In The Classroom Media is a division of The Palmer R. Chitester Fund, Inc. • © 2002

Student Study Guide

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IntroductionEconomics is the science of purposeful human actions and their unintended

or overlooked consequences. Economic theory examines the choices people makeand the way these decisions affect others. You are an active part of the U.S

economy. Every decision, even to buy an orange instead of an apple,reverberates throughout the economy by impacting on prices, output, wages,investments and profits. Since all actions have consequences, it is important

to trace the logical sequence of events arising from people’s choices.Applying economic theory to a wide variety of everyday situationsenables us to view the world in an unexpected and exciting way.

“It is not from the benevolence of the butcher,the brewer, or the baker, that we expect our dinner,

but from their regard to their own interest.

We address ourselves, not to their humanitybut to their self-love, and never talk to themof our necessities but to their advantages.”

Adam Smith1

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Values and IncentivesA person's values or needs guide the choices she makes.Everyone has a different set of values that they wantsatisfied. As Adam Smith observed, humans are moti-vated by self-interest, which is another way of saying,people are generally greedy, they like to possess things.The butcher, brewer and the baker do not labor andsweat everyday because they want to help strangers. As John Stossel demonstrates in Video 2, ranchers raisecattle to meet their own self needs. By providing dinnersfor strangers, they gain the means to acquire a house, a car, and an education for their children.

In this sense, everyone is greedy. Entrepreneursrarely refuse extra profits, and employees rarely turndown pay raises. Consumers never feel prices are toolow. Sellers never complain that their prices are toohigh. Even philanthropists "greedily" strive to helpothers. Defined this way, greed is everywhere you look,even in our genes.2

Some people believe Mother Theresa was notgreedy because she devoted her life to caring for India’sless fortunate. Imagine that she eliminated all povertyin India. Would she have retired to a convent? Notlikely. Mother Theresa desired – or in other words, shewas greedy for – the pleasure of helping others and pursuing a Christian mission.

Greed occurs because individuals have unlimiteddesires. Everyone can dream of a better state of affairsfor herself or others. When we succeed in improvingour lives, the second we think we’re happy, we wantmore. Once accustomed to the current state of affairswe begin to think of ways it could be better. Call it thetreadmill of happiness principle in economics. Forexample, if you get a job that pays double your previ-ous wage, you’ll likely feel very rich. But that good feel-ing will eventually fade, and you’ll once again feel theneed for more.

Unfortunately, scarcity prevents us from simultane-ously satisfying all human desires. Mother Naturerarely provides goods and services in such abundancethat all human needs are fulfilled. Nature is the ulti-mate Scrooge! We arrive in this world naked, hungry,ignorant and challenged to survive.

We combat Mother Nature’s stinginess by producinggoods and services where none exist to satisfy our ever-growing array of needs. However, when more peopledesire something, the less available it becomes. Thisconflict between unlimited needs and limited resourcesforces each individual to purposefully choose amongalternatives. Fulfilling some needs causes others to gounsatisfied. The value a person places on the foregonealternative is called the good’s opportunity cost. You can-not go to the movies and attend a party at the same time.

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The Pervasivenessof Human Greed

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Video Segment 1

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ggrreeeeddYour opportunity cost for attending the party is not goingto the movies. Even a free lunch isn’t free since the timespent eating could be used doing something else, andthe resources used could be applied to alternate uses.

Competition and the Market ProcessCompetition arises from scarcity and greed (needs).Competition has some role to play in most human rela-tions: entrepreneurs vie for profits, sports teams competefor victory and scientists contest for scholarly acclaim,such as the Nobel Prize. Obviously, the winners benefitfrom competition, but the losers often gain as well.People trying to start businesses often fail. Frequently,that failure helps them learn lessons that lead to thembecoming the next Bill Gates. And, whether the entre-preneur wins or loses, the consumer almost always wins.A competitor trying to give consumers a better productthan Microsoft may fail and go out of business, but inthe meantime they’ve forced Microsoft to keep pricesdown and quality up. Fans win from watching athletescollide in the Super Bowl. Sick people win when scien-tists compete to discover cures for life-threatening diseases. Computer users win when small companiesbased in Taiwan compete with Michael Dell’s company.Competition and greed create vast unseen beneficial side-effects. When competitors pursue personal gain, theyindirectly enhance the quality of life for all.

Values and Voluntary ExchangeWhat happens when someone else has what you desire?How do you get it? Only three ways exist for gettingwhat you want in life: (1) gifts, (2) trade or voluntaryexchange and (3) coercive transfers. In the economy,scarce resources are transferred using one of these three methods.

Some gifts come from nature, like wild berries wait-ing to be picked, but even these require the time andeffort of gathering. Most gifts come as presents frompeople who expect nothing in return, such as yourfamily or friends. Seldom do strangers pass out gifts.Since strangers own most goods we desire, waiting forgifts or begging for a new Corvette usually doesn’t suc-ceed. In human societies, voluntary trade and coercionare the most common ways things are acquired.

In a free market economy, most needs are metthrough voluntary exchange. Individuals trade some-thing they value less for something that they valuemore. At the time of exchange, each trader believes shewill be better off after the exchange. Additionally, tradepromotes cooperation, understanding and trust.Exchange requires knowing the other person’s needs or wants, and knowing that promises will be kept con-cerning the quality and quantity of the traded goods.

Fallacies of ExchangeA common misconception suggests that exchangeoccurs because individuals place equal values on goodsand services. If true, trade becomes impossible sinceneither person benefits. Trade is not an end in itself,rather, it is a means to satisfy a higher-valued need.Differences in subjective values create the potentialgains from trade. The following blocked example illustrates this point.

Values and TradeSuppose Jones meets Smith. Jones owns a baseball, andSmith owns a basketball. Both would like to possess abasketball and baseball. Their relative subjective valuesare ranked as follows:

Both equally value the basketball over the baseball. In this case, voluntary exchange is impossible. AlthoughJones eagerly wants to trade for the higher-valued basketball, Smith refuses to trade for a lower-valuedbaseball. Mutually beneficial exchange happens onlywhen both traders have inverse values as in the tablebelow:

Another common fallacy implies that trade is zero-sum, where one person’s gain is another’s loss.Frequently, journalists and politicians incorrectly usethe phrase “trade wars.” This phrase confuses peacefuland mutually beneficial trade with the violence of warin which a victor plunders the loser. Trade and war arecompletely opposite principles of social relations. Thecoercion by force in war guarantees a win/lose, zero-sum, or even negative-sum result, whereas voluntarytrade generates a win/win, positive-sum outcome. Trade only occurs when both parties feel they will be better off. If a person expected to lose from trade,why would they voluntarily trade?

SubjectiveRank Jones Smith

1st Basketball Basketball

2nd Baseball Baseball

SubjectiveRank Jones Smith

1st Basketball Baseball

2nd Baseball Basketball

Underlined items are those owned by each trader.

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Total Time MinutesSpent Spent on

In Minutes Each Chore

Without WithChore Adam David Trade Trade

Mowing Lawns 40 120 160 80

Weeding Gardens 60 100 160 200

Time working without trade 100 220 320 —

Time working with trade 80 200 — 280

Net gain from trade 20 20 — 40

The zero-sum fallacy implies a fixed economic piewith the winners getting bigger slices than the losers.As David Kelley explains to John Stossel, human productivity creates new wealth. The Earth is a self-contained economic system. Where did the world’swealth come from? Cave dwellers didn’t find clothes,cars and VCRs just lying around in Nature. How wasthis wealth created? The chart below explains theanswer. In this world, individuals work every day to create the wealth consumed or traded away. The economic pie grows because of greed and trade.

David Ricardo and Comparative AdvantageIn 1817, Adam Smith’s student David Ricardo discovered the economic reason for specialization andexchange. Ricardo determined that we trade because of “comparative advantage.” One of economics’ mostimportant concepts, comparative advantage, explainswhy specialization arises even when the other personenjoys an absolute advantage in producing all goods. In essence, comparative advantage means we do whatwe do best and trade for the rest! The table belowillustrates this point:

Adam and David each have a lawn to mow and agarden to weed. If Adam mows both lawns and Davidweeds both gardens, each saves 20 minutes they canspend at leisure with family and friends. AlthoughAdam enjoys an absolute advantage in both activities,he benefits by trading. This occurs because each per-son is relatively more efficient in one activity than the other. By specializing and trading, both are better off on their own terms and in the aggregate by saving 40 minutes mowing and gardening. Thus, trade pro-duces a win/win result and not a zero-sum game, evenwhen one trader does everything better than the otherand gardening takes longer under trade.

Coercion and Human RelationsIf men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary.

James Madison3

Threats and violence, or coercive transfers, is the thirdway people meet their needs. Sadly, coercive transfersare as old as humankind. Through most of history, governments in the form of the king, the emperor, thedictator, or a privileged few, have taken wealth from citizens. Of course, all crimes are coercive transfers,including murder, theft and fraud. As James Madisonwisely observed, men are not angels. We need govern-ment to catch and punish criminals, so in a free societywe give government police power, or legitimate force.Criminals do not voluntarily give up their freedom to stay in jail. This seems like a good use of force.Moreover, few Americans would disband the armedforces, which protect us from aggression by otherstates. The government's police power is a practicalnecessity in a world of criminals and dictators who disrespect the rights of others.

However, coercion does have a downside. Whetherfunding the military or health care and education, allgovernment actions involve coercive transfers. Don'tbelieve it? Refuse to pay your taxes and after a series of legal procedures, IRS agents will seize your property,put you in prison, or both. Force – or threats of force –is power. Madison understood that government powerwas needed for a stable society, but he also knew peo-ple in power would be tempted to use police power to take away individual liberty. At the ConstitutionalConvention in 1787 and in the Bill of Rights of 1789,the founders of our nation set up constitutional rules to protect citizens from government and the abuse ofpower of government officials.

John Stossel echoes Madison by correctly notingthat the power to tax separates Baby Doc from BillGates. The Haitian dictator amassed huge riches bystealing from rich and poor alike through arbitrary taxation and regulation. It’s not that Gates wouldn’tlike to tax his competitors or compel consumers to buyMicrosoft products, but the marketplace doesn’t allow it.Microsoft must continuously persuade consumers thatit sells the best computer software, at the best price.Gates asks for money. Baby Doc just takes it. He andother dictators, from Hitler in Germany to Fidel Castroin Cuba, stole millions or billions from their poorercitizens and killed many who resisted.

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ggrreeeeddprices and improving quality and service. Nevertheless,critics claim that big business can lead to monopoliesthat gain at the expense of consumers, employees orother smaller business. These claims illustrate moreversions of the zero-sum fallacy.

The word monopoly means "single seller."Economists and politicians use this word when talkingabout many issues, such as "price fixing," "marketshare," "predatory pricing" and "product safety." Theconcern is whether the sellers have structured the mar-ket in a manner that is not fair to consumers. "Unfairadvantage" is a phrase that is often used in discussingmonopolies, but the two terms are not necessarily syn-onymous. Stossel is raising the question of whetherany company or individual that obeys the law in a free-market economy can take undue advantage of consumers.

Predictably, small competitors often claim theirlarge rival has an unfair advantage. Unfair advantagetypically means the bigger business charges consumersa lower price. Often competitors then ask governmentto order the larger company to raise its prices. Thelower price usually reflects greater efficiency throughsuperior management, better technology and the massproduction of output. Why should government force a business to be as inefficient as its worst rival? That’swhat government is doing when it orders a company to raise its prices. If this approach were applied consis-tently, the National Basketball Association (NBA) wouldhave been forced to strap 50 lb. ankle weights onMichael Jordan so he would rebound as badly as the NBA's worst player. Not many people would watchor enjoy a game if all the players were equally bad.Eventually, all players would be worse off, even theNBA’s worst, because wages would fall as fans stoppedwatching professional basketball.

Unfortunately, not every firm depends exclusivelyon voluntary exchange to get dollars or labor.Occasionally, a firm distorts the market by using fraudto discredit competitors and/or fool consumers, or bygetting government to change the rules in their favor.These tactics include misleading advertising, tariffs,selective regulations, counterfeit products, and subsidies.A firm that uses government power to compete iscalled a political entrepreneur – a true modern version of the old robber baron. John Stossel deals with theseactivities in another Stossel in the Classroom Video Kit,Freeloaders. As documented by economic historians, it was political entrepreneurs not the so-called “robberbarons,” who committed the majority of injustices inthe 19th century.7

Voluntary Restraints on FraudAgainst violence, greed and voluntary trade in the private sector offer few satisfactory remedies. Throughthe Rule of Law we use government to protect us fromviolence and from fraud. Against fraud, greed does pro-vide some protection. (More on page 10) To earn moremoney, entrepreneurs have an incentive to report rivalswho cheat customers or employees. Once cheated by a false promise, people take their business elsewhere.These scam artists destroy the trust required for build-ing long-term relationships with employees and repeatcustomers. Truly greedy entrepreneurs want profitstoday, tomorrow and forever.

Businesses demonstrate their honest intentionsthrough a variety of signaling mechanisms. Reputation,or “good will,” is a greedy businessperson’s most valuableasset.4 Reputation informs prospective employees, suppliers and customers that the entrepreneur has no intention to cheat them. Features like guarantees or warranties act in a similar manner by offering con-sumers a legally binding commitment about a product’spromised quality. Other ways markets solve the prob-lem of fraud include pensions, certified credentials, col-lateral, and advertisements of brand names.5 In mostcases, these solutions prevent honest entrepreneursfrom sliding over the line into fraud.

The Robber Baron Myth6

Many people believe that "big" is bad and symbolizesgreedy excess. Nowhere is this bias against size moreobvious than in business. Typically, critics of free enter-prise condemn the entrepreneur who runs the mostsuccessful business as a rapacious robber baron whoexploits a vulnerable public. This view perverts theterm's original meaning as philosopher David Kellypoints out in the video.

During the Middle Ages, barons who lived in themountainous "high lands or highways" extracted tolls andpassage fees from merchant caravans crossing the landthey governed. Sometimes they took everything from themerchants. Thus, the term robber baron was coined.This "highway robbery" by the baron was the powerfulgovernment stealing from vulnerable business persons.

Robber Barons: True and FalseApplying the label, robber baron, to entrepreneurs whoearn their profits in a competitive market is not accu-rate. Businesses, large or small, cannot force you to buyanything. Businesses compete and profit by lowering

Case Study: John D. Rockefeller Robber Baron or Social Benefactor?“Let the good work go on. We must remember we are refining oil for the poor man and he must have it cheap and good.”

John D. Rockefeller8

John Stossel points out that people vilify CorneliusVanderbilt as a robber baron, although he dramaticallylowered transportation costs for ordinary people. John D. Rockefeller has been equally maligned. Many people mistakenly believe that Rockefeller’sStandard Oil of New Jersey exploited consumers andworkers. Didn’t he get fabulously rich? Didn’t the government use the antitrust laws to break up hisgreedy monopoly? Let’s take a closer look.

Rockefeller entered the oil industry in the 1860s.He relentlessly used technology to cut costs and lowerprices. From 1873 to 1883, gross margins, whichinclude profits, on refined oil dropped from 7.3¢ pergallon to 0.9¢ per gallon.9 As the table below demon-strates, price plummeted and output soared from 1870to 1911, when the Supreme Court ruled that StandardOil violated the antitrust laws.10

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Market Price/Gallon 26.4¢ 7.5¢ 4.7¢

Output ✝ 3.9 28.2 121.0

Number of Refiners 200 104 147

Standard Oil’s Market Share 4% 88% 64%✝ millions of 42-gallon barrels of refined oil

1870 1890 1911

of recovering the losses in the future. If the predatoryfirm charges a monopoly price, new companies willenter and force the price back down to the competitivelevel. In his review of the entire 13,500 pages of trialrecords against Standard Oil, Law Professor John McGeeconcluded there was no evidence that Standard Oil everused any predatory pricing.13

Rockefeller created enormous wealth by makingpoor consumers and workers richer. In further gesturesto the community, he donated $550 million to charity,and his scientists discovered the cures for yellow fever,meningitis and hookworm.14 As suggested in the examplebelow, new technology and Rockefeller may deservemuch of the credit for saving the whales.

Look Who Freed Willie!America was once the world’s leading whaling nation. In 1846, we had 735 whaling ships that did 80% of theworld’s whaling. In the first two decades of the 19th century, whalers killed an average of 15,000 whalesannually and produced 4 million to 5 million gallons ofsperm-whale oil, 6 million to 10 million gallons of trainoil, and 1.6 million to 5.6 million pounds of bone. Theseproducts lighted lamps and provided soaps, paint, lubri-cation, candles, perfume, corset stays, buggy whips andother useful products.

When whaling finally stopped at the turn of the 20th century, there were an estimated 50,000 whales left.Surely, if an average annual kill of 15,000 whales a yearhad continued, whales would now be extinct. What savedthe whales? Was it a triumph by Green Peace or earlyanimal rights advocates?

It can be argued that whales were saved by the self-interested motives of the much-maligned “robber baron”John D. Rockefeller. The first step was made by Dr.Abraham Gesner, a Canadian geologist. In 1849, hedevised a method whereby kerosene could be distilledfrom petroleum, but it took Rockefeller to make keroseneproduction a commercial success. With his partner,Samuel Adams, Rockefeller set up a network of kerosenedistilleries that later became Standard Oil.

As kerosene became cheaper and more availablethroughout the nation, our whaling fleet fell from 735 in 1846 to 39 in 1876. The last American whaling shipleft port in 1924 and grounded on Cuttyhunk Island thenext day. Spring steel came to replace whalebone incorsets, automobiles replaced carriages, and the demandfor whalebone buggy whips and wagon suspensions collapsed. In 1879, Thomas Edison began marketing the incandescent bulb. As our country became electrified,both whale oil and kerosene were driven from the illumination market.

You may say, “Rockefeller didn’t mean to confer these benefits, so it doesn’t count!” If one takes that position, nothing counts. After all, we have cars, housesand food, which I think is wonderful. But I doubt thatproducers of these goods labored for our benefit becausethey cared about us. That brings up the great insight ofAdam Smith, “I have never known much good done bythose who affected to trade for the public good.”Walter Williams’ “A Robber Baron Saved the Whales,” Issues & Views(Summer 1997), (New York: Creators Syndicate, Inc., 1997), pp. 1-2.

Refined Oil

Because of Rockefeller’s efforts, millions ofAmericans switched their indoor lighting from expen-sive whale oil to cheap kerosene. In addition, StandardOil chemists developed numerous valuable goods fromthe waste generated by refining kerosene: gasoline, tar,naphtha, varnish, paint, paraffin and lubricants.11 Hisgreed for profit led to these discoveries. His competitorstended to discard the waste, hurting the environmentand making it harder for them to compete withRockefeller.

Consumers benefitted from Standard Oil’s efficiencythrough lower prices and a wider variety of products.But this dramatic lowering of costs followed by pricereductions led to complaints and political attacks by other oil refiners. Ida Tarbell’s A History of theStandard Oil Company accused Rockefeller of usingpredatory pricing to achieve industry dominance. Predatory pricing occurs when a firm sets its product’sprice below its cost of production. After the big firmdrives out the competition, it charges a monopoly price.Most economists reject the logic behind predatory pricing.12 With predatory pricing, the large firm incursguaranteed up-front losses but faces uncertain odds

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ggrreeeeddProvocative Statements: Do You Agree or Disagree?Video Segment 1 contains a number of provocative statements, several of which are listed below. First, explain how youinterpret the statement. Then say whether you agree or disagree with the statement. What sorts of evidence could youuse to convince someone else of your position? What sorts of evidence would convince you that your position is wrong?

1. No one will ever catch Bill Gates. (a.) Your interpretation (b.) Do you agree or disagree with this statement?Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence to refute your position

2. Rich businessmen are evil. (a.) Your interpretation (b.) Do you agree or disagree with this statement?Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence to refute your position

3. America is about competition and rising above that competition. That is at the basis of what makes our economyin our society tick. (a.) Your interpretation (b.) Do you agree or disagree with this statement?Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence to refute your position

4. From day one, he (the businessman) has to be concerned with “Who’s buying this? What need am I satisfying?”.If that’s called greed, then I say greed is good. (a.) Your interpretation (b.) Do you agree or disagree with this statement? Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence to refute your position

5. Everybody’s greedy. (a.) Your interpretation (b.) Do you agree or disagree with this statement?Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence to refute your position

Were there any other statements made in Video Segment 1 that provoked you?

ExercisesExercise 1: Would you ever think of “greed” as a desirable personal characteristic? Why? When?

Exercise 2: The United States is commonly described ashaving a market economy. Check each of the followingthat you think is a market.

❒ A place where you can buy fresh fruit and vegetables.

❒ Trading stocks and bonds.

❒ The weekend flea market.

❒ When teenagers swap CDs and tapes.

❒ Any exchange of goods or services that is voluntary.

❒ The evolution of language.

❒ The choice of a husband or wife.

❒ Choosing a college or university to attend.

❒ Businesses competing for employees.

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Total Time Spent Minutes Spent on Each Chore

Without WithChore Myself Trade Trade

Time working without trade —

Time working with trade —

Net gain from trade —

Exercise 4: The Greek City States feared democracybecause___________________________

Exercise 3: Please complete the following table, chartingan exchange that you have made with a friend or familymember.

Key Words and Conceptscoercion

comparative advantage

competition

economic freedom

exchange

greed

incentives

opportunity cost

political entrepreneur

End Notes1 Adam Smith, An Inquiry into the Nature and Causes of the Wealth

of Nations, (New York: The Modern Library, 1937), p. 14.

2 Richard Dawkins, The Selfish Gene, (Oxford: Oxford University Press,1976).

3 James Madison, “Federalist No. 51,” The Federalist Papers fromSelections from The Federalist, Henry Steele Commager ed.,(Arlington Heights, Illinois: Harlan Davidson, Inc., 1949), p. 86.

4 Daniel Klein, Reputation, (Ann Arbor, Mi.: University of Michigan Press,1997).

5 Benjamin Klein and Keith Leffler, “The Role of Market Forces inAssuring Contractual Performance,” Journal of Political Economy, 89(August 1981), pp. 615-641.

6 Matthew Josephson, The Robber Barons: The Great AmericanCapitalists, 1861-1901 (New York: Harcourt, Brace, and Whirled).

7 Thomas DiLorenzo, “The Origins of Antitrust: An Interest GroupPerspective,” in The International Review of Law and Economics(1985) No. 5, pp. 73-90. Jack High, Regulation: Economic Theoryand History, (Ann Arbor: University of Michigan Press, 1991). GabrielKolko, The Triumph of Conservatism: A Reinterpretation of AmericanHistory 1900-1916 (New York: Free Press of Glencoe, 1963).

8 Burton Folsom, The Myth of the Robber Barons (Herndon, Va.: YoungAmerica’s Foundation, 1996) p. 83.

9 Harold Williamson and Arnold Daum, The American PetroleumIndustry: The Age of Illumination 1859-1899 (Evanston:Northwestern University Press, 1959).

10 Dominick Armentano, Antitrust and Monopoly: Anatomy of a PolicyFailure (New York: John Wiley & Sons, 1982), p. 66; San Schurr andBruce Netschert, Energy in the American Economy, 1850-1975(Baltimore: John Hopkins Press, 1980); Harold Williamson and ArnoldDaum, The American Petroleum Industry: The Age of Illumination1859-1899 (Evanston: Northwestern University Press, 1959); andHistorical Statistics of the United States, Colonial Times to 1970(Washington D.C.: U.S. Government Printing Office, 1975), Series M123-1146 and pp. 231-300.

11 Burton Folsom, The Myth of the Robber Barons (Herndon, Va.: YoungAmerica’s Foundation, 1996) p. 86.

12 Robert Bork, The Antitrust Paradox: A Policy at War with Itself (NewYork: Basic Books, 1978), pp. 144-160.

13 John McGee, “Predatory Price Cutting: The Standard Oil (NJ) Case,”The Journal of Law and Economics No.1, (October 1958), pp.137-169.

14 Burton Folsom, The Myth of the Robber Barons (Herndon, Va.: YoungAmerica’s Foundation, 1996), pp. 97-98.

political freedom

predatory pricing

property rights

robber barons

Rule of Law

scarcity

unlimited desires

zero sum

Greed andCivilization

Greed and CitizenshipWhat makes a good citizen? Voters participate in elections held every two or four years. A small numberof people work on election campaigns. A very few citi-zens run for office. On a daily basis, the overwhelmingmajority of social relations have little or no directinvolvement with the institutions of government.Rarely does a citizen interact with the police, other civil servants or elected representatives. And studiesconsistently demonstrate that only a small minority of voters can correctly name their elected represent-atives.1 Yet, most people can name the clerk at the local convenience store, as well as their bank teller.

The repeated interaction in our private life withthe neighbor down the street, fellow employees andfriends creates the most significant bonds holding society together. Citizenship is truly multidimensional.We interact with each other in many roles such asvoter, producer, consumer and neighbor. Being aresponsible citizen encompasses serving others in many public and private ways.

Citizenship and MarketsIs greed compatible with good citizenship? CharlesMurray’s In Pursuit of Happiness and Good Governmentexplores this question.2 Happiness and good governmenthas resulted whenever and wherever people make acommitment to the Rule of Law, which requires equaltreatment of every citizen. Government must alsorespect the Rule of Law to prevent the exercise of arbi-trary political power. This helps create more peacefulconduct between citizens and increases the chances foreach citizen to achieve some happiness.

The shoemaker only wants to sell shoes at a profit.With that profit, he buys a swimming pool from whichhis family and friends enjoy many happy days. This is not the whole story. Earning a profit required com-peting against all goods and services for the consumer’sdollars. So the shoemaker developed working relation-ships with creditors and suppliers, invented new pro-duction techniques, created new shoe styles, andemployed many workers at higher wages. In short, the profit is a reward for social cooperation, productiveachievement, and deferred consumption.

In the market, greed holds people responsible for the consequences of their action. In this way, themarket leads people toward good citizenship. The goodcitizen earns the esteem of others by producing value-enhancing goods and services.3 Like the hot-dog vendor in the video, people admire and respect thosewho earn their money, who provide for themselves, whoare creative and productive. The competitive challenge

Video Segment 2

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of free markets enables people to discover their mostproductive talents, leading to financial success, self-esteem, happiness and good citizenship.4

On the other hand, look at the quality of citizen-ship in societies that abolish greed (self-interest), freemarkets and the Rule of Law. Many empirical casesexist but one will suffice, the former Soviet Union. TheUSSR “officially” eliminated greed and private propertyfor more than 70 years. Yet greed was still expressed in the form of political power. Government officialsand Communist party bureaucrats enjoyed many luxu-ries, while the average citizen suffered a lower standardof living and persecution if he complained.

Channeling GreedRemember the money bowl experiment in the video?Initially, most players competed to get the most moneyand emptied the bowl. There was no Rule of Law sosome were losers. By taking turns and leaving somebehind for the Professor to “double,” they would makemore and more money as long as they sat at the tableand cooperated. When the Rule of Law is establishedthey all benefit.

Economics of the Money BowlThe table, or payoff matrix, below illustrates how thebehavior of two students, Lorain and George, changes the outcomes in a similar situation.

In the above game, the bowl contains $4, and players face the following payoffs: (i) if both obey the law, eachgets $1 forever because the scientist replaces the $2 taken (ii) if they both try to cheat, one may get a wind-fall of $4, but neither gets any money in the future, and(iii) if one person obeys the law and the other cheats, the one who cheats gets $4 and neither gets any moneyin the future. Given these assumptions, if Lorain andGeorge follow the Rule of Law they’ll keep getting moneyforever until one of them cheats and empties the bowl.

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Rules MatterRules can overcome the common-ownership problems.When everyone owns something, then no one owns it.Common ownership has been shown to lead to overuseor exploitation of the resource to the point of exhaus-tion. Environmental biologists call this result thetragedy of the commons.5 As with the students and the money bowl, people have no incentive to conserveresources held in common. The “first capture rule,” or Law of the Jungle, dominates behavior in the commons. You better grab everything before yourneighbor does! Since there is no agreement as to how to determine ownership, there is no incentive to preserve the commons.

Private property rights, established through theRule of Law, solve the “tragedy of the commons” byallowing owners to exclude others.6 Property rightsare human rights. They are the moral sanctions to ownand control whatever the individual creates with herbrains and the sweat of her brow. Defining propertythat you own automatically places boundaries aroundthe things other people own. The rule of private property cultivates respect for the rights of others. The rule of private property turns greed into socialcooperation.

Lorain Obeys the Law Lorain Cheats

Lorain – $1 forever Lorain – $4George – $1 forever George – $0

Lorain – $0 Lorain – $2George – $4 George – $2

George Obeysthe Law

GeorgeCheats

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Provocative Statements: Do You Agree or Disagree?Video Segment 2 contains a number of provocative statements, several of which are listed below. First, explain how youinterpret the statement. Then say whether you agree or disagree with the statement. What sorts of evidence could youuse to convince someone else of your position? What sorts of evidence would convince you that your position is wrong?

1. The rich get richer and the poor get poorer. (a.) Your interpretation (b.) Do you agree or disagree with this state-ment? Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence to refute your position

2. The profit company delivers a better service at a cheaper price. (a.) Your interpretation (b.) Do you agree or disagree with this statement? Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence to refute your position

3. Profit is going to make people do it better. (a.) Your interpretation (b.) Do you agree or disagree with this statement?Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence to refute your position

4. Those areas where people say we’re motivated by caring...there is disaster in this country. (a.) Your interpretation(b.) Do you agree or disagree with this statement? Agree/Disagree/Undecided (c.) Evidence to support your position(d.) Evidence to refute your position

5. In a free market, you get more for yourself by serving your fellow man. (a.) Your interpretation (b.) Do you agreeor disagree with this statement? Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence torefute your position

Were there any other statements made in Video Segment 2 that provoked you?

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ExercisesExercise 1: How many people do you know who workin the private sector? How many work in government?

Exercise 2 (fill in the blanks)

The Pilgrims came to America to gain ______________

freedom. Their plan was to ___________ all work and

property _________. Early in 1623, after three winters

of hunger and misery and two years of meager harvests,

William Bradford, Governor of the settlement, reports

in his diary Of Plimoth Plantation. “At length after

much debate, the Governor, with the advice of the

chief among them, allowed each man to plant corn for

____________________, and to _________________

for that.....”

“This was very successful. It made all hands very

industrious, so that much more corn was planted...”

“The failure of this experiment of ____________ living,

which was tried for several years, and by good and

honest men proves the emptiness of the theory of Plato

and other ancients, applauded by some of later time -

that the taking away _____________________ and the

possession of it ___________________ by a common-

wealth would make a state happy and flourishing; as if

they were wiser than God.”

William Bradford, Of Plimoth Plantation, [commonly spelled OfPlymouth Plantation] (Roslyn, New York: Classics Club, 1948).

Key Words and Conceptsgreed

common ownership

competition

cooperation

junk bonds

Rule of Law

property rights

tragedy of the commons

End Notes1 Michael Caprini and Scott Keeter, “Stability and Change in the U.S.

Public’s Knowledge of Politics,” Public Opinion Quarterly (Winter1991) Vol. 55, pp. 583-612.

2 Charles Murray, In Pursuit of Happiness and Good Government(New York: Simon and Schuster, 1988).

3 Nathaniel Branden, Self-Reliance and the Accountable Life: TakingResponsibility (New York: Simon and Schuster, 1996).

4 Ayn Rand, The Virtue of Selfishness (New York: The New AmericanLibrary, 1964).

5 Garret Hardin, “The Tragedy of the Commons,” Science 1968,pp. 1243-1248.

6 Harold Demsetz, “Toward a Theory of Property Rights,” AmericanEconomic Review (1967), pp. 347-59.

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Greed and theEconomic Pie

Greed and the Economic PieTwo important questions arise concerning greed and a nation’s wealth. First, what determines the amount of wealth in a society? How big is the economic pie?Second, what determines the share of total income thatindividuals receive for their efforts? How big is myslice of the pie? Economics provides answers to both questions and refutes other fallacies of incomedetermination.

Common Fallacies about the Economic PieMany people mistakenly believe that a nation’s naturalresources determine its wealth. Natural resources donot automatically make a country richer. Many of theworld’s wealthiest places contain few natural resources,such as Japan, Switzerland and Hong Kong. On theother hand, many countries with enormous reserves ofnatural resources remain very poor, like Russia, Burmaand Zaire. Natural resources typically don’t matterbecause they can always be imported.

It has also been claimed that correlations existbetween density of population, levels of pollution, anorganized labor force, government support of highereducation and a nation's wealth. These and other fac-tors do not seem to have any consistent influence onthe GNP or per capita income of nations. For example,in the United States, the percentage of the unionizedlabor force has declined from 35.5% in 1945 to about16% today, yet the real wage has grown tremendouslyover this time.1

Why Economies GrowPut simply, economic growth depends on labor produc-tivity, or the output per unit of labor input (per person).Four variables largely determine the extent of laborproductivity: comparative advantage, capital accumu-lation, new technology, and economic freedom. Asshown in prior sections, comparative advantage resultsin gains from trade. These gains permit people to produce other goods which increase economic growth.

Capital accumulation increases economic growthby making possible tools, equipment, and machinerythat amplify a worker’s productivity. Machines then do most of the work. Farmer Jones in Kansas doesn’tsweat harder to grow wheat than farmers in Ethiopia;rather, he accesses sophisticated machinery which makeshis work more productive. The quantity of capital isone factor that separates poor countries from rich.This capital can be physical, as in the case of machines,or a workforce's stock of skills, education and trainingcalled human capital. Education and training allow us

Video Segment 3

15

0 5,000 10,000 15,000 20,000 25,000 30,000

Real GDP Per Capita

$27,178 USA

$3,383 China

$9,020 Taiwan

$1,240 N. Korea

$13,553 S. Korea

$2,000 Cuba

$22,149 Japan

to utilize knowledge in more productive ways. Thehuman mind is always the greatest tool in any economy.2

Technology applies capital in new ways, thus influencing labor productivity.3 Think about Bill Gates'achievement. He created Microsoft, an organizationthat harnesses the human capital of thousands of theworld's brightest computer programmers. In doing so,Gates generated hundreds of billions of dollars of realwealth in the world economy. Henry Ford's applicationof the assembly line provides another illustration.Ford's technology made his employees very productiveand allowed him to dramatically raise real wages andlower the price of a Model T. Like Gates, Ford onlyreceived a small fraction of the benefits he bestowedupon the world. Workers and consumers received a windfall gain in their standard of living from thehuman capital of Gates and Ford.

Last But Not Least: Economic FreedomEconomic freedom, with minimal government interference in the market, private property rightsand voluntary exchange based on the Rule of Law, is the proven road to prosperity. When citizens haveeconomic freedom, they are free to open businesses, freeto buy or not buy from any supplier, free to work ornot work for any employer, free to hire or not hire anyemployee. With economic freedom, unrestricted supplyand demand determine market prices and wages, andgreedy entrepreneurs compete for economic profits or

* The Index ranges from 1 to 5, where 1 equals most free and 5 is repressive.

GDP Per CapitaCountry Index*

USA 5 1.90

Russia 104 3.45

Japan 12 2.05

Cuba 154 5.00

S. Korea 24 2.30

N. Korea 154 3.75

Taiwan 7 1.95

China 120 3.75

Economic Freedom 4

$4,285 Russia

RankAmong

AllNations

$ $ $ $ $ $

suffer losses. The evidence is strong that free marketsmake a nation rich. The graph below compares severalrelatively free-market societies with their socialist counterparts in terms of Gross Domestic Product in per capita dollars.

On the other hand, government planning guaranteesless freedom and more poverty. As predicted by NobelLaureate Friedrich von Hayek in 1944, central planninghas always led to totalitarianism.5 Meaningful politicalfreedom seems to depend on economic freedom. In Chile,economic freedom was permitted by an authoritarianpolitical regime. Political freedom came about shortlythereafter. In Free to Choose, Nobel Laureate MiltonFriedman and his wife Rose Friedman powerfullydemonstrate that political and economic freedom areinseparable. Taiwan is another example of economicfreedom leading to political freedom. Currently, in Chinaeconomic freedom is widely permitted. Since economicand political freedom seem to go hand in hand, China willprove to be an interesting case study of this correlation.6

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Your Slice of the Economic Pie: Marginal ProductivitySince workers bring revenues to the firm, the expectedvalue from the worker’s effort sets the limit of howmuch a firm will bid against other firms for that worker’slabor. This is called the marginal productivity theory ofwages. Low wages in a rich country reflect a worker’slow productivity.

John Stossel examines the pay of CEOs and whythey earn so much more money than other employees.CEOs earn vast incomes because their decisions aremore crucial to the firm’s survival. A positive correla-tion exists between the size of the firm’s total sales andits executive compensation.7 The decisions made bythe CEO of General Motors, IBM or Disney affect billionsof dollars. Making a correct choice means billions inprofits, and a mistake costs billions or bankruptcy. Incomparison, the decisions of the company’s janitor haslittle impact on a firm's profitability, which explains thejanitor's low wages. Of course, some CEOs have beenpaid millions for doing a lousy job, and some janitorsare paid for poorly performed work. Limitations of CEO compensation based on factors other than productivity harms the firm’s owners, employees andcustomers, as Stossel highlighted with Ben & Jerry’s Ice Cream Company.

Case Study:The Role of the Corporate RaidersSuppose corporate management is substantially over-paid relative to the productive value of their decisions.The firm's profits will fall. In publicly traded compa-nies, a decline in profits relative to rival firms shows upin a lower price for the firm's stock. A declining stockprice often signals mismanagement within the firm.Corporate raiders seeing this signal and often usinghigh-yield bonds called junk bonds, buy a controllinginterest in the mismanaged company. Once in control,the raiders replace the firm's senior management. Byaligning corporate manager's pay with their productivity,the raiders correct the drain on profits, and the firm'sstock price rises. For their efforts, the raiders enjoy a capital gain on the appreciated stock.8 Other share-holders also receive the benefit from the increase in the firm's stock price. The empirical evidence stronglyindicates that corporate take-overs generally benefitshareholders.9 Corporate raiders usually serve the interests of shareholders held hostage by overpriced or incompetent senior managers. Typically, the mostvocal opponents of corporate take-overs are those inefficient managers who will lose their jobs if the take-over succeeds.10

Where’s The Junk? The label “junk bond” is truly misleading. Glenn Yagosummarized the economic record of junk bonds:

“Researchers have found that issuers of high-yield debt as a group have outperformed industrial averages in many important measures of industrial performance,including employment growth, productivity, sales, capitalinvestment, and capital spending. Overall, high-yieldfirms increased employment at an average annual rate of 6.7 percent, compared with 1.4 percent for industryin general from 1980 to 1987. High-yield firms also out-performed their industrial counterparts in produc-tivity. In output per hour of labor, industries with higherutilization of high-yield securities were more productive.In sales per employee, high-yield firms averaged 3.2 percent growth annually, compared with an industrialaverage of 2.4 percent. The total invested capital of high-yield firms grew at an average annual rate of 12.4 percent, compared with 9.9 percent for industry ingeneral. New capital expenditures for property and plantand equipment grew more than three times as fast amonghigh-yield firms as they did for industry in general (10.6 percent vs. 3.8 percent).”

Glenn Yago, “Junk Bonds,” The Fortune Encyclopedia of Economics,David Henderson, ed., (New York: Warner Books, 1993), pp. 588-590.

Source: Edward Altman, “The Anatomy of the High-Yield Bond Market,”Financial Analysts Journal (July-August 1987), p.15.

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Provocative Statements: Do You Agree or Disagree?Video Segment 3 contains a number of provocative statements, several of which are listed below. First, explain how youinterpret the statement. Then say whether you agree or disagree with the statement. What sorts of evidence could youuse to convince someone else of your position? What sorts of evidence would convince you that your position is wrong?

1. TJ. Rodgers, CEO of Cypress Semiconductors, comments in the video about his nice house that cost him $1 millionand says “So what? I’ve earned it...I built it, I own it, I deserve it.” (a.) Your interpretation (b.) Do you agree or disagree with this statement? Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidenceto refute your position

2. I want as much for me as I can get. (a.) Your interpretation (b.) Do you agree or disagree with this statement?Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence to refute your position

3. When people are this rich, shouldn’t they give more money away? (a.) Your interpretation (b.) Do you agree or disagree with this statement? Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence to refuteyour position

4. Why do we think that giving away money is better than making money? (a.) Your interpretation (b.) Do you agreeor disagree with this statement? Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence torefute your position

5. Who did more for the world, Mother Teresa or Michael Milken? (a.) Your interpretation (b.) Do you agree or disagree with this statement? Agree/Disagree/Undecided (c.) Evidence to support your position (d.) Evidence torefute your position

Were there any other statements made in Video Segment 3 that provoked you?

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2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

Exercise 2. List five jobs that require different skills.

———————————————————————

———————————————————————

———————————————————————

———————————————————————

———————————————————————

Using different-colored pencils for labeling each of your graph lines, complete this graph showing the changes in wagesfor the five jobs of your choice over the past 10 years.

ExercisesExercise 1: Doing your own research using theresources in End Note 4, list the four nations that rankabove the United States according to the freedom index.

1.

2.

3.

4.

Key Words and Conceptscapital accumulation

capitalism

comparative advantage

corporate raiders

distribution of income

economic freedom

greed

human capital

junk bonds

marginal productivity

political freedom

property rights

Rule of Law

wealth-creating resources

End Notes1 Datapedia of the United States: 1790-2000, ed. George Thomas

Kurian (Lanham, Md.: Bernan Press, 1994) Series D 946-951.

2 Julian Simon, The Ultimate Resource 2 (Princeton, N.J.: PrincetonUniversity Press, 1996).

3 Preston J. Miller and James A. Schmitz, “Breaking Down the Barriersto Technological Progress,” Federal Reserve Bank of Minneapolis:1996 Annual Report, pp. 3-18.

4 Data sources: James Gwartney and Robert Lawson, EconomicFreedom of the World 1997, (Vancouver, B.C.: Fraser Institute, 1997),Bryan Johnson, Kim Holmes and Melanie Kirkpatrick, 1998 Index ofEconomic Freedom (Washington, D.C.: The Heritage Foundation,1998) and The 1992 Information Almanac (Boston: Houghton MifflinCompany, 1992).

5 Friedrich von Hayek, The Road to Serfdom (Chicago: The University of Chicago Press, 1944).

6 Milton Friedman and Rose Friedman, Free to Choose: A PersonalStatement (New York: Harcourt, Brace and Jovanovich, 1980).

7 Stephen Walters, Enterprise, Government and the Public (New York:McGraw Hill, 1993), p. 209.

8 Henry Manne, “Mergers and the Market for Corporate Control,”Journal of Political Economy (February 1965), pp. 110-120.

9 Michael Jensen and Richard Ruback, “The Market for CorporateControl: The Scientific Evidence,” The Journal of Financial Economics (April 1983), pp. 5-50.

10 Amar Bhide, “In Praise of Corporate Raiders,” Policy Review,(Winter 1989), pp. 21-3.

$20,000 $40,000 $60,000 $80,000 $100,000

19

ggrreeeeddConclusion: Greed and Social EthicsWhether you're a miser, an investor, a hedonist or aphilanthropist, competitive capitalism channels yourgreed into the service of others. If you're a miser andwant to horde money, you must first earn it. Societygains from the goods and services you invented and/orproduced. When you die, your heirs will spend thedough on goods and services others invented and/orproduced. If you're an investor, everything reinvestedaccumulates capital that creates jobs and higher incomesfor those inventing or producing new or better productsand services. Again, others are served by your greed asan investor.

The same is true if you're a hedonist, a pleasure-seeking consumer. Free markets and the Rule of Lawrequire hedonists to earn the money used in their shop-ping spree. Everywhere you spend, money creates jobsand wealth. The same is true if you're a philanthropist.You can't give what you don't have. To earn somethingto give away, you must serve the needs of others. Bychanneling greed into the service of others, free marketcapitalism builds a productive and humane civilization.

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Stossel In The Classroom

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