Econ model project
saizo0816
TheoryofCapitalismSpr191.pptxTheory of Capitalism
The Moral Philosophers
Hobbes; The Leviathan (1660)
Advocates an all powerful, “Leviathan”, state.
Competition is “a condition of nature” and “war of man against man”.
An unaccountable sovereign is the remedy for the disorder of nature.
The Leviathan’s subjects should accept the “peace and defense” that state power to “terrorize” brings.
Locke; Two Treatises of Government (1689)
Advocates a limited state.
Natural Rights
Property is a natural right derived from the addition of value.
Man has a right to defend his “life, health, liberty, or possessions”.
The Social Contract
Legitimate government is governed to protect their natural rights.
Citizens submit to determination of the majority and have no obligation to obey a government that violates the contract.
Should a government exceed its power, citizens are justified in dissolving government and returning to “Original Liberty”
Thomas Hobbes
1588-1679
John Locke
1632-1704
The Moral Philosophers
Smith; The Wealth of Nations (1776)
Considered the “Father of Economics”
Refutes Hobbes notion of self-interest as destructive
“It is not from the benevolence of the butcher, the brewer, or the baker,
that we can expect our dinner, but from their regard to their own interest”
Invisible Hand
A highly efficient and harmonious economic system is the result of competitive markets functioning freely without government intervention.
Laissez-Faire
A policy that the state should not intervene in private economic transactions except in strictly limited cases.
Opposed Mercantilism as a restraint on trade, specialization, and prosperity.
The belief that a nation’s prosperity required protecting and seizing important natural resources.
Mercantilists promoted a strong government to protect the nation’s wealth.
Adam Smith
1723-1790
Institutions of Capitalism (Rules of the Game)
Property Rights---Private
Typically enforced through the Rule of Law and Constitutional limits on Government.
Decision-Making Arrangements---Decentralized
Information and resources allocated by individuals and small-scale organizations.
Economic Coordination---Markets (simple and complex)
Voluntary exchange between buyers and sellers in free markets.
Includes markets to channel savings into investment such as financial intermediaries and financial markets.
Incentives Mechanisms---Material and Moral
Positive, rather than negative, reinforcement.
Public Choice System---Democracy
Typically a representative democratic form.
Market Allocation & Efficiency
Competition: many buyers and sellers keeping prices flexible to pursue equilibrium.
Efficiency: Allocating resources such that benefits exceed costs; equilibrium in the market.
Markets & Information
Mises and Hayek’s Information Economics
Analyzes how markets cause specialization in the generation and utilization of information.
The principal economic problem is not how to allocate resources but rather to generate the information necessary to allocate those resources.
It is a problem of compiling knowledge not available to any one individual in its entirety.
The principal advantage of capitalism is its ability to generate information in the form of prices which enable producers and consumers to plan their actions in a rational and efficient manner.
F.A. Hayak
1899-1992
Market Failures & State Intervention
Monopoly
The emergence of a single producer of a product limited or no good substitutes.
Inefficient: market produces less output at higher prices.
Productive Inefficiency: lower level of output causes higher average costs.
Allocative Inefficiency: lower level of output implies some consumers willing to pay more than it costs to produce will not get the good.
Deadweight Loss: Overall, the gains to the monopolist are less than the losses to the consumer creating a net loss in efficiency for society.
Government Solutions
Regulate by setting mandates for output levels and prices charged.
Risk: Regulatory Capture; when regulators favor the interests of the monopolist rather than the interests of the public.
Anti-Trust Legislation to break-up or prevent monopolies from forming.
Market Solutions
Monopolies may be “natural” and create scale economies in production.
Creative Destruction may eventually eliminate monopoly power as profits are too enticing to competitors.
Consumer resistance may limit monopolists from exerting power.
Market Failures & State Intervention
Externalities
Occurs when market transactions affect uninvolved third parties.
Inefficient: market produces too much or too little output.
Positive Externality:
Private Benefits < Social Benefits; market will produce too little of a good.
Negative Externality:
Private Costs < Social Costs; market will produce too much of a good.
Government Solutions
Tax and Subsidize
Subsidize when market produces too little.
Tax when market produces too much.
Regulate
Augment private production of goods that generate positive externalities.
Set a quota on goods that generate negative externalities.
Cap and Trade (hybrid of market and government).
Market Solutions
Coase Market: If transaction costs are low and market participants have full information, voluntary exchange may occur to eliminate externalities.
Ronald Coase
1910-2013
Market Failures & State Intervention
Public Goods
Goods that are non-excludible and non-rival in nature.
Causes a Free Rider problem.
Inefficiently produced: markets produce too little or none.
Government Solutions
Replace market production with state production.
Risk: Government Inefficiency
Public Choice Economics
Studies the efficiency of public decision making in Capitalist-Democratic society.
Median Voter Theorem
Candidates that win elections have a policy position closest to the “typical” voter.
Reduces diversity of political representation.
Rationally Ignorant Voter
Voters lack the information necessary to make efficient decisions.
Log-Rolling
Quid pro quo arrangement to sponsor specific legislation.
Pork Barrel Legislation
Unrelated legislation packaged up and voted on in a single bill.
James Buchanan
1919-2013
Market Failures & State Intervention
Income Distribution
Natural Justice Proponents
Income distribution should be based on a worker’s Marginal Revenue Product.
The more productive you become, the higher your income.
Material Incentives serve to increase productivity.
The needy will be served through private charity.
Natural Justice Opponents
Marginal Revenue Product is influenced by complimentary resources each individual may not have contributed themselves (e.g. access to education & public infrastructure)
Private charity may be insufficient to care for needy (free-rider problem).
John Rawls “Veil of Ignorance”
Hypothetical scenario in which people would be born without any clue of the advantages of disadvantages that lay before them in life.
In this scenario rational people would choose an equal distribution of income to ensure they are not impoverished.
Society should therefore pursue an equal distribution of income.
Profits: a reward for risk-taking or exploitation of the worker?
Arthur Okun’s “Leaky Bucket” from redistribution.
John Rawls
1921-2001
Arthur Okun
1920-1980
Market Failures & State Intervention
Macroeconomic Instability
Classical Theory (Pre-Great Depression)
The business cycle is not endemic to a capitalist system.
Markets automatically equilibrate.
Say’s Law: supply creates demand so all that is produced is bought.
Keynesian Theory (Post-Great Depression)
The business cycle is endemic to a market system.
Market economies do not automatically equilibrate.
Rejected Say’s Law: demand creates supply so surpluses and shortages are common.
Keynesian Revolution
General acceptance of Keynes proposition that governments must actively counter economic downturns with demand-side policies.
Policy Activism
Policies to prevent or minimize the business cycle.
Monetary Policy: use of a Central Bank’s control over the money supply to stabilize the business cycle.
Fiscal Policy: use of the government’s control over taxation and spending to stabilize the business cycle.
John Maynard Keynes
1883-1946
Jean Baptiste Say
1767-1832
Market Failures & State Intervention
Macroeconomic Instability
Friedman’s Monetarism (1970s and early 80s)
Accepts classical tenets and rejects policy activism as destabilizing.
Contends price stability is critical to economic stability.
Government should only use Monetary Policy to stabilize prices.
Lucas’s Rational Expectations (late 80s-present)
Accepts classical tenets and rejects policy activism as impotent.
Individuals use all available information to try to anticipate the future, eliminating the long-term effectiveness of fiscal and monetary policies.
Milton Friedman
1912-2006
Robert Lucas
1937-present
Two Different Versions of Capitalism
Heirs of Marx & Hobbes
Concerned with market exploitation and market distribution of income/wealth
Democrats
Progressives
Socialists
Heirs of Locke & Smith
Concerned with state exploitation and redistribution of income/wealth
Republicans
Libertarians
Anarcho-capitalists
Relative Performance of Capitalism
Efficiency
Relatively high efficiency
Consumer Choice and the Profit Motive lead productive endeavors to be undertaken and unproductive ones to be rejected.
Monopolies, externalities, and limited public good production reduce overall efficiency and need to be dealt with via government or complimentary market forces.
Stability
Stable: Classical, Friedman, and Lucas: minimal role for government.
Unstable: Keynes: larger role for government.
Income Distribution
Unequal distribution of income.
Often touted as “fair in opportunity” but “unfair in outcome” but assessment is subjective.
Economic Growth
High growth from dynamic efficiency and intensive growth.
Lower due to savings/investment being at the discretion of individuals instead of state.
Viability
TBD but currently has survived centuries with no evidence of impending collapse.
Today, represents the dominant system across the globe.
