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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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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?
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies24.04.2014
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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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies
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
Elsner/Heinrich/Schwardt: Microeconomics of Complex Economies
Chapter 01: Introduction to Microeconomics of Complex Economies24.04.2014
22
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