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ENVIRONMENTAL ECONOMICS

For centuries, traditional economics has been used to explain how people can create wealth and improve their lives through the supply and demand of goods and services. Starting in the 1960s, however, people began to realize that traditional economics failed to take into account other factors that greatly influenced quality of life, such as social welfare and the environment. Thus, environmental economics was born.

Environmental economics seeks to measure the external environmental effects, or costs, of economic decisions and propose solutions to mitigate or eliminate those costs to better manage natural resources and promote social well-being. Unlike traditional economics, which focuses on private ownership of property, environmental economics primarily concerns itself with the management of common or public property, such as lakes, rivers, game and parks.

Environmental economics functions on the theory of “market failure.” Simply stated, market failure occurs when markets fail to efficiently allocate limited resources in a way that benefits society most. For example, assume that a town has a large, freshwater lake. A parts manufacturing facility, responding to a market demand for car parts, moves into the town and begins using the lake water to process the parts. Without pollution controls in place, the water is soon contaminated, becoming unsafe to drink and killing all the fish. Since the lake was the town’s main source of food, recreation and drinking water, its citizens are forced to move away to find a new water source, leaving the manufacturing facility without a ready labor pool or a nearby consumer base. As a result, the company’s labor and shipping costs increase dramatically. Though the company simply responded to market forces by using the lake, its actions resulted in massive inefficiency caused by environmental degradation. Environmental economists seek to remedy such inefficiency by establishing environmental regulations, pollution quotas and property rights so that market suppliers can become wealthy without negatively impacting others.

Types of market failure include externality, non-exclusion and non-rivalry. Externality refers to the effect of an economic choice that is not factored into a product’s price. Non-exclusion exists when restricting someone’s access to a resource would be too costly. Non-rivalry means that a benefit provided to one individual, business or country can be enjoyed by others, reducing the incentive for economic actors to contribute to the public good. Some aspects of all of these can be seen in the example above. Because the lake was common property, the manufacturing facility was able to use it freely (non-exclusion). With unlimited use of the resource and no pollution controls in place, the facility could cheaply produce many parts to meet demand (externality). The townspeople had up until then kept the lake clean and properly managed, from which the company benefited without ever contributing to it (non-rivalry).

In order to address these market failures, environmental economists must first assess the value of environmental resources and assets. This can be quite tricky, since environmental resources are often viewed as having value beyond their economic use. People may want to preserve resources for undiscovered future use, to bequeath to future generations, or to simply enjoy their existence. Economists can calculate a resource’s non-use value by researching nearby land values, surveying the public, or examining what people are willing to pay to access or protect the resource. Once the value of the environmental asset is determined, economists can then establish policies that will preserve the long-term viability of the resource while still allowing it to be used for economic gain. Thus, environmental economics plays an important role in managing and allocating scarce natural resources.

(http://en.wikipedia.org/wiki/Environmental_economics)

BEHAVIORAL ECONOMICS

Meet Consumer A. Consumer A needs a new computer so she can work from home. The computer must be reliable and have a large processor since Consumer A will be using it daily to do several complex tasks. However, Consumer A only has a limited amount of money to spend, so she must ensure that she gets the best computer possible for her money.

Before going to the store, Consumer A carefully researches her options, comparing prices and reading consumer reviews of different computers. Finally, being fully informed, she selects one that will best meet her needs. In this way, Consumer A is a textbook example of the “economic man” in neoclassical economic theory: the always rational and informed consumer who drives all economic activity.

Now, meet Consumer B. Consumer B just had a bad day at work. He’s depressed, bored and craving some excitement. He goes to the mall to do some browsing and sees a stylish new fishing pole on display. Consumer B hasn’t been fishing in six months and already owns two other fishing poles, but this particular fishing pole arrests his attention. Consumer B starts thinking about how much he would like to own this fishing pole and how exciting it would be to buy it.

Like Consumer A, Consumer B has a limited amount of money to spend, and the fishing pole is very expensive. However, Consumer B quickly rationalizes his purchase by arguing that it will make him happy. Without even knowing how well the fishing pole will work or when he will use it, Consumer B purchases it on the spot with his credit card. This type of economic behavior is commonly referred to as “retail therapy”: shopping to improve one’s mood.

The concept of retail therapy, however, is surprisingly absent from neoclassical economics. For centuries, economists have assumed that people’s economic choices are always rational since they are motivated by need and limited by scarcity. But as retail therapy proves, that is not always the case. So where is the theory that takes into account irrational economic behavior like retail therapy?

That theory is called behavioral economics. Behavioral economics seeks to unite the basic principles of neoclassical economics with the realities posed by human psychology. The theory grew out of neoclassical economics in the early 20th century when neoclassical theory fell short of explaining the anomalies that occur within market economies.

Although behavioral economics arose from the writings of several notable economists, one of the theory’s leading principles came from economist Herbert Simon in the 1950s. Simon postulated that man could not always act logically because he possessed a “bounded rationality.” In other words, human minds are finite; they do not have unlimited information to solve problems, nor do they have all the time in the world to think about them. Humans also struggle to analyze problems objectively when the outcomes directly affect themselves, especially when viewing problems through a “frame” of personal experience warped by social or cultural bias.

To cope with these realities, humans apply their own rules of thumb, or “heuristics,” when making quick decisions. While it is inherently rational to do so, the rules themselves and the behavior they lead to may not be. In fact, heuristics, as described by leading behavioral economist Daniel Kahneman, are inherently irrational.

For example, in a common heuristic known as gambler’s fallacy, consumers take risks on what appears to be a future outcome in an instance of random chance, like a coin toss. Their logic is based on seeing the same outcome occur several times in a row and assuming a different outcome is due. The logic is, of course, faulty, since the odds for either outcome remain the same in every instance.

From Simon’s concept of bounded rationality sprang the idea that other aspects of humanity may be bounded as well, such as the self-interest that motivates the neoclassical “economic man.” Behavioral economists accept that other factors may drive consumers’ economic choices, like altruism or self-control.

Of course, an economic theory that allows for such variance in consumer logic and behavior poses a problem: how can economists rely on it to accurately predict economic outcomes? After all, pure neoclassical theory is much tidier by comparison, basing its mathematical models on a few basic, if convenient, assumptions.

Obviously, behavioral economists cannot rely as heavily on mathematical models to predict outcomes. Instead, they collect real world data on past consumer behavior and conduct experiments involving real transactions to gauge how consumers might behave in future situations. The goal in collecting such data is to eliminate unlikely outcomes so that likely ones come into focus. Although not as exact of a science compared to using mathematical equations, behavioral economists often manage to make startlingly accurate economic predictions. Economists have found that making realistic assumptions about human nature generally leads to a more precise result.

However, some economists still find reason to reject behavioral economics. Those who cling to pure neoclassical theory insist that the economic man is more rational than the natural man because market competition forces consumers to make rational choices. They claim that behavioral models based on data gleaned from experiments, mostly illustrates one-time choices, not complex economic behavior exhibited over time. Also, economists who prefer the stark, impartial rigidity of neoclassical mathematical models view behavioral economics experimental approach with distrust. They say experiments and surveys can be skewed by participants’ biases. They see little application for behavioral models in real markets.

Nevertheless, behavioral economics has succeeded in explaining market anomalies where neoclassical economics could not. For instance, it has been used to examine the roles played by human greed and fear in the 2008 financial crisis. The promise of windfall profits lead financial companies to create and sell highly complex credit default swaps without fully understanding their risk. When the stock market crashed, fear drove usually adventurous hedge fund investors to withdraw their money from the market, even when they could have bought good stocks at record-low prices. Behavioral economics can explain other phenomena as well, such as why some prices or wages refuse to change with market forces (price stickiness), why stock markets perform worse on Mondays (calendar effect) and why some investors choose to hold onto poorly performing stocks while selling high-performing ones (disposition effect).

(http://en.wikipedia.org/wiki/Behavioral_economics)

DEVELOPMENT ECONOMICS

Development economics is a branch of economics that focuses on how to improve the economies of developing countries. Its major concern is the development of third world economies. Development in such countries is met by improving the basic amenities to promote the welfare of its citizens and to maintain a certain set standard of living for all its citizens. The sectors that should be improved according to the development economists are health, education, employment, inflation, domestic and international economic policies. This branch of economics is specially tailored to the developing country to help them transform into a prosperous nation through progressive economics.

Development economics concepts might differ from one nation to the other because of the existence of unique features for different countries like political and social background. The concepts of macro and micro economics are greatly borrowed in the development economics on structures of developing economy and efficient domestic and international growth.

The economic development field looks at both the traditional measures of economics like the GDP and more modern measures of the Economy like the standard of living and equal rights opportunities. Development economics can also be seen as the only branch of economics that is concerned more with political processes. It is very keen on the economics agenda that have been passed by the political class in each economy. The most fundamental features of development economics became very clear after World War II. Although some primitive forms of this economy were still practiced by some countries, especially the major empires. The need to expand the concept of development economics came after the war-ravaged nations started the process of economic building. World War II had left major economies especially in Europe in shambles.

Development economics is surrounded by many theories. The earliest being the linear stages of growth model. The basic idea in this theory is that economic development and steady growth are to be achieved through the pooling and holding of huge capital from domestic and international savings. The theory failed immediately after being advanced because it did not recognize the necessary preconditions for takeoff. The other development theory that was advanced by developing economy was the international dependency theory. This theory suggests most of the economic problems facing the developing economy were from external forces beyond their control. There was a huge outcry on this theory and this gave birth to the neoclassical theory of development economics. The neoclassical theory suggests that economic development can only be achieved if government removed all the controls and regulations to make the market free and allow demand and supply to play the important roles in economic equilibrium and control. The theory has been adopted by many institutions such as the World Bank with some few differing points on the degree to which the market should be free. A market friendly approach is adopted by the World Bank and allows for some government regulation. The market free schools of thought suggest a free economy that is not influenced by external factors rather than the market forces.

(http://en.wikipedia.org/wiki/Development_economics)

MANAGERIAL ECONOMICS

Managerial economics is a social science discipline that combines the economics theory, concepts and known business practices in order to make the process of decision making easy. It is a very useful concept for every manager that is planning for the future. This is so because it assists the managers to make rational decisions on various obstacles facing the firm. Most of the complex management decision facing a firm can be broken down in a series of logical solutions. A key area of managerial economics is the theory of a firm that entails the best mix of the scarce resources to maximize profits within the firm. Marginal benefits and cost analysis are also another broad area in managerial economics. Managerial economics can be viewed by most modern economists as a practical application of economics theory in using effectively the firm’s scarce resources.

Managerial economics as a science is useful to managers in making decisions relating to a firm’s customer’s base, competitors and strategic future decisions. A lot of mathematical concepts especially statistics and analytical tools are required because of the probabilistic nature of future decisions that the firm wants to make. Most people might ask the questions why study managerial economics while one can make decisions based on past data. It is a genuine question but it is not possible to make a conclusion merely on the bases of prior data because of the dynamic nature of the current market. We have seen a lot of unexpected events that have happened in the past that we never expected. One is the crash of major banks in the US and the current crisis in Greece. Based on these examples it is now clear that we need an approach like managerial economics which will not only take into consideration the prior data but will allow us to include future risks in the posterior data.
Managerial economics helps the manager or the group/ groups of people making the decisions to increase their problem analytics skills as well as formulation solution to probabilistic problems. The main difference between managerial economics and the other branches of economics such as macro and micro economics is as follows. Micro economics involves the allocation of scarce resources on household level. Macro economics involves the study of economics as a whole. While managerial economics applies the tools learnt in these branches to come up with viable business ideas. Managerial economics is very broad and it is not only used in decision making by profit oriented organizations but also by non-profit making organizations in the proper utilization of their scarce resources. The concept of management economics is also very useful in price determination, long term capital budgeting, and insights into the demands of a commodity.

(http://en.wikipedia.org/wiki/Managerial_economics)