The Economic Way of Thinking 10e ©Prentice Hall 2003 1 “The Economic Way of Thinking” 10 th Edition by Paul Heyne, Peter Boettke, and David Prychitko “Information,

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The Economic Way of Thinking 10eThe Economic Way of Thinking 10e ©Prentice Hall 2003©Prentice Hall 2003

““The Economic Way of Thinking”The Economic Way of Thinking”1010thth Edition Edition

by Paul Heyne, Peter Boettke, by Paul Heyne, Peter Boettke, and David Prychitkoand David Prychitko

“Information, Middlemen, and “Information, Middlemen, and Speculators”Speculators”

““The Economic Way of Thinking”The Economic Way of Thinking”1010thth Edition Edition

by Paul Heyne, Peter Boettke, by Paul Heyne, Peter Boettke, and David Prychitkoand David Prychitko

“Information, Middlemen, and “Information, Middlemen, and Speculators”Speculators”

PowerPoint Slides prepared by PowerPoint Slides prepared by Assistant Professor Assistant Professor

Paul HarrisPaul HarrisCamden County CollegeCamden County College

PowerPoint Slides prepared by PowerPoint Slides prepared by Assistant Professor Assistant Professor

Paul HarrisPaul HarrisCamden County CollegeCamden County College

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The Economic Way of Thinking 10eThe Economic Way of Thinking 10e ©Prentice Hall 2003©Prentice Hall 2003

Chapter OutlineChapter Outline

I.I. IntroductionIntroduction

II.II. Real Estate Agents As Information Real Estate Agents As Information ProducersProducers

III.III. Reducing Search CostsReducing Search Costs

IV.IV. Middlemen Create InformationMiddlemen Create Information

V.V. Varieties of SpeculationVarieties of Speculation

VI.VI. Consequences of SpeculationConsequences of Speculation

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Chapter OutlineChapter Outline

V11.V11. Prophets and LossesProphets and LossesVIII.VIII. The Complex Question of The Complex Question of

“Insider Trading”“Insider Trading”IX.IX. The Liability QuestionThe Liability QuestionX.X. Physicians and Malpractice SuitsPhysicians and Malpractice SuitsXI.XI. Commodity Speculators and the Commodity Speculators and the

Futures MarketsFutures MarketsXII.XII. Once over LightlyOnce over Lightly

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IntroductionIntroduction

The costs and benefits that affect decisions to The costs and benefits that affect decisions to demand or to supply are always expected demand or to supply are always expected (marginal) cost and benefits.(marginal) cost and benefits.Mistaken decisions are sometimes costly.Mistaken decisions are sometimes costly.Avoiding mistakes is costly.Avoiding mistakes is costly.

One way to avoid mistakes is to acquire One way to avoid mistakes is to acquire more information.more information.Information is also a scarce good with its Information is also a scarce good with its own acquisition cost.own acquisition cost.

The costs and benefits that affect decisions to The costs and benefits that affect decisions to demand or to supply are always expected demand or to supply are always expected (marginal) cost and benefits.(marginal) cost and benefits.Mistaken decisions are sometimes costly.Mistaken decisions are sometimes costly.Avoiding mistakes is costly.Avoiding mistakes is costly.

One way to avoid mistakes is to acquire One way to avoid mistakes is to acquire more information.more information.Information is also a scarce good with its Information is also a scarce good with its own acquisition cost.own acquisition cost.

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Real Estate Agents Real Estate Agents As Information ProducersAs Information ProducersReal Estate Agents Real Estate Agents As Information ProducersAs Information Producers

““How to save about $5,000 and lose How to save about $5,000 and lose $15,000…right on your own home.”$15,000…right on your own home.”

Question……….Question……….

Is this possible?Is this possible?

““How to save about $5,000 and lose How to save about $5,000 and lose $15,000…right on your own home.”$15,000…right on your own home.”

Question……….Question……….

Is this possible?Is this possible?

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Realtors Realtors Serve as middlemenServe as middlemen

QuestionQuestionWho do they serve--buyers or sellers?Who do they serve--buyers or sellers?

Answer……Answer……Actually, both can gain from the services of Actually, both can gain from the services of a realtor because the realtor enables each to a realtor because the realtor enables each to obtain additional information at a low cost.obtain additional information at a low cost.

Realtors Realtors Serve as middlemenServe as middlemen

QuestionQuestionWho do they serve--buyers or sellers?Who do they serve--buyers or sellers?

Answer……Answer……Actually, both can gain from the services of Actually, both can gain from the services of a realtor because the realtor enables each to a realtor because the realtor enables each to obtain additional information at a low cost.obtain additional information at a low cost.

Real Estate Agents Real Estate Agents As Information ProducersAs Information ProducersReal Estate Agents Real Estate Agents As Information ProducersAs Information Producers

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• Information is a scarce good.Information is a scarce good.– For buyers and sellers to continue to For buyers and sellers to continue to

acquire information:acquire information:

AnticipatedAnticipatedmarginal gainmarginal gain

AnticipatedAnticipatedmarginal costmarginal cost>>

Real Estate AgentsReal Estate Agents As Information Producers As Information ProducersReal Estate AgentsReal Estate Agents As Information Producers As Information Producers

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Quantity of information

Va

lue

of

co

sts

an

d b

ene

fits Anticipated Anticipated

marginal benefitmarginal benefitAnticipated Anticipated

marginal costmarginal cost

Worthwhile Not

Real Estate Agents As Information Real Estate Agents As Information ProducersProducers

Real Estate Agents As Information Real Estate Agents As Information ProducersProducers

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• MiddlemenMiddlemen

– Increase people’s wealth by Increase people’s wealth by acting as low-cost producers of acting as low-cost producers of informationinformation

– Reduce transaction costsReduce transaction costs

Real Estate Agents As Information Real Estate Agents As Information ProducersProducers

Real Estate Agents As Information Real Estate Agents As Information ProducersProducers

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Reducing Search CostsReducing Search Costs

Question…….Question…….Would you save money if you Would you save money if you sold your Yahoo stock yourself sold your Yahoo stock yourself instead of using a stockbroker?instead of using a stockbroker?

Internet brokers have emerged to Internet brokers have emerged to compete against traditional compete against traditional brokers by substantially lowering brokers by substantially lowering their fees and commissions. their fees and commissions.

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Question…..Question…..Why is “getting it wholesale” a popular Why is “getting it wholesale” a popular pastime for many people.pastime for many people.

Retailers provide valuable information.Retailers provide valuable information.Market competition among suppliers Market competition among suppliers and middlemen encourage them to find and middlemen encourage them to find ways of informing potential customers ways of informing potential customers and reducing their transaction costs. and reducing their transaction costs.

Reducing Search CostsReducing Search Costs

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Question….Question….What role do job-placement agencies serve?What role do job-placement agencies serve?

People frequently resent the fee charged by the agency.People frequently resent the fee charged by the agency.Unless they expected the information obtained through Unless they expected the information obtained through the agency to be worth more than the fee, they the agency to be worth more than the fee, they presumably they would never have used the agency’s presumably they would never have used the agency’s services.services.But they choose to use it. But they choose to use it. As soon as they find a suitable employer they begin to As soon as they find a suitable employer they begin to look at the fee as an imposition. look at the fee as an imposition.

Reducing Search CostsReducing Search Costs

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Middlemen’s Negative ReputationMiddlemen’s Negative ReputationComes from our habit of comparing actual Comes from our habit of comparing actual situations with better but nonexistent onessituations with better but nonexistent ones

Middlemen’s Negative ReputationMiddlemen’s Negative ReputationPeople perceive that middlemen take People perceive that middlemen take advantage of our ignorance.advantage of our ignorance.

Middlemen produce real wealth.Middlemen produce real wealth.

Reducing Search CostsReducing Search Costs

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Middlemen Create Information

Markets generate high-quality Markets generate high-quality information at low cost.information at low cost.Middlemen serve a crucial role in the Middlemen serve a crucial role in the market process.market process.Well-Organized MarketsWell-Organized Markets

Bids and offers of many prospective buyers Bids and offers of many prospective buyers and sellers have been brought together to and sellers have been brought together to create a single price for a fairly uniform create a single price for a fairly uniform good over a wide geographic area.good over a wide geographic area.

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QuestionsQuestionsIs the stock market well organized?Is the stock market well organized?The furniture market?The furniture market?The grocery market?The grocery market?The Beanie Baby market?The Beanie Baby market?

Middlemen Create Information

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Prices provide information about Prices provide information about available opportunities.available opportunities.MiddlemenMiddlemen

Organize marketsOrganize marketsCreate valuable informationCreate valuable informationSpecialize because they feel they have a Specialize because they feel they have a comparative advantagecomparative advantageSometimes called “speculators”Sometimes called “speculators”

Middlemen Create Information

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Varieties of SpeculationVarieties of Speculation

Speculation (dictionary definition)Speculation (dictionary definition)

Trading in the hope of profit Trading in the hope of profit from changes in the market pricefrom changes in the market price

Question……..Question……..

Is this adequate?Is this adequate?

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Examples…Examples…

““Bears” on Wall StreetBears” on Wall Street

Commodity speculationCommodity speculation

Your education expenditureYour education expenditure

Consumer expecting price increasesConsumer expecting price increases

Varieties of SpeculationVarieties of Speculation

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Consequences of Speculation

Question…Question…What would farmers do if they expected a What would farmers do if they expected a

disease to wipe out part of this year’s corn disease to wipe out part of this year’s corn crop?crop?

Answer….Answer….People who think this is likely to occur will People who think this is likely to occur will

expect a higher price for corn in the fall.expect a higher price for corn in the fall.This will induce some people to pull some This will induce some people to pull some

corn out of current consumption to hold in corn out of current consumption to hold in expectation of the higher fall prices.`expectation of the higher fall prices.`

That’s That’s Speculation!!Speculation!!

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P

Q

Year 1 Year 2

D

Sold HarvestedP

Q

D

SoldHarvested

Consequences of Speculation

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Question….Question….

How can speculators reduce risk How can speculators reduce risk to others?to others?

Speculators purchase risk.Speculators purchase risk.

Hedgers sell risk.Hedgers sell risk.

Consequences of SpeculationConsequences of Speculation

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Prophets and Losses

Questions…Questions…What if the speculators are incorrect in What if the speculators are incorrect in their anticipations?their anticipations?What would you do if you had disagreed What would you do if you had disagreed with the speculators’ anticipations?with the speculators’ anticipations?

Answers……..Answers……..Speculators provide information.Speculators provide information.They offer express judgments.They offer express judgments.Their generated prices are indexes of value.Their generated prices are indexes of value.

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Farmers’ decisions are affected by Farmers’ decisions are affected by futures prices.futures prices.

Natural disasters have relatively little Natural disasters have relatively little affect on food prices due to speculators.affect on food prices due to speculators.

Prophets and Losses

Middle men Middle men coordinate marketcoordinate market exchanges acrossexchanges across

regions.regions.

Speculators coordinateSpeculators coordinatemarket exchangesmarket exchanges

throughthroughtime.time.

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The Complex Questionof “Insider Trading”

Questions…Questions…What would occur if speculators’ decisions What would occur if speculators’ decisions were impacted by information they had no were impacted by information they had no right to know?right to know?What do buyers have the right to know?What do buyers have the right to know?What do sellers have an obligation to reveal?What do sellers have an obligation to reveal?Is full disclosure possible when many people Is full disclosure possible when many people are not paying attention?are not paying attention?When is “inside information” both desirable When is “inside information” both desirable and ethical?and ethical?

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Fiduciary ObligationsFiduciary ObligationsMoral and legal duties taken on by contract Moral and legal duties taken on by contract or other agreementor other agreementIt is illegal when “insider trading” occurs as It is illegal when “insider trading” occurs as a result of the violation of these obligations.a result of the violation of these obligations.

Questions……Questions……Should all “insider trading” be made Should all “insider trading” be made illegal?illegal?What is an “unfair” advantage? What is an “unfair” advantage?

The Complex Questionof “Insider Trading”

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The Liability Question

• QuestionsQuestions– What should be done about What should be done about

transactions that don’t turn out as transactions that don’t turn out as expected?expected?

– Who is liable?Who is liable?– What would motivate a seller to accept What would motivate a seller to accept

more liability?more liability?

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Courts have been Courts have been throwing out contractual throwing out contractual agreements.agreements.

Assuming unfair advantageAssuming unfair advantage

““Deep-pocket” judgments Deep-pocket” judgments have become common.have become common.

The Liability Question

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Question

What are the costs of the “deep-pocket” judgments?

The Liability Question

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Caveat EmptorCaveat Emptor ““Let the buyer beware”Let the buyer beware”

Caveat VenditorCaveat Venditor ““Let the seller beware”Let the seller beware”

The Liability Question

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Question………….Question………….

What would sellers do if What would sellers do if they were forced to pay they were forced to pay for the foolish actions of for the foolish actions of buyers?buyers?

The Liability Question

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Physicians andMalpractice Suits

• MalpracticeMalpractice– Once meant negligent or improper Once meant negligent or improper

action by a physician that resulted in action by a physician that resulted in death or injury to the patient.death or injury to the patient.

• QuestionQuestion– What does it mean today?What does it mean today?

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QuestionsQuestions

Won’t malpractice suits Won’t malpractice suits motivate physicians to try to motivate physicians to try to make fewer mistakes?make fewer mistakes?

Is this good or bad?Is this good or bad?

Physicians andMalpractice Suits

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Questions…..Questions…..

How many tests are necessary How many tests are necessary to ensure a diagnosis?to ensure a diagnosis?

What does this cost?What does this cost?

Is prolonging life always Is prolonging life always worth the cost?worth the cost?

Physicians andMalpractice Suits

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End of Chapter 7

Next, Chapter 8Next, Chapter 8On “Profit and Loss”On “Profit and Loss”