Econ 207 Comparative Economics and Financial SystemsProf DohanT/Th 1:40-2:55

4 components of the course

Quizzes (20%)

Quizzes will be announced a week in advance.

Midterm (20%)

The date for the midterm is in the syllabus.

Reports, including the final report (30%)

Will be assigned throughout the semester, approximately 4 reports and 1 final report about 1-2 pages.

Final exam (30%)

Date will be announced later.

Different types of economic systems in terms of:

Institutions

Various types of resources (private-type versus public-type)

Decision-making systems (market v. centrally planned v. traditional)

Information systems (completely centralized v. completely decentralized or something in between)

Distribution systems (markets and prices v. traditional distribution v. rationing from the center)

Financial and monetary systems

Infrastructure

Institutions

Institutions are Rules of the Game or more fundamentally are the humanly devised constraints that shape human interactions. In consequence, they structure incentives and human exchange, whether political, social or economic.

They include customs, voting procedures, legislation, organization the political, social and economic rules that affect the way people deal with each other in exchange of private or public goods.

Societal Institutions: The Rules of the Game

Type of Rule Convention

Physicians not charging for referrals

Suburban residents cut their lawns

Ethical rule

Not selling customer defective goods

Religion is a set of ethical rules

Customs

Students do the assignments given by the professor

Corporate officers act in the interest of the corporation (fiduciary responsibility)

Private rule

Rules accepted by the members of the organization, eg stock exchange

State law

Full disclosure laws

Anarchy

Absence of any rules of the game

Means of Enforcement

Self-enforcing

Self-commitment

Informal social control

Organized private enforcement

Organized state enforcement

No rules at all

Organizations

Is an administrative or functional structure formed for particular purpose.

We are interested in organizations:

That produce goods and services

Participate in political decision-making

Organize the exchange of factors of production

Organizations can be simple or extremely complex.

Organizations include non profit organizations, churches, charities, clubs

Complex organizations are usually organized in hierarchy, which divides an organization into superior and subordinate levels. The person in higher level is superior to subordinates in lower levels.

Public choices studies how political system is organized, tax citizens and spend public resources.

Organizations have certain characteristics:

Their goals or purposes for existing

How they deal with information

Their behavioral rules

Their decision-making arrangements

Their ownership structure

Types of Institutions

Property rights

Decision-making arrangements

Market Versus Plan: Institutions for the provision of information and for coordination

Incentive mechanisms for setting goals and for inducing people to meet these goals

Procedures for making public choices

What is an economic resource? Resources are either physical goods or intellectual concepts that are used in the

production of goods and services.

Labor who are able to work. (more on labor force later)

Natural resources: often referred to as “land,” but actually includes

Agricultural lands, which in turn arable lands, meadows and forests.

Water resources and fisheries

Minerals, such as iron ore, gold, sand, oil

Capital is at any given time always limited in quantity and is an input to production that is also an output from production. Examples are physical structures, machinery, a herd of livestock, physical inventory.

The stock of capital = ∑(investment – depreciation)

Human capital: is the work experience and education of the labor force.

An experienced farmer

A building engineer

Computer programmer

Technology is knowledge about how to do things or makes other resources more productive.

Building a steam engine

Private type versus public type goods and services

Private type good or service: if used by one person cannot be used at the same time by another person. Examples: food, housing, clothing, books, computers, cell phones. These types of goods are at the core of most economics taught today

Public type good or service: non rivalrous which means if used by one person, it can also be used at the same time by another person. Examples: TV broadcast, cell phone signals, lighthouse, street lights, software, downloadable music.

Macro and micro economics as taught today is principally the theory of production and distribution of private type goods and services and resources. This course focuses on public type goods and how important they are in our quality of life.

More on economic resources Technology is a public type resource which use is nonrivalrous.

Technology has been a major source of economic growth because its use is non-rivalrous.

Same technology can be used to produce many copies of the same machine.

Technology is also often transferred to countries by “embedding” it in a machine or raw material.

A major problem with technology is that it is difficult to prevent copying the technology that was very expensive to develop. Many medical drugs are produced and sold by India at a small fraction of their US price.

Technological progress, it can be argued has accounted for or made possible 100% of economic growth because it has led to

More productive capital

More efficient ways of organizing labor

More efficient ways of finding and exploiting natural resources.

More on economic resources

Land, labor, capital and human capital are private type resources with rival uses.

To have socio-economic growth, we have to increase the supply of one or more of these private type resources.

These resources can be substituted for each other in production (Iso-quant)

The most important characteristic is they are each subject to law of diminishing marginal return.

The law of diminishing marginal return means that if you hold all other resources constant, each additional unit such as labor will eventually increase output by smaller and smaller amounts.

The law of diminishing marginal returns creates the Malthusian result that population growth, ceteris paribus, can run up against the barrier of limited food supplies.

Thus the concept of subsistence level of output is an economy that produces between 1700-2000 calories per person per day in order to sustain life.

The corollary of this is that output greater than 1700-2000 calories per day could be saved and used to produce other things including capital.

Decision-making systems An institution required to decide on and allocate resources to produce

sufficient amount to continue on to the next period.

Market system is primary method of decision-making method using private incentive systems (prices, profits, individual purchase and offer of resources for use)

Democratic system (or some sort of government system) (Congress, Parliament) for deciding on the use of output (private versus public), who pays for public goods, education systems and safety nets (tax systems), provision of “safety nets” for old age and disabled.

Traditional system (based on what “people” did in earlier times)Roman times, most economies up through early 1800’s

Mixed market system using markets, political system, expert management, charitable organizations, public opinion, etc.

Planned system based usually on dictatorship.

Information system

Are institutions and organizations that collect information about needs and resources.

Decentralized system is a market system which uses prices to measure relative ones and supply in each market of good or service. Essentailly planned economy attempts to measure statistical or planning apparatus of production capabillity of the economy and how they compare to the centralized target of the planner of ruler.

Distribution System

Distribution system is a system of institutions and organizations that distribute the output or resources according to various rules.

A market system distributes resources and output according to profit maximization and prices which measures the utility or benefit that the buyers will get and sellers will be paid.

A rationing system takes existing output and distributes it according to whether people have permission to receive the good or not.

Financial Systems

Financial systems are set of institutions and organizations that perform three basic functions:

The use of money as a medium of exchange to facilitate the distribution of goods.

To facilitate the deferral of purchases or payments to a time in the future.

To act as a unit of account to help people compare the relative costs of various goods and services.

Infrastructure Refers to the physical capital in a society used to perform many functions.

Roads, railroads, airports, ports are all crucial infrastructure that permit the transportation of goods and services.

Buildings such as houses are private type goods. Buildings used for housing are part of the capital stock

If you think about it our housing stock in this country provides us with an immensely important service far beyond the value of housing evaluated in United States GDP.

Educational buildings are immensely important infrastructure to provide a place of instruction. In a modern economy you will find many other types of infrastructure, traffic signs, parks, museums, hospitals, laboratories, which are not found in any great supply in less developed economy.

Communication infrastructure is relatively new, mostly 19th century with the development of the telegraph, the telephone, cellphone, radio, TV etc.

The lack of infrastructure is one major reason that an economy is not able to grow especially if it is due to a weak transformation and communication infrastructure.

The role of government

The government must provide law and water for any economy to succeed. The role of government is heatedly debated in the united states. We know that bad or corrupt governments retard economic growth. Most important thing the government should provide is fair and equitable common law.

How an economic system actually works?

A dynamic picture of the economy and its components:

Buyers have the desire to buy a good or service and the means – money or credit – to buy the goods they want based on the marginal benefit they are getting from the last unit bought.

Sellers want to sell any quantity that they can produce up to the quantity where the price covers the marginal cost of the last unit produced.

A market equilibrium is reached when the quantity demanded at that price equals the quantity supplied at that price. Thus the quantities bought and sold of a private type good depends on its price, marginal utility to the buyer and marginal cost to the seller.

If the quantity is larger or smaller than the equilibrium quantity we have a deadweight loss.

Producing too much of a private type good means that the buyers are not willing to pay the full marginal cost of production beyond the equilibrium point.

Too much output is produced, resources are being wasted

Producing too little of a private type good means that buyers are deprived of the opportunity of buying the extra amount of goods at a price greater than its marginal production cost.

Too few resources are being used

A Graph of market equilibrium for a private type good

Price, P

Quantity, Q

D S

P*

Q*

Assuming price paid by the buyers = price received by the seller

Priceb= ∆B/∆Q∆Q = change in total benefits / change in quantity∆B = change in consumers utility, buyers net incomePrices= ∆TC/∆Q∆TC = change in total costs / change in quantity = marginal costQ is a unit of homogeneous good (wheat, oil, eggs)Q* = equilibrium quantity P* = equilibrium price

Conclusion: buyers and sellers by observing market prices buy and sell the amount of output where the marginal cost of last unit sold equals the marginal benefit of last unit bought. This is true only for goods, services and resources that are entirely of a private type.

Deciding on who makes economic decisions

Most modern economies post 1990s have decided to let the market system as a whole answer the questions of what to produce, how to produce and for whom to produce.

Governments interfere more or less in the market system by

Collecting taxes and other revenues

Distributing subsidies

Safety net payments

Regulating the economy

National income taxes affect

The payment for current government goods and services

Income distribution (Lorenz curve)

Payment for infrastructure

Payment for public goods

Fundamental theory of economic growth

Allocating sufficient resources to growth inducing activities through a combination of taxes and monetary policies, rule of law and encouraging thrift and education, proper balance of private-type goods and public-type infrastructure, etc.

Economic growth depends on:

Adding physical capital with higher levels of investment

Adding and improving human capital (education, apprenticeships, libraries)

Investment of technological progress

Better management of natural resources, labor, capital and infrastructure.

Improved infrastructure

To that list we have to add the following:

Improved health of the population

Improved administration of laws, and justice

Greater freedom of scientific research

Enforcement of property rights, absence of violence, improvement of income distribution ( to some extent)

Models can be Extensive (Common with technological progress) or Intensive (using more and more resources to produce more goods).

Some abstract models of economic growth

Malthusian model of population and growth with limited land and diminishing marginal product of labor.

Harrod-Domar Model of growth dependent on capital with unlimited labor

Models with various degrees of input substitution and technological progress using Cobb-Douglas Production Functions which exhibit “diminishing marginal product if one or more inputs are fixed (ceteris paribus assumption) and increasing, constant and decreasing returns to scale.

Growth dependent of rate of accumulation of capital and technological progress

Saving and depreciation rate (Solow model and W Arthur Lewis Model)

Romer model modified by Romer ‘s assumption of public type knowledge and technology progress that also could exhibit increasing returns to scale.

Comparative system model (Gregory and Stewart. Heilbroner and Milberg) where the growth of output depends greatly on the different institutions, rule of law, as well as the population’s propensity to save, get educated and social mobility.