Lecture on Allocation, Distribution, and Stabilization

Scarcity

Productive resources are always limited while demand for resources is unlimited

All resources are scarce

• land - natural resources are limited

• labor - quantitative and qualitative limits

• capital - savings behavior/investment decisions

The Allocation Function

Resources are allocated through an economic system

• Market - private sector

• Government - public sector

• All economic systems are mixed - market and government

• Scarce resources can not be substituted equally between the public and private sector

• some goods are produced more efficiently by one sector

• law of diminishing returns - increasing costs for additional production

Adam Smith and The Wealth of Nations (1776)

The allocation function and the role of government

• protect society from external violence and invasion

• establish a system of justice to provide internal law and order, to protect property

• establish and maintain beneficial public institutions (public works) that can not be provided on a profitable basis

• maintain a sovereign government

EVALUATING ECONOMIC PERFORMANCE

Efficiency - what is the level of goods and services provided

• production - least cost method of production

• consumer satisfaction - goods produced that are valued by consumers

• distribution - each commodity is distributed to consumers who values it the most

EQUITY - THE DISTRIBUTION FUNCTION

Efficient markets may not produce an equitable distribution of economic well-being

Markets may not be efficient

Types of equity

• Equity of endowment

• Equity in process

• Equity in outcomes

THE STABILIZATION FUNCTION

Unemployment

• frictional unemployment

• structural unemployment

• cyclical unemployment

The business cycle

• Trough

• Expansion

• Peak

• Recession

CONTRASTING VIEWS ON THE BUSINESS CYCLE AND UNEMPLOYMENT

Say's Law

• the business cycle is natural - economic recession/depression cures itself

• unemployed workers must take lower wages to be re-hired

• employed workers buy lower priced goods

Marx

1. capitalist compete for profits - surplus value

2. wages rise as labor becomes more valuable

3. surplus value falls as labor is paid more

4. machinery is substituted for labor - workers are fired

5. this cycle is repeated again and again - each worse than the next