --> 00:24:08,940 In this world, you can imagine people could make mistakes. 554 00:24:08,940 --> 00:24:11,100 They could not really sit down and quite 555 00:24:11,100 --> 00:24:13,048 understand what they're doing, and they 556 00:24:13,048 --> 00:24:15,090 could have sold their kidney when it's really not 557 00:24:15,090 --> 00:24:16,300 in their own long-term interest. 558 00:24:16,300 --> 00:24:16,880 Yeah. 559 00:24:16,880 --> 00:24:18,670 AUDIENCE: Would another example be 560 00:24:18,670 --> 00:24:20,967 if there's a family that is in extreme poverty, 561 00:24:20,967 --> 00:24:22,550 even though they only have one kidney, 562 00:24:22,550 --> 00:24:24,060 they might sell the other one, just to get more 563 00:24:24,060 --> 00:24:25,650 money for the family, per se? 564 00:24:25,650 --> 00:24:27,970 JONATHAN GRUBER: Well, in some sense that would be, 565 00:24:27,970 --> 00:24:29,280 once again-- 566 00:24:29,280 --> 00:24:33,700 if we took this factor out, if the market works well 567 00:24:33,700 --> 00:24:35,700 with its behavioral effects, we'd say, you know, 568 00:24:35,700 --> 00:24:37,350 that's their decision. 569 00:24:37,350 --> 00:24:41,550 If they otherwise they starve, who are you to say? 570 00:24:41,550 --> 00:24:43,950 But once you choose this, say, wait a second, 571 00:24:43,950 --> 00:24:46,200 maybe they're not evaluating the trade-offs correctly. 572 00:24:46,200 --> 00:24:48,840 Even if there's no fraud, even if there's perfect information, 573 00:24:48,840 --> 00:24:51,552 they may not know how to process that information correctly. 574 00:24:51,552 --> 00:24:53,010 But that is not standard economics. 575 00:24:53,010 --> 00:24:55,552 That's not what we'll spend a lot of time on in the semester, 576 00:24:55,552 --> 00:24:58,270 but it's obviously realistic. 577 00:24:58,270 --> 00:25:00,750 So those are a bunch of good comments, great comments. 578 00:25:00,750 --> 00:25:02,790 And yeah. 579 00:25:02,790 --> 00:25:05,050 AUDIENCE: Also, in inelastic demand, 580 00:25:05,050 --> 00:25:07,042 such that people always need kidneys-- 581 00:25:07,042 --> 00:25:09,250 JONATHAN GRUBER: That won't turn out to be a problem. 582 00:25:09,250 --> 00:25:11,562 That doesn't turn out to be a problem. 583 00:25:11,562 --> 00:25:13,270 We'll come back-- that's a great comeback 584 00:25:13,270 --> 00:25:15,010 that we talk about the shape of demand curves. 585 00:25:15,010 --> 00:25:16,570 We want to return to that question in a few lectures, 586 00:25:16,570 --> 00:25:18,400 but that doesn't actually cause a problem. 587 00:25:18,400 --> 00:25:20,110 It's just that's more of a positive thing about why 588 00:25:20,110 --> 00:25:22,570 the price is so high, but it's not a normative issue about 589 00:25:22,570 --> 00:25:25,240 whether you should allow it or not. 590 00:25:25,240 --> 00:25:28,450 So basically, these are exactly-- 591 00:25:28,450 --> 00:25:30,460 to me, honestly, I spend my life thinking a lot 592 00:25:30,460 --> 00:25:31,252 about these things. 593 00:25:31,252 --> 00:25:33,110 I think these are really interesting issues. 594 00:25:33,110 --> 00:25:34,990 But you can't get to the normative issues 595 00:25:34,990 --> 00:25:36,740 without the positive analysis. 596 00:25:36,740 --> 00:25:38,890 You do the positive analysis to understand 597 00:25:38,890 --> 00:25:41,050 the economic framework before you start 598 00:25:41,050 --> 00:25:42,670 jumping to drawing conclusions. 599 00:25:42,670 --> 00:25:43,390 That's no fun. 600 00:25:43,390 --> 00:25:44,900 We all want to jump to draw conclusions, 601 00:25:44,900 --> 00:25:46,390 saying this should happen, this shouldn't happen. 602 00:25:46,390 --> 00:25:47,140 You can't do that. 603 00:25:47,140 --> 00:25:48,890 We have to be disciplined. 604 00:25:48,890 --> 00:25:53,240 We have to start with the fundamental economic framework. 605 00:25:53,240 --> 00:25:55,908 And basically, the bottom line-- 606 00:25:55,908 --> 00:25:57,950 I said I'll teach this course with a policy bent, 607 00:25:57,950 --> 00:26:00,530 but you have to recognize that economics at its core 608 00:26:00,530 --> 00:26:02,630 is a right-wing science. 609 00:26:02,630 --> 00:26:04,910 Economics at its core is all about how 610 00:26:04,910 --> 00:26:09,390 the market knows best, and that basically governments only mess 611 00:26:09,390 --> 00:26:11,490 things up. 612 00:26:11,490 --> 00:26:13,497 That's sort of the basic, a lot of what 613 00:26:13,497 --> 00:26:14,580 we'll learn this semester. 614 00:26:14,580 --> 00:26:16,038 As the semester goes on, we'll talk 615 00:26:16,038 --> 00:26:17,670 about what's wrong with that view 616 00:26:17,670 --> 00:26:18,900 and how governments can improve things. 617 00:26:18,900 --> 00:26:21,067 Indeed, I teach a whole course about the proper role 618 00:26:21,067 --> 00:26:22,600 of government the economy. 619 00:26:22,600 --> 00:26:26,460 But the standard of economics is, "the market knows best." 620 00:26:26,460 --> 00:26:29,670 And that leads us to the last thing I want to talk about, 621 00:26:29,670 --> 00:26:33,330 which is basically, how freely should an economy function? 622 00:26:33,330 --> 00:26:35,305 Let's step back to the giant picture. 623 00:26:35,305 --> 00:26:36,930 Let's step back from a market for roses 624 00:26:36,930 --> 00:26:38,760 to the entire economy. 625 00:26:38,760 --> 00:26:42,000 How freely should a market, should an economy function? 626 00:26:42,000 --> 00:26:45,740 We have what's known as a "capitalistic economy." 627 00:26:45,740 --> 00:26:48,770 In a capitalistic economy, firms and individuals 628 00:26:48,770 --> 00:26:51,080 decide what to produce and consume, 629 00:26:51,080 --> 00:26:54,090 maybe subject to some rules of the road set by the government. 630 00:26:54,090 --> 00:26:55,730 There's some minimum rules of the road 631 00:26:55,730 --> 00:26:58,100 to try to avoid fraud or misinformation, 632 00:26:58,100 --> 00:27:00,110 but otherwise, we let the dice roll. 633 00:27:00,110 --> 00:27:04,970 Firms let consumers decide sort of what to do. 634 00:27:04,970 --> 00:27:08,770 Now, this has led to tremendous growth. 635 00:27:08,770 --> 00:27:10,730 America was not a wealthy nation, 636 00:27:10,730 --> 00:27:12,660 was not a very wealthy nation 100 years ago, 637 00:27:12,660 --> 00:27:14,140 or 150 years ago. 638 00:27:14,140 --> 00:27:16,210 Led to tremendous growth, where we are now 639 00:27:16,210 --> 00:27:18,585 the most powerful, still the most powerful and wealthiest 640 00:27:18,585 --> 00:27:24,160 nation the world, largely driven by the capitalistic nature 641 00:27:24,160 --> 00:27:26,020 of our economy. 642 00:27:26,020 --> 00:27:28,120 On the other hand, we are a nation 643 00:27:28,120 --> 00:27:30,190 with tremendous inequality. 644 00:27:30,190 --> 00:27:34,720 We are by far the most unequal major nation in the world. 645 00:27:34,720 --> 00:27:39,460 The top 1% of Americans has a much higher share of our income 646 00:27:39,460 --> 00:27:42,500 than in any other large country in the world, 647 00:27:42,500 --> 00:27:44,830 any other large developed country in the world. 648 00:27:44,830 --> 00:27:48,830 The bottom 99% has less of our income corresponding 649 00:27:48,830 --> 00:27:49,970 with anywhere else. 650 00:27:49,970 --> 00:27:51,910 So it's led to major inequality. 651 00:27:51,910 --> 00:27:53,420 And it's led to other problems. 652 00:27:53,420 --> 00:27:54,970 It turns out that the government can't appropriately 653 00:27:54,970 --> 00:27:57,460 set the rules of the road to avoid things like fraud, as we 654 00:27:57,460 --> 00:27:59,890 saw with Enron, if you remember back to that, 655 00:27:59,890 --> 00:28:02,320 or a lot of what happened in the financial meltdown. 656 00:28:02,320 --> 00:28:03,820 It turns out it's hard to get people 657 00:28:03,820 --> 00:28:05,395 perfect information, et cetera. 658 00:28:05,395 --> 00:28:06,520 So we've seen the problems. 659 00:28:06,520 --> 00:28:08,650 We've grown very wealthy as a nation. 660 00:28:08,650 --> 00:28:12,230 We've introduced a whole set of problems through this system. 661 00:28:12,230 --> 00:28:16,390 Now, the other extreme is what's called the "command economy." 662 00:28:16,390 --> 00:28:18,160 Rather than a capitalist economy, 663 00:28:18,160 --> 00:28:21,370 it's what's called a "command economy." 664 00:28:21,370 --> 00:28:24,820 In this case, the government makes all the production 665 00:28:24,820 --> 00:28:25,960 and consumption decisions. 666 00:28:25,960 --> 00:28:28,210 The government doesn't just set the rules of the road, 667 00:28:28,210 --> 00:28:30,460 the government owns the road. 668 00:28:30,460 --> 00:28:32,710 The government says, we're going to use this many cars 669 00:28:32,710 --> 00:28:35,200 this year. 670 00:28:35,200 --> 00:28:36,770 And people can get them in some way. 671 00:28:36,770 --> 00:28:38,770 It could be a lottery, could be waiting in line. 672 00:28:38,770 --> 00:28:40,510 How do we decide how to allocate them? 673 00:28:40,510 --> 00:28:41,890 We're not going to let the market allocate them. 674 00:28:41,890 --> 00:28:43,515 We, the government, will allocate them. 675 00:28:43,515 --> 00:28:47,230 We'll allocate how many get produced and who gets them. 676 00:28:47,230 --> 00:28:48,980 And this was the model of the Soviet Union 677 00:28:48,980 --> 00:28:50,630 that I grew up with. 678 00:28:50,630 --> 00:28:55,670 This was the pre-1989 Soviet Union. 679 00:28:55,670 --> 00:28:58,410 The government decided how many shirts, cars, TVs, everything. 680 00:28:58,410 --> 00:29:00,243 It's sort of bizarre to think that literally 681 00:29:00,243 --> 00:29:03,363 everything the government decided how much to produce. 682 00:29:03,363 --> 00:29:05,780 And by and large, the government decided who got it partly 683 00:29:05,780 --> 00:29:08,690 through corruption-- that is, the party members, 684 00:29:08,690 --> 00:29:10,130 party leaders got it first-- 685 00:29:10,130 --> 00:29:12,950 and often just through waiting in line for the remaining 686 00:29:12,950 --> 00:29:14,870 application. 687 00:29:14,870 --> 00:29:17,960 Now in theory, this ensured equity 688 00:29:17,960 --> 00:29:20,450 by making sure that everybody had shot at things. 689 00:29:20,450 --> 00:29:22,790 In practice, it didn't work well at all 690 00:29:22,790 --> 00:29:24,470 and actually was what dragged down 691 00:29:24,470 --> 00:29:26,810 the collapse of the old Soviet economy, 692 00:29:26,810 --> 00:29:30,550 was that the command model simply doesn't work. 693 00:29:30,550 --> 00:29:33,850 Partly there's just too many opportunities for corruption. 694 00:29:33,850 --> 00:29:35,530 When the government controls everything, 695 00:29:35,530 --> 00:29:40,150 that means there's no checks and balances on the opportunity 696 00:29:40,150 --> 00:29:41,490 for enormous corruption. 697 00:29:41,490 --> 00:29:43,990 The capitalist economy puts some natural checks and balances 698 00:29:43,990 --> 00:29:45,560 on that. 699 00:29:45,560 --> 00:29:48,380 And partly because it turns out that it's 700 00:29:48,380 --> 00:29:50,150 hard to control human nature. 701 00:29:50,150 --> 00:29:51,980 And Adam Smith had it right. 702 00:29:51,980 --> 00:29:54,680 Adam Smith talks about the "invisible hand" 703 00:29:54,680 --> 00:29:56,150 of the capitalist economy. 704 00:29:56,150 --> 00:29:59,115 The invisible hand is basically the notion 705 00:29:59,115 --> 00:30:00,740 that the capitalist economy will manage 706 00:30:00,740 --> 00:30:05,510 to distribute things roughly in proportion to what people want. 707 00:30:05,510 --> 00:30:07,910 And that's where folks want to be. 708 00:30:07,910 --> 00:30:09,470 Folks who want a certain kind of car 709 00:30:09,470 --> 00:30:11,120 are going to want to get to that kind of car, 710 00:30:11,120 --> 00:30:12,680 and if the government has it wrong, 711 00:30:12,680 --> 00:30:13,805 they're going to get upset. 712 00:30:13,805 --> 00:30:17,850 And it's going to lead to a less functional economy. 713 00:30:17,850 --> 00:30:22,590 So basically, Adam Smith's view is that-- 714 00:30:22,590 --> 00:30:26,250 the invisible hand view is that consumers and firms serving 715 00:30:26,250 --> 00:30:31,080 their own best interest will do what is best for society. 716 00:30:31,080 --> 00:30:33,510 So the fundamental core of the capitalistic view 717 00:30:33,510 --> 00:30:37,770 is that consumers and firms serving their own best interest 718 00:30:37,770 --> 00:30:40,207 will do what ends up being best for society. 719 00:30:40,207 --> 00:30:41,790 And that's essentially the model we'll 720 00:30:41,790 --> 00:30:43,940 learn to start in this course. 721 00:30:43,940 --> 00:30:45,890 Yeah. 722 00:30:45,890 --> 00:30:47,390 AUDIENCE: In that definition, are we 723 00:30:47,390 --> 00:30:51,680 defining the best for society as in everybody 724 00:30:51,680 --> 00:30:53,120 has the most money? 725 00:30:53,120 --> 00:30:56,892 Or everyone has the best health or the best standard of living? 726 00:30:56,892 --> 00:30:58,100 What is the best [INAUDIBLE]? 727 00:30:58,100 --> 00:30:58,830 JONATHAN GRUBER: Great question. 728 00:30:58,830 --> 00:31:00,170 We're going to spend a lot of the semester talking 729 00:31:00,170 --> 00:31:01,100 about that. 730 00:31:01,100 --> 00:31:03,650 For now, we're going to define "best for society" 731 00:31:03,650 --> 00:31:07,062 as the most stuff gets produced and consumed. 732 00:31:07,062 --> 00:31:08,520 That's how we're going to find it-- 733 00:31:08,520 --> 00:31:10,312 obviously raises a set of issues about what 734 00:31:10,312 --> 00:31:13,120 about pollution, what about health, et cetera. 735 00:31:13,120 --> 00:31:15,630 We're going to come to those, but for the first two-thirds 736 00:31:15,630 --> 00:31:18,630 of the course "best for society" means 737 00:31:18,630 --> 00:31:21,270 what we're going to call "maximum surplus," which 738 00:31:21,270 --> 00:31:25,230 is the most stuff gets produced that people value. 739 00:31:25,230 --> 00:31:26,730 So that's how we're going to do it. 740 00:31:26,730 --> 00:31:28,647 And in his view, the invisible hand does that. 741 00:31:28,647 --> 00:31:35,730 And by and large, it's a very helpful framework to turn to. 742 00:31:35,730 --> 00:31:37,890 However, at least it can lead to outcomes 743 00:31:37,890 --> 00:31:39,730 that are not very fair. 744 00:31:39,730 --> 00:31:42,060 So the way we're going to proceed in this course 745 00:31:42,060 --> 00:31:44,550 is we're going to start by talking about how 746 00:31:44,550 --> 00:31:46,290 Adam Smith's magic works. 747 00:31:46,290 --> 00:31:47,880 How does the magic happen? 748 00:31:47,880 --> 00:31:49,800 How does individuals and firms acting 749 00:31:49,800 --> 00:31:52,950 in their own self-interest, without caring about anybody 750 00:31:52,950 --> 00:31:58,530 else, end up yielding the largest possible 751 00:31:58,530 --> 00:32:00,750 productive economy? 752 00:32:00,750 --> 00:32:02,442 How does that happen? 753 00:32:02,442 --> 00:32:03,900 And we're going to talk about that. 754 00:32:03,900 --> 00:32:05,940 We'll start with demand, which is 755 00:32:05,940 --> 00:32:07,560 how do consumers decide what they 756 00:32:07,560 --> 00:32:10,120 want given their resources. 757 00:32:10,120 --> 00:32:12,805 We'll talk about the principle of utility maximization, 758 00:32:12,805 --> 00:32:14,430 the idea that I have a utility function 759 00:32:14,430 --> 00:32:18,300 that I can mathematically write down what I want. 760 00:32:18,300 --> 00:32:20,940 I'll have a budget constraint, which is the resources I have, 761 00:32:20,940 --> 00:32:22,950 and those two constrain optimization. 762 00:32:22,950 --> 00:32:25,258 We'll say given what I want and the resource I have, 763 00:32:25,258 --> 00:32:26,300 what decisions do I make? 764 00:32:26,300 --> 00:32:28,280 Boom, we get the demand curve. 765 00:32:28,280 --> 00:32:31,280 Then we'll turn to supply, and we'll talk about how do firms 766 00:32:31,280 --> 00:32:33,368 decide what to produce. 767 00:32:33,368 --> 00:32:35,160 That's much more complicated, because firms 768 00:32:35,160 --> 00:32:38,030 have to decide what inputs to use 769 00:32:38,030 --> 00:32:40,560 and what outputs to produce. 770 00:32:40,560 --> 00:32:42,510 And we'll talk about how firms can operate 771 00:32:42,510 --> 00:32:44,230 in very different markets. 772 00:32:44,230 --> 00:32:46,710 There is a competitive market that Adam Smith envisioned, 773 00:32:46,710 --> 00:32:47,918 but that doesn't always work. 774 00:32:47,918 --> 00:32:50,490 Sometimes we get monopoly markets, 775 00:32:50,490 --> 00:32:51,713 where one firm dominates. 776 00:32:51,713 --> 00:32:53,130 And you can actually have outcomes 777 00:32:53,130 --> 00:32:55,080 which aren't the best possible outcome, even 778 00:32:55,080 --> 00:32:57,290 with the invisible hand. 779 00:32:57,290 --> 00:32:59,860 So we'll talk about different kinds of markets. 780 00:32:59,860 --> 00:33:02,830 Then we'll put it together to get market equilibrium, 781 00:33:02,830 --> 00:33:04,900 and talk about Smith's principles. 782 00:33:04,900 --> 00:33:07,780 And then from there, we'll talk about how it breaks down 783 00:33:07,780 --> 00:33:09,940 in reality, different change in reality, 784 00:33:09,940 --> 00:33:12,310 how there are various market failures that 785 00:33:12,310 --> 00:33:14,710 can get in the way, why we have to care about equity 786 00:33:14,710 --> 00:33:17,830 and what implications that has, about behavioral economics, 787 00:33:17,830 --> 00:33:20,260 about a set of other factors. 788 00:33:20,260 --> 00:33:23,930 So that's basically how we're going to proceed this semester. 789 00:33:23,930 --> 00:33:25,960 As I said, the lectures are important, 790 00:33:25,960 --> 00:33:28,060 but the recitations are as well. 791 00:33:28,060 --> 00:33:29,950 Once we're sort of in steady state, 792 00:33:29,950 --> 00:33:34,690 the recitations will be about half new material and half 793 00:33:34,690 --> 00:33:36,760 working through problems to help you prepare 794 00:33:36,760 --> 00:33:37,855 for that next problem set. 795 00:33:37,855 --> 00:33:39,730 So the way the problem sets are going to work 796 00:33:39,730 --> 00:33:41,670 is the problem set that's assigned 797 00:33:41,670 --> 00:33:44,663 will cover material that's taught up to that date. 798 00:33:44,663 --> 00:33:46,330 So for example, problem set one is going 799 00:33:46,330 --> 00:33:47,887 to be assigned next Friday. 800 00:33:47,887 --> 00:33:49,720 That will cover everything you've learned up 801 00:33:49,720 --> 00:33:52,690 through next Wednesday. 802 00:33:52,690 --> 00:33:54,340 Therefore, in section on next Friday, 803 00:33:54,340 --> 00:33:57,312 we'll do a practice problem which you should understand 804 00:33:57,312 --> 00:33:59,520 because it'll cover things that were taught in class, 805 00:33:59,520 --> 00:34:01,103 and help prepare you for the problems. 806 00:34:01,103 --> 00:34:02,460 And we'll do that every week. 807 00:34:02,460 --> 00:34:03,770 That's about half the section. 808 00:34:03,770 --> 00:34:06,280 The other half of the section will be new material. 809 00:34:06,280 --> 00:34:08,849 This Friday, the section on Friday is all new material. 810 00:34:08,849 --> 00:34:11,170 What we do on Friday is cover the mathematics. 811 00:34:11,170 --> 00:34:12,620 I don't like doing math. 812 00:34:12,620 --> 00:34:14,050 I always get it wrong. 813 00:34:14,050 --> 00:34:17,110 So I leave math for the TAs, who are smarter than I am. 814 00:34:17,110 --> 00:34:19,630 So this Friday, we'll be doing the mathematics of supply 815 00:34:19,630 --> 00:34:22,018 and demand, and how you take the intuition here 816 00:34:22,018 --> 00:34:23,560 and the simple graphics, and actually 817 00:34:23,560 --> 00:34:26,380 turn it into mathematical representations, which is what 818 00:34:26,380 --> 00:34:27,790 you need for the problem sets. 819 00:34:27,790 --> 00:34:28,780 That's this Friday. 820 00:34:28,780 --> 00:34:30,447 Then we'll come back on Monday and start 821 00:34:30,447 --> 00:34:32,889 talking about what's underneath the demand curve. 822 00:34:32,889 --> 00:34:36,010 All right, any other questions? 823 00:34:36,010 --> 00:34:37,860 I'll see you on Monday.