Political Economy Exam Ii

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Frederik von Hayek

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Nobel prize for economics

Austrian school of economic thought

markets are conducive to change and growth

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Why are markets held in high regard by mainstream economists?

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1) they permit mutually advantageous exchanges

2) efficient allocation of economic resources

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Two underlying assumptions with faith in markets

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1) desirability of private property

2) undesirability of a substantial role for the state in the economy

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Markets encourage __________ & _________ while penalizing _________.

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innovation & risk-taking; failure

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Connection to Social Darwinism

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Markets reward enterprise and weed out inefficiency

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William Stanley Jevons

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1835-1882

English economist

Marginalism

diminishing marginal utility

developed the idea that an addition amount consumed of something would lead toa diminished utility.

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Carl Menger

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1840-1921

Austrian economist

Marginalism

value of goods depends on relationship to our needs-- it is not inherent. changes in relationship lead to changes in value.

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Leon Walras

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1834-1910

Swiss economist

General Equlibrium Theory

developed the idea of equilibrium that would occur at the intersection of producer and consumer decisions. Changes in consumers’ patterns would change the price the price of goods. Developed mathematical formula to show that. The two were interdependent. Theory of value for NCE differed from CPE. CPE saw value as a function of labor cost. NCE see value as a function of utility - the relationship to our need.

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Marginalism

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emphasizes small/incremental adjustments; "a little more of this, a little less of that." the adjustments a consumer might make in deciding which combinations of commodities might yield most pleasure.

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Diminishing Marginal Utility

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utility gained from consuming extra units of each commodity will diminish as more is consumed; the more you have, the less you'll dig it

--commodities abundant in supply generally have lower prices

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General Equilibrium Theory

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intricate relationships will ensure that the pattern of production will continuously adjust to the pattern of demand

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Five Market Failures

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1) Externalities

2) Markets fail to provide goods and services

3) Equity in distribution (inequality undermines social cohesion)

4) Imperfect competition

5) Instability

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Externality

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The free market produces a lopsided/imbalanced pattern of economic activity. It has downfalls and benefits not reflected in the cost

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Positive externality

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you pay for something where people benefit as a byproduct (i.e. by paying for your own education, you indirectly benefit society by added to its overall human resources). These benefits are NOT reflected in the cost.

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Alfred Marshall

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Wrote Principles of Economics (1890)

--SUPPLY and DEMAND: equally important in determining price. Formalized Adam Smith's work on the same topic.

--blended marginal analysis with Classical Political Economy

--Professor of Econ at Cambridge

--VICTORIAN IDEALS: blend practical concerns w/ scientific analysis

--mathematician

--thought econ would have greater potential for scientific development when DETACHED from moral philosophy

-- thought WRITTEN expressions of economics should take priority mathematics/diagrams

--wanted econ to mirror aspirations of enlightened middle class and raise standard of living for ordinary people in order to raise standard of living for ALL society

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Why did neoclassical theory develop when it did?

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--scientific revolution and a tie to intellectual inquiry; economists sought to become a hard science/apply scientific method

--Markets became bigger

--^ dominant social classes felt better about justifying the "invisible hand of the market" then the "iron fist of imperialism" (think of "i don't SEE race")

--Alternative to Marxism (dominant classes feared uprising and wanted to display capitalism in a more favorable light)

--shifting focus away from how LABOR creates VALUE over to how CONSUMERS shape DEMAND

--reflection of popular schools of thought at the time (utilitarian philosophy & Bentham). applied economics to prevailing intellectual fashion.

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How neoclassical economists frame capitalism

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a market economy in which freedomof exchange would ensure socially beneficial outcomes

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Jeremy Bentham's role in shaping neoclassical theory

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consumers driven by evaluations of how to maximize pleasure and minimize pain

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Political economy's "law" parallel to Newton's law of physics

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self-interest; markets are the NATURAL state in which the equilibrating mechanism works best

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CPE and NCPE overlap and differences

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OVERLAP: pro-capitalist ideology and economic liberalism

DIFFERENCE: no longer a quest to understand complex social, economic, and political institutions and the conditions for social progress. JUST about market competition.

CPE concerns: production, distribution, growth, and accumulation

NCPE concerns: exchange relations

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neoliberalism

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a preference for the market and a general aversion to state intervention

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The Theory of Determination of Price by Supply and Demand

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--supply (cost of production) and demand (utility) are EQUALLY important in determining price

--if sellers supply MORE when price RISES, and buyers demand MORE when price FALLS, supply will equal demand

--market price will respond accordingly to changes in demand (demand rises, so does equilibrium price and amount sold)

--market price will also respond to changes in supply (i.e. cost of production falls due to new technology, so too does equlibrium price)

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Does the theory of demand and supply apply to particular goods and service?

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no; all goods and services.

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Markets tend toward ___________

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equilibrium.

MAXIMUM SOCIAL WELFARE = EQUILIBRIUM

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Ball in the saucer

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ball will be disturbed if saucer shakes, but it will tend toward its central position. in markets, prices respond to changes in demand (i.e. due to changing tastes) or supply (i.e. due to new technology). responses shift to a NEW equilibrium position but stability is always restored.

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marginal analysis

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small changes in demand and supply bring about small changes in prices necessary to restore equilibrium

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Assumptions of NCPE

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--consumers tastes are a given; can be represented by indifference map

--distribution of income and state of tech is a given

--only small adjustments are necessary to achieve optimal economic outcomes

--Prices and incomes determine budget; interaction of these determine demand curve;

--Fall in price increases welfare

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positive economics

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what IS, rather than what ought to be

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Profile of the rational consumer

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--Does not let income affect tastes

--Always prefers more to less

--Gets less utility out of each additionalunit (diminishing marginal utility)

--Can always tell which bundle he/sheprefers

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What determines budget?

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prices and incomes

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What determines the demand curve?

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interaction of prices and incomes

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Indifference Curve

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The point of intersection is where you're most indifferent/where you can best balance amount of biscuits and bananas purchased to get the best deal (maximum utility at given relative prices).

Price & quantity combined show the demand curve

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Supply output is increased by adding more of the variable factor (______) to the fixed factor (______)

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labor; capital

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diminishing marginal productivity

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output eventually rises at a diminishing rate

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the principle of diminishing returns

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productivity decreases with each worker added (group projects).

affects supply curve

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Substitution effect

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Consumers are likely to substitute one commodity for another when the latter's price has risen.

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Income effect

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the rise in the price of the commodity effectively reduces that person’s real disposable income. And the person will buy less of other commodities too.

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Consumer sovereignty

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the consumer is king. Shoppers rule and consumer preferences determine production.

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Elasticity of Demand

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how demand changes relative to price

low elasticity: you will still buy it even if prices go up

high elasticity: stop paying for it bc prices go up

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Goals/Objectives of Firms

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1. Minimum standard of living

2. Security and long-term growth

3. Satisficing (accept an available option as satisfactory)

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Difference between firms and markets

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FIRMS: buy labor, decision-making done through hierarchy, command, & control

MARKETS: respond to demanders (the people)

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Firms maximize profits when they are _______ or __________

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active-- taking an active role in the shaping of economy w/ new technologies, new markets, collusion, and driving down workers’ wages.

passive-- taking market situations as a GIVEN an optimizing production accordingly

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ideology of NCPE

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the market is the necessary underpinning for freedom of choice and efficient allocation of economic resources

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NCE treats firms as...

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single decision-making units operating in a market context

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Universal goal of firms

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profit maximization

WHEN MARGINAL COST = MARGINAL REVENUE

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Marginal cost

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the additional cost of producing an extra unit of output

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Marginal revenue

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the additional income that results from selling an extra unit of output

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Perfect Competition

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--Lots of sellers and homogenous buyers

--No customer loyalty

--Lots of information about product

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How does NCE measure competitiveness in the market?

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By the number of firms in the market

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Monopolisitic Competition

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--Lots of sellers who sell the samething (i.e. gas stations, pharmacies)

--Geography matters

-- Consumer can tell the difference between the products of the various firms in the industry

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Oligopoly

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--Few firms producing a product

--Huge departure from perfect competition

--Often exploitative ofconsumers

--Some times oligopolies make sense (i.e. industries which require a lot of investment/capital, such as large aircraft producers)

--Price rigidity

--Collusion is strong

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Monopoly

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--One producer

--The firm is the industry

--Restricts outputs and raises prices in order to maximize profits.

--Monopolists have the power to raise prices up their marginal costs.

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3 Factors of Production (what determines who gets what?)

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1) land

2) capital (investment & anything OTHER than land and labor)

3) workers (labor)

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When to stop hiring

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when additional cost = additional benefit. employee's utility is fulfilled and there is NO labor surplus. income = marginal benefit offered to company. What I get paid should match exactly to the worth of my production.

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Income distribution depends on..

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where resources are distributed. were you born wealthy? does your employer have ample resources?

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3 Policy approaches in NCE

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--Policy should seek to establish the ideal competitive market whenever possible

--Regulate business behavior

--Allow imperfect competition to continue but focus on the outcomes. are firms unfairly getting rents from the structure of the market? If so then taxing them might be better than regulating the firm's structure.

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4 things that affect the price of factors

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1) Volume of production

2) technology

3) Amount of capital and labor used

4) No economic surplus

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Pareto Principal (compensation principal)

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winners compensate losers-- those who benefit are required to compensate those who do not

as long as SOME people are better off and NO people are worse off, an action should be taken

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___________ are the buyers and ______________ are the sellers.

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Firms; households

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How do we know when the company should hire more workers or use a machine?

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Need to know the relative prices of capital and labor.

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Supply of factors of production will fulfill ____________

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demand

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The ratio of the marginal products of any factor of production (labor, land, or capital) is equal to ____________

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its cost.

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What happens asthe price of labor, land, or capital go up?

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more will be provided

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Five assumptions with the model of supply of factors of demand

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1) Distribution of resources is taken as a given

2) Ignores the role of economic power in shaping the pattern of factor prices

3) State is a key player in shaping income distribution.

4) Measure of productivity difficult to disaggregate and define.

5) Profit is seen as the marginal productivity of capital

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A. C. Pigou

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Economic welfare is:

--Not the same as social welfare. Simply means society has more wealth overall.

--Related to income distribution

--Marginal utility

--Progressive taxation