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[[Economics|Economics Lectures]] - <nowiki>[</nowiki>[[Economics_Lecture_One|1]] - [[Economics_Lecture_Two|2]] - [[Economics_Lecture_Three|3]] - [[Economics_Lecture_Four|4]] - [[Economics_Lecture_Five|5]] - [[Economics_Lecture_Six|6]] - [[Economics_Lecture_Seven|7]] - [[Economics_Lecture_Eight|8]]<nowiki>]</nowiki>
[[Economics|Economics Lectures]] - <nowiki>[</nowiki>[[Economics_Lecture_One|1]] - [[Economics_Lecture_Two|2]] - [[Economics_Lecture_Three|3]] - [[Economics_Lecture_Four|4]] - [[Economics_Lecture_Five|5]] - [[Economics_Lecture_Six|6]] - [[Economics_Lecture_Seven|7]] - [[Economics_Lecture_Eight|8]]<nowiki>]</nowiki>
Fifth Lecture – Short Run Output, also Coase Theorem
Instructor, Andy Schlafly
==Introduction==
We have talked about the concept of “equilibrium”, which is when the price and quantity settle down to their appropriate amounts after bouncing around for a while. At equilibrium, supply price and quantity equal demand price and quantity. But it may take time to get to equilibrium, with much trial and error in pricing in the meantime.
We have talked about the concept of “equilibrium”, which is when the price and quantity settle down to their appropriate amounts after bouncing around for a while. At equilibrium, supply price and quantity equal demand price and quantity. But it may take time to get to equilibrium, with much trial and error in pricing in the meantime.
We will not spend this entire class on marginal cost and revenue. We are also going to introduce two other concepts basic to modern economics: efficiency and the Coase Theorem. You’ll find those topics extremely interesting. However, let’s cover the basics first.
We will not spend this entire class on marginal cost and revenue. We are also going to introduce two other concepts basic to modern economics: efficiency and the Coase Theorem. You’ll find those topics extremely interesting. However, let’s cover the basics first.
==The Short Run==
Imagine yourself as the President of a company making widgets, our imaginary good. If it costs you $200 to make 10 widgets and $205 to make 11 widgets, then what is your marginal cost (MC) of the 11th unit? It is only $5. What is its average cost? Nearly $19 ($205 total cost divided by 11 total units). Average cost is often greater than the marginal cost. This makes sense, because once you pay for your factory and workers, you do not have much additional cost to produce an extra unit. This is called economies of scale: the bigger your operation, the cheaper you can make one more unit.
Imagine yourself as the President of a company making widgets, our imaginary good. If it costs you $200 to make 10 widgets and $205 to make 11 widgets, then what is your marginal cost (MC) of the 11th unit? It is only $5. What is its average cost? Nearly $19 ($205 total cost divided by 11 total units). Average cost is often greater than the marginal cost. This makes sense, because once you pay for your factory and workers, you do not have much additional cost to produce an extra unit. This is called economies of scale: the bigger your operation, the cheaper you can make one more unit.
Let’s make sure we understand this by looking at another example. Suppose that hiring one more sales agent at $80 per day in our clothing store enables us to sell 8 more dresses. What is our marginal cost for dresses at that point? It is simply the additional cost of $80 (the wage) divided by that employee’s marginal productivity of 8 new sales, yielding a marginal cost of $10 per dress.
Let’s make sure we understand this by looking at another example. Suppose that hiring one more sales agent at $80 per day in our clothing store enables us to sell 8 more dresses. What is our marginal cost for dresses at that point? It is simply the additional cost of $80 (the wage) divided by that employee’s marginal productivity of 8 new sales, yielding a marginal cost of $10 per dress.
==Efficiency==
Imagine what your day is like as President of the widget factory. You arrive to work earlier than everyone else, because you care the most about the success of your company. During the workday you walk through your factory to see how things are going. You see employees chatting at the water cooler, talking to their friends on the phone, or not showing up for work at all. This irritates you because you are paying for their time. You tell them to get back to work.
Imagine what your day is like as President of the widget factory. You arrive to work earlier than everyone else, because you care the most about the success of your company. During the workday you walk through your factory to see how things are going. You see employees chatting at the water cooler, talking to their friends on the phone, or not showing up for work at all. This irritates you because you are paying for their time. You tell them to get back to work.
Some transaction costs are imposed by governmental regulations. In many areas, homeowners must receive permission to chop down trees on their yards or build an addition. The time and expense in obtaining that approval by the local zoning board are transaction costs.
Some transaction costs are imposed by governmental regulations. In many areas, homeowners must receive permission to chop down trees on their yards or build an addition. The time and expense in obtaining that approval by the local zoning board are transaction costs.
==A Brief Look at Law and Economics==
We live in what is known as the “regulatory state.” The government regulates almost every aspect of business. It is even worse in most other countries. In many industries, the government tells business how much they can charge, how much they can pollute, how much they have to pay their employees, and so on. Government has even more regulations for itself, regulating nearly every aspect of hiring and firing government employees and doling out benefits to the public.
We live in what is known as the “regulatory state.” The government regulates almost every aspect of business. It is even worse in most other countries. In many industries, the government tells business how much they can charge, how much they can pollute, how much they have to pay their employees, and so on. Government has even more regulations for itself, regulating nearly every aspect of hiring and firing government employees and doling out benefits to the public.
To take another example, states tried to eliminate people from welfare when they felt it was no longer needed or desirable. People eliminated from welfare sued, demanding a formal hearing on their “rights” to welfare before being eliminated. In a U.S. Supreme Court case entitled Goldberg v. Kelly (1970), the Court agreed with the welfare recipients and created a constitutional right to a hearing prior to be removed from a welfare program. Can you think of a purely economic argument against that requirement?
To take another example, states tried to eliminate people from welfare when they felt it was no longer needed or desirable. People eliminated from welfare sued, demanding a formal hearing on their “rights” to welfare before being eliminated. In a U.S. Supreme Court case entitled Goldberg v. Kelly (1970), the Court agreed with the welfare recipients and created a constitutional right to a hearing prior to be removed from a welfare program. Can you think of a purely economic argument against that requirement?
==The Coase Theorem==
There is a remarkable economist named [[Ronald Coase]], who is now over 95 years old. He is responsible for perhaps the single greatest economic insight of the past fifty years, for which he won an entire Nobel prize in 1991 (most Nobel prize awards are shared among multiple recipients, but not this one).
There is a remarkable economist named [[Ronald Coase]], who is now over 95 years old. He is responsible for perhaps the single greatest economic insight of the past fifty years, for which he won an entire Nobel prize in 1991 (most Nobel prize awards are shared among multiple recipients, but not this one).
Homework questions will explore some of the consequences. But here is one example to start you in the right direction. Suppose the government of the State of Massachusetts heard that Ralph Waldo Emerson built a better mousetrap and many people were beating a path to his door to buy it. The government then seized the rights to the mousetrap and auctioned those rights off to the highest bidder, pocketing the cash. Afterwards, will more or less mousetraps be sold? The exact same number will be sold. It doesn’t matter who owns the mousetrap (assuming transaction costs are zero).
Homework questions will explore some of the consequences. But here is one example to start you in the right direction. Suppose the government of the State of Massachusetts heard that Ralph Waldo Emerson built a better mousetrap and many people were beating a path to his door to buy it. The government then seized the rights to the mousetrap and auctioned those rights off to the highest bidder, pocketing the cash. Afterwards, will more or less mousetraps be sold? The exact same number will be sold. It doesn’t matter who owns the mousetrap (assuming transaction costs are zero).
==Assignment==
Read and, if necessary, reread the above lecture. Then answer these questions:
Read and, if necessary, reread the above lecture. Then answer these questions:
Introductory: 1. Your boss asked you to work overtime. Is that a short-run or long-run solution for him?
===Introductory===
1. Your boss asked you to work overtime. Is that a short-run or long-run solution for him?
2. Explain briefly economic “efficiency”. Give an example of something that is efficient, and something else that is not.
2. Explain briefly economic “efficiency”. Give an example of something that is efficient, and something else that is not.
Intermediate: 4. Your widget company has the following costs: Producing 10 widgets, your costs are $2000. Producing 8 widgets, your costs are $1800. Producing 6 widgets, your costs are $1500. Producing 4 widgets, your costs are $1200. Producing 2 widgets, your costs are $800. Producing 0 widgets, your costs are $400. What is your fixed cost? What is your MC for widgets 7 & 8? What are your average costs for producing 4 widgets?
===Intermediate===
4. Your widget company has the following costs: Producing 10 widgets, your costs are $2000. Producing 8 widgets, your costs are $1800. Producing 6 widgets, your costs are $1500. Producing 4 widgets, your costs are $1200. Producing 2 widgets, your costs are $800. Producing 0 widgets, your costs are $400. What is your fixed cost? What is your MC for widgets 7 & 8? What are your average costs for producing 4 widgets?
5. A regulator had to choose new regulation A or B: (A) imposed substantial new transaction costs on consumers, while (B) did not. Which option would the Coase Theorem tend to prefer? Say why.
5. A regulator had to choose new regulation A or B: (A) imposed substantial new transaction costs on consumers, while (B) did not. Which option would the Coase Theorem tend to prefer? Say why.
7. Explain the difference between marginal cost and average cost.
7. Explain the difference between marginal cost and average cost.
Honors: Write a 300-word essay on one or more of the following:
===Honors===
Write a 300-word essay on one or more of the following:
10. Democratic politicians complain about the gap between the rich and poor. Would the economy work any better if the gap were smaller? Assume the absence of transaction costs.
10. Democratic politicians complain about the gap between the rich and poor. Would the economy work any better if the gap were smaller? Assume the absence of transaction costs.