Download 2016-2 Maximizing Wealth

Maximizing Wealth Means
Maximizing What Others See as
our Wealth.
Wealth is what we value and we assume in macroeconomics that if everyone is at
least as well off as they used to be, but some are better off, then we have added to
the wealth and we will continue to add to wealth until we reach a point of
satisfaction or satiation given what we can afford.
What we can afford is determined by what we are willing to give up in order to produce
what we are good at and trade it with the rest of the world, which in recognizing the
value to them of what we can offer, are willing to support our relative wealth.
What we value is determined , in turn , by our tastes and preferences which leads us
to utility maximization in a microeconomic sense and therefore to a wealth
maximization position in a macroeconomic sense.
This collective hedonism is aggregated over all economic actors and it is assumed
that there will exist a representative agent acting in an economic fashion that holds
the predominant tastes and preferences of all members of the macro economy and
therefore seeks to maximize wealth in the same way as any individual would
maximize utility with the same economic results.
Graphics of Wealth Maximization
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For A*B* we have wealth W* For A’ B’ we have Wealth W’ so W’ is preferred
to W* for a Representative Agent or “Citizen”
Wealth
All Other Goods
(B)
B’
W’
B*
W*
A*
A’
The Good Analyzed
(A)
Analytics of Wealth Maximization
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For W* we have a trade off of A*/B* and for W’ we have a trade off of A’/B’.
These are the prices of A in terms of B.
If A*/B*=A’/B’ then the wealth curve is a straight line
If A*/B* < A’/B’ the wealth curve is diminishing as we move along it.
If A*/B* > A’/B’ then wealth is increasing as we move along it.
Because we observe that A*/B* < A’/B’ we support that wealth delivers
decreasing marginal returns.
This means that when we let all other goods be represented as money and
we plot only two dimensions we have wealth contours that are “concave
with respect to the origin” and that each contour represents a level of wealth
increasingly higher as we move away from the origin.
Moreover any point along that curve is “indifferent” to any other point such
that the citizen is just as happy with a combination of A” B” as with A’B’ if
they are both on the same “iso-wealth curve”.
But A^B^ is preferred to either A’B’ or A”B” if A^B^ is on a higher “iso-wealth
curve”.
Iso-wealth curves
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A’B’ = A”B” because they are on Iso-wealth curve I but A^B^ is >A’B’ and A^B^>A”B”
because A^B^ is on iso-wealth curve II
All Other Goods
(B)
B’
B^
B”
II
I
A’
A”
A^
The Good Analyzed
(A)
The Link to the Aggregate Demand
Curve
• As we change the price of one good in terms of another and use
money as the measure we can plot the quantity of the analyzed
good A versus its price.
• Note as the price of Good A increases we can get more of Good B
for each level of utility as a result the quantity of A falls as it’s price
increases. Thus the demand curve is downward sloping.
[If the demand curve were upward sloping it would imply that as the
price rises we would see greater quantity consumed and that would
perhaps work for a “snob” good.]
[Note also that we could consume more of A and B if income rose. If
income increases as we consume more that is called a ”normal”
good. If it falls as income increases we call it an “inferior” good,
We will deal only with “normal” goods.]
We Assume Rationalization of
Markets in Wealth Maximization
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Markets are rationalized when we participate in market activities only for things that we consider
to be “good” as we would not be making ourselves more wealthy if we pursued things that are
“bad” or not relevant to our lifestyle.
Thus we have predominant tastes and preferences that are reflected in the goods that are
produced and this sends a signal to other parts of the world of the cultural values that our
economy holds. In order to access our cultural values they must purchase what we have to offer
with what they offer because they value it locally. If the goods in a trading partner’s cultural
economy are useful in our economy then they will value what we have to offer on the basis of how
much of their production they are willing to give up to gain some of our production. Wealth can
only be maximized in terms of a trading rationalization amongst states.
Wealth must also be rationalized between the current period and a following period or set of
periods given that temporary surpluses may provide us with the opportunity to set aside
something for the future and that places a value or a price on today’s goods with respect to
tomorrow’s goods. Wealth can only be maximized in terms of an efficient market for savings
and investment.
Wealth must also be managed by a benevolent or widely supported government that maintains
the security of the state and the welfare of its citizens such that others have confidence in the
stability and “rightness” of its economic choices. Wealth can only be maximized in a peaceful
setting wherein the government adds and subtracts resources according to the welfare
needs of its citizens.
The Aggregate Demand Curve
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This is a record of the quantity of a good demanded from the market as the price
changes. It is downward sloping and has several key elements.
There is reservation price at which a good is offered for sale for the very first time.
There is also a saturation quantity at which the market will not pay anything at all for
the good.
The demand cure represents both the ability of consumers to demand a product from
the market and also the willingness (based on preferences) to pay any price between
the reservation price and the saturation quantity.
This is the total surplus that consumers dedicate to this market. It is the implicit value
based on how good A is valued in terms of all other goods B. If such a trade off were
not made there would be no market at all for good A so the price of A is a “true”
reflection of the value of A within the economy when each individual preference
choice of each individual consumer is simply added up.
This is also a disciplined market in the aggregate recognizing
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that other countries may also produce the good and the landed price of an imported good
rationalizes what consumers are able and willing to pay for this good.
That there is a need for stability into the future that is supported by a freely functioning
banking system that supports and encourages savings and investment.
That there is benevolent government that supports the welfare of its citizens.
Aggregate Demand Curve
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Economic Surplus is Wealth when it is typical of a nations economic choices relative to the rest
of the world, to the future, and to the welfare of its citizens.
Price of A
Reservation Price
Economic Surplus = Wealth
Saturation Quantity
Quantity of A
Endowment Impacts on Aggregate Demand
Differences in geography, culture and climate have a profound impact on the
potential for an economy to produce a set bundle of products even if they are more
valued than they are in another location. Combined with the level of technology and
the security and confidence in the rules under which trade is conducted in that
economy leads to a set of varying bundles that are feasible to produce. This set of
bundles is known as the Production Possibilities Curve(PPC).
The PPC is the boundary of efficiency (the lowest possible input set for the
greatest combination of goods) and also the boundary of effectiveness (the
greatest availability in terms of infrastructure for the greatest combination of goods).
It is therefore convex with respect to the origin. Therefore when the price from the
aggregate demand line (which is always linear) is tangent to the PPC there is an
equilibrium point at which the representative agent is satiated with the amount of
production and the value of that production and this point is both efficient and
effective.
As a result the wealth is optimized as is the welfare of the macroeconomic economy
at this equilibrium point.
The Production Possibility Curve
Good A
Production Possibility
Curve
A*
Allocation A*:B* is efficient
and effective for Aggregate
Demand and the Production
Possibility Curve
Aggregate
Demand
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B*
Good B
Similarities to Consumer Demand
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The Consumer Demand and the Aggregate Demand are analyzed in the
same way and have equilibria that are both efficient and effective but have
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International Markets
additional requirements in the Aggregate for
Banking and Finance
Political Stability of The
Government