Lecture Economics (9/e): Chapter 23 - David C. Colander

Chapter 23 - Microeconomic policy, economic reasoning, and beyond. In this chapter you will: List three reasons why economists sometimes differ and sometimes agree in their views on social policy, explain the cost/benefit approach the typical economist takes to analyze regulations, describe three types of failure of market outcomes, explain why most economists are doubtful government can correct failure of market outcomes.

Microeconomic Policy,

Economic Reasoning, and Beyond

If an economist becomes certain of the  solution of any problem, he can be  equally certain that his solution is  wrong.

      — H. A. Innis

Chapter Goals

Ø List three reasons why economists sometimes differ

and sometimes agree in their views on social policy

Ø Describe three types of failure of market outcomes

Ø Explain the cost/benefit approach the typical economist

takes to analyze regulations

Ø Explain why most economists are doubtful government

can correct failure of market outcomes

Economists’ Differing Views About Social Policy

Ø Economists’ views on social policy differ widely because:

• They have different underlying values

• They interpret empirical evidence differently

• They use different economic models

Ø Any policy proposal must embody both economic analysis and value judgments because the goals of policy reflect

value judgments

How Economists’ Value Judgments

Creep into Policy Analysis

Interpretation of the Policymaker’s Values

Ø In practice, social goals are vaguely understood and

vaguely expressed

Ø Some economists have argued that economists should

recommend only Pareto optimal policies

Ø Pareto optimal policies are policies that benefit some

people and hurt no one

Ø Pareto optimal policies don’t exist because all policies

make some people better off and some people worse off

How Economists’ Value Judgments

Creep into Policy Analysis

Choice of Economic Models

Ø An economist’s choice of models, which focus on certain

aspects of economic reality, is influenced by value judgments

Ø Some economic models are:

• Mainstream economic analysis is presented in the

text and includes the standard supply/demand model

• Marxian (radical) focuses on equitable distribution

of power, rights, and income

• Public choice focuses on economic incentives as

applied to politicians

Economists’ Cost/Benefit Approach

to Government Regulation

The cost/benefit approach to problems - assigning costs

and benefits, and making decisions on the basis of the

relevant costs and benefits

• This requires the determination of a quantitative cost

and benefit for everything, including human life

• Many regulations are formulated for political expediency

and do not reflect cost/benefit considerations

Putting Cost/Benefit Analysis in Perspective

Ø Cost/benefit analysis is often biased toward quantifiable

costs or it involves ambiguity as nonquantifiable costs

are quantified

Ø Regulations will often change other things, too;

minimum wage is an example

• The subjectivity and ambiguity of costs are reasons

why economists differ in their views of regulation

• If firms replace workers with machines in one industry, employment in the machine industry might rise

The Cost/Benefit Approach in Context

Ø Cost/benefit analysis is an application of the

supply/demand model

• The supply curve represents marginal costs

• The demand curve represents marginal benefits

Ø Equilibrium of demand and supply in competitive markets achieves economic efficiency

• Economic efficiency - achieving a goal; in this case, producing a specified amount of output, at the lowest

possible cost

Failure of Market Outcomes

Ø Failure of market outcomes occurs when, even though

the market is functioning properly (there are no market

failures), the market is not achieving society’s goals

Ø Three types of market failure:

• Failures due to distributional issues

• Failures due to rationality problems of individuals

• Failures due to violations of inalienable or at least partially inalienable rights of individuals

Distribution Issues

Ø The market doesn’t necessarily distribute consumer

surplus as we’d like it to:

• The U.S has luxury goods but not enough health care for the poor

• In some African countries, almost 30% of the population has AIDS, but most don’t have the money

to get the necessary drugs

Ø The sole purpose of society is not necessarily to maximize consumer and producer surplus; societies integrate other

Consumer Sovereignty and Rationality Problems

Ø The supply/demand framework assumes individuals are

rational, that what individuals do is in their own best

interest

Ø Rationality failure of individuals is that sometimes we are irrational and do things that aren’t good for us

Ø Governments can intervene to get people to do what’s

good for them

Ø Governments levy sin taxes, which are taxes that

discourage activities society believes are harmful (sinful)

Government Failure

Ø Failure of market outcomes does not necessarily call for

government action

Ø For the government to correct a problem, it must:

• Recognize the problem

• Have the will to do something positive about the

problem

• Have the ability to do something positive about

the problem

Ø Government seldom can do all three of these well

Government Failure

Response By Public Choice Economists

Ø Public choice economists point out that politicians are

subject to the laws of supply and demand

Ø Politicians’ goal is to provide a policy that their voting

constituency likes

• This can result in larger and larger government

Ø Public choice economists advocate as little government

intervention as possible, even in the cases of market

failures or failures of market outcomes

Ø Economists’ views differ because of different underlying

value judgments, because empirical evidence is subject

to different interpretations, and because their underlying

models differ

Ø Economists tend to agree on certain issues because

their training is similar; they use models that focus on

economic incentives and rationality

Ø The economic approach to analyzing issues is a

cost/benefit approach

Ø The cost/benefit approach and the supply/demand

framework deemphasize the possibility that market

Chapter Summary

Ø Three failures of market outcomes are failures due to (1) distributional issues, (2) rationality problems of

individuals, and (3) violations of inalienable rights

Ø Society does care about how total surplus is distributed

Ø The supply/demand framework assumes that individuals are rational, but individuals are not always rational in

practice

Ø Inalienable rights cannot be bought or sold

Ø Economics provides the tools, not the rules, for society