PRINCIPLES OF MACROECONOMICS

Term: Spring 2007

Course Number: ECO 2013 – 741; MWF [10:00 – 10:50]ECO 2013 -- 743; MWF

Meeting Times Monday, Wednesday & Friday @ 10:00 - 10:50 [039- 1016] and Location: “ “ “ “ @ 11:00 - 11:50 [039-1016]

Course Description No prerequisites. This course cannot be used to satisfy upper-level and Prerequisites: requirements for a degree in business administration and/or economics.

The course is intended to provide students with an introduction to the principles of macroeconomics, income determination and national income accounting. The approach to the materials is both diagnostic and prescriptive (policy). A primary focus of analysis is on the use of monetary and fiscal policy to accomplish the goals of full employment, economic growth and price stability.

Instructor: Louis A. Woods, PhD.University of North Carolina, Chapel Hill.

Office Hours: Monday, Wednesday, & Friday – 9:30 – 10:00; 12:00 to 1:00; and by appointment.

Phone: [904] 620-2641

E-mail: lwoods@unf.edu

Required Texts: R. Glenn Hubbard & Anthony P. O’Brien. 2006. Macroeconomics. First Edition. Pearson/Prentice-Hall.

James D. Gwartney, Richard L. Stroup & Dwight R. Lee. 2005. Common Sense Economics: What Everyone Should Know About Wealth and Prosperity. New York, NY: St. Martin’s Press. James Madison Institute.

Outside Readings: In addition to the assigned reading material in the text, each student is expected to read a total of ten (10) articles (not editorials or book reviews) from scholarly journals over the term. Time, Businessweek, Fortune, The Wall Street Journal, etc. are all popular periodicals and DO NOT qualify as scholarly journals. Several examples of scholarly journals are Harvard Business Review, Business Economics,

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Journal of Developing Areas, Land Economics, Journal of Marketing. Some students may prefer to read the daily articles found on the Mises Institute website (www.mises.org); the Foundation for Economic Education website (www.fee.org) or Economic Insights found at the Dallas Federal Reserve Bank’s website (www.federal reserve.org). Each of the articles should be reviewed, summarized or outlined as a written report on 5" x 8" note-cards. These reports are to be turned in on a weekly basis, beginning the week of January 18.

Additional Each student is expected to be well informed on current economic issues --Requirements: both domestic and international -- by reading the Investor’s Business

Daily (especially the Monday issues, which are sold on the newsstands on Saturday) or the Wall Street Journal; and by viewing Market Wrap on CNBC (now MSNBC), Nightly Business Report (PBS), or Lou Dobbs on CNN on a daily basis.

There will be Exercises’ handed-out periodically in class for students to complete. These exercises involve reading the text, supplementary reading materials and answering questions relating to materials, including materials found on the internet, to demonstrate an understanding of the materials. Each exercise will have a full value of 10 (ten) points -- which will be incorporated into the final grade.

There will be NO opportunities for ‘make-up’ or ‘late-submittals of class’ assignments WITHOUT a written excuse from a Hospital Administrator, a Doctor or a Judge for an unexcused absence.

Course Outline and Schedule:

Jan. 8 - Spring Term 2007Spring Term 2007 May 4

January 8 First Day of Classes Introduction/background/housekeeping

Jan. 8 - Introduction to economics and key questions and issues: Feb. 9 What is economics? What are the tools that are used in economics?

What are the critical elements of macroeconomics and of economic

reasoning? These topics will be illustrated using editorial materials from current popular media sources, written by professional economists.Production possibilities, economic growth, benefits of specialization and exchange/trade. The role of markets, supply and demand. Market equilibrium. Macroeconomic concepts. Overview of Gwartney, Stroup & Lee’s [Common Sense Economics, 2005.] “Ten Key Elements

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of Economics”, 3-31] Major definitions and relationships. Time – the measure of many things. National income accounts; inflation and techniques for adjustment. Hubbard and O’Brien, Chapters 1-6.

READ CAREFULLY:

** Frédéric Bastiat’s (1805-1850) “That Which is Seen, and That Which is Not Seen,” (1850, printed posthumously); available @ www.bastiat.org. Yes, I fully realize that Bastiat is an old, dead European male,

nonetheless, his ideas remain as true today as they did in the middle of the 19th

Century. Hence, material from this essay will be included on quizzes. Read the first paragraph closely and study the I. THE BROKEN WINDOW. Compare Bastiat’s ideas with Gwartney, Stroup & Lee’s “Key Elements of Economics,” # 10: “Too Often Long-Term Consequences, or the Secondary Effects, on an Action Are Ignored,” (27-31). Somehow I prefer the way Gwartney and Stroup put in the earlier version of their book [What Everyone Should Know About Economics and Prosperity, 1993]: “Key Elements of Economics,” # 10: Ignoring Secondary Effects and Long-term Consequences is the Most Common Source of Error in Economics,” (27-9)

Bastiat begins his essay with the following statement:

In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause – it is seen. The others unfold in succession – they are not seen: it is well for us, if they are foreseen. Between a good and a bad economist this constitutes the whole difference – the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee.…the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come – at the risk of a small present evil. (1)

Notice that Gwartney, Stroup and Lee point out several instances of the secondary

effects (‘that which is unseen’) that are largely ignored. (27-31)

▪ ‘the case of rent controls on apartment’;

▪ ‘trade protectionist policies to protect jobs’;

▪ ‘government spending expands (creates) jobs;’ and

▪ ‘the West Virginia teacher’s pencil stub dilemma.’

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Bastiat, then points out:

In fact, it is the same in the science of health, arts, and in that of morals ….

This explains the fatally grievous condition of mankind. Ignorance surrounds its cradle: then its actions are determined by their first consequences, the only ones which, in its first stage, it can see. It is only in the long run that it learns to take account of the others. It has to learn this lesson from two very different masters – experience and foresight. Experience teaches effectually, but brutally. It makes us acquainted with all the effects of an action, by causing us to feel them; and we cannot fail to finish by knowing that fire burns, if we have burned ourselves. For this rough teacher, I should like, if possible, to substitute a more gentle one. I mean Foresight. For this purpose I shall examine the consequences of certain economical phenomena, by placing in opposition to each other those which are seen, and those which are not seen. (1, Emphasis added)

Several observations may be made concerning these comments of Bastiat. First, is the realization that ‘ignorance’ surrounds mankind’s condition; stated in a slightly different manner, Gwartney, Stroup & Lee have stated:

…that we are a nation of economic illiterates. (x)

Second, Bastiat identifies mankind’s two great teachers – experience and foresight – by contrasting the initial or primary effects resulting from an action with their “secondary effects and long-term consequences” (See: Gwartney, Stroup & Lee, ‘Key Element # 10,’ 27-31).

Bastiat’s preliminary analysis – his famous ‘broken-window fallacy’ – is followed up by a number of other examples of such ‘befuddled economic reasoning’ – including, the consequences of disbanding the military; the politicians’ use of taxes; and, public support of the ‘arts’. (27) Such foolishness ignores the role of the alternative- (‘opportunity’) cost doctrine in making sound economic decisions.

Interestingly, H.A. Scott Trask. [2004. “Ten Recurring Economic Fallacies, 1774-2004,” @ www.mises.org/fullsrory.aspx?control=1568], places

the Broken Window Fallacy as Myth # 1. Trask writes:

The fallacy lies in a failure to grasp what has been foregone by repair and reconstruction – the labor and capital expended, having been lost to new production. This fallacy, seemingly so simple to explain and grasp, although requiring an intellectual effort of some mental abstraction to comprehend, seems to be ineradicable.

He then cites the destruction of the Twin Towers (I would add Hurricane Katrina and the tsunami in Indonesia) and the reaction of the media

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quoting both corporate and academic economists, that – “…the attacks would help bring an end to the [alleged] recession.” Write your answers

to the following questions and be prepared to submit them on January 19.

Look up the definition of ‘recession’ in Hubbard and O’Brien (204). Then go to Wikipedia and look up the definition of ‘recession’ (http://en.wikipedia.org/wiki/

Recession).

Are the definitions the same?

What are the differences?

(To see if there was indeed a recession in 2001, go to www.bea.gov [click on: National GDP → Latest NIPA tables… → Interactive → Frequently Requested → Table 1.1.1. Percent Change … → Quarterly: 1999QI – 2006QII]; THEN, identify the magnitude and quarters of ‘negative growth’.)

Were there ‘”two consecutive quarters of negative real economic growth.”?

The text also speaks of previous recessions [1980-82 and 1990-91], see Figure 11.4 (340). Repeat the exercise for the ‘Recession of 2001’ for the 1980-82 Recession and the Recession of 1990-91.

Does the Wikipedia definition of ‘recession’ describe the 1980-82 Recession?

Were there “two consecutive quarters of negative real economic growth” during the 1980-82 Recession? What were the quarters and how large were the percentage declines?

How about the Recession of 2001, were there “two consecutive quarters of negative growth”? In which quarters and how large were the declines?

You may wish to compare this Table with Table 1.1.6 and identify the actual values of GDP.

Many economists apparently defer to the designation of what is a 5

recession and when does a ‘recession’ occur to the Business Cycle Dating Committee (BCDC) of the National Bureau of Economic Research (NBER). The BCDC bases their designation on a “…decline in business activity, in such things like [sic.] employment, industrial production, real income and wholesale/retail activity.”

NOTICE –Hubbard and O’Brien NEVER mention ‘two consecutive quarters of negative real growth in GDP’ in their text.

Hubbard and O’Brien write: “The long economic expansion that began in March 1991 ended in March 2001, when a recession began …. (389).

Compare the data in the BEA Tables 1.1.1. and 1.1.6. Did the recession being in 2000QIII or 2001QI? What were the sizes of the declines in ‘real GDP’ in each of these quarters? Are the differences large?

Neither do they discuss the roles of the Federal Reserve’s (conducted by the ‘Maestro’ Alan Greenspan) actions – changes made in Fed Funds rates and the supply of money. Fed Fund rates rose between December ’93 and June ’95, they then remained essentially constant through late summer ’98. Rates then declined through mid-1999 – they then rose to 6.40% in December of 2000, then they declined to 0.98% (December ’03), since they rose to July ’06 to 5.24% and have remained at that rate since. Confirm these data:

www.federalreserve.gov ↓

[left side] ‘Economic Research and Data’ ↓

‘Statistical Research and HistoricalData’

↓[right side] ‘Interest Rates’ H15

↓ ‘Historical Data’

↓‘Federal Funds’ (Monthly)

A review of Money Supply (M1 + M2) growth (January 1996 and November 2006), available from the Federal Reserve’s website as Money Stock Measures H6, reveals the following:

% Change in6

Money Supply Money Supply Year (M1 + M2) (M1 + M2)

January 1996 3,661.2 ----January 1997 3,833.7 4.71January 1998 4,061.7 5.95January 1999 4,411.1 8.60January 2000 4,676.9 6.03January 2001 4,978.9 6.46 January 2002 5,451.1 9.48January 2003 5,792.4 6.26 January 2004 6,050.0 4.44January 2005 6,401.7 5.81January 2006 6,694.6 4.58

November ’05 6,651.5 ----November ’06 6,990.4 5.09

Notice the rapid additions to ‘liquidity’ (money supply) during 1998 and 1999, as Alan Greenspan and the Federal Reserve fretted about the ‘potential Y2K (Year 2000) problem’! This issue hinged on: “Would computer software written during an era of limited memory that included years designate by the last two digits ’99 = 1999. Would ’00 be read as 1900 or 2000? If it did read the date as 1900, what would the consequences be – freezing bank accounts, rejection of checks? To be safe, Greenspan and Company dramatically expanded the money supply in the moths leading-up to 2000. When no ‘glitches’ occurred and fearing the potentiality for inflation [Nobel Prize winner, Milton Friedman had stated that “Inflation is always and everywhere a monetary phenomenon.”], liquidity was quickly drained from the system during 2000 and 2001, slowing the growth of the money supply. Notice, between January, 2001 and January, 2002 liquidity growth rate spiked up to nearly 9.5%.

The whole process relating interest rates, money supply and ‘malinvestment’ issues and may be found in an essay by Murray N. Rothbard, “The Interest Rate Question,” in his book: Making Economic Sense (1995), 42-5. Do not be dismayed if you are unable to follow all of what follows, with a little effort, it will become clear by the end of the term:

… As in the case of other prices, interest rates move inversely withthe supply, but directly with the demand, for credit. If the Fed enters the open market to buy securities [promissory notes or pieces of paper sold to the public], it thereby increases the supply of credit [moneyin the hands of the public which had owned the promissory notes], which will tend to lower interest rates; and since this same act will

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increase bank reserves by the same extent, the banks will now inflate money and credit out of thin air by a multiple of the initial jolt, now-adays about ten to one [the reserve requirement and reserve ratio]. (43)

See: Hubbard and O’Brien, ”Money, Banks and the Federal Reserve System,” 414-19.

Rothbard continues his explanation:

… the supply and demand for credit are themselves determined bydeeper economic forces, in particular the amount of their income that people in the economy wish to save and invest, as opposed tothe amount they decide to consume. The more they save, the lowerthe interest rate; the more they consume, the higher. Increased bank loans may mimic an increase in genuine savings, yet they are not the same thing.

Inflationary bank credit is artificial, created out of thin air; it doesnot reflect the underlying saving or consumption preferences of thepublic. Some earlier economists referred to this phenomenon as ‘forced’ savings; more importantly, they are only temporary. As increased money supply works its way through the system, prices and all values in money terms rise, and interest rates will then bounce back to something like their original level. (43)

The key to Rothbard’s analysis follows:

Only a repeated injection of inflationary bank credit by the Fed willkeep interest rates artificially low, and thereby keep the artificial andunsound economic boom going; and this is precisely the hallmark of the boom phase of the boom-bust business cycle. (43-4, emphasis inthe original)

This raises the thorny issue once again, “Who is responsible?” as well as the issue of ‘things seen and things unseen’ and, ironically, Alan Greenspan’s early identification of the distorting effects of government interventions into ‘free markets’ (“Antitrust,”:

… Like subsequent legislation controlling business, the Act[Interstate Commerce Act of 1887] was an attempt to remedy the economic distortions which prior government interventionshad created, but which were blamed on the free market. (65, Ayn Rand, Capitalism: The Unknown Ideal.)

Rothbard continues:

But something else happens, too. As prices rise, and as people begin to anticipate further price increases, an inflation premium is placed on interest rates. Creditor tack an inflation premium onto rates because they don’t propose to continue being wiped out by a fall in

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the value of the dollar; and debtors will be willing to pay the premium because they too realize they have been enjoying a windfall.

Rothbard, then derives the conclusions of his brief analysis:

And this why, when the public comes to expect further inflation, Fedincreases in reserves will raise, rather than lower, the rate of interest. And when the acceleration of inflationary credit finally stops, the higher interest rate puts a sharp end to the boom in the capital markets (stocks and bonds), and an inevitable recession liquidates the unsound investments of the inflationary boom. (44)

Next Rothbard explains the international implications:

…. As a long run tendency, capital moves from low-return investments(whether profit rates or interest rates) toward high-return investmentsuntil rates of return are equal. This is true within every country and also throughout the world. Internationally, capital will tend to flow from low-interest to high-interest countries, raising interest rates in theformer and lowering them in the latter.

In the days of the international gold standard, the process was simple.Nowadays, under fiat money, the process continues, but results in a series of alleged crises. When governments try to fix exchange rates …,then interest rates cannot fall in the United States without losing capital or savings to foreign countries. (44)

…. Price inflation is the consequence of the monetary inflation pumped in by the Federal Reserve for several years before the spring of 1987,and interest rates were therefore bound to rise as well.

… the Fed, as in many other matters, is caught in a trap of its ownmaking; for the long-term trend to equalize interest rates throughout the world is a drive to equalize not simply money, or nominal, returns, but real returns corrected for inflation. But if foreign creditors and investors begin to receive dollars worth less and less in value, they will require higher money interest rates to compensate – and we will be back again, very shortly, with a redoubled reason for interest rates to rise. (45, emphasis in the original)

With his wry humor, Rothbard concludes his observations with the following statement:

In trying to explain the complexities of interest rates, inflation, money and banking, exchange rates and business cycles to my students, I leave them with this comforting thought: Don’t blame me for all this, blame the government. Without the interference of government, the entire topicwould be duck soup. (45)

The following exercises are due on January 26January 26, to be handed in before the first quiz – No exercises, no test!

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Internet exercise with Chapter 7 (215) – changes in real GDP: Go to: www.bea.govClick on: ‘GDP’Click on: ‘Interactive NIPA Tables’Click on: ‘Frequently requested NIPA Tables’Click on: “Table 1.1.6 – “Real GDP, chained dollars”

Select your own time period, I chose 1970 to 2005 (annual).

Internet exercise to accompany Chapter 7 – percent changes in real GDP (growth rates):

Go to: www.bea.govClick on: ‘GDP’Click on: ‘Interactive NIPA Tables’Click on: ‘Frequently requested NIPA Tables’Click on: “Table 1.1.1 – “Percent Change from Preceding period,

in real GDP”Select your own time period, I chose quarterly data, 1988 (QI) to 2006 QII.

Much is often made by politicians, and their academic allies, of the economic performance under their fiscal (tax rates and spending) policies. To be an informed citizen it is your responsibility to be able to separate ‘fact-from-fiction’.

Over the period 1970 and 2006, what was the greatest rate of change in GDP? _________ What year did this occur? ___________ Whowas President? _____________ Which Party controlled the Congress? __________________

Internet exercise to accompany Chapter 8 – historic annual CPIGo to: www.bls.govOn the far left, under “Inflation and Consumer Spending,”

click on: “Consumer Price Index”Click on: “Tables Created by BLS” [Bureau of Labor Statistics]Click on: “Table Containing History of the CPI, 1913 – Present”

Note – results by monthly, annual average, and percentchange

Convert the price Dr. Woods paid for his first microcomputer (an IBM) in 1982 ($ 2,875) into current, 2006 dollars. Use the BLS’s “Inflation Calculator” found on its home page (www.bls.gov). What would it have cost in ’06 dollars? _____________ How does this compare with the current average price for a microcomputer?

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Consider the CPI over the period 1970-2006. Look for the highest annual (December to December) rates of inflation:

The year with the worst (highest rates was _______ and the rate was ______%The second worst year was ___________ and the rate was_______%

The third worst year was _________ and the rate was _______%

The fourth worst year was _________ and the rate was______%

The fifth worst year was _________ and the rate was_______%

Do you notice a clustering of high inflation rates in time?

What might account for these high rates?

Internet exercise with Chapter 8 – unemploymentGo to: www.bls.govOn the far right, under “Employment and Unemployment,”

click on: “National Unemployment”click on: “Tables created by BLS”

See: ‘Annual averages – Household Data’ in red lettersBelow itClick on: “Employment Status”

Just as politicians seek to use growth of GDP and inflation rates as success indicators, so too do they employ the unemployment rates as a club to beat-up their opponents --- “The worst unemployment since the Great Depression” … yata, yata, yata ….

What was the year with the largest percent, unemployed? _______

Over the period, 1970 to 2006:What year had the highest unemployment rate? ________ What was

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the rate? ______%

The second highest rate was _______ and occurred in _________.

The third highest rate was _______ and occurred in ________.The fourth highest rate was _________ and occurred in _______.

The fifth highest rate was _________ and occurred in ________.

Jan. 12 Last day for Drop/Add, late registration

Jan. 15 Martin Luther King Day – University Holiday

Jan. 18 First of the article reviews is due. One is due each week for the next 10 weeks.

Feb. 12 FIRST QUIZ

Feb. 14 - Preliminary issues and long-run fundamentals March 14

Changes through time, economic growth, productivity and wealth creation (as opposed to wealth re-distribution). Long-tern growth and theories of growth. Savings or consumption, Ah, that is the question (present vs. future – ‘instant-’ vs. ‘delayed-gratification’). [See: Scott Peck, The Road Less Traveled or People of the Lie]. Investment and capital; interest rates and GDP. The underpinnings of financial decisions. The nature and operation of labor markets; employment, unemployment, and wages. Myths and realities – Is it really the worst economy since the Great Depression? [For verification, go to: the U.S. Department of Labor, Bureau of Labor Statistics website: www.bls.gov. Look at the Unadjusted and adjusted unemployment rates for 1986 through 2006 – pay particular attention to 1993-1994; 1996 in comparison with 2002 through 2004] Money supply growth, inflation. Review the CPI and the use of the ‘Inflation calculator’ on the BLS website. Economic growth Business cycles and cycle theory.Hubbard & O’Brien, Chapters 7-12.

March 16 SECOND QUIZ

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March 19 – SPRING BREAK March 24

March 26 - Money, money supply and the role of banks and the Fed. Inflation. April 27 Monetary and fiscal policies. Alleged tradeoff between inflation and

unemployment and growth [the much revered ‘Phillips Curve’]. Monetary and fiscal policy International issues. Current policy issues. Spatial specialization (comparative advantage) and the gains from trade. Hubbard & O’Brien, Chapters 13-8.

April 27 LAST DAY OF CLASSES

April 30 FINAL QUIZ

Section 743 11:00 – 12:50

May 2 FINAL QUIZ

Section 741 9:00 – 10:50

Note: The final quiz will be held in the regular classroom.ECO 2013 – 741; MWF [10:00 to 10:50] -- 9:00 to 10:50 W; ECO 2013 -- 743; MWF [11:00 to 11:50] – 11:00 to 12:50 M.

Grading: Three, equally weighted quizzes (100 points) will comprise 75% of the final grade. The remaining 25% of the final grade will be determined, equally by the outside readings summaries and the assigned applications exercises. The following aggregate grading scale will be used:

400 to 370 (100% to 92.5%) ............... A369 to 342 (92.4% to 85.5%) .............. B341 to 306 (85.4% to 76.5%) .............. C305 to 278 (76.4% to 69.5%) .............. D Less than 278 (69.4%) ..................... F

Things to Ponder:

James D. Gwartney and Richard L. Stroup. 1993. What Everyone Should Know About Economics and Prosperity. Tallahassee, FL: The James Madison Institute.

Purpose of using this book – eliminate economic ignorance! Many notions that people hold about economics are in error, largely because they have been given the theoretical mechanics, but not the broader rudimentary concepts that form the structural framework, e.g., the ‘law of demand’ vs.

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‘incentives matter’. It also adheres to the military’s KISS [Keep It Simple, Stupid] principle.

The authors’ open with a simple statement that incorporates one of the ‘key elements of economics’ – “there’s no such thing as a free lunch’ (TANSTAAFL). “We realize that your time is valuable.” (iv) Embedded in this statement is the recognition that: (i) resources, including your time, are scarce (the ‘ law of scarcity’; and (ii) they can be put to alternative uses (they have an alternative or opportunity cost). One of the primary reasons that learning the ‘basic’ economic principles outlined in the book is that they: “…enhance your ability to differentiate between sound arguments and economic nonsense” i.e., separate the truth from the BS that constantly presented in the media. Often the media elite make misleading statements such as: “Gasoline prices are at an all time high.” Which is true, if you fail to discount prices for the influence of inflation, brought to us by the government’s ability to print (create) money without constraint. Ask yourself, what has happened to the five-cent Hershey bar, the dime cup of coffee and the quarter Saturday morning movie? Equally misleading is their confusion over Revenue and Profit when reporting “Oil companies profits are up 350 percent!”, when the true metric, what they are reporting is Gross Revenue. And, again, “Health care costs (prices) are too high in the United States,” implyin vg that this is a result of greedy businesses and medical professionals, without inquiring further about WHY they are high! Without too much effort, it is possible to deduce several reasonable reasons that account for the high costs of health care, though, not necessarily in order of importance:

(i) the role of Medicare (government intervention into free markets):[by setting reimbursements to doctors, hospitals and other medical

professionals at below market clearing (equilibrium) prices, the unfunded costs are shifted onto consumers with insurance or who pay cash. This raises the premiums on health insurance, as well.]

(ii) the ‘greed’ of tort lawyers (Fast Eddy Farah and John Edwards): [skimming-off 33%, PLUS costs from the gross award, results in higher premiums paid by doctors for mal-practice insurance, translating into even higher bills to health insurance companies and higher premiums to consumers and employers. Transfer wealth from those that have (greedy insurance companies) to themselves.]

(iii) a gradually aging population:[the need for medical care increases with age, placing greater demand on the healthcare system.]

and

(iv) technological change which has improved diagnostic and treatment protocols, including: lithotripters; MRIs, sonagrams, etc. But, these improvements come at a cost, yet provide profound benefits (less invasive procedures, lower risks and shorter hospital stays.

Murray N. Rothbard has observed: “But why are rates (health care) high and rising? The answer is the very existence of health-care insurance, which was established or subsidized or promoted by the government to help ease the previous burden of medical care.” (78) By this he means that there is a system of third party payers (government or private insurers) that, “…pay, not a fixed sum, but whatever the doctor or hospital chooses to charge.” (79) Moreover, he reports that “…medical customers…have come to think of unlimited third-party payments as some sort of divine right….” (79) Further, he notes: “…there is another deep flaw in the medical insurance concept. Theft is theft, and fire is fire, so that

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fire or theft insurance is fairly clear-cut – the only problem being the ‘moral hazard’ of insurees succumbing to the temptation of burning down their own unprofitable store….” (79) “…there is no way to prevent a galloping moral hazard, as customers – their medical bills reduced to near zero – decide to go to the doctor every week to have their blood pressure checked or their temperatures taken. ” (79) Health insurance became a commonality during WWII as wages were fixed, but benefits were not…so companies needing workers began to compete with one another to attract employee by providing health insurance, in lieu of pay increases (which were under price-controls).

Somewhat later in his article, Rothbard wrote:

But the roots of the current medical crisis go back much further than the 1950s and medical insurance. Government intervention into medicine began much earlier, with a watershed in 1910, when the much celebrated Flexner Report changed the face of American medicine. [Named after Abraham Flexner and commissioned by the Carnegie Institute for Medical Research.]

Flexner’s report was virtually written in advance by high officials of the American Medical Association, and its advice was quickly taken by every state in the Union.

The result: every medical school and hospital was subjected to licensing by the state,which would turn the power to appoint licensing boards over to the state AMA. The state was supposed to, and did, put out of business all medical schools that were proprietary and profit-making, that admitted blacks and women, and that did not specialize in orthodox, ‘allopatic’ medicine: particularly homeopaths, who were then a substantial part of the medical profession, and a respectable alternative to orthodox allopathy.

Thus through the Flexner Report, the AMA was able to use government to cartelize the medical profession: to push the supply curve drastically to the left (literally half the medical schools in the country were put out of business by post-Flexner state governments), and thereby raise medical and hospital prices and doctors’ income.(80, emphasis added)

Notice, ‘the AMA was able to use government,’ and consider Robert Formaini’s review of James M. Buchanan’s contributions [‘public choice theory’, largely eschewed by mainstream economists] to contemporary economics: the mutually beneficial (parasitic) relationship forged between recipients of government largess and bureaucrats (government workers). Formaini refers to these relationships as ‘wealth-trading’ or ‘rent-seeking’. [For a full explanation, see: Robert L. Formainu. “James M. Buchanan –The Creation of Public Choice Theory,” Economic Insights, 8 (2); available @ www.dallasfed.org.research/ei/ ei0302,html.] Also, notice: Mankiw assiduously avoids any discussion of ‘rent-seeking behaviors’ by market participants. Thankfully, Gwartney and Stroup forthrightly address this issue: Part III “Economic Progress and The Role of Government,” Element # 4 ‘Unless Restricted by Constitutional Rules, Special Interest Groups Will Use the Democratic Political Process to Fleece Taxpayers and Consumers,’ 79-82. They observe, explicitly:

Unfortunately, democratically elected officials can often gain by supporting policies that favor special interest groups at the expense of the general public….substantial personal gain for … a well-organized group (for example, industrial interests, members of a labor union, or farmer) at the expense of the broader interests of taxpayers or consumers. (G & S, 79)

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It is important to understand that Gwartney and Stroup’s list could easily be expanded to include the ‘environmental movement’ and academic researchers that self-identify ‘potential’ catastrophic events – soil erosion, deforestation, the population explosion, and ‘human induced’ climate change – first, it was global cooling (the coming Ice Age), then, global warming, and, now ‘human-induced global warming, induced global cooling’ (da’ ‘Big Freeze’) – then expect government funding (TAXPAYER DOLLARS) to find solutions to their self-identified, highly theoretical and, perhaps, low-probability, cataclysmic events. What this amounts to is a vast transfer of wealth from the poorly- or under-educated classes (lower income) to the highly- or over-educated groups (highly paid, well-positioned rent-seekers) only too willing to use the power of government to impose their normative visions on the majority of the population. Those who consider these observations to be extreme may wish to read the writings of Julian Simon and John Stossel, especially: Julian Simon’s Hoodwinking the Nation (1999). Simon, a gifted economist wrote: “Public opinion surveys tell us this for sure: most persons in the United States believe that our environment is getting dirtier, we are running out of natural resources, and population growth in the world is a burden and a threat,” (1, Emphasis added) He continues:

It also is sure by now that these beliefs are entirely wrong. Though it is not well-known to the public, there is broad scientific consensus that the air and water in the United States are getting cleaner rather than dirtier, that natural resources are becoming less scarce rather than more scarce, and there is no quantitative evidence that population growth is detrimental to economic growth in poor countries or rich ones. (1)

All of this is NOT NEW, but has been ignored in a most irresponsible way (see: The Doomsday Syndrome by John Maddox [former editor of Nature]. It should be noted that this is just another example ‘opinions’ and ‘beliefs’ trumping demonstrable facts – the ‘real’ price (‘inflation-adjusted’) of natural resources have declined since the 1870s – falling prices in a quasi-free market economy can only mean an increase, NOT a decrease, in supply. Additionally, even a cursory review of world population figures reveals that population growth rates began to decline in the 1980s (See the latest edition of U.S. Department of Commerce, Bureau of the Census, World Population.)

Rothbard continues his evaluation of the U.S. health-care industry:

…the medical establishment was now able to put competing therapies (e.g., homeopathy) out of business; to remove disliked competing groups from the supply of physicians (blacks, women, Jews); and to replace proprietary medical schools financed by student fees with university-based schools run by the faculty, and subsidized by foundations and wealthy donors.

…our very real medical crisis has been the product of massive government intervention, state and federal, throughout the century; in particular, the artificial boosting of demand coupled with an artificial restriction of supply. The result has been accelerated high prices and deterioration of patient care. (81)

Source: M.N. Rothbard. 1995. “Government Medical ‘Insurance,’ Making Economic Sense. Auburn, AL:

Ludwig von Mises Institute, 78-81 (Emphasis added).

[It must be noted that the AMA was pursuing what economists call ‘rent-seeking behavior.’ Rent-seeking frequently involves going to government (especially the legislative or judicial branches) to get what they are unable to obtain through free-market transactions. [The legislative branch is most

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easily influenced by ‘special interest groups’ (SIGs) by virtue of CAMPAIGN CONTRIBUTIONS. Zoltan J. Acs and Daniel A. Gerlowski have defined ‘rent-seek behavior’ more narrowly: “An attempt by some interested party to alter the allocation of rents in a contractual agreement; in general, does not create value within the organization.” 1996. Managerial Economics and Organization. Upper Saddle River, NJ: Prentice Hall, 448, emphasis added.]

Dr. Walter E. Williams (Professor at George Mason University), one of my favorite Black economists, has provided some additional observations of ‘health care providers’, government and ‘rent-seeking’. In a short editorial, he has written:

Let’s start out by not quibbling with American socialists’ false claim that health-careservices is a human right that people should have regardless of whether they can pay for it or not and that it should be free. [2004. “Free Health Care,” (July 21). www.townhall.com/columnists/walterwilliams/20040721.html.]

Before anyone ‘buys-off’ on all of this hooey, we need to gather the facts, evaluate them, and, using economic theory, interpret the outcomes. Dr. Williams draws upon the work of the Fraser Institute (Vancouver, British Columbia) associated with ‘free’ (‘socialized’) health care in Canada:

…has come out with its 13th annual waiting-list survey. It shows that the average time a patient waited between referral from a general practitioner to treatment rosefrom 16.5 [four months] weeks in 2001-02 to 17.7 weeks in 2003. Saskatchewan had the longest average waiting time of nearly 30 weeks [nearly 10 months], while Ontario has the shortest, 14 weeks [more than three months]. (Emphasis added)

One of the first things the leaps to mind is that Saskatchewan is a region with an economy largely based on large-scale agriculture. The population is predominantly ‘rural’ and lightly dispersed across the landscape, similar in many ways to the farm-landscape of North and South Dakota and eastern Montana – many small to medium sized towns, supporting the farms in the surrounding areas. In contrast, Ontario is a major metropolitan [‘urban’] center, with all of activities supported by a concentrated urban population, including retailing and heath care activities. Dr. Williams then observes:

Waiting lists also exist for diagnostic procedures such as computer tomography(CT), magnetic resonance imaging (MRI) and ultrasound. Depending on what province and the particular diagnostic procedure, the waiting times can rangefrom two to 24 weeks [six months].

…, in some instances, patients die on the waiting list because they become too sick to tolerate a procedure….hip-replacement patients often end up non-ambulatory while waiting an average 20 weeks for the procedure, and that’s afterhaving waited 13 weeks just to see the specialist. The wait to get diagnostic scans followed by the wait for the radiologist to read them just might explain why Cleveland, Ohio, has become Canada’s hip-replacement center.

Adding to Canada’s medical problems is the exodus of doctors. According to a March 2003 story in Canada News, about 10,000 doctors left Canada during the 1990s. Compounding the exodus of doctors is the drop in medical school graduates….Ontario has chosen to turn to nurses to replace to replace its bolting doctors. It’s ‘creating’ 369 new positions for nurse practitioners to take up the slackfor the doctor shortage. [Emphasis added]

Such outcomes must be considered carefully – Why would doctors ‘flee’ Canada? [inability to maximize

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their income] Have incentives in the health care been distorted by government intervention? [price controls (below market clearing levels) result in ‘consumer demand’ exceeding ‘provider supply’ of the services – SHORTAGES of health care] Who bears the costs of government interventions? [both consumers of health care (longer waiting periods’ and less-well trained practitioners) and taxpayers (higher taxes)] To avoid these circumstances, many Canadians (those who can afford to) CHOOSE to come to the United States to obtain medical services. What does the main-stream media play up? Lower costs of drugs in Canada – price controls imposed on pharmaceutical producers – but Canada is such a small market for drugs, the drug makers cave-in and pass the added costs onto consumers in the United States and other nations. Even more revealing is:

Some patients avoided long waits for medical services by paying for private treat-ment. In 2003, the government of British Columbia enacted Bill 82, an ‘Amendment to Strengthen Legislation and Protect Patients.’ On its face, Bill 82 is to ‘protect patients from inadvertent billing errors.’ That’s on its face. …Bill 82 would disallow anyone from paying the clinical fees for private surgery, where previously only the patients themselves were forbidden from doing so. The bill also gives the government the power to levy fines of up to $ 20,000 on physicians who accept these fees or allow such a practice to occur. This means it is now against Canadian to opt out of the health-care system and pay for your own surgery. {Emphasis added]

Again, serious questions are provoked – (i) do you own your own body [property-rights]? (ii) does this force patients (that can afford it) and doctors to seek health care services and provision of services in the United States? (iii) does it eliminate ‘third-party’ payers (insurance companies) from covering surgery? And (iv) does this create a government MONOPOLY in the health care industry? One must ask: If monopolies give rise to so-called ‘market failure’ à la A.C. Pigou [and the mythology of the caring, dedicated, self-less government worker (bureaucrat)] what’s to prevent massive ‘government failure’ in a socialized health care system? Remember, the government has a monopoly on the use of police power (coercion), while private sector firms and industries cannot FORCE consumers to buy services exclusively from them.

Another, recent example of both ‘rent-seeking’ and TANSTAAFL has been borne out by the November 2004 elections in Florida. One of the initiatives that passed overwhelmingly was to increase the ‘minimum wage’ to a ‘living level’ as of January 1, 2005. Has anyone been to a McDonald’s since New Year’s Eve 2005? What has happened to the price of a Big Mac, or a Big Mac Meal? Raising the minimum wage to businesses (you know, those GREEDY folks) has increased their ‘costs-of-doing’ business, and they have decided to ‘share their pain’ by passing these increases on to their customers (roughly a 30% increase in the price of a Big Mac), rather than cutting the size of a burger or order of fries. [Keep in mind, this higher minimum wage applies to ALL firms, not just ‘fast-food’ operations – retail outlets (Kmart, Target, Wall Mart), leads to higher prices on the goods and services they provide; grocery stores (Publix, Winn-Dixie, Food Lion) which means higher cost for groceries; hospitals, which means higher medical bills and health insurance premiums; movie theaters which pass on their higher costs in the form of higher prices for tickets and concessions, as well as more pre-movie advertisements, and so on…. One should expect to pay higher prices in ALL areas in order for the providers of goods and services to cover these higher labor costs.] Since Florida’s voters believed that the costs would be borne by ‘businesses’, they have once again demonstrated that “…we are a nation of economic illiterates,” able to perceive that which is seen, but unable to ‘foresee’ “that which is unseen.” See: Mankiw, 2007. 120-3, especially Figure 6, Chapter 6; and read carefully “FYI – Who Earns the Minimum Wage?” 324. Here Mankiw (Principles of Macroeconomics) has reported on the finding of a2005 U.S. Department of Labor study. The salient conclusions were:

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▪ 2% of men and 4% of women reported that they received wages at or below theminimum wage;

▪ half of the minimum wage workers earning the minimum wage or less were underthe age of 25 and a quarter were between the ages of 16 and 19; [YOUNG]

▪ about 2% of workers over the age of 16 who only had a high school diploma vs.1% of college degrees were earning the minimum wage; [LESS EDUCATED]

▪ 7% of part-time workers (less than 35 hours/week) received the minimum wag vs.only 1% of full-time workers; [PART-TIME]

▪ about 60% of all minimum wage workers paid at or below minimum wage were employed in the leisure and hospitality sector (food services and adult beverages), anindustry in which tips provide a major source compensation; [TIPS] and, finally,

▪ “The proportion of hourly paid workers earning the prevailing federal minimum wage orless have trended downward since 1979, when data collection first began on a regular basis.” [SHARE DECLINING ↓]

Why, then, is there such demands for increasing the minimum wage? Could it be that most union contracts have a clause that links ‘union wages’ to the minimum wage level (an escalator clause) – if the minimum wage level is increased by some amount, union wages must be adjusted upward!

A ‘true science’ does not ‘vote’ on/for the validity of a theory (science is not democratic, or we would still be in the Dark Ages – remember what has happened to those who bucked the prevailing ‘world-view’, including Galileo), rather the theory is tested and it is either upheld (verified) OR rejected (disproved). If rejected, a wholly new theory must be formulated, not just a warming-over (adding or deleting a variable) of the rejected theory! Nonetheless, we find Robert M. Alston, J. R. Kearl, and Michael B. Vaughn. 1992. “Is There Consensus Among Economists in the 1990s?” American Economic Review (May), 203-9 – “Proportion (and percentage of economists who agree) …. 8. A minimum wage increases unemployment among young and unskilled workers. (79%)” [34] Yet, (93%) agree with “1. A ceiling on rents reduces the quantity quality of housing available.” The inconsistency of this analysis reveals a ‘political motivation’ rather than a scientific conclusion: Prove this to yourself by studying carefully: “4.2 Making the Connection”, Price Floors in Labor Markets: The Minimum Wage (106-7) – notice the price/wage for labor established ABOVE ‘market-clearing’ (or equilibrium) levels [(Supply = Demand)] → surplus (unemployed) labor!!! This concept is too difficult for politicians to understand … Senator Bill Nelson, [D., FL] denies that raising the minimum wage WILL CAUSE more unemployment!

By way of contrast, “Price Ceilings: The Example of Rent Controls,” Figure 4.8 “The Economic Effect of a Rent Ceiling,” (107-8). This represents price/availability of housing BELOW ‘market-clearing’ (or equilibrium) levels [(Supply = Demand)] → shortage of housing!!! Note that an article appeared (June 7, 2003) in that notoriously liberal British periodical, The Economist. The amazing thing is that “Only one-third of New York City’s 2 million rental apartments are free of some kind of price restraint . A city board sets annual price increases and administers and ever more complicated system .” Isn’t it amazing that members of New York City’s City Council are more omniscient than even a free-market responding to the expressed wants/needs of consumers. Please read on:

Technically, new construction is free from these constraints. In fact, a complex system of tax inducements persuades most clever builders ‘voluntarily’ to agreeto rent-stabilization restraints. Not surprisingly under these conditions, building is anemic; even with the largest surge in construction since the 1960s, the number of building permits issued in the past year [2002] will add less than 1% to New York’s housing supply. Needless to say, in such a sclerotic system, the poor

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suffer most….. (Greg Mankiw, 120)

… It is hard to find any economist who supports rent restraints. Price controls, even if laboriously tweaked, inevitably produce inefficiencies, reduce supply and cause bad side-effects. Black markets thrive, building maintenance is often ignored. Landlords and tenants find themselves in poisonous relationships, sincethey are linked by law rather than by voluntarily renewable contracts…..

… Meanwhile, a vast bureaucracy has grown up to administer the price controls,supported by volunteers and litigators….. (121)

It should be obvious from the muted criticism that something is amiss … “produce inefficiencies,” this is ‘the property of society NOT getting the most it can from its scarce resources.’ (5) “Reduced supply” – less living space at the prevailing price. “Bad side-effects” – black markets (higher prices, bribes), formation of slums, etc. become commonplace. Hubbard and O’Brien Summarize the outcomes (111):

The Results of Government Intervention: Winners, Losers, and InefficiencyWhen the government imposes price floors or price ceilings, three important results occur:

• Some people win.• Some people lose.• There is a loss of economic efficiency.

For the minimum wage, the winners are union members whose contracts are ‘geared to’ the minimum wage. The losers are ‘marginal workers’ (women, young folks, minorities and unskilled workers) AND ALL CONSUMERS who face higher prices … cost of a ‘Big Mac’ before and after Florida raised the minimum wage --- a small number of workers benefited, BUT ALL CUSTOMERS were losers!

The price floors and ceilings seen above are simple examples of government intervention into the free market and DISTORTING THEM and reducing the levels of TOTAL SOCIAL WELFARE. This raises a disquieting set of questions: (i) were the results (less housing and more unemployment) unintended – those pesky ‘little’ unintended consequences outlined by Gwartney, Stroup and Lee in “Key Element of Economics # 10 – “Ignoring Secondary Effects and Long-term Consequences is the Most Common Source of Error in Economics,” 27-31. Like so many things, this has been known for a very long time, but again, has been ignored in a most irresponsible (“befuddled economic reasoning”) manner. [See: 1850. Frédéric Bastiat. “That Which is Seen, and That Which is Not Seen.”]

Nota bene (note well): The increased costs of labor associated with a higher minimum wage HAVE NOT BEEN ACCOMPANIED by an increase in labor productivity!!! The importance of this observation may be seen the fifth “Key Element of Economics” cited by Gwartney and Stroup (1993), “Increases in Real Income are Dependent Upon Increases in Real Output ,” below.] Anything else is simply a ‘shell-game,’ designed to divert the attention of consumers, tax payers and voters. There are still several adjustments that may be expected, if you understand economic processes – (i) the substitution of capital (equipment) for labor, which means (ii) fewer entry level jobs will be available for young workers, (iii) which in turn serves to reduce opportunities for young women and minorities to obtain work experience leading to BETTER jobs in the future. Milton Friedman once stated in an interview with Playboy (early 1970s), in regard to the ‘minimum wage question’: “It is better to be employed at $3.50 and hour, than unemployed at $5.00 an hour.” [See: Robert L. Formaini, “Milton Friedman – Economist

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as Public Intellectual,” Economic Insights, Vol. 7, No. 2; available at: www.dallasfed.org/research/ei/ei0202.html.] Additionally, some firms may be forced to REDUCE their labor force due to higher labor costs, resulting in higher rates of UNEMPLOYMENT… this result may be seen clearly in a number of European nations that have heavy handed government intervention in their economies, especially in labor markets, foe example France and Germany, which have unemployment rates twice those in the United States. Such secondary outcomes are referred to by economists as ‘unintended consequences’ (note: the tenth “Key Element of Economics” cited by Gwartney, Stroup and Lee, below) and they have unintended costs.

Economic ignorance seems to stem from a concentration on the theoretical mechanics of economics (mathematical models, etc.), rather than focusing on the basic principles. This result is a tuning-out of students that can solve mathematical problems, but are unable to understand the magnitude and scope of their arithmetic results. The key principles have been provided to people from the cradle onward, but without simple approaches to the messages, e.g.,

Aesop’s fable of the ‘Grasshopper and the Ants’ – what is the message of the fable? Simply, it is self-reliance and self-responsibility! Rather than accepting responsibility it is easier

(more convenient?) to seek self-absolution by passing the blame or responsibility onto others or society, as a whole, e.g., the old Flip Wilson character (Geraldine) – “The Debil made me do it!” Place reliance on some third party to take responsibility – the government, disregarding its inability to effectively/efficiently solve ‘real human’ problems because of its propensity to distort markets, to create unintended consequences and to presume that ‘one-size fits all’ social policies.

The child’s story, “Chicken Little,” has a message, too: THINK for yourself, don’t be stampeded into life-(changing) threatening decisions on the basis of faulty information, no matter how loud the message is shouted or how often! “The sky is falling! The sky is falling! Would TurkeyLurky and Ducky Lucky and all the other barnyard critters have been better-off had they just sat down and thought Chicken Little’s foolishness through. But, what did they do? They followed a self-appointed false prophet (Foxy Loxy) to there doom. Are there many ‘self-appointed false prophets’ out there? Count on it! Global warming, the ‘population bomb’ has exploded (Thomas Malthus and Paul Ehrlich) genetically modified (GM) foods (Jeramy Rifkin), and vaccines will harm children, to name a few!

“The Little Red Hen” provides an additional example of a child’s story with a profound message – the role

of incentives and property rights (physical/ intellectual and individual/group) in a well-ordered barnyard or society. We are always and everywhere constrained by scarcity, whether of

resources or of time. This reality means that ALL human needs/wants cannot be satisfied at a moment in ime, consequently some individuals have more than others – an uneven distribution of looks, income, wealth, land…. Those that have less would always like to have more. Hence laws and their enforcement are necessary. An un-spoken truth of the tale, expressed by the Little Red hen is a property right to her and her children’s labor – ‘we worked to produce the final product, and it is ours to use as we see fit.’ Keep in mind the Three Inalienable Rights espoused by the Founding Fathers – ‘Life, Liberty and Pursuit of Happiness,’ remember they were barrowed from John Locke’s ‘Life, Liberty and Property’. Contrast this with the nonsense that everyone should have ‘equal shares’ à la Karl Marx, “From each according to his ability, to each according to his need,” and Stalin’s re-write, “From each according to his ability, to each according to his work’!

Gwartney, Stroup and Lee point out the fact that “political rules and policies” affect the economy –

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largely as a result of the ‘law of unintended consequences’. Decisions are made and policies implemented with utter disregard to potential future outcomes, which have probabilities that

must be estimated and the consequences calculated. Consider their admonition:

…we are a nation of economic illiterates. Our democracy {actually, it is a REPUBLIC] puts voters in charge of choosing our policy makers, so the consequences of economic illiteracy can be disastrous. People who do not understand the sources of economic prosperity are susceptible to schemes that undermine their own prosperity and their country’s prosperity. A nation of economic illiterates is unlikely to remain prosperous for very long. (x)

The following Ten Key Elements of Economics are from the original book (1993) by Gwartney and Stroup. Compare them with the Ten Elements provided by Gwartney, Stroup and Lee. What has been deleted and what has been added?

Ten Key Elements of Economics

1. Incentives Matter. In simple terms, if you want more of a certain activity or behavior, reward it, if you want

less, then penalize it. The ‘reward’ may be profits (sales), an ice cream cone (a child minding his/her parents), or a kindly word (a ‘Thank you’) for a good deed done. The penalty may be a higher tax on the activity, a spanking, or deprivation of a pleasurable activity (watching a favorite TV program for a naughty child) or a rebuke for bad behavior. Responses are not instantaneous, but require time for behavioral adjustments (a ‘lagged effect’). Since the effects are ‘lagged’ there is a general tendency by ‘economic illiterates’ to fail to make the connection between ‘cause’ and ‘effect.’ This failure provides politicians with the opportunity to avoid responsibility for their actions, and, then blame the free market, in general (so-called ‘market-failure,’ à la A.C. Pigou), ‘greedy businessmen’ who place ‘profits’ above all other things, or member of the opposing political party! Perhaps the classic example of such dishonest posturing may be found an early article written by the former Chairman of the Federal Reserve, Alan Greenspan:

That Act [the Interstate Commerce Act of 1887] was not necessitated by the ‘evils’ ofthe free market. Like subsequent legislation controlling business, the Act was an attempt to remedy the economic distortions which prior government interventions had created,but which were blamed on the free market. The Interstate Commerce, in turn producednew distortions …. [1961. “Antitrust,” paper presented at the Antitrust Seminar of the National Association of Business Economics (September 25); printed in Ayn Rand. 1967. Capitalism: The Unknown Ideal. New York: Signet Books. Emphasis added.]

Adjustments to changes in prices, by both buyers and sellers, serve to allocate ‘scarce’ resources to their highest and most desired social uses. Any distortion of the market-determined price and quantity serves to divert scarce resources away from ‘socially optimal’ uses, re-channeling them into uses preferred by the ‘special interest groups’ (SIGs) that have been most successful in influencing public policy and ‘enabling legislation’. Note: A change in tax rates (an increase or a decrease) behave the same way, as households must adjust their expectations and spending behaviors to both higher and lower rates. Please note the comment (4):

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….market prices will coordinate the actions of both buyers and sellers.

The example provided of ‘higher gasoline prices’ of the 1970s (and, again in 2005/6), are both timely and telling. The connection between voters and political candidates is also worthy of comment – see: Robert L. Formaini. 2003. “James M. Buchanan – The Creation of Public Choice Theory,” Economic Insights, 8 (2); available at: www.dallasfed.org/research/ei/ei0302. Buchanan won the Nobel Prize in Economics in 1986. Gwartney and Stroup provide the insight that incentives also matter in socialist/communist societies is significant in avoiding wishful thinking and the belief that certain economic laws may be ‘repealed by caring politicians’ – ‘Let’s impose price controls’ – in the mistaken belief that there will be no consequences! [SHORTAGES]

Finally, Gwartney & Stroup field a common notion: “…economic analysis only helps explain the actions of self-centered, greedy materialists.” (5) By observing that “This view is false.”

2. There is No Such Thing as a Free Lunch. (or, more crudely: TANSTAAFL) TANSTAAFL was a term

coined by Milton Friedman, the 1976 winner of the Nobel Prize in Economics: see: Robert L. Formaini. 2002. “Milton Friedman – Economist as Public Intellectual,” Economic Insights, 7 (2); available at: www.dallasfed.org/research/ei/ei0202. html. [Note: this is the same as Mankiw’s “Principle # 1 “People Face Tradeoffs”, 4-5]. The factor underpinning these statements is the so-called immutable ‘law of scarcity’, which gives rise to the principle of alternative (or opportunity) costs. These costs are associated with the facts that we must contend with limited resources and unlimited wants (and, perhaps more importantly, needs). Money spent on lighting bridges for the Super Bowl is no longer available to add classrooms or new textbook to public schools. This means that if we want more of one item, it will be necessary to forego or give up alternative items as we transfer resources into the production of the item desired. We must make choices between/among various alternatives because of scarcity. This principle applies to government, as well as individuals, despite socialist protestations that they are able to repeal this iron-law, again, this is ‘befuddled economic reasoning’ – since “there are things that are seen, and there are things that are unseen” – things that are revealed at the moment, and things that are only revealed after the passage of years! In addressing the ‘law of scarcity’, D.W. MacKenzie (2003) observed:

Resources are Scarce and all have alternative uses. Any time we consume any good,it comes as an expense to someone. Government does not create, it redistributes. Thetrue costs of the things that government supplies to people may be dispersed or unseen,but they exist as surely as we do.

Since government is not a cornucopia, we must account for costs in production. As Mises proved, markets provide the only basis for calculating the value of capital goods. Private ownership in the means of production leads us to examine and follow the dictates of consumers, as reflected in profit and loss statements.

Economic calculation is impossible without markets. So, as long as costs are relevant we must accept the only feasible means to calculate them rationally. Socialist writers have at times denied the relevance of costs. As Mises noted, Keynes’s alleged general theory is an abundance theory, where we ‘turn stones into bread.’ This is an entirely fair assessment of Keynes’s beliefs, as he himself stated before even writing The General Theory. …

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A devout follower of his applied this ‘reasoning’ to the Soviet Union:

‘On the economic front, for the first time in its history the Soviet leadership was able to pursue successfully a policy of guns and butter as well as growth… The Soviet citizen-worker, peasant, and professional – has become accustomed in theBrezhnev period [1964 - 1982] to an uninterrupted upward trend in his well-being.” John Kenneth Galbraith, Professor of Economics, Harvard University, New Yorker,1984. “What Scarcity Implies,” The Free Market, 21 (2), 3.

Surely, you may remember this basic idea from the Production Possibilities Curve found in all Principles of Economics texts. Of all costs, it is the costs that reflect ‘lost alternatives’ that are most frequently ignored by individuals (if I go partying tonight, how will it affect my grade on tomorrow’s test?), businesses (if we allocate investment dollars to this product, what alternative investments must be give-up?) and government bureaucrats (if we provide public housing to this group, what services must be foregone by other groups?). The Congress consistently ignores this principle (TANSTAAFL)! They can always raise taxes, impose user-fees, impose price-controls, and, thereby, distort markets even further, i.e., divert spending on PRIVATE sector goods and channel it into the production of PUBLIC sector goods. This does not reflect the desires of consumers, but the wishes of special interest groups, i.e., it represents rent-seeking behavior. (go to: Robert L. Formaini. 2003. “James M Buchanan. – The Creation of Public Choice Theory,” Economic Insights, 8 (2); available at: www.dallasfed.org/research/ei/ei0302.) Such costs are a critical force in directing scarce resources to their ‘highest and best uses’ and avoiding mal-investment! See: Robert L. Formaini. 1999. “Hayek – Social Theorist of the Century,” Economic Insights, 4 (1); also available at: www.dallasfed.org/research/ ei/ei9901; Robert L. Formaini. “Ludwig von Mises, Economic Insights, 6 (4); available at: www.dallasfed.org/research/ei/ei0104.html. Roger W. Garrison. 2001. Time and Money: The Macroeconomics of Capital Structure. London: Routledge/Taylor & Francis Group, esp. Chapter 3; Ludwig von Mises, 1998. Human Action: A Treatise on Economics. Auburn, AL: Ludwig von Mises Institute, esp., Chapter XX, “Interest, Credit Expansion, and the Trade Cycles,” 535-83.

Prices provide signals to both consumers and producers: higher prices – buy less and produce more; and lower prices – buy more and produce less [revealed in the demand/supply relationship]. In this process, increased consumer demand for a good, stimulates producers to attempt to increase output. Output expansion requires producers to ‘bid’ resources away from their uses in the production of other goods (their alternative uses). It is always necessary to remember Mises admonition: in a free market, the consumer is king and that all production is for consumption! Note the emphasis that Gwartney & Stroup place on the provision of so-called ‘free’ goods to an ‘individual or group’ and the opportunity costs that these ‘free’ goods impose on others. (7) They are emphatic in their assessment:

…this merely shifts the costs; it does not reduce them. Politicians often speak of ‘free’ education’, ‘free medical care,’ or ‘free housing’. The terminology is deceptive. None of these things are free. (emphasis added)

Something to ponder, the Bush II administration’s Medicare Prescription Drug Bill (so-called ‘compassionate conservatism’), what are the likely opportunity costs associated with this bill? Lower profits and fewer incentives for the discovery and development of NEW LIVE-SAVING DRUGS by pharmaceutical companies! And, what are the potential unintended consequences? Lives that might have been saved aren’t, or, alternatively, deaths that could have been prevented

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will not be. The things that are seen are ‘cheap drugs’ for the wealthiest segment of our society (the elderly retirees), at the expense of those with the lowest incomes (young workers paying high Medicare taxes)!

In spite of many government attempts in the past, none have been able to repeal the ‘Law of Scarcity’. However, its restrictive nature has been loosened over the long haul, not by government, but rather by the much maligned activities of the innovative actions of the ‘entrepreneurs’ or ‘greedy businessmen’ responding to ‘potential’ profits as an incentive. Notice, when an ‘entrepreneur’ is successful (Bill Gates) and makes a fortune, she is criticized as GREEDY (unless they are ‘big-hearted’ Democrats, such as the indicted ‘inside-trader’ George Soros or Wall Street tycoon– Governor/Senator Jon Corzine). But, what happens when they fail and loose all of their hard-earned money? Oh, well, that just how markets work! See: W. Michael Cox. 2001. “Schumpeter – In His Own Words,” Economic Insights, Vol. 6, No. 3; available at: www.dallasfed.org/htm/pubs/ei/ei6_3_01. For example, as demand for copper has grown and prices have risen, and it has been displaced in many uses by cheaper and more efficient substitutes, i.e., optical fiber. Other examples include the longer term shift in energy and illumination sources: wood to animal fats (candles) to whale oil to coal to liquid fuel stocks, to nuclear power, to gaseous fuels, to WHAT next?

If the past is prelude to future, new technologies will emerge, and as they are developed and as production expands, costs will fall making them available at reasonable prices to the vast majority of citizens! This occurred with Polaroid cameras, video and cassette tapes, VCRs, microwave ovens, personal computers, yata, yata, yata! A current example is the improving efficiency, and falling prices (costs) of photo-voltaic [PVs] (or ‘solar-’) cells originally developed to provide energy for earth-orbiting satellites in the 1960s and began to be commonly seen powering handheld calculators during the 1980s. According to Wikipedia (‘photovoltaics’) the costs of production are falling currently at 3% to 5% per year, opening many new areas for use, increasing production and adding to further cost reductions. In 2006 the average cost per watt is about $ 4.50, with an average life expectancy of between 20 and 30 years.

3. Voluntary Exchange Promotes Economic Progress. Individuals pursuing their own self-interest entering

into exchange realize a ‘mutuality of benefits.’ Without a ‘mutuality of benefits’ voluntary exchange will not take place. ‘Exploitation’ is only possible by the use or the threat of the use of force – a theft. It should be noted that governments reserve to themselves the exclusive legal use of force (police power) against its citizens. Exchange or “Trade is productive; it permits each of the trading partners to get more of what they want.” (8) Gwartney and Stroup provide an answer to “why it increases the wealth of people.” Specialization enables individuals and societies to expand total output (to be more productive – more output with the same or even fewer inputs.

(i) “First, trade channels goods and services to those who value them most”; manifested through a willingness to pay! “A good or service does not have value just because it exists.” (8)

(ii) “Second, exchange permits trading partners to gain from specializing in the things they do best,” including individuals, regions and nations resulting in lower costs for goods and services.[The so-called ‘Law of Comparative Advantage, see: Robert L. Formaini. “David Ricardo: Theory of Free International Trade,” Economic Insights, Vol. 9, No 2; available at: www.dallasfed.org/researh/ei/ei0402.html.]

(iii) “Third, voluntary exchange permits us to realize gains derived from cooperative effort, division

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of labor, and the adoption of large-scale production methods.” It is necessary to contrast outcomes under situations of individual (household) production, known as ‘subsistence or self-sufficiency production’ involving small-scale production, with those of collective effort (factory or mass production) known as ‘commercial production’. It is wise not to equate ‘collective effort’ with the Marxist/Socialist model… Mass production yields vastly larger output per worker at substantially lower costs [the realization of ‘scale economies’]. See: Robert L. Formaini. “Adam Smith – Capitalism’s Prophet,” Economic Insights, Vol. 7, No.1; available at: www.dallasfed.org/research/ei/ei0201.html. for Adam Smith’s observations on the gains from specialization of task, or, alternatively, division of labor. He provides what has come to be known as ‘the pin factory’ case as an example of worker specialization and improvements in output.

4. Transaction Costs Are An Obstacle to Exchange; Reducing This Obstacle Will Help Promote Economic

Progress. The source of the idea of ‘transaction costs’ is to be found in the work of Ronald Coase, especially: 1937. “The Nature of the Firm,” Economica, 4 (November), 386-405; and expanded upon in his: 1960. “The Problem of Social Costs,” Journal of Law and Economics, . A primary aspect of Coase’s conceptualization of the firm is that it is ‘a bundle of contracts’ (with suppliers, labor, customers, share-holders). For a brief overview of Coase and his contributions, see: Robert L. Formaini and Thomas F. Siems. “Ronald Coase – The Nature of Firms and Their Costs,” Economic Insights, Vol. 8, No. 3; available at: www.dallasfed.org/research/ei/ei0303.html. Notice that nowhere does Mankiw mention, let alone discuss Ronald Coase and his major contributions to economics, despite his Nobel Prize in Economics in 1991.

Gwartney and Stroup note: “Voluntary exchange is productive because it promotes social cooperation and helps us get more of what we want. However, exchange is also costly. The time, effort and other resources necessary to search out, negotiate, and conclude an exchange is called transaction costs.” (11, emphasis added) Other transaction costs include the monitoring and enforcement of behaviors, are implicitly or explicitly implied in any exchange contract. The text identifies two major sources of high transaction costs: (i) physical obstacles – oceans, rivers, marshes, and mountains; and (ii) institutional obstacles – taxes, licensing requirements (radio, television, etc.), government regulations, price controls, tariffs and quotas. (11) They further observe that “…high transaction costs reduce the potential gains from trade. Conversely, reductions in transaction costs increase the gains from trade and thereby promote economic progress.” In contrast, ‘forced exchange’ means that one party is able to benefit at the expense of the other party – cheating, robbery or theft. Some might even say that if one party ‘educates’ herself and, on the basis of this superior information gets the better part of the deal that that is ‘unfair’ and taking advantage of a less well informed party, despite the opportunity of both parties to acquire ‘better’ information!

5. Increases in Real Income are Dependent Upon Increases in Real Output. “Higher income and standard of

living are dependent upon higher productivity and output.” (13) This relationship should be intuitively obvious – productivity is ‘output per unit input (labor, capital, etc.) per unit of time’. With increases in productivity (more output for the same, or even fewer inputs), prices of goods fall, while returns to factor owners (land, labor, etc.) rise. Gwartney and Stroup continue: “Once the linkage between output and income is recognized, the real source of economic progress is clarified. We improve our standard of living (income) by figuring out how to produce more output (things that people value). Economic progress is dependent, for example, on our ability to build a better house, computer, or video camera with the same or a lesser amount of labor and other resources. Without increases in real output – that is, output adjusted for inflation – there

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can be no increases in income and improvement in our living standard. (13, emphasis added) Gwartney and Stroup, rightly point out: “Politicians often erroneously talk as if the creation of jobs is the source of economic progress….Focusing on jobs is a potential source of confusion. More employment will not promote economic progress, unless the employment expands output.” (14, emphasis added) Consider the ‘economic’ rationality of President F.D. Roosevelt’s ‘make-work projects’ what he euphemistically called ‘pump-priming’ (WPA, CCC, for example) in this light, especially given what Gwartney and Stroup have to say: “We do not need more jobs, per se. Rather, we need more productive workers, more productivity-enhancing machinery, and more efficient economic organization so we can produce more output per capita.” (14, emphasis added) Productivity, then, depends, according to Mankiw, on: physical capital (machinery, equipment); human capital (education, training, skills; natural resources (availability or substitutability); and technological knowledge (invention and innovation). (245-7)

Gwartney and Stroup continue, reporting: “Some observers argue that technology adversely affects workers.” Such observers are reminiscent of General Ned Ludd, see: www.albany.edu/~rs7921 /quick.html. “In fact, just the opposite is true. Once you recognize that expansion in output is the source of higher wages, the positive impact of improvements in technology is apparent: better technology makes it possible for workers to produce more and thus to earn more.” (14, emphasis added) There is a whole new breed of ‘luddites’ in the world today, following in the pattern of Mary Shelley (authoress of Frankenstein), opposing numerous technologies that increase human well-being, for example: the issue of ‘genetic engineering’ … more and better food sources; more effective pharmaceutical products; bacteria that destroy harmful compounds (nuclear wastes, chemical waste products); save endangered species (elm and chestnut trees; and panda). One of the most outrageous of these Neo-Luddites is Jeramy Rifkin. Often these neo-luddites engage in ‘terrorism’ (destroying other peoples’ property and killing folks – e.g., the Unibomber), in the name of doing a social good. One of Joseph Schumpeter’s primary contributions to economics was his recognition of the beneficial destructiveness of technological change, resulting from both invention and innovation, summarized by the phrase “the perennial gale of creative destruction.” W. Michael Cox. 2001. “Schumpeter – In His Own Words,” Economic Insights, Vol. 6, No. 3; available at: www.dallasfed.org/htm /pubs/ei/ei6_3_01. Gwartney and Stroup have incorporated these ideas: “Sometimes specific jobs will be eliminated….These changes, however, merely release human resources so they can be used to expand output in other areas….Other tasks can now be accomplished with the newly released resources and, as a result, we are able to achieve a higher standard of living than would otherwise be the case.” (15)

Ironically, Gwartney and Stroup’s small book was published by The James Madison Institute in Tallahassee, Florida, but their insights consistently have been ignored by politicians and policy makers in that city. For example, the likely ‘unintended consequences’ of state-mandated minimum wages were ignored, and the socially undesirable outcomes (higher prices, fewer choices, higher unemployment; fewer work opportunities for teenagers) will likely be blamed on the greedy business community (read, greedy capitalist). They wrote in 1993: “Recognition of the link between output and income also makes easier to see why minimum wage legislation and labor union fail to increase overall wages of workers. A higher minimum wage will price some low-skill workers out of the market.” [More unemployed low-skill workers.] “Therefore, their employment will decline, reducing total output. While some individual workers may be helped, overall per capita income will be lower because per capita output will be lower.” (15) They conclude, emphatically: “Without high productivity per worker, there can be no high wages per worker….Production provides the source of income.”

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Associated with improved technologies, increased output, and higher wages is the need for fewer workers, especially fewer unskilled or semi-skilled workers.

6. The Four Sources of Income Growth are (a) Improvements in Worker Skills, (b) Capital Formation, (c)

Technological Advancements, and (d) Better Economic Organization. The term ‘growth’ involves change(s) over some period of time. (i) Skilled workers are more productive – leading to higher levels of output. Skills are improved by both formal training (schools, apprenticeships) and on the job learning (OJT). (ii) Additions to capital stock (new machines, software) enable workers to be more productive. (iii) Improvements in technology (new equipment, new products) permit the increase in output per worker per unit of time. (iv) Improvements in organizational structures, both in the private and the public sectors support increased productivity…the shift from craft to factory product/mass production. All four elements stimulate economic growth (increases in output). Gwartney and Stroup cite the role of legal systems and the creation of patent protection…”Effective economic organization will facilitate social cooperation and channel resources toward the production of goods that people value, Conversely, economic organization that protects wasteful practices and fails to reward the creation of wealth will retard economic progress.” (18) All too frequently firms and individuals will pursue ‘rent-seeking’ behaviors, i.e., going to government to obtain what they have been unable to obtain through the free market, e.g., Barksdale and Netscape (US Department of Justice) vs. Gates and Microsoft.

7. Income is Compensation Derived from the Provision of Services to Others. People Earn Income by Helping Others. “…we must not lose sight of precisely what income is. Income is simply compensation received in exchange for productive services supplied to others. People who earn large incomes provide others with lots of things that they value….There is a moral here. If you want to earn a large income, you had better figure out how to help others a great deal.” (19) They point out a common fallacy in regards to high incomes: “Some people have a tendency to think that high-income individuals must be exploiting others… The late Sam Walton (founder of Wal Mart Stores) became the richest man in the United States because he figured out how to manage large inventories more effectively and bring discount prices on brand-name merchandise to small town America.” (20) Currently, many ‘luddites’ oppose Walmart because: they run small, ‘mom-and-pop’ retailers out of business! But, they provide consumers with lower prices, enabling them to buy more items that provide them with satisfaction of both wants and needs. Keep in mind Henry Ford drove the Stanley Steamer out of business, as his mass production factories reduced the price of automobiles from an average of $ 2,000 per vehicle to less than $ 800; yes, jobs were lost in the Stanley Steamer plants, but were added in the factories producing Fords. In addition, lower prices permitted lower income families to acquire an automobile.

8. Profits Direct Businesses Toward Activities that Increase Wealth. “At any given time, there is virtually an

infinite number of potential investment projects. Some will increase the value of resources and promote economic progress. Others will reduce the value of resources and lead to economic decline. If economic progress is going to proceed, the value-increasing projects must be encouraged and the value-reducing projects avoided. This is precisely what profits and losses do in a market setting.” (21) Often individuals, pursuing their own self-interest promote value-reducing projects by recruiting government intervention in markets to assure the value-reducing projects take precedence over value-increasing projects. Such actions reduce general, social

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welfare below levels that it would have otherwise have attained. In spite of all the negative comments by critics, “…profit is a reward that business owners earn if they produce a good that consumers value more (as measured by their willingness to pay) than the resources required for the good’s production (as measured by the cost of bidding the resources away from their alternative employment possibilities). In contrast, losses are a penalty imposed on businesses that reduce the value of resources…Losses and bankruptcies are the market’s way of bringing such wasteful activities to a halt.” (21) Gwartney and Stroup conclude this section: “Essentially, profits and losses direct business investment toward projects that promote economic progress and away from those that squander scarce resources.” 23)

9. The ‘Invisible Hand’ Principle – Market Prices Bring Personal Self-Interest and the General Welfare

Into Harmony. Gwartney and Stroup quote Adam Smith’s Wealth of Nations: “Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society which he has in view….He intends only his own gain, and he is in this, and in many other cases, led by an invisible hand to promote an end which was not part of his intention.” They continue, “…the remarkable thing about an economy based on private property and freedom of contract is that market prices will bring the actions of self-interested individuals into harmony with the general prosperity of a community or nation.” (24) [See: Robert L. Formaini. “Adam Smith – Capitalism’s Prophet,” Economic Insights, Vol. 7, No.1; available at: www.dallasfed.org/research/ei/ei0201.html.] Despite Adam Smith’s observations, “The invisible hand principle is difficult for many people to grasp because there is a natural tendency to associate order with centralized planning. If resources are going to be allocated sensibly, surely some central authority must be in charge.” (24, emphasis added)

The ancient Greeks and modern depth psychologists (e.g., Carl G. Jung) would suggest that the cause is hubris or egocentric projection (the ‘shadow’ or negative-side of the psyche), both of which result in disaster! More to the point, historic (empirical) evidence demonstrates the inability of ‘central planning’ to out-perform the free market in meeting real human needs and wants, see: the former Soviet Union and its client states in Central and Eastern Europe. All of this had been predicted by von Mises ; [Robert L. Formaini. “Ludwig von Mises, Economic Insights, 6 (4); available at: www.dallasfed.org/research/ei/ei0104.html] and Hayek [Robert L. Formaini. 1999. “Hayek – Social Theorist of the Century,” Economic Insights, 4 (1); also available at: www.dallasfed.org/ research/ei/ei9901] in their debates with communists/socialists during the 1920s. Gwartney and Stroup continue, “When private property and freedom of exchange are present, market prices will register the choices of literally millions of consumers, producers, and resource suppliers and bring them into harmony. Prices will reflect information about consumers preferences, costs and matters related to timing, location, and circumstances that are well beyond the comprehension of any individual or central-planning authority. This single summary statistic – the market price – provides producers with everything they need to know in order to bring their actions into harmony with the actions and preferences of others [consumers and suppliers]. The market price directs and motivates both producers and resource suppliers to provide those things that others [consumers] value highly, relative to their costs.” (24-5, emphasis added) For a detailed explanation, see: F.A. Hayek.1945. “The Use of Knowledge in Society,” American Economic Review, 35 (4), 519-30. [Available @ www.virtualschool.edu/mon/Economics/HayekUseofKnowledge.html; and F.A. Hayek. 1937. “Economics and Knowledge,” Economica, IV (new ser.), 33-54; available @ www.virtualschool.edu/mon/ Economics/HayekEconomicsAndKnowledge.html.] (This is a difficult

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article, but well worth the effort.) In a brief, telling statement, Gwartney and Stroup, noting that central planning is unnecessary, write, “When the prices of these [wheat, houses, furniture] and other products indicate that consumers value them as much or more than their production costs, producers seeking personal gain will supply them….producers will seek out the best resource combination and most cost-effective production methods because lower costs mean higher profits” (25-6)

10. Ignoring Secondary Effects and Long-term Consequences is the Most Common Source of Error in Economics. Gwartney and Stroup attribute Henry Hazlitt (Economics in One Lesson) with

pointing out the importance of ‘secondary’ and ‘long-term’ effects of human decisions. “Hazlitt’s one lesson was, that when analyzing an economic proposal, one:

must trace not merely the immediate results but the results in the long run, not merely the primary consequences but the secondary consequences, and not merely the effects on some special group but the effects on everyone.(27, emphasis in the original)

Gwartney and Stroup conclude: “It is difficult to argue with this point [failure to adhere to this warning is the most common source of economic error]. Time and again, politicians stress the short-term benefits derived from a policy, while completely ignoring longer-term consequences. Similarly, there seems to be an endless pleading for proposals to help specific industries, regions, or groups without considering their impact on the broader community, including taxpayers and consumers.” (27, emphasis added) They report sadly, “Of course, much of this is deliberate…When the benefits are immediate and easily visible, while the costs are less visible and mostly in the future, it will be easier for interest groups to sell befuddled economic reasoning.” (27) They cite: rent controls – more housing for the poor, lower returns for landlords, less construction of rental units, increased shortages and declining quality of existing rental units… They then quote a Swedish economist: “In many cases rent control appears to be the most efficient technique presently known to destroy a city – except for bombing.” (28) Rent controls create SLUMS…Next, they identify tariffs and quotas to ‘protect jobs’ as an example of ignoring long run, secondary effects…tariffs/quotas on foreign (imported) automobiles serve to protect jobs in Detroit and increase automobile prices, auto consumers must curtail consumption of other goods and services, resulting in job losses in other industries…fewer foreign cars sold, exporting nations have fewer dollars with which to purchase US manufactured goods further affecting employment in non-automobile producing industries in the US!!! Gwartney and Stroup conclude: “Once the secondary effects are considered, the impact on employment is clear. The restrictions do not create jobs; they reshuffle them.” (29, emphasis added) Other examples include government spending on favorite projects and minimum wage legislation….

When considering Mankiw’s “Ten Principles of Economics” and Gwartney and Stroup’s “Ten Key Elements of Economics,” it would be a good idea to also consider Murray Rothbard’s “Ten Great Economic Myths,” (in Making Economic Sense, 18-29):

Myth 1: Deficits are the cause of inflation; deficits have nothing to do with inflation.

In recent decades we always have had federal deficits. The invariable response of the party out of power, whichever it maybe, is to denounce deficits as being the cause of perpetual inflation. And the invariable response of whatever party is in power has been to claim that deficits have nothing to do with

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inflation. Both opposing statements are myths.

Deficits mean that the federal government is spending more thanit is taking in in taxes. Those deficits can be financed in two ways.If they are financed by selling Treasury bonds to the public, then the deficits are not inflationary. No new money is created…

On the other hand, the deficits may be financed by selling bonds to the banking system. If that occurs, the banks create new money bycreating new bank deposits and using them to buy the bonds. The newmoney, in the form of bank deposits, is then spent by the Treasury, and thereby enters permanently into the spending stream of the economy, raising prices and causing inflation. …. In short, thegovernment and the banking system it controls in effect ‘print’ newmoney to pay for the federal deficit. (19, emphasis added)

Myth 2. Deficits do not have a crowding out effect on private investment.

In recent years there has been an understandable worry over the low rate of saving and investment in the United States. One worry is that the enormous federal deficits will divert savings to unproductive government spending and thereby crowd out productive investment, generating ever-greater long-run problems in advancing or even maintaining the living standards of the public.

Some policymakers once again attempted to rebut this charge by statistics. Interest rates fell because of the drop of business borrowingin a recession. In 1982-83, they declare deficits were high and increasing while interest rates fell, thereby indicating that deficits have no crowding-out effect.

This argument once again shows the fallacy of trying to refute logic with statistics. Interest rates fell because of the drop of business borrowing in a recession. ‘Real’ interest rates (interest rates minus the inflation rate) stayed unprecedentedly high, however – partly because most of us expectrenewed inflation, partly because of the crowding-out effect. (20)

Thus, deficits, whichever way you look at them, cause grave economic problems. If they are financed by the banking system, they are inflationary. But even if they are financed by the public, they will still cause severe crowding-out effects, diverting much-needed savings from productive private investment to wasteful government projects. … the greater thedeficits the greater the permanent income tax burden on the American people for the mounting interest payments, a problem aggravated by the high interest rates brought about by inflationary deficits. (21)

Myth 3. Tax increases are a cure for deficits.

Those people who are properly worried about the deficit unfortunatelyoffer an unacceptable solution: increasing taxes. Curing deficits by raising taxes is equivalent to curing someone’s bronchitis by shooting him.The ‘cure’ is far worse than the disease. …raising taxes simply gives government more money, and so the politicians and bureaucrats are likelyto react by raising expenditures still further.

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… inflation is a form of taxation, in which the government and other earlyreceivers of new money are able to expropriate the members of the public whose income rises later in the process of inflation. But, at least withinflation, people are still reaping some of the benefits of exchange. (21)

Myth 4. Every time the Fed tightens the money supply, interest rates rise (or fall);every time the Fed expands the money supply, interest rates rise (or fall).

The financial press now knows enough economics to watch weekly money supply figures like hawks; but they inevitably interpret these figures in a chaotic fashion. If the money supply rises, this is interpreted as lowering interest rates and inflationary; it is also interpreted, often in the very same article, as rising interest rates. And vice versa. If the Fed tightens the growth of money, it is interpreted as both raising interest rates and loweringthem. Sometimes it seems that all Fed actions, no matter how contradictory,must result in raising interest rate. Clearly something is very wrong here.

The problem is that, as in the case of price levels, there are several causal factors operating on interest rates and in different directions. If the Fed expands the money supply, it does so by generating more bank reservesand thereby expanding the supply of bank credit and bank deposits. The expansion of credit necessarily means an increased supply in the credit market and hence a lowering of the price of credit, or the rate of interest.On the other hand, it the Fed restricts the supply of credit and the growth of the money supply, this means that the supply in the credit market dec-lines, and this should mean a rise in interest rates. (22)

And this is precisely what happens in the first decade or two of chronic inflation. Fed expansion lowers interest rates; Fed tightening raises them. But after this period, the public and the market began to catch on to what was happening. They begin to realize that inflation is chronic because ofthe systematic expansion of the money supply. When they realize this fact of life, they will also realize that inflation wipes out the creditor [the lender] for the benefit of the debtor [the borrower]. … a Fed tightening will now tend to dampen inflationary expectations again lower interest rates; a Fed expansion will whip up those expectations [inflationary prospects] again and raise them. There are two, opposite causal chains at work. And so Fed expansion or contraction can either raise or lower interest rates, depending on which causal chain is stronger. (22-3)

Myth 5. Economists, using charts or high speed computer models, can accuratelyforecast the future.

The problem of forecasting interest rates illustrates the pitfalls of fore-casting in general. People are contrary cusses whose behavior, thank good-ness, cannot be forecast precisely in advance. …. Every economic quantity, every price, purchase, or income figure is the embodiment of thousands, even millions, of unpredictable choices by individuals.

Many studies, formal and informal have been made of the record of fore-casting by economists, and it has been consistently abysmal. (230

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Myth 6. There is a tradeoff between unemployment and inflation.

Every time someone calls for the government to abandon its inflationary policies, establishment economists and politicians warn that the result can only be severe unemployment We are trapped, therefore, into playing off inflation against high unemployment, and become persuaded that we must therefore accept some of both.

This doctrine is the fallback position for Keynesians. Originally, theKeynesians promised us that by manipulating and fine-tuning deficits and government spending, they could and would bring us permanent prosperity and full employment without inflation. Then, when inflation became chronic and ever-greater, they changed their tune to warn of the alleged tradeoff, so as to weaken any possible pressure upon government to stop its inflationary creation of new money. [Emphasis added]

Wow! Now, isn’t that strict adherence to the Baconian Scientific Method! The Keynesian model fails to predict accurately, so, let’s change the model to fit the present reality (empirical evidence). Yep! Let’s all vote on Einstein’s ‘Law of Relativity,’ E = mc2, or Newton’s ‘Law of Gravity,’ Gij = Mi * Mj/ dij

2!

The tradeoff doctrine is based on the alleged ‘Phillips Curve,’ a curve invented many years ago by the British economist A.W.Phillips. Phillips correlated wage rate increases with unemployment,and claimed that the two move inversely: the higher the increases inwage rates, the lower the unemployment. On its face, this is a peculiardoctrine, since it flies in the face of logical, commonsense theory. Theorytells us that the higher the wage rates, the greater the unemployment, and vice versa. If everyone went to their employer tomorrow and insisted on double or triple the wage rate, many of us would be promptly out of a job.Yet, this bizarre finding was accepted as gospel by the Keynesian Economic establishment. (24-5, emphasis in original)

By now, it should be clear that this statistical finding violates the facts aswell as logical theory. For during the 1950s, inflation was only about one or two percent per year, and unemployment hovered around three or four percent, whereas later unemployment ranged between eight and 11%, andinflation between five and 13%. In the last two or three decades, in short, both inflation and unemployment have increased sharply and severely. Ifanything, we have had a reverse Phillips curve. There has been anything but an inflation-unemployment tradeoff. (Emphasis in original]

But ideologues seldom give way to the facts, even as they continuallyclaim to ‘test’ their theories by Facts. To save the concept, they havesimply concluded that the Phillips curve still remains as an inflation-unemployment tradeoff, except that the curve has unaccountably ‘shifted’ to a new set of alleged tradeoffs. On this sort of mind-set, of course, no one could ever refute any theory.

…. Inflation brings recession and unemployment inevitably in its wake. (25)

Myth 7. Deflation – falling prices – is unthinkable, and would cause a catastrophicdepression.

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The public memory is short. We forget that, from the beginning of the Industrial Revolution in the mid 18th century until the beginning of World War II, prices generally went down, year after year. That’s because continually increasing productivity and output of goods generated by free markets caused prices to fall. … (25-6)

Virtually the only time that prices rose over those two centuries were periods of war (War of 1812, Civil War, World War I), when the warringgovernment inflated money supply so heavily to pay for the war as more than offset continuing gains in productivity.

We can see how free-market capitalism, unburdened by governmental or central bank inflation, works if we look at what has happen in the last fewyears to the prices of computers. (26)

And it’s not just computers – look at the prices of TVs, color TVs, Blackberries, cell phones, VCRs and DVDs, microwave and convectional ovens. In each case as a costly new product is developed, its price on entry to the market is high, but as production is ramped-up prices fall, and often dramatically, making the products available to nearly all segments of society. Contrast that with what has happen in the ‘centrally planned economies’ before “Mr. Gorbachov tear-down this wall” and the fall of the Soviet Empire!

Computer firms are successful

Myth 8. The best tax is a ‘flat’ income tax, proportionate to income across the board,with not exemptions of deductions.

It is usually added by flat-tax proponents, that eliminating suchexemptions would enable the federal government to cut the current tax rate substantially.

But his view assumes, for one thing, that present deductions fromthe income tax are immoral subsidies or ‘loopholes’ that should beclosed for the benefit of all. A deduction or exemption is only a ‘loophole’ if you assume that the government owns 100% of every-one’s income and that allowing some of that income to remain untaxed constitutes an irritating ‘loophole.’ (26)

Myth 9. An income tax helps everyone; not only the taxpayer but also the governmentwill benefit, since tax revenues will rise when the rate is cut.

This is the so-called ‘Laffer curve,’ set forth by California economistArthur Laffer. It was advanced as a means of allowing politicians tosquare the circle; to come out for tax cuts, keeping spending at current levels and balance the budget all at the same time. (27)

I should think we would be more interested in minimizing governmentrevenue by pushing tax rates far, far below whatever the Laffer Optimummight happen to be. (28)

Myth 10. Imports from countries where labor is cheap cause unemployment in the United States.

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One of the many problems with this doctrine is that it ignores the question:why are wages low in a foreign country and high in the United States? ...Basically they are high in the United States because labor productivity ishigh – because workers here are aided by large amounts of technologicallyadvanced capital equipment. ….

But what of certain industries in the U.S. that complain loudly and chronically about the ‘unfair’ competition of products from lo-wage countries? (28)

If the steel or textile industries in the United States find it difficult to compete with their counterparts abroad, it is not because other American industries have bid up American wage rates to such a high level that steeland textiles cannot afford to pay. In short, what’s really happening is that steel, textiles, and other such firms are using labor inefficiently as com-pared to other American industries. Tariffs or import quotas to keepinefficient firms or industries in operation hurt everyone, in every country,who is not in that industry. (29)

Library Scholarly journals may be located in the periodical section of the library Assignments: (The Third Level).

Written The individual article summaries will comprise one of the written Communication communication requirements in this course. Please note that the cards= Requirements: format, particularly the Bibliographic material, should conform to those

found in the Chicago Manual of Style.

Oral Class participation constitutes the demonstration of oral Communication communication skills. At all times, class discussion and class Requirements: participation is strongly encouraged.

Computer Use of the Internet for data searches, articles from scholarly journals Applications: and data manipulation are encouraged. The need for students to access the

instructor=s home page to download syllabi, class materials, and project

instructions serves as an additional set of computer applications.

International Mankiw devotes several chapter to international issues. Lectures and Coverage: handouts are used to augment the international component of this course.

Environmental Externalities/market failures, as well as government policies, are used Issues Covered: to examine environmental issues. In addition, the regulatory response and

burden on private markets are discussed. The role of private property in a

free-market economy and its implications for economic efficiency vis-a-vis the public provision of goods and services are examined in the so-called

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>tragedy of the commons=.

Ethical Issues Ethical issues related to illegal or immoral activity within the economy will Covered: be discussed where and as appropriate. This is particularly appropriate,

given recent scandals—Enron, Global Crossing, etc. and elected governmental officials. Since the course addresses aggregates, aggregate behavior of producers, consumers, regulators will be considered.

Academic Integrity: Each student is expected to do his/her own work on assigned activities and on all quizzes. An understanding of what constitutes plagiarism and abuse of copyright >fair use= laws is expected of each student.

Students With Students with a disability, as defined under the Americans with Disabilities: Disabilities Act (ADA), who may require special classroom

accommodations, should inform the instructor of any special needs during the first week of class. Students should also contact the Office of Disabled Services Programs (620-2769) immediately.

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