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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.
Introduction: Thinking Like an Economist CHAPTER 2 CHAPTER 23 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 McGrawHill/Irwin Copyright © 2013 by The McGrawHill Companies, Inc. All rights reserved Microeconomic Policy, Economic Reasoning, and Beyond 23 Chapter Goals Ø Ø Ø Ø 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 232 Microeconomic Policy, Economic Reasoning, and Beyond 23 Economists’ Differing Views About Social Policy Ø Economists’ views on social policy differ widely because: • • • Ø They have different underlying values They interpret empirical evidence differently They use different economic models Any policy proposal must embody both economic analysis and value judgments because the goals of policy reflect value judgments 233 Microeconomic Policy, Economic Reasoning, and Beyond 23 How Economists’ Value Judgments Creep into Policy Analysis Interpretation of the Policymaker’s Values Ø Ø Ø Ø In practice, social goals are vaguely understood and vaguely expressed Some economists have argued that economists should recommend only Pareto optimal policies Pareto optimal policies are policies that benefit some people and hurt no one Pareto optimal policies don’t exist because all policies make some people better off and some people worse off 234 Microeconomic Policy, Economic Reasoning, and Beyond 23 How Economists’ Value Judgments Creep into Policy Analysis Ø Ø Choice of Economic Models An economist’s choice of models, which focus on certain aspects of economic reality, is influenced by value judgments 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 235 Microeconomic Policy, Economic Reasoning, and Beyond 23 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 not reflect cost/benefit considerations 236 Microeconomic Policy, Economic Reasoning, and Beyond 23 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 The subjectivity and ambiguity of costs are reasons why economists differ in their views of regulation Regulations will often change other things, too; minimum wage is an example • If firms replace workers with machines in one industry, employment in the machine industry might rise 237 Microeconomic Policy, Economic Reasoning, and Beyond 23 The Cost/Benefit Approach in Context Ø Ø Cost/benefit analysis is an application of the supply/demand model • The supply curve represents marginal costs • The demand curve represents marginal benefits 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 238 Microeconomic Policy, Economic Reasoning, and Beyond 23 Failure of Market Outcomes Ø 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 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 239 Microeconomic Policy, Economic Reasoning, and Beyond 23 Failure of Market Outcomes Distribution Issues Ø The market doesn’t necessarily distribute consumer surplus as we’d like it to: • • Ø 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 The sole purpose of society is not necessarily to maximize consumer and producer surplus; societies integrate other goals into the market 2310 Microeconomic Policy, Economic Reasoning, and Beyond 23 Failure of Market Outcomes Consumer Sovereignty and Rationality Problems Ø Ø Ø Ø The supply/demand framework assumes individuals are rational, that what individuals is in their own best interest Rationality failure of individuals is that sometimes we are irrational and things that aren’t good for us Governments can intervene to get people to what’s good for them Governments levy sin taxes, which are taxes that discourage activities society believes are harmful (sinful) 2311 Microeconomic Policy, Economic Reasoning, and Beyond 23 Government Failure Ø Ø Ø Failure of market outcomes does not necessarily call for government action For the government to correct a problem, it must: • Recognize the problem • Have the will to something positive about the problem • Have the ability to something positive about the problem Government seldom can all three of these well 2312 Microeconomic Policy, Economic Reasoning, and Beyond 23 Government Failure Response By Public Choice Economists Ø Ø Ø Public choice economists point out that politicians are subject to the laws of supply and demand Politicians’ goal is to provide a policy that their voting constituency likes • This can result in larger and larger government Public choice economists advocate as little government intervention as possible, even in the cases of market failures or failures of market outcomes 2313 Microeconomic Policy, Economic Reasoning, and Beyond 23 Chapter Summary Ø Ø Ø Ø Economists’ views differ because of different underlying value judgments, because empirical evidence is subject to different interpretations, and because their underlying models differ Economists tend to agree on certain issues because their training is similar; they use models that focus on economic incentives and rationality The economic approach to analyzing issues is a cost/benefit approach The cost/benefit approach and the supply/demand framework deemphasize the possibility that market outcomes may be undesirable to society 2314 Microeconomic Policy, Economic Reasoning, and Beyond 23 Chapter Summary Ø Ø Ø Three failures of market outcomes are failures due to (1) distributional issues, (2) rationality problems of individuals, and (3) violations of inalienable rights Society does care about how total surplus is distributed 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 2315 ... applied to politicians 23 5 Microeconomic Policy, Economic Reasoning, and Beyond 23 Economists’ Cost/Benefit Approach to Government Regulation The cost/benefit approach to problems - assigning costs... Economic efficiency - achieving a goal; in this case, producing a specified amount of output, at the lowest possible cost 23 8 Microeconomic Policy, Economic Reasoning, and Beyond 23 Failure of Market... even in the cases of market failures or failures of market outcomes 23 13 Microeconomic Policy, Economic Reasoning, and Beyond 23 Chapter Summary Ø Ø Ø Ø Economists’ views differ because of different