Matt Nolan

What is modern business cycle theory

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If you want to know, have a look at this post. It is completely non-technical, and explains the way macro-economists look at things pretty danged well! (ht Marginal Revolution).

Fundamentally, this view of the business cycle is highly focused on methodological individualism – the business cycle occurs in the context of individuals maximising their happiness given constraints.

Before this strain of thought came out, business cycle theory was a surprising holistic section of economics – something that did not match with the individualistic nature of microeconomics (see Schumpeter). Furthermore, business cycle theory, long-term growth theory, and near term macroeconomics (effectively old school Keynesianism) were relatively incompatible.

Following the collapse of the “consensus” in macroeconomics during the oil crisis the one ray of hope was that we macroeconomics could be recreated in a way that is consistent with microeconomics. According to Kids prefer cheese this research area is still active – which is exactly what we want to hear.

Update: Paul Walker discusses the same article.

Matt Nolan

A very inconvenient question

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Over at Econlog they mention a uncomfortable question that is asked at Instapundit:

If somebody offered us our current income tax system for the first time, would we buy it?

Now when we have defended progressive taxes on this blog we have often assumed that it is a revealed preference for society – in fact this is a favored measure we have for actually revealing (to some degree) what is optimal (here, here, can’t actually find any of the tax posts 🙂 ).

How could this work? How could we have a system that is not optimal.
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Matt Nolan

The value of value

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One of the major questions I face when discussing economics is:

Why do we feel that prices are the appropriate measure for illustrating the value someone receives from a product?

Now I only have a limited understanding of welfare economics, but I am going to attempt to discuss the issue anyway 😉 . If anyone more knowledgeable would like to correct me I would be happy to hear from them.

In a micro sense this idea could be criticised insofar as one person may have a lower “willingness to pay” for a product which may stem from having a higher opportunity cost (as they have a lower wealth level then other people) rather than truly receiving less value from the consumption of the good/service. If this is the case we may feel that we should re-distribute the resource from the wealth to the poor in order to increase the level of aggregate welfare.

Now accepting this relative ranking of preferences and the given endowment in the market this could be a suboptimal situation in terms of welfare. After all, we know that the poor person values both of these goods more than the wealthy person (assuming no linkages between them) so “total satisfaction” in society will be maximized by this implicit “redistribution” resources. However, this does not make the price mechanism pointless, let me attempt to explain.

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jamesz

Making sense of insurance

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I recently mentioned that prospect theory tells us that most people are risk seeking in losses. CPW commented that this seems to be at odds with the fact that people buy insurance. After all, if people like risky losses, why would they pay money to avoid them by purchasing insurance? According to John Nyman the answer lies in a straightforward reframing of the choice consumers face when they buy insurance. Read more

Matt Nolan

The economist’s economic growth bias

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Reading the titles of the last two posts (the birth rate vs the growth rate and growth forecasts and government) I realised that neither rauparaha or myself defined what ‘growth’ we were talking about. Like all economists, we took ‘Growth’ to be synonymous with growth in gross domestic product.

Could this possibly imply that economists such as rauparaha and myself have an inherent bias when discussing normative statements about welfare that points us towards pro economic growth policies – even when there is a hefty trade off in other social values. Do economists focus too strongly on technical and allocative efficiency without taking social efficiency and equity into account?
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dant03

Water – is there a role for demand management at the household level?

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Lately, water shortages, and in particular rural droughts, have been in the news. While the farmers in many regions certainly are suffering, and there are definitely enough meaty economic issues around farmers’ current water allocations and associated issues, I want to concentrate on economic issues around water use by (mainly urban) households, and what role demand management should play.

For the most part, New Zealand has heaps of water. Yet in Wellington, where I live (for instance) sprinkler usage is currently rationed, and there is talk of an all out sprinkler ban if a big downpour doesn’t happen soon (the recent trickles are only holding things off for a while). That is because the main sources of drinking water in the region – the water catchment area in the rimutukas (near Wainui), the Hutt River near Kaitoke, and the Aquifers under the Hutt Valley, are all at about the limit of what they can give without incurring major damage, due to the recent low water flows.
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