History of economic thoughtWhat is economic thinking about

Petr Wawrosz

The term „economy“ or „economics“

Term „economy“ or „economics“

• Word „economy“ comes from Greek word „oikonomos“

• Oikonomos = one who manages a household.• What does have the household and economics

common?

Household faces decision

• - which members of the household do which task and what each member gets in return.

• Examples (economic question that a household faces):- Who cooks dinner?- Who does the laundry?- Who gets the extra dessert at dinner?- Who gets to choose what TV show to watch?

• Household must allocate its scare resources among its various member, taking into account each member´s abilities, efforts and desires.

Society faces decision too

• Society must decide what jobs will be done and who will do them.

• Economic question the society faces:What goods will be produced?How the goods will be produced?Who will receive the produced goods?

• Economic as the science gives answer how the different society solves above mentioned problems and what solutions are better.

What is economic about

One of the definitions

• A person, household, some group (e.g. of food gatherers or animals hunters), society have to decide:- how to allocate scare resources to produces useful goods (goods satisfying human needs).

• Economics is the science which studies human behavior as the relationship between ends and scare means which have alternative uses (Lionel Robbins, 1932).

Microeconomics and macroeconomics

• Micro = the branch of economics that focuses on how human behavior affects the conduct of affairs within narrowly defined units , such as individual household or business firm.

• Macro = the branch of economics that focuses on how human behavior affects outcomes in highly aggregated markets, such as the market for labor or consumers products.

Individual and collective choice

• Economics is about individual choice.• People often group to form collective

organizations.• Individual choices still underlie and direct the

decision made within organization.

Scarcity

• Fundamental concept of economics that indicates that there is less of a good freely available from nature than people would like.

• Scarcity does not mean poverty!Scarcity – objective concept. Poverty subjective concept.

• Scarcity leads to competitive behavior!

• Scarcity is „beyond“ basic economic questions!

Trade-offs

• People face trade-offs (as the consequence of the scarcity):- for what production the scare resources should be used- how the scare resources should be use (in which technology)- who should use scare goods.

• Trade-off between efficiency and equity.

Efficiency versus equity

• Efficiency =person (society) gets the maximum benefits from scare resources (and use minimum amount of resources).

• „The size of the pie“

• Equity = benefits are distributed fairly among society´s member.

• „How the pie is divided“

Positive versus normative economics

• Positive economics: what is among economic relationships.

• Normative economics: what ought to (should) be.

• Normative economic views very often influence our attitude toward positive economic analysis.

Pareto-efficiency

• there is no way of improving the situation of one person, without making that of another person worse

• Example: Edgeworth´s box, PPF

Opportunity cost (OPC)

• OPC = whatever must be given up to obtain some actions.

• When we decide how to use:- some scare resources or good we must take into account the utility (profit) from its alternative use.

Some principles that is economics based on

People are rational

• An economic subjects - systematically and purposefully do their best they can to achieve his/her objectives- uses all available information- weighs benefits and costs of each action

Rational people think at the margin

• Marginal change = small incremental adjustment to a plan of action

• Rational subject compares marginal benefits and marginal costs (benefits and costs of additional activity).

• Marginal benefit depends on amount of units that is available (water-diamond paradox)

People respond to incentives

• Incentives = something that induce a person to act

• Examples: price, norms, law, behavior of other people

• Change of incentives generate direct as well as indirect effects.

• Example: G. Depardieu and his choice to give up French citizenship.

Direct versus indirect effects

• Direct = visible, primary effects.• Indirect = invisible, secondary effects

• Frederic Bastiat: „That Which Is Seen and That Which Is Unseen“Parable of the broken window(http://en.wikisource.org/wiki/That_Which_Is_Seen,_and_That_Which_Is_Not_Seen)

• See http://www.youtube.com/watch?v=gG3AKoL0vEs

Trade can make everyone better one

• Absolute advantage• Comparative advantage• Marginal rate of substitution.

Country´s standard of living depends on its ability to produce goods

• Productivity = amount of goods produced from one unit of resources.

• If a society wants to be wealthy in long-run it must increase its productivity.

The value of goods is subjective.

• Peoples, preferences differ.• Example: the indifferent curve of gourmand and the

indifferent curve of person preferring clothes (or the indifferent curve of skinflint and the indifferent curve of spendthrift person).

• The good has no objective value!

• Economics does not place any inherent moral judgment on value on one personal person´s preference over another´s – in economics all individual preferences are counted equally.

The middleman as a cost reducer

• Middleman = a person who buys and sells goods or arranges trade.

• Middleman reduces transaction costs.• Example: car dealer, a grocer, a stockbroker, a

realtor, a merchant

• Transaction cost = cost connecting with finding part of contract, make a deal, solving problems of contract (including enforcement of fulfillment).

The importance of property rights

• Property rights• 1. the right to exclusive use the property (the

owner has sole possession control and use of the property, including the right to exclude others).

• 2. legal protections against invasion from other individual who would seek to use or abuse the property without owner´s permission

• 3. the right to transfer, sell, exchange or mortgage (lend) the property

The importance of property rights

• Private owners can gain by employing their ownerships (resources) in ways that are beneficial to others and they bear the opportunity cost of ignoring the wishes of others.

• Private owners have a strong incentive to care for and properly manage what they own: otherwise they lose the value of their property.

The importance of property rights

• Private owners have an incentive to conserve their property for the future, particularly if the property is expected to increase in value.

• Private owners have an incentive to lower the chance that their property will cause damage to the property of others.

Some mistakes in economic thinking

Ceteris paribus condition

• Ceteris paribus = other thing constant

• Economics very often supposes ceteris paribus condition, however in dynamic world many thing can happen and things can change.

Good intentions do not guarantee desirable outcomes

• Intentions have direct and indirect effects.

Association is not causation

• Two effects occurred in same time can be independent.

• Situation when effect A precedes effect B does not necessarily mean that effect A causes effect B.

The fallacy of composition

• The fallacy of composition: what is true for one might not be true for all.

• Example: - elasticity of individual and market demand or supply curve- Prisoner´s dilemma (arms race, duopoly race)

Prisoner´s dilemma

Centrally planned economies versus Market economies

Main economic questions

• What goods will be produced?How the goods will be produced?Who will receive the produced goods?

• The questions can be solved through the market (market economy) or through government (centrally planned, planned economy).

Centrally planned economies versus Market economies

• There are generally 2 basic system how on the society level the economic questions are solved:- centrally planned economy- market economy

• Text na centrally and market economy

Centrally planned economy

• the government (or some other authority) decides what will be produced (the set of the goods, the amount of the specific goods), how a good will be produced (which factors will be used), which people will have rights to buy a good (and in which amount, rationing).

Centrally planned economy

• Difficulties:• see:

http://www.slideshare.net/Geckos/difficulties-with-centrall-planned-economies-presentation

Market economy

• rely primarily on privately owned firms to produce goods and how to produce them.

• Markets determine who receives the produced goods.

• Firms must produces goods meeting the wants of consumers (characteristics of a good, its price …)

Market economy

• Market are usually a good way to organize economic activity.

• However: market failures- public goods, free rider, externalities, lack of competition, information asymmetry, weak side of the contract, protections of property rights and voluntary contracts

• Some of the problems can be solved by market no necessarily by government!

Government

• Government can sometimes improve market outcomes.

• Allocation• Redistribution• Legislation and regulation• Macroeconomics outcome

The differences and similarities between governments and markets

• Competitive behavior is present in both the market and public sector!(Similarity).

• What does e.g. politics or public-sector employees compete for?

• Elective offices, Taxpayer dollars, higher authority (power)

The differences and similarities between governments and markets

• Both sectors face opportunity costs and trade-offs.(Similarity)

• Resources the government uses for one purpose have alternative uses, in and out of government!

The differences and similarities between governments and markets

• Private-sector action is based on mutual agreement, public-sector action is based on majority rule!(Difference).

• The minority must accept majority decision.• The majority decision can be inefficient.• Bus-stop example.

The differences and similarities between governments and markets

• When collective decision are made, voters must choose among candidates who represent a bundle of position on issue.(Difference).

• Average elected representative is asked to vote on roughly 1000 different issues during one year (in the USA).

The differences and similarities between governments and markets

• Public-sector organization can break the individual consumption-payment link.(Difference)

• Sometimes people receive very large benefits from the government even though they do not pay any money.

• On the contrary individuals can be required to pay dearly for a government program though they derive any benefits.

The differences and similarities between governments and markets

• Income and influence are distributed differently in the each sector.(Difference)

• Market: people who supply more highly valued good have larger income.

• Government: one vote rule. However people who have more money, persuasive skills, organizational abilities can receive more benefits from the political arena.

Different opinions on market and government

• „Fight of the century“ (Keynes versus Hayek).• See

http://www.youtube.com/watch?v=GTQnarzmTOc

Some names

Some names

• Frederic Bastiat (1801 – 1850)• Francis Edgeworth (1845 – 1926)• Vilfredo Pareto (1848 – 1923)• John Maynard Keynes (1883 – 1946)• Lionel Robbins (1898 – 1984)• Friedrich August Hayek (1899 – 1992)• Paul Samuelson (1915 - 2009)• James Buchanan (1919 – 2013)