Econ 2: Spring 2014: UC Berkeley: Problem Set 4 Answers DRAFT
Evening Must-Read: Narayana Kocherlakota on Monetary Policy

Notes for Debate with Jeff Miron on Marty Nemko's Radio Show

[Pre-Debate Notes:]( * The first question, I think, is how much does each of us owe to all the rest for there being here to help us? The answer is, I think, everything: drop any of us naked and alone into the pre-human settlement Missouri Valley and we are chewy and taste good with ketchup to grizzly bears. Life is then nasty, British--and very short. Thus each of us owes the others who came before us and now surround us and who kept the grizzly bear population down and rebuilt the civilization--well, each of us owes the others everything.
* The second question, I think, is how much do others owe each of us? How much larger are humanity's collective resources because each of us is around? The answer to this is, I think, not very much. If I had not been there, my dissertation advisers would have advised somebody else who would have done almost as good a job with all the human capital that has been invested in me. The difference to humanity because I am here is that we have an extra pair of eyes, a next repair of years, next your brain, and an extra pair of hands. And in the United States today, extra human without much human capital attached is worth maybe $10,000/year--in the world, maybe $300/year. Thus the way I think is that I have a right to, n ironclad claim to--maybe--$300/year of what I am paid, and that those who have made investments in me have equal or perhaps superior right-claims to the other $299,700/year. How that other $299,700/year should be distributed is, I think, a matter not of philosophy but of political economy: what distribution of it will attain the greatest good of the greatest number? * Trying to use the government to produce commodities, pay for commodities, or provide social insurance is hazardous and inefficient: there are lots of forms of government failure. And they are mighty. But leaving things up to the market occasions failure as well. For markets to actually produce the greatest good of the greatest number, they must fulfill eight requirements: 1. They must be competitive. 2. They must be in equilibrium. 3. They must be free from substantial externalities. 4. People must be able to accurately calculate what their interests are. 5. They must be free of moral hazard or adverse selection. 6. The commodities traded must be excludible--that is, it must be possible to cheaply and efficiently charge people a price for making use of them. 7. The commodities traded must be rival--that is, the fact that one person is using something valuable must ipso facto keep others from making use of that same something--and the requirement of *rivalry* fails the moment valuable knowledge enters the picture. 8. And wealth must be rightly distributed: control of the purchasing power that gives command over the market must be in the hands of those who need it and deserve it. When any of those eight requirements fail, all the economists' theorems of market optimality and the invisible hand fail as well. It then becomes a matter of balancing off government failure against market failure case-by-case, and looking for the sweet spot: the spot where private is where it belongs, public is where it is needed, and circumstances alter cases. * For the past five centuries, ever since the Commercial Revolution, we have had a rather market-heavy version of our mixed economy. As we move into the twenty-first century it is, however, becoming more and more clear to me at least that the sweet spot division between market and state is shifting, and shifting in a way that enlarges the proper sphere of government payment and government provision. Markets do a lousy job at basic research and development in particular, and at information goods more generally--and as we become richer and pile up more physical stuff than we can use that information-good share of the economy is going to grow. Alan Greenspan--no socialist he, rather a core follower of Ayn Rand--places great stress on the fact that the weight of GDP is decreasing, and thinks this has powerful implications. Markets do a lousy job at education, at health care, and at defense. Markets do a lousy job at providing long-term pensions. And markets do a lousy job of providing social insurance. None of these, save possibly for defense, are falling as shares of GDP. Most are rising. The right political debate should not be about shrinking the government but about right-sizing it, and figuring out how to short-circuit the many and severe channels of government failure.