Chapter 23: Microeconomic Policy, Economic Reasoning, and Beyond

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinChapter GoalsList three reasons why economists sometimes differ and sometimes agree in their views on social policyDescribe three types of failure of market outcomesExplain the cost/benefit approach the typical economist takes to analyze regulationsExplain why most economists are doubtful government can correct failure of market outcomes Economists’ Differing Views About Social PolicyEconomists’ views on social policy differ widely because:They have different underlying valuesThey interpret empirical evidence differentlyThey use different economic modelsAny policy proposal must embody both economic analysis and value judgments because the goals of policy reflect value judgmentsHow Economists’ Value Judgments Creep into Policy AnalysisInterpretation of the Policymaker’s ValuesIn practice, social goals are vaguely understood and vaguely expressedSome economists have argued that economists should recommend only Pareto optimal policiesPareto optimal policies are policies that benefit some people and hurt no onePareto optimal policies don’t exist because all policies make some people better off and some people worse offHow Economists’ Value Judgments Creep into Policy AnalysisChoice of Economic ModelsAn economist’s choice of models, which focus on certain aspects of economic reality, is influenced by value judgmentsSome economic models are:Mainstream economic analysis is presented in the text and includes the standard supply/demand modelMarxian (radical) focuses on equitable distribution of power, rights, and income.Public choice focuses on economic incentives as applied to politiciansEconomists’ Cost/Benefit Approach to Government RegulationThe cost/benefit approach to problems - assigning costs and benefits, and making decisions on the basis of the relevant costs and benefitsThis requires the determination of a quantitative cost and benefit for everything, including human lifeMany regulations are formulated for political expediency and do not reflect cost/benefit considerationsPutting Cost/Benefit Analysis in PerspectiveCost/benefit analysis is often biased toward quantifiable costs or it involves ambiguity as nonquantifiable costs are quantifiedRegulations will often change other things, too; minimum wage is an exampleThe subjectivity and ambiguity of costs are reasons why economists differ in their views of regulationIf firms replace workers with machines in one industry, employment in the machine industry might riseThe Cost/Benefit Approach in ContextCost/benefit analysis is an application of the supply/demand modelThe supply curve represents marginal costsThe demand curve represents marginal benefitsEquilibrium 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 costFailure of Market OutcomesFailure of market outcomes occurs when, even though the market is functioning properly (there are no market failures), the market is not achieving society’s goalsThree types of market failure:Failures due to distributional issuesFailures due to rationality problems of individualsFailures due to violations of inalienable or at least partially inalienable rights of individualsFailure of Market OutcomesDistribution IssuesThe 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 poorIn some African countries, almost 30% of the population has AIDS, but most don’t have the money to get the necessary drugsThe sole purpose of society is not necessarily to maximize consumer and producer surplus; societies integrate other goals into the marketFailure of Market OutcomesConsumer Sovereignty and Rationality ProblemsThe supply/demand framework assumes individuals are rational, that what individuals do is in their own best interestRationality failure of individuals is that sometimes we are irrational and do things that aren’t good for usGovernments can intervene to get people to do what’s good for them Governments levy sin taxes, which are taxes that discourage activities society believes are harmful (sinful)Government FailureFailure of market outcomes does not necessarily call for government actionFor the government to correct a problem, it must:Recognize the problemHave the will to do something positive about the problemHave the ability to do something positive about the problemGovernment seldom can do all three of these wellGovernment FailureResponse By Public Choice EconomistsPublic choice economists point out that politicians are subject to the laws of supply and demandPoliticians’ goal is to provide a policy that their voting constituency likesThis can result in larger and larger governmentPublic choice economists advocate as little government intervention as possible, even in the cases of market failures or failures of market outcomesChapter Summary Economists’ views differ because of different underlying value judgments, because empirical evidence is subject to different interpretations, and because their underlying models differEconomists tend to agree on certain issues because their training is similar; they use models that focus on economic incentives and rationalityThe 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 societyChapter Summary Three failures of market outcomes are failures due to (1) distributional issues, (2) rationality problems of individuals, and (3) violations of inalienable rightsSociety does care about how total surplus is distributedThe supply/demand framework assumes that individuals are rational, but individuals are not always rational in practice Inalienable rights cannot be bought or soldEconomics provides the tools, not the rules, for society