2.0
Introduction
This section is arguably the core of the course. In it the Standard
Model of Market Economics is established. This model describes
manufacturing or secondary industries. Ten primary economic
concepts used or implied throughout the required text are defined.
It is from variations from perfectly competitive norms of the
Standard Model that the impact of environmental costs and benefits
external to market price are assessed for both public and private
goods.
Public policy efforts to abate problems like pollution are intended
to establish the price/quantity relationship that should exist under
such normative conditions. The critical role of Law particularly
property rights in correcting environmental problems is also
examined including the so-called ‘Tragedy of the Commons’ – both
natural and artificial. Consideration is also given to the role of cost-benefit
analysis, present value and the precautionary principle in
determining appropriate public intervention in the marketplace for
both private and public goods .
2.12.1 Analytic Engine: 'X' Marks
the Spot
For nearly half a century the world lived with a 15 minute warning
threatening all of humanity with nuclear winter because of a
domestic dispute in economics. One branch broke off to form the First World of democratic market economies while the
second
coalesced into the Second World of communist command economies. The
dispute centred on the question of private versus public
property.
Origins
Unlike
Marxism
with its bible,
Das Kapital, the ideology of the market developed in two
historically disconnected stages, the first in the late 1770s and
the second in the 1870s. The first coincided with the Republican
Revolution. The American started in 1776, the same year Adam Smith
published his Wealth of Nations, generally considered the
beginning of modern economic thought. This was followed by the
French in 1789 and the Bolivarian Revolution in Latin America that
continued into the 1820s followed by the Chinese Republican
Revolution of 1910. These revolutions replaced an Ancient Regime of
subordination by birth by one in which each adult Natural Person
mark their ballot with an ‘X’ thereby determining their government –
popular democracy.
These revolutions gave birth to two critical political economic
ideas - laissez faire and laissez passer. The first–
laissez faire – means let private persons, not a monarch,
decide what to produce and how. Until this time the Sovereign made
grants of industrial privilege, i.e., economic monopolies –
foreign and domestic - to friends and supporters. In Britain, the
granting of domestic monopolies ended with the Statute of
Monopolies in 1624. Foreign trade monopolies, however, such as
the 1670 royal charter to the Company of Adventurers of the Hudson
Bay, continued to be arbitrarily granted for more than two
centuries.
The second term – laissez passer – means let workers move to
the work. Thus until 1814 when the British House of Commons
abrogated the Statute of Artificers (in force since the time
of Elizabeth I) workers were restricted to working in their place of
birth. Guilds controlled entry into and managed the trades
restricting members to their own city, town or region. In fact the
guilds provided popular education until displaced by compulsory mass
education in the late 1860s.
At the age of seven a young lad or lass would be apprenticed
(effectively sold) to a Master who would then employ them for seven
years generally as a gopher. If satisfied the Master might then
extend the apprenticeship for another seven years at which time the
apprentice might earn journeyman’s papers and eventually become a
Master in turn, It should be noted that the original duration of
patents of invention and copyrights was 14 years – the term of two
apprenticeships.
The second stage in the development of market ideology occurred in
the 1870s with the
Marginalist Revolution.
The decade began dramatically enough with the fall of Napoleon III
before an ascendant Prussia which shortly unified many Germanys into
one – the Second Reich. Napoleon III was replaced by the Third
French Republic reinvigorating republican ideology on the Continent
and beyond. Yet the fall of the last Bonaparte also marked by the
rise of the first Communist State – the Paris Commune of 1871.
Marxism too was ascending.
Since before the time of Adam Smith economics had concerned itself
primarily with the growth and distribution of national wealth among
factors of production – land (natural resources in general) that
collected rent, labour that collected wages and capital that
collected interest or profits. It was Adam Smith and his
successors from Ricardo to John Stuart Mill (On Liberty and The
Subjugation of Women ) who make up the Classical School of
economics. Its vocabulary was of aggregates and of classes. In
this sense Marx was a ‘classical’ economist. It is ironic that
Marx himself named all those who came before him as the
‘Classical School’. It should also be recalled that Marx claimed
his theory rested on proofs derived from the science of political
economy.
The Marginalist Revolution changed the vocabulary. It split
political economics into Market and Marxist economics. In a very
real sense it allowed Market Economics to catch up with the politics
of the Republican Revolution. It shifted focus from class to the
individual ‘atomized’ consumer and producer. It shifted attention
from economic growth and distribution of national wealth to
allocative efficiency in consumption and production.
This was made possible by the marriage of Newton’s calculus of
motion and
Jeremy Bentham’s calculus of
human happiness or
felicitous calculus. The result was a model and a method that
satisfied the requirements of a true science according to Rene
Descartes, one of the 17th century founders of the Scientific
Revolution. It is based on a set of simple assumptions from which
mathematically provable and geometrically demonstrable deductions
may be drawn. Thus Thomas Kuhn in his seminal work The
Structures of Scientific Revolutions places economics as the
closest of the social sciences to ‘normal science’.
Bentham
is arguably the most
important public policy figure in Anglosphere history. His
influence is still felt in criminal justice, education and public
assistance systems throughout the English-speaking world. He is
also considered the successor of Adam Smith even though a lawyer,
not an economist. Like his contemporaries Bentham longed to find
the social equivalent to Newton’s physical laws and calculus of
motion. He found an answer, however, not in Aristotle or Plato like
most social theorists of his day but in the ideas of their ancient
Greek contemporary, Epicurus. Epicurus, however, was an atheist
unlike Aristotle and Plato both of whom objected to the Epicurean
pleasure ideal as did the Christian church
Bentham’s epistemology is based on the atomic materialism of
Epicurus (341-271 B.C.E.). He acquired it from the De Rerum
Natura (On the Nature of Things) written by the Roman
Epicurean poet Lucretius (99-55 B.C.E.), whose work, unlike that of
Epicurus himself, survived the fall of the Roman Empire and the
censorial fires of the Church.
Like Epicurus, Bentham believed that physical sensation was the
foundation of all knowledge. Knowledge, including preconceptions
such as ‘body,’ ‘person,’ ‘usefulness,’ and ‘truth’, form in the
material brain as the result of repeated sense-experience of similar
objects. Ideas are formed by analogy between or compounding such
basic concepts. For Bentham such sense experiences involved a unit
measure of pleasure and pain called the ‘utile’ from which Bentham’s
brand of Utilitarianism - Ethical Hedonism - emerged. Utiles would,
according to Bentham, eventually be subject to physical measurement
and he proposed a formal ‘felicitous calculus’ of human happiness.
The expression “the greatest good for the greatest number” reflects
this vision. His materialism matches the definition of an ideology
as secular theology – an explanation of how the world works without
reference to a divinity.
For my purposes, three assumptions of this calculus are relevant.
First it is assumed consumers and producers have perfect knowledge.
This has profound implications for any knowledge-based economy which
I will not explore at this time. Second, it is assumed human beings
practice calculatory rationalism, i.e., they are
constantly calculating and weighing the relative probability and
magnitude of present and future pleasure against present and future
pain. Third, while utiles cannot be physically measured it is
assumed they can be reified, i.e., an abstraction made
concrete, in this case of happiness made money. The presence of
money brings pleasure; its absence pain. The willingness to pay in
monetary terms is taken as the measure of the happiness a consumer
believes a good or service will deliver. It is ironic that the
standard model of market economics achieves what Plato, speaking of
Art, feared most in politics, that: “not law and the reason of
mankind, which by common consent have ever been deemed best, but
pleasure and pain will be the rulers in our State”. To quote
Bentham, however:
Nature has placed
mankind under the governance of two sovereign masters, pain and
pleasure. It is for them alone to point out what we ought to do, as
well as to determine what we shall do. On the one hand the standard
of right and wrong, on the other the chain of causes and effects,
are fastened to their throne.
In the hands of Francis Ysidro
Edgeworth
(1845-1926) Bentham’s felicitous calculus of human happiness was
successfully married to Newtonian calculus of motion and reduced to
geometric expression subject to mathematical proof in his 1881
Mathematical Psychics. His geometry and its related calculus
permitted erection of what became the standard model of market
economics – first in consumption and then in production theory.
The conceptual key is the term ‘marginal’, hence the name of the
revolution. In effect what in Newtonian calculus of motion is a
derivative – first order, the rate of change; second order, the rate
of change of the rate of change – defines decision-making at the
margin in economics. Hence ‘marginal utility’ is the additional
satisfaction of an added unit in consumption while ‘marginal
product’ is the additional output of an added unit input in
production. The outcomes of such actions can be demonstrated in
mathematics, geometry and words – the three languages of economics.
There is, however, also great disquiet around the world about an
ideology that reduces human choice to atomistic calculation of
profit and loss, not just in the marketplace, but in all human
activities ranging from marriage and child rearing to art, education
and culture. It is, as we will see, an ideology framed by the ‘X’
of intersecting market supply and demand curves marking the spot
where maximum human happiness and private profit is to be found.
Before the Republican Revolution, the economy was embedded in
society through guilds and a class structure of subordination by
birth. Today, some fear that human society itself is being embedded
into a global economy in which everything is for sale – hearts,
kidneys, lungs as well as the entire natural and human built
environment – much as Karl Polanyi suggested in his 1944 The
Great Transformation: The Political and Economic Origins of Our Time.
Such lingering concerns may be the genetic fragments of a not quite
dead Marxism or remembrances of forgotten republican roots –
equality, fraternity and liberty. In a way, the Republican
Revolution sought political freedom for the individual and in the
process spawned the free self-regulating market as its economic
corollary. The Communist Revolution, on the other hand, sought
economic freedom for the individual (each according to one’s need)
through a centrally controlled command economy and spawned the
one-party Leninist state as its political corollary. Arguably both
freedoms – political and economic - are required to realize full
human potential.
It was not, and is not, however, just the far Left that has concerns
about Bentham’s felicitous calculus and the standard model of market
economics. Joseph
Schumpeter of ‘creative
destruction’ fame called it “the shallowest of all conceivable
philosophies of life that stands indeed in a position of
irreconcilable antagonism to the rest of them”. John Maynard Keynes
went further identifying its dangerous ideological flaws:
I do now regard that as the worm which has been gnawing at the
insides of modern civilization and is responsible for its present
moral decay. We used to regard the Christians as the enemy, because
they appeared as the representatives of tradition, convention and
hocus-pocus. In truth, it was the Benthamite calculus, based on an
over-valuation of the economic criterion, which was destroying the
quality of the popular Ideal. Moreover, it was this escape from
Bentham… which has served to protect the whole lot of us from the
final reductio ad absurdum of Benthamism known as Marxism.
In fact, each generation of economist since his time has tried to
escape Bentham’s thrall. Nonetheless, Benthamite felicitous
calculus survives. Like a vampire it won’t die! There are at least
four reasons.
First, it is elegant - meaning simple and effective.
Second, it is flexible. Even altruism can be accommodated. How
much money you are willing to give to the Save the Whatever Fund is
the measure of utiles you get in return. There are no selfless
deeds.
Third, it is, in a sense, politically correct. Concepts like
consumer sovereignty and dollar democracy resonate with
our political roots. And economic growth defined as more money in
one’s pocket is a unifying principle in a multicultural world where
most people do not agree about many things, e.g., language
and religion.
Fourth, it is exportable. As we will see the concept of constrained
maximization has been transported into Law, Sociology, Social Work
and many other disciplines and practices.
The ‘X’
Economics, among other things, is about choice. More specifically
microeconomics is about the constrained maximization of consumer
happiness and producer profit in a marketplace where goods &
services can be freely bought and sold, in other words, where Supply
meets Demand.
Demand – Consumer Theory
On
the one hand, the consumer strives to maximize happiness through the
consumption of goods & services. On the other, the consumer is
subject to a
budget constraint. If there were no constraint then
the consumer could ascend to one’s bliss point, a technical
term in welfare economics corresponding to metaphysical concepts
such as satori in Zen or epiphany in Christianity.
In
symbolic logic, and restricted to a two-commodity economy, this
process begins with the consumer maximizing:
U = f (X, Y) where:
‘U’ stands for consumer happiness defined as utility measured as
the sum total of all pleasure ‘utiles’ acquired;
‘f’ stands for some function reflecting the taste of the
consumer; and,
‘X’ & ‘Y’ stand for goods and services
The consumer, however, is subject to a
budget constraint,
expressed as:
I = PXX + PYY where:
‘I’ stands for income earned through work considered ‘disutility’
or pain;
‘P’ stands for price; and,
‘I’ must be exhausted on some combination of X & Y, i.e.,
happiness is obtained only through the consumption of goods &
services that have associated monetary prices.
Assuming that the
price of only one commodity changes
while all other variables remain fixed or ceteris paribus,
i.e., the price of other goods, income and consumer taste remain
the same, we can derive the
consumer demand curve
for a product.
The demand curve shows how much a consumer is willing to pay
for a given quantity to maximize happiness subject to the budget
constraint. It will usually be downward sloping reflecting the Law
of Demand: the lower the price, the greater the demand; the higher
the price, the lower the demand. By horizontally summing up how
much each consumer is willing to buy at each specific price we
generate the market demand curve.
Supply –
Producer Theory
On
the other side of the economic equation, the producer or firm wants
to maximize output.
The
production function
of a firm in symbolic logic is expressed as:
Q = g (K, L, N) where:
‘Q’ stands for output;
‘g’ stands for some function reflecting the technology or
‘know-how’ available to combine factors of production (K, L, N) to
produce ‘Q’’;
‘K’ stands for capital as physical plant and equipment, the value
of which can be expressed in financial terms;
‘L’ stands for labour including productive (shop floor), managerial
and entrepreneurial talent; and,
‘N’ stands for natural resources that can be enframed and enabled
to serve human purpose.
If
the firm cannot increase Q without increasing inputs, i.e.,
K, L and/or N, it is ‘technically efficient’. The producer,
however, is subject to a cost constraint which, assuming a
two-factor economy, is expressed as:
C = PKK + PLL where:
‘C’ stands for cost;
‘P’ stands for price;
‘K’ stands for quantity of capital; and,
‘L’ stands for quantity of labour.
Thus for a
given ‘Q’ there is an associated ‘C’ determined by the sum of the
quantity times the price of each factor employed. How much Q will
actually be produced is dependent, however, on
market price,
i.e., how much consumers are willing to pay for a given
quantity. So long as that price maximizes profit (or minimizes loss
at or above the firm’s ‘shutdown’ point) it will provide a
corresponding Q.
From the resulting cost function we can determine
the supply curve of the firm,
i.e., how much it is willing to produce at each
price. The supply curve is the marginal cost curve of the firm
above the shut-down point. If the firm cannot earn enough to cover
all its variable costs, it shuts down. The curve will in the
short-run be upward sloping reflecting the Law of Supply: the higher
the price, the greater the supply; the lower the price the smaller
the supply. By horizontally summing up how much each firm is
willing to provide at each price above its shut-down point we
generate the market supply curve.
Market Theory
Markets are any arrangement that
enables buyers and sellers or consumers and producers to get
information and do business with each other. Put another way,
markets are where demand meets supply. Markets can be described by
reference to whether they are:
- geographic or commodity-based;
- in or out of equilibrium;
- sensitive to change in prices and
incomes (elasticity); or,
- influenced by any individual or group
- consumer, producer or government.
With Market Demand and Supply Curves we
generate an ‘X’-shaped
graph with Demand increasing as price
goes down and Supply increasing as price goes up. The point where
they intersect is called market equilibrium, the point at which the
willingness to buy and the willingness to sell are
equal. Ceteris paribus, this will be a stable equilibrium,
i.e., if all variables remain fixed, e.g., technology,
factor prices, consumer taste, income and the price of all other
goods & services, the price-quantity equilibrium will be maintained.
Under such fixed conditions if the price rises above equilibrium,
for whatever reason, firms will be willing to provide more than
consumers are willing to buy. A surplus is created. To eliminate
the surplus firms lower price returning eventually to equilibrium.
Similarly, if price drops below equilibrium demand exceeds supply
and a shortage results. Consumers will then bid up the price until
it returns to equilibrium. These constitute so-called ‘market
forces’.
Choice in microeconomics, however, is made ‘at the margin’. In the
case of the consumer, consumption of ‘X’ will increase until, dollar
for dollar, the additional satisfaction (marginal utility or MU)
from the last unit consumed equals the satisfaction, dollar for
dollar, of the next unit of good ‘Y’. In symbolic logic this is
expressed as:
MUx/Px = MUy/Py where:
‘MU’ stands for the additional or marginal utility to the consumer
from the next unit consumed; and,
‘P’ stands for the price.
Similarly, the firm will increase output until the additional or
marginal cost of the last unit produced equals the additional or
marginal revenue earned from its sale. All previous units cost less
than revenue earned and profit is maximized when, in symbolic logic:
MC = MR where:
‘MC’ stands for marginal cost
‘MR’ stands for marginal revenue
The actual market equilibrium – price/quantity – will depend on the
nature of the market. If there are many, many sellers of identical
goods and many, many buyers there is ‘perfect
competition’
and ‘X’ marks the spot. If not, the outcome reflects the exercise
of market power by either consumers or producers.
This constitutes the standard model of market economics developed
during the last quarter of the 19th and first quarter of the 20th
centuries especially in the hands of
Alfred Marshall
(1842-1924)
of Cambridge University. It is alternatively known as the
Marshallian, Neoclassical or Perfect Competition model
While Marshall contributed its iconic centerpiece - the ‘X’ - which
is often called the ‘Marshallian scissors’, Marshall himself held a
much more subtle, complex and biological view of the economy. As
with the work of many great economists, however, including Adam
Smith, some of Marshall’s work became part of the canon while other
parts were simply forgotten. One thing should not be forgotten:
one of Marshall’s Cambridge students went on to create the
standard model of macroeconomics and arguably the current world
economic order –
John Maynard
Keynes.
The Nine E’s of Economics
Coincidentally, perhaps, economics engages a number of concepts
beginning with the letter ‘e’. I now consider seven and connect
them to the ‘X’.
I - Efficiency
Efficiency plays many roles in economics. Consider. First,
allocative efficiency implies that all factors in production and all
commodities in consumption are in their best use and receive their
opportunity cost.
Economic choice involves how to satisfy infinite human wants, needs
and desires subject to scarce resources. It requires a choice
between alternatives, e.g., a pensioner choosing food or
medicine. The choice of the best alternative, however, implies that
the next best alternative is not chosen. Put another way, the cost
of choosing one possibility is the next best alternative foregone.
This is called 'opportunity cost'. All economic costs are
opportunity costs even those not expressed by market prices. This
distinguishes economic from accounting or business cost.
For allocative efficiency to exist three conditions must hold:
(i)
Consumer Efficiency: when consumers cannot increase utility
by reallocating their budgets;
(ii)
Producer Efficiency: when firm cannot reduce cost by shifting
the input mix;
(iii)
Exchange Efficiency: when all gains from trade have been
exhausted. Gains to consumer is called
consumer surplus
which measures the difference between what consumers are willing to
pay and what they actually pay for a given quantity of a good or
service. Gains to producers are called
producer surplus
which measures the difference between what they are willing to
accept and what they actually receive for a given quantity of a good
or service.
Second, in production efficiency refers to the ratio of outputs to
inputs. To measure efficiency one must therefore be able to
calculate both inputs and outputs. This is most easily done in the
production of goods rather than services, especially in
manufacturing, e.g. cars produced per worker.
Technical efficiency is achieved when it is not possible to increase
output without increasing inputs. Economic efficiency occurs when
the cost of production for a given output is as low as possible. A
secondary consideration is that such output is sold at a price
sufficient to compensate all factors of production at their
opportunity cost, i.e., no excess or economic profit or rent
is earned. Thus all economically efficient solutions are
technically efficient but not all technically efficient solutions
are economically efficient, that is, something may be technically
efficient but uneconomic. It cannot pay its own way, e.g.,
space exploration and the military.
It is also important to distinguish between technical and functional
obsolescence. Equipment becomes technically obsolete when newer
equipment can do the job more efficiently, e.g. the Pentium
CPU made the 486 and 386 technically obsolete but they can still do
the job for which they were intended. Functional obsolescence
occurs when old equipment cannot do the job.
II - Effectiveness
In some goods and most services especially those produced by
government, neither inputs nor outputs can be readily calculated and
hence efficiency cannot be determined. Accordingly, a less stringent
test - cost effectiveness - is applied. Surrogates or proxy
indicators of inputs and outputs are used. For example, the
“recidivism rate” per parole officer (percentage of repeat
offenders) can be used as an imperfect proxy for output rather than
the more difficult to measure concept of “rehabilitation” measured
in human, social, and/or economic terms. Similarly, average salary
per parole officer can be used as a crude surrogate for inputs
rather than the more difficult to measure opportunity cost of
relevant financial, human, information, and physical resources in
alternative applications, e.g., early education rather than
later incarceration.
III - Elasticity
Elasticity refers to the sensitivity of one variable to a one
percentage change in another. Economic theory recognizes three
principal types:
i -
income elasticity of demand
- with all prices constant refers to the percentage change in the
quantity of a commodity demanded compared to a one percent change in
income;
ii - price elasticity of
demand
or
supply
- refers to the percentage change in the quantity of a commodity
demanded or supplied compared to a one percentage change in its
price. The amount demanded or supplied can increase:
a) more than proportionately, i.e. elasticity is greater than
one - at the extreme a horizontal demand or supply curve is
perfectly elastic - a small increase in price results in a large
change in the quantity demanded or supplied;
b) proportionately, i.e. elasticity is equal to one (unitary
elasticity); or,
c) less than proportionately. i.e. elasticity is less than
one (inelastic) - at the extreme, a vertical demand or supply curve
is perfectly inelastic - any change in price results in no change in
the amount of the commodity demanded or supplied; and,
ii - elasticity of substitution or
cross-elasticity
in production refers to the percentage change in the amount of an
input substituted for another in response to a change in their
relative prices. Similarly, the cross-elasticity in consumption of
one commodity substituted for another by a consumer in response to a
change in their relative prices can be calculated.
IV - Employment
While popular discussion focuses on employment with respect to
labour in fact all factors of production are subject to employment,
underemployment and unemployment. In manufacturing the concept of
capacity utilization captures employment of physical plant
and equipment, i.e., what percentage of potential output –
24/7 - is actually produced. Similarly ‘undeveloped’ refers to
natural resources not yet employed in the production process.
In the case of labour there is the concept of the labour force
defined as all persons aged between 15 and 65. Then there is the
related concept of the participation rate, i.e., what
percentage of the labour force has or is actively seeking
employment. There is season unemployment, e.g., in the ski
industry; cyclical unemployment which follows the business cycle;
and, structural unemployment often reflecting the effects of
technological change such as afflicted the Maritime provinces of
Canada with the shift from sail to steam powered vessels late in the
19th century.
There is also the concept of the ‘natural rate’ of unemployment
which varies between countries due to structural and policy factors
such as the generosity of unemployment insurance programs. Thus
traditionally the
Canadian
natural rate of unemployment has been higher than the
U.S.A.
V - Equilibrium
Equilibrium is a condition which once achieved will continue
indefinitely
unless one of the variables is altered. In the case of markets, the
equilibrium price 'clears' the market, that is the quantity
demanded by consumers equals the quantity supplied by producers.
More generally, economic theory recognizes four types of
equilibrium:
i - general equilibrium: which refers to a condition when the entire
economy is under perfect competition. It is a static state where
all prices are at their long run equilibrium, individuals are
spending income to yield maximum satisfaction, and the demand and
supply factors of production are equated throughout the economy;
ii - stable equilibrium: which refers to a condition which once
achieved continues indefinitely unless there is a change in some
underlying conditions. Changes in economic conditions will be
followed by reestablishment of the original equilibrium. Example: a
ball resting at the bottom of a cup; shake it and the ball moves;
stop shaking and it returns to the bottom of the cup; and,
iii - unstable equilibrium: which refers to a condition which once
achieved will continue indefinitely unless one of the variables
changes and then the system will not return to the original
equilibrium. Example: a ball resting on the top of an overturned cup
- shake it and the ball falls off never to return to the same place;
and,
iv - multiple equilibria: which refers to the condition in which
more than one equilibrium exists. This is particularly true in
developmental economics where a developing country may find itself
in a stable equilibrium but one that is not optimal for its economic
growth and development. The unaided market cannot move the economy
to the preferred outcome.
VI - Equity
The economic concept of equity evolved out of English legal
history. At the same time that the Common Law began another unique
Anglosphere legal institution emerged – Equity. With the Norman
Conquest of 1066 all rights and privileges of the previous regime
were abrogated by right of conquest. In effect William the Conqueror
had carte blanche to shape a kingdom without accounting for
pre-existing feudal rights and obligations. Unlike other European
kingdoms, it was his exclusive unqualified and personal domain. He
was absolute Sovereign. Nonetheless, what he conquered was a
patchwork of Angle, Saxon, Jute, Danish, Viking and Celtic
settlements, regions, laws and languages. The new King divided up
his new Property, after accepting fealty, to a new Anglo-Norman
aristocracy. The new local rulers, while subject to the King, also,
in effect, inherited rights and privileges acceded to traditional
rulers under local legal systems. Some were honoured and survived to
become incorporated into Common Law.
William’s new subjects, however, soon brought to his attention (and
that of his successors) inequities in a supposedly unified kingdom.
At the extreme, in one jurisdiction theft of a loaf of bread cost a
hand; in another, two days in the stocks hit by rotten vegetable and
insults thrown by one’s neighbours. It was not guilt or innocence
they cried but fairness of punishment before the King. This is
arguably the root of Equity – a separate and distinct strand of
jurisprudence parallel to the Common Law of precedent.
Over time responsibility for hearing calls for mercy was transferred
to the King’s Lord Chancellor and a court of his own – the Court of
Equity also known as the Court of Conscience or of Morality. In fact
until Sir Thomas More (a lawyer) became Chancellor in 1529, all had
been men of the cloth. Two aspects of Equity played a critical role
in the Sovereign’s ability to control his vassals. These were trusts
and tenant-landlord disputes. Trusts (from which modern charities
and financial trusts evolved) generally concerned widows and orphans
left to the mercy of a local lord. The most famous is Lady Marion of
the Robin Hood legend who was an orphan and ward of the King. With
respect to tenant-landlord disputes, Equity balanced the feudal
local lords by judiciously connecting the King to his subjects. This
was called the ‘rent bargain’ by
John R.
Commons.
It stabilized the social system of post-Conquest England.
While Magna Carta (1215) and subsequent developments
increasingly limited the King, Equity and Common Law continued to
develop as parallel systems of courts with precedence given to
Equity. It was not until 1873 in the United Kingdom that the two
systems of courts merged. Nonetheless the two strands of Anglosphere
jurisprudence continue to this day in all Common Law countries with
Equity retaining precedence.
The economic concept of Equity arguably derives from legal Equity.
In fact the Chancellor of the Exchequer (who in Canada we call 'the
Minister of Finance') exercised a concurrent jurisdiction in Equity
with the Lord Chancellor’s Court. There are two economic definitions
of Equity, each reflecting its historical roots.
First, there is Equity as the capital of a firm which, after
deducting liabilities to outsiders, belongs to the shareholders.
Hence shares in a limited liability corporation are also known as
equities. This links back to the historical treatment of trusts
under Equity.
Second, there is Equity as ‘fairness’. While often used with
reference to taxation it is a general economic concept. With respect
to taxation Equity has three dimensions: horizontal, vertical and
overall burden. Horizontal Equity refers to ‘like treatment of
like’. Vertical Equity refers to ‘unlike treatment of unlike’.
Overall Equity refers to the accumulated impact of all forms of
taxation. Crudely, it is the difference between earned and
disposable income after all taxes – income, excise, sales, et al.
Equity is also applied in a number of market interventions by
government, e.g., minimum wage and rent control. Examples of
government intervention for reasons of equity will be discussed in
the next lecture in this series.
VII - Excludability
Excludability and rivalrousness are characteristics of a private
good. If I buy a car I can exclude others from using it by lock and
key. I alone extract its utility. Similarly, if I am driving no
one else can, i.e., driving is rivalrous in
consumption/production.
On the other hand, public goods are non-rivalrous in consumption,
i.e. my consumption does not reduce the amount available to
you. If I watch a fireworks display it does not reduce the amount
available to you. Similarly, public goods are non-excludable,
i.e. a user cannot be easily prevented from consuming a public
good. This creates the ‘free-rider’ problem. Extending the
fireworks example, while I may not be willing to pay to enter the
stadium but I can still watch the display from the balcony of my
apartment at no charge.
Allowing for externalities (discussed below) there is in fact a
spectrum of goods ranging from pure private to pure public in
nature.
VIII - Expectations
Time plays a critical role in economic analysis. In fact there are
two distinct forms of analysis based on time: static and dynamic.
Static analysis involves an economic variable or phenomena in a
specific fixed moment in time. Dynamic analysis involves analysis
through time, that is from the past to the present, or from the
present into the future.
Three great economists enhanced our economic understanding of Time.
John Maynard Keynes introduced the concept of 'expectations'. Over
time people's changing expectations of what tomorrow will bring
causes their actions to change today.
Friedrich August von
Hayek
stressed ‘foresight’. Similarly,
John R. Commons introduced the
concept of 'futurity' meaning people live in the future but act in
the present. The difference between what we plan to do tomorrow and
what we actually do today in expectation of tomorrow introduces a
constantly changing dynamic to economic analysis, especially
macroeconomic analysis. For example, if we expect interest rates
will fall tomorrow, we hold off borrowing money today. But when
tomorrow comes and interest rates do not fall our plans must be
changed.
IX - Externalities
See
2.2 Externalities below.
The Big‘O’ in
Economics – Opportunity Cost
The choice of the best alternative implies that the next best
alternative is not chosen. Put another way, the cost of choosing
one alternative possibility is the next best alternative foregone.
This is called 'opportunity cost'. All economic costs are
opportunity costs serving to
distinguish economics from accounting or business costs.
And with respect to the economics of the environment this is a
critical difference. As noted in the title of this site: Elemental
Economics – Not Accounting, Not Business, Not Commerce, Not
Mathematics - Economics!
