concepts

Rational economic man – Homo Economicus

Rational economic man – Homo Economicus

Homo Economicus is a hypothetical concept that humans are: Self-interested Know what they want Make rational choices to maximise their utility. These choices are based on concept of marginal utility. This concept of a rational economic man is an important cornerstone of neo-classical economic theory. It creates a framework to model how consumers and firms will respond to different situations. How ‘rational economic…

Life-Cycle Hypothesis

Life-Cycle Hypothesis

The Life-cycle hypothesis was developed by Franco Modigliani in 1957. The theory states that individuals seek to smooth consumption over the course of a lifetime. Graph shows individuals save from 20 to 65 As a student, it is rational to borrow to fund education. Then during your working life, you pay off student loans and begin saving for your retirement. This saving during working life enables you to maintain similar levels of income during your retirement. It suggests wealth will build up…

Measuring utility

Measuring utility

Utility is a concept given to how much satisfaction/happiness a person gains from a particular action. Utility derived from the philosophy of utilitarianism. An early advocate of Utilitarianism was Jeremy Bentham who argued that utility was the accumulation of pleasure and avoidance of pain. The concept was refined by others such as J.S. Mill who argued there were higher pleasures, such as a love of literature and culture. Therefore, a decision to forego pleasure now and study could be a rational way to maximise total utility. Utils We can try to measure utility…

The economics of discrimination

The economics of discrimination

Discrimination in the labour market occurs when employers make decisions on wages and employment based on prejudices, such as race, gender, religion. It can lead to variations in wages for the same job and different employment rates. Kenneth Arrow defined discrimination as: “the valuation in the market-place of personal characteristics of the worker that are unrelated to worker productivity.” For example, employers refusing to employ people from ethnic minorities or paying women lower wages for comparable work. In 1968, 850 women machinists at the Ford factory in Dagenham went on strike over equal…

Rotten Kid Theorem

Rotten Kid Theorem

The Rotten Kid Theorem states that in a family with a wealthy altruistic parent  – even selfish kids – can have a financial incentive to be harmonious and kind to their siblings. This theory of family behaviour was first proposed by Gary Becker in an article (1974). “A Theory of Social Interactions”. He later expanded on the idea in ‘a Treatise on the Family’ (1981) Assumptions of the Rotten Kid Theorem We start off with a wealthy family head. This head of…

Economies of scope

Economies of scope

Economies of scope occur when a firm can gain efficiencies from producing a wider variety of products. These efficiencies can involve lower average costs. It can also involve increased revenue from being able to increase sales in new, related markets. It is similar to concept of economies of scale – where higher output leads to lower average costs. But, there is a difference. Economies of scope is not about producing the same good at lower average cost, but using its size and resources to produce similar or related goods. Examples of…

Rational expectations

Rational expectations

Rational expectations is an economic theory that states – when making decisions, individual agents will base their decisions on the best information available and learn from past trends. Rational expectations is the best guess for the future. Rational expectations suggests that although people may be wrong some of the time, on average they will be correct. In particular, rational expectations assumes that people learn from past mistakes. Rational expectations has implications for economic policy. The impact of say expansionary fiscal policy will be different if people change their behaviour because they expect…

Diminishing marginal utility of income and wealth

Diminishing marginal utility of income and wealth

Diminishing marginal utility of income and wealth suggests that as income increases, individuals gain a correspondingly smaller increase in satisfaction and happiness. Utility means satisfaction, usefulness, happiness gained. Utility could be measured by the amount you are willing to spend on a good. Marginal utility of first £100 If you have zero income and then gain £100 a week. This £100 will improve your living standards significantly. With this £100 you will be able to pay for the basic necessity of life – food, drink, shelter and heating. Without this basic £100…