Unit 5: Property and Power - Mutual Gains and Conflict

Institutions and Power

• This unit transitions from individual decision-making to interactions within legal and institutional frameworks.
• It covers institutions, power, Pareto efficiency, fairness, and how these elements shape economic outcomes and welfare.
• Key concepts include Institutions, Power, Bargaining power, Pareto efficiency, Substantive and procedural concepts of fairness, Economic rent, Coercion and bargaining.

Institutions, Power, and Rent Distribution

• Institutions: Formal and informal rules governing interactions and distribution of economic rents (surplus).
• Power: The ability to achieve desired outcomes in interactions.
• Property owners can exert bargaining power by:
  • Setting terms in a take-it-or-leave-it manner.
  • Bargaining with multiple workers, creating competition.
  • Imposing costs or threatening contract termination.

Property and Power in Capitalist Systems

• Property ownership can grant power (e.g., employers setting wage terms).
• Changes in labor supply/demand and new institutions (trade unions, voting rights) can shift bargaining power.
• Monopolies can exert power over consumers.
• Institutions in democratic societies protect against coercion and promote voluntary exchange.

Evaluating Institutions and Outcomes

• Allocation: The outcome of an economic interaction.
  • Includes each person’s contribution, the project's product, and the distribution of the product.
• Institutions and outcomes are evaluated based on efficiency and fairness.

Efficiency vs. Other Considerations

• In economics, efficiency differs from engineering (sensible methods) and business (profitability).
• Pareto Efficiency: An allocation where no alternative can make one person better off without harming another.
  • If an allocation is not Pareto efficient, it's considered inefficient.
  • The question "Is poverty efficient?" is posed.

Pareto and Efficiency

• Vilfredo Pareto sought to establish economics and sociology as fact-based sciences.
• Pareto Law: A small group holds most wealth (e.g., 80-20 rule).
• Pareto argued people compete over shares of the pie, either through production or appropriation.
• He is renowned for defining efficiency in economics.

Pareto Improvement

• Pareto Improvement: A change that makes at least one person better off without harming anyone else.
  • No trade-off is involved.
• If a Pareto improvement is possible, the initial allocation is Pareto inefficient.
• Pareto efficient allocation: No Pareto improvements possible; any change involves a trade-off.

Pareto Efficiency Example: TV Time

• Scenario: Two siblings with one TV, differing show preferences, and 4 hours of TV time.
• Question: Is a 2-hour split Pareto efficient?
• To determine, consider if alternative allocations lead to Pareto improvements.

Pareto Efficiency: TV Time Allocations

• Allocating 3 hours to the brother and 1 to the sister isn't a Pareto improvement (sister is worse off).
• Similarly, 2.5 hours to the sister and 1.5 to the brother isn't a Pareto improvement (brother is worse off).

Pareto Efficiency: Full Allocation

• No TV time allocation can improve one sibling's situation without worsening the other's.
• All allocations using the full 4 hours are Pareto efficient.

Pareto Efficiency: Book and Skateboard

• Siblings Lisa (prefers books) and Bart (prefers skateboards) receive mislabeled presents.
• Lisa gets a skateboard, Bart a book.
• Question: Is this allocation Pareto efficient? Is a Pareto efficient allocation possible?

Achieving Pareto Efficiency

• The Pareto efficient allocation: Lisa gets the book, and Bart gets the skateboard.

Mutually Beneficial Exchange

• Children trading Halloween candy exemplify Pareto efficiency.
• Trades improve one child’s utility without harming others.
• The final distribution is Pareto-efficient, as mutually beneficial trades are exhausted.
• Mutually beneficial exchanges indicate the original allocation was Pareto inefficient.

Prisoner's Dilemma

• The Prisoner's Dilemma is presented with a payoff matrix for Anil and Bala using Integrated Pest Control (IPC) or Terminator.
• The matrix shows payoffs for each combination of choices.
  • Anil IPC, Bala IPC: (3, 3)
  • Anil IPC, Bala Terminator: (1, 4)
  • Anil Terminator, Bala IPC: (4, 1)
  • Anil Terminator, Bala Terminator: (2, 2)

Efficiency in the Prisoner’s Dilemma

• A social dilemma is a Nash equilibrium that is Pareto inefficient.
• Figure 5.1 illustrates outcomes and their efficiency:
  • I,I (Both use IPC) is efficient.
  • I,T (Anil uses IPC, Bala uses Terminator) is efficient.
  • T,I (Anil uses Terminator, Bala uses IPC) is efficient.
  • T,T (Both use Terminator) is inefficient.

Pareto Criterion Limitations

• The Pareto criterion doesn't determine the