McConnell Economics, Chapter 2

[Jin+Guice]

Discussion of the curriculum McConnell, Brue, Flynn Economics text, chapter 2.

[ertyu]

This might work better if you wrote out what you think are the salient points of the chapter and also your thoughts about them. This will give people a starting point to discuss and will serve as a reminder if it's been a while since they studied the book, as in my case. I studied this book and got an A in the class way back when, but I don't remember what's in chapter 2 and I've long since decluttered the original textbook. Still, It would be useful for me to participate in this thread.

[mathiverse]

Chapter 2 defines the "economizing problem" which is figuring out how to use scarce resources in order to provide the maximum utility. The production possibilities model is discussed as a way to understand the opportunity cost of producing one assortment of goods vs another assortment given fixed resources. The circular flow model which describes the flow of economic resources and the flow of money between businesses, households, the resource market, and the product market is also discussed.

Several folks in the forum are planning to read the book at approximately similar paces. That's the reason this thread was created and why a summary isn't necessary. Although I added one here for my own benefit.

[mathiverse]

The circular flow model (Figure 2.6 in the 15th edition) reminded me of the "Financial cash flow charts" in section 7.1 of the ERE book. Figure 7.1 in ERE seems to be a simpler variant of the circular flow model. Or perhaps zoomed in versions is a better description. What do you think?

Figure 7.1 from the ERE book
https://imgur.com/a/Y1HVxNl

The model in the book is interesting since it only shows the high level. Really there are a few more lines from Households back to Households where they supply their own labor or from the Resource Market to Households and then Households back to Households where they provide their own goods. There isn't always a business intermediary. In relation to the ERE ideal those additional edges I mentioned might be the only edges an individual household traverses.

Here is a picture of the edges I'm talking about added to a sketch of the textbook diagram.
https://imgur.com/a/MGHmjU9

Here is the textbook diagram.
https://imgur.com/a/AKxeRyB

Side note, if there is a way to post pictures 1) so they are embedded in the post and/or 2) so I don't have to upload them to imgur, then please let me know. Those two things would be preferred, but I couldn't figure it out.

[ertyu]

The PPC is a neat way to illustrate diminishing returns, I think. It also has a provision where if you decide to sacrifice consumption today and invest in capital goods (machines etc.) instead, you increase your ability to consume at a future point. Quite aligned with the save-and-invest mindset.

The diminishing returns thing: aka, "80% of the benefit comes from 20% of the work". That one is also a truism that can be used to keep things in perspective.

Utility, on the other hand, is a great murky piece of bullshit. The idea that you have limited resources so you'd better think hard about how you want to choose to use them is legit. I guess "utility" can be defined as your subjective criteria for what constitutes a desirable outcome -- which is good in theory but becomes really iffy when you start to model it mathematically. Incidentally, Kahneman got his Nobel for showing that the way economists model utility and decision-making is completely bogus and not at all like how actual people think and behave.

[Jin+Guice]

First a clerical note: I accidently purchased a custom edition of the 19th edition for brookdale community college which doesn't have a bunch of the chapters. Last week I purchased the full 15th edition and it seems that the information is largely the same but the chapters are different. Much of Chapter 2 in the 15e was in Chapter 1 in the 19e. Not sure how much of a problem this is between books, just be aware that there may be some overlap between chapters.

Salient points from 15e Chapter 2:

Unlimited wants and scarce resources: We discussed this a bit in the chapter 1 thread but, from an economic standpoint, consumer want are unlimited and are ultimately constrained by limited availability of resources.

Production Possibilities Curve (PPC): Shows the trade-off between using resources to make 2 different goods. If I give up some of Good 1 I get more of Good 2. The PPC shows all available combinations. The PPC assumes that there are only 2 goods produced by an economy, that all extracted resources are used and that the economy is at full-employment. The PPC also assumes fixed resources and fixed technology.

I find the PPC pretty self-explanatory but it holds some concepts that are central to economics (no shame if it confuses you though). First of all, economics is about finding and isolating interesting trade-offs. The question we are generally trying to answer is what would to Y if we changed X, holding everything else equal? This is the reason for all the assumptions and simplifying models. The PPC also assumes that we want to produce the maximum amount of goods with maximum efficiency (or at least know what the world would look like if we did), which generally holds through every economic model you'll encounter.


Opportunity Cost: This might have been introduced in Chapter 1, but it is super important. Opportunity cost is the cost of all other possibilities. You could have used that flour to make bread but you made pizza. The forgone bread must be accounted for.



Law of Increasing Opportunity Cost: This is the law of diminishing returns. I've never heard it put this way, but it's an interesting way to introduce it.




Economic Systems: Shameless promotion of capitalism as the best and brightest economic system to save humanity.

Circular Flow Model: I think the important takeaway from this section is that all people/ countries/ businesses/ whatever you are looking at are considered producers and consumers and that many markets are linked together.

Some of my personal propaganda: If we lived in a zero-waste economy as nature does, all markets would be linked together in a circular flow.

[white belt]

I found the distinction between consumer goods and capital goods interesting. Isn't part of ERE focusing on acquiring capital goods (tools, etc) that can later meet the requirement of consumer goods, rather than just buying consumer goods? Additionally, the renaissance man blurring the distinction between a business and a household seems to be an essential part of ERE.

I see a contradiction between the assumption that for society "more production is always better" and the idea of marginal utility. Isn't there a point of diminishing returns, or is that only in reference to production of a particular consumer good rather than consumer goods in aggregate?

It's interesting to see an economy depicted using the circular flow model and to contrast that with the linear model depicted in a video called "The Story of Stuff" that I saw from a Rob Greenfield article (link). Circular flow implies a closed loop system, but as J+G said, that's not the case unless we're talking about a zero-waste economy.

[ertyu]

I see a contradiction between the assumption that for society "more production is always better" and the idea of marginal utility. Isn't there a point of diminishing returns, or is that only in reference to production of a particular consumer good rather than consumer goods in aggregate?

For how economists model the answer to this question, go to the production possibilities frontier. At any given level of resources (labor, capital, land, tech), every additional unit of butter you give up yields you fewer and fewer guns (diminishing marginal benefit). But if you somehow get more resources, your PPF will shift out. This will allow you to get BOTH more guns, and more butter. So the tl;dr: is, there is such a trade-off but only if you assume resources are fixed so that getting more and more of one thing would mean giving up ever increasing amounts of the other. Of course, this assumes that expansion of resources is in itself a pure positive. If you discover oil, for instance, this is Good because it expands your PPF. Resource depletion is not considered in the model. Similarly, if you invest in capital goods and this increases your factor of production capital and shifts out your PPF because your factories can now churn out more, this is a Good - environmental degradation is not considered in the model.

As for "more production is always better" - yes, econ does assume this. You start chapter one of every textbook with the "unlimited wants, limited resources" mantra - unlimited wants implies want satisfaction is a net positive.

Marginal utility = marginal benefit from consumption as it applies to an individual consumer. Marginal utility applies to the joy an individual consumer gets from eating additional snickers bars, buying additional pens, whatever (hedonic adaptation, but also, each additional pencil or whatever good is less and less useful to you. First one moves you from can't write to can write, second one moves you from can write to, if the first one breaks I have a spare). On the individual level, additional units of whatever you're consuming bring you less and less "consumer happy." On the social level, however, more pencils are better because this means more people's wants for additional pencils can be satisfied. (externalities like pollution etc. will be introduced in later chapters).

#QuarantineDay8. Thanks for coming to my TED talk.

[Jin+Guice]

@white belt: The assumptions are also necessary for the model to work. There are certain ways to relax certain assumptions, but they make the math difficult. There have been studies where assumptions that are necessary for the model to work mathematically have been disproven. Someone like Greenfield is from a completely different paradigm so he's not going to fit the model.

Learning the economic model is useful for three reasons. It's still broadly describes how our economy functions even if certain assumptions don't hold in certain cases. Just because the quantitative analytic model won't work without these assumptions doesn't mean the qualitative model is useless. Economics is also a way of thinking and I think it's a useful thinking modality to be able to access. Finally, this is how economics is discussed and if you're not familiar with the model and some of its counterintuitive results, people who are familiar with the model will talk circles around you and you won't be able to present your ideas. Sometimes I debate Marxists or Austrians and none of us has any idea what the fuck the other person is talking about.

We've assembled a charming team of economic skeptics here, but within the profession itself there are many who think or at least act as if the neoclassical model is the most accurate possible model of our economy (and we should therefore take it literally).

I promise I'll have less opinions when we get to the finance books.

[guitarplayer]

Sorry for the typos and such, I will revisit this later.

I will mainly focus here on the market system as I am geared towards becoming fluent in the market system. I have some lived experience of the command system though I was small back then and these are mostly fond memories

From the positive point of view, the market system has the feature that it has systemic inefficiencies which can be pin pointed, and this is whenever normative position is entertained.

Characteristics of the market system are:
- private property - that either 'land', 'labour, 'capital' or 'entrepreneurial activity' is always assigned to some one entity
- freedom of enterprise and choice
-- that those entities can arrange their private property in combinations as they see fit
-- that those entities can make free choices under conditions of scarcity
- self-interest - that it is a western world type of model where self is at the centre and not something else.
- competition - that because of freedom of choice to enter or exit exchange and some other market conditions (e.g. many agents, similar goods and there was a fourth one that I don't remember), whatever one finds useful, there will be many offering it in exchange for what they find useful from the one. If the former is the 'buyer' and latter 'sellers', then 'sellers' will undercut each other for what they want in return for the stuff they have, with the limit being the point where 'marginal gain' and 'marginal cost' (from chapter 1) are equal.
- market and prices - this happens in the market environment. In the book there is the example of 'prices' everywhere and 'ceteris paribus'. Equally, you could think about the currency being 'fashion / popularity' and then 'price / money' would be in the 'ceteris paribus'. Ultimately for those familiar with regression analysis, all these factors could be included in such analysis where an assumed 'utility' demand schedule would be displayed.
- technology and capital goods - climbing up the ladder of complexity and leverage as per Meadows on Leverage Points
- specialization and resulting division of labour (also geographic specialization) - this builds on CCCCCC and comparative advantage
- use of money - it is perhaps risky and potentially contentious but I would think of using money in 'barter' terms, I would not give money that much of a special status. On a spectrum, it is more liquid and less useful other than a medium of exchange. It has some uses, store of value being one. Persuasive power as it moves the FIRE movement. You have to pay taxes in it. measuring stick to compare with the johnses. I am not particularly attached to these views and open to debate this.
- active but limited government - to fix normative (AQAL 'left') 'market failures'. Consequently there are (AQAL 'right') 'government failures.

Five fundamental questions are:
- what will be produced - whatever agents choose to bring most utility compared to other opportunities.
- how will the goods and services be produced - in a way that optimizes for opportunity cost of not producing and keeping status quo / doing something else.
- who will get the output - those who offer utility at the margin in the market exchange.
- how will the system accommodate change - change of the overall utility of a good; less / more of it will be available on the exchange
- how will the system promote progress - through know-how and more stuff. ERE is excellent at promoting progress through know-how.

The Circular Flow Model:
- household is presented as a unit that outputs raw ingredients (land, labour and entrepreneurial ability) or capital (if they own it, so there's a feedback loop here) in exchange for a medium of exchange (here money) and in turn exchanges the medium for the above again. Come to think of it, businesses are not much different, barring some legal differences.
- I would see 'consumer goods' from the 'product market' as an 'overhead' for running a household, much like there is an 'overhead' to running a business. Thus the 'product market' is the 'resource market' for households. In my view, this could be reduced to any two entities exchanging in market conditions.



How the market system deals with risk:
- is about how to manage the fact that due to (un)known (un)knowns I might get less utility in exchange for more utility.
- often agents lock in and externalize risk, this is done by getting a salaried job contract, relying on state pension, buying annuity or generally getting insured. The risk is still there, but externalized. It feels better to many. Those who like looking under the hood can build a DIY hedge system, this is ERE or 'competent man'.

[guitarplayer]

There is a book called Economics for Mathematicians which I will try to hunt as it should align with my present life.