Saturday, November 15, 2008

Economic Thought: Discussion Board 3

1.        What is the meaning of Say’s Law?  How might it apply today?  Consider U.S. auto sales dropping from 16 million in 2007 to 13.5 in 2008.  How might Say's Law be in force, or perhaps not...have prices fallen on autos?

Say’s Law has been popularly abridged by most economists to state that “Supply creates its own demand.” In other words, the desire to consume, or, the demand for goods is driven by their existence and availability from producers: supply. People prefer to consume things that are produced and brought to market. They do not tend to consume goods that don’t exist. Would a consumer demand Coca-Cola if it did not exist? That may be an oversimplification but many reject the notion of Say’s Law. Say believed that general overproduction and underproduction (surplus or shortage) were temporary conditions that would be overcome when the market corrects itself. The idea that the market would correct itself assumes a free and unhampered market.

The lessons of Say’s Law in our own time tend to apply but meet with tremendous difficulty. This difficulty is primarily the direct result of the artificial hampering by governments and cartels. Enter the U.S. auto industry, which has seen sales drop from 16 million in 2007 to 13.5 in 2008. In an unhampered market, this would be seen as a market correction. However, the auto industry in the United States is an extremely hampered market from many aspects. Consider the following:

-The Big Three is a cartel that benefits from blatant government intervention.

-The Big Three depends on other extremely hampered industries:

            Finance – The most hampered industry

            Steel – Hampered by tariffs and unions

            Oil – Hampered by excessive restrictions, cartelistic behavior, and a lack of refinery capacity.

Demand has dropped considerably for their vehicles due large in part to these various forms of intervention. To suggest that Say’s Law was a player in all of this is a stretch at best. The drop in demand is not primarily due to overproduction. It is better attributed to the inferiority of Big 3 cars brought about by decades of interventionist policies.

2.      Discuss the view of the utopian socialists (Robert Owen, et al) and contrast them with John Stuart Mill’s view of the evolution of the economy 

Utopian socialism suggests that human nature can be altered under the assumption that humans are merely products of their own environment. Furthermore they are not responsible for their own actions, desires, and will. To the utopian socialist people are merely a means to an end; programmable actors whose lot in life is determined by their environment, or determined by utopian socialist authorities that can manipulate them and beat them into submission. Religion to the utopian socialist is disregarded as belief in a fantasy that dulls the mind, and makes men weak.

Utopian Socialism is essentially the antecedent of Marxist socialism and communism. All of these systems can only be brought about with deliberate violence and sustained coercion to keep people in check, and tell them what to do. In the utopian socialist system people are told what to do, where to live, what to produce, etc. in order to serve the common good, which is defined by those in control. The utopian socialist economy is a planned economy versus a free economy. Like its Marxist and communist offspring, utopian socialism attempts to bring about heaven on Earth.

Mil on the other hand was a defender of individual liberty rooted in his utilitarian beliefs. Mill endeavored to develop and build upon the ideas put forth by Adam Smith and David Ricardo. Mill believed that with liberty and freedom the overall utility of a society is better served when individuals are free to make their own decisions and pursue their own self-interests. Furthermore, Mill believed that freedom was a necessary ingredient to the development of a person as a whole person. This is bi-polar to the Utopian Socialist ideal that a person’s character is formed independently of oneself, and determined exclusively by external factors. To Mill the economy would evolve as a free system, but it would not be completely unhampered by interventionism. Mill supported the regulation of labor, mandatory education, taxation of inheritances, and protectionist measures such as tariffs and embargoes.

This is certainly an interesting comparison to make at a Jesuit institution since Utopian Socialism lies is stark opposition to the Ignatian ideals of care for the whole person, free will to choose one’s own course, and engagement in critical thought as individuals!


3.      Why is the theory of comparative advantage the basis for all trade including international trade?

David Ricardo’s theory of comparative advantage is the basis for all trade because it demonstrates that market participants, be they individuals or nations, can enjoy gains from trade even if they produce fewer goods than the other party. It essentially is the ability of one market actor to produce a good at a lower opportunity cost, relative to other goods, compared to another market participant. As it relates to international trade, a nation that has comparative advantage, in a free and unhampered market, will most likely seek to export goods to another country. Likewise, the other country will apply the same theory to its own goods. The end result is an exchange in which both sides realize gains.

It is important to remember that comparative advantage deals with opportunity cost, not financial costs. That is absolute advantage.

Suppose that Ricardia and Malthusia, ceteris paribus, both make widgets and gadgets. In Ricardia it takes 15 hours to make one widget, and 5 hours to make one gadget. In Malthusia, it takes 4 hours to make one widget, and 2 hours to make one gadget. Malthusia has absolute advantage in making both because it can do so cheaper. What about comparative advantage? In Ricardia, to make one car, the opportunity cost is 3 gadgets. In Malthusia, to make one widget, the opportunity cost is only 2 widgets. So as it relates to widgets, Malthusia, with a lower opportunity cost, has comparative advantage.

Dealing with gadgets, in Ricardia, the opportunity cost of making one is 1/3 of a widget. In Malthusia, the opportunity cost of making one gadget is ½ of a widget. So as it relates to gadgets, Ricardia, with a lower opportunity cost, has comparative advantage. So, with Ricardia with its comparative advantage in gadgets, and Malthusia with its comparative advantage in widgets, the two nations are able to engage in trade that will be mutually beneficial. 

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