1st lecture

 DEFINITION OF ECONOMICS
Logic – structure of thought / Economics – structure of action

1. Adam Smith and his followers regarded economics as a science of wealth which studies the process
of production, consumption and accumulation of wealth.

“The great object of the Political Economy of every country is to increase the riches and power of that
country.” Like the mercantilists, he did not believe that the wealth of a nation lies in the accumulation of
precious metals like gold and silver.

To him, wealth may be defined as those goods and services which command value-in- exchange. Economics
is concerned with the generation of the wealth of nations. Economics is not to be concerned only with the
production of wealth but also the distribution of wealth. The manner in which production and distribution
of wealth will take place in a market economy is the Smithian ‘invisible hand’ mechanism or the ‘price
system’. Anyway, economics is regarded by Smith as the ‘science of wealth.’

Other contemporary writers also define economics as that part of knowledge which relates to wealth. John
Stuart Mill (1806-73) argued that economics is a science of production and distribution of wealth.

2. Alfred Marshall defines economics as “a study of men as they live and move and think in the
ordinary business of life.” He argued that economics, on one side, is a study of wealth and, on the
other, is a study of man.

Emphasis on human welfare is evident in Marshall’s own words: “Political Economy or Economics is a study
of mankind in the ordinary business of life; it examines that part of individual and social action which is
most closely connected with the attainment and with the use of the material requisites of well-being.”

According to Marshall, wealth is not an end in itself as was thought by classical authors; it is a means to an
end—the end of human welfare.

This Marshallian definition has the following important features:

i. Economics is a social science since it studies the actions of human beings.

ii. Economics studies the ‘ordinary business of life’ since it takes into account the money-earning and
money-spending activities of man.

iii. Economics studies only the ‘material’ part of human welfare which is measurable in terms of the
measuring rod of money. It neglects other activities of human welfare not quantifiable in terms of money.
In this connection A. C. Pigou’s (1877- 1959)—another great neo-classical economist—definition is worth
remembering. Economics is “that part of social welfare that can be brought directly or indirectly into
relation with the measuring rod of money.”

iv. Economics is not concerned with “the nature and causes of the Wealth of Nations.” Welfare of mankind,
rather than the acquisition of wealth, is the object of primary importance.

3. Lord Robbins’ Scarcity Definition:

According to Robbins neither wealth nor human welfare should be considered as the subject-matter of
economics. His definition runs in terms of scarcity: “Economics is the science which studies human
behaviour as a relationship between ends and scarce means which have alternative uses.”

From this definition, one can build up the following propositions:

(i) Human wants are unlimited; wants multiply—luxuries become necessities. There is no end of wants. If
food were plentiful, if there were enough capital in business, if there were abundant money and time—
there would not have been any scope for studying economics. Had there been no wants there would not
have been any human activity. Prehistoric people had wants. Modern people also have wants. Only wants
change—and they are limitless.

(ii) The means or the resources to satisfy wants are scarce in relation to their demands. Had resources been
plentiful, there would not have been any economic problems. Thus, scarcity of resources is the
fundamental economic problem to any society. Even an affluent society experiences resource scarcity.
Scarcity of resources gives rise to many ‘choice’ problems.

(iii) Since the prehistoric days one notices constant effort of satisfying human wants through the scarcest
resources which have alternative uses. Land is scarce in relation to demand. However, this land may be put
to different alternative uses.

A particular plot of land can be either used for jute cultivation or steel production. If it is used for steel
production, the country will have to sacrifice the production of jute. So, resources are to be allocated in
such a manner that the immediate wants are fulfilled. Thus, the problem of scarcity of resources gives rise
to the problem of choice.

Society will have to decide which wants are to be satisfied immediately and which wants are to be
postponed for the time being. This is the choice problem of an economy. Scarcity and choice go hand in
hand in each and every economy: “It exists in one-man community of Robinson Crusoe, in the patriarchal
tribe of Central Africa, in medieval and feudalist Europe, in modern capitalist America and in Communist
Russia.”

In view of this, it is said that economics is fundamentally a study of scarcity and of the problems to which
scarcity gives rise. Thus, the central focus of economics is on opportunity cost and optimisation. This
scarcity definition of economics has widened the scope of the subject. Putting aside the question of value
judgement, Robbins made economics a positive science. By locating the basic problems of economics — the
problems of scarcity and choice — Robbins brought economics nearer to science. No wonder, this
definition has attracted a large number of people into Robbins’ camp.

4. Cairncross’s definiton
“Economics is a social science studying how people attempt to accommodate scarcity to their wants and
how these attempts interact through exchange.” By linking ‘exchange’ with ‘scarcity’, Prof. A. C. Cairncross
has added another cap to economics.

 THE DIFFERENCE BETWEEN ECONOMICS AND OTHER SOCIAL AND APPLIED

SCIENCES (TECHNOLOGY,PSYCHOLOGY, ETHICS)
Positive science: It does a cause and effect analysis. If there is a particular issue, it analyses and then seeks
the answer to that problem. (Economics)

Normative Science is not based on facts, rather is based on different aspects like social, cultural, political
and so on, so we can say that it is based on opinion. (Technology, psychology, ethics)

Positive science is concerned with 'how and why' and normative science with 'what ought to be'. The
distinction between the two can be explained with the help of an example of increase in the rate of
interest. Under positive science it would be looked into as to why interest rate has gone up and how can it
be reduced whereas under normative science it would be seen as to whether this increase is good or bad.

Economics and Psychology:

Economics is particularly concerned with consumption, production and resource use by individuals and
groups. Economics is also concerned with the procures by which households and firms make decisions
about the use of scarce resources.

Inevitably, this definition of the ‘territory’ of economics leads to some overlapping with the other
disciplines. Psychologists and economists share an interest in what motivates people to take certain action.

However the primary interest of economists lies in those actions that are reflected in market activity or in
economic decisions made through government.

Economics and Ethics

Ethics is a social science. It deals with moral questions. It discusses the rules that govern right conduct and
morality. It deals with questions of right and wrong. It aims at promoting good life.

There is connection between economics and ethics. While economics, according to Marshall, aims at
promoting material welfare, ethics aims at promoting moral welfare. When we discuss economic problems,
often we consider ethical issues. The government introduced prohibition in many states for ethical reasons,
though there was heavy loss of revenue to it.

But Lionel Robbins strongly believes that an economist as an economist should not consider ethical aspects
of economic problems. But many economists do not agree with him. They believe that economics cannot
be dissociated from ethics. Even Marshall considered economics as a handmaid of ethics. He looked at
economics as a study of means to better the conditions of human life.

 DEFINITION OF SOCIETY
A society is a group of individuals involved in persistent social interaction, or a large social group sharing
the same geographical or social territory, typically subject to the same political authority and dominant
cultural expectations. Societies are characterized by patterns of relationships (social relations) between
individuals who share a distinctive culture and institutions; a given society may be described as the sum
total of such relationships among its constituent of members. In the social sciences, a larger society often
exhibits stratification or dominance patterns in subgroups.

Insofar as it is collaborative, a society can enable its members to benefit in ways that would not otherwise
be possible on an individual basis; both individual and social (common) benefits can thus be distinguished,
or in many cases found to overlap. A society can also consist of like-minded people governed by their own
norms and values within a dominant, larger society. This is sometimes referred to as a subculture, a term
used extensively within criminology

 SOCIETY AS A NECESSARILY ECONOMIC PHENOMENON AND ECONOMICS AS

A NECESSARILY SOCIAL ONE.
Economics is a social science—it is about people and about how we organize ourselves to meet our needs
and enhance our well-being. Ultimately, all economic behavior is human behavior. Any economic outcomes
are determined by human decisions or behavior.

 ROBINSON CRUSOE ECONOMY

no society = only rudimentary economic phenomena

In the Robinson Crusoe economy, there is only one individual – Robinson Crusoe himself. He acts both as a
producer to maximise profits, as well as consumer to maximise his utility. The possibility of trade can be
introduced by adding another person to the economy. This person is Crusoe's friend, Man Friday. Although
in the novel he plays the role of Crusoe's servant, in the Robinson Crusoe economy he is considered as
another actor with equal decision making abilities as Crusoe. Along with this, conditions of Pareto Efficiency
can be analysed by bringing in the concept of the Edgeworth box.
The basic assumptions of the Robinson Crusoe economy are as follows:

The island is cut off from the rest of the world (and hence cannot trade)

There is only a single economic agent (Crusoe himself)

All commodities on the island have to be produced or found from existing stocks

Crusoe (no society = only rudimentary economic phenomena)

A Robinson Crusoe economy is a simple framework used to study some fundamental issues in economics. It
assumes an economy with one consumer, one producer and two goods. The basic assumptions of the
Robinson Crusoe economy are as follows: The island is cut off from the rest of the world (and hence cannot
trade); There is only a single economic agent (Crusoe himself); All commodities on the island have to be
produced or found from existing stocks.

https://courses.lumenlearning.com/zelixeco201v2/chapter/robinson-crusoe-economics/

 ECONOMIC AND POLITICAL MEANS (OPPENHEIMER)

Franz Oppenheimer argues that there are two fundamentally opposed ways of acquiring wealth: the
“political means” through coercion, and the “economic means” through peaceful trade.

There are two methods…whereby man’s needs and desires can be satisfied. One is the production and
exchange of wealth…the economic means. The other is the uncompensated appropriation of wealth
produced by others…the political means (eg. State which stands as primarily a distributor of economic
advantage, an arbiter of exploitation…an irresponsible and all-powerful agency standing always ready to be
put into use for the service of one set of economic interests as against another.)

 ECONOMIC POLICY (MISES)

So we see that the best economic policy is to limit government to creating the conditions which permit
individuals to pursue their own goals and live at peace with their neighbors. Government's obligation is
simply to protect life and property and to allow people to enjoy the freedom and opportunity to cooperate
and trade with one another. In this way government creates the economic environment that permits
capitalism to flourish.

When government assumes authority and power to do more than this, and abuses that authority and
power, as it has many times throughout history—notably in Germany under Hitler, in the U.S.S.R. under
Stalin, and in Argentina under Peron—it hampers the capitalistic system and becomes destructive of human
freedom.

 THE ACHIEVEMENTS OF THE ECONOMIC AGE (THE INDUSTRIAL REVOLUTION

AND BEYOND):
Real income per head rose by anything from 2500 to 5000 percent.

Global population: 1 billion in 1800 to almost 8 billion today.

Global average life expectancy: 32 in 1800 to 70 in 2012.

Global poverty halved from 1990 to 2010.

How industrial revolution changed economics:

The Industrial Revolution transformed economies that had been based on agriculture and handicrafts into
economies based on large-scale industry, mechanized manufacturing, and the factory system. New
machines, new power sources, and new ways of organizing work made existing industries more productive
and efficient.
How industrial revolution changed society:

The Industrial Revolution increased the overall amount of wealth and distributed it more widely than had
been the case in earlier centuries, helping to enlarge the middle class. However, the replacement of the
domestic system of industrial production, in which independent craftspersons worked in or near their
homes, with the factory system and mass production consigned large numbers of people, including women
and children, to long hours of tedious and often dangerous work at subsistence wages. Their miserable
conditions gave rise to the trade union movement in the mid-19th century.

 VALUE FREEDOM AND VALUE RELEVANCE OF ECONOMICS

Economics is value free but it’s value relevant.

Economics should focus on facts and present general principles, leaving the choice of various technical
alternatives to policy makers. The separation between facts and values, positive and normative, is and
ought to become a concern in conventional economic analyses.

2nd lecture
 ECONOMICS AS CONCERNED WITH SOCIAL FACTS
With what kind of facts we have to deal in the social sciences? This question immediately raises another
which is in many ways crucial for my problem: What do we mean when we speak of "a certain kind of
facts"? Are they given to us as facts of a certain kind, or do we make them such by looking at them in a
certain way? Of course all our knowledge of the external world is in a way derived from sense perception
and therefore from our knowledge of physical facts. But does this mean that all our knowledge is of
physical facts only? This depends on what we mean by "a kind of facts."

In short, in the social sciences the things are what people think they are. Money is money, a word is a word,
a cosmetic is a cosmetic, if and because somebody thinks they are

 SCARCITY AND UTILITY

earthly nirvana [no utility], the garden of Eden [no scarcity]

Scarcity refers to the basic economic problem, the gap between limited—that is, scarce—resources and
theoretically limitless wants. This situation requires people to make decisions about how to allocate
resources efficiently, in order to satisfy basic needs and as many additional wants as possible. Any resource
that has a non-zero cost to consume is scarce to some degree, but what matters in practice is relative
scarcity.

For example, time and money are characteristically scarce resources. In the real world, it is common to find
someone with little of one resource or even both. A person without a job may have a lot of time but still be
unable to meet his basic personal needs. An executive of a prestigious company may have a lot of money
and able to retire at any time, yet he can only afford to go for a ten-minute lunch or sleep for just five hours
each night. People who have an abundance of both money and time are very few in the real world.

Underlying the laws of demand and supply is the concept of utility, which represents the advantage,
pleasure, or fulfillment a person gains from obtaining or consuming a good or service. Utility, then, is used
to explain how and why individuals and economies aim to gain optimal satisfaction in dealing with scarcity.
Adam Smith, John Stuart Mill, and Jeremy Bentham believed that people are driven to find pleasure and
avoid pain.  Utility can be seen as a measure of how much one values a particular good. This depends
entirely on the preferences of that individual, rather than some external, or universal measure. 

Although the total amount of utility gained usually increases as more of a good is consumed, the marginal
utility usually decreases with each additional increase in the consumption of a good. This decrease
demonstrates the law of diminishing marginal utility. Because there is a certain maximum threshold of
satisfaction, the consumer will no longer receive the same pleasure from consumption once that threshold
is crossed. In other words, total utility will increase at a slower pace as an individual increases the quantity
consumed. For example, the pleasure of eating the first cookie is much greater than the pleasure received
from eating the tenth or eleventh cookie in a sitting. Utility may measure how much one enjoys a movie, or
the sense of security one gets from buying a deadbolt.

 VALUE THEORY: A HISTORICAL SKETCH

initiated in Ancient Greece and which became dormant during the Middle Ages, later re-emerged at the
close of the seventeenth century to dominate economic thought for the next 200 years.

Early Economic Thought:

 The 1st was Aristotel - the source of value was based on need, without which exchange would not take
place. Originally, it was he who distinguished between value in use and value in exchange.
 Then the debate on value was centred and henceforth retarded by a normative approach - what value
should 'justly' be, instead of what actually is. During this period, utility was widely held as the
determinant of value with only a minority of theorists such as St. Thomas Aquinas (1225-
1274) and John Duns Scotus (1265-1308) taking note of the cost of the production side.
 The search concerning value was continued in the direction of utility by early mercantilists during the
16th and the first half of the 17th century. The supremacy of this argument was highlighted in 1588
when Bernardo Davanzati unsuccessfully attempted to construct a utility theory of value in Lecture On
Money. It is not surprising that they concentrated on the determinants of the demand for goods
(utility), since the merchants' profits depended on the exploiting of the difference between the market
buying and the selling prices rather than controlling the production process. For medieval theorists,
value depended not on any intrinsic value but on utility and scarcity. – Subjective approach to valur
theory.

Pre-Classical Thought:

 solution in the cost of production. 

 William Petty - objectively searched for the natural and intrinsic laws of reality - of which 'natural
value' was one of them. According to Petty, the market price ('actual price') of any commodity would
fluctuate perpetually around its natural value . - a true description of value in highly specific cases.
 Richard Cantillon - labour-and-land theory of value - a true description of value in highly specific cases.
 Nicholas Barbon - the natural value of goods was simply represented by their market price. For
him 'the value of all wares arise from their use; things of no use, have no value
 Ferdinando Galiani - a theory of utility value and even implicitly described the notion of diminishing
marginal utility. - failed to develop it into a fully-fledged supply and demand analysis.
 John Law - outlined the old water / diamond paradox of value, in which
comparatively 'useless' diamonds are more highly valued than the more 'useful' water and reconciled
the mystery by using a supply and demand analysis. Unlike his predecessors and his immediate
successors (until Walras and Marshall), Law used both demand and supply factors in determining the
value of a good which has a use in society. Henceforth any changes in the value of goods were due to a
change in the quantity supplied or demanded.
 John Locke  - developed a theory of price determination earlier, it lacked the clarity, precision and
understanding of Law.

Classical Thought:

 Adam Smith - swung the value debate back towards Petty's objective labour theory of value, borrowed
the water / diamond paradox from Law without acknowledging it, failed to resolve the riddle and the
resulting relationship between use-value and use-exchange, by mistakenly focusing on total rather than
 marginal utility. He provided a labour cost and a labour command theory of value for a primitive society
and finally a cost of production theory for an advanced one. 
 David Ricardo - value depended upon the quantity of labour necessary for production which would be
calculated by time. His value theory therefore only applies to freely reproducible goods in competitive
markets. he used time as a measure of labour quantity, accommodated the different skills of labour by
comparing wages to productivity and also assumed that capital influence on value was neutralised since
it was merely stored up in labour. He also added a theory of land rent, in which he claimed that rent is
price determined (not price determining) and provided reasons why profits had varying effects on value
 Karl Marx - approach to value was essentially Ricardo's labour theory of value. According to Marx, the
values of 'All commodities are only definite masses of congealed labour time. In his labour theory, he
developed his original rate of exploitation (s'=s/v) and its resulting critique of capitalism
 John Stuart Mill – gave up the classical-Ricardian search for absolute value. recognised the effects of
demand on the supply in different time periods of a value theory.

Neo-Classical Thought:

 William Jevons and Carl Menger - developed the new tool of marginal analysis in 1871 as a means of
understanding value. = value depends entirely on utility. Menger used his marginal utility table to
explain the old water / diamond paradox. The value of diamonds was greater than the value of water
because it was marginal utility and not total utility that determines consumer choice and hence value.
 Leon Walras - also independently discovered the concept of marginal utility. he created his theoretical
model of General Equilibrium as a means of integrating both the effects of the demand and supply side
forces in the whole economy. 
 Alfred Marshall - partial equilibrium framework. Marshall divided his study into four time periods:
market period (value of a good is determined by its demand), short-run period (firms can change their
production but cannot vary their plant size, which allows supply as well as demand to have an effect on
value), long-run periods (plant size can be altered), secular period (technology and population are
allowed to vary).
 LABOR THEORY OF VALUE AND OBJECTIONS TO IT
The labor theory of value (LTV) is a normative classical theory of value that argues that the price of a good
or service should be (morally) equal to the total amount of labor value (wages) required to produce it.
Smith and other classical economists saw the price of a commodity (good) in terms of the labor that the
purchaser must expend to buy it. Adam Smith held that, in a primitive society, the amount of labor put into
producing a good determined its exchange value, with exchange value meaning in this case the amount of
labor a good can purchase. However, according to Smith, in a more advanced society the market price is no
longer proportional to labor cost since the value of the good now includes compensation for the owner of
the means of production: "The whole produce of labour does not always belong to the labourer. He must in
most cases share it with the owner of the stock which employs him.

Classical economist David Ricardo's labor theory of value holds that the value of a good (how much of
another good or service it exchanges for in the market) is proportional to how much labor was required to
produce it, including the labor required to produce the raw materials and machinery used in the process.
David Ricardo stated it as, "The value of a commodity, or the quantity of any other commodity for which it
will exchange, depends on the relative quantity of labour which is necessary for its production, and not as
the greater or less compensation which is paid for that labour."

Marx later modified this normative (moral) theory of value to become a new idea, that the economic value
or price of something was literally determined by the "socially necessary labor", rather than by the use or
pleasure its owner gets from it and its scarcity value. For that reason, LTV is usually associated with Marxian
economics. The LTV is central to Marxist theory, which holds that the working class is exploited under
capitalism, and dissociates price and value. Marx never referred to his own theory of value as a "labour
theory of value" even once. Neoclassical economics tends to reject the need for a LTV, concentrating
instead on a theory of price determined by supply and demand.
Objections:

1. No place for transactions

2. The value of natural goods
3. Idle labor (intensity is not always equal to productivity)
 MARGINAL UTILITY
Marginal utility is the additional satisfaction a consumer gains from consuming one more unit of a good or
service. Marginal utility is an important economic concept because economists use it to determine how
much of an item a consumer will buy. Positive marginal utility is when the consumption of an additional
item increases the total utility. Negative marginal utility is when the consumption of an additional item
decreases the total utility.

Example: Consider a person has four bottles of water and purchases a fifth bottle of water. Next, imagine
that a second person has 50 bottles of water and purchases one more bottle of water. The first person
buying the fifth bottle of water will get far more utility from that fifth bottle of water because of its
proportion to the total. This fifth bottle increases the total water by 25 percent. The second person gains
far less utility from purchasing a 51st bottle of water, precisely because its proportion to the total is so low.
This 51st bottle of water increases the total water by only 2 percent. As a person purchases more and more
of a product, the marginal utility to the buyer gets lower and lower, until it reaches a point where the buyer
has zero need for any additional units of the good or service. At that point, the marginal utility of the next
unit equals zero.

The economists observed that the value of diamonds was far greater than that of bread, even though
bread, being essential to the continuation of life, had far greater utility than did diamonds, which were
merely ornaments. This problem, known as the paradox of value, was solved by the application of the
concept of marginal utility. Because diamonds are scarce and the demand for them was great, the
possession of additional units was a high priority. This meant their marginal utility was high, and consumers
were willing to pay a comparatively high price for them. Bread is much less valuable only because it is much
less scarce, and the buyers of bread possess enough to satisfy their most pressing need for it. Additional
purchases of bread beyond people’s appetite for it will be of decreasing benefit or utility and will eventually
lose all utility beyond the point at which hunger is completely satisfied.

 METHODOLOGICAL INDIVIDUALISM
The phrase methodische Individualismus was actually coined by Weber's student, Joseph Schumpeter

Methodological individualism is the principle that subjective individual motivation explains social
phenomena, rather than class or group dynamics which are (according to proponents of individualistic
principles) illusory or artificial and therefore cannot truly explain market or social phenomena.

In neoclassical economics, people's behavior is explained in terms of rational choices as constrained by

prices and incomes. The neoclassical economist accepts individuals' preferences as given. Gary
Becker and George Stigler provide a forceful statement of this view:[2]

On the traditional view, an explanation of economic phenomena that reaches a difference in tastes
between people or times is the terminus of the argument: the problem is abandoned at this point to
whoever studies and explains tastes (psychologists? anthropologists? phrenologists? sociobiologists?). On
our preferred interpretation, one never reaches this impasse: the economist continues to search for
differences in prices or incomes to explain any differences or changes in behavior.

Weber articulates the central precept of methodological individualism in the following way: When
discussing social phenomena, we often talk about various “social collectivities, such as states, associations,
business corporations, foundations, as if they were individual persons”.Thus we talk about them having
plans, performing actions, suffering losses, and so forth. The doctrine of methodological individualism does
not take issue with these ordinary ways of speaking, it merely stipulates that “in sociological work these
collectivities must be treated as solely the resultants and modes of organization of the particular acts of
individual persons, since these alone can be treated as agents in a course of subjectively understandable
action” 

 GOOD ECONOMICS: SHORT-TERM AND LONG-TERM CONSEQUENCES

Bastiat pointed out the universal truth that you can’t get something for nothing.

"Look at all the good that government spending does. Look at these fine public works. Consider, if you will,
the many jobs these public works create. Surely you wouldn’t suggest that government spending be
reduced when so many jobs depend on it."

The concrete results of government spending are what is seen. What is not seen is what would have
happened to the taxpayers’ money if it hadn’t gone for taxes.

The money would have been spent or saved. If it had been spent then it would have created jobs in the
private sector just as jobs were created in the public sector, except that people would have been spending
their money on what they wanted.

If it had been saved then, directly or indirectly, it would have been invested and turned into factories,
machines, and tools. That is, the money would have been converted into capital goods that create jobs for
millions of workers.

We are all aware of public works. They are what is seen. What is not seen are the vacations never taken,
homes never built, appliances never bought, and who knows what else that never came into being because
the taxpayers couldn’t afford them. They couldn’t afford these things because the money that would have
paid for them was taxed away and spent on public works.

In evaluating public works, we must always remember that they came into being at the expense of
whatever the taxpayers’ money would have created if the money hadn’t gone for taxes. Whatever the
money would have created is, of course, not seen. It is, however, the price we pay for the public works that
are seen.

The entire question of government spending is perhaps best perceived when one realizes that the
government is not a source of wealth. The people themselves are the only true source of wealth. Hence the
government can only give to the people what it has already taken from the people. You can’t get something
for nothing!

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or
policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

 ECONOMICS AGAINST DESTRUCTIONISM (THE BROKEN WINDOW FALLACY)

The broken window fallacy was first expressed by the great French economist, Frederic Bastiat. Bastiat used
the parable of a broken window to point out why destruction doesn't benefit the economy.

In Bastiat's tale, a man's son breaks a pane of glass, meaning the man will have to pay to replace it. The
onlookers consider the situation and decide that the boy has actually done the community a service
because his father will have to pay the glazier (window repair man) to replace the broken pane. The glazier
will then presumably spend the extra money on something else, jump-starting the local economy. (For
related reading, see Economics Basics.)

The onlookers come to believe that breaking windows stimulates the economy, but Bastiat points out that
further analysis exposes the fallacy. By breaking the window, the man's son has reduced his father's
disposable income, meaning his father will not be able purchase new shoes or some other luxury good.
Thus, the broken window might help the glazier, but at the same time, it robs other industries and reduces
the amount being spent on other goods. Moreover, replacing something that has already been purchased is
a maintenance cost, rather than a purchase of truly new goods, and maintenance doesn't stimulate
production. In short, Bastiat suggests that destruction - and its costs - don't pay in an economic sense.

The broken window fallacy is often used to discredit the idea that going to war stimulates a country's
economy. As with the broken window, war causes resources and capital to be funneled out of industries
that produce goods to industries that destroy things, leading to even more costs. According to this line of
reasoning, the rebuilding that occurs after war is primarily maintenance costs, meaning that countries
would be much better off not fighting at all.

The broken window fallacy also demonstrates the faulty conclusions of the onlookers; by only taking into
consideration the man with the broken window and the glazier who must replace it, the crowd forgets
about the missing third party (such as the shoe maker). In this sense, the fallacy comes from making a
decision by looking only at the parties directly involved in the short term, rather than looking at all parties
(directly and indirectly) involved in the short and long term.

Productivity ^ - Goods 0 (seen); Productivity ^ - Goods ^ (unseen).

 OPPORTUNITY COST
the opportunity cost, also known as alternative cost, of making a particular choice is the value of the most
valuable choice not taken. When an option is chosen from two mutually exclusive alternatives, the
opportunity cost is the "cost" incurred by not enjoying the benefit associated with the alternative choice.

When economists refer to the “opportunity cost” of a resource, they mean the value of the next-highest-
valued alternative use of that resource. If, for example, you spend time and money going to a movie, you
cannot spend that time at home reading a book, and you cannot spend the money on something else.
an opportunity cost is the potential benefit that someone loses out on when selecting a particular option
over another. 

3d lecture
 “HOCKEY STICK” CHARTS (ILLUSTRATIONS OF THE UNPRECEDENTED CHARACTER OF THE
INDUSTRIAL REVOLUTION)

the hockey stick diagram is often used to implicate the Industrial Revolution of the 1800s. it points to 1800
as the time when human growth (industrial, agricultural, whatever) became significant on a global scale. 

 POSSIBLE EXPLANATIONS OF THE INDUSTRIAL REVOLUTION:

1. Resources
- No correlation between the abundance of resources and wealth
- “ the curse of resources”

The term resource curse represents an economic phenomenon associated with the abundance of natural
resources in certain countries. The term summarizes a paradox that those naturally gifted resource
countries do not always develop and grow their economies.

During the Industrial Revolution, which began around 1750, people found an extra source of energy with an
incredible capacity for work. That source was fossil fuels — coal, oil, and natural gas — formed
underground from the remains of plants and animals from much earlier geologic times. When these fuels
were burned, they released energy, originally from the Sun, that had been stored for hundreds of millions
of years.

It should be understood that if a country has a significant resource allocation, it should use them to their
advantage. However, this has not always been the case in many countries with large reserves of resources.
In fact, some studies reveal that such resource abundance has been pernicious to countries who own
2. Imperialism
- no correlation
- Pareto-inferiority [enhanced redistribution instead of enhanced production]
3. Slavery, colonialism
- slaves have no incentive to invest in their productivity,
- additional costs of surveillance,
- no free labor markets and no economically rational appraisal of slave labor
4. Intelligence
- the growth of intelligence is at best evolutionary, not revolutionary;
- the Flynn effect

the wealthier the community is the more intelligent they are

The Flynn effect, first described in the 1980s by researcher James Flynn, refers to the finding that scores
on IQ tests have increased in the past century.

Another explanation for the Flynn effect has to do with societal changes that have occurred in the past
century as a result of the Industrial Revolution. In a TED talk, Flynn explains that the world today is “a
world where we've had to develop new mental habits, new habits of mind.” Flynn has found that IQ
scores have increased the most rapidly on questions that ask us to find similarities between different
things, and more abstract types of problem solving — both of which are things that we need to do
more of in the modern world.

- the catching up effect

The catch-up effect is a theory speculating that poorer economies will tend to grow more rapidly than
wealthier economies, and so all economies in time will converge in terms of per capita income. In other
words, the poorer economies will literally "catch-up" to the more robust economies.

- no correlation

[e.g., according to the standard IQ tests, East Asians are more intelligent than Northwestern Europeans;
Middle Eastern, Far Eastern, and Southern European civilizations are far older than those of
Northwestern Europe]

5. Ideas
- the labor theory of property [Locke]

The Lockean labor theory is the justification of private property that is based on the natural right of
one's ownership of one's own labor, and the right to nature's common property to the extent that
one's labor can utilize it.

- the invisible hand [Smith]

an economy can work well in a free market scenario where everyone will work for his/her own interest.

He explained that an economy will comparatively work and function well if the government will leave
people alone to buy and sell freely among themselves. He suggested that if people were allowed to
trade freely, self interested traders present in the market would compete with each other, leading
markets towards the positive output with the help of an invisible hand.

In a free market scenario where there are no regulations or restrictions imposed by the government, if
someone charges less, the customer will buy from him. Therefore, you have to lower your price or offer
something better than your competitor. Whenever enough people demand something, it will be
 supplied by the market and everyone will be happy. The seller end up getting the price and the buyer
will get better goods at the desired price.

- economic harmonies [Bastiat]

he develops and defends the thesis that the interests of all members of society are harmonious if and
insofar as private property rights are respected or, in modern parlance, that the unhampered market
can operate independent of government intervention.

- bourgeoisie dignity [McCloskey]

“Bourgeois Dignity” states that change in the rhetoric surrounding the value of business, innovation, and
entrepreneurship was the main factor responsible for the takeoff of economic growth in Northwest Europe
in the late 18th century. focuses on arguing that there was a fairly significant and unprecedented takeoff of
economic growth, and that existing explanations for this takeoff are inadequate.

4th lecture
 RECAPITULATION OF THE ORIGINS OF THE INDUSTRIAL REVOLUTION
While the Industrial Revolution contributed to a great increase in the GDP per capita of the participating
countries, the spread of that greater wealth to large numbers of people in general occurred only after one
or two generations during which the wealth was disproportionately concentrated in the hands of a
relatively few. Still, it enabled ordinary to enjoy a standard of living far better than that of their forebears.
Traditional agrarian societies had generally been more stable and progressed at a much slower rate before
the advent of the Industrial Revolution and the emergence of the modern capitalist economy. In countries
affected directly by it, the Industrial Revolution dramatically altered social relations, creating a modern,
urban society with a large middle class. In most cases, the GDP has increased rapidly in those capitalist
countries that follow a track of industrial development, in a sense recapitulating the Industrial Revolution.

 TRADE AS THE ESSENCE OF COOPERATION

Even the so-called survivalists and extremely isolated communities such as the Sentinelese (one of the
world's last uncontacted peoples) benefit from it.

 THE PREREQUISITES OF TRADE

1. The existence of other purposive agents
2. Heterogeneity of resources

Most expositors say that trade is mutually beneficial only if factors of production vary in their attributes.
Resorce heterogeneity is therefore a prerequisite for the gains from trade

3. Diversity of talents and skills

Conditions for exchange and therefore increased productivity for the participants will occur where each
party has a superiority in production in regard to one of the goods exchanged, a superiority that may be
due to either to better nature given factors or to the ability of the producer. Rothbard says that if all
people were equally skilled and equally interested in all matters and if all areas of land were
homogeneous with all others, there would be no room for exchanges.

 ABSOLUTE AND COMPARATIVE ADVANTAGE

If anyone is better at sth it develops the productivity of goods significantly
According to Adam Smith countries should only produce goods that they have an absolute advantage in. A
country is said to have an absolute advantage if the country can produce a good at a lower cost than
another. Furthermore, this means that fewer resources are needed to provide the same amount of goods
as compared to the other country. This efficiency in production creates “an absolute advantage,” which
allows for beneficial trade.

Comparative Advantage theory was developed by David Ricardo, argues that a country doesn’t have to
have an absolute advantage for beneficial trade to occur. Comparative advantage refers to an economy's
ability to produce goods and services at a lower opportunity cost than that of trade partners. A
comparative advantage gives a company the ability to sell goods and services at a lower price than its
competitors and realize stronger sales margins.  Put simply, an opportunity cost is the potential benefit that
someone loses out on when selecting a particular option over another. In the case of comparative
advantage, the opportunity cost (that is to say, the potential benefit which has been forfeited) for one
company is lower than that of another. The company with the lower opportunity cost, and thus the
smallest potential benefit which was lost, holds this type of advantage. 

Absolute advantage refers to the ability to produce more or better goods and services than
somebody else. Comparative advantage refers to the ability to produce goods and services at a
lower opportunity cost, not necessarily at a greater volume or quality.
People learn their comparative advantages through wages. This drives people into those jobs they are
comparatively best at. If a skilled mathematician earns more as an engineer than as a teacher, he and
everyone he trades with is better off when he practices engineering. Wider gaps in opportunity costs allow
for higher levels of value production by organizing labor more efficiently. The greater the diversity in people
and their skills, the greater the opportunity for beneficial trade through comparative advantage.

Example:

1. To see the difference, consider an attorney and her secretary. The attorney is better at producing legal
services than the secretary and is also a faster typist and organizer. In this case, the attorney has an
absolute advantage in both the production of legal services and secretarial work.Nevertheless, they benefit
from trade thanks to their comparative advantages and disadvantages. Suppose the attorney produces
$175 per hour in legal services and $25 per hour in secretarial duties. The secretary can produce $0 in legal
services and $20 in secretarial duties in an hour. Here, the role of opportunity cost is crucial.To produce $25
in income from secretarial work, the attorney must lose $175 in income by not practicing law. Her
opportunity cost of secretarial work is high. She is better off by producing an hour's worth of legal services
and hiring the secretary to type and organize. The secretary is much better off typing and organizing for the
attorney; his opportunity cost of doing so is low. It’s where his comparative advantage lies.

2. consider a famous athlete like Michael Jordan. As a renowned basketball and baseball star, Michael
Jordan is an exceptional athlete whose physical abilities surpass those of most other individuals. Michael
Jordan would likely be able to, say, paint his house quickly, owing to his abilities as well as his impressive
height. Hypothetically, say that Michael Jordan could paint his house in 8 hours. In those same 8 hours,
though, he could also take part in the filming of a television commercial which would earn him $50,000. By
contrast, Jordan's neighbor Joe could paint the house in 10 hours. In that same period of time he could
work at a fast food restaurant and earn $100.In this example, Joe has the comparative advantage, even
though Michael Jordan could paint the house faster and better. The best trade would be for Michael Jordan
to film a television commercial and pay Joe to paint his house. So long as Michael Jordan makes the
expected $50,000 and Joe earns more than $100, the trade is a winner. Owing to their diversity of skills,
Michael Jordan and Joe would likely find this to be the best arrangement for their mutual benefit.

 TRADE DEFICITS
Balancing factors:
 - Foreign stock investments
- Hoarding the reserve currency / accumulating liquidity

A trade deficit is an economic measure of international trade in which a country's imports exceeds

its exports. A trade deficit represents an outflow of domestic currency to foreign markets.

A trade deficit is an amount by which the cost of a country's imports exceeds the cost of its exports. It's one
way of measuring international trade, and it's also called a negative balance of trade.

A trade deficit occurs when a country does not produce everything it needs and borrows from foreign
states to pay for the imports. That's called the current account deficit.

A trade deficit also occurs when companies manufacture in other countries. Raw materials for
manufacturing that are shipped overseas to factories count as exports. The finished manufactured goods
are counted as imports when they're shipped back to the country. The imports are subtracted from the
country's gross domestic product even though the earnings may benefit the company's stock price, and the
taxes may increase the country's revenue stream.

Initially, a trade deficit is not necessarily a bad thing. It can raise a country's standard of living because its
residents gain access to a wider variety of goods and services for a more competitive price. It can also
reduce the threat of inflation since it creates lower prices. A trade deficit may also indicate that the
country's residents are feeling confident and wealthy enough to buy more than the country produces.

Over time, however, a trade deficit can cause more outsourcing of jobs to other countries. As a country
imports more goods than it buys domestically, then the home country may create fewer jobs in certain
industries. At the same time, foreign companies will likely hire new workers to keep up with the demand
for their exports.

 DUMPING
Dumping, in economics, is a kind of injuring pricing, especially in the context of international trade. It occurs
when manufacturers export a product to another country at a price below the normal price with an injuring
effect. The objective of dumping is to increase market share in a foreign market by driving out competition
and thereby create a monopoly situation where the exporter will be able to unilaterally dictate price and
quality of the product.

Dumping policies:

politization of economy (special privilidges):

 potential solutions:
1) diversification (The strategies of diversification can include internal development of new products
or markets, acquisition of a firm, alliance with a complementary company, licensing of new
technologies, and distributing or importing a products line manufactured by another firm.
Generally, the final strategy involves a combination of these options) and product differentiation (is
the process of distinguishing a product or service from others, to make it more attractive to a
particular target market. This involves differentiating it from competitors' products as well as a
firm's own products.)
2) qualitative competition
3) becoming a local distributor of the dumped products (distribution management)
4) temporary withdrawal coupled with reliance on cash reserves
 THE GLOBALIZATION OF FREE TRADE AS A PEACEMAKING PROCESS
By learning to put aside the idea that force and threat of force is the most effective means affecting
international behavior and adopting instead the economist’s perspective that behavior is best influenced
through incentives and creating opportunities for mutual gain, we can guide the change that is swirling all
around us in more constructive directions. We can create a web of international economic relationships
that not only serves our material needs, but also provides strong positive incentives to make and keep the
peace. And rather than a world of deepening inequality and growing insecurity, we can build a world that is
at once more equitable, more prosperous, and more secure.

5th lecture
 CLASSIFICATION OF GOODS

CLASSIFICATION OF
GOODS

economic goods
free goods
(satisfy our desires
(available in a great
but available in a
amount, eg. air)
limited amount

consumer (final)
producer goods
goods

land (free gift of labor (involve humn

Factors of nature, we don't efforts - physical
production create them) and mental)

capital goods (the

mix of land and
labor, eg.

Free goods - item of consumption (such as air, water, sunlight) that is useful to people, is naturally in
abundant supply, and needs no conscious effort to obtain it. A free good is a good with zero opportunity
cost. This means it can be consumed in as much quantity as needed without reducing its availability to
others.

Economic good is a good or service that has a benefit (utility) to society. Also, economic goods have a
degree of scarcity and therefore an opportunity cost. With economic goods where there is some scarcity
and value, people will be willing to pay for them (in some form).

Consumer goods are products bought for consumption by the average consumer. Alternatively called final
goods, consumer goods are the end result of production and manufacturing and are what a consumer will
see on the store shelf. Clothing, food, and jewelry are all examples of consumer goods.

Producer goods, also called intermediate goods, in economics, goods manufactured and used in further
manufacturing, processing, or resale. Producer goods either become part of the final product or lose their
distinct identity in the manufacturing stream.

Factors of production is an economic term that describes the inputs used in the production of goods or
services in order to make an economic profit. They include any resource needed for the creation of a good
or service. The factors of production include land, labor, capital and entrepreneurship.
Land has a broad definition as a factor of production and can take on various forms, from agricultural land
to commercial real estate to the resources available from a particular piece of land. Natural resources, such
as oil and gold, can be extracted and refined for human consumption from land.

Labor refers to the effort expended by an individual to bring a product or service to the market. Again, it
can take on various forms. For example, the construction worker at a hotel site is part of labor as is the
waiter who serves guests or the receptionist who enrolls them into the hotel. Within the software industry,
labor refers to the work done by project managers and developers in building the final product. Even an
artist involved in making art, whether it is a painting or a symphony, is considered labor.

Capital goods are tangible assets that a business uses to produce goods or services that are used as inputs
for other businesses to produce consumer goods. Said another way, capital goods are tangible assets, such
as buildings, machinery, equipment, vehicles and tools that one organization uses to produce goods or
services as an input to produce consumer goods and goods for other businesses. Manufacturers of
automobiles, aircraft, and machinery fall within the capital goods sector because their products are used by
companies involved in manufacturing, shipping and providing other services. Another feature of an
economic good is that if it can have a value placed on the good, it can be traded in the marketplace and
valued using a form of money.

 CAPITAL STRUCTURE OF PRODUCTION

- Time consuming
- Requires prior restriction of consumption
- Requires delayed gratification
Time preference says that individuals prefer satisfaction now to later, present to future. This explains the
loan market. In the structure of production, the capitalist pays wages now, despite the fact that he himself
does not get paid until the final stage when the product actually comes to market.

Consumption, saving, investment and spending occur in every production stage – across time. The interest
rate is the rate of price spread. It is what the capitalist earns for time preference.

 SUBSISTENCE FUND
To maintain life and well being, man must have at his disposal an adequate amount of final goods, also
called consumer goods. These goods, however, are not readily available; they have to be extracted from
nature. Without any tools at his disposal and so by means of his bare hands, man can only secure from
nature very few goods for his survival.

For instance, take an individual, John, stranded in a jungle. In order to stay alive, he can only pick up some
apples from an apple tree. Apples are the only good available to him that can sustain him. Let us say that by
working 20 hours a day, he manages to secure 20 apples, which keep him alive. The 20 apples that John has
secured from nature is his ‘pool of funding’ which sustains him. Being a sophisticated individual, John
realizes that if he had a special stick this would allow him to become more productive. His daily production
of apples could be 40 apples (i.e., double his current production). The problem, however, is that the stick is
not available—it must be made. To make the special stick requires two days of work. If John was to decide
to make the stick he would have a problem. By spending his time on making the stick he would not be able
to pick up the apples that are required to keep him alive. The only way out of this predicament is for John
to put aside an apple a day for the next forty days. In other words, by saving an apple out of his daily
production and enduring hunger, after forty days he will have an adequate stock of apples that will sustain
him while he is busy making the stick. (We make the unrealistic assumption here that apples can be
preserved in edible form for forty days). Thus, after forty days, John’s pool of funding will be comprised of
40 apples, which will see him through while he is making the special stick. We can see here that the saved
or unconsumed 40 apples enable the making of the stick, which raises the production of apples and lifts
John’s living standard.
  TIME PREFERENCE
is the current relative valuation placed on receiving a good at an earlier date compared with receiving it at a
later date.

There is no absolute distinction that separates "high" and "low" time preference, only comparisons with
others either individually or in aggregate. Someone with a high time preference is focused substantially on
their well-being in the present and the immediate future relative to the average person, while someone
with low time preference places more emphasis than average on their well-being in the further future.

Humans tend to substitute present state of affair by future state of affair

1. High (means you want things right now eg.old people because they are present oriented)
2. Low (means you’re willing to wait - someone with low time preference places more emphasis than
average on their well-being in the further future.)

Example:

A relatively famous test of Time Preference is to offer a child a cookie right now, but tell them they can
have two cookies if they wait 10 minutes. Some children take the cookie right now, some wait ten minutes,
and some try to wait ten minutes but succumb to the cookie right now about halfway through.

if Jim and Bob go out for a drink and Jim has no money so Bob lends Jim $10. The next day Bob comes back
to Jim, and Jim says, "Bob, you can have $10 now, or at the end of the month when I get paid I will give you
$15." Bob's time preference would change depending on if he trusted Jim and how much he needs the
money now, thinks he can wait, or would prefer to have $15 at the end of the month than $10 now.
Present and expected needs, present and expected income affect the time preference.

Negative time preference – someone wants to achieve sth in future rather than in th present (but this is
logically impossible)

Zero time preference - a person is highly satisfied all of the time (also logically impossible)

Time preference can’t be negative or zero, it is always positive.

Consequences of positive time preference:

1) Longer production processes are more productive than short ones

2) The existence of positive interest rates
 INTEREST RATE
1) Intertemporal price of money
2) The difference in valuation between present and future goods

– the difference in valuation between present and future goods. Example: Let's say the purchasing power of
money falls, and the price of an apple increases by 10% to $1.1. The lender will not accept $1.1 in one year
time, since $1.1 will only buy him one apple. He will require $1.21 to agree to lend since $1.21 will secure
the lender 1.1 apples.

– the intertemporal price of money. Money – universal need of exchange, which constitutes a price system
– universal scale of exchange value.

Interest rate is the amount charged, expressed as a percentage of principal, by a lender to a borrower for
the use of assets.

 CHARACTERISTICS OF CAPITAL GOODS

1) Heterogeneous – they all are different
2) Multi-specific can be used for different purposes and in different ways.
3) Complementary - may be combined with other different capital goods in order to reach different
results.
 PRICE SYSTEM AND ECONOMIC CALCULATION AS THE SOLUTION TO THE
PROBLEM OF VALUE INCOMMENSURABILITY BETWEEN VARIOUS CAPITAL
GOODS AND PRODUCTION PLANS
Economic calculation – comparison of present costs and anticipated benefits

Money (a universal need of exchange) – price system (a universal scale of exchange value expressed in
conditional numbers eg.1,2,5,50,2650)

Price system is a component of any economic system that uses prices expressed in any form of money for
the valuation and distribution of goods and services and the factors of production. Except for possible
remote and primitive communities, all modern societies use price systems to allocate resources, although
price systems are not used exclusively for all resource allocation decisions.

The economic calculation problem is a criticism of using economic planning as a substitute for market-
based allocation of the factors of production. It was first proposed by Ludwig von Mises in his 1920 article
"Economic Calculation in the Socialist Commonwealth" and later expanded upon by Friedrich Hayek.

Mises and Hayek argued that economic calculation is only possible by information provided through market
prices, and that bureaucratic or technocratic methods of allocation lack methods to rationally allocate
resources. Mises argued that the pricing systems in socialist economies were necessarily deficient because
if a public entity owned all the means of production, no rational prices could be obtained for capital goods
as they were merely internal transfers of goods and not "objects of exchange", unlike final goods.
Therefore, they were unpriced and hence the system would be necessarily irrational, as the central
planners would not know how to allocate the available resources efficiently. He wrote that "rational
economic activity is impossible in a socialist commonwealth".

 CHARACTERISTICS OF CAPITALISM
 the owners control the factors of production.
 Owners derive their income from their ownership (That gives them the ability to operate their
companies efficiently. It also provides them with the incentive to maximize profit.)
 free market economy
 A Two-Class System - the capitalist class, which owns the means for producing and distributing goods
(the owners) and the working class, who sell their labor to the capitalist class in exchange for wages.
 Profit Motive - The motive for all companies is to make and sell goods and services only for
profits. Companies do not exist solely to satisfy people's needs. Even though some goods or services
may satisfy needs, they will only be available if the people have the resources to pay for them.
  Minimal Government Intervention - Capitalist societies believe markets should be left alone to
operate without government intervention. However, a completely government-free capitalist society
exists in theory, only.
 Competition - Without competition, monopolies exist, and instead of the market setting the prices, the
seller is the price setter, which is against the conditions of capitalism.
 Willingness to Change - the ability to adapt and change. Technology has been a game changer in every
society, and the willingness to allow change and adaptability of societies to improve inefficiencies
within economic structures is a true characteristic of capitalism.

6th lecture
 MARKET EQUILIBRIUM
is a market state where the supply in the market is equal to the demand in the market. The equilibrium
price is the price of a good or service when the supply of it is equal to the demand for it in the market. If a
market is at equilibrium, the price will not change unless an external factor changes the supply or demand,
which results in a disruption of the equilibrium.

 A market occurs where buyers and sellers meet to exchange money for goods.

 The price mechanism refers to how supply and demand interact to set the market price and
amount of goods sold

 At most prices planned demand does not equal planned supply. This is a state of disequilibrium
because there is either a shortage or surplus and firms have an incentive to change the price.

 ECONOMIC DYNAMISM
Economic dynamism - changes in an economic system over time, particularly those reflected in the
behavior of markets, businesses, and the general economy.

Market equilibrium occurs where supply = demand. When the market is in equilibrium, there is no
tendency for prices to change.

Factors:

1) Changing consumer preferences

2) Changing availability of resources
3) Technological change
 TWO COMPLEMENTARY CONCEPTIONS OF ENTREPRENEURSHIP
Schumpeter:

Entrepreneur = Innovator not inventor

Invention – innovation only if it can be used in terms of economic productivity

Enterpeneur – is disaqualibrating agent ( he introduces new products and pushes boundaries – supply
demand).

Schumpeter believes that creativity or innovation is the key factor in any entrepreneur’s field of
specialization.  Being an entrepreneur is not a profession at all, and certainly not a conventional rule, or
even a comfortable state. Very briefly, a person is an entrepreneur if he performs new combinations, even
if he is not the creator of the materials of the new combinations (in fact, this is not the most important for
the author). According to Schumpeter, an entrepreneur is a person who is willing and able to convert a new
idea or invention into a successful innovation. Example: The introduction of the compact disc and the
corresponding disappearance of the vinyl record is just one of many examples of creative destruction: cars,
electricity, aircraft, and personal computers are others.

Kirzner:

Enterpreneur – Coordinator: equilibrating agent “Luxury of today is an ordinary thing tomorrow “

Imitators – product imitation

Arbitrageure – price arbitrage

the conception of the entrepreneur as a pure decision-maker and arbitrageur who owns no property.
Kirzner emphasized that the "pure entrepreneur" was a non-owner, writing: An important point . . . is that
ownership and entrepreneurship are to be viewed as completely separate functions. Once we have
adopted the convention of concentrating all elements of entrepreneurship into the hands of pure
entrepreneurs, we have automatically excluded the asset owner from an entrepreneurial role. Purely
entrepreneurial decisions are by definition reserved to decision-makers who own nothing at all. An
example of such an entrepreneur would be someone in a college town who discovers that a recent increase
in college enrollment has created a profit opportunity in renovating houses and turning them into rental
apartments.

Product imitation a strategy involving the introduction of a product which emulates or copies a product
already on the market (in so far as it is legally possible under patent and trademark laws). Product imitation
may be used to exploit high-volume market segments or to compete with new innovative products in a
rapidly growing market.

Price arbitrage is the simultaneous purchase and sale of an asset to profit from an imbalance in the price. It
is a trade that profits by exploiting the price differences of identical or similar financial instruments on
different markets or in different forms. Arbitrage exists as a result of market inefficiencies and would
therefore not exist if all markets were perfectly efficient.

Knight:

Knight made his reputation with his book “Risk, Uncertainty, and Profit”. In it Knight set out to explain why
“perfect competition” would not necessarily eliminate profits. His explanation was “uncertainty,” which
Knight distinguished from risk. According to Knight, “risk” refers to a situation in which the probability of an
outcome can be determined, and therefore the outcome insured against. “Uncertainty,” by contrast, refers
to an event whose probability cannot be known.

Entrepreneur = Uncertainty-bearer with unique vision of the future

7th lecture
 ENTREPRENEUR VS MANAGER (THE BERLE-MEANS THESIS AND VARIOUS
WAYS OF DEALING WITH ITS NEGATIVE PREDICTIONS)
An entrepreneur is a person with an idea, skills, and courage to take any risk to pursue that idea, to turn it
into reality. On the other hand, manager, as the name suggests, is the person who manages the operations
and functions of the organisation.

The difference between entrepreneur and manager can be drawn clearly on the following grounds:

- A person who creates an enterprise, by taking a financial risk in order to get profit, is called an
entrepreneur. An individual who takes the responsibility of controlling and administering the
organisation is known as a manager.

- An entrepreneur focuses on business startup whereas the main focus of a manager is to manage
ongoing operations.

- Achievements work as a motivation for entrepreneurs. On the other hand, the primary motivation
is the power.

- The manager’s approach to the task is formal which is just opposite of an entrepreneur.

- An entrepreneur is the owner of the enterprise while a manager is just an employee of the
company.

- A manager gets salary as remuneration for the work performed by him. Conversely, profit is the
reward for the entrepreneur.

- An entrepreneur’s decisions are driven by inductive logic, courage, and determination; that is why
the decision making is intuitive. On the contrary, the decision making of a manager is calculative, as
they are driven by deductive logic, the collection of information and advice.
 - The major driving force of an entrepreneur is creativity and innovation. As against this, a manager
maintains the existing state of affairs.

- While entrepreneur is a risk taker, the manager is risk averse.

Berle-Means theory is about governance in public corporations where the ownership and control is
separated, and the owners (shareholders) rely on the board of directors to represent their interests. The
theory states that over time the boards become so dominated by the management that their supervisory
role becomes ineffective and the executives get to have the final say. Named after Adolf A. Berle and
Gardner C. Means, the US authors of the 1932 paper 'The Modern Corporation and Private Property.'

- The real control over company is carried out by managers, not by owners.

- Managers could be short-term oriented.

- “Moral hazard”. Managers could expose company to the serious risks, but real losses will not
influence these managers directly, but owners.

Solutions:

- Supervisory board which mission is to oversee/control managers’ activity.

- Market for corporate control: internal competition between different levels of management +
cooperation.

- Control of external financiers.

- Hostile takeovers: the acquisition of one company (called the target company) by another (called
the acquirer) that is accomplished by going directly to the company's shareholders or fighting to
replace management to get the acquisition approved. External investors obtain majority of shares
and completely change managers in order to “heal” mismanaging company, and after this
restructuration return shares to previous owners.

 ENTREPRENEUR VS CAPITALIST
Capitalists have money.

Capitalist already have money and they use it to invest in commerce in accordance with the principles of
capitalism.

They are lowering one’s time preference.

Entrepreneurs want money. Entrepreneurs raise money from capitalists in an attempt to create money for
themselves and the capitalist.

They are bearing uncertainty.

 SOCIAL FUNCTIONS OF PROFIT

1) Motivational - if profit is good it gives certain emotional motivation and vice versa
2) Signaling – if the rofit is high it means that the market is immature + the expost perspective – an
indication of wrong actions
3) Allocative - realocation of capital from less siuccessful to more successful enterpreneaurs
 ARTIFICIAL NEEDS? DEPENDENCE EFFECT AND ITS CRITIQUE
great part of the wants, which are still unsatisfied in modern society are not wants which would be
experienced spontaneously by the individual if left to himself but are wants which are created by the
process by which they are satisfied (we would not desire any of the amenities of civilization-or even of the
most primitive culture - if we did not live in a society in which others provide them.). The innate wants are
probably confined to food shelter, and sex. All the rest we learn to desire because we see others enjoying
various things. To say that a desire is not important because it is not innate is to say that the whole cultural
achievement of man is not important. It is then represented as self-evident that for this reason such wants
cannot be urgent or important.

American demand for goods and services is not organic. That is, the demands are not internally created by
a consumer. These such demands - food, clothes, and shelter - have been met for the vast majority of
Americans. The new demands are created by advertisers and the "machinery for consumer-demand
creation" that benefit from increased consumer spending. This exuberance in private production and
consumption pushes out public spending and investment. He called this the dependence effect, a process
by which "wants are increasingly created by the process by which they are satisfied"

8th lecture

 THE CHARACTERISTICS OF PROPERTY AND OWNERSHIP

1) The freedom to use and enjoy
2) The freedom to alienate (transfer, exchange, etc.)
3) The freedom to exclude (private property is exclusive)

 THE SOCIAL FUNCTIONS OF PROPERTY RIGHTS:

1) Peaceful resolution of conflicts over scarce (rivalrous) resources:
- various criteria of appropriation and their strengths and weaknesses
 verbal declaration
 conquest
 labor mixing (Locke’s labor theory of property)
 self-ownership

Alternatives to the self-ownership system:

 slave system (no justification for arbitrative restriction of self ownership between
individuals; doesn’t pass the criteria of universability)
 “universal communism” (everyone possesses everyone’s freedom, which leads to
inactivibility - in order to do sth we have to ask permission of everyone)
2) Value conservation and value enhancement
- the tragedy of the commons (problem of overexploition, prisoner dilemma) (a situation in a
shared-resource system where individual users acting independently according to their own
self-interest behave contrary to the common good of all users by depleting or spoiling that
resource through their collective action)
Solutions:
 soft institutions (customs, traditions, implicit norms, etc.)
 privatization (to convert common good into private property, giving the new owner an
incentive to enforce its sustainability)
3) Economic calculation and rational allocation of resources
Economic calculation is possible only if private property is available
Resource allocation involves balancing competing needs and priorities and determining the most
effective course of action in order to maximize the effective use of limited resources and gain the
best return on investment.

 LEGAL STABILITY AND REGIME UNCERTAINTY

Regime uncertainty:
- One of the reasons of the Great Depression in USA
- Reduce the activity of enterpreneurs due to legal and political unstability
Concept invented by Higgs, which describes a pervasive lack of confidence among investors in their ability
to foresee the extent to which future government actions will alter their private-property rights.
This uncertainty can arise from many sources, ranging from simple tax-rate increases to the imposition of
new kinds of taxes to outright confiscation of private property. Threats can arise from various sorts of
regulation, for instance, of securities markets, labor markets, and product markets. The security of private
property rights rests not so much on the letter of the law as on the character of the government that
enforces, or threatens, presumptive rights

 HIERARCHY OF INSTITUTIONAL LEVELS

 “the rules of the game”:
(Regime uncertainty)
- Hard institutions (formal property rights, contract law)
- Soft institutions ( traditions, customs, religion)
 “the play of the game”
(Market uncertainty)
- Allocation of resources
- Corporate governance (incentive structures, specialized competences)
 NEGATIVE EXTERNALITIES AS PROPERTY RIGHTS VIOLATIONS/ THE COASE
THEOREM.
Externalities (external economies) could be positive or negative (eg. freely shared knowledge’ pollution)
A negative externality (also called "external cost" or "external diseconomy") is an economic activity that
imposes a negative effect on an unrelated third party. It can arise either during the production or the
consumption of a good or service. Pollution is termed an externality because it imposes costs on people
who are "external" to the producer and consumer of the polluting product. Many negative externalities
are related to the environmental consequences of production and use.
Negative externalities are common where there are no property rights over assets and resources. It means
that consumers can abuse them without worrying about court cases since there is nobody to file a lawsuit
against them.
For example, oceans are a public utility, and nobody holds private rights over them. It means that ships and
boats can pollute the sea since there are no property rights in the deep seas. The pollution affects other
ocean users like fishermen who depend on the ocean water for their livelihood.
The Coase Theorem:
1) Well-defined property rights
2) Sufficiently low transaction costs
Result: externalities will disappear/ are internalized
describes the economic efficiency of an economic allocation or outcome in the presence of externalities.
The theorem states that if trade in an externality is possible and there are sufficiently low transaction costs,
bargaining will lead to a Pareto efficient outcome regardless of the initial allocation of property.
The Coase theorem states that where there is a conflict of property rights, the involved parties can bargain
or negotiate terms that are more beneficial to both parties than the outcome of any assigned property
rights. The theorem also asserts that in order for this to occur, bargaining must be costless; if there are
costs associated with bargaining, such as those relating to meetings or enforcement, it affects the outcome.
The Coase theorem shows that where property rights are concerned, involved parties do not necessarily
consider how the property rights are granted if they can trade to produce a mutually advantageous
outcome.
  FREE TRADE AS A METHOD OF BUILDING PROPERTY-PROTECTING
INSTITUTIONS
9th lecture
 FAIR DISCRIMINATION VS UNFAIR DISCRIMINATION
Fair discrimination - The law sets out four grounds on which discrimination is generally allowed:
- Discrimination based on affirmative action;
- Discrimination based on inherent requirements of a particular job;
- Compulsory discrimination by law; and
- Discrimination based on productivity.
Unfair discrimination – equaly working employees get different wages
Any employer’s policy or practice showing favour, prejudice or bias against employees in terms of
the abovementioned grounds and which is not fair can be deemed to be unfair discrimination.
For example an employer follows a policy of remunerating a female employee on a lower scale
simply because she is a woman, whereas a male employee is remunerated at a much higher scale
for doing the same work.

 IMPUTATION AND MARGINAL PRODUCTIVITY

Imputation - factor prices are determined by output prices (i.e. the value of factors of production is the
individual contribution of each in the final product, but its value is the value of the last contributed to the
final product (the marginal utility before reaching the point Pareto optimal).
Marginal productivity - is the market value imputed or attributed to the use of one more, or one less, unit,
i.e., the marginal unit, of labor or a material factor of production. – additional employers

 MARKET PENALIZATION OF UNFAIR DISCRIMINATION

e.g., streetcar companies in the US during the period of racial segregation
An example of the effect of market penalties on prejudicial hiring occurred in South Africa in the early
1900s. In spite of penalties threatened by government and violence threatened by white workers, South
African mine owners sought to increase profits by laying off high-priced white workers in order to hire
lower-priced black workers. Higher-paying jobs were reserved for whites only after white workers
successfully persuaded the government to place extreme restrictions on blacks’ ability to work (see
apartheid). Market penalties for discrimination also mitigated the effects of prejudice in the McCarthy era
when profit-maximizing producers defied the Motion Picture Academy’s blacklist and secretly hired
blacklisted screenwriters.
Although government intervention often blunts the market mechanisms that penalize bigotry, people who
unequivocally support such intervention often do so because they believe that unfair discrimination exists
whenever outcomes for a particular group differ from those of the population as a whole. Economist
Thomas Sowell calls the idea that “various groups would be equally represented in institutions and
occupations were it not for discrimination . . . the grand fallacy of our times.”1 People differ in their tastes,
aptitudes, and childhood experiences, in the skills they acquire from their extended families, and in the
geography they must adapt to. People who have lived in cities for generations are less likely to become
farmers. Those whose families have spent generations in rural areas may be less likely to move to the city
and earn the higher wages associated with urban life. The children of military officers are more likely to
choose military careers than the children of Quakers. People subscribing to the grand fallacy ignore these
details, preferring instead to ascribe many occupational differences to discrimination. Determined to
equalize the representation of various protected groups in all spheres of social activity, they support
government-sanctioned discrimination as long as it fosters their version of equality.

 WHY NO EQUAL REPRESENTATION?

(in various groups of various ocupations)
1) Different tastes and preferences (farmers in village)
2) Different skills and talents
3) Individual choices and lifestyles
4) Statistical discrimination (e.g., Marie Curie passed over by the hiring committee at a physics
research center due to economizing on limited information)
5) Consumer sovereignty (including consumer bigotry)
 DISCRIMINATION AS A MENTAL PLACEHOLDER. UNEXPLAINED
DIFFERENCES IN WAGES CANNOT AUTOMATICALLY BE ATTRIBUTED
TO DISCRIMINATION
 “AFFIRMATIVE ACTION” AS YET ANOTHER FORM OF DISCRIMINATION.
is the policy of promoting the education and employment of members of groups that are known to have
previously suffered from discrimination.
1) Falsification of economic signals
2) Erosion of confidence
3) Anti-meritocracy
“Affirmative action” policies, which discriminate in favour of members of disadvantaged groups,
are widespread in America and many other countries. Critics, including many supporters of the
Harvard suit, argue that they should be illegal.
In many countries, the state gives a leg-up to members of certain groups because they have
suffered discrimination in the past or continue to endure it today. America offers preferences to
black people, whose ancestors were enslaved. India has quotas for dalits, formerly known as
“untouchables”, who are at the bottom of the Hindu caste system. Some countries have
affirmative action for members of groups that are on average poorer than their neighbours, even if
those neighbours have not historically done them wrong. For example, Malaysia has positive
discrimination for native Malays, who are poorer and do worse in school than their Chinese and
Indian compatriots.

10th lecture
 Rationality
Formal rationality:

 intentional acting
 means-ends thinking

Formal rationality involves the rational calculation of means to ends that are founded on laws, rules and
regulations apply in general. It also relates to a structure including legal, economic, scientific spheres and
the bureaucratic domination with industrialization

Examples of “criminal rationality”:

- Targeting old ladies rather than, e.g., hunters or martial artists (economics)
- the organisztional form of criminal enterprises (relatively small and decentralized)
- Willingness to keep drugs criminalized

Substantive rationality:

Substantive rationality refers to the clusters of values that lead people in their everyday lives, particularly in
how they choose the means to ends. It involves the choice of means to ends guided by a set of human
values. For example, Calvinism is when one feels one is fulfilling a duty and Calvinism attempts to
rationalize the world in ethical ways and consistent with God’s commandments (Weber, 1958). Other
examples include friendship, communism, hedonism Buddhism etc

Weber sees substantive rationality as an action that emphasizes on outcomes, an action can be rational
also because it reaches successful ends. Therefore, substantive rationality means the success or failure that
due to actions are driven by economical orientation in order to achieve final objectives that can be
economic or non-economic, for instance, justice and equality

 THE ECONOMIC REASONS FOR MAKING THEFT ILLEGAL

- Discouraging the diversion of productive resources towards non-productive (criminal) activities
- Incentivizing productivity
- Encouraging investment by keeping time preferences low
- Incentivizing absolutely rather than just relatively productive (i.e., preventative and protective)
activities

Consider the question of laws against theft. At first glance, it might seem that, however immoral theft may
be, it is not inefficient. If I steal ten dollars from you, I am ten dollars richer and you are ten dollars poorer,
so the total wealth of society is unchanged. Thus, if we judge laws solely on grounds of economic efficiency,
it seems that there is no reason to make theft illegal.

That seems obvious, but it is wrong. Opportunities to make money by stealing, like opportunities to make
money in other ways, attract economic resources. If stealing is more profitable than washing dishes or
waiting on tables, workers will be attracted out of those activities and into theft. As the number of thieves
increases, the returns from theft fall, both because everything easy to steal has already been stolen and
because victims defend themselves against the increased level of theft by installing locks, bars, burglar
alarms, and guard dogs. The process stops only when the next person who is considering becoming a thief
concludes that he will be just about as well off continuing to wash dishes—that the gains from becoming a
thief are about equal to the costs.

So the existence of theft makes society as a whole poorer, not because money has been transferred from
one person to another, but because productive resources have been diverted out of the business of
producing and into the business of stealing.

would be higher to the extent that theft results in additional costs, such as the cost of defensive
precautions taken by potential victims. The central conclusion would, however, remain—that we will, on
net, be better off if theft is illegal.

 THE “OPTIMAL” AMOUNT OF THEFT

This conclusion must be qualified by the observation that, to reduce theft, we must spend resources on
catching and punishing thieves. Theft is inefficient—but spending a hundred dollars to prevent a ten-dollar
theft is still more inefficient. Reducing theft to zero would almost certainly cost more than it would be
worth. What we want, from the standpoint of economic efficiency, is the optimal level of theft. We want to
increase our expenditures on law enforcement only as long as one more dollar spent catching and
punishing thieves reduces the net cost of theft by more than a dollar. Beyond that point, additional
reductions in theft cost more than they are worth.

- Deterrence:

This raises a number of issues, both empirical and theoretical. The empirical issues involve an ongoing
dispute about whether punishment deters crime and, if so, by how much. While economic theory predicts
that there should be some deterrent effect, it does not tell us how large it should be. Isaac Ehrlich, in a
widely quoted (and extensively criticized) study of the deterrent effect of capital punishment, concluded
that each execution deters several murders. Other researchers have gotten very different results.
One interesting theoretical point is the question of how to choose the best combination of probability of
apprehension and amount of punishment. One could imagine punishing theft by catching half the thieves
and fining them a hundred dollars each, by catching a quarter and fining them two hundred each, or by
catching one thief in a hundred and hanging him. How do you decide which alternative is best?

At first glance, it might seem efficient always to impose the highest possible punishment. The worse the
punishment, the fewer criminals you have to catch in order to maintain a given level of deterrence—and
catching criminals is costly. One reason this is wrong is that punishing criminals is also costly. A low
punishment can take the form of a fine; what the criminal loses the court gains, so the net cost of the
punishment is zero. Criminals generally cannot pay large fines, so large punishments take the form of
imprisonment or execution, which is less efficient— nobody gets what the criminal loses and someone has
to pay for the jail.

- Proportionality:

(punishments proportional to the crimes)

A second reason we do not want maximum punishments for all offenses is that we want to give criminals
an incentive to limit their crimes. If the punishments for armed robbery and murder are the same, then the
robber who is caught in the act has an incentive to kill the witness. He may get away, and, at worst, they
can hang him only once.

 THE SUBJECTIVIST CRITIQUE

Individual psychological utilities and disutilities cannot be adequately expressed in terms of monetary gains
and losses. In addition, certain goods may be subjectively regarded as invaluable (e.g., one’s own life).

 FUNDAMENTAL INCOMPLETENESS:
law without justice. Justice cannot be defined in purely economic terms.

11th lecture
 FORMAL AND SUBSTANTIVE RATIONALITY REVISITED
Formal rationality:
(mainline economics utilizes the former)
Mainline economic focus on incentive structures and the social functions of property rights offers
important insights into the conditions under which substantive rationality flourishes: spending one’s own
resources on one’s own goals is usually the best way to make well-motivated and well-informed decisions.
Substantive rationality:
(Behavioral economics utilizes the latter)
Horseshoe example:
horseshoe theory asserts that the far-left and the far-right, rather than being at opposite and opposing
ends of a linear political continuum, closely resemble one another, much like the ends of a horseshoe.

 A SEMANTIC DIGRESSION
since behavioral economics does not study the logic of action, but the cognitive errors and biases
associated with specific instances of action, it is, strictly speaking, not so much a branch of economics as
the psychological study of economic decision making.

 EXAMPLES OF ECONOMICALLY RELEVANT COGNITIVE BIASES

- asymmetric treatment of gains and losses
 Current law taxes profits immediately, while losses often reduce taxes only with a delay. A perfectly
symmetrical treatment of losses and profits would require the income tax value of a loss to be
refunded in the year the loss is incurred, just as profits are taxed immediately as they occur. If the
losses are carried forward, the real value of losses should be preserved by adjusting them by an
appropriate rate of inflation and the normal real return to capital (in effect, augmenting them by an
appropriate interest rate).
- January effect
The January effect is a seasonal increase in stock prices during the month of January. Analysts generally
attribute this rally to an increase in buying, which follows the drop in price that typically happens in
December when investors, engaging in tax-loss harvesting to offset realized capital gains, prompt a sell-
off. Another possible explanation is that investors use year-end cash bonuses to purchase investments
the following month.
The second principle of the efficient market hypothesis is unpredictability. In an efficient market, it is
not possible to predict future stock price movements based on publicly available information. Many
early violations of this principle had no explicit link to behavior. Thus it was reported that small firms
and “value firms” (firms with low price-to-earnings ratios) earned higher returns than other stocks with
the same risk. Also, stocks in general, but especially stocks of small companies, have done well in
January and on Fridays (but poorly on Mondays).
 DESCRIPTIVE VS PRESCRIPTIVE BEHAVIORAL ECONOMICS. SOFT
(“LIBERTARIAN”) VS HARD PATERNALISM.
Descryptive: eg. Psychological behavior towards money (quickly sell winning stocks, but keep the loosing
stocks)

Prescriptive: study of certain biases; various experts should perform paternalistic actions

- Soft paternalism (dubious) – eg. Private pension plans

Here's how public and private institutions could nudge us in the right direction — without violating
our liberty. Simply put, it's the idea that even highly competent, well-informed people fail to make
choices in their best interest — and that it's okay for private and public institutions to step in and
nudge them in the right direction without eliminating freedom of choice, or liberty.
Example:
Still on the pension front, Thaler and Sunstein devised a scheme in which a fraction of workers'
future pay increases are diverted into pension savings before reaching their pay check. The basic
idea is that people are more willing to part with tomorrow's cash than today's. Moreover, as long
as they increase their saving rate by less than their pay raise, it won't feel like a cut in their
disposable income (increased standard-of-living costs notwithstanding). This strategy was actually
put into place at a medium-sized manufacturing company; after four annual pay raises, the joiners
had lifted their savings rate from just 3.5% to 13.6%. A result that prompted Thaler to write, "We
plead guilty to the charge of trying to be paternalistic." But since they didn't infringe on freedom of
choice, they see no impropriety.
- Hard paternalism (harmful)
Hard paternalism involves heavy restriction of choice opportunities. Hard paternalism was
supposed “to guide them, whether they like it or not, toward their own good”. In some instances it
is legitimate for the state to intervene in a person’s actions, even when that person is acting
voluntarily and knowledgably.

John Stuart Mill gives the example of a person about to walk across a damaged bridge. We can't tell the
person the bridge is damaged as he doesn't speak your language. According to soft paternalism, we would
be justified in forcing him to not cross the bridge so we could find out whether he knows about the
damage. If he knows and wants to jump off the bridge and commit suicide then we should allow him to.
Hard paternalists say that at least sometimes we are entitled to prevent him from crossing the bridge and
committing suicide.
  ASYMMETRIC INFORMATION AND EXPERT KNOWLEDGE
The crucial aspect of individual meta-expertise: determining for oneself which expert to listen too. Market
democracy as the ultimate test of efficiency, including advisory efficiency.

 THE DANGERS OF BUREAUCRATIC SOCIAL ENGINEERING:

- institutionalized moral hazard
- corruptibility
- lust for power
 “LIBERTARIAN PATERNALISM” VS CONSUMER SOVEREIGNTY.
 BOUNDED RATIONALITY
a decision to settle on something that is good enough instead of looking for the best may be perfectly
rational (even in the substantive sense of the term) if one wants to economize on limited time and other
search costs.

Hotel example:

Imagine that I visit a foreign province and I want to stay in the best hotel available. I do not know which is
best, but I do know that the natives do not like choosy visitors and that they will become very hostile
toward me if I make a reconnaissance into three consecutive hotels and stay in neither. So if in three
attempts I will not find the best hotel, I will settle for the best of what I have found—that is, I will satisfice.
But it might also fortunately happen that the first hotel I will stumble upon will turn out to be the best hotel
in the province, which will give me a chance to maximize. The former procedure need not necessarily
overlap with the latter and there is clearly no difference in rationality between the two.

Maximizing vs satisficing.

Satisficing is supposed to be a more reality-oriented (rather than model-oriented) counterpart of

maximizing. Whereas maximizing appears to require that perfect information and infinite time belong to
the background of any rational decision-making process, satisficing is more suited to acting in a world of
ubiquitous scarcity: Satisficing is rational as a time- and other resource-saving strategy: Given our limited
resources, we sometimes settle for what’s good enough in order to devote resources elsewhere. We could
hold out for the best price when buying or selling a car, but that could consume a lot of time and energy
that we would prefer to spend elsewhere. (Byron 2004, p. 5) In other words, satisficing emerges as
maximizing that factors in the inescapable constraints of essential resources. This is the so-called
“instrumental conception of satisficing” (Slote 2004, p. 14), which I think of as the only compatible with my
contention that irrationality should be decoupled from uninformedness. An alternative view, which
conceives of satisficing as intrinsically valuable, suggests that it consists in exercising the virtue of
moderation (Slote 2004, p. 16). Let me say very briefly why I find this view implausible.

satisficing always aims at maximizing, but takes account of the pertinent constraints.

 THE VALUE OF AUTOMATING ROUTINE ACTIVITIES IN ORDER TO CONSERVE

MENTAL RESOURCES. CONSTRUCTIVE VS ECOLOGICAL RATIONALITY.
MARKET COMPETITION AS A DISCOVERY PROCEDURE.
Constructive rationality – leads to rational predictive models of decision that motivate research hypotheses
that experimentalists have been testing in the laboratory since mid twentieth century. Although the test
results tend to be confirming in impersonal market exchange, the results are famously and recalcitrantly
mixed in ‘personal exchange,’ notably in a great variety of two person extensive form games where some
half of the people attempt and frequently succeed when risking cooperation, even when anonymously
paired.
Ecological rationality - Ecological rationality uses reason— rational reconstruction—to examine the
behavior of individuals based on their experience and folk knowledge, who are ‘naïve’ in their ability to
apply constructivist tools to the decisions they make; to understand the emergent order in human cultures;
to discover the possible intelligence embodied in the rules, norms and institutions of our cultural and
biological heritage that are 8 created from human interactions but not by deliberate human design. People
follow rules without being able to articulate them, but they can be discovered. This is the intellectual
heritage of the Scottish philosophers, who described and interpreted the social and economic order they
observed.

Ecological rationality, in contrast, claims that the rationality of a particular decision depends on the
circumstances in which it takes place. What is considered rational under the rational choice account thus
might not be considered rational under the 'ecological rationality' account, and vice versa.

Market competition as a discovery procedure:

Competitionisaprocedurefordiscoveringfacts,which,iftheproceduredidnotexist,would remainunknownor
wouldnotbeused. Inotherwords,competitionisimportantonlywhenwedon’tknowthecircumstancesthat
determine the behaviour of the players, i.e. it is important only when its outcomes are unpredictableand
onthewholedifferentfromthosethatanyonewouldhavebeenableto consciouslystrivefor.

Themarketorderisaformofimpersonalcoercion, whichisblindtospecificneeds,andwhichcauses
individualstochangetheirbehaviour or forcesthemtoimitateimprovements,andthatiswhypeople
tendtorebelagainstit.