MODERN MICROECONOMICS:A RICH AND MOVEABLEFEAST - PowerPoint Presentation

1. MODERN MICROECONOMICS:A RICH AND MOVEABLEFEAST

2. INTRODUCTIONTraditional microeconomics and macroeconomic behavior are discussed within equilibrium frame work.Modern micro economic theory full of new sights and applications. It has added new analytical twists

3. INTRO….The new twists of contemporary microeconomic theory consists of (1) Providing formal analysis how market outcomes change when we relax simplifying assumption about consumer and firms .(2)Applying new tools of interesting and novel questions which were previously considered beyond the purview of economist (e.g. crime, drug use, family relations and so on)

4. INTRO…Novel tools are emerging to address the new problems but these tools are refinements of earlier principles of classical and new classical periods. For example the new theory of household production pioneered by Gary Becker rests on principles of utility maximization established by Jevons, Menger, and Walras.

5. CONSUMPTION TECHNOLOGY: MODERN VIEWSTraditional microeconomics imposes clear division between producers and consumers while modern microeconomics treats this division as oversimplification of the process by which goods are purchased and consumed.

6. The Household as a FactoryModern economists regard the household as analogous to a small factory that combines capital goods ,raw materials and labor to clean ,feed, procreate and otherwise produce useful commodities(Becker, A Theory Of Allocation Of Time ,p.496)Individual consumers become part of household production and consumption

7. The Household as a FactoryChildren are regarded as consumer goods in new microeconomics.Time is an opportunity cost which must be calculated along with the market prices of any good or activity in making economic decisions.Market goods and time is necessary to produce ultimate goods or servicesSo ultimate consumption is a function of market goods and time inputs.This approach has several benefits

8. Implications Of New Consumer TheoryIt highlights the full cost of household production, it expresses the value of household production in terms of opportunity cost.When earnings from market work rises the opportunity cost of household activities also increase so less time in household activities is expected to consume wide spread use of time reducing appliances is example of this phenomena.Greater use of child care services, outside contracting for households services etc. are related to wage and earnings increases over time.Another implication is change in pattern of consumption of consumers for example when family income rises goods intensive commodities tend to substituted with capital intensive ones.Modern inventions are successful because they allow substitution which allow people to economize by reallocating time-intensive consumptions.

9. Household ProductionPreviously no value was assigned to household work and was choice between leisure and workWhen goods produced at home are given economic value the home producer will ordinarily allocate effort among three activities(1) home production (2) market work (3) leisureIn 1977 Reuben Gronau provided a choice-theoretic framework for analyzing decisions between leisure, market work and home production.For reference see figure 23-2 page 615 (Modern Microeconomics: A Rich And Moveable Feast)Twenty four hour grocery stores and other similar accommodations that allow workers to make partial adjustments to the time and productivity constraint are examples of new microeconomic analysis.

10. Information and searchThe modern theory of consumption technology has let another genie out the bottle by regarding information as an economic good.In Marshallian world, consumers are aware of all information and prevailing conditions of the market at a zero cost and the market will be highly competitive.Information was regarded as an economic good by George J. Stigler in 1961.Every information has some cost which the producer and consumer both pay. A simple example is of a price cut (SALE) at any outlet of a brand. The producer has to do advertisement to convey information of the price cut and the producer has to invest on fuel and spare time to go and have a look at the reduced prices of the brand. There will be more than one price for the same commodity even if the market is in equilibrium.For reference see figure 23-3 page 617 (Modern Microeconomics: A Rich And Moveable Feast)

11. A New Role for AdvertisingNeo classical writers ignored advertising in a market economy.Static models that assume perfect information regard advertising unnecessary.The new economies of search provides a rational explanation for the existence of advertising.In the new microeconomics advertising is a low cost means of producing information.Gathering information by investing time is costly and time has an implicit value however advertising saves time to acquire information about prices or quality.

12. For reference see figure 23-3 page 619 explanation (Modern Microeconomics: A Rich And Moveable Feast) The existence of advertising reduces the amount of time consumers spend in searching for lower prices. They have more time left to devote to more desirable activities.There are in effect two sacrifices involved in consuming most goods: 1- the money price of the good 2- the value of the time forgone in search and other transaction costsIn the informed modern view advertising economizes on search time and therefore lowers the full price of goods and services.

13. Demand Theory InnovationsMarshallian demand theory assumes that consumers purchase goods and services that are desired directly for their utility.Household is viewed now as purchasing combinations of market goods and time to produce more ultimate and desirable commodities.Development in demand theory emphasizes the attributes of goods and services rather than the good and service itself.New perspective holds that consumers do not demand market goods for the direct utility provided by the good or service itself, but for the utility derived from certain combinations of utility-producing characteristics.See reference fig 23-4, page 620 (Modern Microeconomics: A Rich And Moveable Feast)

14. Goods satisfy utility on the basis of different dimensions. The point commonly attributed to Kelvin Lancaster consumers demand jointly produced characteristics rather than products or services themselves.This approach has clear advantages over traditional Marshallian analysis of demand. Lancaster’s approach to consumer behavior, along with Becker’s innovations reminds economists that purchase of market goods is merely an intermediate step to satisfaction of some more ultimate demand.The demand for market goods is therefore a derived demand.The enlarged focus on goods as bundles of characteristics where the characteristics are numerous and variable, sheds light on the some times sudden emergence and rapid disappearance of market goods in the consumption bundles of individuals or households.

15. New Theories of the FirmThe economic function of a firm is to combine economic resources in order to produce goods and services demanded by consumers.Standard theory tell us that firms that succeed in meeting these demands efficiently survive and prosper while those that do not make losses and fall.The traditional economic theory aims at combining cost curves based on resource productivity with demand and other revenue curves to make market models.The traditional analysis fails to answer the question why do firms exist at all?

16. All advanced economies are based upon the division of labor. Division of labor is vented in an incredible array of activities based upon different skills and talents of individuals. The concept of economic coordination reveals answer of the question. To explain why firms exist we should be able to distinguish market and firm coordination.Market coordination exists when the price system directly provides signals (through supply and demand) that guide production and consumption. It is by nature decentralized.Firm coordination exists when division of labor is carried on and directed by managers. It is by nature centralized.Employees agree voluntarily to the commands of the managers.Contemporary microeconomics seeks to provide satisfactory answers to questions why is there need of firms if the market and firm coordination is similar.

17. Why Firms? The Coasian PerspectiveRonald Coase proposed a simple and elegant answer to question why are firms necessary in a classic paper entitled, “ The Nature of the Firm,” published in 1937.Coase argued that firms emerge and exist as a least-cost means of economic coordination.There are costs to use market coordination. Market coordination provides certain benefitsFirm is only obligated for a short term and is able to hire resources more flexibly.When firms hire secretarial services they use market coordination rather than firm coordination.

18. Market coordination gives way to firm coordination. Entrepreneurs begin to use firm coordination when a comparison of costs and benefits between alternative forms of coordination indicates positive benefits to coordination within rather than without.It may pay to organize secretarial tasks within firm by hiring a secretary on a regular, longer term basis rather than hire temporary help.A firm therefore emerges as a conglomeration of resources that are gathered together under the centralized direction of a manager because it is cheaper than organizing and directing resources through overt market mechanisms.Firms face a limit to growth in the form of rising marginal costs of organization and direction. When net benefits derived from internal organization and direction fall below the net benefits of organizing tasks through market contracts, the fir stops growing and again resorts to market condition.Market coordination is more efficient in some specialized tasks.Each task within the firm may be examined from standpoint of whether net benefits derived from inside coordination.

19. Team Production and Shirking in the FirmCoase’s innovative theory of the firm has a number of theoretical extensions. The more promising off-shoots of the theory has been the “team production” view of how activities are organized within firms. Most of the activities of the firms include team work, and a team, like a chain, is only as strong as its weakest link.How can firm prevent its team members from shirking in unproductive behavior?One answer has been given by Armen Alchian and Harold Demsetz, who maintain that manager acts as a team monitor to ensure efficiency in those instances where several individuals must work together to accomplish a task.

20. Specialization, as Adam Smith recognized long ago, leads to increased productivity. Without policing someone’s behavior all individuals have an incentive to shirk.Workers have an incentive to be monitored, since their returns are, to a large degree, adversely affected by shirking behavior of other members of the team.These circumstances explain emergence of manager as the person given the responsibility to discipline those who shirk and to reward superior performance.In the absence of team production, individual producers are disciplined by market competition, i.e., the actions of rivals.The worker who shirk bears cost of behavior by receiving lower earnings. In these circumstances, an internal monitor is not necessary.Firms that employ monitors obviously face increased costs over those that do not, so it is only when the benefits of increased productivity to team production outweigh costs of monitoring that team production replaces individual production.

21. In the evolutionary scheme of things, when teams can produce goods and services at lower costs than individuals can, firms emerge and survive.The Alchian-Demsetz view therefore regards a firm as the logical consequence of positive net benefits that derive from team production even in the face of higher costs of monitoring team performance.Who will monitor the team production is the question that comes in mind when it comes to team production. The monitor also has the incentive to shirk. The answer to this question is found in the institutional composition of the firm, specifically in the pattern of incentives both positive and negatives given to the managers as monitors.On the one hand, Managers are disciplined by the market. If they perform poor, monitor-managers will be fired and competing managers will be installed by owners or stockholders.On the other hand, managers can be rewarded as residual claimants who share in the profits or rewards of team production. Managers thus have both negative and positive incentives to be efficient monitors of team production.

22. Other Applications and ExtensionsInterest in the economics of information as a central part of the new microeconomics has raised a number of provocative issues related to the qualities of products. The central question concerns the determination of product quality and the kind of information buyers and sellers have before the purchase of products. If sellers possess information concerning product qualities that buyers do not, sellers may have incentives to sell substandard products or services.This observation has generated various approaches to the issue of quality.

23. Asymmetric information “The Lemons Problem”In the labor-market variant of the information problem, different employees may have different productivity potentials which are unknown to employers.To improve information, employers may develop screening techniques for sorting prospective employees.Good screening techniques should signal which workers have the highest productivity potential.There are certain worker attributes that tend to be highly correlated with productivity.As economic theory would predict, employers will tend to utilize screening techniques that emphasize characteristics which can be measured reliably at low cost.Individuals have more control over certain desirable attributes than others.

24. Ever since Hayek pioneered the notion of markets as processors of information, it has generally been recognized that price itself is a “signal”.How reliable this signal is? The information can be asymmetric. The possibility and the implications of asymmetric information in economic markets have been analyzed by George Akerlof in a study of automobile market.In this market, it is difficult for the buyer to get complete information before the purchase. A new car may be dependable and trouble-free, or it may be in constant need of repair. The customer usually does not know, nor can he or she know, if a car is a lemon or nor until afer the purchase.For reference see page 624,625 (Modern Microeconomics: A Rich And Moveable Feast)