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Elemental Economics

Not Accounting, Not Business, Not Commerce, Not Mathematics  - Economics  






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Competitiveness of Nations

Cultural Econom


Elemental Economics

World Cultural Intelligence Network


Dr. Harry Hillman Chartrand, PhD

Cultural Economist & Publisher

Compiler Press


215 Lake Crescent

Saskatoon, Saskatchewan

Canada, S7H 3A1

Curriculum Vitae


Launched  1998




2.0 Environmental Economics

2.0 Environmental Economics

Page A

2.0 Introduction

2.1 Analytic Engine: 'X' Marks the Spot


The ‘X’

Demand – Consumer Theory

Supply – Producer Theory

Market – Theory

The 9 E’s of Economics

I- Efficiency

II - Effectiveness

III - Elasticity

IV - Employment

V - Equilibrium

VI - Equity

VII - Excludability

VIII - Expectations

IX – Externalities

The ‘O’ in Economics – Opportunity Cost

Page B

2.2 Externalities

Costs & Benefits External to Market Price

Public & Private Goods & Bads


(a) By Type

(b) By Geography

(c) By Absorptive Capacity

(d) By Policy Instrument

2.3 Property Rights

Anglosphere Common Law

European Civil Code

The Commons (Natural & Artificial) & International Law

2.4 Cost/Benefit Analysis, Present Value & the Precautionary Principle

Cost/Benefit Analysis

(a) Measurement of Costs & Benefits

(i) Pollution

(ii) Environmental Assets

Present Value

Precautionary Principle

2.5 Links

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. 



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!