Chapter 2 the one lesson of business

Chapter 2 The One Lesson of Business Chapter 2 — Summary of main points – Voluntary transactions create wealth by moving assets from lowerto higher-valued uses. – Anything that impedes the movement of assets to higher-valued uses, like taxes, subsidies, or price controls, destroys wealth. – Economic analysis is useful to business for identifying assets in lower-valued uses. – The art of business consists of identifying assets in low-valued uses and devising ways to profitably move them to higher-valued ones. – A company can be thought of as a series of transactions. A welldesigned organization rewards employees who identify and consummate profitable transactions or who stop unprofitable ones. 3 Introductory anecdote – Two prominent hospitals recently refused patients for kidney transplants because the organs were from “ directed donations. ” – Demand for organs is high — far exceeding supply – and many never receive them. – Despite high demand and low supply, buying and selling organs is illegal. – Why? 1 Capitalism 101 To identify , you must first understand how wealth is created (and sometimes destroyed). – Definition: Wealth is created when assets are moved from to uses – Definition: Value = – + . 4 . – The chief virtue of a capitalist economy is its ability to create wealth – create wealth. , between individuals or firms, 5 Example: Robinson Crusoe economy – A house is for sale: – The buyer values the house at $130, 000 — – The seller values the house at $120, 000 — . . – The buyer and seller must agree to a price that “ splits” surplus between buyer and seller. Here, $128, 000. – The buyer and seller both benefit from this transaction: – Buyer surplus = – Seller surplus = – Total surplus = = difference in values 6 Wealth-Creating transactions – Which assets do these transactions move to higher-valued uses? – Factory Owners – Real Estate Agents – Investment Bankers – Corporate Raiders – Insurance Salesman – Discussion: How does eBay create wealth? – Discussion: Which individual has created the most wealth during your lifetime? – Discussion: How do you create wealth? 2 Do mergers create wealth? – The movement of assets to a higher-valued use is the wealthcreating engine of capitalism. – Our largest and most valuable assets are . 7 – Dell-Alienware merger: – In 2006, Dell purchased Alienware, a manufacturer of high-end gaming computers. – Dell left design, marketing, sales and support in Alienware’s hands; manufacturing, however, was taken over by Dell. – With its manufacturing expertise, Dell was able to build Alienware’s computers at a much lower cost – Despite this example, many mergers and acquisitions do not create value — and if they do, value creation is rarely so clear. – To create value, the assets of the acquired firm must be . 8 Does government create wealth? – Discussion: What’s the government’s role is wealth creation? – Discussion: Why are some countries so poor? – No , no – Discussion: Much of the justification for government intervention comes from the assertion that markets have failed. One money manager scoffed at this idea. “ The markets are working fine, but they’re giving people answers that they don’t like, so people cry market failure. ” 9 The one lesson of economics – Definition: an economy is efficient if . – This is an unattainable, but useful benchmark – The One Lesson of Economics: the art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups. – Policies should then be judged by whether they move us towards or away from efficiency. – The economist’s solution to inefficient outcomes is to argue for a change in public policy. 3 10 One lesson of economics (cont.) – Taxes Destroy Wealth: – By deterring wealth-creating transactions — when . – Which assets end up in lower-valued uses? – Destroy Wealth: – Example: flood insurance — encourages people to build in areas that they otherwise wouldn’t – Which assets end up in lower-valued uses? – Destroy Wealth: – Example: rent control ( ) in New York City – deters transactions between owners and renters – Which assets end up in lower-valued uses? 11 The one lesson of business – Definition: Inefficiency implies the existence of unconsummated, wealth-creating transactions – The One Lesson of Business: the art of business consists of identifying assets in lower valued uses, and profitably moving them to higher valued uses. – In other words, make money by identifying unconsummated wealth-creating transactions and devise ways to profitably consummate them. 12 The one lesson of business (cont.) – Taxes create a profit opportunity – Discussion: 1983 Sweden tax – Subsidies create opportunity – Discussion: health insurance – Price-controls create opportunity – Discussion: Regulation Q. & euro dollars – Discussion: What about ethics? 4 13 Companies create wealth – Companies are collections of transactions: – They go from buying raw materials, capital, and labor ( ) – To selling finished goods & services ( ) – Why do some companies have difficulty creating wealth? – They have trouble moving assets to higher-valued uses – Analogy to taxes, subsidies, price controls on internal transactions 14 Alternate intro anecdote – Zimbabwe experienced economic contraction of approximately 30 percent per year from 1999 to 2003 – Unemployment rates have been as high as 80 percent and life expectancy has fallen over 20 years during the reign of Robert Mugabe – Why has economic growth been so low? Alternate intro anecdote (cont.) – One main problem occurred in 2000 – Mugabe backed his supporters takeover of commercial farms, essentially revoking property rights of these farmers – The state resettled the confiscated lands with subsistence producers – many with no previous farming experience. Agricultural production plummeted. – Farm debacle had economic ripple effects through the banking and manufacturing sectors – Declining production deprived the country of ability to earn foreign currency and buy food overseas – Widespread famine ensued – The government’s initial attack on private property eventually led to more direct intervention in the economy and the destruction of political freedom in Zimbabwe. 15 5