History of economic thought What 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 ( en,_and_That_Which_Is_Not_Seen) en,_and_That_Which_Is_Not_Seen See

Task: Peltzman effects, visible and invisible.

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.

Text z understanding microeconomics

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: -with-centrall-planned-economies- presentation see -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 mTOc mTOc

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 ( ) James Buchanan (1919 – 2013)