All language subtitles for Lec 1: Introduction to Principles of Microeconomics and Supply & Demand.en

JONATHAN GRUBER:
Let's get started.

This is 1401, microeconomics.

And I'm Professor John Gruber.

Now a couple notes
about the course.

There's a distinct policy
angle to this course.

I think personally what
makes economics most exciting

is you can use it to think
intelligently about the problems

that policymakers face
every day as they try

to decide how to
make the economy work

the best for its citizens.

In fact, I teach a whole
course about this called 1441.

But I'm going to bring some of
those insights into this class

and use policy-based
examples and things like that

to try to motivate and organize
our thinking about economics.

Lastly, three points
about my teaching style.

First of all, I don't write
everything on the board.

For the freshmen here, we're
not in high school anymore.

You need to pay attention
and listen to what I say,

not just what I write.

So it's important
to remember that.

The second point is, as you
can tell, I talk really fast

and my handwriting
is really bad.

OK?

So please, please
don't be afraid to ask

what the hell I
just said or wrote.

OK?

If you don't know,
chances are at least 40%

of the class
doesn't know either.

We'll learn later this
semester about the concept

of public good.

A public good is
something you do

which has a personal cost
and a social benefit.

I understand raising
your hand in a class

as large as this
can be intimidating.

But remember, in doing
so, you're not just

helping yourself, you're
helping your fellow classmates.

So please don't lean
and whisper loudly,

what the hell did he just say,
to the person next to you.

Raise your hand and ask me.

Because if you
didn't understand,

many other people
didn't as well.

More generally, it's hard to get
class participation in a class

this large, but I really
encourage people to participate

as much as possible.

I've never had a
year in this class

where there's been too
much participation.

I've had, every single year,
too little participation.

So please follow up with
questions, things like that.

And then finally, the third
point about my teaching style

is I have a bad tendency to
use the term 'guys' in a gender

neutral sense.

So when I say guys,
I don't mean men.

I mean economic agents,
people, everyone.

And I'm sorry guys
has a gendered word.

Often, I don't mean it that way.

It's just kind of an economist
talk for economic agents,

we call them guys.

What we're going to do
today is talk about what

is microeconomics, what are you
going to learn in this course?

What is the basic field about?

And then we'll dive in
next time into actually

starting to learn
about the models that

make up basic microeconomics.

Microeconomics is
fundamentally, in a sense,

the study of how
individuals and firms make

themselves as well off as
possible in a world of scarcity.

It's how individuals
and firms make

themselves as well off as
possible in a world of scarcity.

Scarcity is key.

The core of microeconomics
is constrained optimization.

Basically, individuals or firms
assessing the trade-offs they

face every day in the
decisions they make,

and then trying to decide
the best decision given

those trade-offs.

So that is, microeconomics
is really about trade-offs.

Microeconomics is really
about you can't have it all.

So what are you going to
do with what you can have?

How are you best going to
use your limited resources?

And the key concept behind
all this, probably the--

I'm going to say
about 100 times,

this is one of the most
important concepts in economics.

I'm sorry about that,
but this is really

one of the most important
concepts in economics,

is the concept of
opportunity cost.

Opportunity cost.

OK?

An opportunity
cost is the notion

that every action
or inaction has

costs in terms of what you
could have done instead in terms

of the next best opportunity.

If you buy a shirt, you are
forgoing spending that money

on buying something else.

So if you're deciding
to do shirts and pants,

you buy the shirt,
you're forgoing

buying the pair of pants.

If you study, if you
spend all night studying,

you're forgoing the
opportunity to go

see a band you like in concert.

And vice versa.

Every action you
take is a trade-off.

Every decision you make
involves a trade-off

because there's always
an opportunity cost.

There's always something
you could have done instead.

Yeah.

AUDIENCE: Is it just trade-off
for opportunity cost?

JONATHAN GRUBER: Great question.

Actually, let me come back
to that in one minute.

I want to come back to that.

Or five minutes.

OK.

So this is why economics is
called the dismal science.

We're called the dismal
science because the role

of the economists is
to basically say, well,

you think that's
free, but it's not.

You think you can just relax and
watch TV, but by watching TV,

you're giving up the opportunity
to study, the opportunity

to go out to see a
concert or the opportunity

to do something else.

OK?

So that's why I call
it the dismal science.

Now, some people may call
it dismal, I call it fun.

And maybe that's because I
was an MIT undergraduate.

And what is an
engineering school

but the land of
constrained optimization?

That's what engineering
and science is.

It's all about what
engineering is.

It's constrained optimization.

What better example could there
be than the two double oh seven

contests, where you're
given a set of materials

and asked to build something?

That's a constrained
optimization exercise.

Indeed, economics was invented,
modern economics was invented

at MIT by the economist Paul
Samuelson, who essentially said,

the mathematics that
science and engineers

use can be applied to analyze
really the essay-like approach

that people have taken
to economics before him.

So he basically brought the
tools of science to economics

and basically developed
the course I'll teach today

and the course that's
taught all over the world,

was developed right here at MIT.

Modern economics was born here
because we introduced the tools

of constraint optimization.

Now, over here,
I'm usually going

to try to do an outline
of what we're covering.

So we've talked about course
details, what is micro.

Now let's talk about how we
do that, what economics does,

which is we use models.

And I'll talk about a
model of supply and demand.

How do we actually teach you
all about these trade-offs?

OK.

The way we do it is by
building simplified models.

What is a model?

A model is technically
the description

of any relationship between two
or more variables, is a model.

Now, but unlike explaining
relationship between energy

and mass, we do not
have scientific laws

and constants in our universe.

OK?

Economics is, as much as we hate
to say it, not a real science.

It is a social science.

Which means that basically we
don't have rigid laws that we

can write down,
say they're all--

they're everywhere applicable.

We have to use models to
basically try to explain

the world as much as we can.

And so in doing so,
we have to make a set

of simplifying assumptions.

A set of simplifying assumptions
to try to essentially trade-off

two goals.

One goal is to explain
as much as we can.

The other goal is to
have parsimonious models

that I can teach you.

The more complicated the model
gets, the harder it is to teach,

the harder it is to solve.

This comes to the
earlier question

about are you really just
trading off two goods.

Well, of course, you're never
just trading off two goods.

But we're going to write
our models like you are.

And it's going to turn
out that gives you

all the intuition you need for
a model with this three or four

goods.

It's just a lot easier math.

So it turns out everything you
learn in the model of two goods

tells you everything you need to
know for a model with n goods,

just with easier math.

So that's the kind of
simplifying assumption.

That's a fairly non-offensive
simplifying assumption,

because it doesn't
really change anything.

We'll make other
simplifying assumptions

which are noxious and offensive,
and we'll talk about those.

And if you are offended
by them and bothered,

and want to see what happens
without those assumptions,

then that's exactly why you
should be an economics major.

Because that's what we go on and
do in the rest of the classes.

Say, OK, now let's move on
from these simplified models,

add some richness and see
what it does to the world.

OK.

The statistician George Box once
wrote that all models are wrong,

but some are useful.

OK?

and that's exactly what we're
going to try to work with today.

OK?

When I teach you
economics, I'm going

to try to teach it to
you on three levels.

The first is what
MIT is, mathematical.

The second is graphical,
and the third is intuitive.

Really, if you want to
succeed in this class,

you need to
understand all three.

Now, not every model
will I use all three,

but you want to understand
all three of those concepts

to really understand the
material we're learning here.

And we'll start with the
model of supply and demand.

The very first economic model
developed by Adam Smith in 1776

and the book that was the
founding of economics,

the Wealth of Nations.

Adam Smith asked the question--

think about two goods.

Think about water and
think about diamonds.

Nothing is more essential
for life than water.

We cannot function without it.

Nothing is probably
less essential for life

than diamonds,
especially back then

when diamonds didn't
have industrial uses.

They were just baubles.

Water is clearly just essential.

Diamonds aren't.

Yet the price of
diamonds is very high

and water is essentially free.

He asked, how could this be?

And the answer is because
what I've just described

is only one half of the
model of where we get

the price of water or diamonds.

I've described the demand.

I've described the demand
for water and diamonds.

I've said the demand for
water is much, much larger

than the demand for diamonds.

What I haven't talked
about is the supply,

which is the supply of
water is even more relative

to the supply of diamonds.

Water is everywhere.

Diamonds are rare to find.

And what Adam Smith said is that
while the demand for diamonds

may not be as high as
the demand for water,

the supply of diamonds
is much, much smaller

than the supply of water.

And that is why you can
end up with a good that's

inherently less valuable to
life having a higher price.

And Smith's point is you can't
just think of supply and demand

in isolation.

You need to think
of them together.

Oh, Pedro, could you grab
me a copy of the handout?

AUDIENCE: Yeah.

JONATHAN GRUBER: Thanks.

OK, so that's the intuition.

That's the intuition of
supply and demand model.

Now let's talk about the
graphics and the math.

So now let's talk about an
example of a supply demand

model.

And let's focus on
the market for roses.

What is a market?

A market is what it sounds like.

It's buyers and sellers
coming together.

Are there any more?

Any extra handouts around?

Does everyone have one?

Does everyone have a handout?

OK, good.

That's fine then.

OK.

Let's talk about
the markets for--

let's talk about the
market for roses.

OK?

First of all, what is a market?

A market is-- think
of a market to start.

AUDIENCE: Like
another page, right?

JONATHAN GRUBER: The
handout has graphs on it.

Does anyone have the handout?

AUDIENCE: I don't know.

JONATHAN GRUBER: How
many did you print?

What's that?

Is there any-- is there
an extra pile sitting

around there of handouts?

We got some extras there.

OK, pass those around.

Make sure you pass those around.

And

AUDIENCE: OK, next time
I'll put them over there.

JONATHAN GRUBER: Yeah, next
time they'll be in the back.

So please, raise your hand
if you don't have a handout.

And let's try to
pass those around.

OK.

Pedro, can you grab one for me?

So basically let's think
about the market for roses.

What is a market?

A market is a place where
buyers and sellers come together

to make transactions.

Think of it like the old timey
markets of ancient England,

where literally the
only way to transact

was physically being
in the same place

where the buyers
and sellers would

come to market once a week, and
the people who bring their cows

and people who wanted milk would
come in, or meat, would come in

and they would transact.

Think of the market that way.

Now, of course, that's not
how the modern market works.

But that's the way we want
you to intuitively think

of a market, is literally a
place where buyers and sellers

are interacting.

And it turns out that
intuition will work,

even given the modern economy.

Who else doesn't have handouts?

Everyone got the graphs?

OK.

All right.

So now let's talk about
the market for roses.

In figure 1.1, we have
the market for roses.

On the x-axis, the
horizontal axis,

we have the quantity of roses.

I'm going to, by the way, try to
have handouts for all the graphs

because my handwriting
is so brutal.

So you shouldn't have to see--
hopefully, if all goes well

this semester, you
should never see

me draw a graph on the board.

So on the x-axis, we have
the quantity of roses.

On the y-axis, we have
the price of roses.

The demand curve
represents the relationship

between price and quantity from
the consumer's perspective.

So the demand
curve, in this case,

is represented by the equation
q equals 1,800 minus 400p.

Now you're immediately saying,
well, where's the 1,800,

400 come from?

It doesn't matter right now.

That's what I'm going to teach
you in the next few lectures.

Right now that's an equation
that represents a line.

And the critical
aspect of that equation

is that there's a negative
relationship between price

and quantity.

As price goes up,
consumers want fewer roses.

Why is that?

Well, it's just because
of opportunity cost.

The more expensive is
a rose, the more you

have to give up to buy it.

So it's opportunity cost is
higher, so you want it less.

So the higher is the price,
the fewer roses you want.

So we get a downward
sloping demand curve.

The blue line.

Now the supply curve represents
the same relationship

between price and quantity but
from the supplier's perspective.

A supply curve in this case
that we've drawn here has

the equation q equals 200p.

200p.

You'll see here there is
a positive relationship

between price and quantity.

That is, the supply
curve is upward sloping.

As price goes up, farms
will produce more roses.

Why?

Once again, opportunity cost.

With a low price,
producing a rose

means you can't use that farm
to produce something else.

If the price of
roses is low, you're

going to use the farm
for something else.

The price of roses is
high, you will then

use that farm to produce roses,
because that is a better choice

than the next best alternative.

So once again, this
concept of opportunity cost

has already helped explain
the basic model of economics.

The single most important
model of economics

is represented in this graph.

And you can understand
it just by the concept

of opportunity cost.

That is why we are such a
powerful social science.

That's why all the
other social sciences

are fucking jealous of us.

OK?

Because we can use simple tools
to explain much of the world.

And here's a perfect example.

Now we call the
point where those two

curves meet the equilibrium.

The point where supply and
demand are in agreement

is the equilibrium.

That is the point
at which suppliers

are willing to sell roses
at the same price consumers

are willing to pay for them.

So with 600 roses, 600 boxes
of roses or whatever it is,

the equilibrium price is $3.

Well, it's a rose.

So with 600 rose, the
equilibrium price is $3.

That is, both parties
are happy in equilibrium.

The key point about
equilibrium, as the name

implies, as the term
equilibrium implies,

it's the point
where the system has

come to rest, where both parties
are happy with the outcome.

Both parties are happy because
it's on the demand and supply

curve.

Since it's on the
demand curve, consumers

are willing to pay
$3 for 600 roses.

They wouldn't pay $4 for 600
roses, but they'd pay $3.

Since it's on the
supply curve, suppliers

are willing to accept
$3 for 600 roses.

They wouldn't accept
$2 for 600 roses,

but they'll accept $3
because it's on the curve.

So basically, it's just two
equations and two unknowns.

You set these two things equal
to each other and you solve,

and you get q star equals--

q star equals 600.

And p star equals 3, just by
two equations and two unknowns.

Once again, why we
only have two goods.

I could have done this
in three dimensions.

The graph would
have been uglier.

The math would have been harder,
but nothing would have changed.

Yeah.

AUDIENCE: If the variable
is dependent, then

how come on the graph
is on the y-axis?

JONATHAN GRUBER: Oh,
that's a great question.

Basically, they are--
it's a good question.

We write down the function
of basically invertible

and we use them both
ways, is the bottom line.

It doesn't-- we're really
writing down equilibration

between q and p.

It doesn't really
matter what x and y is.

We're really just writing
down an equilibrium.

It's just the convention
is to put q on the x-axis,

even though the convention--
even though the convention will

sometimes write demand curves
with p on the left hand side.

The graphing convention
will never change.

But how I write the
curves might change.

How we write the
equations might change.

Yeah.

AUDIENCE: How did you
use opportunity cost

to justify why demand
is downsloping?

JONATHAN GRUBER: Great question.

OK, let's go through it.

That's exactly the
kind of question

I want to hear this semester.

The reason demand
is-- does someone

want to take a crack at it?

Anyone want to explain?

Yeah.

And speak up.

AUDIENCE: If the price is higher
in order to get that rose,

you had to give up more
because the price represents

your opportunity.

JONATHAN GRUBER: Right.

The opportunity cost of any good
in the free market is its price.

So as the price goes up, the
opportunity cost goes up.

Why?

Because there's more other
stuff you could have bought.

So if it's $3 a rose,
you could have bought

a slice of pizza and a Coke.

But if it's $4 a rose, you get--

$4 a rose, you don't enough
money left to buy both the Coke

and the slice of pizza.

But that's a great
question because that's

exactly where we're
going to go next,

is the next three lectures
are going to tell you

where this equation comes from.

We're going to start with the
basic principles of people's

preferences.

Really almost philosophical.

And we're going to
derive this curve.

Then after that, the
next five lectures

will be deriving this curve.

We'll start with
the basic principles

of how firms make decisions and
will derive the supply curve.

Yeah.

AUDIENCE: So when you
say $3, is that for one

rose or is that for a
certain quantity of roses?

Is it for one rose?

JONATHAN GRUBER: Well,
it depends on what

I've written on the axis.

You're right.

This is confusing.

Pedro, you should make a note.

We should probably make
this clearer next time.

We should have called
this number of rows.

Shouldn't have been
called quantity of roses.

That's a great point.

We should call this number
of roses or boxes of roses.

But it's per quantity that's
specified in the model.

Great question.

The thing is with MIT, you
cannot get away with sloppiness

here.

I love it.

Harvard, what the hell, you
write whatever you want.

Yeah.

AUDIENCE: I find the
vectors are usually linear.

Or are they often nonlinear?

JONATHAN GRUBER: Great question.

Indeed, this is
another cheat we'll do,

which will often write down
nonlinear representations

but draw them linearly.

This is a linear representation.

But sometimes we'll
have nonlinear curves

and draw them linearly.

When we do think of it
is a local approximation.

Think of the linear piece
as the local approximation

to the larger function.

OK.

Great questions.

I love it.

OK.

Now this raises-- this model
raises a very important

distinction that we're going
to focus on this semester.

And it's going to trip you up,
I guarantee, a number of times.

So I want you to be very careful
in thinking about this, which

is the distinction between
positive economics and normative

economics.

Positive economics is the
study of the way things are,

while normative
economics is the study

of the way things should be.

Positive economics,
study the way things are.

Normative economics is the study
of the way things should be.

Now to consider--
to understand this,

let's consider a great
example of economics

at work, which is eBay.

When eBay came along--

I know it is older than all of
you, but it's younger than me.

When eBay came along,
economists were very excited

because economists
love auctions.

Auctions are, if you will,
the standard market that used

to exist in 15th
century England.

It's literally people
bidding against each other

in a way that reveals who
wants the good the most.

And what's wonderful
about that, and we'll

come back to this
throughout the semester,

is it has two great features.

One is it makes sure the
right amount gets produced,

and two is it makes
sure the people who

want it the most get it.

One beautiful feature
of free markets

is that they don't just get you
to the right aggregate quantity,

they also get the
goods in the hands

of people who are willing
to pay the most for them.

And that's what eBay did.

Now one auction eBay
got a lot of example--

got a lot of
attention, I'm sorry.

Got a lot of attention, which is
that somebody put their kidney

for auction on eBay.

They auction their kidney.

They said, I'll give you my
kidney for-- let the bidding

start at $25,000.

The bidding got up to $5
million before eBay shut it

down and said no auctioning
human body parts on eBay.

Now, I don't why they stopped at
5 million earlier, but whatever.

With this example,
we can ask both

a positive and a
normative question.

The positive question is, why
did the price get so high?

And here, we only need appeal
to supply demand model.

The demand for a kidney is
going to be pretty high.

If you need a kidney
to live, you're

going to pay approximately
everything you have to get it.

The supply of kidneys on the
free market is pretty low.

Like, that was the
only one I know of.

So it's a classic case of with
a very high demand and a very

low supply, you're going
to get a very high price.

And so it's not surprising
the price went up,

and probably would
have gone up further

if eBay hadn't shut it down.

But now we come to the
normative question, which

is more interesting
and harder, which is,

should we be allowed to sell
our bodily organs on eBay?

You might think that this is
a question here in philosophy

class, but fundamentally,
this is an economics question.

Many folks die in
America because we do not

have enough organs to help
those with organ failure.

We have a limited
supply of organs.

I hope you all are organ
donors on your driver licenses.

Doesn't cost you anything.

You're gone anyway.

And it can save a life.

But many people don't do that.

And even if they
did, we're just--

we have a higher demand
for organs than we can fit.

Now, if someone who
wants an organ is

wealthy and willing to
pay a lot of money for it,

and there's someone else who
says, look, I got two kidneys.

You can function
just fine with one.

The odds you have kidney
failure is really low.

Someone says, look, I
am in desperate straits.

I can't feed my family.

I can't house my family.

I can sell one kidney,
still function fine,

and change my life forever.

Educate my children,
build a house,

do the things I need to do.

Why shouldn't we
let that happen?

So standard economics
would say, great,

let them auction
their body parts.

But in fact, there's reasons
why we don't think many--

there's many reasons why that
may not be a good outcome.

What are those?

What are reasons
we might not want

to just say, sure, let it rip?

What are some reasons?

Yeah, go ahead.

AUDIENCE: Are you sure
maybe like a black market

is really cool?

JONATHAN GRUBER: Yeah,
so there's fundamentally

two kinds of reasons.

The first kind is what
we'll call market failures.

Market failures are
something we're not

going to cover for about
the first 11 lectures.

For the first 11 lectures, the
free market is going to be king.

Let me be very clear with you.

Economics is fundamentally
a right-wing science.

As will become clear
through the semester,

I'm kind of a left-wing guy.

But economics is pretty
much a right-wing science.

In basic economics says,
the market knows best.

And there's only two
reasons why you should ever

interfere with the market.

And the first is
because for some reason,

the market's not
working properly.

This is an example
where it would be fine

if everyone knowledgeably
went into this transaction.

But what if it turns out
this can cause people

to force their children
to give up their kidney

or do things against their will?

Other criminal activities.

What if people don't really
understand how dangerous it

is to give up your kidney?

There's 50,000
Americans every year--

there's now currently about
100,000 Americans living with

hepatitis C, which
causes kidney failure.

Hepatitis C can live dormant
for years before you have it.

What if you give up your
kidney, you find hepatitis C?

Then you're dead.

So there's lots of reasons
why I think, well, maybe

this market doesn't
work quite as

well as economists say it does.

People might be misinformed.

People might be-- people
might be forced to do it.

What's interesting is the
black market is not necessarily

one of those reasons.

And here's why.

Because the black market
economists say is a market.

Let's say eBay doesn't allow
you to sell your kidneys,

so you have to go sell
it on the black market.

Well, if there's no other
market failures, that's OK.

For the same reason
economists think

it would be OK to
sell your body parts,

there's no reason why
you sell your body

parts on a formal market
and informal market.

The only reason
why it would be bad

would be if that
informal market comes

with other unsavory
features, like forcing people

to sell their body parts
or not being informed.

That's what would be bad.

OK?

What other reasons
might we care?

Might we be worried about
people selling their kidneys?

Yeah, white t-shirt in the back.

AUDIENCE: It would mean that
only really rich people would

be able to get them.

JONATHAN GRUBER:
Great answers, guys.

The second reason we care
is what we call equity,

or fairness, which is we might
not think it's fair that rich

people get to live and
get to live longer and buy

their organs, and
poor people don't.

We might think this
is an unfair outcome.

Now, this is what's fascinating
about America, which

is even though we
pride ourselves

on being the land of
the market economy,

we also care a lot about
fairness as a nation.

And this is viewed by
many as being blatantly

unfair that the richer you
are, the more you can just

buy body parts off poor people.

Now here's what's a little
bit sad about this class,

and sad about the limitation of
only having the number of weeks

we have, which is I'm not
going to talk nearly as much

about equity as I'd like to.

Ninety percent of this course
is going to be about efficiency.

It's going to be about,
does the market work?

Does the market deliver the
right quantity of goods?

It's not about equity,
which is, well,

does that right quantity
end up going-- end up

causing huge
inequality in society?

So that is kind of another
reason why we might care.

And we will discuss equity
later in the semester,

but unfortunately
not until much later.

All right.

Other questions or
thoughts about that?

OK.

Let me finally talk about
one last thing, which

seems like you got to talk
about in the first lecture

of an economics class, which
is, what about the underlying

structure of the economy?

How do we think about
different models

of how economies function?

And the fundamental conflict
is between a capitalist model

and a command model.

The capitalist model in its
purest form, what's called

the laissez-faire,
or let it be, model

is one where individuals
decide what to produce

and consume with
no interference.

It's a purely free market.

It's the market that existed
500 years ago before we had--

but the truth is
it never existed.

There's no such thing.

We will do a lot of teaching
by extremes in this course.

We'll talk about extremes.

It's a great learning
device, but there's never

been such thing as a purely
capitalistic economy.

Most economies, like the US, are
market-driven, but government

and socially constrained.

What does that mean?

That means yes, we let GM
decide how many cars to produce,

but we have standards on what
emissions those cars can have

and how safe they have to be.

In a purely
capitalist economy, GM

could produce the most
dangerous cars they wanted.

No one would care.

And they could be smog
laden and no one would care.

Obviously, we don't
have that in America.

We have regulations.

We have taxes on gas.

We have rules on
what you can learn

and where you can
learn it, et cetera.

So we have what we call a
constrained capitalist economy,

where fundamentally the
decisions on what to produce

and what to consume
are made by individuals

within a set of rules
set up by the government

and some also set
up by social norms.

OK?

Now the opposite extreme is
what we call a command economy.

And we actually had
almost the closest model

that could exist
to this, which was

the Soviet Union of my youth.

The Soviet Union
of my youth, it's

typically associated
with communism,

although it doesn't have to be.

Command economies don't have to
be associated with communism.

Germany and World War
II was a command economy

in the service of fascism.

But it's typically
associated with communism,

is what we call a
command economy.

In that extreme, the government
makes all production allocation

decisions.

People don't decide
what they get.

The government
decides what they get.

So it's the other extreme.

There's no free transactions.

It's the government making
all the rules, not just about

how much should be produced,
but who gets what's produced.

So in the free
market, the market

substitutes that of government--
you guys have bowled.

There's the bumpers you can put
up when you were a little kid

and you bowl and they keep
the ball on that bowling lane.

So think of the government
in a capitalist economy

is those guides on the side that
help keep the ball on the lane.

But you get to throw
the ball and decide

where you're going to-- which
pin you're going to go for.

And in command economy,
they literally--

they tell you go to the end of
the lane and knock down pin 7.

OK?

It's a very different model.

Now in theory, the argument
for the command model

is that it can ensure
that the right goods get

produced and distributed
as fairly as possible.

The theory is quite simple.

It goes back to Karl Marx.

The theory makes a
lot of sense, which

is, look, the government's
job is to make sure society

is as well off as possible.

It does that by making
sure the right things

get produced and get
to the right people.

And we can't trust
the market to do that.

Only the government can do that.

OK?

This is a great
argument in theory.

In practice, it doesn't work.

And it doesn't work
for two reasons.

First of all, it's
just too damn hard

to make all those decisions.

Any government, no matter how
large and how benevolent cannot

make the enormous, massive
quantity of billions

and billions of decisions
that need to be made.

Think about every
good we consume

in America, a government
deciding how much of it to make,

and literally who gets it.

It's overwhelming.

Governments can't do it.

So that led to things
like in East Germany.

I was in East
Germany a year ago,

and I went to the
Museum of East Germany.

And they talk about how back in
communist days in East Germany,

no one had cars, but
they had so much bread,

they would feed bread
to their pigs for food.

Because the government screwed
up and decided to make--

commanded too much
bread and too few cars.

That's natural.

It's going to happen.

It's just too hard.

The second problem
is that human nature

being what it is, a
command economy inevitably

leads to massive corruption.

Because when a
handful of people are

in charge of deciding
everything, of course,

they're going to make
their lives the best first.

I'm not saying
there's not corruption

in capitalist
economies, but it's

inherent in a command economy.

It's inherent because you're
giving a set of people

the power to decide
who gets what.

And it's inevitably
in human nature

to still decide to give
themselves the most in first.

So that is why, really, why
the Soviet Union collapsed.

Because the command economy
simply couldn't get it done.

And let's be clear, it
did not appear inevitable.

In the 1950s, there was
huge envy in the US of what

the Soviet Union
was accomplishing.

They came out of
a devastating war

and built a
manufacturing base that

was the envy of the
entire world, even

in the US, almost overnight.

It was incredible.

And a lot of people questioned
whether that might after all,

not be the right model.

It's just it turns out
over about 30 years,

it fell apart because it
just wasn't sustainable.

Now the alternative, of
course, is the US economy.

The capital economy, which
operates by what the famous--

the father of economics, Adam
Smith, calls the invisible hand.

The notion the
invisible hand is you

don't need a government to
make all these decisions

because the market
makes it for you.

The invisible hand
of the market decides

how much you get produced
and who should get it.

Not through any one person
making decisions, but just

through people coming
together in a market

and working together to
make those decisions.

And that's what we'll teach
you this semester, how

the market works, and how
that invisible hand can

lead through the
magic of the market

to the right goods being
produced and getting

in the hands of
the right people.

So that's a huge advantage.

And it's worked.

America is the richest
nation in the world.

We've grown rapidly
for centuries now.

And we're very successful.

On the other hand, it leads
to tremendous inequality,

because the way-- the right
person to have the good

is the person who can
pay the most for it.

Right?

In the command economy,
the right person

has the good, corruption aside,
is who needs it the most.

We take our kidney example.

The command economy
would say, well,

let's find the person closest to
death and give them the kidney.

The capitalist economy
say, let's find

the person willing to pay the
most to give them the kidney.

Well, that's unfair.

And that is an inevitable
outcome of a capitalist economy.

America is the most unequal
major nation in the world.

Our inequality dwarfs what
we see in other countries

around the world.

The top 1% of Americans control
25% of all the income in the US,

which is at least 5% higher
than any other major nation

in the world.

So we have large inequality
because basically it's

inevitable in a market that will
happen because people who want

to pay the most get the stuff.

So that gives you the trade-off.

The consensus, I would say
among virtually every economist

is that a command economy
is not the way to go.

The debate is within
the capitalist model,

how far the government
should intervene.

If you look at
countries like Europe,

they have a much more
interventionist economy.

You'll often hear
Europe countries

being called socialist.

They're not socialist.

Socialist means the government
controls the industry.

Socialist would
be they're still--

consumers will
decide what to buy

but the government
produces everything.

The government runs the banks.

The government
runs the airplanes.

The government decides
how much steel to produce.

The government--

So in some sense, the
socialist is halfway

between capitalist
and command economy,

where the government
does the production

but market forces
decide the allocation.

That's not true in any other
major country in the world.

These countries are all
different levels of constrained

capitalist economies.

They're all different width
of those bowling alleys.

In Europe and many
European nations,

they have much more constrained
capitalist economies.

Much higher taxes, much more
government intervention.

Also, much more equal.

And we'll be talking
about this semester

and what I focus on
much more in my course

1441 is how do we think about
those trade-offs between a freer

economy, which is
larger but leads

to more inequality in the
US, and a less free economy

with less inequality.

So to guide you to
where we're going to go,

I'm really big on making sure
you have a big picture of where

we are in this class.

And once again, if
you're confused not just

about the little picture but
the big picture, let's talk.

I do urge people
to come talk to me.

I generally my rule is if it's
like a question about a problem

set, go see the TAs.

If it's a question about, I
don't understand a concept

or I want to talk about
economics in general or life

in general, or music or
whatever, then come see me.

And I really do urge you
folks to come see me.

Now that I'm chairman, I have
to be around all the time.

So I'm around plenty of time.

Please just make an
appointment and come see me.

So where are we going
to go from here?

What we're going to do, like I
said, is the next few lectures,

we're going to map out
what makes a demand curve.

Then we're going to map out
what makes the supply curve.

Then we're going to put them
together and talk about--

basically, in some sense,
come back to where we started.

But now with an understanding
of what demand and supply mean

and why the equilibrium
makes sense.

We'll then talk about--

we'll then turn to
normative economics and talk

about why the market equilibrium
is really the best outcome.

We're then going to
start to talk about where

the standard-- so we'll spend
about the first, I would say,

half of the class on the
standard economic model.

The second half
of the class will

be focused on where the
standard model breaks down.

What happens when there's
monopolies, like Google,

effectively a monopoly
on search engines.

What happens when we want to
trade with other countries?

What happens when we have
to decide how much to save

and how hard to work?

What happens when we have
to decide where to invest

and what to do about
global warming?

These are all the
questions we'll

tackle in the second
half of the class.

OK.

So let me stop there and
I hope I'll be seeing you

all every Monday and Wednesday.

Thank you.