Welcome to the video on economics as a science. This video discusses the question whether economics is a science. Economics deals with questions in a context of scarcity. Only 24 hours in a day, the limitations of technology, and of course no unlimited budget, not even for the state. Scarcity is not a given, instead it's part of economic behavior itself. Economics is about means and ends due to scarcity, but first the means are not fixed. When you were lost in a desert, you will value water over diamonds. Not because what's which was more scarce. But because in this particular context, you value it much more. Second, ends are not fixed. People develop new desires over their life cycle. And we are influenced by advertisements to make us buy goods that we did not want before. And third, scarcity can be manipulated by those with power. For example by private firms who have patents for widely used food crops so that farmers have to pay high prices for the seeds. From recognizing that economics is a social science, we distinguish three types of actors in the economy. Firms, the state and community actors, such as households and civil society organizations. If markets are about exchange, they require freedom to do so, right? Freedom is a moral value, hence markets are not value free. The state operates on basis of legitimacy and values of justice, and communities on the basis of solidarity. And all the social values, often referred to as caring. And the three domains and values are related. Now, does economics have values too? Well, yes. Efficiency is a value and a key criterion for assessing market outcomes. Narrow efficiency is the maximization of output with minimization of input. Broad efficiency is the minimization of waste throughout the economy and society. The difference between broad and narrow efficiency is that narrow efficiency may imply that environmental cost such as air pollution, are shifted to society as a whole. Polluting firms may produce efficiently simply because they externalize pollution. Instead, broad efficiency includes negative externalities. For example, using air filters or using pollution taxes. Next to efficiency there are other important values that are employed in economics like fairness, freedom, trust, and equality. This course presents four theories of economics. These will be applied to all topics of the course. The four theories are social economics, institutional economics, post-keynesian economics, and new classical economics. Each has its own logo that we will use throughout the course. I want to briefly explain each theory. In Social economics, we recognize that the economy is part of society. We call this embeddedness. And we therefore recognize that the economic agents have a variety of motives. Ranging from greeds to altruism, and from status orientation to solidarity. To illustrate that we're not always rational, and acting in our best interests, let us look at a so called loss function. People often prefer minimization of loss over maximization of a possible but not certain outcome. The diagram shows that we tend to value the loss of x, see the red box, bigger than the gain of x, see the blue box. Even if the amount of money is the same, say one euro. In other words people's loss function is shaped in such a way that we suffer more from the loss of one euro than we enjoy the gain of 1 euro. Institutional economics is about institutions. Formal institutions are codified rules, regulations, and organizations. For example, laws, food quality regulation, and banks. Informal institutions are unwritten rules, beliefs, and rules of thumb. For example, the belief that men make better leaders than women. Or the rules of thumb of investors who sell assets only after an asset price has reached a particular level. Asymmetric institutions are institutions that have different effects on different groups. For example, citizenship groups that enable access to social security for nationals but not for immigrants. This diagram illustrates the working of an information institution on our economic behavior. It shows the distribution of consumer goods, of ourselves and others and that this is influenced by social norms. At least for the majority of people. You see the blue budget line enabling you to buy, ten units of coffee or ten cakes. Or any combination in between. If you buy six cakes, how many cups of coffee can you buy? The answer is four cups of coffee. Check out on the blue line. With six cakes you go up in a vertical line to the budget constraint and then horizontally to the y-axis for coffee. You will hit the y-axis at the point four, so four cups of coffee. When a friend is visiting you and you belong to the 90% of people who value social norms, your budget line becomes the red line. Now, you can only consume 9 cakes or 9 coffee, leaving one of each for your visitor. Now let's move on to Post Keynesian economics. This approach looks more at economy as a whole than at the individual level. Aggregate demand, abbreviated as AD, is the total demand of all households, firms, government, and the rest of the world. So the demand for consumer goods, services, and investment goods. Low AD results in pessimism. Consumers will save more and spend lest, and investors will wait with new investment which further lowers AD and on and on. Only the government can help an economy out of such a recession relatively quickly by increasing its spending. Another important post Keynesian concept is market power. This means have firms have to power to reduce competition to their own advantage. This is standard in our world. Post Keynesian stated really free market with full competition, is rather a utopia then a reality. A third key post Keynesian concept is uncertainty. Uncertainty versus risk means that we simply do not know what may happen and how likely that is, versus known options and their probabilities to occur. So risk is like dice. A known number of options and chances for each option to occur. Uncertainty is rather like an earthquake. One can insure against risk but not against uncertainty. Finally, I'll come to the fourth economic theory. Neoclassical economics. It's a rather abstract theory, and assumes an ideal market without market power. And only risk and not uncertainty and perfectly rational agent who act in their self interest. This allows mathematical theorizing in terms of solving optimization problems. Market equilibrium means that supply meets demand so that all resources are fully employed. The economy functions at full capacity. Moreover market equilibrium implies efficiency. But only under the condition that every agent is useful labor available for which there is demand. The diagram shows a typical, neoclassical microeconomic analysis. It pictures a so called utility function. It shows you how the addition of a single good on the y axis declines with the number of goods consumed. In this case, glasses of water which you see on the x axis. This is the law of diminishing marginal utility. For every additional unit of good the extra utility obtained decreases the additional utility. Utility function goes up but less and less deep with more and more glasses of water. One glass of water gives you the size of a utility unit, two glasses of water gives you the size of b utility units. If you look at the y axis you will know the utility from the first glass of water distance zero to a, is bigger than the utility from second class of water distance, A to B. Once you know the law of diminishing marginal utility, you will understand why, in a trade off between coffee and cake, most people will prefer five cups of coffee with five cakes rather than nine coffee and one cake. Unless they're a strong caffeine addicts, of course. Let me now summarize my presentation of the four theories by zooming in on the concept of rationality. We do this in a two-by-two diagram. The two columns distinguish between an open and a closed information base. And the two rows distinguish between groups and self. And socioeconomic rationality combines the group level with an open information base, resulting in strong reciprocity. It's the dominant form of decision making. Remember this is a kind of rationality that focuses on shared values in groups. In institutional economics, groups are also important but behavior is guided by clearly defined institutions, not necessarily by moral values. Post Keynesian rationality is at the level of the self. But under conditions of uncertainty hence it has an intuitive character. Like trying to find your way in a strange city without a map. Finally, the rationality definition in neoclassical economics combines focus on the self with a closed information based. Hence, it implies a cost-benefit attitude or what's in it for me. This concludes the presentations for week one. At week two, I will explain economic behavior of individuals in households and as consumers in the market. Do you care about your self interest? Do you share what you have? How do you maximize your utility from consumer goods? Find out in week two.
