Neoclassical Model and Alternatives Flashcards
Utilitarianism
-Happiness/well being/welfare/satisfaction
AC Pigou (1877-1959)
- Goal is to maximize aggregate utility or welfare
- Argued that a given sum of money makes a bigger difference un utility to a poorer person than it does to a rich person (diminishing marginal utility of income)
- Assumed that the relationship between income and utility was similar across individuals
- Favored egalitarian policies even though he didn’t care about equality for its own sake, but only for its effect on aggregate utility (modest tendency)
- Oppose policies that increase inequality
Diminishing Marginal Utility of Income
-As income increases, utility increases, the increases diminish
How should people be compensated?
-By their skill set/experience
What does different salaries provide?
-Provides incentives and competition
What kind of distribution maximizes aggregate utility?
-Equal distribution
Equality would _______________
-Take away incentives to work or develop a better skill set
Distribution of income affects _________, because differences in income provide __________
- Productivity
- Incentives for work and investing in building skills
Lionel Robbins (1898-1984)
-Argued that it’s impossible to measure utility accurately, but that emotions felt by one human being are fundamentally different from those felt by others``
Accepting Robbins’ Argument
-The only way to be sure that a policy increases utility is if it makes at least one person better off, without hurting anybody (pareto improvement)
Pareto Improvements
-Very rare in the real world, most policy proposals have both winners and losers (Ex. Healthcare)
How is economic value measured?
- By the willingness to pay for receiving a benefit, or to accept payment for a bearing cost
- A change that increases economic value makes it possible for the winners to compensate the losers, thus creating the potential for a pareto improvement
Which class of people are more willing to pay more for any given benefit?
-Wealthier people
Actual Pareto Improvement
-Paid for
Potential Pareto Improvement
-No intention of paying for compensation
- Ex. Nixon Administration- start using cost benefit analysis in policy making:
- -Compared safety regulations between planes and cars
Robbins’ Criticisms of Utilitarianism
-Paved the way of mainstream economics to switch its focus away from aggregate happiness in favor of maximizing aggregate economic value, using the creation of potential pareto improvement as justification
Assumptions of Neoclassical Model
- Economic agents are self-interested
- Economic agents are rational (People make choices that serve their own interests)
- Utilities are independent (No altruism; No desire to harm or out-perform others)
- Preferences are determined exogenously (Can’t model efforts, such as advertising, to shape preferences)
Daniel Kehnemann
-Rejects Neoclassical assumption that individuals are perfectly rational, in favor of the idea of “bounded rationality”
Herbert Gintis and Samuel Bowles
-Argue that human beings have evolved norms of “strong reciprocity” which foster competitive behavior
Norms
-Standards of behavior, rules
Nudge Theory
-A small change produces large effects of behavior
