ECON 305 Test 1

14. The MIT-Sloan Article "Does it Pay to Be Good?" described how potential consumers respond to ethical business practices. What management lessons did you derive from this article and the subsequent classroom discussion? Be very specific.

1. Companies have an incentive to be good no matter what. If they aren't, and the public finds out, the negative reaction is much more amplified than the gains from ethical production 2. If you are to produce unethically, it would be a great idea to suppress info about your unethical production, as negative backlash from the public will slash willingness to pay from consumers, which can possibly put you out of business 3. Being somewhat ethical will benefit you greatly, as the degree of "ethicalness" of a company doesn't effect willingness to pay too much, what matters is being at least somewhat ethical

1. A. Your roommate is having trouble understanding why economists are so crazy about free markets. Use what you have learned in this class so far to make the case for free market capitalism over other forms of organizing economic activity where your argument is based on efficiency grounds.

Free markets allocate resources quickly and efficiently. As in Cassidy, Hayek says that there is a divide in the knowledge that the free market possesses and the knowledge that individuals have o Price mechanism quickly and accurately determines price o Centralized planner deals with all kinds of information and decision lags that slow adjustments in the market. ▪ Moleskin's in Russia inflating supply artificially ·Fewer taxes (taxes being needed to fund distribution of goods) leads to greater producer and consumer surplus

7. A. Your friend, who has not taken Economics 305, is certain that completely free markets under "pure" capitalism are the only reasonable way to organize economic activity. Given the opportunity to dismantle the government's role in the economy, she would do so. B. Using discussions and reading materials from this class, give your friend something to think about to challenge her position. What is the best argument you can offer for government intervention in the economy? Be as specific as possible. (NOTE: You might agree with your friend, and that is fine. Just give the best argument you can for the other side.)

· (Sandel) Unregulated markets often find ways to marketize things that aren't traditionally so o This emphasizes the importance of affluence in everyday life. As more things become price-driven, the more that your money matters to your wellbeing. With stagnant wages, this could be a huge danger to people in the future, and quality of life could actually decrease o Marketization can corrupt goods. When you can "purchase" a child for adoption, that changes the nature of how you view a child, as they are more like a good than before · (Armour) Monopolization of markets creates inefficiencies, governments are the best tool to stop them o Valeant and Turing exorbitant price hikes on drugs exploited struggling families, without regulation this could be done in any industry that provides more necessary goods · Globalization of trade creates winners and losers (Pareto inefficiencies) which can create nationalist views of vindictiveness within communities · Inequalities (wealth and income) are amplified with the removal of progressive tax systems

4. CLAIM: "Merck should never have given the ivermectin drug away for free." Provide a counterargument to this statement given what you know about Merck's deliberations after the ivermectin product had been developed and had successfully completed clinical trials but had not yet been widely distributed or used commercially. What forces led Merck to give the drug away?

· Biggest reason: Merck's scientists' morale hinges on the release of this drug o A large success would be a boost, while failure would be demoralizing · Merck was "held up" as they produced the drug by spending the money before asking for assistance from NGOs o Therefore, they are stuck between the bad PR of having the resources to, but not going through with, curing river blindness and the good PR of giving the drug away and sticking to their mission of "alleviate suffering." · Additionally, releasing the drug could help build relationships with governments and NGOs for future endeavors in the market of third-world countries, which would open Merck to future profits

18. In the novel Atlas Shrugged, Ayn Rand speaks through more than one character to communicate her objectivist philosophy. Name one of the characters she speaks through and explain how that character's actions or words are representative of objectivism.

· Dagny Taggart is the truest form of an objectivist, as everything she does is in the book is for her own self-interest o She does not take upon the job of the John Galt Line to sacrifice something from herself for the community. She even says to reporters it is intended to make her a lot of money (rejection of altruism) o She is disgusted at the people that don't have a purpose; she adores Francisco for him always doing something purposeful (purpose leads to productiveness in objectivism) o She has an immense level of self-esteem. The words of people around her do not affect her, as she finds satisfaction in her work through herself, not the effects on others o She has to fight against the forces of altruism that try to take from objectivists like her, Dagny simply calls them looters

6. In the days following Hurricane Katrina and many other natural disasters, demand for many critical goods and services spike, including (but not limited to) generators, gasoline, food, and bottled water. Give an argument, based in economic logic, for allowing price "gouging" during a natural disaster. In other words, why would it be economically logical to allow higher prices when demand surges rather than outlawing such price increases?

· Demand surges not only in total, but for individuals, so limited price gouging has negative effects o Individuals often over-purchase "just to be safe" which leads to shortages · Price mechanism will ensure that those that really need a product will get it, while others will think twice about if they will really find a use for it during the disaster · Higher prices accurately reflect the short-term decrease in supply that will leave areas without resupply for the time being, so it will often be even longer for those that get nothing · The existence of black markets will reflect price shocks anyway, as the people that got their first will sell for a profit

15. A. What does it mean to say that a market is efficient? B. Taxes "distort" markets by introducing a wedge between the price consumers pay and the price producers receive. Explain why markets with taxes are inefficient. Be very explicit about how your explanation lines up with the definition of efficiency. If you would like to explain through an example, feel free. GRAPHS MAY HELP YOUR CASE!

· Efficient markets are defined as those that capture ALL total surplus · Some people are willing to pay for an item just above the equilibrium price o Implementation of taxes removes the consumer surplus of those people near the equilibrium price, which lowers sales

B. Explain why a market with taxes is not efficient. Be very clear about how your answer lines up with the definition of efficient markets. If it helps, you may use a graph/figure to explain your answer.

· Efficient markets are defined as those that capture ALL total surplus · Some people are willing to pay for an item just above the equilibrium price o Implementation of taxes removes the consumer surplus of those people near the equilibrium price, which lowers sales

16. "Merck is an altruistic company." Evaluate the validity of this statement using information from the case and from classroom discussion. Do not pick "TRUE" or "FALSE" but, rather, present the evidence both in favor of this statement and in opposition to this statement.

· FOR: Merck sacrificed its profits for the greater good, in that they ended up giving away the human form of Ivermectin o They knew going into the development that the drug had a poor market in the third world, profitability was not straightforward o "Alleviate suffering," Merck's mission, was completed through giving the drug away at the expense of the company o Opportunity cost of making other, potentially more profitable, drugs was assumed in the development · AGAINST: There is a path to profitability for Merck in giving the drug away o Government/NGO relationships could open up the third world market to profitable projects from Merck o The cost for the drug was low due to the related drug being previously approved. The external profitability of learning about parasiticide could very much outweigh the costs o The decision to give away was not made from the start. The project was pushed forward with the hopes that government/NGO assistance would be in line to help distribute the drug o The situation with the drug was very unique; low cost scenario and the morale hinging on the production does not happen often, which is what made this a special case for Merck

3. Our bread and fish experiment shows that free trade serves to raise average income in both trading countries. Yet the U.S. has not fully embraced free trade. How do you explain the difference between the economic logic of free trade and the choices the U.S. government often makes to restrict free trade? (Hint: think about Pareto improvements)

· Free trade implies that no matter from where the goods are sourced, the most specialized workers will produce their products, allowing others to fill the gaps to capture the most utility o However, this will often leave the less specialized local producers out of a job, actually making the move Pareto inefficient · "Losers" of free trade are mitigated through, subsidies, tax breaks, protectionism, etc. o Subsidies allow for local producers to lower total costs and continue production o Tariffs and quotas limit the capabilities of other countries to gain market share, which protects the US producers from being pushed out of the market · NOTE: The US sits somewhere in the middle to try to alleviate complete outer dependence

21. The MIT-Sloan Article "Does it Pay to Be Good?" described how potential consumers respond to ethical business practices. Describe the findings of this paper and explain how these findings relate to Milton Friedman's thesis on "The Social Responsibility of Business." (For full credit, you must describe Friedman's argument as well as the MIT paper's argument.)

· Friedman says that executives do not have any social responsibility, as their only responsibility is to shareholders o It is the responsibility of citizens to allocate their own resources towards causes external to profits ▪ Principal trusts agent to make him money, agent should not spend their money as he/she pleases · The "Does it Pay to Be Good?" experiments found that, at least under certain conditions, customers react quite strongly towards the ethicality of a company o Negative reactions of unethical production were much stronger than the positive reactions of ethical production o If companies are to be profit maximizing, taking the route of unethical production to maximize profits can actually come back to bite companies ▪ Consumers actually can hold businesses accountable for their actions by decreasing their willingness to pay (decreasing sales) o The article finds that social responsibility can actually have a significant effect on the bottom line, so maybe it is within the job of executives to take on social responsibility

20. A quote from Jim Taggert: "Selfish greed for profit is a thing of the past. It has been generally conceded that the interests of society as a whole must always be placed first in any business undertaking." This quote, among others, defines Taggert as the quintessential business altruist. Compare the views expressed in this statement and other actions taken by Taggert in the book to those of John Mackey. How are the views of these two men similar and how are they different?

· Mackey and Taggart both believe that there is a higher purpose of business than simply serving shareholders o Mackey believes that there must be a shift in the branding of capitalism, much like Taggart's claim that greed is of the past, companies must show that they are not only profit-maximizing · Taggart, however, believes that the only truly good actions are ones that you sacrifice part of yourself for others o He always puts Taggart Transcontinental's best interest aside to help "the little guy," in that he kills production to take orders from smaller businesses while investing in failing countries that are struggling to develop ▪ The greater value created solely outside the company, the better o Mackey believes that shareholders are still part of the equation, and hardly anything needs to be lost by the company to do good; in fact, sometimes gains come from these actions ▪ The greater value created by the company for all involved, the better

11. Consider this quote: "Companies should not have a singular view of profitability. There needs to be a balance between commerce and social responsibility. . . The companies that are authentic about it will wind up as the companies that make more money." Howard Schultz, CEO of Starbucks Discuss this quote in the context of the Mackey/Friedman debate contained in the Reason.com article.

· Mackey believes that if a corporation is to focus on the well-being of all of its stakeholders, it will get the profits it is seeking as a side effect of those efforts along with the "business as usual" profit focus (stakeholder view) o The "enlightened corporation" · Friedman believes that for a corporation to act on its social responsibility, it is betraying its chief purpose of maximizing the wealth of its shareholders o Acting on social responsibility is considered as a principal/agent relationship where the agent is spending money on behalf of the principal in a way that is counterproductive · Friedman believes that investment in the company itself rather than donation actually provides more social value than if it were given away. · Friedman, however, believes that Whole Foods actually is profit maximizing due to tax laws that benefit corporations

19. From Cheers (2011)1: 1 Cheers, Zachary. 2011. The Corporate Social Responsibility Debate. Senior Thesis submitted to the faculty at Liberty University. Retrieved from Digital Commons on March 9, 2015. A quote from Steve Milloy, mutual fund manager and critic of [Corporate Social Responsibility]: "Shareholders do not hire CEOs to be the [United Nations], to act like a government or be a charity. They were hired to make money for shareholders. Business is society's wealth creation machine." Based on his comments in the readings for this class and in class discussion, how would John Mackey respond to this statement?

· Mackey would disagree on the grounds that businesses are meant to provide wealth for ALL parties involved (stakeholders, which includes shareholders) · Missions of some companies should definitely enable the CEO to make decisions as such, as they voluntarily joined a company that is intended to serve others · Ethically positive charity actions can actually be profit maximizing. So to say that they were not hired to act like a charity but only to maximize profits can become quite contradictory · Dodge v. Ford showed that while shareholder interest is the chief purpose of business, the CEO can decide the trajectory of the business as they see fit

13. Despite results to the contrary from our in-class bread and fish experiment, in real life, it is frequently argued that a shift from limited trade to free trade is not Pareto improving. Explain why.

· Our example is one where this are only two goods and two groups of producer/consumers o In the real world, when there are many producers and consumers, the shift to free trade will leave those that are less specialized hanging, as all of their business goes to the cheaper specialized goods o While, say, foreign producers and local consumers both benefit, the local producers suffer. This is more like a zero-sum game, where gains are the product of losses elsewhere (not pareto improving) ▪ This explains the reasoning behind subsidized production in the US. It keeps local producers competitive, keeping them in the market · This is why no countries live in completely free trade, and explains the existence of the Trade Adjustment Assistance program that eases the movement of losers of trade to new industries

22. Give an "objectivist critique" of altruism. How is Rand's philosophy at odds with an altruistic world view? Do you share Rand's opinion of altruism? If so, give additional justification that shows how your own values are opposed to altruism. If not, give a counterargument to her critique of altruism based on your own set of values.

· Rand believes that altruists see self-gain through industry akin to a bank robbery · Altruism implies that one's happiness is subordinate to others, while objectivism states that self-esteem is one of the highest virtues someone can possess · Rand sees altruism as the man that marries a poor little girl out of sacrifice for himself, when he never really loved her, just to see her happy when he will never feel the same · Sense of self provides a reason for existence, living purely for the purpose of others lends no reason for existence · Agree: If someone puts their value on their own life external to themselves, they will have no sense of self value for their daily life o Whether people believe it or not, most people are intrinsically objectivist. Often people believe that they would act in the interest of others whenever they can, but the moments when people actually do act in such a way, it usually has some benefit to themselves as well o Most people knowingly invest in mutual funds that are profit-maximizing. Evidence shows that people do not willingly cut into their own profits to support funds that promote benefit of others o Doing nice things does not entail that you are not objectivist, but the sense of value in yourself should not hinge on doing those nice things ▪ Charity is still fine within objectivism, as long as no values are being laid down for the self for others, so societal and personal benefit can still coexist o I am not selfish to find happiness through my work and success, it is a visible goal of myself with which I can feel success or failure resulting from it o Givers in society are often blamed for not giving enough

26. A. Anu Partanen argues that socialism in the Nordic countries does not depend on altruism. Explain why one might connect socialism with altruism. What evidence does Partanen give that Nordic socialism does not depend on altruism?

· Socialism has many critiques from Americans, one being higher taxes o Higher taxes might be seen as "taking away" part of one's benefits to give to others in the form of healthcare, education, etc. o Equalizing things is often seen as taking from one to give to others. Everyone benefiting identically from policies seems to stem from some love for others, not the concept that it will also help yourself · Partanen argues that Nordic countries adopted socialism for their own best self-interest. This means that they simply prefer these policies for themselves; they are not some hyper-connected all-loving society that believes they must take from ones self to give to others

B. What are the moral limits of this approach according to Michael Sandel ("What Isn't for Sale?")? Specific examples will be helpful in making your point.

· Some things are best left allocated by means other than the pricing method o Organ donations are not allocated by price. Disease is relatively indiscriminate, so why should the person with the most money get the organ first? o Completely private education would not benefit the country as a whole, as affluence would once again decide who gets educated ▪ Less people educated leads to lower levels of innovation and competition, as a select few are extraordinarily advantaged relative to others · Price mechanisms can shift the view that people have on them o Marketization can corrupt goods. When you can "purchase" a child for adoption, that changes the nature of how you view a child, as they are more like a good than before · If everything were allocated by price, your standard of living would begin to correlate more and more with wages and wealth, would it be moral for only financially well-off people to live comfortably?

B. John Mackey, in the video we watched in class, suggests that capitalism needs a new branding campaign - one that emphasizes the good consequences of capitalism rather than "talking about maximizing profits all the time". Defend free market capitalism on John Mackey's terms.

· Sometimes, the pursuit of social welfare is actually profit maximizing o "Does it Pay to be Good?"—companies with a good cause and product match see profits from social responsibility · It is within the rights of the company to behave socially responsible and not just serve the shareholders; if the shareholders bought knowing this was the case, they shouldn't be upset o "Stakeholder view" allows businesses to focus on the entire value that business provide to communities, employees, suppliers, and consumers · Free market capitalism can break free of the greed association through focusing on all of the outside effects it has

B. Does the stated policy reflect socialistic tendencies, communistic tendencies, or both? Justify your answer.

· Subsidies reflect socialist tendencies, as the government is distributing resources to try to equalize industry woes. o The firms are still private, so it is definitely not communist-leaning · Socialism is seen by private firms producing goods like a capitalist economy, but the government distributes the goods to enable greater equality · Market prices and price mechanisms do not rule the farming industry like pure capitalism would

23. A. Identify a specific *economic* policy, in the U.S. or any other country, that reflects a departure from pure capitalism. This policy can be directed towards either business or individuals. Be sure to give enough detail so that I can understand what the policy is/does. Also be sure to read Part B of this question before answering Part A.

· The US spends a great deal of money on agricultural subsidies every year o This is a form of fiscal policy in which the United States gives money to farmers to provide additional resources and keep the industry running and profitable o Money is collected from taxes, then allocated to the agriculture industry

5. A. On the first and second days of class, we walked through an example on taxes where I was buying a sandwich and one of you was selling a sandwich. In that example, we first interacted in a world without taxes and then in a world with taxes. Using that scenario, or any other relevant experience, explain how taxes can be viewed as a limit on economic freedom.

· The additional money that other consumers still spend here is no longer free for them to spend where they want · Producers no longer reap the full benefit of their labor, which limits their resources and their decisions to allocate these resources where they want · Producers that produce at a unit cost close to equilibrium are forced out of the market and are forced to move elsewhere

12. Ayn Rand's novel, Atlas Shrugged, is intended to be both a critique of socialism and to buffet her objectivist philosophy. Discuss Atlas Shrugged as a tool for promoting objectivism. To do so, give two examples from the book (characters or scenes/plot themes) that serve to support Rand's intent and fully explain how those examples depict objectivism in a positive way.

· The great success of The John Galt Line was the result of two objectivists focusing on profits for themselves, and in doing so they created something amazing that would provide great value to everyone in the country o Meanwhile, the socialists of the world were trying to take down objectivists like Rearden that owned multiple companies. They thought this was promoting the growth from the bottom, when all of the real growth in the world was coming from people like Hank and Dagny · The relationship of Dagny and Rearden (objectivist) differs greatly from the relationship of Jim and Cherryl o Dagny tries to show Rearden that his awful desires are actually the best thing about him, as it is what makes him great. This is reflected in their relationship, as Rearden buys Dagny gifts purely for his enjoyment of seeing her wear them o Jim marries Cherryl as an act of pitied altruism. Rand intends to show that Jim doesn't love Cherryl, but marries her as another act of helping the little guy. Of course, this will not last. Jim buys gifts for Cherryl to see her happy about Jim's great monetary sacrifice for her. o The dichotomy of the two shows a couple that is truly happy under objectivism versus one that is bound to be unhappy built on the terms of altruism

17. A. Give an argument for allocating goods and services using prices as opposed to other mechanisms for allocating the same. In doing so, be specific about how a price-based allocation scheme achieves some worthwhile goal.

· The price mechanism is extraordinarily fast o Challenger explosion, market prices correctly identified the cause of the problem by the end of the day · Pricing mechanism tells the truth about supply and demand, the real value of products to the people in the market · Shortages and surpluses are limited by the "wealth of knowledge" that Hayek describes markets have intrinsically o Moleskin pricing in Russia caused artificial spike in supply with little rise in demand o Central planners cannot possess the wealth of knowledge, so they cannot know what is best o Data must be real time and perfect for central planners to consistently beat market · Conclusion: The price mechanism eliminates inefficiencies and human errors by unknowing consensus. Products and services that are valued by the public are shown, and unneeded/unwanted products are driven out to force innovation

9. What are some features of the American economy that represent departures from pure capitalism, either in the direction of socialism or communism? Be as specific as possible, and list at least two features. Your answer should demonstrate your knowledge of the definition of each option.

· The purchasing of banks and automobile companies during the 2008 recession is a quintessential example of American departures from pure capitalism o In this case, the US is in ownership of means of production (traditionally for-profit firms), which is an aspect of communism · Welfare programs are a socialist aspect of the US economy, as the government is in control over the distribution of goods and money towards the poor o Another example of this government distribution is in the form of agricultural (or other industries) subsidies, as the US government is taking it upon themselves to distribute resources to farmers or business owners to enable growth and sustainability · Government-owned utilities companies (like TVA) are another aspect of communism in everyday US life, as the government owns them to ensure equal distribution of power and water across the country

25. Your grandmother wants to be sure you know that socialism doesn't "work". She points to Venezuela as the perfect example. You know that other countries, like the Nordic countries, also claim to be socialist, but their economies haven't experienced the same nosedive. Explain this difference to your grandmother in the space below. How can you explain the demise of Venezuela and the relative success of Sweden? What lessons are there for the U.S. in those comparisons, if anything?

· The underlying political environment can affect the outcomes of socialism much more than the choice between socialism and capitalism o Venezuela was a dictatorship, while Nordic countries are democracies o Venezuela was experiencing a dictator's dilemma, where the wishes of the majority are sacrificed for the elites so the dictator can stay in power, but they also risk an overthrowing. ▪ This is an opposing force to socialism, and can disrupt the economy greatly o Money mismanagement, inflation, and extreme nationalization all contributed to the demise of Venezuela. Much is to blame on the poor decisions of the leaders · Nordic countries' policies are directed towards the self interest of everyone, rather than certain groups. This combined with their democracy creates a much less volatile environment o Stable environment enables better informed decisions, much less likely to fail

24. Merck executives, in deciding to pursue a cure for river blindness, are subject to the criticism that their action is not "generalizable". Explain why this is a concern (i.e., demonstrate that you understand the term "generalizable"). What options does management have to deal with this issue?

· Was the Ivermectin situation a unique case? Or is it one that can be repeated in the future for other widespread third-world diseases? o Will the pursuit of this drug yield future opportunities that Merck can benefit from? · The fact that the base drug was developed drastically lowered the costs, and this scenario is obviously not repeatable o In following through with giving it away, they could set a precedent for themselves to be "that company" to give away drugs as charity ▪ This could have long-term implications on profitability, which is a huge problem for shareholders · However, if the setup is right, Merck could find assistance from governments/NGOs that would be willing to fund the costs BEFORE research is completed o This could have better implications of a more profitable market in the future

2. Luigi Zingales argues that the increasingly common practice of local governments providing financial incentives for firms to locate in their districts is a departure from free market capitalism that makes the American economy less efficient, in addition to being "Un-American and Unconstitutional". (The Amazon subsidies are an example of this practice.) How do these incentives make the economy less efficient? Lay out your best argument in the space below.

· With tax incentives, Amazon gets less pressure from the market and less competition which are both key disadvantages of State Owned Enterprise (SOE) structures · Innovative pressure is lightened, and big value-creating firms are no longer pushed to find new answers to problems · Crony capitalism results, as the well-connected large firms benefit while small firms are left without those benefits.

B. Do you think capitalism is the only system for organizing economic activity that is consistent with Rand's objectivist philosophy? If not, why not?

· Yes. Rand's objectivism is fairly clear cut in the way that it states that cutting into the profits and wealth resulting from the success of someone is utterly evil o Even for the poor, objectivism does not see the world through classes and groups, but as individuals. These poorer individuals are still entitled to pursue their self interest · Capitalism is the only way of organizing an economy in which they product of one's work is solely based on the value of his work, nothing intrinsic about it · Socialism would take from those that have "won" in objectivism, which works against the very nature of her philosophy · Communism implies that people are all working for the benefit of the state. For obvious reasons... this doesn't work with objectivism