Download Econ 207 Comparative Economics and Financial Systems Prof Dohan

Econ 207
Comparative Economics
and Financial Systems
Prof Dohan
T/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
Means of Enforcement
 Self-enforcing
 Suburban residents cut their lawns
 Ethical rule
 Not selling customer defective goods
 Self-commitment
 Religion is a set of ethical rules
 Customs
 Informal social control
 Students do the assignments given by the
professor
 Corporate officers act in the interest of the
corporation (fiduciary responsibility)
 Private rule
 Organized private enforcement
 Rules accepted by the members of the
organization, eg stock exchange
 State law
 Organized state enforcement
 Full disclosure laws
 Anarchy
 Absence of any rules of the game
 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 nonrivalrous.
 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 17002000 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
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
income
Prices= ∆TC/∆Q
∆TC = change in total costs / change in
quantity = marginal cost
Q is a unit of homogeneous good (wheat, oil,
eggs)
Q* = equilibrium quantity
P* = equilibrium price
Quantity, Q
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.