Societies: facts and challenges
Inleiding
Talking about policy 1
Talking about policy
- Positive: how is the reality?
- Normative: how should things be?
- Correlation: statistical association between variables
- Causation: change in one variable causes a change in another variable
- Correlation does not imply causation
→ A third (confounding) variable may have an effect on both variables
- E.g. ice cream sales and sweating are correlated (hot temperatures affects
both variables separately)
→ Reverse causality
- E.g. poverty and low self-esteem are correlated (does poverty cause low
self-esteem or vice versa?)
- Formulating policy recommendations and policy advice
- Requires a good understanding of the society
- In particular of the causal mechanisms between the variables of interest
(which may be complex (e.g. when there is a causal web))
- Are conditional on a normative position (which society do we want?) and we
may disagree on our normative position
1
, When markets fail
Societies: facts & challenges
Intro 1
Central questions 1
Librarian ideal 1
Benchmark model 2
Invisible hand 2
Market failures 2
1: Rational individuals 2
2: Perfect information 3
3: Perfectly competitive 3
4: Complete markets 4
5: No public goods 4
6: No externalities 5
Overview 5
Social investment 5
Final reflections 6
Government failures 6
Social rights 6
Intro
Central questions
- Why don’t we leave everything to free exchange between families and firms on a
self-regulating market?
- Why do we need a government that modifies the market forces?
- Why do we need a welfare state?
- Arguments based on efficiency
- Arguments based on justice
Librarian ideal
- Libertarianism: political philosophy that takes liberty as a central value and argues
that government intervention is (morally) wrong
- Nozick: the nightwatchman state → a state with a self-regulating free market
in which the government only provides the public good “safety”
- Hayek: the goal of social justice (equality) will destroy liberty
→ Philosophical underpinnings of “Chicago School” economics → open market
(Free market with little government intervention is the best)
- Recent wave of libertarian ideas in politics
1
, - But problem for social-economic scientist
- How would a society with a self-regulating market without a government look
like?
- How can we imagine such a counterfactual society?
- ≠ Liberalism: political philosophy that takes liberty as a central value and argues that
governments are a tool for ensuring these liberties
Benchmark model
- Model of a society that allows the study of a imaginary society
- It provides a simplified, idealized framework to analyze economic behavior
- We start from a benchmark model
- Not meant to be a realistic model
- Like a perfect vacuum in physics, …
- We make 6 assumptions in the benchmark model
Invisible hand
- “First Welfare Theorem. In the benchmark model, free exchange on a self-regulating
market leads to a Pareto efficient outcome”
- Pareto-efficient
- An assignment is Pareto efficient when it is impossible to make a Pareto
improvement
- After a Pareto improvement someone is better off and nobody is worse off
- It’s about not waiting, it’s not about fairness
- Why does free exchange lead to a Pareto improvement?
- Intuition: If both parties involved in the free exchange would not
benefit from it, they wouldn’t exchange
- Voluntary trade + no trade possible anymore → Pareto-efficient
- Is the benchmark model realistic?
- No, it is not very realistic, in reality there are market failures
- And that is one reason why we need a welfare state
Market failures
- When one of the requirements of the benchmark model is not completed
1: Rational individuals
- Be careful with the jargon
2
, - Rational for an economist means: “consistent”
- Rational for other people means: “smart”
- Lessons from psychology and behavioural economics
- Real individuals are not always rational
- Strategies to change behaviour
- Framing changes how information is presented to influence choices
- Eg saying "90% success" instead of "10% failure"
- Nudging is a way of presenting choices that steers people toward
certain decisions without taking away freedom
- Eg putting healthy food at eye level
- Nudge decision making
- Governments can nudge individuals by thinking carefully about the
framing of decisions (the choice architecture)
- Place of chocolate in resto
- Organ donation
- Behavioural-insights-team in UK and many other countries
- Raises ethical questions: “Libertarian paternalism”
- Real individuals suffer from bounded will-power
- Eg Tomorrow I’ll start studying …
2: Perfect information
- In the benchmark model, individuals need perfect information about price and quality
- Prices are not always clear
- Quality is often not clear
- Buying a second car
- Buying bio-products
- We need to improve the information!
- Government regulates information on products
- European Union plays an important role
3: Perfectly competitive
- In a perfectly competitive market, there are many buyers and sellers, without market
power
- Buyers and sellers are price takers, taking the market price as given in deciding how
much to buy or sell
- That means:
- No monopoly → one seller
- No monopsony → one buyer
- No oligopoly → a few sellers
- Free entry in the market
- Increase the market power?
- Monopoly power of superstar-companies: Amazon, Google, Walmart, …
- They increase their market power constantly!
→ With more market power, they can set higher prices
→ This leads to greater profits, but not higher salaries
3
Inleiding
Talking about policy 1
Talking about policy
- Positive: how is the reality?
- Normative: how should things be?
- Correlation: statistical association between variables
- Causation: change in one variable causes a change in another variable
- Correlation does not imply causation
→ A third (confounding) variable may have an effect on both variables
- E.g. ice cream sales and sweating are correlated (hot temperatures affects
both variables separately)
→ Reverse causality
- E.g. poverty and low self-esteem are correlated (does poverty cause low
self-esteem or vice versa?)
- Formulating policy recommendations and policy advice
- Requires a good understanding of the society
- In particular of the causal mechanisms between the variables of interest
(which may be complex (e.g. when there is a causal web))
- Are conditional on a normative position (which society do we want?) and we
may disagree on our normative position
1
, When markets fail
Societies: facts & challenges
Intro 1
Central questions 1
Librarian ideal 1
Benchmark model 2
Invisible hand 2
Market failures 2
1: Rational individuals 2
2: Perfect information 3
3: Perfectly competitive 3
4: Complete markets 4
5: No public goods 4
6: No externalities 5
Overview 5
Social investment 5
Final reflections 6
Government failures 6
Social rights 6
Intro
Central questions
- Why don’t we leave everything to free exchange between families and firms on a
self-regulating market?
- Why do we need a government that modifies the market forces?
- Why do we need a welfare state?
- Arguments based on efficiency
- Arguments based on justice
Librarian ideal
- Libertarianism: political philosophy that takes liberty as a central value and argues
that government intervention is (morally) wrong
- Nozick: the nightwatchman state → a state with a self-regulating free market
in which the government only provides the public good “safety”
- Hayek: the goal of social justice (equality) will destroy liberty
→ Philosophical underpinnings of “Chicago School” economics → open market
(Free market with little government intervention is the best)
- Recent wave of libertarian ideas in politics
1
, - But problem for social-economic scientist
- How would a society with a self-regulating market without a government look
like?
- How can we imagine such a counterfactual society?
- ≠ Liberalism: political philosophy that takes liberty as a central value and argues that
governments are a tool for ensuring these liberties
Benchmark model
- Model of a society that allows the study of a imaginary society
- It provides a simplified, idealized framework to analyze economic behavior
- We start from a benchmark model
- Not meant to be a realistic model
- Like a perfect vacuum in physics, …
- We make 6 assumptions in the benchmark model
Invisible hand
- “First Welfare Theorem. In the benchmark model, free exchange on a self-regulating
market leads to a Pareto efficient outcome”
- Pareto-efficient
- An assignment is Pareto efficient when it is impossible to make a Pareto
improvement
- After a Pareto improvement someone is better off and nobody is worse off
- It’s about not waiting, it’s not about fairness
- Why does free exchange lead to a Pareto improvement?
- Intuition: If both parties involved in the free exchange would not
benefit from it, they wouldn’t exchange
- Voluntary trade + no trade possible anymore → Pareto-efficient
- Is the benchmark model realistic?
- No, it is not very realistic, in reality there are market failures
- And that is one reason why we need a welfare state
Market failures
- When one of the requirements of the benchmark model is not completed
1: Rational individuals
- Be careful with the jargon
2
, - Rational for an economist means: “consistent”
- Rational for other people means: “smart”
- Lessons from psychology and behavioural economics
- Real individuals are not always rational
- Strategies to change behaviour
- Framing changes how information is presented to influence choices
- Eg saying "90% success" instead of "10% failure"
- Nudging is a way of presenting choices that steers people toward
certain decisions without taking away freedom
- Eg putting healthy food at eye level
- Nudge decision making
- Governments can nudge individuals by thinking carefully about the
framing of decisions (the choice architecture)
- Place of chocolate in resto
- Organ donation
- Behavioural-insights-team in UK and many other countries
- Raises ethical questions: “Libertarian paternalism”
- Real individuals suffer from bounded will-power
- Eg Tomorrow I’ll start studying …
2: Perfect information
- In the benchmark model, individuals need perfect information about price and quality
- Prices are not always clear
- Quality is often not clear
- Buying a second car
- Buying bio-products
- We need to improve the information!
- Government regulates information on products
- European Union plays an important role
3: Perfectly competitive
- In a perfectly competitive market, there are many buyers and sellers, without market
power
- Buyers and sellers are price takers, taking the market price as given in deciding how
much to buy or sell
- That means:
- No monopoly → one seller
- No monopsony → one buyer
- No oligopoly → a few sellers
- Free entry in the market
- Increase the market power?
- Monopoly power of superstar-companies: Amazon, Google, Walmart, …
- They increase their market power constantly!
→ With more market power, they can set higher prices
→ This leads to greater profits, but not higher salaries
3
