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An Introduction to Economics

“Whereas the liberal mistake is to think that there is a program or

policy to alleviate every problem in the world, the conservative flaw is to be vigilant against concentrations of power in government only

- not in the private sector.”

Introduction: Why economics? We live in extraordinary times, where change seems to be the only constant and the "rules" are being continuously rewritten. As you prepare for your move into this "real world" there are some real benefits to studying economics because economist John Maynard Keynes was right when years ago he wrote: "Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back." As for the structure of introductory economics courses, there tend to be two separate courses. The first is Microeconomics. The analysis of a career choice, as well as the choice of someone to teach you economics, would be the subject matter of microeconomics where the emphasis is on the choices made by individuals and firms - how many hours to work, how many children to have, how much output to produce, and how many workers to employ. As you will hear me say many times, we look at decision makers as calculators continuously weighing the costs against the benefits associated with any decision/choice, and we'll look closely at how those calculators work. The second is Macroeconomics where the emphasis is on how well these aggregate markets function. Can we expect the labor market to function effectively so all people looking for work can find it? Will there be a job waiting for you when you graduate? Can we expect the output market to function properly? Will there be inflation eroding the buying power of your earnings, and will there be economic growth so we can enjoy a future in which the standard of living continues to rise? And will the capital market provide enough funds so people can borrow money to finance their education and buy their cars and homes on credit, or will there be a return to 18 percent mortgage rates and credit crunches. In this course we will look at the scribbling of economists, which should help you navigate the many choices you will face in your lives and provide valuable insights into public policy issues such as climate change, health care, and pension reform on which you will be casting your vote in upcoming years. At the center of the economists' view of the world is scarcity, which is reflected in the first rule of economics: there are no free lunches. We are bombarded with ads promising a free lunch, but be careful because they do not exist in a world where scarcity is omnipresent. In our world choices are inescapable, and in microeconomics economists study the choices made by individual decision makers - individuals, businesses, and government. In fact unit 3 is devoted to opportunity costs – the peculiar way economists look at costs that should prove invaluable to you as you face your own choices. Should Mary go to college? Should Bill buy a high-mileage car? Should URI replace tenure-track faculty with part-time faculty? Should the government re-regulate banks? Should it impose a carbon tax or a national sales tax? These are just a sample of the choices we examine in the course in units on individual choice, business choice, and government. Scarcity also imposes on societies the need to make choices: What will be produced? How will it be produced? And Who will get it? These three questions have existed from the beginning of time and societies have struggled to find ways to solve them. The solutions are called economic systems, and this is where we will start this course – with a look at the alternative “economic systems” developed to solve those three questions. We will also look

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at why economists seem a bit like Congress with two very different views of how the world works – or should work. These worldviews are called ideologies, and you will need to understand what you read in publications such as the New York Times or Wall Street Journal. Differences in values also matter, and we’ll look at the difference between positive economics, where we get more agreement, and normative economics where many of those differences originate. There is an additional question we will look at: why so many find economics so difficult? Some of the difficulty comes from the fact economists’ attention is focused on quantitative phenomenon – wages, interest rates, unemployment, output - so we tend to use a lot of quantitative reasoning. In the next unit we will look into the “math” you will need, but you can be assured that the math should not be beyond you because everything you are asked to do is an expected skill of high school grads. What is difficult is that you do have to think critically and solve problems, which you do need some practice since a quick check of the sites devoted to what employers are looking for in job applicants will reveal critical thinking is high on the list. To make sure we are on the same page, there is a brief section on critical thinking and abstract thinking, which economists do when developing models. Economic Systems You know from your history courses that ancient Greece was different from ancient Egypt and Rome, and that the US today is also different from Germany, Japan, and China, but to understand economic systems we will focus on the similarities and discuss four major types of economic systems - Traditional, Command, Market and Mixed Systems. The differences between these systems are readily apparent when you look at how you ended up at URI, why you are majoring in Engineering (or TMD, Pharmacy, Communications or Business), and why you are in this economics course. One approach to allocating limited number of "university slots" would be to allocate them the way they had always been allocated. If your parents went to college, then you would go to college: if your father was an engineer, then you would be an engineer; if your mother liked her economics course or thought it was valuable, then you would enroll in an economics course. Scarce resources would be allocated as they had always been - by tradition – and if this were how choices were made we would have a Traditional economy. There could also be a modern-day Czar who makes the decisions on who goes to college and who majors in engineering and who takes economics courses. You would go to URI and major in Economics because you were commanded to do so, and if this were how choices were generally made, we would have a Command economy. You could also be here because you chose to be an engineering student at URI - maybe because a parent enjoys life as an engineer, maybe because the higher-than-average starting salaries for engineering graduates appealed to you, or maybe because you love applied mathematics. It really does not matter why – all that matters is that you made the choice. When people pursuing their own interest determine the allocation of resources we call it a Market economy, where markets play a key role. This is why early on in the course there is a unit on markets and how those markets operate to “solve” the problems created by scarcity. And finally you could be here because you chose to be a TMD major, but this required you to take an ECN course. Here we have a combination of a little command and a little market, and when we have an economic system with a bit of both command and market we have a Mixed system. If we look back over time, ancient history was mostly the rise - and fall - of empires such as Babylonia, China, Egypt, Greece, Rome, and Islam – what we would be command economies. The "script" went something like the following: someone exerting either military or religious "power" assumed absolute control of society, surrounded himself – it was mostly men - with a few with whom he shared the wealth, and established the rules condemning the overwhelming majority of the people to live their lives at a subsistence level. This was a static world where everyone knew their place and one where economic growth was nonexistent.

life was governed by traditional institutions that subordinated the choices and destinies of individuals to various communal, political, and religious structures. These institutions kept change to a minimum, blocking people from making much progress but also protecting them from many of life's vicissitudes.i

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In this world there were no stories about economic growth that you can see in the graph of GDP per capita - what you should think of as the income earned by the "average" person. For many centuries life was characterized as a zero-sum game where total income changed little so the gains of any individual were offset by the losses of others. For the "common person" there was little difference between life in Egypt under Ramses II in 1200 BC, in Italy under Julius Cesar in 50 BC, and life in feudal Europe in 1200 AD. The overwhelming majority of people lived off the land, were illiterate, never ventured more than a few miles beyond their home, and died young. There was simply no concept of progress, and around the world, the rules were simple: if you wanted more you simply took it, which may be why so much of ancient history is about the rise and fall of empires that relied on territorial conquest to increase their wealth. Eventually, however, the rise of external powers, often coupled with internal decay, would bring about a power shift and the process would start again. Then, as you can see in the graph, things began to change. The change started slowly, and it did not take place everywhere at the same rate. Europe, “suddenly” began to experience something very new - sustained economic growth – after the end of the Black Death in the mid 1300s. This was BIG - it changed the world - and despite countless efforts to uncover the "secret" behind that growth, there is no consensus on a single factor responsible for creating this growth in Europe.ii All will agree though that an important factor was the reappearance of long distance trade and the institutions that supported it, but this challenged the existing political and economic order. In both challenges, 1776 stands out in history as an important date. Challenging the existing political order were philosophers such as John Locke and Thomas Paine who were writing about the inalienable rights of individuals to life, liberty, and happiness that showed up in the US Declaration of I5ndependence of 1776 as well as in Martin Luther King’s “I have a dream” speech nearly two centuries later. Locke made the case for personal liberties and property rights - people should actually get to choose what they do, and if they manage to accumulate wealth, then the government should not be able to take it away. Challenging the economic order was the philosopher Adam Smith who described the outlines of a new economic system. In his book The Wealth of Nations published in 1776, Smith laid out the outlines of a system built upon individual freedom. People would now do what they wanted to do, not what they were told to do. In this world government would be limited and choices would be made in a society ruled by laws rather than capricious despots. According to Smith:

the obvious and simple system of natural liberty establishes itself of its own accord. Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men. The sovereign is completely discharged from a duty, in the attempting to perform which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of society.

Smith was laying out the structure of a new economic system - a market system, or what people refer to as capitalism. This economic system would give individuals more control over and responsibility for their own lives than ever before – and this proved both liberating and terrifying as it allowing for both progress and regression.iii What is it about the market system that helped unleash the powers creating unimaginable wealth? How is it an entire system based on the choices of individuals doing exactly what they want to do would actually work? To see this we’ll look at the situation in the market for engineers, although you can substitute yourself and your major here. In today’s economy there is a shortage of engineers – we need more engineers – so how do we get more engineers with everyone free to do as they please? For this system to be effective, more decision makers must choose to be an engineer. For this to happen decision makers need both the information necessary to make informed choices as well as the incentive to make the choice - and prices play the key role. Prices are "to the

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market economy what red cells are to the human body - they both direct vital life-giving resources to the right place at the right time, with little interference or direction." In this case, the shortage of engineers shows up in higher earnings for engineers, but why do students follow the high prices and major in engineering? In the market system property rights that enable the owners of property to use their property or to sell it provide the incentives. This is why you will hear so much about property rights. Because they can keep the money earned from selling their skills, more people will decide to become engineers as the wages of engineers increase. As more people decide to become engineers there will be more people needing to borrow money to finance their schooling and the capital market will send out the appropriate signal (higher price). The higher interest rates (price of money) should increase savings, which should result in an inflow of money into the capital market providing adequate financing for the new students.... We can stop now because you can see the pattern of interaction that defines the market system. A pure market system does not, however, exist. What we have are Mixed economic systems where markets exert considerable power, but governments control certain allocation choices. A very abbreviated overview of the versions can be found in "The good (and bad) model guide," (The Economist) where a number of models including the American, Japanese, German, and East Asian models are described. They differ primarily in terms of the mix between markets and government, with government’s in mainland Europe and Japan playing a bigger role than in the US and other Anglo-Saxon countries. So, which is the best economic system? The answer is one you will hear often in this course: It depends. Economists have a well-earned reputation for disagreement, and here we will look into why we so often disagree. Why we can't just agree: Ideologies There is no question the spread of capitalism brought with it economic growth, but the economic growth associated with the industrial revolution had its dark side. It was associated with visible, grinding poverty captured well in Charles Dickens' works such as The Christmas Carole and David Copperfield. These are stories of human misery in England during the industrial revolution, and the pain was not lost on the economist Karl Marx who published The Communist Manifesto in 1848. Where Adam Smith saw capitalism as possessing a potential for unprecedented economic growth that could improve the lives of all, Marx saw it as a system based on the owners of capital exploiting labor. More importantly, Marx saw capitalism as possessing a fatal flaw that would eventually bring about its collapse. The ever widening gap between the few wealthy and the numerous poor would eventually lead to revolution - capitalism would implode and out of the class conflict would emerge socialism, a "kinder-gentler" economic system in which workers decide on how to allocate scarce resources in a “dictatorship of the proletariat.” This in turn would act as a transition to a stateless, classless system – communism. In the US and Europe, the inevitable conflict forecast by Marx never happened. Beginning with the Progressive movement in the US at the turn of the 19th century, some of the capitalists’ power was reined in, and even more in the 1930s as the world dipped into the Great Depression. As a result no revolution occurred in the US, but this was not the case in Russia, which had fallen well behind Western Europe and the US as it entered the 20th century. In the midst of WW I that created unimaginable hardship in the country, peasants overthrew the Czar in 1917 and opened the door for Marxists, such as Vladimir Lenin, who established the Union of Soviet Socialist Republics (USSR) in 1921. If there were any doubts about the ability of communism to appeal to others, the doubts ended in the 1920s with the beginning of a second "communist" revolution – this one in China where Mao Ze Dong’s communist revolution ended in 1949 with the establishment of the People's Republic of China. The rest, as they say, is history. It did not take long before the world was divided into three groups - capitalist countries led by the United States (US), communist countries led by the Soviet Union (USSR) and China, and the "undecided" countries that the US and the USSR spent a good deal of time and money trying to bring into their sphere of influence. In fact, much of the post WW II Cold War era can be viewed as a battle between two economic systems - capitalism in the West vs. communism in the East - with both sides spending countless billions on building up military capabilities to "protect"

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their territory and "project" their influence in wars such as those in Korea and Vietnam. A powerful image of the differences between capitalism and communism appears in the map of lights on the Korean Peninsula that appeared in The Economist. If you look at the lights as indicators of economic success, it is readily apparent there is something very different between North and South Korea that cannot be explained by culture, location, religion, or climate. The important difference is economic systems - with Communism in the North and Capitalism in the South - and the lights indicate capitalism was far more successful at providing the "good life" than communism. This difference was not lost on the people living within the world's largest communist countries - the USSR and China. In China, after Mao's death in 1976, Deng Xiaoping rose to power and by 1980 he had opened up China to the world and embraced capitalism, decisions that would produce an economic miracle evident at the 2008 Summer Olympics. Economic freedom did not, however, mean political freedom as the world saw in the Tiananmen Square crackdown of 1989. In the Soviet Union, Mikhail Gorbachev, who assumed power in 1985, set in place a set of forces that ultimately brought down the Berlin Wall in 1989 and the consensus was that capitalism had proved itself superior to communism in producing economic growth. The ideological debate between capitalism and communism seemed to have been settled Francis Fukuyama wrote an essay entitled "The End of History." Although his focus was on political systems, the same could have been said about economic systems. Capitalism had shown itself to be a superior economic system and it would seem to be only a matter of time before it spread across the remainder of the world sweeping aside the last remnants of tradition and communism. While there now may be widespread agreement that capitalism is better than communism, and that a mixed system is better than a pure market system, there is little agreement on the “best” version of capitalism. The differences were there for all to see in the 2012 presidential election and debates over stimulus v. austerity. Economists have very different views of the world, what we will call ideology, and in the US the debate is primarily between two major ideological groups - Conservatives that dominate the editorial pages of the Wall Street Journal, and Liberals that appear in The New York Times.iv The common denominator in their views is a belief in the power of the market system to generate economic growth; where they differ is in the reach and functioning of markets and in the proper size and role of government and it shows up in debates on nearly every important public policy issue. To understand their differences, let's look at the world as a conservative described by Fukayama as follows: "the market based capitalist economic system that went hand in glove with political liberalism required only that people consult their long-term self -interest to achieve a socially optimal production and distribution of goods." Some might even call it a free-market Utopia where consumers get exactly what they want at the lowest possible price because anyone charging above the minimum will be driven out by competition.v As a result we should see “Government barriers to free enterprise disappear. Governments lose most of their functions, serving only to punish crimes, enforce contracts, and provide national defense. Freed of artificial restraints, the world becomes industrialized and prosperous.”vi This is the world envisioned by conservatives who trace their roots back to Adam Smith who was writing at a time where governments - those kings and queens such as Louis XIV - were not friends of the masses of society. Rather than organizing society around what the king wanted, it could be organized around what the people wanted. At the center of this view is the competitive market model - firms maximizing profits and individuals maximizing their satisfactions - and both guided in their actions by prices. In an ideal competitive environment all decision makers agree to all of the trades and there is no additional trade from which all will find benefit - and no one needs to worry about being ripped off by government.vii But what about the real world? Does this sound like the world in which we live? Liberals believe there are reasons to question the assumption that a market system produces the 'best' results for society and is the most efficient system for promoting social welfare. They believe the free-market system, designed to protect people from the tyranny of government, may have exposed people to other tyrannies?

It might be worthwhile to let equality and civilization take their chances in the free market if in return we could expect that the withering of government would serve as a guarantee against oppression. But that is an illusion. For many Americans the danger of tyranny lies not in government but in employers or insurance companies or health-maintenance organizations, from which we need government to protect us. To say that any worker is free to escape an

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oppressive employer by getting a different job is about as realistic as to say that any citizen is free to escape an oppressive government by emigrating.viii

For those willing to leave the utopian world behind, in the final four units of the course we revisit our assumptions about the markets and the players. First is the Extension of Theory of Individual Choice. If people are not quite as rational as we thought, then there are real problems and modern behavioral economics - or just casual observations of people's choices - provides compelling evidence that rationality is not as pervasive as we thought. The market also loses some of its "beauty" if we allow for the possibility of some players achieving market power - the ability to influence price. When we need to buy an operating system for our computer, there are not many choices, so we will look at the issue of market power a bit closer in the unit on Imperfect Competition. Another feature of market systems is the wide disparities in income they produce, and in the Inequality unit we look more closely at an issue that has become increasingly important in recent years – something you saw in 2011 with the Occupy Wall Street movement’s focus on the growing power of the world’s top 1 percent. And let’s not forget the economic crisis of 2007-2009. This macroeconomic shock revealed another potential problem with the idealistic free market model, economic instability, which is a focus of the macroeconomics course. A problem also arises if someone can push off costs on to someone else. For example, when I buy gas for my car, who is paying for the impact this has on the planet's climate? Or what about the decision to walk away from my house because I cannot pay the mortgage, even though I know it will become a hangout for drug pushers? Who will pay my neighbors for the reduction in the quality of their life? In a market system the answer is no one, even though a fairer system would have someone pay, and we will look at this issue in the Externality unit. In each of these cases, the limitations of markets opens the door for government policy interventions - opportunities for conservatives and liberals to 'fight" over the proper balance between the Invisible Hand of the market and the Visible Hand of government. The fact is we are in the midst of a bitter ideological war over the future of government and you can see it everywhere – in the battles over taxes, government spending, climate change, and regulation of industry and certainly in the 2012 presidential election.ix It is very unlikely that we will ever be able to write an article entitled "The End of Ideology." Like taxes and death, ideological differences are a certainty, but we can expect to see shifts in the relative power of the two groups. Economic policies tend to be grounded in the dominant economic theories of the time and there is little pressure to unseat those theories and policies as long as the economy is performing adequately. It is only in times of economic crises where there is any real movement in public policies and any shift in the balance of power among theorists. When we look at US history there have been only two ideological turning points - although some would say that the 2008 election marked a third, smaller shift.x The first shift occurred during the economic collapse of the Great Depression in the 1930s that was so complete that it is difficult to comprehend its magnitude today.xi At the outset of the depression conservative economists dominated the profession and policy makers in Washington, but with nearly 25 percent of the nation's workers unemployed and countless thousands migrating out of the cities and farms and heading westward, it was time for the country to reconsider the status quo.

The catastrophic destruction of the Great War and the economic nightmare of the Great Depression brought the contradictions of modernity to a head, seemingly revealing the bankruptcy of the liberal (conservative) order and the need for some other, better path. As democratic republics dithered and stumbled during the 1920s and 1930s, fascist and communist regimes seized control of their own destinies and appeared to offer compelling alternative models of modern political, economic, and social organization.xii

Capitalism had produced unimagined growth and turned a rural agricultural poor nation into an industrial, urban world power in little more than 50 years, but with the growth came unprecedented economic insecurity and inequality. At the voting booths the nation turned to Roosevelt who in turn looked to one of those academic scribblers – the liberal John Maynard Keynes – for a plan of attack. What emerged was “the most successful system the world has ever seen … [w]hat eventually emerged victorious from the wreckage was a hybrid system that combined political liberalism with a mixed economy.”xiii Keynes believed it was the responsibility of the

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government to protect its people in times of economic crisis, and Roosevelt’s programs known as the New Deal was grounded in his theories. The philosophy of the liberals is captured in a 1960s Supreme Court decision:

We have come to recognize that forces not within the control of the poor contribute to their poverty. .... Public assistance, then, is not mere charity, but a means to "promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity.xiv

The promise of the liberal order began to fade, however, in the 1970s as the US suffered through the Great Stagflation - the simultaneous appearance of both high levels of inflation and unemployment. This is the worst of all possible macroeconomic worlds, and liberal economists found themselves unable to adequately explain the rising unemployment and inflation rates [right side graph]. The loss of 100,000s of American jobs to foreign competition, double-digit inflation rates, and home mortgage rates nearing 20 percent, opened the door for new ideas and new solutions. This time the scribblers were free-market conservatives centered at the University of Chicago who had been working outside of the mainstream since the 1960s. These economists provided the theoretical basis for Ronald Reagan's movement of the country back to the ideological right. Since the Reagan election, the “United States seems to have embraced a form...of individualism, which endorses rights of private property and freedom of contract but claims to distrust 'government intervention' and insists that people must fend for themselves.”xv This is where the country was at the onset of a recession in 2007, but as the recession deepened into the biggest economic crisis since the Great Depression, liberals believed the time was right to regain the economic and political high ground. There was a bitter battle waged between Democrats and Republicans in 2008 and 2012 over the size and scope of the government, one that reached a point where the federal government was shut down.xvi There has not, however, been a third ideological shift, although it has been called a half-shift. What is true is the nastiness of the battle has intensified, which we see in the increasingly dysfunctional Congress. For those interested in better understanding the gridlock that has become the US government, this is a link to a brief section that describes six factors behind the widening ideological gap. The even shorter version is:

1. Slow growth 2. A missing middle 3. Increased heterogeneity 4. Gerrymandering 5. Fracturing of media 6. Values

The truth, as so often happens, probably falls somewhere in the middle. For those with an open mind I trust you will find truth in the statement: “the liberal mistake is to think that there is a program or policy to alleviate every problem in the world, the conservative flaw is to be vigilant against concentrations of power in government only - not in the private sector.” Keep this in mind as you read the op-ed pieces in The Wall Street Journal pushing the conservative agenda and The New York Times pushing the liberal perspective. For example in 2003 the Wall Street Journal continually supported the Bush tax cuts designed to "starve" the government of funds and force it to get smaller, while The New York Times relentlessly focused on the cuts in government services that were associated with the tax cuts. You will find similar debates on a wide array of issues that and in this course the discussions will be focused on the ideological spectrum spanned by conservatives and liberals, although there are important ideas about economics that do not fall in that range and we will touch on some of them during the semester.xvii

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Values: Positive v Normative Economics To give you some idea of a second source of disagreement among economists, consider the next few statements.

1. We should subsidize college loans 2. Expansion of student loans will result in increased numbers of defaults 3. The expansion of fracking will lower gas prices 4. Fracking should be expanded 5. Tax revenues in RI will increase if we lower the sales tax 6. RI should extend unemployment benefits to the long-term unemployed 7. You should turn your cell phone off 8. Grades are higher for students that turn their cell phones off 9. Government intervention is bad 10. Economics majors earn more than Sociology majors 11. Everyone should take an Economics course 12. Government should provide basic healthcare to all citizens 13. Enrollment of the young will reduce average health care expenditures

These statements range over a number of topics, but for our purposes we will divide them into two categories. The first are statements are can be proven true or false that would fall into what we would call Positive Economics. This does not mean economists will agree on them, but we can assess the validity of the statement by looking at the facts and there is much more agreement on these type of statements. What statements would you put in this category? The second are statements based primarily on values that would fall into what we would call Normative Economics. This is, as you would expect, where the biggest differences in economics occur, so what in the list would you put here? In my grouping I would have 2, 4, 6, 8, 10, and 12 as examples of positive economic statements because we could envision an experiment that would allow us to determine its validity. For example, for statement 4 I could look at the historical record of natural gas prices and the amount of fracking to determine the nature of the relationship; a negative relationship that shows prices tend to be lower with increased fracking “proving” this statement to be true. I could also use basic Supply & Demand economic theory where we prove that an increase in supply will decrease price. For question 10, meanwhile, we could simply look at the available data on earnings that does exist and we would find that this is true. In fact in one studyxviii of earnings for 2013-14, the starting salaries of economics majors came in 15th out of 130 majors, while Sociology came in tied for 100. In the normative category would be the statements 1, 3, 5, 7, 9, and 11. Let’s look at 1. There is clearly no fact that will allow us to determine the validity of the statement, which is the same with 11. If I value the future of the economy and believe today’s youth are the future, then I would support more loans. If on the other hand I felt we should protect the elderly because of their vulnerability and because families should be most responsible for their children, then I may not be so inclined. As for the ECN requirement, I may believe this to be true, but this is based on my values. If I turned it into a statement that anyone who takes an ECN course in college earns more or is happier, I could envision a study where the validity of the statements could be validated or invalidated. Why economics is so difficult and why it is worth the investment As mentioned earlier, economics is difficult because economists spend a lot of time pushing numbers around and many people are not very good at that. We see it in the international test scores, and we will look into this in the next unit. Here we will look at another aspect of economics that causes great difficulty – the high level of abstraction required of students. To give you an idea of what is involved, we’ll begin with a simple example of model building - a key part of how economists try to make sense out of a very complex world. It is not easy for sure, but I caution you to think twice, maybe three times, before giving up and uttering the words – I was never good at this – and the unit closes with my effort to explain why it is worth the effort. Economists, like most researchers, begin with a question, and here the question is: what will expanded fracking do to the price of natural gas? Before reading on, spend a few minutes and answer it yourself. Jot down on a

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piece of paper the outlines of your approach and your answer – and when you have it read on to see how one economist would approach it. First, we need to know what fracking is, which we can get from a simple online search. With the search you would find that fracking is a controversial drilling technology that has greatly increased the supply of natural gas. Second, we need to know what determines prices. We know many things affect the price of natural gas, so economists begin by eliminating many of the details that are of secondary importance. We begin by acknowledging prices are determined in markets, so to understand the price of natural gas we need to look at the market for natural gas. Third, markets are complicated also, but when we get past the complications we find there is a common structure to all markets. Markets are simply where buyers and sellers, so economists build a model of a market – something we will look at in detail in a later unit. Fourth, in our model we make some simplifying assumptions about the buyers and sellers. We assume buyers will buy more of something if its price drops, and suppliers will be willing to supply more if its price rises. Fifth, we make assumptions about how markets function. We assume that if a surplus exists – too much supply so inventory begins to accumulate on store shelves –prices will fall. Sellers will try to eliminate the surplus by lowering the price and buyers respond by expanding their purchases. If a shortage exists, you would some empty shelves and declining inventories and we expect sellers to raise their price, which would prompt buyers to reduce their purchases. Sixth, we now have the market price, what we call the equilibrium price. This is the price that equates supply and demand and without any change in either supply or demand, this would be the price. Furthermore, if there were an increase in supply this would create a surplus, and as we saw above, the market’s response would be a lower equilibrium price. If there was an increase in demand this would create a shortage and the market’s response would be an increase in price. Seventh, we now pull the pieces together. We know that fracking is an increase in supply and we know an increase in supply will drive down price, so based on our supply and demand model of prices, we will forecast a decline in the price of natural gas. Eight, this is where it gets tricky. Economists move from this verbal description to a mathematical version. Sometimes it is in the form of equations, and sometimes it is in the form of a graph. In the graph below you will see the supply and demand graphs that are a visual representation of a market for gas. Once you understand the graph you see how this is a lot easier to work with than those paragraphs filled with descriptions, which is why economists use them. In the world before fracking the price of natural gas would be P*. As you will see in the S&D unit, the increase in supply from fracking shows up as an outward shift in the supply curve and you can see in the right-side graph the new equilibrium is in fact lower – precisely the forecast from the words

This was not easy for sure, although it will be much easier after we look at the S&D unit. It is, however, worth it and here I will try to make that case. Beginning in the early 2000s there was a growing concern among those

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living in the world's wealthiest countries about the rise of China and India and the impact this would have on earnings in the US. Peter Drucker, a well renowned management consultant and author of two Atlantic Monthly articles, "The Age of Social Transformation" and "Beyond the Information Revolution," provides some insight into the issue.

[You are the] first society in which ordinary people - and that means most people - do not earn their daily bread by the sweat of their brow. It is the first society in which ''honest work' does not mean a callused hand. ...Knowledge workers...may not be the ruling class of the knowledge society, but they are already its leading class. ... And in their characteristics, social position, values, and expectations, they differ fundamentally from any group in history that has ever occupied the leading position.

In this world education has taken on increasing importance as a gateway to the "promised land," a world in which flexibility and mobility are keys to success. The elite in this new society will be, what former Secretary of Labor Robert Reich called "symbolic analysts," individuals who are encouraged to be "skeptical, curious, and creative" and to "become problem solvers par excellence, equal to any challenge. Unlike those who engage in mind-numbing routines, they love their work, which engages them in lifelong learning and endless experimentation."xix This is also the central theme of Thomas Friedman's book The World is Flat. For much of its history the US has been protected from the rest of the world by limited transportation and communications technology, two large oceans, and by the decisions of the Soviet Union, China, and India to insulate themselves from the west after WWII. As we head into the 21st century, those walls and barriers that once protected the US are gone, and Americans no longer have the high ground that is easy to protect. One of the implications of this flattening can be seen in the graphs of personal income per capita. In the left-side graph you have per capita income for two regions in the US - the Middle Atlantic region in the North (think NY, NJ, PA)) and the South Atlantic) in the South (think MD to FL)). In 1840, before the US Civil War, incomes in the North were almost 40% more than the US average, while those in the South were earning only 30% less than the US average. After the Civil War, though, as a result of transportation and communications innovations (think railroad, telegraph, telephone), those differences nearly disappeared, as the US got "flatter." If you look around the cities of the north today you will find textile and apparel mills that are empty because they began moving south by the late 1880s in search of cheap labor, and you will also find many people who can trace their roots to the South since they moved north in search of higher wages. The result was pressure on wages in the North to decline and in the South to rise - a flattening of those income differences.

Now fast-forward to today. As you look around the world you see some really rich countries - the developed countries such as the US, Germany, Japan), and some really poor countries – the developing countries such as China, India, Pakistan. Now think about the graph of the per capita income differences between these groups in the future the improvements in technology that are making the world flatter and ask yourself: what will happen to these differences in income? One possibility, as we see in the right-side graph, is that the future for the world will look very much like the history of the US as people in the poorer countries will move to the wealthier countries (think of immigration) and factories and offices move to the poorer countries in search of cheaper labor (think offshoring to China and India).

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So how do Americans protect their high standard of living? There is no one answer, but I am certain that when URI revised its General Education Program in 2005 to ensure that students develop “the ability to think critically in order to solve problems and question the nature and sources of authority," it moving in the right direction. This sounds good, but what does it mean - and how is it related to this course? Read carefully the following definition of critical thinking, and then think about the skills that you would expect to be "rewarded" in the flattening world.

the ideal critical thinker is habitually inquisitive, well-informed, trustful of reason, open-minded, flexible, fair-minded in evaluation, honest in facing personal biases, prudent in making judgments, willing to reconsider, clear about issues, orderly in complex matters, diligent in seeking relevant information, reasonable in the selection of criteria, focused on inquiry, and persistent in seeking results which are precise as the subject and the circumstances of inquiry permit.

In this course you will get some practice at many of the dimensions of critical thinking - interpreting, analyzing, evaluating - and we'll work on getting you closer to that 'ideal" critical thinker that is inquisitive, informed, reasoned, and persistent. In this course you will be called on repeatedly to solve problems using critical thinking skills, with the expectation that when you leave the course you will be better problem solvers. The good news is that this is an incredibly valuable skill; while the bad news is that it is not easy.xx Also, never lose sight of the fact that too many powerful decision makers have realized that too few people worry about the future so we see politicians designing policies that have most of the benefits accruing today and the costs being borne by future generations. A perfect example has been the funding of the war in Iraq and the Bush tax cuts. President Bush went to the American people and told them to do their patriotic duty and get out there and spend, which they did, and then he financed those tax cuts and the war by borrowing money - much of it from foreign investors. My generation made no sacrifices to pay for the tax cuts and war because it was 'easier" to simply pass on the debt to future tax payers - you. I trust you can see the political gain in this strategy - tomorrow's generation who pays the bills do not vote today - so be sure to keep this image in mind as you evaluate policy decisions. Now let's get to the course, and we begin with a unit on data analysis skills you will need in the class.

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Introduction i Jerry Muller, “Capitalism and inequality,” Foreign Affairs, M/A 2013 ii In a recent article war was identified as the factor that allowed Europe to maintain the income per capita advantage over the rest of the world that emerged in the aftermath of the Black Death. Nico Voigtl.nder and Hans-Joachim Voth, “Gifts of Mars: Warfare and Europe’s Early Rise to Riches,” JEP, Fall 2013 iii Jerry Muller, “Capitalism and inequality,” Foreign Affairs, M/A 2013 iv You can also see the significance of ideology in the following excerpt that appeared in Harpers magazine. A journalist documented changes in the US Fish and Wildlife Service website in the week following Bush's inauguration. The words with the strikethrough were dropped from the wording under the Clinton administration. ("Dept. of Corrections" Harpers 6/2001).

<s>The Arctic National Wildlife Refuge is the most pristine unit in the National Wildlife Refuge System. Oil and gas exploration and development in the Refuge would permanently and irreversibly. Destroy the unique wildland values of a world class natural area; Disrupt ecological and evolutionary processes in one of the most pristine conservation areas in the North American Arctic; Diminish the Refuge's scientific value as a benchmark for understanding these processes; Damage the biological and ecological integrity of the entire Refuge.</s> One hundred thirty-five species of birds are known to use the area, including numerous shorebirds, waterfowl, loons, songbirds, and raptors. <s>Oil development in the Arctic Refuge would result in habitat loss, disturbance, and displacement or abandonment of important nesting, feeding, molting, and staging areas.</s> One <s>species of bird that could be greatly impacted by oil development</s> notable example is the snow goose. Large numbers of snow geese, varying each year from 15,000 to more than 300,000 birds, feed on the Arctic Refuge coastal tundra for three to four weeks each fall. They feed on cottongrass and other plants to build up fat reserves in preparation for their journey south, eating as much as a third of their body weight every day. The rich vegetation of the coastal tundra enables them to increase fat reserves by 400 percent in only two to three weeks. Snow geese feed on small patches of vegetation that are widely distributed across the Refuge's coastal tundra, so a large area is necessary to meet their needs. They are extremely sensitive to disturbance, often flying away from their feeding sites when human activities occur several miles distant. <s>Oil exploration and development would displace snow geese from areas that are critically important to them.</s>

v A good example of where economists favor a market solution to a scarcity problem would be airline overbooking. Airlines long ago realized not everyone shows up for their flight so they decided to overbook, and every once in a while they found themselves with too few seats. Their solution was to simply make a list of people whose reservations were cancelled, which was not a great system. Imagine the person flying from Providence to Miami for a cruise who was told they could not go, while another passenger with no deadline boarding the plane. In 1968 economist Julian Simon proposed a different solution - creating of an auction so the people who cared least about that flight could be "bribed" to take another flight. In 1978, after the airlines were deregulated and the system with seats assigned by auctions was adopted. vi Steven Weinburg, "Five and a Half Utopias," Atlantic Monthly. This is the world neocons envisioned bringing to Iraq. The US invasion was a way to replace terrorism with this is the world neocons envisioned bringing to Iraq. The US invasion was a way to replace terrorism with treaties, desperation with hope, and weapons of mass destruction with means of mass production. In this world individuals and firms are engaged in battles, but these battles are in the markets where prices determine the battles’ outcomes and not in the streets. And to ensure fairness, there are no players big enough to "rig" the market vii And they do have a point since governments can look a lot like a Taking Hand. In Naked Economics, a name designed to evoke an economy with limited government intervention, reference is made to a study in which the researchers looked at the process of starting a business in different countries around the world. It was easiest in Canada where is took only two procedures and two days, while in Bolivia it took twenty procedures and in Mozambique it took about six months, and in some countries (Vietnam, Mozambique…) entrepreneur needed to give up 1-2 times an annual salary to get a new business licensed. For those looking for the philosophy of conservatives, it is captured in the following quotes - the first from President Hoover in 1931, and the second from a clergy member in Syracuse, NY focus on how the policies alter the incentives to work, while the third from the Treasury Secretary Mellon focuses on the "cleansing" nature of recessions that weed out the weakest.

1. This is not an issue as too whether people shall go hungry or cold in then United States. It is solely a question of the best method by which hunger and cold shall be prevented. It is a question of whether the American people...will maintain the spirit of charity and mutual self-help... as distinguished ... from appropriations out of the Federal Treasury for such purposes... If we break down this sense of responsibility and individual generosity ... in times of national difficulty and if we start appropriations of this character we have ... impaired something infinitely valuable in the life of the American people... Once this has happened... we are faced with the abyss of reliance in future upon government charity in one form or another. I am confident that our people have the resources, the initiative, the courage, the stamina and the kindliness of spirit to meet this situation in the way they have met their problems over generations. 2. ...the care of the indigent aged and crippled children and those unemployed through no fault of their own, is a most worthy objective. It would seem to me, however, that time is granted the old should be just above

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subsistence level, for the reason that otherwise savings and preparation for that time is discouraged, and thrift is indirectly penalized. There is already appearing and growing stronger a widespread tendency to depend upon the government, which where it appears tends to replace the older American spirit of independence. This may be unavoidable, but in any case it is a sign of decadence and most alarming. It goes along with the failure of personal initiative.

3. Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. … It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people." viii Steven Weinburg, "Five and a Half Utopias," Atlantic Monthly ix There were three developments that can be traced back to the 1980s that brought the issue of the role of the government to the center of public debate and contributed to the ferocity of the disagreements in the early 21st century. The first was the explosion in federal red ink in the US. The US government was spending much more each year than it was taking in taxes - in large part the result of Reagan's massive tax cut and defense spending increases in the 1980s. The result was a budget deficit (negative surplus) in 1992 that had grown to almost $300 billion, and a national debt that had risen to $3 trillion, numbers so staggering that there was a general consensus something had to be done to control the deficits because the US could not continue indefinitely borrowing hundreds of billions of dollars each year to pay for its expenses. If you fast-forward past the budget surpluses of the latter Clinton presidency that marks one of the more remarkable financial turnarounds, you find the situation is little changed when we look at the deficits approaching $500 billion under the Bush administration. These deficits, combined with the severe budgetary pressures at the state level, the same ones that "forced" those double-digit tuition rate increases at many public universities, have brought government finances under public scrutiny and prompted heated debates over how the government should spend its money. There have also been heated debates on taxes, which is nothing new, as many of you know from your history courses. In the earliest days of the nation - actually before there even was a nation - the rallying cry of the American colonists in their battle for independence from Britain was "no taxation without representation." And the debate did not end when the nation actually gained its independence. Alexander Hamilton, the first Secretary of the Treasury, after having made a "deal" in which the new government of the United States would assume the debts incurred by the states during the war, had to find the money to back the deal, and he settled on a tax on distilled liquor. The result was the Whiskey Rebellion in 1794 in which some Americans rebelled against the imposition of this federal tax on whiskey. More recently, but still before the time of most of you reading this, there was the tax revolt led by Howard Jarvis in California that became known as Proposition 13. In 1978 the voters of California approved Proposition 13 that, according to Steven Moore from the conservative Cato Institute, "was a political earthquake whose jolt was felt not just in Sacramento but all across the nation, including Washington, D.C. Jarvis's initiative to cut California's notoriously high property taxes by 30 percent and then cap the rate of increase in the future was the prelude to the Reagan income tax cuts in 1981. It also incited a nationwide tax revolt at the state and local levels. Within five years of Proposition 13's passage, nearly half the states strapped a similar straitjacket on politicians' tax-raising capabilities and many of those tax limitation measures remain the law of the land today." It was an earthquake and the US is still experiencing the after shocks as you could see in the 2000 election, an election you should remember. Taxes were once again an issue with candidate Bush promising massive tax cuts and a restructuring of taxes as centerpiece of his economic program. The third reason was the "collapse of the wall" separating the communist and capitalist worlds - a wall that had divided the world since the end of WW II. Winston Churchill described the situation at a speech in March of 1946 at Westminster College in Fulton, MO. As Churchill saw it, "From Stettin in the Baltic to Trieste in the Adriatic an iron curtain has descended across the Continent…" The line that Churchill mentions appears in the diagram below as the red line that runs from Germany in the north to Italy in the south, and much of the Cold War can be thought of as a series of hot (Vietnam, Korea) and cold (Berlin airlift, Cuban missile crisis) conflicts between these two blocks of countries. By 1990, however, the wall had begun to crumble. For the countries of the former Soviet Union, those to the right of the line, this meant the end of communism and the need to determine the proper mix of command and market in their emerging economies. In those countries to the left of the line, the capitalist democracies that included the economic and military superpower United States, it was a time to reconsider the role of government in light of the fact that the "Cold War threat" of communism was now greatly diminished. The expectation was that there should be a corresponding reduction in defense spending and it was time to look at how the United States was going to spend this "Peace Dividend." Unfortunately this discussion of the Peace Dividend was put on hold indefinitely when the Bush administration launched the "War on Terrorism" it says could last for 40 years - about the length of time of the Cold War - and began a massive buildup in military spending to wage that war. x Economic crises play an enormously important role in the ideological shifts in economic theory and policy. Bruno and Easterly (1996) suggest that economic crises, in this case crises triggered by bouts of hyperinflation, can speed the process of economic reform in lower income countries and the return of growth will be faster in those countries that experienced the hyperinflation. If we follow the logic a bit further we end up where Albert Hirschman (1987) did and conclude that "inflation has acted as the equivalent of war in eliciting change" or Alesina and Drazen (1991) who "model delayed stabilization as a war of attrition." In the early days of the Obama administration we heard much about the phrase "You never want a serious crisis to go to waste," popularized by Rahm Emanuel, which seems to simply extend the central theme in Naomi Klein’s "Disaster Capitalism" (Harpers Oct 2007). Klein goes as far as any in describing how the conservatives have used economic crises to push their agenda.

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xi The following passage from John Steinbeck's book, The Grapes of Wrath, provides some sense of how the American people were ready for change, ready for someone to offer them hope.

And then the dispossessed were drawn west - from Kansas, Oklahoma, Texas, New Mexico: from Nevada and Arkansas families, tribes, dusted out, tractored out. Carloads, caravans, homeless and hungry; twenty thousand and fifty thousand and two hundred thousand. They streamed over the mountains, hungry and restless... The kids are hungry. We got no place to live. Like ants scurrying for work, for food, and most of all for land... and the dispossessed, the migrants, flowed into California, two hundred and fifty thousand, and three hundred thousand. Behind them ... [other] tenants were being forced off [their lands]. And new waves were on the way, new waves of the dispossessed and the homeless, hardened, intent, and dangerous.

xii Gideon Rose, “Making Modernity Work,” FA J?F 2012 xiii ibid xiv "Evident Truths," Harpers July 2004 xv "Evident Truths," Harpers July 2004 xvi These ideological battles also sounds similar to what was happening in Europe in the 2011-2012 in the debate over what to do with the PIIGS – Portugal, Italy, Ireland, Greece and Spain that were suffering through a severe recession. Should these countries that could not pay their bills be bailed out to help them increase government spending to create jobs, or should we impose an austerity program that slashes government spending in an effort to reduce government indebtedness? To see where you fit on the ideological spectrum, think about your answers to the following questions that will be addressed in the course. 1. Should the government ban cigarette smoking in public places? 2. Should the US impose a tax on carbon to reduce carbon monoxide emissions and slow climate change? 3. Should the government eliminate the estate tax? 4. Should the government impose a tax on sugar to combat the rise in obesity? 5. Should firms be allowed to charge workers for their excess weight, smoking, or other unhealthy lifestyles? 6. Should the federal government provide aid for rebuilding to help victims of hurricanes and tornadoes? 7. Should the government subsidize student loans? 8. Should people, businesses, and political groups be allowed to contribute unlimited sums of money in elections? xvii There are many alternative views that would not agree with the framework accepted by liberals and conservatives. Included in this would be six heterodox approaches - Austrian, post- Keynesian, Institutionalist, Radical, feminist, and religious. For a good overview I suggest David Collander's introductory economics textbook. • Austrian - best thought of as libertarians who have no trust in the ability of government to improve the lives of

people - either because of bad intentions or limited information. Famous economist - Friedrich von Hayek. • Post-Keynesian - believe that uncertainty is central issue in economics - and that this necessitates government

actions. • Institutionalist - believe that markets might be powerful, but so are institutions. Famous economist - Thorstein

Veblen. • Radical - believe the instability and irrationality and class conflict at core of social problems and the central

need of government is redistribution of income / wealth • Feminist - believe in strong gender biases in profession

xviii http://www.payscale.com/college-salary-report-2013/majors-that-pay-you-back xixRevolt of the Elites xx And as you think about making the sacrifice, consider the message in Alan Blinder's Foreign Affairs article "Offshoring: The Next Industrial Revolution." The world has entered a third industrial revolution where the 'rules of the game" have been significantly altered in ways that will affect the value of an education. Many "people blithely assume that the critical labor-market distinction is, and will remain, between highly educated (or highly skilled) people and less-educated (or less-skilled) people," but those days may be numbered because "[t]he critical divide in the future may instead be between those types of work that are easily deliverable through a wire (or via wireless connections) with little or no diminution in quality and those that are not. And this unconventional divide does not correspond well to traditional distinctions between jobs that require high levels of education and jobs that do not." Or you might read my op ed, College degree no longer a sure bet."