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INTRODUCTION
1. Economic Analysis
Economic analysis can be classified into two broad categories:
 Positive analysis: trying to understand economic behavior. This typically involves the estimation of the
decision rules used by decision makers. This can focus on private decisions (e.g., production,
consumption, investment decisions) as well as public decisions (e.g., government decisions). Also, it
can be applied at the individual level (micro economics) as well as the aggregate level (macro
economics). This helps better understand the economic behavior of individuals, markets, or public
institutions (e.g., government agencies). Also, this often helps make better predictions about the future.
 Normative analysis: evaluating the "optimality" of current decision rules and/or making
recommendations about particular economic or policy decisions.
This course focuses on normative economic analysis. Normative economic analysis means
evaluating the welfare of economic agents involved in an economy: private firms producing goods and
services (including trading services), consumers, and public institutions (e.g., government agencies). In this
context, the question is: how to evaluate the "optimality" and desirability of particular policies and
allocation schemes?
2.
Efficient Allocation
An allocation is said to be efficient if it satisfies the Pareto optimality criterion: Resource
allocation is Pareto optimal in a given group if it is not possible to make someone better off without
making some else worse off.
Example: A pure exchange economy with 2 individuals (say A and B) and two goods (the "Edgeworth
box"). The Pareto optimal allocations are the set of points where the marginal rate of substitution between
the two commodities is equal for each individual. In general, there are an infinite number of such points,
going from giving all the resources to individual A to giving all the resources to individual B.
One advantage of the Pareto efficiency criterion is its generality: it can be applied to any economy.
For example, it does not require that markets exist. And it does not specify the nature of institutions
supporting the economy. As such, it can involve various levels of centralization, going from very
decentralized allocations (e.g., the case of market participants in competitive markets) to very centralized
allocations (e.g., the case of centralized governments).
However, the empirical evaluation of the Pareto efficiency criterion can be challenging, especially
if it involves evaluating the welfare of many individuals. A major part of the course will focus on the
conceptual and empirical evaluation of Pareto efficiency. In other words, we will provide the conceptual
and empirical framework to answer the question: how do we know that a particular allocation or policy is
"efficient"?
3.
Welfare Theorems
In the economic literature, the so-called "welfare theorems" establish that, under complete
competitive markets, a market economy generates a Pareto optimal allocation of resources.
Note 1: Under competitive markets, relative prices are equal to the marginal rates of substitution (or
marginal rates of transformation for producer goods) among commodities.
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Note 2: If complete markets do not exist, there is often treated as a case of "market failure" which results
in inefficient resource allocation. And if markets are not competitive (the case of oligopolies/oligopsonies
or monopolies/monopsonies), the resulting resource allocation may not be efficient. In these situations, the
welfare theorems can be interpreted to mean that, in general, a market economy without "government"
would not generate a Pareto optimal allocation of resources.
4.
Distribution Issues
Pareto optimality is a rather "weak" criterion since it can generate an infinite number of efficient
allocations. This raises the question of choosing among Pareto efficient alternatives. It involves choosing
how to distribute resources and welfare among individuals. Thus, the analysis of resource allocation is
often divided into two steps:
1/ Identify Pareto improving moves that would get us to the Pareto efficiency set. This is
"efficiency analysis". A major part of the course will consist in the conceptual and empirical evaluation of
economic efficiency.
2/ Choose a point on the Pareto efficiency set. This involves the analysis of distribution issues.
This will be addressed in this course through the evaluation of the role of "bargaining" and of "fairness" in
welfare analysis.
5.
The Role of Government
Throughout, we will use the term "government" to represent all public institutions involved in
public policy and projects. This can include local public agencies, national government, as well as
international agencies (e.g., the World Trade Organization, WTO). The government can provide "public
goods" to individuals: infrastructure (e.g. roads and communications); maintenance of law and order;
provision of information (e.g., agricultural research and extension); etc.
However, government activities tend to stimulate rent seeking behavior. Rent seeking behavior can
take several forms:
 the use of resources to capture privately the benefits of property rights created by governmental
activities.
 lobbying cost: the beneficiaries (victims) of government policies tend to organize to support (oppose)
such policies and lobby for increasing gains (reducing losses) generated by such policies. For
example, exporters (importers) typically lobby against (in favor) of tariffs or quotas on trade.
 bureaucratic advocacy: those individuals administering government policies tend to become advocate
of these policies.
 some government agencies can end up serving the interests of specific groups ("special interest"
groups).
Note that rent seeking behavior can be legal as well as illegal. Some economists believe that the
social cost of rent seeking behavior is large, leading to "government failure". In this context, the existence
of a "market failure" is not a sufficient condition to justify government intervention.
What is the comparative advantage of government? Government tends to have a comparative
advantage:
 when the services provided by government are highly valued.
 when governmental actions have low costs.
 when bureaucratic input is small (thus minimizing bureaucratic advocacy).
 when scope for rent seeking behavior is limited.
 when the implications of government policies are transparent (i.e. with low information cost).
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