6.2.2 Issues In Property Rights
incentives and to allow others to use intellectual property to extend
knowledge. Culture and knowledge progresses by building on the past:
Creators here and everywhere are always and at all times building upon
the creativity that went before and that surrounds them now. That
building is always and everywhere at least partially done without
permission and without compensating the original creator. No society,
free or controlled, has ever demanded that every use be paid for or that
permission for Walt Disney creativity must always be sought. Instead,
every society has left a certain bit of its culture free for the taking—free
societies more fully than unfree, perhaps, but all societies to some
degree. (Lessig, Free Culture, p 29)
The questions become:
•
What form should intellectual property rights take if creativity is to be promoted?
•
How can property rights be structured to provide incentives for creators to
continue to develop new ideas?
A free culture is not a culture without property: it is not a culture in
which artists don’t get paid. A culture without property, or in which
creators can’t get paid, is anarchy, not freedom. Anarchy is not what I
advance here. Instead, the free culture that I defend in this book is a
balance between anarchy and control. A free culture, like a free market,
is filled with property. It is filled with rules of property and contract that
get enforced by the state. But just as a free market is perverted if its
property becomes feudal, so too can a free culture be queered by
extremism in the property rights that define it. (Lessig, Free Culture, p
xvi)
There is a history of just such a property system that is well known in
the Anglo-American tradition. It is called “feudalism.” Under feudalism,
not only was property held by a relatively small number of individuals
and entities. And not only were the rights that ran with that property
powerful and extensive. But the feudal system had a strong interest in
assuring that property holders within that system not weaken feudalism
by liberating people or property within their control to the free market.
Feudalism depended upon maximum control and concentration. It
fought any freedom that might interfere with that control. As Peter
Drahos and John Braithwaite relate, this is precisely the choice we are
now making about intellectual property. We will have an information
society. That much is certain. Our only choice now is whether that
information society will be free or feudal. The trend is toward the feudal.
(Lessig, Free Culture, p 267)
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6.2.2 Issues In Property Rights
As changes in technology pushes us into the age of information, the
question of property rights will become more difficult.
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7 Economic Way of Thinking
7 ECONOMIC WAY OF THINKING
7.1 MARKET EXCHANGE AS AN ALLOCATIVE MECHANISM
Exchange is a voluntary transaction between two or more persons. The
conditions of the transfer are clearly specified. It is a quid pro quo
arrangement. Market exchange is a contract or agreement between the
parties to the transaction. These agreements or contracts may be implied or
explicit, formal or informal. There is no need for one party of the exchange to
know the other. Each party only needs to know the terms of the exchange and
that the other party will fulfill the agreement. There is no need for any
relationship between the parties other than the exchange. In many ways
anonymity of the parties to the exchange may make the exchange less
complicated. Often it is more difficulty to sell your used car to a relative or
friend than to a stranger. In other cases some of the features of reciprocity
and redistribution may facilitate or improve the process of market exchange.
In the diamond trade in New York City or on the farm in Iowa, participants
may know and trust each other to meet the conditions of the market
exchange. This reduces the effort or transaction cost of negotiating the
agreement. In other cases redistribution by an authority may facilitate market
exchange. An individual who fails to comply with the terms of the contract or
exchange may by sued in a system of courts that has the authority to enforce
the exchange.
A major advantage of market exchange as an allocative mechanism is that
once you have found others to contract or exchange with, each actor only
needs information about their own preferences and what they are willing and
able to do. It is not necessary that all information be available in a central
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7.1 Market Exchange as an Allocative Mechanism
location or to a planner. It may be useful to think of a market as a
communication system. The preferences and feasible alternatives available to
each agent or individual are communicated through the market. Relative
prices and quantities are pieces of information that may be used by the actors.
The buyer of a good demonstrates that they prefer the good they purchase to
the money or the other things that an equal amount of money would buy.
Similarly, the seller demonstrates a preference for the money (or what it will
buy) to the good they sold. A good sold for a price of €5 is valued at or is
“worth” at least €5 to the buyer or the buyer would not have purchased the
good. Risk and uncertainty are a part of virtually all human choices. While an
individual may think they will receive some level of benefit or utility from a
purchase, they may fail to do so.
A second advantage attributed to the market is that it is flexible and
provides information and incentive to encourage agents to adapt quickly to
changes in technology, supplies of inputs and environmental conditions. In
order for individuals and society to benefit from market exchange, there are
two fundamental conditions that must hold. One is that exchanges must be
voluntary. The other is that property rights must be “nonattenuated.”
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7.1.1 Voluntary Exchange
7.1.1 VOLUNTARY EXCHANGE
I n neoclassical economics, the objective of an economy is to increase the
welfare or utility of the individuals who make up the society. One of the basic
concepts described in Chapter I Introduction was “Pareto Efficiency or Pareto
Optimality.” To review, remember that a Pareto efficient or optimal solution to
the allocation problem exists when all the alternatives that will improve the
welfare (utility) of a least one person, without making anyone else “worse off”
have be exhausted. Any alternative that will improve the welfare or utility of at
least one person without decreasing the welfare or utility of another person
would increase the welfare of society. This improvement is called a Pareto
improvement and the result is said to be Pareto superior to the initial
alternative.
Generally, a person would enter into a voluntary exchange if they can
improve their welfare or increase their utility. It is assumed that an individual
who voluntarily enters into an exchange would not make himself or herself
“worse off.” Therefore, any voluntary exchange will increase the welfare of one
or both parties and neither will be any worse off.
Jeremy Bentham [1748-1832] attempted to make “utilitarianism” the operative
mechanism to improve the welfare of society. He and many of his followers
attempted to find a way to quantify utility and use it for decision-making.
Bentham proposed a felicific calculus to make be used. However, it is not
possible to make interpersonal comparisons of utility, i.e. if each of 100
persons is given one Euro (€) each there is no reason to believe that they
would all get the same utility. Nor is it possible to assume that the utility or
welfare of the group would be maximized by that distribution.
Consider a distribution where every member of society is given 1 case of
cola and 1 box of tea bags. Since individuals do not have the same preference
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7.1.1 Voluntary Exchange
for cola and tea, there is no guarantee this equal distribution of cola and tea
would maximize the utility or welfare of the group. Information on the
preferences of all individuals is not held in one central place, utility cannot be
measured and summed, so it is impossible to redistribute cola and tea by
eminent domain and insure an increase in total utility. Voluntary exchange is
believed to increase the utility of the members of society. Individuals who
prefer cola to tea should trade (or exchange) cola for tea with those
individuals who prefer tea to cola. The utility of all individuals, whether they
prefer tea or cola would increase (or at least not go down). The parties to the
exchanges must have information about their own preferences and who the
others are that are willing to trade. It would be helpful to have information
about the preferences of others before one offers to trade. If I knew you liked
tea did not like cola, I would offer to trade a small amount of tea for a large
amount of cola. It would be to your advantage that I not know your true
preferences. Information is valuable. You might try to convince me that you
liked cola to get a “better deal.” This is called “haggling or bargaining.” The
negotiations for a contract often include the process of discovering the
preferences and the maximum amount the other person will trade for a good,
i.e. “the best deal.” As trades are negotiated among the members of a society,
information about these transactions becomes valuable. If you wish to buy or
sell a used car you may consult the Kelly Blue Book or Edmunds to find out the
average prices that other exchanges. Providing false information may be
regarded as fraud or deceit. In communities where others often know one
another, one’s reputation is often based on “honest” dealings. In more
complex societies, law and legal suits may be used to prosecute fraud and
deception.
The maximum price the buyer is willing and able to pay for a good is called
the “reservation price of the buyer (RPB)” and the minimum price the seller
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7.1.1 Voluntary Exchange
will accept for the good is the “reservation price of the seller (RPS).” So long
as the RPB is greater than the RPS, a trade can take place. If the RPS is
greater than the RSB, no trade will occur. Neither the buyer nor seller wants
the other party to know their reservation price. Haggling is the process by
which a mutually agreeable price can be determined. The price at which the
exchange will occur will be greater than the RPS and lower than the RPB
(RPS>P>RPB). In the case of a single transaction, the price will be closer to
the reservation price of the seller or buyer with the most information and the
greatest skills in negotiation. The degree to which individuals adhere to a pure
quid pro quo and consequentialist ethic may give individuals an advantage
over individuals who are constrained by a deontological ethic.
Over time an expected pattern of trade emerges. A given amount of cola is
expected to trade for a specific number of tea bags. The ratio at which cola
and tea trade can be called the exchange ratio. The exchange ratio is the price
of one good in terms of another. This exchange ratio is determined by the
preferences of the individuals, the relative amount and distribution of cola and
tea. If it is established that on average, 1 cola trades for 5 tea bags,
individuals who do not like cola will be willing to accept cola on trade because
they know its will trade for tea. If 1 cola (1c) trades for 5 tea bags (5t),
money can be used to facilitate the exchanges. The use of money results in
monetary prices rather than prices in terms of other goods. The monetary
price of cola will be labeled, PC, the price of tea Pt. The relative prices of cola
and tea are established by the exchange ratio. If one cola will trade for 5 tea
bags,
1c = 5t,
if P = $1 implie
s P = $.20
c
t
if P = $1 implies P = $5
t
c
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7.1.1 Voluntary Exchange
In microeconomics it is the relative prices that are important. If the
exchange ratio is 1c = 5t, the “correct” set of prices can be either
P = $1 and P = $.20
c
t
or
P = $5 and P = $1
c
t
Any voluntary exchange reflects the preferences of the parties to the
exchange. If Joan buys a cola for €1, she must prefer the cola to €1 or she would
have kept her money. If John sells Joan a cola for €1, he must prefer the €1 to the cola
or he would have kept the cola. Therefore if Joan voluntarily buys a cola from John (who
voluntarily sells it) they are both “better off” or have increased their utility.
The problem arises as to what is meant by “voluntary.” Some actions, such
as “duress” clearly violate the concept of voluntary. Any contract concluded
under duress is unenforceable in most countries. Contracts or exchanges with
minors are also unenforceable. If Joan holds a gun to John’s head to force him
to sell the cola, that would clearly be duress or coercion and violate the
conditions of voluntary exchange. If the instructor of a class suggests you buy
his or her book, is that coercion? If your mother says, “You go ahead and do
what you want to do but it will break my heart!” Is that coercion? “Voluntary”
exchange is often a matter of degree. Often the only “voluntary” choice open
to an individual in a pure market is to “exit.” The person may choose to
participate or not.
7.1.2 ECONOMIC WAY OF THINKING
E conomic theory provides a “map” or structure to aid in the interpretation
of economic data or information. The nature of the map (economic theory)
determines the nature of the questions asked. Joan Robinson’s [1903-1983]
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7.1.2 Economic Way of Thinking
comment was, “If you don’t ask the right question, you won’t get the right
answer.”
N eoclassical microeconomics is based on the belief that individuals are
rational and that they attempt to optimize.
7.1.2.1 INDIVIDUALS ARE RATIONAL
1. objectives are known
2. all feasible alternatives are known
3. each alternative is evaluated with respect to the objective
7.1.2.2 BENEFIT - COST FORMAT [PARETO EFFICIENCY/POTENTIAL]
M ost of economic theory is based on individuals making “optimal
choices.” Objectives or goals are usually based on the maximization or
minimization of some variable, i.e. the maximization of utility, output or profit
or the minimization of cost per unit.
Benefit/cost analysis is a basic approach that is used. If the benefits
associated with a choice (alternative) exceed the costs incurred with the
choice, there is an increase in net benefits. If the costs exceed the benefits of
a choice, it will not increase net benefits. Notice that it is the cost and benefit
associated with a choice. This requires “marginal analysis.” B/C analysis is a
variation of the Pareto Potential criterion.
7.1.2.3 MARGINAL ANALYSIS
D ecisions in economics are always made at the “margin.” A decision to
change one variable will cause a change in some other related variable. A
change in the price of a good will change the quantity sold, a change in the
quantity sold will change the total revenue collected. The change in total
revenue caused by a change in units sold is called marginal revenue. The
marginal concept is applied to a wide variety of relationships. In principles of
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7.1.2 Economic Way of Thinking
economics these are usually described as a “one unit” change in the variables.
The Greek letter delta, ∆ is used to identify a change calculated by subtraction.
In other cases a derivative (d) or partial derivative (∂) will be used to denote a
change that approaches 0.
The use of marginal is applied to many economic relationships. In fact, the
early period of the development of microeconomics (mid to late 19th century)
was called the “marginalist revolution.” Below are some definitions of several
useful marginal relationships.
1. Marginal Cost (MC)
MC is defined as the change in Total Cost (TC) or variable cost (VC) caused
by a one unit change in the quantity produced, output (Q). MC represents
opportunity cost.
ΔTC
ΔVC
MC =
=
ΔQ
ΔQ
2. Marginal Benefit (MB)
MB is defined as the change in total benefit (TB) caused by a one unit
change in quantity consumed (Q).
ΔTB
MB = ΔQ
3. Marginal Utility (MU)
MU is the change in utility caused by a change in quantity consumed (Q)
ΔTU
MU = ΔQ
4. Marginal Revenue (MR)
MR is the change in Total Revenue (TR) caused by a one unit change in the
quantity sold (Q).
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7.1.2 Economic Way of Thinking
ΔTR
MR = ΔQ
5.
Marginal Product (MP)
The marginal product is the change in output (Q) caused by a change in a
variable input (L or K).
ΔQ
ΔQ
MP =
, MP =
L
ΔL
K
ΔK
7.1.2.4 MARGINAL ANALYSIS AND OBJECTIVES
1. To maximize utility
So long as the MU > MC, consume the next unit. If MU<MC reduce the
level of consumption. Where MU=MC maximum utility is attained.
If there are two or more goods that have a price (or cost), the process of
utility maximization requires that each additional expenditure be
made on the good that has the highest marginal utility. To
maximize utility with several goods that have economic prices,
the “equimarginal principle,” is used.
MU
MU
MU
X =
Y = … =
N
P
P
P
X
Y
N
Subject to B ≥ P Q + P Q + . . . + P Q
X
X
Y
Y
N
N
When P = price of good i , B = budget, Q = Quantity of good i
i
i
2. To maximize profit (Π)
So long as the next unit of output can be produced at a cost that is less than it
can be sold for, do it!
When MR >MC, produce
When MR <MC reduce output,
Maximum profits when MR = MC
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7.1.2 Economic Way of Thinking
3. Maximum welfare of buyers and sellers
The market is a social institution that provides information to guide the
allocation process in a society. Buyers should purchase additional
units of a good so long as the MB > P.
The producers (sellers) of a good should continue to produced and sell
more of a good so long as the P > MC.
The welfare of buyers and sellers will be maximized when
MB = P = MC
7.1.2.5 APPENDIX I: SCHOOLS OF ECONOMIC THOUGHT
H uman behavior can be viewed from many different perspectives.
Sociology, political science, psychology, anthropology, history, and economics
are just a few of the basic approaches to the study of the individuals and
society. Within each of these disciplines there are differences in perspectives.
In economics, there are “schools of thought” that have alternative approaches
to the analysis of economic processes. These schools of thought may ask
different questions and use different methods in their attempts to answer
them.
Within microeconomics the mainstream view is “Neoclassical economics”
which is the topic of this outline. Other approaches include, Austrians, “Old”
Institutionalists, “New” Institutionalists, Walrasians, Marxists, Public Choice
theorists, law and economics, Chicago, Keynesian and social economics. Some
of these schools focus on macroeconomics while others are primarily deal with
microeconomic issues. While many of these schools have different approaches,
there is often overlap. It is useful to know a little about some of these
alternative approaches to understand how mainstream economics has
developed and which aspects of Neoclassical economics might be subject to
criticism and how it may be adapted.
George Stigler (1911-1991), described a school of economic thought,
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7.1.2 Economic Way of Thinking
A school within a science is a collection of affiliated scientists who
display a considerably higher degree of agreement up on a particular set
of