Class Forty Two

Profit= total revenue - total cost
Why do we get wages and pay rents?
We ALSO know that the profitability of investing in any asset must be zero over time, so that the value of our formula is zero.What is a wage and why can we get the wage?
Wage is a contractual agreement between worker and employer that specifies precisely what worker will be doing and what employer will be getting and giving.


Contract lays out what a worker should do and how much he can get; employer knows how much he gets and how much cost he bears to hire the worker.

So the whole essence of wage is to eliminate uncertainty.


Rent also functions to reduce the uncertainty.
Lenders know how much he can get as compensation and borrowers know how much he must produce.

What is interest?
It is the price of using money today rather than future.
Price comes from demand and supply.
People want purchasing power that they don't possess now, so interest is the price of obtaining unearned resources, the price to persuade lenders to give their current purchasing power to the borrowers.


So wages are return of working, rent are return of leasing machinery, interest is return of loaning out purchasing power.

What is the distinction between accounting profit and economic profit?
Application:
Suppose Rachel can earn $30000 per year as a secretary. She owns a building that rents for $6000 per year. She also has a savings account $23000, and the interest rate is 10%.

Now Rachel wants to quit her current job and open a pizza shop. She will use her own building, cash out all 23000 bucks and borrow 20000 dollars from the bank. She estimated that she can have revenue of 85000 dollars.

Question: Is it a good choice for Rachel?

Explicit cost: 23000+20000+20000*10% So account profit is 40000
Implicit cost: foregone wages 30000, normal rate of return 23000*10%, foregone rent 6000
So econ profit is revenue-implicit-explicit= $1700, which means that Rachel will be $1700 richer to be an entrepreneur than if she choose second best option.


When there is a profit, new competitors will come in to get profit they will (1)lower price (2)increase quality, but the consequence is that total revenue will be lower and less efficient producers will be rationed out of the market, leaving the most competent ones to compete.

The prosperity of pizza market will increase demand for raw material and thus the total cost will increase.
So in a perfect market, price will be the marginal cost of good.
Econ profit is the return of entrepreneur ability


Question: why does econ profit exist?
(1)people's wants are unlimited (2)licensure and patent

Losses are key to market because it's the signal whether you are good at what you do.
What's the problem of insulating losses?
(1) Losses destroy resources
(2) U lose feedback, having no idea whether you are good at what you do or not.
(3) people will be more audacious.

The incentives between profit and non-profit organizations are different.
Capitalism is full of uncertainty and it's too dynamic for some people.

EWOT Thirteen

Like most sport fans, I watched some NFL football this weekend. During one of the commercial breaks, a promo for a show called GangLand began playing.

California is notorious for having some gang issues. In oder to deal with this problem, the California police department decided to create, along with public support, California's Top 10 Most Wanted Gang members. Sounds like a  good idea right? Not exactly- we're about to see some untended consequences. Well California's gangbangers now had an incentive to even create more harm than before...in order to make it on the list, thus validating their street credit. After the list was released, violent crimes increased as more gang members tried to make their way onto the list. Now was this the police departments' intent? I doubt it. But this example does highlight the dangers of unintended consequences.

The Heart That Pumps Innovation

A) Kling claims the reason for America's economic success stems from the innovation of our entrepreneurs. He contrasts our private-ownership system with Europe's public-ownership system. I wish Kling would give statistics to back up his claims that Europe's economy is stagnating when compared to the U.S., or that "it is easier for large businesses to fail in America." I found the claim that only paranoid businesses survive very interesting; entrepreneurs must adapt to constantly changing market conditions in order to keep up with the competition. Many entrepreneurs usually experience failure before success. I also found the Entrepreneur's Ten Commandments were really interesting - its basically saying that in order to help the company, you must defy it first. However, entrepreneurship forces companies (i.e. shareholders) to bear most of the cost rather than the intrapreneur. My favorite line is: "Someone who fits the description of an un-entrepreneur would be perfectly suited in another role - as a bureaucrat."

B)
1. How many businesses does the typical entrepreneur start before creating a successful business?
2. Is the appeal of starting your own business greater today than it was 10 or 20 years ago?
3. Can you think of any businesses that actually promote entrepreneurship?

C) Entrepreneurialism advances the market, while benefiting the consumer, because of competition between rising and incumbent firms. However, in order to create a successful business model, entrepreneurs must be able to adapt to the ever changing preferences of consumers.

Class Thirty Seven

Profits, Losses, and Entrepreneurs
Society doesn't celebrate the accumulation of wealth, only its distribution.

Failure is part of the natural cycle of business. Companies are born, companies die, capitalism moves forward.

Industries and commerce are not static things, but dynamic processes, in which particular products, individual companies and whole industries rise and fall, as a result of relentless competition under changing conditions.

The company which first introduces a product that consumers like may make large profits, but those very profits attract more investments into existing companies and encourage new companies to form, and thus drive down the price.

Losses force business to change with changing conditions and shift to what they are comparatively good at.

Knowledge is one of the scarcest of all resources in any economy and the insight distilled from knowledge is even more scarce.
 Entrepreneurs - When starting a business, the most important thing to do is understand your real costs.
Factors of Production: (1) land, (2) labor, and (3) capital. You can about explicit and implicit costs
1) Explicit:rent ; Implicit: rent (cost of forgone opportunities)
2) Explicit:wages ; Implicit: forgone wages
3) Explicit: rent (projectors, laptops) ; Implicit: forgone rent

What decides whether you should buy or rent something: The equation of profitability
Profitability = Rental Rate + Appreciation Rate - Interest Rate
Benefits of buying an asset: its the forgone rental payments you would have to make.
So annual:
[(rental payments) / (price of good)] + [(Change in asset price)/(price)](It's the expectation of how much you wanna sell the next year) - 10% = 2.5%
37.5% + (-25%) - 10% = 2.5%

Suppose the lease payment: 12000 dollars per year
Buy a car: $32000 sell it next year: 24000 bucks
Interest rate: 10% (associated with The cost of administrate loans, risk, time preference, inflation )

Rental rate= 12000/32000 = 37.5%
Appreciation rate= -8000/32000= -25%
Interest rate: 10%
Profitability= 37.5% + (-25%) - 10% = 2.5%

If the outcome is larger than 0, you should buy the stuff.

What does 2.5% mean?
It shows how much richer you are every year if you own the thing rather than rent the thing.
2.5% means: how much richer I am each year from owning the car as compared to if I rented the car. If the number is positive you should buy; if the number is negative you should rent. If you buy, you are $250 richer than if you had rented the car.

Class Thirty Six

Two odds about tax:

i.                     Raising tax prevent otherwise mutually beneficial transactions from happening.

ii.                   I aim to make the producers to bear the burden, but the truth is the demanders also shared the burden.

The other costs of taxation that do not appear on the supply and demand curve. When we say tax is bad, we mean the deduction of valuable transaction that you place the wedge.

i.                     Bureaucrats are reluctant to any change/

ii.                   The time and effort spent doing and preparing the tax is too big, about 400 billion dollars per year. That's a great waste. It’s not productive activity.

iii.                  Tax can be misused.

The problem of tax is the deadweight loss part, and I’ll show you how to avoid that.

Sales tax: the legal liability of tax is upon the consumers.
The effect of sales tax and excise tax is identical.

When you post a tax on the buyers, it’s the buyers that are affected. The amount of demand will shift down just exactly the same amount of the tax.

You can charge tax whichever side you want, but all taxes are burden by both suppliers and producers. The economic incidence of tax is completely independent of legal incidence of tax.

Social security is actually paid by workers: the burden is determined by the relative elasticity of both suppliers and demanders of labor. The fact is more workers are inelastic, and firms’ demand for labor is really elastic under current international trade background. The more elastic of one part, the more destructive to that part.

What’s good tax policy? Your goal part is elastic and the other one inelastic (not really much deadweight loss)

*Slum sum: no marginal incentive change, but not good for the poor

Would you support that we should put all the tax only on things that the firms take the whole burden?
Answer: NO. Firms consist of shareholders and workers. We shift between the identities of consumers and producers, so the argument doesn't make any sense.

Subsidy can benefit both producers and buyers, and the more inelastic the curve is, the more benefit it can get.

But the subsidy doesn't mean the market will be better off.
Reason: Think about how people respond to incentive and opportunity cost of resources.
When there is a subsidy, the cost of the good is artificially lower, so producers shift resources, which have alternative uses, to make this product. But the low cost is merely an artificial phenomenon, so resources(whether land, workers, capital or time) that could have been used more efficiently are now used to make the product with the subsidy. That's a waste.

Besides, a subsidy may lead producers to overproduce (price now lose the role of signal) and deadweight loss will occur.

So subsidy, like tax, is still an intervention of market, which makes the price no longer the truth teller of market transactions.
Subsidy is mere another way of economic fallacy. What's seen is the prosperity of one field, what's not seen is its damage to fields that could have made the resources more efficiently.

Class Thirty Five

When you make something illegal, you don’t eliminate the want; instead, you raise the opportunity cost of suppliers. There is additional cost that doesn’t show on the supply and demand picture.

When you make something illegal, you have to enforce law. Illegal requires enforcement. To do that requires two costs, one not so bad, one really bad:

i.                     (Not so bad) you have to raise taxes to do it. (Tax is not costly itself, it’s just a transfer. The act of raising tax is costly)

ii.                   (Really bad) These bureaucrats can do other things that are productive. (This is really costly)

Consequences:

i.                     when you make a certain profession illegal, the job participants don't have to pay payroll tax, insurance money. They can get more pure profit, even exceeding the increasing cost. (the original and the new supply curve may intersects) The supply curve may actually shift out, even if it becomes more inelastic (price goes down): precisely the opposite that you want to see.

ii.                   There’s a strong correlations between crime rate (the big profit entices more people to join and compete) and drug law enforcement.

If we punish severely on some small sins, like smoking in the bathroom, we actually lower the marginal cost for people to commit the severe crimes.

Some people say that one of the benefits when prostitution is legalized is that government can get tax for revenue. But this opinion is odd:

i.                     Tax itself is neutral; it’s just a transfer of wealth from private sector to public sector, so no one gets benefit or hurt. It’s neither cost nor profit.

ii.                   Why is government tax revenue benefit? The signal of wealth is not how much money the government has but how many goods and services people produce.

The economic incidence of supply and demand curve
Application: Taxation

1. Excise tax: legal liability for tax is upon suppliers
the result of a tax
(1) customers and suppliers share the burden of tax and the more inelastic, the more loss the group has to suffer
(2) if the tax is $1, price doesn't go up by $1. Reason: both demand curve and supply curve usually have a slope (equilibrium quantity decreases, causing deadweight loss)
(3) The government cannot get as much tax revenue as it intended to get because of the second reason.
(4) The market is affected. Deadweight loss occurs (the forgone opportunity)
(5) We have to hire bureaucrats to enforce the law, but they don't produce anything new.
(6) People can cheat on tax
<a> they have to waste resources to avoid the tax
<b> others have to pay for your tax

The economic incidence of supply and demand curve

A way for a free market to get efficiency and equity at the same time
Head Start Theorem (Kenneth Arrow)
An appropriate program of lump-sum taxes or subsidies that puts everyone on equal footing.

EWOT Thirteen

On the recitation this week, we played the the public-private account game. I think it was a really interesting game. To be honest, I was one of the mean guys who put 20 tokens in private account every round. Why did I do this?　Because I see no reason why I shouldn't have done this way. It was just simple calculation: Every round I gain the same income from public account as every body does in the classroom, so the only difference between my total income and others is my gain from private account. As a result, to make sure that I gain more income than others, I put 20 tokens in private account.

However, we have to notice that, although put 20 tokens in private account seems to be the dominant strategy, this is so because our goal is to get higher income than everybody else. It is true that if everybody put all tokens in the public account, we get the highest income, but all same income actually no income at all. I think people who put 20 tokens in public account should not be accused mean. On the contrary, their behavior is reasonably justifiable.  In this case, 20-0 combination is the dominant strategy, any rational people who well realized what's going on will surly make this decision.

Bethpage Gray (market)

A) At Bethpage Golf course, which is a public golf course, a shortage currently exists because there are not enough tee-times to meet the demand of golfers. Also, the allocation of tee-times has allowed a black (secondary) market to emerge. With roughly 70,000 golfers trying to play the course, and only 35,000 rounds per year, a secondary market was bound to emerge. While tee-times are free if given out by Bethpage, nygolfshuttle.com plays the system in order to create a business of supplying tee-times (albeit for upwards of $500) to golfers who value playing on Bethpage on a given day, at a given time. Bethpage has taken issue with a company making money off a public golf course by "scalping" tee-times. The golf course has tried to combat the problem through various measures, but NYgolfshuttle adapts to accordingly. The problem Bethpage officials have is they have to find a balance between keeping tee-times from scalpers without "encroaching on the real life schedules of everyday golfers." I found it interesting that NYgolfshuttle is expanding into other public golf courses - clearly this shows they believe this is a viable business model.

B)

1. What could Bethpage officials do differently to keep NYgolfshuttle from obtaining tee-times?

2. Do you believe what NYgolfshuttle is doing is unethical?

3. What could Bethpage do to increase the supply? Reduce the demand?

C) Bethpage's golf course has seen a secondary market (black market) emerge because supply cannot meet demand. Therefore, the market for tee-times at Bethpage is in a shortage.

Class Thirty Four

I.                    Price floor:

Recall the rent control.

In the long run, not only you make houses less available, you actually make those poor people to get the house. It’s not even cheap for people who end up with the price you controlled.

*If curves become flatter (elastic), the problem got even worse.

There is a better to help the poor: give them wage subsidy.
This will not impair the market and people are free to use the money: not all of them will spend all the money in the houses; they may value other things more. So the clothes factories, for instance, may get profit and since now the house demand is really higher in a free market, it gives incentive to landlords to provide more houses with high quality.

i.                     labor market (the concept also applies.): Your productivity (determines your wage) is your ability to pick apples plus how much you value apples (how much society value). When there’s a price floor, like minimum wage floor, the quantity supplied exceed quantity demanded, you create a surplus (binding). It’ll be even worse when firm’s demand for labor is really elastic.

ii.                   Consequences :

(1) The law makes fewer people get the job (besides, the labor market demand is elastic, about 3, which means that a 1% increase of wage rate can result in 3% decrease in the number of workers hired) and make the existing workers harder to keep the job (because of the abundant existence of substitutes)
(2) Some workers just don't worth the new wage, it's a waste of cost.
(3) The cost has to come from somewhere. So may be the health care is gone, the vacations are gone, and the since the cost of productions are now higher, the price of the product can be higher. If you take the whole economy into consideration, a minimum wage law doesn't make any sense.
(4) The impact of minimum wage law is small.
(5) There's a better way other than the law. Give subsidy to producers. They will have freedom to hire workers, do researches or invest.
(6) Only a small portion of people live by minimum wage. Who earns the minimum wage? Basically no one makes minimum wage is poor! It’s not the people you aim! So a law intended to benefit only a small amount of people isn't good.

Rarity vs. Scarcity
Scarcity only implies that people want it more than it is available.  So the term is a relative term. People put strong value on oil, which is always abundant, so now oil is scarce despite its physical abundance. Things that are rare may not be scarce because people don't value it so much.

Surplus vs. Scarcity

Something is scarce only means we have to do trade-off to get it. Something surplus does not mean we don’t need to do trade-off. Surplus is a price phenomenon. It only tells you that prices are wrong.

Making things illegal:

The demand for drugs is really inelastic and you have some supply. Then we say that that drug is illegal to be bought and sold. Does that make your behavior go away? NO! Whose behavior is likely to change more when something is illegal? The suppliers: The supply curve tells you how the opportunity cost changes with the quantity of drug.  

i.                     Increase in elasticity (increasingly difficult to produce)

ii.                  Change the composition of producers.  Leaves more profitable opportunities for people currently engaged in drugs. People who have comparative advantage in illegal business enters.

iii.                  Drug dealers try to make more powerful drug (increase quality as same to increase quantity) since the probability of getting caught is the same.