Eco 1.pdf

Public Economics: Aims and tools of analysis Economics is the social science that studies the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek for oikos ("house") and nomos ("custom" or "law"), hence "rules of the house (hold)". Can we...

Public Economics: Aims and tools of analysis Economics is the social science that studies the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek for oikos ("house") and nomos ("custom" or "law"), hence "rules of the house (hold)". Can we say it has little or no relevance to contemporary economics? Why? Both approaches hold that the rationality of any economic action is dependent on the frugal use of means, but…. contemporary economics is largely neutral between ends, while in ancient economic theory, an action is considered economically rational only when taken towards a praiseworthy end. Contemporary economics is “fundamentally distinct from ethics” (Robbins 1935), and its theory “is in principle independent of any particular ethical position” (Friedman 1953). “Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses” (Robbins, 1935) Scarcity means that available resources are insufficient to satisfy all wants and needs. Economics is the study of how human being coordinate their wants and desires, given the decision-making mechanisms, social customs, and political realities of the society (Colander, 2006) What about Public Economics? Public Economics studies all aspects of the intervention of governments in the economy, e.g., how government policy affects individuals’ behavior or what is the government’s role in the allocation of real resources that includes, but is not limited to, government’s financial behavior. It provides a framework for analyzing whether or not public intervention in the market is needed and to what extent. Another definition from another perspective Political Economy lies on the boundary between Political Science and Economics: like Political Science it is interested in issues of Collective choice, Conflict and Institutions; like Economics, it focuses on outcomes rather than on processes. It is concerned on how the political environment affects economic outcomes. Public Economics and Ideology Organic view of government – Society is a natural organism Government is the heart. Individuals are parts of the organism that have significance only as part of the community, which is stressed above the individual. Mechanistic view of government – Government is not an organic part of society but created by individuals for individuals. Libertarians vs. Social Democrats: Role of government Government at a Glance: The Size of Government How to measure the extent to which society’s resources are subject to control by government. Annual expenditures Types of government expenditure – Purchases of goods and services – Transfers of income – Interest payments Budget documents – Unified budget: Itemized list of federal government revenues and expenditures. – Regulatory budget: Economic costs of government regulations. The Role of Theory Economic models Provide frameworks for thinking about the factors that might influence behavior. Generate hypotheses whose validity can be assessed through empirical work. Virtue of simplicity: it reduces a problem to its essentials. Empirical analysis: Analysis based on observation and experience. Used to test hypotheses. Causation vs. Correlation Conditions required for government action X to cause societal effect Y rather than just correlate (move together) with effect Y. – X must precede Y – X and Y must be correlated – Other explanations for any observed correlation must be eliminated The importance of the distinction for policy. – Example: There is a positive correlation between being married and wages…Does that mean government should enact a policy encouraging marriage as a way of increasing wages? Bear in mind that…Correlation does not imply causation! Empirical Work: Experimental Studies Experimental (or randomized) study: subjects are randomly assigned to either a treatment group or control group. – Treatment Group: Group of people who are subject to the intervention being studied. – Control Group: Comparison group of people who are not subject to the intervention being studied. Empirical Work: Experimental Studies Randomization improves the chances that the control and treatment groups have similar characteristics – Focus can then be on possible causation between treatment and outcome. Randomization has a large potential to eliminate biased estimates. – Biased estimate: conflates the true causal impact with the impact of outside factors. Pitfalls of Experimental Studies Ethical issues Technical problems Response bias Impact of limited duration of experiment Generalization of results to other populations, settings, and related treatments Empirical Work: Observational Studies Observational study – empirical study relying on observed data not obtained from experimental study Sources of observational data – Surveys – Administrative records – Governmental data Econometrics: statistical techniques to establish and estimate causal relationships in absence of randomization. Empirical Work: Types of Observational Study Data Cross-sectional data: contains information on individual entities at a given point in time. Time-series data contains information on a single entity at different points in time. Panel (longitudinal) data combines features of both. – Contains information on individual entities at different points in time. Pitfalls of Observational Studies Data collected in non-experimental setting – Difficult to ensure that the control group forms a valid “counterfactual” Counterfactual: the outcome for people in the treatment group had they not been treated. Specification issues – Not all variables that should be included are available in dataset and/or cannot be measured. Summary Economic theory provides a framework for analyzing the causal relationship between government policy and individuals’ behavior. Empirical work tests hypothesis arising from economic theory to determine if it is consistent with real-world phenomena. Various methods for conducting empirical work exist. Positive and Normative Theory Positive Theory explains the causes of an economic phenomenon Normative Theory states what should be done to reach certain results Normative Theory We can make a distinction between Goals and Tools. Goals can be fixed or flexibles. An economic policy model is controllable if the political authority can pursue its objectives. G1 = T1: the system is exactly determined; one goal - one tool G1 > T1: the system is underdetermined, and there will be infinite solutions - there are more tools than goals G1 < T1: the system is not solvable, as there are more goals than tools. The golden rule of Tinbergen (1966) The number of instruments available to the policymaker has to be at least equal to the number of objectives. In this historical phase there’s the widespread belief that a decentralized market economy is more efficient than an economy in which government intervention is large. Why? Thanks to the results of the Theory of Welfare Economics What is Welfare Economics? It is concerned with the social desirability of alternative economic states. It is composed by different streams of research: e.g., old and new welfare economics - The starting point is individual satisfaction (utility) and wellbeing. It studies how the structure of markets, and the allocation of economic goods and resources determine the overall well-being of society - This relates directly to the study of economic efficiency. What is efficiency? “Getting the most out of the resources used.” The particular sort of efficiency to which economists refer is the PARETO EFFICIENCY. The Pareto criterion It is a criterion for comparing alternative allocations of resources. The Pareto improvement: a group of people improves their satisfaction if, moving from situation a to situation b, at least one individual increases their satisfaction. The Pareto Optimality (allocative efficiency): if in situation C, all the possible Paretian improvements are exhausted, however, you move from C, it is impossible to increase an individual's utility without worsening that of at least another. Assumptions The Pareto criterion is based on the following assumptions: Utilitarianism: Each individual is the best judge of their own wellbeing The well-being of a society is given by the sum of the well-being of the individuals that compose it The well-being of society increases if the utility of at least one individual increases without worsening that of another