Strategic Econ

You are here: Home / Archives for John Fountain

by Leave a Comment

Menu for the “Doug and John” show – microeconomic principles

Annotated Table of Contents for Doug and John’s webcast series

 

Introduction to the series (by John Fountain )

The typical pattern in each webcast is for John to raise questions for Doug about the important economic concepts that are introduced in Doug’s first year microeconomics course, Econ 103 at Simon Fraser University.

Hold on. Aren’t first year econ courses a dime a dozen these days? What’s different about Doug’s course? Well, 2 things – first the text , and next, the instructor. . Doug’s textbook “Economic Principles: 7 ideas for thinking about almost anything ” and his course, challenges students – and instructors who adopt the text for their own courses -to think, reason, argue, and apply the key ideas of economics within a box: the neoclassial model of economics. Thinking through the lens of a model is a key componeet of scientific thinking and thinking like an economist ( or learning to think like an economist) is a key component of economics as a science. This course and this text (especially the end of chapter questions) is not a course where rote memorisation or mechanical calculations will enable you to pass, much less do well. In fact, I (JF speaking ) haven’t seen a textbook like this since Alchian and Allen’s text “Exchange and Production: Competition Coordination and Control.”. It turned out that both Doug and I taught first year econ courses from Alchian and Allen way back….decades before most students we teach now were born! And that book taught us to “be” economists. Doug’s book is doing that now for students at SFU.

But the book is one thing, Doug the instructor is another. He is everything a student could ask for in a university instructor, everything – dynamic, challenging, stimulating, interesting, funny ….his lectures are a treat! And not just for undergrdas. Every grad student in economics, every sessional instructor, every new, and most seasoned, introductory economics instructors should themselves engage with introductory microeconomics Doug Allen style. As he says, students either love my course or hate my course…there is no middle ground. So this series is as much an introduction to Doug as an economist as it is to the basic ideas of economics and of economic reasoning. Enjoy !.

1 Maximisation , Greed and Self -interest
What makes an argument or an explanation an “economics” argument , and “economics” explanation? Doug claims it – economics – has to incorporate the concept of greed. Greed is maximisation – or is it? John challenges Doug’s views here . Aren’t greedy people cold, calculating, grabbing, narcissistic……well, all the bad stuff? The answer, for Doug, is that greed and maximisation – people do the best they can with what they’ve got – are one and the same. Someone with what we’d all call nice friendly cooperative other regarding objectives or preferences is greedy, just as someone with sicko, evil , nasty sadistic or masochistic preferences – self or other regarding – can also be greedy. Hmmm. Subtle stuff here: the tradeoffs in a set of preferences are NOT the same thing as the maximisation process that is directed at improving these objectives. That maximisation process is what Doug means by greed, not the content of the objectives. Oh, and by the way, the basic modelling assumption of greed or self interest is used to explain behaviour, not judge it or condone it. That’s an important distinction we take up later when we discuss positive and normative. (Back to Table of Contents)

2 What about doing good? altruism?
John asks – what “is” non-maximizing behaviour? Doug answers , “pure” altruism. But what do we understand by that idea? When A does good for B and does not further his/her own objective? For example, A loves her children and (tries) to do good for them. Fair enough, but A herself furthers her own objectives or preferences doing those loving acts. Going back to the discussion on greed and maximisation..that motivation does not mean your objectives aren’t to do good for others. Maximisers help others, well some maximisers, an some others. An intriguing idea here is that maximisation itself is unobservable, it is an assumption, a way of guiding thinking, but not itself directly testable, observable. Ditto for altruism, well pure altruism, the kind where A does good for others without any net benefit to herself. John brings in a question about opportunism and maximisation – where does that fit into the economists way of thinking? (Back to Table of Contents)

3 Positive and Normative economics?
Positive economics is about explanation of behaviour, not judging it, not condoning it….even if the motivations behind it are, sometimes, less than “desirable”. Normative economics is about what should be, about how to change or improve institutions, behaviours, events often from a political perspective using political power. So how do economists, and how does economics, impact on policy? There is a deep philosophical literature within the economic tradition addressing “optimal” this and “optimal” that, sometimes based on an idea of maximizing a “social welfare function”. Maximisation again. But what role does economics play in improving social welfare . Doug explains.(Back to Table of Contents)

4 Measuring and thinking about “value” in economics
Economists bring a fresh, and scientific, twist to the age old concept of “value”. In a fascinating dialogue, John and Doug tease out the ways value can be measured, marginal value(s), total value(s), surplus value(s) of apples and oranges, of life and death. The concepts discussed here are fundamental ones for all economists – some are controversial even within economics , and most are simply alien to non-economists. Anyone interested in the conceptualisation and measurement of value, befit, and cost – beyond the persuasive rhetoric of moral philosophers , or advertisers, or policy makers – will learn something new from this clip.(Back to Table of Contents)

5 Humans, robots , and choice
Do our models in economics model human beings as robotic calculators? After all, given an objective function and given some constraints, computers can be programmed to find the choice – THE choice. Where does humanity come in – or not? learning?mistakes? Does “free will” or conscious individual or social deliberation come into this model? Doug makes the distinction between ability to act within a constraint set and willingness to make selections available from that constraint set to argue that our models are NOT in fact robotic….the “could have done otherwise” is always present, and important in the modelling. John raises the question of conscious choice, exploration of options and implications with, perhaps, the aid of a consultant and then…in a limited state of information or ignorance , making a choice? Doug explains the difference between neoclassical economics built on assumptions of either simple well know stations or modern economics where uncertainty, ambiguity and learning…about preferences and constraints occurs. Then we return to the issue of accountability and voluntary choice , and evidence for accountability and voluntary choice in bargaining situations, negotiating decisions….with an example from the dynamics of family: to paint or not to paint the house, that is the question! But what arrows of outrageous fortune undermined the perfect reasonable choice!!(Back to Table of Contents)

6 Wealth and Income
“What is the difference between income and wealth? “ Doug explains the difference in terms of stocks and flows and illustrates why the difference matters in terms of a practical policy problem – measuring poverty and doing something about it. (Back to Table of Contents)

7 ”What is economic profit?”
DA explains the concept of economic profits – which is very different from accounting profits or a common sense idea of something “added on” to input costs in the process of production. Are large “profits” shameful? Are “losses” – negative profits – events that require subsidising? DA explains how economics conceptualises profits from productive activities as a difference in values : the values created out of the goods and services produced less the values of the inputs used to make/create the outputs. The key idea about “economic profits” here is that when inputs are taken from low valued (other) uses and turned to high valued uses (in a different, specific, business activity) that difference is positive, net value is created. When inputs are taken from low valued (alternative) uses and turned to even lower valued uses that difference is negative, net value is destroyed. JF cites a personal example of trying to develop and run a small computer reselling business that besides having large cash flows, in and out, also had enormous personal risks and huge time costs, none of which showed up in the accounting books. DA explains a basic and important difference between accounting profits and economic profits and discusses the role of non-monetary benefits form certain productive activities – e.g. being a musician, running a family farm, etc? Then we ramble a bit about changes in income “really” over the last 20 centuries. (Back to Table of Contents)

8 Consumers, producers and specialisation
IS there a duality deep within economics? We have consumers who maximize utility and producers that maximize profits – but really aren’t there just people, maximizing? How do these two apparently separate processes of maximisation fit together, in our models, and more importantly in the real world? Answering this questions leads us into a discussion of the marvel’s of specialisation in exchange and production. We don’t use the terminology of the Fisher separation theorem named after the great economist Irving Fisher who articulated the idea – but the concept is huge. Maximizing net income or profit in highly specialised production activities using highly specialised knowledge and then solving an immense coordination problem for actually getting all that specialised output to the consumers who want it through market exchanges is part and parcel of utility maximisation for the workers managers and owners in the producing units. The flip side of the gains from specialisation re the opportunity costs of restrictive polices where the extent of specialisation is sharply constrained: compare health services for people in New Zealand and in Canada compared to health care for cat and animal pets!(Back to Table of Contents)

9 Selection Bias , observations and measurements, and….ticket scalping!
Economics brings an interesting perspective to empirical social science research , whether based on survey data or on more direct observation. The “data” we observe is biased! That is, we know in our model that what we observe and measure is the outcome of self interested behaviour, maximizing choice(s). Take for example the apparently obvious and overwhelming response to a popular singer’s concert – “it was great”. Was it? AN economist would be skeptical, somewhat, because you’d expect that response from a true fan who chose to spend hours waiting in line. How could it not be great, for them? Selection bias is everywhere, once you start looking for it. But in true Doug and John style, the example raises the question of why there are often many empty seats at otherwise popular events, and why ticket scalpers are often (usually wrongly, but possibly rightly) vilified . We digress….but what did you expect? We’re economists….(Back to Table of Contents)

10 Intensive and Extensive Margins
What is the meaning of the intensive margin and the extensive margin of a market? John asks, Doug explains….on the supply side, and on the demand side. This would make a great short answer exam question!(Back to Table of Contents)

11 Economic Profits and Economic Rents
John asks – what does the zero profit theorem really mean? How can firms exist without making a profit? Doug begins his answer with a careful distinction between the concept(s) of accounting profts and economic profits, developing the idea of a return to owners as a “residual claim” and explaining (again) the difference between accounting cost categories and conventions as compared to opportunity cost measurements and concepts. Zero economic profit is completely consistent with a positive accounting net income! A positive economic profit – at the margin – in some activity X is a signal indicating that net value of more inputs in activity X are higher than elsewhere – so maximisers will move resources into X to try to capture that value. But not all suppliers have the same opportunity costs, so some will make positive economic profits – i.e. difference between their revenues and their own opportunity costs in equilibrium. That difference is called an economic rent. Doug explains how those who earn positive and large economic rents in equilibrium can in fact be exploited….mainly because the values to them of doing different things in different activities – their opportunity costs – are low so the costs to them of exiting are actually very large. Paradoxically, this actually makes them more susceptible to exploitation than others with lower economic rents. They are trapped by the economic rents they earn!(Back to Table of Contents)

12 Returns to Scale
The concept(s) of returns to scale -are used in every day contexts and by economists, and more often than not mis-used. After defining the concepts of returns to scale – increasing, decreasing, and constant – Doug identifies two problems. First, decreasing average costs per unit over a range of outputs is associated with increasing returns to scale, yes. But it is also associated with a fixed input or set of inputs to which additional variable inputs are applied. Using an example from air travel Doug explains how more often that not the fixed input explanation is the more likely one – because not all inputs actually can be scaled up to increase output , some have to remain fixed. Second. can their really be anything other than constant returns to scale – the replication (cloning) argument.(Back to Table of Contents)

13 Monopolies – are they a bad thing?
Are monopolies a bad thing? Don’t they just rise prices, restrict output, crush – or absorb – competitors to protect their high returns and squelch innovation? Doug answers “No”, or in a true economists’ fashion, “No not necessarily”. It depends …..To be sure collusive activities can and do occur, and many of our leading ideas on the evils of monopoly stem from an era of discovering and controlling collusive action between competitors, actions sometimes sanctioned by the political institutions of the day. But GM and IBM in their heyday were large because they were good…and now they are not so large because Honda, Toyota, Apple, Microsoft, Google and Apple came along and THEY were also good, indeed sometimes better. Before jumping to the normative question – how can we keep the good and eliminate the bad? – Doug argues that we do need to learn, using our models of maximisation in a world of costly information, how this dynamic process works and the role that monopoly power plays in it.(Back to Table of Contents)

14 Pangloss Efficiency
This is a GREAT clip, contains some deep questions, and was a lot of fun to make. JF starts by asking why Voltaire’s “Candide” is one of Doug’s favourite economics books of all time and why he assigns it for his students to read ! Voltaire is mocking the intellects who started our discipline, the very idea of an “invisible” hand made famous by Adam Smith. Doug is unique among economists at confronting head on the implications of the economic view of the world – behaviour, institutions, conventions, are , in the model of human behaviour that defines economics, constrained efficient…so in the model, we all live in the best of all possible worlds given the constraints. The Panglossian dilemma. Dr Pangloss rules OK – or does he? Most economists simply ignore the implications here, others (e.g. moi, Milgrom and Roberts) recognize them but can’t stomach it. But Doug quite persuasively argues that the opposite point of view, espoused in the huge literature of market failures and social welfare economics – and some parts of behavioural economics – is really intellectual arrogance. We, economists, will tell others who are doing the best they can with what they’ve got that, well, they’re not? We may not understand their behaviour (yet), we may not like or condone that behaviour, but we view it as a maximizing solution to a problem that individual or group is facing and need to dig deeper to understand what is their problem what is their solution – not our problem with our solution which we would like them to implement. But we dig deeper with maximizing models, not by abandoning maximizing models. (Back to Table of Contents)

15 Costly Information
Aren’t the assumptions are made about information, ignorance, lack of knowledge in the neoclassical model ridiculously simplistic? No…and yes , says Doug (he’s an economist after all!). The assumption of being completely informed and of free information actually provides a model of human behaviour that works very well to explain prices and quantities in markets. BUT, developing a model (not the neoclassical model) that uses different assumptions – that people are ignorant of most things, that they are uncertain about even what they think they know, that they learn and make mistakes – makes economics even more interesting. The maximising principle is still there but attention now turns to modelling “information” problems. Information is not free and freely available and we need to recognize this in our thinking, because otherwise – the bad news – is that we run into the logic of the Coase theorem but – the good news – we also have a Nobel Prize winning idea from Ronald Coase. Doug explains the Coase theorem, showing how Coase used it to focus economists’ attention on a particular type of cost, transactions costs, to help understand why ownership, property rights, rules, laws, organisational form do matter, can’t be explained by the neoclassical model, but can be explained by maximizing models that recognize a vast array of transaction costs.(Back to Table of Contents)

16 property rights
Many people, economists included, think of property rights as exclusively to do with laws, legislation, enforcement by police and the Court system in a modern state. A deep thinker, economist Armen Alchian of UCLA changed all that: economic property rights are about ability to make choices, about effective control and decision making power, whether or not the law is on your side. As Doug explains, in most cases, having legal rights helps to extend and empower economic property rights, but the two are quite different concepts. Think of the social conventions and institutions of marriage or employment in any modern organisations, public service , manufacturing or high finance, or war for that matter. Economic property rights created in those institutions exist “in the shadow” of legal rights that themselves are sometimes very inadequately articulated or enforced , or that are in conflict with emerging economic property rights. Doug uses the example of the family to discuss constraining/enabling economic property rights, customisation and standardisation , greed and selfishness and love …as an economist! This is a fascinating and challenging webcast to watch and to learn from – it, and the next companion webcast on transaction costs create a truly revolutionary way of thinking as an economist!(Back to Table of Contents)

17 transactions costs
The key idea here is that transactions costs and property rights are fundamentally linked together. Transactions costs are the costs of establishing and maintaining ongoing economic property rights (i.e. being able to make choices and decisions over relevant resources in a world of other maximisers who are also trying to enlarge their own economic rights over resources) . But they also include deadweight losses – the values of potentially beneficial exchanges and interactions not undertaken – associated with distrust – indeed Doug argues that the reduction of transactions costs associated with bargaining and (mis) trust is one of the most significant ways that wealth has been created in history. This clip is worth following through to the end for a couple of reasons – first because it shows how an imperfect, unscripted intellectual argument/discussion proceeds as John tries to explain an important idea through an example ….imperfectly…but eventually. Doug wonders if we’re getting off track but after a little to and fro in the end we get there, and the result is worth it. Not only are the important ideas understood after an initial mis understanding, but Doug uses the dialogue to sum up the significance of the Coasian view of the world via the economists’ transactions cost lens.(Back to Table of Contents)

18 Traffic
Economics can give insights, understanding, and explanation to ….anything. In this webcast Doug takes to the whiteboard to discuss how decentralised solution between drivers at intersections can lead to….chaos or coordination, efficient or inefficient laws, or as in the case of Rome’s roundabouts, chaotic coordination that works!!(Back to Table of Contents)

19 Garbage Collection
One of the end of chapter questions examines a change in the pricing of garbage collection for residents of Toronto. The city charged $12 a week, no matter how many cans were put out on the curb-side, and on average residents disposed of 3 cans of garbage each week. A proposal was made to change the pricing structure to $4 per can. Does this change to the pricing structure make any difference? Well, an economist thinks “on the margin”, so Doug reconstructs enough information about individual demand curves to……analyse the problem. And yes, this change will make a difference – in fact, several differences- in the number of cans and in the weight per can!! People respond to incentives. (Back to Table of Contents)

20 “People not Profits – Smash Capitalism” Bumper Sticker Economics
Danny, an econ 103 student, asks Doug about a question in the textbook – how to think about the bumper sticker statement “people not profits – smash capitalism”. As in webcast 7, its important to go back to definitions and measurements when thinking (like an economist) about profits . Profit, thought of correctly, is not an additional “thing” that is added on to “costs” , and something that can just be wiped off the slate. Doug explains that economic profits always exist wherever there are people making choices, since profit from an activity is the difference in value of a bundle of resources used in that activity compared to the value those resources could have in (the next highest valued) other activities. . Even a non profit organisation like a sports club or a school or a church “makes” an economic profit in the economic sense of the term from the real resources (capital goods) it uses. . Remember though, economic profits in the sense of differences in value can be positive (“make a profit”) or negative (“bear a loss”), and somebody, an owner(s), has to claim these profits or bear these losses. And “smash capitalism”. Why? Everyone is a capitalist, because even in a system of communism ordinary people own themselves , you yourself are a capital good, and you earn (pos or neg) economic profit from hiring out your labour services .(Back to Table of Contents)

21 The Stag Hunt Game and Coordination
Vlad, an econ 103 student, asks for some help in creating a payoff matrix for the stag hunt game. John provides some context for the game, and analyses it with Vlad, the introduces and explains the concept of a Nash Equilibrium, In this game there are two Nash equilibrium, creating a coordination problem: what will people expect? How will those expectations be formed? Vlad asks whether the Stag Hunt is a prisoner’s dilemma game – the answer is no, and John provides a brief explanation why. (Back to Table of Contents)

22 extreme prices for sports events and the “values” of the very wealthy.
Danny describes a debate with his brother about apparently ridiculous prices, $58000 a ticket, for a curtsied seat at an NBA game. The brother claims a wealthy person would never sell such a seat. Doug explains how even the extremely wealthy (1) face tradeoffs and (2) have their “price”, in some currency.(Back to Table of Contents)

23 Biology , Economics and Evolution
What is the closest “subject” to economics? Business? accounting? No argues Doug – it’s biology. There are a couple of reasons. One is they share a principle of “natural selection” and survival…even without conscious appreciation . Another is the idea of maximisation and reciprocity. Doug explains, again, why the ideas of reciprocity and altruism (self sacrifice) are fundamentally distinct. (Back to Table of Contents)

24 Crime and Punishment
One of the questions in the text is why large penalties for any and every crime – stealing a loaf of bread or murdering someone – might lead to more serious crimes, even while they reduce the overall crime rate. Doug explains some interesting incentive effects of heavy handed punishment regimes , using the ideas of marginal returns and marginal punishments, and the extensive and intensive margin concepts discussed in an earlier podcast.(Back to Table of Contents)

25 Oil and Gas
Ryan, an econ 103 student, asks : Why would British Columbia both buy electricity from Alberta and sell electricity to Alberta? Doug uses simple supply and demand reasoning to explain what is going on and how trade in electricity benefits both provinces – even though BC sells at high prices and buys at low while Alberta buys at high prices and sells at low prices . The key ideas on the supply side are (1) very low marginal costs for electrical power in hydro power systems compared to the other two sources, (2) fairly constant marginal costs up to the limits of production capacity in all systems, and (3) indirect electricity storage possibilities with hydro that aren’t available with coal or natural gas plants. And, on the demand side, the key idea is low demand in the night, high demand in the day (in both provinces). Put the those ideas together and…voila! understanding of what would otherwise be puzzling? (Back to Table of Contents)

26 Economics and the Movies
Sometimes being and economist can ruin a movie for you! The plot by Goldfinger to destroy Fort Knox in order to increase the price of gold is, well, bad economics!. Harrison Ford as Indiana Jones ….normally a pretty intelligent character…violates the canons of dominant strategy reasoning in the Temple of Doom. But some movies get the economics right…Dr Strangelove and the Doomsday Device. Enjoy!!(Back to Table of Contents)

27 Intertemporal Choice
Vlad , an econ 103 student, asks: When you are young you give up health to get wealth. When you are old you give up wealth to get health? How does this behaviour fit in with the maximisation idea? Doug explains using the idea of marginal value – marginal value of wealth, and marginal value of health, at different stages of your life depending on the variations in “availability” of different amounts of wealth and health over a lifetime. Marginal reasoning and maximisation rule OK!(Back to Table of Contents)

28 Ramblings on Game theory
Doug asks John some questions about Game Theory, why Game Theory models seem to have taken off and captured the imagination of both students and academics. The conversation wanders back and forth discussing assumptions in models made about consciousness and beliefs, reasoning ability – or lack thereof , takes a deeper look at the Prisoner’s Dilemma game, mentions Schelling’s “Strategy of Conflict” in the same breath as Ondaatje’s “the English Patient” , examines repeated game ideas and the notion of “institutions” to examine how maximisers try to “escape” prisoner dilemma type situations and move away from bad equilibria coordination problems. (Back to Table of Contents)