Intermediate Microeconomics

May 9, 2000

Class Notes (Chapter 6-10)

Chapter 6

1. Introduction: importance of coordination: possession of resources (or what outsiders call resources) is not enough. A thing won't be a resource unless someone knows how to coordinate it with other resources.
2. Coordination in a One-Person Situation
1. Two types of actions: ordinary and learning
2. Coordination of ordinary actions
1. The fisherman's use of his knowledge of tides
2. The many actions of the fisherman on the day he decides to fish.
1. Other actions involved in fishing
2. Other non-fishing actions
3. Actions, sub-actions, and coordination
1. Complementarity and potential conflicts among sub-actions
2. Coordination of so many acts as a marvel
4. Coordination among animals and plants: absence of a will
1. Humans have the capacity to make errors, regret choices, and to correct the errors for the future
3. Coordination of learning programs: breaking down actions into sub-actions, and then improving the sub-actions; but this is costly.
4. Coordination of Learning and Non-Learning Actions
1. Five types of coordination
1. coordinating the separate sub-actions in each learning sub-action
2. coordinating the learning of each sub-action with the learning of other sub-actions
3. coordinating the various learned sub-actions
4. coordinating his learning actions with his other actions
5. coordinating his improved actions with his other actions.
5. Coordination in a utility sense: Coordination in the utility sense means that the individual regards his sub-actions as having a more desirable result than if the sub-actions were combined in some other way. Compare with coordination in a material sense.
6. Coordination in a utility sense means the choice of the optimal alternative
1. Actor considers alternative uses of energy and time
2. She chooses the one that is best
7. Errors: full coordination can probably never be achieved
8. Insider and outsider view
1. Problem of adopting the insider view in describing interaction among many people.
3. Types of Planning and Coordination in a Market Economy
1. Centralized planning:
1. Definition: actions performed by different individuals that are coordinated by a single individual
2. Types
1. Coercive planning: performed by a master under slavery
2. Collective planning: performed by an appointed leader through a collective choice by members of a voluntary group
3. Business planning: employees agree to follow instructions, within limits, of an employer.
2. Decentralized Planning
1. Definition: separate actions performed by different individuals are coordinated separately and voluntarily because the goal of each individual is to gain from exchange.
2. Problems with the ideas of "unintended effects" and "spontaneous result"
1. all actions are intended
2. individuals have an incentive to discover unintended consequences
3. spontaneous result may imply absence of deliberation; yet all choices require deliberation
3. Types of Decentralized Planning
1. Decentralized planning of employers of business organizations, independent contractors and agents - from the point of view of others
2. Centralized planning of employers of business organizations
3. The D.H. Robertson quote - p. 7.
4. Coercive Planning in the Hypothetical Command Society
1. Definition: a society in which an omniscient, omnipotent, and benevolent commander controls all the resources and uses them in a way that most benefits the people.
2. Purpose: its use as a counterfactual
3. Achieving the Goals of Distribution
1. Efficiency of distribution: one in which the greatest total satisfaction is achieved
2. Assume that the commander has distributed all goods efficiently but one; she could easily determine who would get the most satisfaction from the one good that is left
3. But no real human being could have such omniscience; a commander who has the task of distributing goods would fail.
4. Efforts by a non-omniscient, non-omnipotent commander to distribute goods equally will fail if markets are allowed.
1. The emergence of specialist intermediaries and arbitragers
2. How this would frustrate the commander's desire to distribute goods equally
1. Individuals would trade.
2. The intermediaries would get rich.
3. Laws to prevent this would reduce overall satisfaction, require resources, and lead to corruption
4. Achieving the Goals of Production
1. Efficiency in Production: it is not possible to shift a resource from one place in the structure of production to another without reducing the amount of at least one type of good produced
2. To achieve this, the commander would need all of the specialized economic knowledge which, in the market economy, is possessed by all of the separate business planners, independent contractors and agents.
5. Real Command Societies
1. Characteristics
1. lack of knowledge of wants results in efforts to redistribute goods equally
2. lack of technical knowledge results is a most serious problem
2. Ways of dealing with lack of technical knowledge
1. Limit the number and varieties of goods produced
2. Make the production of each good a separate enterprise managed by a bureaucratic manager; special privileges and income for the managers
3. Assign quotas
3. Problems with Bureaucratic Management
1. Bureaus with resource quotas are unresponsive to changing conditions
1. persistent shortages, but few surpluses due to incentives
2. Quality will tend to be uniform
1. due to inability of government agents to discover demands
3. Bureau manager has incentive to shift to lower cost, lower quality production
1. due to costs of monitoring and inadequate incentives for government agents to monitor effectively
4. Low incentive of government monitors to monitor production
6. Agency Problems in Business Planning
1. The principal-agent relationship: The principal hopes that the agent will act in the interest of the agent.
1. owner-employer tries to create an environment in which each of the employees or contractors (i.e., agents) will find it in her personal interest to perform actions that are in the interest of the owners.
2. Characteristics of desirable agents from the owner-employer's point of view
1. loyalty
2. competence in making decisions in the employer's interest
2. Agency Problem
1. Definition: the problem faced by principals of causing their agents to act in their behalf.
2. Methods of solution
1. Hire loyal and competent employees
2. Create an incentive system that rewards loyalty and competence
3. Evolution of incentive systems due to trial and error
7. Agency Problems in Centralized Planning
1. The need for trustworthiness and competence throughout the whole system of production and distribution. Loyalty to the leader is essential. But the knowledge needed by the leader of trustworthiness and competence is impossible for one person to acquire.
2. The repressive nature of centralized planning in practice
1. Led by a single strong leader.
2. A trusted elite, secret police, and purges of people suspected of being disloyal.
3. Disloyalty is the highest crime.
4. Indoctrination of the young to love the leader and the nation.
5. Block of emigration and of communication with illegal emigrants.
8. The Command Society Over Time
1. The solitary actor
1. Absence of specialization
2. The choice to allocate time between ordinary production and research for the production of each good.
2. The market economy
1. Specialization
1. in estimating future demands for and competition in the supply of new goods and new methods of production.
2. competent researchers who can identify new goods and methods of production and cause them to be produced.
2. emergence of business organizations who would employ people from both specializations in each industry.
3. Command Economy: A commander would have to know enough to decide which individuals should be specialists and to assign the specialists to the different industries. No commander is likely to be capable of acquiring such knowledge.

1. Market Economy Consumers as Principals
1. If we conceive of consumers as principals, the entrepreneurs in the different industries can be conceived as their agents.

Chapter 7

1. Introduction: chapter concerned with coordination of the many types of resources, including human capital, described earlier in the book To get an appreciation of this coordination, think about some good that is at hand and try to imagine all of the coordination that was necessary to produce it and show you how you could improve your situation by buying it.
2. Two types of cooperation described by Wakefield
1. Simple: several men lifting the same weight or working on the same project
2. Complex: several people or groups of people employed at different times and different places, and in different businesses; yet all are required to make it possible for a consumer to enjoy the satisfaction of a good.
3. Reinterpretation in light of the modern market system
1. Simple: coordination by a planner through an employment agreement
2. Complex: coordination by means of a series of separate agreements involving independent contractors who have a business relationship with only one or a few of the others.
4. Reinterpretation in terms of planning
1. Simple: centralized business planning
2. Complex: decentralized planning of businesses, independent contractors, and agents.
5. The case of vertical integration: transforms complex coordination into simple coordination
3. Interpersonal coordination
1. Intrapersonal and interpersonal coordination. An example of the latter is trade.
2. Subjective vs. output point of view of coordination: use the case of slavery to distinguish the two
3. Elitist point of view: presumes to know (a) utility of each person or (b) what is best for people.
1. Equality elitist
1. equality overrides all other considerations.
2. Two possible presumptions:
1. presumes to know utilities and assumes that greater equality of utilities is best.
2. presumes that equality in an output sense is best
4. Professional economics: interpersonal comparison of utilities is illegitimate
1. Demonstrated preference: unless people make errors, choice demonstrates preference; therefore exchange demonstrates greater coordination, unless the exchanging parties make errors.
5. Errors and haggling
1. Errors mean that exchange may not result in greater coordination although it is expected to.
2. Haggling means that individuals sometimes have an incentive not to achieve greater coordination because they believe that they can gain more of the surplus through hard bargaining.
4. Coordination Among Many People in a Market Economy
1. Definition of market coordination in a utility sense: a situation in which at least two actions by two individuals yield increased utility to at least one individual yet do not decrease the utility of another individual.
1. Why no situation satisfies this definition.
2. Compensation models are imaginary
3. Conclusion: there is no way to judge whether a particular exchange causes an economy to be more or less coordinated from the subjective point of view.
2. Practical meaning of market coordination
1. The concept of local interpersonal coordination
2. Tracing the effects of a technological advance
1. invention of a superior consumers' good
2. invention of a superior resource (third-order good)
3. even a technological advance does not necessarily lead to greater market coordination in the utility sense.
1. superior consumers' goods have substitutes, the demand for which would decrease.
2. superior resources have substitutes, the demand for which would decrease.
3. Concept of full coordination: imaginary economy in which resources are used in a way that they generate the greatest possible consumer satisfaction, as measured in money.
1. It is not possible for two resources to change places without reducing the output of at least one of the goods and also without reducing the utility of one of the consumers.
5. Specialist Coordinating Roles
1. The intermediary role: discovering and taking advantage of gains from exchange
1. The contractor who needs fencing materials.
2. The role can be played by either trader or by a specialist intermediary.
3. How the intermediary role promotes specialization: wheat farmer, miller, baker.
1. Note that anyone can act in the role of the intermediary
4. "Coordination by markets and prices" means coordination by individuals acting in the intermediary role
2. The undertaking role: coordinates by command; coordination typically requires monitoring
3. The limited purviews of intermediaries and undertakers
6. Coordination of Learning Programs
1. Undertakers play a relatively minor role
1. Lack of incentive because labor and skills are owned by the person who possesses them
2. Means of overcoming this lack of incentive: fringe benefits, pension
3. Job-specific human capital
2. Anticipated coordination
1. Development of talents in the arts and in athletics; if the talent is in demand, an intermediary will probably emerge to coordinate, since coordination will be profitable.

Chapter 8

1. Introduction
1. Two problems in describing economic interaction under the conditions of the market economy
1. Complexity: we have only a limited capacity to comprehend the actions of others
1. specialization
2. inability to see into others' minds
2. Invention: individuals are inventive: they can invent new resources, new goods, and new methods of production and distribution
2. Although we cannot understand inventive activity, we can incorporate it into our descriptions of economic interaction. We do this by including in our descriptions a contrast between a model of a robot economy, or a no entrepreneur economy, and an economy that contains pure entrepreneurs: the pure entrepreneurial economy.
2. The Entrepreneur Role
1. Introduction
1. Characteristics of the Entrepreneur
1. Appraisement
2. Undertaking
3. Uncertainty bearing
2. How some individuals gain control over more resources than others: some deliberately set out to gain control while other deliberately set out to sell or rent their control over resources
3. The role of the robot maximizer helps us focus exclusively on the enterpreneurship
2. Non entrepreneur roles in the market economy
1. Concept of a role
1. why we use the concept of a role: to isolate particular aspects of total action for further study.
2. building a composite of the aspects, or characteristics, in which we are interested
3. the example of the "student role"
4. reservation or qualification: no one is ever only a student
2. Consumer saver role: maximizes utility, has time preference. We often use the term "consumer" to refer to this role, but the saving characteristic is implied.
1. consumers as borrowers and lenders; consumers are always net lenders, since producers must borrow their money in order to maintain or replace their capital.
1. Borrowing and lending in a pure exchange economy
2. Borrowing and lending in an economy with production
3. Resource supplier role: maximizes income from use of resource
3. Detailed consideration of the entrepreneur role
1. Three functions
1. appraisement
1. definition of an appraisal: an estimate of the money value of a resource in the production and exchange of some good
2. an intermediary, or arbitrager, is the purest example of appraisement
2. undertaking: making a decision to employ resources to produce and sell a good
1. directing resources
3. uncertainty-bearing
1. definition: period of production
2. lack of knowledge during the period of production
1. knowledge of wants, methods of production, others knowledge
2. changes in these
3. uncertainty-bearing in everyday life
1. dividing up the uncertainty bearing through financing
2. laws absolving individuals of uncertainty bearing obligation
2. Producing entrepreneurs as final controllers of resources: those who deliberately desire to control resources in an effort to profit from their decisions
3. Entrepreneurial action as a bet: a bet that her knowledge about the wants, abilities, and knowledge of others is correct.
4. Profit and loss
1. definition
2. anticipated and realized profit and loss
3. profit is uniquely perceived (determined) by each individual; what one person regards as profit (loss) may not be so regarded by another.
5. Uncertainty vs. risk
1. uncertainty refers to knowledge of peoples' actions; it is typically uninsurable at reasonable rates
2. risk refers to technical, or scientific, knowledge; it is often insurable
1. class probability: role of a die
2. case probability: science cannot predict for certain because not enough knowledge yet exists; typically non-insurable
6. Active vs. passive roles
4. The Pure Entrepreneur
1. Embodies all of the active characteristics of the human being
2. Special assumptions
1. produces a single good from start to finish: he is perfectly vertically integrated
2. completely guarantees all loans. Therefore, he must possess wealth
1. guaranty: wealth that is not used to finance business but which guarantees that the money lent in business will be repaid
2. function of this assumption: to transfer all uncertainty bearing to the pure entrepreneur
3. How to elucidate inventiveness
1. contrast human action with the behavior of a machine
2. contrast human action with the behavior of animals
3. The No Entrepreneur Economy
1. Roles
1. Robot producers
1. borrow money from consumer-savers
2. buy resources from resource suppliers
3. produce and sell consumers' goods to consumer-savers
4. repay loans with interest
5. no profit, choice or uncertainty
2. Robot resource suppliers
1. pure income maximizes
2. select highest paying employment for their resources
3. turn income over to consumer savers
3. Robot consumer savers
1. pure utility maximizes
2. use income to either buy consumers' goods or save
3. select highest interest on their saving
4. No time, although we can conceive of a kind of simulated period of production
2. Households, Firms, Industries, and the Structure of Production
1. Households
1. Real households
1. consist of members who act together as a unit
2. own resources and financial assets, including net worth in businesses
3. produce goods and services
4. plan and coordinate
5. participate in undertaking of businesses
6. act as intermediaries
7. speculate
8. bear uncertainty
9. make errors and adopt means of reducing the harmful effects of their errors
2. No entrepreneur economy households
1. a utility maximizing robot consumer saver
2. consumes perishable goods
3. an income maximizing robot resource supplier
4. cannot appraise resources; can only respond to prices bid by firms
2. Firms
1. Real firms
1. are sole proprietorships, partnerships, or corporations
2. produce products of different qualities and types
3. may be conglomerates
4. may be only partly vertically integrated
5. are often continuously engaged in research
2. No entrepreneur economy firms
1. are sole proprietorships
2. produce only one consumers' good
3. are perfectly vertically integrated
4. produce the same product again and again according to the same methods of production
5. borrow money from households, buy resources from households, sell their goods to households, use the proceeds to repay their loans plus interest
6. cannot earn profit
3. Assumptions about Alternatives
1. Homogeneous units of heterogeneous goods
2. Productivity differences among resources of the same type
3. Capital vs. non-capital resources
4. Assumption of markets and prices
5. Absence of time; time represented by the need to produce capital goods before achieving the lowest production cost
6. Competition
1. Absence of inventiveness
2. No distinctly human copying; all copying is immediate
3. Absence of rivalry; price competition means that all firms must charge same price

Chapter 9

1. The Market Demand Curve
1. A relationship between price and quantity demand for all consumers of a good.
2. Demand curve is an aggregate: the horizontal sum of individual demand curves.
3. Consumers' surplus
1. Good given to the highest valuing consumer(s)
1. Determining the consumers' surplus for one unit
2. Determining the consumers' surplus for many units
1. Unit-by-unit calculation: add the distances.
2. The area under the demand curve
2. Good is sold to anyone who is willing to pay more than the market price
1. Determining the consumers' surplus for many units
1. Unit by unit calculation: add the distances.
2. The area under a demand curve but above the price line (this assumes that the same market price is available to all consumers and that consumers can buy as many units as they want)
4. Applications of Consumers' Surplus Analysis
1. Change in consumers' surplus due to a change in market price
2. Each consumer must pay the highest price he is willing to pay for each unit
2. Supply and Cost
1. The assumption of increasing marginal costs
2. Why supply has an upward slope
1. Specialized resources Limited in Number
1. Definitions of specialized and non-specific resources
2. The concept of a superior resource
3. The example of a fixed amount of rice-growing land: An increase in the demand for rice raises the demands for the land. Although no more land is available, each producer competes with the others for the existing land in order to increase his profit. The rising bids for land raise the price of the land, thereby raising cost to each supplier of supplying the additional amount of rice (i.e., raising the marginal cost).
4. The case of a decrease in demand: how it decreases the bids.
2. Diminishing marginal utility of other goods equals rising marginal opportunity cost
1. Assume a non-specific resource that is limited in supply
2. As more is bid away from other industries, the marginal utility of goods in those other industries rises (figure 9-6)
3. Firms hire the most productive resources first
1. Ranking a specialized resource in terms of its productivity.
2. Assume that highly productive and lowly productive units of the resource have the same opportunity cost.
3. Then rice growers would hire the most productive units first.
4. An increase in demand for rice would increase the demand for rice-growing land, leading rice growers to demand a larger amount of it. But the only land available would be less productive than that which was already being used. Since growers would have to pay the same price for it (because we assumed equal opportunity cost), the marginal cost of producing an additional quantity of rise would be higher.
4. Increasing marginal disutility of work
1. Seems like a reasonable assumption
3. Suppliers Gain
1. Represented similar to the representation of consumers' surplus
2. Concept of producers' surplus questionable because producers cannot earn a surplus. Only owners of resources can, as we shall see in Chapter Eleven
3. Shortages, Surpluses and Market Equilibrium
1. Full coordination in a single market: a situation in which (1) all of the units for which the marginal cost is less than or equal to the price charged by producers have been produced and sold and (2) all of the units for which marginal utility is greater than or equal to price have been bought by the individuals who attach the highest utility to them.
2. The tendency toward full coordination
1. If producers charge a price that is higher than the equilibrium price, a surplus will lead producers to reduce price.
2. If producers charge a price that is lower than the equilibrium price, a shortage will lead producers to raise price.
3. Consumers' surplus and suppliers gain in equilibrium

Chapter 10

1. Introduction
1. Two models of competition among firms: long run and short run
1. Long run: capital can be produced; prices of resources reach their "normal" level; at this level, no producer wants to shift from one kind of capital to a different kind.
2. Short run: new capital cannot be produced; prices of specialized resources can be above or below normal; producers of capital want to shift but they cannot. (There is not enough "time.")
2. Two purposes of the two models
1. To show how capital goods prices prompt producers of capital to shift resources toward the production of capital goods with high prices and away from capital goods with low prices
2. To demonstrate the set of prices and quantities that correspond to different assumptions about demands and technology
2. The Traditional Model of the Firm as a Profit Maximizer
1. Short run costs
1. Average cost
2. Marginal cost
3. Relationship between average and marginal cost
2. Long run costs
1. Economies of scale
2. Diseconomies of scale
3. Demand faced by the perfectly competitive firm
1. Price taker vs. price maker; infinitely elastic
4. Short run profit maximization
1. The case of profit
2. The case of loss
1. should a firm stay in business? Only if it is covering its total variable costs - the costs of its variable resource
3. The break-even firm
5. Interindustry long run equilibrium and profit
1. Concept of economic profit: money profit that is greater than what is needed to keep the producer's money in this industry instead of shifting it elsewhere
3. The Firm and the Industry
1. The firm and industry supply curves
1. Firm's supply curve is its marginal cost curve
2. Industry supply curve is the horizontal sum of the firms' marginal cost curves
2. Effects on industry of firms' leaving and entering an industry
3. Effects on firms of firms' leaving and entering an industry
4. Perfectly competitive firm and industry in long run equilibrium
4. A Coordinated Industry Without Profit