To coincide with the release of The Cartoon Introduction to Economics, I’m working on updates of a (free!) companion micro textbook. Here is the latest version (version 5.01) of the textbook: basic and with calculus.
Both versions have chapters that line up with the chapters of The Cartoon Introduction, with follow-up supplemental chapters on inflation, sequential-move-games, etc. Compared to previous versions of this textbook, I’ve also improved the Q&A at the end of each chapter, e.g., you can now easily click back and forth between each Q and the corresponding A.
Please let me know if you’re using the book, and definitely let me know if you find any mistakes!
I’m in PB AF 516!!
On Pg. 17 of the basic book it states: “Comparing the items in the various payoff boxes, we can see that some are in all the payoff boxes and some are not.” However, there appear to be no “items” in figure 2.1’s boxes. Is this referring to a separate diagram or is this figure possibly missing some detail?
I love your website – and started reading the micro textbook – had a question early on – one of the concepts that I found most insightful when I was working towards my degree in econ some 40 years ago was Simon’s idea of “satisficing” vs. “optimizing”. I have felt for years that economists would be wise to incorporate this idea into their work – along with more agency and game theory concepts. Your thoughts?
Agreed, but the question is how. This is what behavioral economists are busy working on. And it’s worth noting that the optimizing model works quite well in a large number of situations. You might also enjoy the discussion of this in the last chapter of my forthcoming cartoon book. (Sorry for the shameless plug, but it’s true 🙂
OK – I will pre-order 🙂
My gut is that the optimizing model works fine – unless the buyer decides he will “settle” for a satisficing outcome – and the problem is he/she does so without telling us in advance which “behavior” he/she prefers.
I am a marketing PhD student and have read a good bit of agency theory stuff – some game theory – any suggestions on how to get better grounded in behavioral economics?
Yoram, I love your discussion of Pareto efficiency and Pareto optimality, but would seriously recommend just scrapping the discussion of cost-benefit analysis.
Let’s take this passage: “These are difficult issues, and it is in large part because of them that cost benefit analysis, though useful in practice, is unattractive in theory. Fortunately, there is an alternative concept [to cost-benefit analysis], one based on the work of Italian economist Vilfredo Pareto (1848-1923).”
Where do I start? Pedagogically, setting up a straw man and knocking him down isn’t that helpful (“Prof, do we need to know this stuff about cost-benefit analysis for the exam?”) For the theory of CBA, see Dreze and Stern – CBA can be done in a beautiful theoretical social choice framework (though, in practice, often isn’t). The Pareto criterion isn’t a useful alternative to CBA – Pareto improvements can be thought of as $20 bills lying on the sidewalk – great if you can find them, but there aren’t many of them around. The Pareto criteria gives an incomplete ordering of states of the world (in Arrow’s terms). In fact, CBA can be thought of as simply an attempt to search for potential Pareto improvements. And it’s not obvious that Pareto is best described as an economist – sociologists claim him too.
It’s a pity, because the discussion of Pareto optimality and Pareto efficiency in the cartoon introduction is just excellent.
Hi Frances, and thanks for your comment. You might be right about the book being stronger without the material on CBA, but first I want to give you some push-back on how “CBA can be done in a beautiful theoretical social choice framework”. You cite Dreze and Stern, but here’s what they say (in section 3.2):
I think (or at least hope) that we can agree that there’s nothing beautiful about social welfare functions. Dreze and Stern seem to think so, because they then have an entire subsection (3.2.1) on “‘Avoiding’ Value Judgments”, where they discuss “four ways of apparently avoiding the use in cost-benefit analysis of judgements concerning distribution across households.”
One of these four ways is to require a strict Pareto improvement, about which they write:
The second way is, as you suggest, to seek potential Pareto improvements; I’ve written a bit about this elsewhere (see my paper with Zerbe and Finkle), but here’s what Dreze and Stern say:
All of this doesn’t seem too far off from what I wrote (“cost benefit analysis, though useful in practice, is unattractive in theory”), yes? Am I mis-reading Dreze and Stern? Or maybe I’m just not being clear enough in the text. My point is certainly not that CBA is not important; my point is that CBA is really about policy and not about theory. Yes you can attempt to provide theoretical justifications for CBA (again, see my paper with Zerbe and Finkle) but in the world of theory CBA skates around on (relatively) thin ice.
Yoram – thanks for taking the time to reply.
I think Dreze and Stern’s position would be that, when making policy decisions, value judgements are unavoidable, and it’s best to be up front about them – e.g. with a social welfare function. Note that they say “four ways of *apparently* avoiding the use…” None of these ways *actually* avoids the use of value judgements.
It sounds like you and I agree that CBA is, in practice, frequently the best way of making policy decisions (Pareto improvements being rare and the potential Pareto criterion being equivalent to a certain type of CBA – though as you know the social choice literature on potential Pareto improvements is vast).
If this is the case, then there must be a reason why CBA is the preferred option. Unless that reason is grounded in theory, then we have serious problems with our discipline – i.e. we don’t have a theoretically sound way of making policy recommendations. So I can’t agree with you that “CBA is unattractive in theory”.
The other thing that, perhaps, we can agree on, is that CBA is complicated (it’s my least favourite thing to teach in public finance, precisely because of these complications, and because I feel like I’m one lonely person with a few sandbags, trying to stem a flood of sloppy, ad hoc, analyses.)
Are you continuing to update the text? I see the on-line version is dated 2010, and the cartoon guide is now being bundled with a variety of first year texts.
Producing e-texts is an amazing service to the profession, kudos to you for taking the time to do it,
Hi Frances: We agree that CBA can’t avoid value judgments, and we agree that CBA is complicated, and we agree that CBA is nonetheless often a good way to make policy decisions. So far so good!
You also ask about the “reason why CBA is the preferred option” and suggest that it must be grounded in theory. Here I think we part ways: lots of things can be preferred for practical reasons rather than theoretical reasons. One that comes to mind is economists’ preference for market mechanisms over central planning: the Fundamental Theorems of Welfare Economics say that well-functioning markets can accomplish just as much as a benevolent and all-knowing central planner, but (for good reason!) they don’t say that well-functioning markets can accomplish more. So why do we prefer markets? You could argue that we don’t have benevolent and all-knowing central planners, but I could reply that we also don’t have complete and competitive markets, and from there we end up stuck in the mud of the Theory of the Second Best. So I would argue that it’s really practical considerations, not theoretical ones, that lead us to favor market mechanisms.
I’ll give you a more specific example that is related: in environmental policy we favor economic tools like carbon taxes over command-and-control approaches. Why? Again, I think the reason has more to do with practical matters than with theory. In my PhD dissertation (which is on my website somewhere 🙂 I showed that there are some situations where command-and-control policies provide stronger incentives for innovation than market-based policies… but I never lost my faith that market-based policies are in general a much better way to go. And most of that faith comes from looking at disasters like corn ethanol and successes like SO2 trading, and from having more confidence in broad-based market-based instruments than in the detailed judgment of politicians and regulators. If you asked me for a purely theoretical justification for preferring economic instruments I’m not sure I could give you a very good answer.
PS. I’m not sure anybody’s using the online text, so I’m not sure I’ll ever update it again. But… maybe. In any case, thanks for your kind words about it!
PPS. Would it be any better to say that CBA is “philosophically troubled” or something like that instead of “unattractive in theory”? I certainly have no desire to imply that CBA is useless.