Economics key terms and theory

• The term "economics" originates from the Greek word "oikonomos."
• Normative theory is used to determine actions to achieve specific results.

Pareto Criterion

• Based on utilitarianism, collective wellbeing relies on individual wellbeing.
• Collective wellbeing is equivalent to the wellbeing of individuals.
• Societal wellbeing increases if at least one individual's utility rises without negatively impacting others.
• Incorporates ethical individualism.
• Economics studies human behavior as it relates to ends and scarce means with alternative uses.
• It explores the production, distribution, and consumption of products and services.
• It examines how individuals coordinate wants and desires considering decision-making mechanisms, social customs, and political realities.

Pitfalls of Experimental Studies

• Ethical issues
• Response bias
• Technical problems
• Generalization of results

Positive Theory

• Explains the causes of an economic phenomenon.
• Tinbergen's golden rule says a policymaker must have at least as many instruments as objectives.
• Welfare economics relates to the social desirability of alternative economic states.
• The structure of markets and allocation of economic resources determines societal wellbeing.
• Collective action theory states individuals act on self-interest within a group.

Public Choice Theory

• Explores how public goods are provided and corresponding matching rules are established.

• It aims to study and influence public choice processes while maximizing social utility.

• "The Calculus of Consent" was authored by Gordon Tullock and James M. Buchanan.

• Nirvana Fallacy is when actual scenarios are compared to unrealistic, idealized alternatives.

• Marcus Olson discusses intermediate, latent, and privileged groups.

• Public choice theory is a positive theory.

• Politicians maximize their self-interest.

• Political outcomes are compared to market outcomes.

• Happiness is random.

• Homo oeconomicus is perfectly rational, maximizes utility, and is self-interested.

• The Easterlin paradox measures subjective wellbeing, noting that beyond a certain income, more money doesn't equate to more happiness.

• Relational goods introduced by Martha Nussbaum, Pierpaolo Donati, Carole Uhlaner, and Benedetto Gui.

• Instrumental motivation is not a relational good feature; identity, reciprocity, fragility, and gratuity are instead.

• Scitovsky introduced comfort and stimulation goods.

• Carl Menger conceptualized external and internal goods.

• A Pareto social optimum can be achieved in a decentralized manner through hierarchical coordination or the market.

Assumptions of the First Welfare Theorem

• Markets are complete.
• Assets are private.
• Information is perfect.
• Wellbeing is maximized.
• Agents are price takers.
• The Second Welfare Theorem says any Pareto-efficient allocation can be realized competitively.
• The First Welfare Theorem suggests under specific assumptions, competitive equilibrium is Pareto optimal.
• The Second Welfare Theorem relies on the assumption that taxes are non-distorting.
• The normative implication of the first welfare theorem encourages the state to enforce the "rule of law."
• A Pareto criterion adheres to utilitarian philosophy.

Pareto Criterion Details

• It does not allow interpersonal comparisons or compensation.
• It does not contemplate meritorious goods.
• It is not a collectivistic view.
• The efficiency frontier marks optimal Pareto equilibrium points within an economic system.

Marginal Rate of Substitution

• The ratio of marginal utilities.
• Measures the subjective equivalence between consumer goods.
• Graphically, it the slope of the indifference curve.
• The Kaldor-Hicks criterion allows for comparing utilities between individuals.
• The Pareto criterion enables comparing alternative resource allocations.

Identifying the Social Optimum

• Identify of the frontier of possible utilities.
• Given the frontier of social well-being, the curves of social indifference drawn.
• Identification of the tangency point between the frontier of possible utilities and a social indifference curve.
• Focus is not on individual optimality of the benevolent dictator.
• The First Welfare Theorem implies any Pareto optimum can be realized as a competitive equilibrium.
• A social welfare function reveals how individual utilities contribute to societal wellbeing.
• Equity is determined by the underlying social welfare function.
• To decide whether to produce, an enterprise considers average cost.