ECONOMICS AND PEOPLE

1. ECONOMICS AND PEOPLE Antony Davies, Ph.D. Duquesne University Part 1 UNIT 2 Click here for instructions.

2. INSTRUCTIONS • Navigation through the course will occur by clicking on the following action buttons located in the lower right corner of each screen: The HOME button will be placed in the center of each slide and will bring you to the Table of Contents for further navigation. The NEXT and BACK buttons will move you through the course content. The EXIT button will be placed at the end of each unit and will exit the unit and return you to the course menu.

3. INSTRUCTIONS • This course is meant to be self-paced, though there will be opportunities to interact with your local and global JPIC groups. • Course content and activities should be completed in the order that they are presented to maximize student success. • The Table of Contents will be your starting point for each Unit

4. ACTIVITY ICONS • Each type of course activity has a unique icon located in the upper right corner of the screen. • In this course you will: Online journal Local discussion Read online Create doc Reflect Global discussion Watch video Quiz/test

5. PART1:ECONOMICS AND INDIVIDUALSUNIT 2:PROFIT, LOSS, AND DISCOVERY

6. UNIT 2: PROFIT, LOSS, ANDDISCOVERY This unit is divided into several sections. Start with the Introduction.Then proceed onto each section. You can click on a link below to navigate to the section where you had recently left off. Introduction Section 1: The Nature of Value Section 2: The Nature of Profit Unit Summary & Assignment

7. UNIT 2: PROFIT, LOSS, ANDDISCOVERY In the previous unit, we learned the importance of thinking in terms of first principles rather than in terms of issues in order to avoid logical contradiction (see Unit 1, Part 3 for further discussion of logical contradictions).

8. UNIT 2: PROFIT, LOSS, ANDDISCOVERY In this unit, we will apply this style of thinking to investigate the nature of profit. Most people think of profit as the difference between a company’s revenue and its costs. In fact, profit is simply “net benefit.” A company’s profit is objectively measurable, but there are many other forms of profit that are less noticed (though just as real) because they are measured subjectively. For example, the happiness you get from eating ice-cream minus the price to purchase the ice-cream and the possible concern over getting fat equals your profit.

9. UNIT 2: PROFIT, LOSS, ANDDISCOVERY • Profit (in this basic sense) is the motivation for all human activity, regardless of the economic system and social order. • Even selfless acts are profit-motivated. For example, if you believe that it is your moral responsibility to give to the poor and that you feel this so strongly that you give away half of your possessions, then the economist would say that you incurred a profit. • The subjective benefit you received (in this case, the satisfaction or peace in knowing that you behaved morally) exceeds the subjective value (to you) of that which you gave away. If not, you wouldn’t have given away your possessions!

10. UNIT 2: PROFIT, LOSS, ANDDISCOVERY This may sound like a depressing view of humanity – that everyone, even the selfless, are really selfish profit seekers. If that is your view, then you don’t yet understand profit. In this unit, we will explore the nature of profit and show that profit is not a sign of exploitation and division but a sign of creation and community.

11. UNIT 2: PROFIT, LOSS, ANDDISCOVERY One view holds that profits are, if not immoral, then highly suspect because when one makes a profit, one makes it at the expense of another. By extension, this view also holds prices as suspect because prices are the mechanism by which one obtains profit. According to this view, there is a cycle wherein greed motivates sellers to charge high prices, high prices generate profit at the expense of buyers, and the quest for profit encourages further greed. Greed Price Profit

12. UNIT 2: PROFIT, LOSS, ANDDISCOVERY An alternate view holds that profits are the reward for creating value. By extension, prices are signals that communicate what goods and services society values most. According to this view, there is a cycle wherein the value consumers place on things determines prices, prices generate profit, the quest for profit encourages producers to innovate, and the innovation generates more value for consumers. Price Profit Value Innovation

13. MICRO-LECTURE View the Lecture (02:59) Read the Text of the Lecture

14. Section 1 THE NATURE OF VALUE

15. ACTIVITY Take a few moments to answer the following questions: What determines something’s value? When a sale is made, who benefits and who loses, the buyer or the seller? Can wealth (value) be created simply through exchange? How much profit, in your opinion, is too much?

16. The two alternate views of profits arise from two opposing theories as to the nature of value. Labor theory of value What makes something valuable is the labor that went into the thing’s production. Subjective theory of value What makes something valuable is that someone desires the thing.

17. What makes something valuable is the labor that went into the thing’s production. The labor theory of valueis appealing because it recognizes that value derives from labor. An object, unto itself, has no value. The value comes about when you add labor to the object. For example: Carving wood into a chair makes the wood valuable. One might argue that the wood itself has value as a source of fuel. But, in order to be used as fuel, someone must go out and collect the wood, split it, and season it – again, labor is required to transform the wood into something of value.

18. What makes something valuable is the labor that went into the thing’s production. The logical implication of the labor theory of value is that an object’s value is objective – that is, the value is the same for everyone. For example, suppose that the wage rate is $1 per hour. If it takes 50 hours of labor to transform wood into a chair, then the value of the chair is $50. Notice what happens when the woodworker goes to sell the chair…

19. What makes something valuable is the labor that went into the thing’s production. If the woodworker charges more than $50 for the chair, then the woodworker cheats the customer. Value = $50 Woodworker Customer $60

20. What makes something valuable is the labor that went into the thing’s production. But, if the customer pays less than $50 for the chair, then the customer cheats the woodworker. Value = $50 Woodworker Customer $40

21. What makes something valuable is the labor that went into the thing’s production. The labor theory of value implies that every transaction is a zero-sum game. When the woodworker sells the chair, he loses a chair worth $50 in exchange for gaining money. When the customer buys the chair, he gains a chair worth $50 in exchange for losing money. If the price is $50, both the woodworker and the customer are as well off after the transaction as they were before. If the price is above $50, the woodworker is better off after the transaction while the customer is worse off. If the price is below $50, the woodworker is worse off after the transaction while the customer is better off.

22. Through the eyes of the labor theory of value, the world is a bleak place wherein every transaction either results in neither party being better off or involves the exploitation of one party at the expense of the other. Fortunately, the labor theory of value is inconsistent with reality. A simple thought experiment demonstrates the inconsistency.

23. Suppose that it takes you 2 hours to collect apples, make a crust, and bake an apple pie. It also takes you 2 hours to collect dirt, mix it with water to make a fine mud, and create a mud pie. According to the labor theory of value, both the apple pie and the mud pie have the same value because each required 2 hours of labor to produce. But, put a $2 price tag on each and see which sells. The fact that no one wants the mud pie but many would want the apple pie indicates that there must be more to value than simply the amount of labor that goes into a product.

24. What makes something valuable is that someone desires the thing. The subjective theory of valueholds that an object’s value is determined by the person. For example, the chair is valuable to both the woodworker and the customer because of the happiness each gets from looking at a nice piece of furniture and having a comfortable place to sit. If it is easy for the woodworker to make another chair, then the value of the chair will be low for him. If the customer badly needs a place to sit, then the value of the chair will be high for him.

25. What makes something valuable is that someone desires the thing. The logical implication of the subjective theory of value is that an object’s value is subjective – that is, the value may be different for different people. For example, suppose that the woodworker can make another chair with relative ease so the value of this chair to the woodworkeris $20. Suppose also that the customer is in need of a chair but that it would be extremely difficult for the customer to make one himself. So, the value of this chair to the customeris $60. Notice what happens when the woodworker sells the chair for $40…

26. What makes something valuable is that someone desires the thing. The woodworker is $20 better off because he gives up a chair that he values at $20 in exchange for $40 cash. Value $20 Woodworker Customer $40

27. What makes something valuable is that someone desires the thing. Meanwhile, the customer is also $20 better off because he gave up $40 cash in exchange for a chair that he values at $60. Value $60 Value $20 Woodworker Customer $40

28. What makes something valuable is that someone desires the thing. The subjective theory of value implies that every transaction is a positive-sum game. In the absence of coercion, the woodworker will only sell the chair if the price exceeds the woodworker’s subjective value of the chair, and the customer will only buy the chair if the price is less than the customer’s subjective value of the chair. By definition, if the transaction occurs, both parties are better off.

29. ACTIVITY • Take a few minutes to reflect upon coercion and answer the following questions (if necessary, go back and view the definition of coercion in the glossary). • Suppose that the woodworker lied to the customer by telling the customer that the chair was made of a rare expensive wood when, in fact, the chair was made of a cheap and common wood. Assuming that the customer believed the woodworker’s lie, would the lie constitute coercion?

30. ACTIVITY • Take a few minutes to reflect upon coercion and answer the following questions (if necessary, go back and view the definition of coercion in the glossary). • Alternatively, suppose that the chair is made of a cheap and common wood but that the customer (for whatever reason) erroneously believes that the chair is made of a rare expensive wood. The customer does not reveal his belief to the woodworker and the woodworker makes no claim as to what type of wood is in the chair. Does the customer’s erroneous belief constitute coercion?

31. WAIT! How can a chair – something that exists objectively – have a value that is subjective? Certainly, one of the two parties is wrong about the chair’s true value! The chair is an objective reality. But, value does not come from the chair. It comes from the person experiencing the chair. The “experience” of the chair might come from sitting in it, or looking at the fine workmanship, or smelling the aroma of the wood with which it was made. The experience can come from storing the chair safely so as to produce the satisfaction of knowing that you have a fine chair should you ever need one, or so as to produce the sense of security from knowing that you can sell the chair later when it is an antique for more than you paid for it.

32. What makes something valuable is that someone desires the thing. • The experience of the chair is specific to the person’s needs, tastes, and beliefs. Therefore the value of the chair is different for different people – that is subjective value. • There are two powerful implications to the subjective theory of value: • In the absence of coercion, exchange usually benefits both the buyer and the seller. • The profit the seller makes corresponds to happiness the buyer receives.

33. ACTIVITY • The profit the seller makes corresponds to the happiness the buyer receives. • Bill Gates is one of the richest people in the world. As of 2010, he is worth over $50 billion. To put that number in perspective, in the time it will take you to read this slide, he will have earned about $1,000 in interest. • Assuming the labor theory of value is correct, consider what his accumulation of this wealth implies about the people who bought his software. • Assuming the subjective theory of value is correct, consider what his accumulation of this wealth implies about the people who bought his software.

34. What you should have noticed by now is that the subjective theory of value implies that profit is one part of the benefit created from a transaction. The other part is the happiness the buyer gets from receiving a good that is (subjectively) worth more than the money the buyer paid. One reason profit is sometimes viewed as bad is that profit can be explicitly seen and counted, while happiness cannot. Because of this, it appears to the untrained eye that only the seller benefits from a transaction. This is falling back into the error of the labor theory of value. Instead, profit (when generated in a non-coercive environment) is a sign that both buyers and sellers are better off – that society has improved.

35. Labor Theory of Value Subjective Theory of Value Exchange zero-sumwin / lose positive-sumwin / win Profit or Loss profit = (labor) value – wages profit = new value created Market Relationships exploitationparasitism THEORIES OF VALUE AND VIEWS OF THE MARKET mutual benefit symbiosis

36. Section 2 THE NATURE OF PROFIT

37. The two theories of value imply two different views of profit.

38. As sellers seek profit, they are constantly looking for ways to harness resources for the good of society. They do this, not out of altruism, but out of self-interest. What is fascinating is that (assuming a non-coercive environment) sellers end up behaving as if they were motivated by altruism. Price Profit Value Innovation What is innovation? Who does the innovating?

39. ENTREPRENEURS Entrepreneurs are people who are skilled at finding new and better ways to do things, and who think up new and better goods and services. Some entrepreneurs work for existing companies, helping these companies to improve their goods and services. Some entrepreneurs create new companies to provide new products or to provide old products in better ways.

40. ENTREPRENEURS • Some entrepreneurs who founded new companies: • Andy Grove founded Intel. • Jerry Yang founded Yahoo. • Sergey Brin founded Google. • Pierre Omidyar founded eBay. • Frederick Smith founded Federal Express. • Bill Gates founded Microsoft. • Steve Jobs founded Apple Computer.

41. ENTREPRENEURS Not all entrepreneurs are successful. Not all ideas are good ideas, and even good ideas can be introduced at the wrong time or the wrong place. Even good ideas introduced at the right time and the right place can be poorly executed. As a result, like aspirants to professional sports, most entrepreneurs fail. But the cost to society of hundreds of failed entrepreneurs can easily be outweighed by the benefit to society of the success of one. So who are entrepreneurs?

42. ENTREPRENEURS • What attributes are common among entrepreneurs? • They are usually people with a higher tolerance for risk. • They are usually people who generate novel ideas. • These attributes can also describe the insane. •  Entrepreneurs can be dangerous as well as beneficial.

43. ENTREPRENEURS • Good Risk vs. Bad Risk • Good risk (or “prudent” risk) is risk that is justified by the potential reward. • Bad risk (or “imprudent” risk) is risk that is not justified by the potential reward.

44. ENTREPRENEURS • Good Ideas vs. Bad Ideas • Good ideas create more value than they consume. • Bad ideas create less value than they consume.

45. ENTREPRENEURS Since we can’t see into the future, we will not be sure whether risks are prudent or imprudent, and we will not be sure whether an idea is good or bad.

46. REFLECTION Who should make the decision to allocate society’s scarce resources to a new idea?

47. REFLECTION • Example • Suppose you live in 1900, before the automobile. Someone suggests to you that society should expend resources to develop and produce automobiles. • Here are some things you, living in 1900, would likely consider: • Anticipated Benefits • Cars will be faster than horses. • Cars will be fun to drive. • Cars will be more comfortable than horses. • Anticipated Costs • Iron smiths will become unemployed (lesser need for horseshoes). • Saddlers will become unemployed. • Horse breeders and traders will become unemployed. • Farmers will make less money on grain (fewer horses to feed).

48. REFLECTION • Example • Suppose you live in 1900, before the automobile. Someone suggests to you that society should expend resources to develop and produce automobiles. • Given the costs and benefits that you anticipate, you might argue that society should not expend resources to develop and produce automobiles because the costs may outweigh the benefits. The problem is that you, being a finite human, are unable to anticipate all of the ramifications of this new idea. For example, in 1900, you would have failed to anticipate: • The creation of new industries needed for the support and maintenance of cars (gas stations, car mechanics, parts stores, etc.). • The creation of new industries to sell products that make cars more useful (computer aided navigation, fast food restaurants, etc.).

49. REFLECTION • Given that we are finite humans, how do we make the best decision as to whether or not to commit society’s resources to a new venture? • There are two possible answers: • Government makes the decision • Entrepreneurs make the decision • When government makes the decisions, we call this a command economy (or a centralized economy). • When entrepreneurs (and investors) make the decisions, we call this a market economy(or a free market).

50. ACTIVITY We cannot perfectly anticipate the future and so always run the risk of making poor decisions. There are two ways we can make poor decisions: we can commit resources to projects that do not benefit society, or we can fail to commit resources to projects that do benefit society. Consider the pros and cons of having government make the decision (a command economy) and of having entrepreneurs make the decision (a market economy).