Markets, Efficiency, and Price Signals: Crash Course Economics #19

Summary

In this episode of Crash Course Economics, Adriene Hill and Jacob Clifford discuss the contrasts between free market and centrally planned economies, highlighting the advantages and inefficiencies of each. They explain key economic concepts like productive and allocative efficiency, price signals, and the impact of government regulation. The hosts also touch on controversial topics like price gouging and predatory pricing, emphasizing the role of consumer choices in shaping the market. The episode concludes with a call for socially conscious consumption and a reminder of the luxury to deliberate on these economic issues.

Takeaways

• 🌐 Central planning and free markets are two different economic systems. Central planning involves government agencies deciding what gets produced, while free markets rely on supply and demand.
• 🏭 In centrally planned economies like the Soviet Union, there was a focus on heavy equipment and military hardware, leading to shortages of consumer goods.
• 📉 Central planning is often inefficient, lacking productive efficiency (making products at the lowest possible cost) and allocative efficiency (producing what consumers actually want).
• 💼 Free market producers use price signals to understand consumer preferences and adjust production accordingly, which can lead to more efficient resource allocation.
• 👖 Price signals can indicate trends, like the popularity of skinny jeans, and guide production decisions in a free market.
• 💻 The success of products like the iPad led to increased competition and market entry, demonstrating how price signals influence production and distribution.
• 🎁 Economists like Joel Waldfogel argue that gift-giving can be inefficient, suggesting that cash gifts might be more economically efficient.
• 🏬 Competition in free markets keeps prices and quality high, a concept described by Adam Smith's 'invisible hand'.
• 🚑 Anti-price gouging laws are controversial; some economists argue they promote inefficiency by reducing incentives to supply essential goods during crises.
• 🏢 Businesses like Walmart can use strategic planning to manage inventory and respond to emergencies, which can be more effective than government intervention.
• 💰 Predatory pricing, where businesses sell at a loss to drive out competitors, is risky and not always successful in the long run.

Q & A

What are the main differences between free market economies and centrally planned economies?

In free market economies, supply and demand determine what gets produced, while in centrally planned economies, government agencies decide what gets produced.

What are some advantages of central planning mentioned in the video?

Central planning ensures that everyone who wants a job has a job and aims to meet an idealized version of society's collective goals.

Why do centrally planned economies often face shortages of consumer goods?

Centrally planned economies, like the Soviet Union, often focus on producing heavy equipment and military hardware, neglecting consumer goods such as soap, sugar, and electronics.

What is productive efficiency and how is it achieved in a free market?

Productive efficiency means products are made at their lowest possible cost without wasted resources. In a free market, individual business owners have an incentive to be efficient to maximize profits.

What is allocative efficiency and why is it important?

Allocative efficiency means that the things being produced are the things that consumers actually want, ensuring that scarce resources are used for products that are valued by society.

How do price signals work in a free market?

Price signals indicate consumer preferences. High prices for a product signal producers to make more of it, while low prices or lack of demand signal producers to make something else.

What role do price signals play in the distribution of products like tablets?

Price signals help distribute products to those who value them the most. For example, high prices for tablets mean only those willing to pay a lot for them will buy them, ensuring efficient distribution.

What is price gouging and why is it controversial?

Price gouging is raising prices for essential items during emergencies. It's controversial because it can exploit consumers but also encourages suppliers to bring more goods to the affected area.

What is predatory pricing and why is it risky?

Predatory pricing is selling products at a loss to drive competitors out of the market. It's risky because the company must eventually raise prices to recoup losses, attracting new competitors.

How can consumers influence corporate behavior in a market-based society?

Consumers can influence corporate behavior by choosing to buy from companies that align with their values, such as those that treat workers well or are environmentally conscious.

Why is it a luxury to discuss the ethics of consumption according to the video?

It's a luxury because many people around the world live in poverty and cannot afford to make purchasing decisions based on conscience, as they struggle to afford basic necessities.

Outlines

00:00

📚 Introduction to Economic Systems

The video script introduces Adriene Hill and Jacob Clifford, hosts of Crash Course Economics, who will discuss various economic topics. They contrast free market economies, where supply and demand dictate production, with centrally planned economies, where the government decides. They note the historical shift away from central planning, exemplified by the Soviet Union's focus on heavy industry over consumer goods, leading to shortages and dissatisfaction. The script also touches on the benefits and drawbacks of both systems, setting the stage for a deeper dive into economic efficiency and market signals.

05:01

🛠 The Efficiency of Economic Systems

This paragraph delves into the concept of economic efficiency, distinguishing between productive efficiency, which refers to the lowest possible cost of production without wasted resources, and allocative efficiency, which ensures that production aligns with consumer desires. Central planning is criticized for its inefficiency, as planners may not prioritize cost or consumer preferences. The script uses the example of the Soviet Union's focus on heavy equipment and military hardware at the expense of consumer goods. It also highlights the adaptability of businesses in a free market, which must respond to price signals or face failure, and contrasts this with the inefficiencies and consumer dissatisfaction associated with central planning.

10:02

📉 Price Signals and Market Dynamics

The role of price signals in a free market is explored, illustrating how they inform producers about consumer preferences and societal demands. The script uses the example of skinny jeans to explain how price signals can indicate trends and drive production decisions. It also discusses the impact of new products, like the iPad, on market competition and consumer behavior. The Thought Bubble segment critiques the tradition of gift-giving from an economic efficiency perspective, arguing that cash gifts are more efficient, though it acknowledges the social benefits of gifting. The paragraph concludes by emphasizing the self-regulating nature of free markets and the role of competition in maintaining quality and affordability.

🏛 Government Regulation and Market Intervention

This section discusses the role of government in regulating markets to prevent perceived injustices and improve social welfare. It provides examples of U.S. regulations, such as FDA standards for wheat, and the government's control over certain markets like defense and education. The script acknowledges that while free markets have their merits, they can fail to meet societal needs, necessitating government intervention. It also touches on the field of public economics, which analyzes the impact of government policies on market outcomes.

🛡 Controversies in Pricing Practices

The script addresses contentious pricing practices such as price gouging during emergencies and predatory pricing, where businesses sell below cost to eliminate competition. It debates the effectiveness and fairness of anti-price gouging laws, suggesting that they may exacerbate shortages by reducing incentives to supply affected areas. The discussion also includes the role of businesses like Walmart in disaster preparedness and the complexities of predatory pricing, which, despite its potential to harm competitors, is rarely successful in court and may not be sustainable in the long term.

🌐 Social Responsibility and Consumer Power

The final paragraph emphasizes the potential for businesses to act responsibly and the role of consumers in driving social change. It challenges the view of capitalism as inherently greedy, suggesting that consumer choices can influence corporate behavior. The script encourages viewers to seek out companies that align with their values, even if it means paying more or consuming less. It concludes by recognizing the privilege inherent in such choices and the importance of collective social goals in a market-based society.

Keywords

💡Crash Course Economics

Crash Course Economics is an educational video series that simplifies complex economic concepts for a general audience. In the script, it serves as the platform through which Adriene Hill and Jacob Clifford discuss various economic themes, making it central to understanding the video's educational purpose.

💡Free Market Economies

Free market economies are economic systems where supply and demand dictate the production of goods and services without significant government intervention. The video contrasts these with centrally planned economies, illustrating the advantages of free markets in meeting consumer needs, as seen in the discussion of productive and allocative efficiency.

💡Centrally Planned Economies

Centrally planned economies are systems where the government decides what to produce, often leading to inefficiencies and consumer dissatisfaction. The script uses the example of the Soviet Union to highlight the shortcomings of central planning, such as shortages of consumer goods despite a focus on heavy industry.

💡Productive Efficiency

Productive efficiency refers to the concept where goods are produced at the lowest possible cost, with no waste of resources. In the video, it is contrasted with the inefficiencies of central planning, where cost minimization is less of a priority, leading to potential resource wastage.

💡Allocative Efficiency

Allocative efficiency is the idea that resources are allocated to produce what consumers actually want. The script explains this through the example of a company producing only skinny jeans, which may be productively efficient but not allocatively efficient if consumer preferences have shifted.

💡Price Signals

Price signals are economic indicators that reflect consumer demand and are used by producers to adjust production. The video script discusses how price signals inform producers about changing consumer preferences, such as the shift away from skinny jeans, and the market response to the introduction of the iPad.

💡Price Gouging

Price gouging is the practice of raising prices for essential goods during emergencies, which some view as exploiting consumers. The script debates the morality and economic implications of price gouging, noting that it can encourage supply to affected areas and deter unnecessary purchases.

💡Predatory Pricing

Predatory pricing is a strategy where a company lowers prices to drive out competitors, with the intention of later raising prices once the competition is eliminated. The script discusses Walmart's alleged use of this strategy and the legal and economic challenges of proving predatory pricing.

💡Invisible Hand

The invisible hand is a concept by Adam Smith that describes the unintended social benefit resulting from individuals pursuing their own interests in a free-market economy. The video uses this concept to explain how competition in markets can lead to better prices and quality for consumers.

💡Socially Conscious Companies

Socially conscious companies are businesses that make efforts to operate ethically and contribute positively to society and the environment. The script encourages viewers to support such companies, emphasizing that consumer choices can drive positive change in the market.

💡Crowdfunding

The term crowdfunding is used metaphorically in the script to describe how capitalism, through its system of price signals, allows consumers to collectively decide what is produced and how it is made. This highlights the power of consumer spending in shaping market outcomes.

Highlights

Differentiation between free market economies and centrally planned economies, with a focus on what gets produced.

Exploration of why competitive markets are more successful at fulfilling consumer desires.

Central planning's inefficiency and consumer goods shortages in the Soviet Union.

The shift away from central planning in countries like China and Cuba.

Productive efficiency in free markets and the incentive to minimize waste for profit maximization.

Allocative efficiency and the importance of producing what consumers want.

The role of price signals in indicating consumer preferences and market demand.

The impact of Apple's iPad on the tablet market and price signal response.

Critique of gift-giving from an economic efficiency perspective.

The invisible hand of the market and its effects on business competition and consumer benefit.

Government regulation in the United States and its balance with free market principles.

Price gouging during emergencies and the debate over its economic implications.

The role of businesses like Walmart in disaster relief and their approach to price gouging.

Predatory pricing strategies and their legal and economic challenges.

The difficulty of proving predatory pricing and its consequences for market competition.

The coexistence of capitalism and social consciousness in corporate practices.

The power of consumer choices in shaping corporate behavior and social impact.

The importance of consumer awareness and the responsibility in seeking ethical companies.

Reflection on the luxury of discussing market ethics and the reality of poverty for many.

Transcripts

Adriene: Hi, I'm Adriene Hill -

Jacob: And I'm Jacob Clifford, and this is Crash Course Economics. Today we're gonna talk about a lot of stuff.

Adriene: Everything from blundering planned economies to heartless free markets from price

gougers to indolent apparatchiks. But it's not all bad news. We're going to learn that

price signals indicate skinny jeans are on the way out.

[Theme Music]

Adriene: We've talked about the difference between free market economies, where supply

and demand determine what gets produced, and centrally planned economies, where government

agencies decide what gets produced. Today we're gonna expand on that, and discuss why

competitive markets have been more successful at providing most of the things people want.

Central planning has some upsides. Everyone who wants a job has a job, and production

aims to meet an idealized version of society's collective goals. But the reality of it has

been less ideal for consumers in those societies.

In the Soviet Union, central planners were focused on producing heavy equipment and military

hardware. There were shortages of consumer goods, like soap, sugar and electronics. It

turns out that people care more about smartphones and good coffee than they care about tractors.

And so countries like China and Cuba have moved away from large-scale central planning.

Jacob: The problem with central planning is that it's inefficient. Now, when economists

talk about efficiency, they're talking about a couple different types of efficiency that's

different than the efficiency that you might know.

The first is productive efficiency: the idea that products are being made at their lowest

possible cost. This means that there are no wasted resources and that raw materials, workers,

and machines are being used to their fullest potential.

Central planners in general, aren't that focused on cost. But in the free market an individual

business owner has an incentive not to be wasteful because they want to maximize profit.

In the words of Milton Friedman; "Nobody spends somebody else's money as carefully as he spends his own."

The second type of efficiency is called allocative efficiency This means that the things we're

producing are the things that consumers actually want. In other words, our scarce resources

are being allocated towards the things we value.

Let's say a company is producing only skinny jeans, now if they're not hiring too many

workers and if they're not ending up with a bunch of extra materials they're producing

at the lowest possible cost and that's productively efficient. The problem is they only make skinny

jeans. Even though the company might be productively efficient they're probably not allocatively

efficient. Consumers don't want only skinny jeans some want boot cuts. Central planners

are less likely to be allocatively efficient because they have a harder feedback about what people want.

Adriene: Free market producers of consumer goods collect a lot of data about consumer

preferences through stuff like market research. But they can also learn a lot about consumer's

wants by looking at prices. Economists call these price signals. Let's go to the Thought Bubble.

Okay, if people are paying high prices for skinny jeans, it tells producers "Society

wants more skinny jeans, start making them." If no one wants skinny jeans, producers start

making something else instead.

Here's another example: tablet computers weren't really popular until apple introduced the

iPad. After that, boom! The market exploded. In fact, I know about 11% of you are watching

this video on a tablet right now. Because I can see you. And I can't believe you're still wearing skinny jeans.

When Google, Samsung, and Microsoft saw Apple selling millions of iPads at $500 and up,

they had an incentive to jump into the market. Price signals not only tell producers what

to make, but they also help distribute tablets to the people that value them the most.

For example: if someone's grandma doesn't really want a tablet and she was only willing

to pay $20 for one, she doesn't get it. Unless her grandkids drag her into the 21st century,

by giving her one for Christmas. Some economists love price signals so much that they argue

against the tradition of giving gifts. This argument was popularized by economist Joel

Waldfogel who argued that gift giving is inefficient. From a macroeconomic point of view, holiday

shopping boosts consumer spending, GDP, and employment. But, if too many people are purchasing

items that the end consumers don't value, then resources are being wasted.

Of course, this analysis doesn't factor in other implicit benefits of gift giving Like

fostering love and affection among family and friends. But the fact remains: The ideal

gift in terms of efficiency is cash. Heart-warming cash.

Thanks Thought Bubble. Theoretically, in a free market, producers cannot make themselves

better off without making consumers better off. If a company makes too many units of

a product or just undesirable stuff, They'll have to adapt quickly, or else it will go

out of business. Competition between businesses keeps prices and quality up. This is our old

buddy Adam Smith's invisible hand.

It's important to take a step back here and point out that we're not saying that free

markets are always good and that government involvement is always bad. Most economists

recognize that markets aren't perfect and they often fail to meet society's needs. In

these cases, economists encourage the government to either regulate or take direct control

of markets to improve social welfare.

In the United States, which is often mistaken for a free market economy, it turns out just

about everything is regulated. For example, FDA regulations reject any wheat that contains

nine milligrams or more rodent excreta pellets and/or pellet fragments per kilogram. And

the government directly controls the markets for national defense and public education.

The field of public economics analyzes this very thing.

Now I love rodent excrement and public education as much as the next girl But let's get back

to markets and the role that prices play in determining how we use our limited resources.

So price signals help us use our resources efficiently, but that doesn't mean that everyone

agrees that they are always right or just. Take price gouging.

Price gouging happens when sellers raise prices for essential items like food, water, or gasoline.

When there's something like an emergency. Some argue that this practice exploits consumers

and as an example of the cruelty of markets. In the US, anti-price gouging laws have been

enacted in 34 states. But many economists say that these laws promote inefficiency and

actually make the problem worse. They argue that allowing prices to increase in times

of crisis encourages others outside the disaster zone to haul in and sell essential goods.

If prices aren't allowed to increase, then there's less of an incentive to bring this

stuff in. Furthermore, higher prices for things like batteries, sleeping bags, and generators

mean that people who don't really need them won't buy them, making them more available

to people who do. Now it might not always be government laws that limit price gouging.

It may be the desire to earn profit that actually keeps prices down.

It's clear that businesses can earn a ton of profit in the short run by price gouging,

but what happens in the long run? Consumers are likely to remember how they were treated.

This is part of the reason some businesses like Walmart has an emergency operation center

and an in-house meteorologist to interpret weather patterns. This allows them to have

goods like water and batteries and stock when they're needed.

Not only is this profitable, it's also a pretty good public relations move. In fact, in some

cases like Hurricane Katrina in 2005, private businesses were quicker to provide disaster

relief than government agencies. A different example of how the price system is perceived

as unjust is below-cost pricing. Sometimes called predatory pricing. This is the idea

that a business can drive out competitors by charging lower prices even at a short term

loss. Competitors that can't sustain such low prices will be forced out of the market,

giving the surviving businesses market share and the ability to raise prices.

Let's talk about Walmart again. Walmart has been the target of numerous predatory pricing

lawsuits. Their size allows them to squeeze distributors and sell products at very low

prices. Although lots of consumers like these low prices, it's bad for competitors. Especially

small mom and pop stores, who are sometimes pushed out of the market. But is it predatory pricing?

In the US, the courts have said it's not. the federal trade commission's website states,

"Although the FTC exampines claims of predatory pricing carefully, courts, including the Supreme

Court, have been skeptical of such claims." So predatory pricing lawsuits are common,

but very rarely successful in the US. In Germany, Walmart faced the same sort of accusations

in 2000 and was ordered to raise some of its prices. The company ended up leaving Germany in 2006.

Predatory pricing is difficult and risky. When a business successfully eliminates their

competitors by selling products at a loss, they're eventually gonna need to increase

their prices above the market price to make up for those losses. In the short run, consumers

would have to pay more. But eventually, other businesses would be attracted by the higher

prices and enter the market. The end result is that there's no guarantee that predatory

pricing is worth it in the long run.

Jacob: There's tons of examples of corporate greed, inequality, and disregard for the environment

that make people wonder if markets are evil. And they are. Thanks for watching! We'll see

you next week! [endscreen music plays, stops] Now, there are some examples of socially conscious

companies that make an effort to protect the environment and help the disadvantaged.

Capitalism, with its focus on prices rather than fairness is often characterized as the

opposite of altruism. But the two can, and do coexist. But here's the big takeaway: Capitalism,

with its system of price signals, is basically crowdfunding. We collectively choose what

we want and how we want it made when we spend our money. After all, companies can't force

you to buy their stuff, they have to earn your money. Now if you want to see real changes

in the world, don't just complain that corporations are greedy; expect more from them.

You also need to expect more from ourselves. If you disagree with the way a retailer treats

its workers, then don't buy from them. Even if they do have the lowest prices and convenient delivery options

Adriene: If we as consumers want our purchases to have a positive impact, it's on us to seek

out companies that try to improve the world. This might mean paying more for the stuff

we buy or it might mean buying less stuff. A market based society still has shared social

goals. They just don't come from a central planner. Sure, some of our social priorities

come from governments, but they also come from each of us and the decisions we make

about how to spend our time, and energy, and money.

It's also worth remembering that it's a luxury to have these discussions. For many, many

people around the world who live in poverty and have trouble affording the basic necessities of

life, paying a higher price, based on conscience isn't an option. Thanks for watching! We'll see you next week.

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