The Great Economic Problem
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0:00 - 0:07♪ [music] ♪
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0:07 - 0:11- [Alex] In our first talk
on the price system, -
0:11 - 0:14we looked at how markets
link the world, -
0:14 - 0:16how markets linked
over space, geographically. -
0:16 - 0:18Today, we're going to look at how
-
0:18 - 0:19different markets are linked
to one another, -
0:19 - 0:22and this is going to give us
a lot of insight into how markets -
0:22 - 0:26solve the great economic problem.
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0:31 - 0:35Earlier, we looked at how the price
of oil affects the market for roses. -
0:36 - 0:41Another example: how does the price
of oil affect candy bars? -
0:41 - 0:45Well, there's one obvious way
in which these are connected. -
0:45 - 0:46A higher price of oil means
a higher transportation cost, -
0:46 - 0:49and anything you transport
therefore becomes -
0:49 - 0:50a little bit more expensive.
-
0:50 - 0:53But what I have in mind is
an actually more subtle -
0:53 - 0:54and important connection.
-
0:55 - 0:58Can you guess what it might be
from the picture? -
0:58 - 1:01Higher oil prices increase
the demand for substitutes -
1:01 - 1:04such as ethanol.
-
1:04 - 1:07In the United States,
ethanol is mostly made from corn. -
1:07 - 1:12But in most of the rest
of the world, including Brazil, -
1:12 - 1:16it's made from sugar cane.
-
1:16 - 1:17Higher oil prices mean
that more of the sugar cane crop is -
1:17 - 1:19going to diverted
into producing ethanol, -
1:19 - 1:24and then less of it is going
to be used to produce sugar. -
1:24 - 1:28That means a reduced
supply of sugar. -
1:28 - 1:31That means an increase
in the price of sugar, -
1:31 - 1:36and that increases the cost
of producing candy bars. -
1:37 - 1:42Who would have thought
that one way of adjusting -
1:43 - 1:47to a higher price of oil is
to eat fewer candy bars, -
1:47 - 1:50yet that is exactly
how the price system works. -
1:50 - 1:52A change in the price
of one resource ripples out -
1:52 - 1:55throughout the world economy,
changing the consumption patterns -
1:55 - 1:59of many, many different goods
-
2:00 - 2:01in first, second,
and third order effects. -
2:01 - 2:07All in order to try and find
the best way of responding -
2:07 - 2:09to this reduced amount
of the resource. -
2:10 - 2:13How do we adjust to less?
-
2:13 - 2:16We adjust on many,
many different margins all working -
2:16 - 2:18through the price system.
-
2:18 - 2:21Here's another example
of how a change in the price -
2:21 - 2:23in one market ripples out
throughout the world economy, -
2:23 - 2:26changing prices, consumption
and production decisions, -
2:26 - 2:30incentives, and choices
throughout the entire world. -
2:30 - 2:34We're going to show how
the price of oil affects -
2:34 - 2:36how driveways are built.
-
2:37 - 2:39A barrel of oil is refined
into gasoline but also -
2:39 - 2:42into many other products,
such as jet fuel, lubricants, -
2:42 - 2:48and also asphalt.
-
2:48 - 2:50Asphalt, in fact, is what's
left over after the other products -
2:50 - 2:53have been extracted.
-
2:53 - 2:56Within limits, refiners can choose
how much of each product to extract. -
2:56 - 2:59A higher price of gasoline will
cause refiners to work extra hard -
2:59 - 3:03to extract more gasoline
from a given barrel -
3:03 - 3:06than they otherwise would.
-
3:07 - 3:09This means as they extract
more gasoline, there's less -
3:09 - 3:12production of asphalt, and that
means a higher price of asphalt. -
3:12 - 3:17So, when someone is thinking
about how to pave their driveway, -
3:17 - 3:22they're going to see
the higher price of asphalt. -
3:22 - 3:26So, they're going to use, instead,
concrete, cobblestone or brick, -
3:26 - 3:29one of the substitutes.
-
3:29 - 3:33Who would have thought that
concrete is a substitute for oil? -
3:33 - 3:36Yet, in fact, it is.
-
3:36 - 3:39That's what the market system does.
-
3:39 - 3:42It causes us to rearrange
our choices in order to get -
3:42 - 3:46the most value from our
resources, and that may involve -
3:46 - 3:50substituting concrete for oil.
-
3:50 - 3:51So, here's the big picture.
-
3:51 - 3:53The great economic problem
is how to arrange -
3:53 - 3:58our limited resources to satisfy
as many of our wants as possible. -
4:00 - 4:04Resources are not equally
valuable in all uses, -
4:04 - 4:07so we must choose where to allocate
our resources in order -
4:07 - 4:13to get the most value
out of those resources. -
4:13 - 4:17If the supply of oil falls,
we want oil to be shifted -
4:17 - 4:20to higher valued uses,
but which uses? -
4:20 - 4:25How are we going to choose
where to use less oil. -
4:25 - 4:30We must use less oil
somewhere, but where? -
4:30 - 4:33And how are we going
to make these decisions? -
4:33 - 4:36There are a couple
of possible methods. -
4:36 - 4:39We could use a central planner,
or we could use the price system. -
4:41 - 4:42One way of solving
the great economic problem is -
4:42 - 4:45through central planning.
-
4:45 - 4:50Make a single official a czar,
or a bureaucracy, responsible -
4:50 - 4:56for allocating our limited resources
to all the different uses. -
4:56 - 4:59This was the approach taken
in the communist countries -
4:59 - 5:00in centrally planned economies.
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5:00 - 5:02Does it work?
It's got big, big problems -- -
5:02 - 5:07problems of information
and problems of incentives. -
5:07 - 5:10Let's look at information first.
-
5:10 - 5:13Think about all
of the different uses of oil. -
5:13 - 5:15Oil is used in producing steel
and is used for growing vegetables. -
5:15 - 5:18If we have less oil, which one
do we cut back most on -- -
5:18 - 5:24on steel or on vegetables?
-
5:24 - 5:26You might think that's easy
because maybe steel is worth -
5:26 - 5:29more than vegetables.
-
5:29 - 5:34Maybe that is true; perhaps there
are really good substitutes for oil -
5:34 - 5:36in its use in producing steel.
-
5:36 - 5:39But no good substitute for oil
in its use in producing vegetables. -
5:39 - 5:45In that case, we would want
to cut back on steel -
5:45 - 5:47and continue to use oil
for vegetables. -
5:48 - 5:49Think about all of the different
responses that we've seen -
5:49 - 5:51to an increase of price of oil.
-
5:51 - 5:57People use less sugar, they had
fewer candy bars, they cut back -
5:57 - 5:58on asphalt and switched to paving
their streets and their driveways -
5:58 - 6:01with concrete and brick.
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6:01 - 6:07Could any bureaucracy,
even a large bureaucracy -
6:07 - 6:10with massive computing power --
could it know all of the many, -
6:10 - 6:12many uses of oil and all
of the substitutes for those users? -
6:12 - 6:16And the substitutes
for the substitutes? -
6:16 - 6:19Could it make all
of these subtle choices? -
6:20 - 6:26The scene that the market makes,
it's highly unlikely. -
6:26 - 6:31The information problem
is too difficult -
6:31 - 6:34even for a massive
computing power to solve. -
6:34 - 6:36Moreover, even if we could
gather all of this information, -
6:36 - 6:37this dispersed information
-
6:37 - 6:42for millions and millions
of people, and even if we could -
6:42 - 6:46compute the right thing to do
with all of that information, -
6:46 - 6:49would anyone have the incentive
to do the right thing? -
6:49 - 6:52Would people have
the right incentive to respond -
6:52 - 6:54to the bureaucracy with the truth?
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6:54 - 6:57No, everyone's going to say,
"My use is really valuable. -
6:57 - 7:02It's the most valuable use.
-
7:02 - 7:04"There are not good substitutes
for oil in my use." -
7:04 - 7:07Even if their use happens to be
heating their swimming pool. -
7:07 - 7:11We saw, in fact, what happened
in the United States -
7:11 - 7:14when the Department of Energy
tried to centrally plan -
7:14 - 7:17the allocation of oil in the 1970s.
-
7:17 - 7:21We had oil rigs off the Coast
of California which could not -
7:22 - 7:25themselves get
enough oil to operate. -
7:25 - 7:28In other words,
under central planning of oil, -
7:28 - 7:30we had massive inefficiencies
and misallocation of resources. -
7:30 - 7:33We saw exactly the same
misallocation of resources -
7:33 - 7:38on a larger scale in the command
economies such as the Soviet Union -
7:39 - 7:44under communism
or China under communism. -
7:44 - 7:46Central planning is not
a good solution -
7:46 - 7:49to the great economic problem
-
7:49 - 7:53because of problems
of information and incentives. -
7:54 - 7:57We need a better approach.
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7:59 - 8:03- [Narrator] If you want to test
yourself, click "Practice Questions." -
8:03 - 8:07Or, if you're ready to move on,
just click "Next Video." -
Not Synced♪ [music] ♪
- Title:
- The Great Economic Problem
- Description:
-
In this video, we discuss how different markets are linked to one another. How does the price of oil affect the price of candy bars? When the price of oil increases, it is of course more expensive to transport goods, like candy bars. But there are other, more subtle ways these two markets are connected. For instance, an increase in the price of oil leads to an increase in demand for oil substitutes, like ethanol. And when the supply of oil falls, oil should shift to higher-valued uses. But, which uses? How do we decide where to use less oil?
This brings us to the great economic problem: how to most effectively arrange our limited resources to satisfy our needs and wants. Which approach — central planning or the price system — is better at solving this problem? Join us as we explore this question further.
Microeconomics Course: http://mruniversity.com/courses/princ...
Ask a question about the video: http://mruniversity.com/courses/principles-economics-microeconomics/economic-problem-central-planning-70s-oil-crisis#QandA
Next video: http://mruniversity.com/courses/principles-economics-microeconomics/information-problem-economics-hayek
- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Micro
- Duration:
- 08:13
Kirstin Cosper edited English subtitles for The Great Economic Problem | ||
Kirstin Cosper edited English subtitles for The Great Economic Problem | ||
Kirstin Cosper edited English subtitles for The Great Economic Problem | ||
Kirstin Cosper edited English subtitles for The Great Economic Problem | ||
Kirstin Cosper edited English subtitles for The Great Economic Problem | ||
MRU2 edited English subtitles for The Great Economic Problem |