Schemi di Introduction to economics

GAINS FROM EXCHANGE

Adam Smith, Wealth of Nation, 1776

It is the maxim of every prudent master of a

1. The necessity of exchange -> “

family never to attempt to make at home what it will cost him more to make

than to buy”. “It is the great multiplication of the productions of all the different

Opulence ->

2. arts, in consequence of the division of labor, which occasions, in a well

governed society, that universal opulence which extends itself to the lowest

ranks of the people” = all the humanity benefits from the efficiency of the

markets (the only type of communication between individuals)

“It is not from the benevolence of the butcher, the brewer, or

Selfishness ->

3. the baker, that we expect our dinner, but from their regard to their own interest.

We address ourselves, not to their humanity but to their self-love, and never

talk to them of our necessities but of their advantages” = the efficiency in using

resources derives from the pursuit of an individual own interests .

“How selfish soever man may

Selfishness 2 (“Theory of Moral Sentiment”) ->

4. be supposed, there are evidently some principles in his nature, which interest

him in the fortune of others, and render their happiness necessary to him,

though he derives nothing from it, except the pleasure of seeing it.”

“What improves the circumstances of the greater part can

Selfishness 3 ->

5. never be regarded as an inconveniency to the whole. No society can surely be

flourishing and happy, of which the far greater part of the members are poor

and miserable.”

Paradox of Easterlin -> finding that people in rich countries don’t report much

greater happiness than those in lower-income countries even though, in any given

country, the rich say they are happier than the poor.

The Protestant Ethic and the "Spirit" of Capitalism

Max Weber,

1. “Calvinist believers were psychologically isolated. Their distance from God could

only be precariously bridged, and their inner tensions only partially relieved, by

unstinting, purposeful labor.”

2. “Remember, that money is of the prolific, generating nature. Money can beget

money, and its offspring can beget more, and so on.”

3. “The ability of mental concentration, as well as the absolutely essential feeling

of obligation to one’s job, are here most often combined with a strict economy

which calculates the possibility of high earnings, and a cool self-control and

frugality which enormously increase performance.”

4. “spirit of capitalism is best understood as part part of the development of

rationalism as a whole”.

EX. Imagine the feasible frontier of two persons that can produce cheese and bread

in the same amount of hours.

Confronting the two graphs it is obvious that one is better at producing than the other.

It is convenient to specialize in the production of the good in which we have a

comparative advantage (where the opportunity cost is lower in absolute value vs

absolute advantage = higher production) and to gain from exchange.

GAINS FROM INTERNATIONAL EXCHANGE

1. Different bundle of goods than all the goods produced by domestic companies.

2. Additional benefits for the citizens can justify a change in the bundle of goods.

ALTERNATIVE ALLOCATIVE SYSTEMS

1. Based on rules or hierarchies -> the allocative problem Is solved by applying

a set of rules or by transmitting decisions from the top to the bottom.

a. religious and cultural traditions as feudal Europe.

b. Communist/socialist countries -> explicit economic calculation based

on national targets set by the government (EX. in the USSR a complicated

mathematic model which determined also the number of production).

c. Economy of the guilds of arts and crafts to ensure the livelihood of

their members (fair salary and fair price, production quantities, number of

apprentice, ban on hoarding for access to raw materials) = fair

competition.

2. Based on collective choices -> direct manifestation and respect for individual

will considering the objective of the conformity of the allocations to the

individual will of the members of the society, or social optimality

Classical liberal principle = “one head one vote”, unanimity vs majority ->

the democratic system is less efficient than the market.

If there is a majority, there is also a minority which needs are different from

majority’s ones = only a narrow realization of social optimality is possible (BUT

most of the time we search for an unanimous principle).

Pareto Allocation = Pareto Efficient -> given 2 allocations A e B, A is

preferable if at least one individual prefers A to B and no one prefers B to A ->

pareto efficiency allocation if there is no other allocation tant allows to

increase the well being of an individual without reducing that of another.

a. Pareto criterion = a desirable attribute of an allocation is to be Pareto-

efficient.

b. Pareto dominant = allocation A Pareto dominates allocation B if at least

one party would be better off with A than B, and nobody would be worse

off.

c. Pareto efficiency = an allocation with the property that there is no

alternative technically feasible allocation in which at least one person

would be better off, and nobody worse off.

d. Pareto improvement = a change that benefits at least one person and

doesn’t make anyone worse off (need to be voted at unanimity).

3. Market systems -> attributing economic power to the individuals and letting

them free to pursue the satisfaction of their needs.

Meaning of markets:

a. Institutional -> market = form of organization of the economic sphere

of society characterized by the private nature of the ownership of

resources and economic transaction.

b. Allocative -> market = one of the possible mechanisms with which

society faces the problem of satisfying individual economic needs ->

records, transmit and coordinates individual economic needs.

c. Operative -> market = set of places where individual economic

transaction take place concretely and operationally.

Type of markets:

a. Centralized markets -> physical location delimited and regulated,

central transaction management operator, many buyers and many

sellers.

b. Decentralized markets -> many points of buy and sell with free access,

bilateral transactions, many buyers.

Market conditions:

a. Competition = many producers and buyers -> perfect competition

market = ideal situation for the neoclassical theory that considers the

market as an allocative place.

b. Oligopoly = few producers.

c. Monopoly = only one producer.

d. Monopsony = only one buyer.

A market requires an institutional framework (= set of formal or informal

constraints that impose a structure on social interactions) that defines property rights,

codes of economic conduct, contractual tools and determines the nature and

modalities of interactions, who interacts with whom, with what title on the resources in

its possession, with what contractual power with respect to that of the counterparty.

Political Institution -> the rules, the manner of the use of force, the

 ways in which power passes from hand to hand, the degree of citizenship

rights.

Economic Institution -> set of rules of the economic games (protection,

 rights, contracts, regulation).

Karl Polanyi (from Bronislaw Malinowski) on the Trobriand Island -> kula trading =

system of trading, one of the main rules was the gift exchange before any bargaining

Indirect reciprocity

Failure of dominance and invariance

PROBLEM 4 (N=150): Imagine that you face the following pair of concurrent

decisions. First examine both decisions, then indicate the options you prefer.

Decision (i) Choose between:

A. a sure gain of $240

B. 25% chance to gain $1000 and 75% chance to gain nothing.

Decision (ii) Choose between:

C. a sure loss of $750

D. 75% chance of losing $1000 and a 25% chance to lose nothing.

PROBLEM 3 (N=86): Choose between:

E. 25% chance to win $240 and 75% chance to lose $760.

F. 25% chance to win $250 and 75% chance to lose $750.

It is evident that option F dominates option E, but making some calculus it results

that option F is the combination of options B and C, which are normally the less

preferred.

Asymmetric dominance – marketing strategy -> selling a product that it makes the

more expensive more valuable and preferable.

Measuring an economy = per capita income/per capita gdp.

Higher economic growth countries:

High protection of property rights and enforceability of contracts.

 High efficiency and low corruption of bureaucratic apparatus

 Political stability

 Protection of civil rights and democratic representation

 Low crime levels

 Low levels of racial segregation and discrimination

 High level of trust

 Efficient financial markets.



Per Capita Income -> the problem of income distribution and inequality.

THE CONSUMER THEORY

Consumer = household -> possess the means of production, holder of the income

from the use of factors, use incomes to satisfy needs.

General Situation = all the wages is transformed into consumption, no savings.

Satisfaction of needs = extracting utility

The goods which prices increase are replaced by goods that satisfy the same

 needs and have lower prices (change in the composition of the consumer

bundle).

As disposable income increases, the consumption of all the goods in the bundle

 increases, especially those of higher quality (change in the quantity of goods in

the basket).

The rational choice -> the household choses the optimal action such that the

associated consequence is the preferred one.

Three characteristics for the action of a household:

Household goal = maximum possible benefit.

 Constraint = availability of resources.

 The family is price-taker = doesn’t control the market and cannot influence it.



THE BUDGET CONSTRAINT

The relation that express all the possible combination of goods which total value

doesn’t exceed income.

Constraint equation -> Income = Expenditure for Consumption + Direct Taxation +

Savings (by hypothesis Direct Taxation and Savings = 0 I = E



Considering the case of the choice between two goods which prices are Pa and Pb and

quantities Qa and Qb

I = E = QaPa + QbPb

It represents a line where I/Pb is the intercept on Qb and I/Pa is the intercept on Qa

and Pa/Pb is the slope.

Qb = -(Pa/Pb)Qa + I/Pb

Given two point A e B

PaQa1 + PbQb1 = PaQa2 + PbQb2

Pb(Qb2 – Qb1) = -Pa(Qa2 – Qa1)

PbDeltaQb = - PaDeltaQa

DeltaQb/DeltaQa = -Pa/Pb (relative

price of the goods) slope of the



budget line = opportunity cost for a.

Variation in the Budget Constraint

Changes in income -> the increase produce a parallel shift to the right, a decrea