Introductory Microeconomics...Introductory Microeconomics An Introduction to the Microeconomics of...

Introductory Microeconomics

An Introduction to the Microeconomics of Complex Economies

Prof. Wolfram ElsnerFaculty of Business Studies and Economics

iino – Institute of Institutional and Innovation Economics

Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies

Chapter 01: Introduction to Microeconomics of Complex Economies24.04.2014

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Readings for this lecture

Mandatory reading this time:

An Introduction to the Microeconomics of Complex Economies, in: Elsner/Heinrich/Schwardt (2014): The Microeconomics of Complex Economies, Academic Press, pp. 3-23.

The lecture and the slides are complements, not substitutes

An additional reading list can be found at the companion website

http://www.amazon.com/The-Microeconomics-Complex-Economies-Institutional/dp/0124115853/ref=sr_1_1?ie=UTF8&qid=1396453322&sr=8-1&keywords=Microeconomics+of+complex+economies


http://booksite.elsevier.com/9780124115859/


Chapter 01: Introduction to Microeconomics of Complex Economies

Economic situations: A much broader and more fundamental range of circumstances than the exchange of goods and services for money, e.g.:

Research and development (R&D) Competitive set-ups Acquiring knowledge in structured ways Increase future earning potential

Results depend on decisions made by other agents as well

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Economic Situations



Multi-personal (social) decision situations

Direct interdependence

Behavior of one influences results of others Of interest is the choice of behavior – individuals have to have

at least two options Individually optimal decision may have negative effects on

results of other agents Overall suboptimal outcomes can result

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Economic Situations



Social situations with interdependent agents can be differentiated by the degree of conflict – individual interests are fully or partly aligned, or in conflict

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Social Situations

Individually optimal behavior leads to optimal social, collective outcome

Individually optimal behavior leads to socially suboptimal outcome

Comparatively worse individual outcomes

Might allow for superior results

How to deal with such situations?



Pareto Criterion: Criterion for evaluating and comparing situations

Pareto Optimum: no agent´s situation can be improved without reducing the payoff of someone else at the same time

Criterion does not include a broader judgment regarding the desirability of an outcome

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Pareto Criterion



Social Optima: Rational and individualistic agents will reach a Pareto-optimal result

Social Dilemmas: Rational and individualistic agents deciding will not reach a Pareto-optimal result

Individually optimal choice does not generate optimal outcome

No one has individualistic incentives to change this choice No possibility to solve this situation (improve the outcome

without outside support, or some change in the situation)

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Social Optima and Social Dilemmas



Coordination Problems: No clearly optimal behavior, different options become more or less attractive, depending on what other agents in a group opt for

Individually optimal behavior cannot be defined without knowing the choices of other agents

Coordinated on a type of behavior, there is no reason to change, at least not individually

There is no guarantee that the coordinated situation would be the best possible result, but it is superior to uncoordinated outcomes

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Coordination Problems



The Invisible-Hand World View

Individually rational behavior would automatically result in a social optimum

Concept of self-organizing social and economic system leading to desirable outcomes without need for supervision

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The Invisible Hand



The Fallacy-of-Aggregation concept contains individually optimal actions that may result in Pareto-inferior outcomes

Individually rational behavior does not result in a social optimum

Importance of expectations Stabilizing and supporting functions for third agents Emergence of behavior that can improve results among the

agents

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The Fallacy of Aggregation



Coordination problems represent a continuum of problem structures beyond the easy case of rational decisions resulting in a Pareto Optimum.

Degree of conflict differs depending on the overall problem structure (Degree of conflict: Can a Pareto-optimal outcome be reached? Are individual interests aligned in the outcome?)

Different situations require different responses to ensure a Pareto optimal outcome

But what are the measures appropriate to ensure a Pareto optimal outcome in a given situation?

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Continuum of Complex Decision Structures



Beyond direct interdependence, real-world situations are commonly characterized by:

Uncertainty

Path Dependence

Boundedly rational agents

Different behavior patterns, and social rules and institutions guiding them

External effects

In the remainder we introduce these aspects

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Important aspects of real world situations



Uncertainty describes a situation in which agents do not know about future states of a system

Do the agents know all possible states? Do they know their probabilities?

Uncertainty is not risk!

In case of direct interdependence: concept of strategic uncertainty

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(Strategic) Uncertainty



Ergodicity means that the properties and the constitution of the system do not change over space and time

Several endpoints in non-ergodic systems A dynamic view is required

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Path Dependence vs. Ergodicity

A

B

AB

BA

BBt

AA



Agents are boundedly rational – they can’t process all information given in one moment (and under uncertainty lack certain information in any case)

What is helpful in such situations for the agent?

Social Rules and Social Institutions reduce complexity for the agents and stabilize behavior pattern and expectations

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Bounded Rationality



Rules and Institutions are able to solve coordination and dilemma problems:

Social Rules help achieve coordination (in the best case on a Pareto-optimal outcome)

Social Institutions help achieve (common) cooperation Cooperation is defined as coordination plus sacrifice (giving up

a short-term advantage for longer term gain) Social institution is a social rule plus sanction mechanism

(should cooperation be refused)

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How Rules and Institutions Can Solve Coordination and Dilemma Problems



The Instrumental dimension of an institution refers to its ability to solve common and collective problems The Ceremonial dimension of an institution refers to it as an instrument to maintain differential power and status Live-Cycle of a rule:

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Instrumental and Ceremonial Dimension of Social Institutions

Emergence as a problem solving device

Introduction of a normative dimension

Emergence of a ceremonial dimension

t



An external effect is an uncompensated consequence of an economic decision to noninvolved agents

Institutions bring about such external effects By reducing uncertainty and strengthening expectations

Economies of scale describes the falling average costs as a result of increasing production volumes or numbers

repeated use of rules and institutions results in this effect for them as well (which can make changing them very challenging)

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External Effects and Institutions



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Different Types of Goods

Rivalry Nonrivalry

Excludability Private goods Club goods

Nonexcludability Commons Public good

Positive external effects of contributing to social rules and institutions Negative external effects of not contributing to the rules and

institutionsSimilarities to network effects



A market is a set of social rules and institutions, serving as a system of allocation of resources and of decision making involving prices and quantities – and one mechanism for addressing economic problems

Different markets may exhibit extremely different sets of rules and institutions

Markets are to be embedded in proper sets of rules and institutions for ensuring positive outcome

Markets are continuously changing over time – a static model of a market is likely miss important aspects of its operation, then

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Markets as Sets of Rules and Institutions



Microeconomics thus is “the” science of complex coordination, cooperation and organization

Directed Interdependence, in different problem structures Uncertainty Path Dependence Bounded Rationality Emergent Behavioral Patterns: Social Rules and Institutions External Effects

Only if these aspects are considered, can Microeconomics help to design measures adequate to support a Pareto optimal outcome in situations that do not obey the Invisible Hand but are subject to Fallacy of Aggregation-type issues

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Summary



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Readings for the next lecture

Compulsory reading:

Introduction to Game Theory, in: Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies, pp. 25-32.

For further readings visit the companion website





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