What’s unit 5 about?
The influence of institutions on the balance of power in economic interactions as well as the fairness and efficiency of the allocations that result.
What helps evaluate economic institutions
criteria of efficiency and fairness can help evaluate economic institutions and the outcomes of economic interactions
Institutions =
written + unwritten rules which govern what people do when they interact in a joint project, distribution of products of joint effort.
- how the game is played, size of total payoff available to participants, how total is divided.
- Essentially determine power of individuals to get desired.
Pareto criterion
Allocation A dominates B if at least 1 party would be better off with A than B and nobody is made worse off to go from B to A.
- an allocation not Pareto dominated by any other allocation is described as Pareto efficient
- Does not allow us to make a conclusion on which outcome is better
Allocations can be deemed unfair due to:
- substantive judgements of fairness: how unequal they are
- Procedural judgements of fairness: how they came about
Biological survival constraint is
Minimum bushels of grain to survive
Technically and biologically infeasible
Points above the feasible frontier are technically infeasible, and points below the biological survival constraint are biologically infeasible.
Bruno initial situation
- Bruno has complete power, he will make her work on feasible frontier and take difference between feasible frontier and BSC
- Therefore should find hours of Angela’s work where vertical distance is the highest = highest economic rent - MRS = MRT point.
Institution has changed to
slavery outlawed and Angela can either accept or reject contract
Any point on CD Pareto efficiency
as the only way to make one better off is by giving the other more and one less
- assume you start at any point on CD, any movement will make one worse off and one better off, so any point ON CD is Pareto efficient
- Any movement from D to another point on the indifference curve is Pareto inefficient, as Angela is indifferent while Bruno gets worse off.
Any point above G is better than F
- from D to F, outcome imposed by new legislation, not win win as Bruno loses economic rent at F compared to D while Angela benefitted
- Therefore, assuming they can negotiate, any point above G benefits both as Bruno gets more grain and Angela works at a higher indifference curve
- Angela may ask for H or just a bit below, so Bruno gets a bit more than his grain under the new legislation, and Angela maximises.
Key factors about this relationship
- technological and biological factors determine ability to mutually benefit.
- For allocations to be economically feasible, must be Pareto improvements relative to reservation options
- Outcome depends on bargaining power which depends on institutions as well as on preferences
Lorenz curve shows
the entire population lined up along the horizontal axis from poorest to richest, height of curve at any point on horizontal axis indicates fraction of total income received by the fraction of the population given by that point on the horizontal axis.
Gini =
- ratio of area between curves to equality line = A/A+B
- Closer to 0 = closer to perfectly equal
- Formula is good for loads of people, but for small use (a/a+b)x(n/n-1)
Economic interactions governed by institutions which specify rules of the game
Overall:
- consider allocations which are technically + biologically feasible
- Looks for Pareto improvement relative to reservation positions
- Feasible allocation which arises depends on bargaining power of each party
- Can evaluate compare allocations using fairness and Pareto efficiency as criteria
Pareto efficiency
Allocation where you can’t make someone better off without making someone worse off
Outcome when Angela has reservation indifference curve
Indifferent between unemployment benefit and MRS = MRT point, so depends on rules. If contract is accepted for MRS = MRT that will be allocation, if not then Bruno can offer just a tiny bit about MRS=MRT allocation to move to a higher indifference curve.
Gini for small population
g = half the relative mean difference in income among all pairs of individuals in the population
1. Find all differences in income between every possible pair
2. Take a mean of those differences
3. Divide this number by the mean income of the population to get the relative mean difference
4. g = RMD/2
