Ch 3 PUP 3002 Normative criteria Focus on what the state of the world should be Positive criteria Focus on what the state of the world is Vilfredo Pareto 1848 1923 Introduced Pareto efficiency to describe the relative levels of performance among alternative states of allocating goods Pareto improvement An allocation of goods among a set of individuals where one individual is better off without making any other individuals worse off o Isn t necessarily equitable or fair Pareto efficient outcome If we obtain an allocation to which no further Pareto improvements can be made Nicholas Kaldor and John Hicks Economists Kaldor Hicks criterion If the beneficiaries of a proposed alternative could hypothetically compensate those who are likely to be made worse off then we may obtain a Kaldor Hicks improvement o More realistic application Compensation principle The notion that beneficiaries of some alternative are able to hypothetically compensate those worse off o No such compensation is actually required Markets Market Any institution or operation wherein individuals can trade goods services or information and services o The pressures of supply and demand determine the prices of goods Supply The amount of a good for which sellers are willing and able to produce and sell it o Determinants of supply technology factor prices productive capacity etc o Law of Supply Holding all else constant as the price of a good increases the quantity of that good that suppliers will produce will increase and vice versa o Shifts in supply Left Same quality of good supplied but higher price Higher prices for goods and services Right Same quality of good supplied but lower price Technological advance reduction in factor prices lower labor cost Demand The amount of a good for which buyers are wiling and able to pay o Determinants of demand The buyer s income the value of other substitutes etc o Law of Demand Holding all else constant as the price of a good increases the quantity of that good that buyers will demand will decrease and vice versa o A change in price will affect a change in the quantity demanded o Choke price of the good zero o Shifts in demand Left Decrease in the quantity demanded at every price Right Increase in the quantity demanded at every price Market equilibrium price At this price the market will clear meaning that there will not exist any over or under production of the good or service At this price suppliers can sell all of the goods and services that they have to sell and consumers are able to acquire all the goods and services that they desire Shortage of supply If a price is set below the market clearing price then a shortage of supply exists Under a shortage excess demand for the good exists but suppliers are unwilling to produce the good at this price o Given the excess demand consumers will bid up the price of this under supplied good and eventually suppliers will have the incentive to produce more so the price will move upward toward market equilibrium price Surplus of supply If a price is set above the market clearing price then a surplus of supply exists Consumers are unwilling to buy the good at this price and so supply builds up Suppliers now have an incentive to lower the price of the good to reduce the supply of their inventory of the good In this scenario no government or non government entity was required to exist to set prices rather the market determined these automatically By merely pursuing their own self interest both parties are satisfied o Theorized by Adam Smith an early economic theorist referred to as the invisible hand of the market How do we measure how free from government regulation one market is relative to another o Economic Freedom Index Includes 4 components Rule of Law Measures property rights and freedom from corruption Limited Government Measures fiscal freedom and government spending Regulatory Efficiency Measures business freedom labor freedom and monetary freedom Open Markets Measures trade investment and financial freedom Property Rights Credible Commitment Property rights The exclusive right to determine how a resource or property is to be used o When property rights are absolute the owner has sole and unlimited authority to make decisions over property access use exclusion and management without interference When property rights are relaxed abrogated or violated non owners exercise a level of authority over property that they do not own Benefits of property rights o Necessary to encourage future investment in economic activity Guarantees protection diminishes risk o Useful for resolving resource difficulties faced in society Elinor Ostrom studied this Individuals who posses property rights over small areas of a common pool resource like coal are incentivized to better manage their resource o Private property is useful as a check against political power Area that state has no authority How are property rights violated o Citizens can violate the property rights of other citizens o The state can violate the rights of its citizens How can we encourage citizens not to violate each other s rights to deter property violations o Thomas Hobbes philosopher proposed a Social contract theory Individuals enter into a contract with a third party for their own protection Referred to third party as the Leviathan Leviathan deters citizen v citizen but not gov v citizen as told by James Madison in Federalist No 51 How does a government police itself o Montesquieu a French political philosopher was one of the first supporters of the separation of powers Con Pro Different branches of gov may not have the coercive ability to enforce a judgment against another branch Barry Weingast a political scientist suggested that Different branches are credible constraints when a sufficient number of citizens believe that the institutions are effective constraints He says that Constitutions provide clues as to what constitutes governmental trespasses Market Limitations or Market Failure Limitations derive from a variety of specific problems including o Externalities public goods asymmetric information and market power These are necessary but not sufficient conditions to generate an inefficient market Rivalrous and Excludable Goods Rivalrousness Refers to whether a good can be used or consumed by one person while another person is using or consuming that good o Rivalrous good One whose use or consumption will limit or eliminate the supply of that specific good to others Ex An
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