Lecture Notes: Oct. 16

Econ. 103, Fall 2002, Prof. Nancy Folbre

Goal today–continue the basic theme about competition its tendency to lower profits...

further examples of the "invisible hand"–also go over key points of Chapter 7.

The Coca Cola Blues

There’s an excellent history of Coca-Cola written by Mark Pendergrast, For God, Country and Coca-Cola (New York: Perseus Books, 2000).

Here’s what he says about the cocaine issue:

(p. 56)

Even as Coca-Cola was rocketing to fame, however, rumors of its cocaine content were stirring. As they would for many years to come, patrons calling for Coca-Cola usually asked for a "dope," a practice which infuriated Candler. On June 12, 1891, just a week after depositing his chain of title with the Patent Office, Candler opened the Atlanta Constitution and read the headline, "What's in Coca Cola? A Popular Drink Which is Said to Foster the Cocaine Habit." His stomach churning and a headache rolling like a thunderclap up the base of his neck, Candler read what a "thoughtful citizen" had told a reporter.

Coca-Cola drinking was, the indignant citizen said, "a very vicious and pernicious thing" and asserted that "people are drinking it a dozen times a day." The informer stated that "the ingredient which makes coca cola so popular is cocaine. There is evidently enough of it in the drink to affect people and it is insidiously but surely getting thousands of people into the cocaine habit." He then related the story of his trend who, in despair over his inability to shake the cocaine habit, had shot himself. The implication, of course, was that drinking a Coca-Cola was the first step on the road to self-destruction.

Candler responded by taking out an ad in which he challenged anyone to prove a case in which Coca-Cola had led to cocaine addiction. "If I thought it could possibly hurt anybody," he asserted, "I would quit the manufacture of Coca-Cola instantly." He stated that the formula for Coca-Cola called for only a half-ounce of coca leaf per gallon of syrup and that "no sensible man would undertake to say that this quantity in a gallon would hurt a person taking a glass of the beverage." If Candler was giving accurate information, he was certainly correct that a glass of Coca-Cola had a negligible amount of cocaine in it, amounting to a little over a hundredth of a grain. Either Candler was lying, however, or he had substantially reduced the amount of coca in the formula, since the Pemberton formula called for ten times the amount Candler claimed to use.

The controversy died down, and Coca-Cola drinkers indulged their nefarious habit with no visible ill effect. Nonetheless, rumors about Coca-Cola's drug content would continue to haunt Candler and the drink in the years to come. It is likely, in fact, that these rumors helped more than hindered sales. People were intrigued by the stigma associated with the drink and felt a sinful thrill when imbibing it.

note: Drug experts...have drawn a legitimate distinction between coca and cocaine...As cocaine got a bad name, Mariani, Pemberton, and then Asa Candler fought to maintain a distinction between the "natural" use of coca leaves, which produced mild stimulation from a mixture of fourteen alkaloids, and the more drastic effects of the pure alkaloid, cocaine.

Next, let's review a key point from Chapter 6–one that is also central to Chapter 8.

The Invisible Hand and the Search for Profits

Competition tends to lower profits–often to zero.

Look around this area that you're living it. It used to be full of small farms. In the eighteenth and early 19^th century much of the land was cleared. Grain and cattle were raised, shipped down river to Springfield and carried overland to Boston. But grain and cattle can be raised more efficiently in the Midwest (comparative advantage!). Once railroads were built, transporting those cheaply to markets on East coast, price competition drove most New England farmers out of business. Some of them moved into truck farming–onions and cucumbers. This was viable for a longer period of time, because this produce had to reach market quickly before spoiling...but advent of refrigeration drove this out...(though there are still some remnants in Hadley).

Then manufacturing sprang up–the rivers of New England provided a comparative advantage for the energy required to power factories....textile mills sprang up, then machine tools....

But the development of centralized electricity generation diminished the advantage of water power, and wages were cheaper elsewhere. In the period after World War II, New England experienced "de-industrialization" as most manufacturing moved either to the South or overseas.

Look at the labels on your clothes and sneakers. It's unusual to find any that are made in the U.S.A.

"Globalization" is an aspect of this process. The increased importance of foreign trade and also the export of U.S. manufacturing facilities overseas, literally "capital mobility"–the capital invested in plant and equipment becoming more mobile and going in search of lower cost inputs–especially cheaper labor. Consumers benefit from this increased competition because it tends to lower prices–prices of clothes, shoes, electronic goods, many manufactured goods. But it drives many U.S. manufacturing firms out of business...

So, we are now becoming a "service" economy. But what about increased international competition in services? If you want to pursue this issue further, there's more discussion of it in The Invisible Heart. See the chapter called CorporNation.

Chapter 7.

The domain of markets.

Competitive markets create some positive incentives–to innovation and to cost-cutting.

They also create some negative incentives–e.g. to deception and cheating.

Analogy: a race in which individuals who use steroids or other drugs enjoy an advantage. If you don't figure out a way to test for drugs and punish drug use, you create a situation in which competitors who don't use drugs are at a disadvantage. Many aspects of regulation perform an analogous role.

Are the positive incentives greater than the negative ones? Most people think so. It depends who you are and what year it is....

Competitive markets do seem to have some advantages in terms of incentives to efficiency, if you take the existing distribution of property and resources as a given, and prohibit any consideration of redistribution.

Pareto efficiency: if you can't make anybody better off without making someone else worse off (even by a teeny bit).

The concepts of consumer surplus and producer surplus provide a good reminder of how supply and demand curves work and also help illustrate the benefits of market forces. See Figure 7.7.

Taxes reduce the "economic surplus."

See Figure 7.19 for a picture of the effect of a per unit tax.

The tax raises revenue for society as a whole. So the overall effects depend on how that tax money is spent!

However, there is also a "deadweight loss" which is a reduction in surplus that is greater than the amount of revenue raised by a tax. See Figure 7.22.

The deadweight loss is smaller if demand and supply are relatively inelastic.

In general, if you're going to tax something, it's best to tax something that is relatively inelastic.

A tax on cigarettes or alcohol changes individual behavior less than a tax on food or housing.

Even better is to tax something that has negative consequences for personal or environmental health...because by raising the price, you discourage consumption of that good....

Next Monday I'll cover two parts of Chapter 8 that we haven't covered yet–the difference between accounting profit and economic profit and calculations of present value. Those are the main things to emphasize in that chapter other than the tendency of competition to lower profits.