Neoclassical Model and Alternatives

Question 1

Utilitarianism

Answer 1

-Happiness/well being/welfare/satisfaction

Question 2

AC Pigou (1877-1959)

Answer 2

• Goal is to maximize aggregate utility or welfare
• Argued that a given sum of money makes a bigger difference un utility to a poorer person than it does to a rich person (diminishing marginal utility of income)
• Assumed that the relationship between income and utility was similar across individuals
• Favored egalitarian policies even though he didn’t care about equality for its own sake, but only for its effect on aggregate utility (modest tendency)
• Oppose policies that increase inequality

Question 3

Diminishing Marginal Utility of Income

Answer 3

-As income increases, utility increases, the increases diminish

Question 4

How should people be compensated?

Answer 4

-By their skill set/experience

Question 5

What does different salaries provide?

Answer 5

-Provides incentives and competition

Question 6

What kind of distribution maximizes aggregate utility?

Answer 6

-Equal distribution

Question 7

Equality would _______________

Answer 7

-Take away incentives to work or develop a better skill set

Question 8

Distribution of income affects _________, because differences in income provide __________

Answer 8

• Productivity

- Incentives for work and investing in building skills

Question 9

Lionel Robbins (1898-1984)

Answer 9

-Argued that it’s impossible to measure utility accurately, but that emotions felt by one human being are fundamentally different from those felt by others``

Question 10

Accepting Robbins’ Argument

Answer 10

-The only way to be sure that a policy increases utility is if it makes at least one person better off, without hurting anybody (pareto improvement)

Question 11

Pareto Improvements

Answer 11

-Very rare in the real world, most policy proposals have both winners and losers (Ex. Healthcare)

Question 12

How is economic value measured?

Answer 12

• By the willingness to pay for receiving a benefit, or to accept payment for a bearing cost
• A change that increases economic value makes it possible for the winners to compensate the losers, thus creating the potential for a pareto improvement

Question 13

Which class of people are more willing to pay more for any given benefit?

Answer 13

-Wealthier people

Question 14

Actual Pareto Improvement

Answer 14

-Paid for

Question 15

Potential Pareto Improvement

Answer 15

-No intention of paying for compensation

• Ex. Nixon Administration- start using cost benefit analysis in policy making:
• -Compared safety regulations between planes and cars

Question 16

Robbins’ Criticisms of Utilitarianism

Answer 16

-Paved the way of mainstream economics to switch its focus away from aggregate happiness in favor of maximizing aggregate economic value, using the creation of potential pareto improvement as justification

Question 17

Assumptions of Neoclassical Model

Answer 17

• Economic agents are self-interested
• Economic agents are rational (People make choices that serve their own interests)
• Utilities are independent (No altruism; No desire to harm or out-perform others)
• Preferences are determined exogenously (Can’t model efforts, such as advertising, to shape preferences)

Question 18

Daniel Kehnemann

Answer 18

-Rejects Neoclassical assumption that individuals are perfectly rational, in favor of the idea of “bounded rationality”

Question 19

Herbert Gintis and Samuel Bowles

Answer 19

-Argue that human beings have evolved norms of “strong reciprocity” which foster competitive behavior

Question 20

Norms

Answer 20

-Standards of behavior, rules

Question 21

Nudge Theory

Answer 21

-A small change produces large effects of behavior