05 August 2007

Economics in Family Decisons

Economics in Complicated Family Decision Making Situations

I was talking to my sister, a MSW (Masters in Social Work), how Economics has changed my perspective in how markets and societies work.

I said that I am a big believer in near laissez faire behavior.
The response was, “well, what about within marriage and families?”
In the interest of conversation simplicity, I had left out a significant stipulation. And the retort question had hit that stipulation right on the head. I didn’t, and don’t have a simple short-winded answer, as good questions don’t usually have that. But, here’s something.

The Fundamental Welfare Theorem of Economics says that under some basic conditions, if everyone does what is directly best for them, then the resulting competitive equilibrium allocates resources efficiently.
[efficiency (pareto efficiency), means that nobody can do better without someone else necessarily being worse off]
This is a good thing in that resources get used without waste and nobody ends up preying on anybody else.

But those basic conditions are crucial. They say that markets need to have perfect competition, and (this next one is the important one in our conversation) that there should not exist externalities (spillover effects). It is the role of government to intervene minimally to correct those potential market failures.

Externalities occur whenever an individuals’ actions indirectly effects the welfare of others. It probably happens all the time in sociology. In economics, it doesn’t happen all the time because most effects are reflected in the price, but still it happens a lot. For example, if you buy a loud stereo, then the direct effect is the change in your wealth and the firms profit, but the indirect effect is the degradation of the welfare of your neighbors. There are positive externalities too. For example, when you pay a good street performer, the direct effects are a deduction in your wealth and an increase in his, but the indirect effects are an increase in the welfare of other passer bys who also get to enjoy watching the performance.

Normally, as stated before, the remedy should be minimal govt intervention to restore fair pricing. In the stereo example, it could be a tax on loud stereos with the government's revenue being used to compensate the disturbed. In the street performer example, it would be each individual paying according to their benefit, and the performer getting rewarded for the total effect of his performance. For the economists out there, you would recognize the fact that externalities are correctable through government intervention as the Coase Theorem (http://en.wikipedia.org/wiki/Coase_theorem).
(New Orleans used to actually do this, in that they would help subsidize some of the performers based upon how they viewed their impact. And other governments do similar things. Good moves. Granted, governments do some pretty bone-head moves also, but that is another story).

The parallel here with marriage and families is that the externality effect is huge. The decision by your spouse has huge indirect effects upon your welfare and vice versa. And similarly the solution should be like a government intervention. A separate entity, the family (or the couple or group), should make that decision for the family (or the couple or group). What are this aggregate unit’s values? What is the best decision for this aggregate unit? Subsequently communication is critical. Now all component parties should know exactly the effect that their decision will have upon the other parties and can now be accurately incorporated into the aggregate’s decision. For instance, if a solution really benefits one party, then that member could use of some of their surplus to appease the other party. This is good that there is a solution, but it is a total burden in the form of ample communication.

For large groups, deciding on the organization and fair operation of the group is a very complicated problem. One must protect against the possible formation of factions that can deviate for subgroup improvement at the cost of the other members. This was the source of the majority of debate by the framers of our constitution in the Federalist papers. In many ways they have succeeded, but in some ways factions have definitely achieved real power. This is another discussion for another post.
http://www.foundingfathers.info/federalistpapers/

So, there is the long winded answer. Good in theory, but not sure if it’s any good for practice.

If still reading, or still interested, the intro on the Wikipedia page kind of explains the same thing.
http://en.wikipedia.org/wiki/Fundamental_theorems_of_welfare_economics
also, see the introduction and discussion associated with figure 2 on the site
http://cepa.newschool.edu/het/essays/paretian/paretoptimal.htm

3 comments:

Adam said...

Mastro,
Intersting piece. Before I can either agree, disagree, or weigh in, I am still having trouble with the definitions. Again, this could probably be resolved by looking in a book, but I choose to bother you.

The definitions rely upon the phrase "an efficient allocation". Which leads me to ask, is this allocation unique in any sense, say in some probablistic measure. Also, what defines efficient, is it efficient to the market (ie allows for maximal market growth), or is it effecient for human survival (ie most people live)? Would optimizing for one of these metrics neccessarily be unoptimal for the other?

Anyway, good luck and I'll talk to you later.

Adam

Jena said...

Yep, communication can minimize those externalities especially with relationships as people often have underhanded or hidden agendas in some of their decision making processes in negative ways of course (passive aggressive behavior) typical female behavior or even in positive ways (hoping to please the other person but going about it the wrong way)typical male behavior. And both of these problems are strictly dysfunctions of a lack of communication.

Anonymous said...

Do you think this translates to animal communities?