Theorie Part 1

• Policymaker/ state/ government- only interested in maximizing utility of society in the most effective/ efficient way

• Social welfare includes fairness and just distribution, these are not defined

• Government

  • sets economic & political frameworks so that markets could function

  • corrects market failures

• Task of economic policy: solve technical problems

• Pure market economy: state has a minor role (providing legal system, setting rules of the game, fighting market power). Liberal economy without much state intervention.

• State-directed economy (socialism, communism): state has the major role of planning and deciding on allocation of production and consumption in society and economy.

• Social market economy (“Soziale Marktwirtschaft”) as a third way: social system complements market economy and market outcomes to realize long-term stability in the market economy and a livable society.

• The state has to provide, ensure, and enforce property rights. These can be

  • centrally or decentrally allocated,

  • inclusive or exclusive.

• The state should ensure smooth functioning of markets. For this, transaction costs should be minimized for a given allocation of property rights.

• Domestic and international rules and institutions should be structured such that they minimize transaction costs.

• They should change if property rights or transaction costs change.

• Rules and property rights structure incentives and behavior, and thereby influence the economic outcome

• Even if the presence of externalities the efficient outcome can be realized if: there are no transaction costs; contracts are enforceable; property rights are well-defined

• Well-defined property rights make private exchange possible

• Role of the State: Define and enforce PR, reducs TC, substitute of negotiations do not work

Das Coase-Theorem ist ein Konzept aus der ökonomischen Theorie, das von dem britischen Ökonomen Ronald Coase entwickelt wurde. Es besagt, dass unter bestimmten Bedingungen effiziente Ergebnisse in Bezug auf die Allokation von Ressourcen erreicht werden können, auch wenn es zu Externalitäten kommt.

• Exclusive right to use

• Exclusive right to exchange/ transfer

  • right of use, rent, sell

• Can be allocated to: public, private, common

• Allocation of PR shapes incentives (socialism, commons, …)

• Rights are usually not unrestricted.

• Operating costs of the economy or the costs of human exchange: costs of initiation, negotiation, decision-making & controlling

• Also include costs of arising from uncertainty about the contractor´s behavior and the costs of implementing an agreement

  • TC increase in model uncertainty and model disagreement (nach North)

• By lowering such costs, economic interaction becomes easier and more specialization is possible which allows to exploit efficiency gains

• These costs also arise in politics

Contract implementation

• Enformenet (Opportunism)

• Agancy Problems (Moral Hazard, opportunism)

• Hold Up.

Uncertainity

• Informational Asymmetry: Adverse selection, post contractual (MH), PAT Problem

• Time Inconsistency

Solutions

• State can set up product standards

• introduce compulsory insurances or warranties

• structure working contracs

• regulate informational duties (to reduce informational asymmetries)

• Set the institutional framework

• Reduce informational asymmetry and uncertainty.

• Correct market failures and improve allocative efficiency

  • Provision of public goods

  • Internalization of externalities

  • Stabilization of economic variables

  • Prevent abuse of market power

• Achieve Pareto-efficiency. (Correct market failures.)

• Redistributional fairness. (Correct market outcomes.)

• Non-rivalrous (in consumption)

• Non-excludable (or exclusion too expensive)

• In theory, each individual should contribute according to his/her marginal benefit from consuming this good. Individuals will understate willingness to pay and try to free-ride on others.

• There is underprovision of such goods.

• Externalities exist when individual behavior affects the utility of other individuals such that individual and social costs or benefits deviate

• Private and social optimum diverge and market prices will not reflect true social costs and benefits. Given distorted prices, there is under or overprovision of private goods and bads as a consequence of this market failure

• State intervention can improve the market outcome if it internalizes the marginal social benefits and cost. Corrected prices ensure efficient market outcome

  
  

• Externalitäten sind Auswirkungen wirtschaftlicher Aktivitäten, die nicht im Preis berücksichtigt werden und Dritte oder die Gesellschaft betreffen. Positive Externalitäten erzeugen Nutzen für andere, z.B. saubere Energie. Negative Externalitäten verursachen Kosten oder Schäden, z.B. Luftverschmutzung. Externalitäten führen zu Marktversagen, da sie nicht vollständig internalisiert werden. Regierungen müssen Mechanismen wie Umweltsteuern oder Regulierungen einführen, um Externalitäten zu berücksichtigen

• If firms have market power, they will not behave as price-takers but set prices strategically

• Prices are too high, supply is too low

• There is redistribution from consumers to producers, and there is a deadweight loss

• State can establish efficient outcome by establishing competition rules and regulating the price in case of natural monopolies.

• Since markets are not fully efficient (informational asymmetries, rigid prices and wages), economic fluctuations entail costs in terms of employment, unused capacities, and failed or misdirected investments.

• Thus, state has also a role in terms of stabilizing macroeconomic variables.

  • In boom times economic policy should reduce government demand. In recessions economic policy should increase government demand.

  • That is, economic policy should be counter-cyclical.

• The magic square in Germany

• In a democracy, the utility of each individual is important; minorities should be protected.

• Economics applies concept of “methodological individualism”.

• The first problem for a “welfare maximizing” policymaker is how to measure individual utility.

  • What enters utility?

  • People have incentives to misreport true preferences for strategic gains.

• The second problem is to aggregate individual utilities to “social welfare”.

  • How to make interpersonal utility comparisons?

  • What is the right aggregation mechanism?

  • Is it possible at all to consistently aggregate?

• Arrow even shows that under very mild conditions for democracy, it is not possible to aggregate individual utilities consistently

The normative view of economic policy is that governments

• Correct market failure to reach efficiency

• Stabilize the economy to ensure efficient use of resources

• Correct market outcomes to ensure efficient use of resources