Class Summary #36 for 11/28/11

Today in class we learned more abut equilibrium. To begin, Prof. Rizzo wrote the following on the board:

Some Properties of EQ: Consider a stylized economy with 5 consumers and 5 sellers (not necessarily distinct).

Then Rizzo posted a supply/demand curve of the Guitar Market and he used the graph to teach us about decentralization vs. centralization. Here are some of the notes we learned when going over the graph:

1. Equilibrium= where lines cross
1. At equilibrium, everyone is happy because neither party can "do" any better. 
2. People who value the item the most will get it and those who don't won't.
2. Demand=willingness and ability to pay.
3. Ration by price---> only those who desire an item the most are going to get it= "willingness to pay"

Then, Prof. Rizzo taught us some more lessons from the graph. We learned that if you use prices to determine who gets which good, it is easier for the buyer and seller to make good economic decisions. The reason behind this is because we have an information problem. 

Buyers and sellers don't need to know whether prices are high and low because that information is embedded in the price itself-thus we don't need a lot of knowledge, all the knowledge we need is embedded in the price, which is a reason why the price system is such a good rationing mechanism. This has really attractive characteristics.

What is different between government and market trial and error? In the government, there is little trial and error. They make a policy for all people in all states and it is difficult to alter such a policy. But, in the market, there is an incentive for people to react to save money and get the policy right. There is less experimentation with policies b the government.

In short, markers are much better equipped to adjust to programs/policies that do not get intended results that is the government. Many times, corrupt governments make policies and thus there is more incentives in the market because prices can adjust to make alterations.

The end lesson: the only way to survive in the complex work is to decentralize our decision making as much as possible. This doesn't mean we shouldn't have government, but we need the government to be decentralized.

A final lesson we went over were some problems with rationing by a central planner. On the graph, S4=$25. $25 is the opportunity cost because the supplier could be making $25 doing something else other than making guitars. If S2=$15 and sells a guitar at that price, we are $10 poorer because we could've sold it for $25. This is where side deals come in. If S4 and S2 combine and sell for $25 they can split the $10 profit and now were all better off.

The same can be said for consumers. If D4=$15 buys guitar and gives it to D5=$10, we now have a surplus and we are richer. The whole world is unhurt and we are better off. Thus, we can always be better off.

Even if Q*=3 and market gets that amount of items consumed right, it is still difficult to make sure the correct/most efficient consumer and producers make the deal.