Economic Rationality: Households, Businesses, and the Public Sector

Economic Rationality

Economic rationality assumes that households and businesses use their scarce resources to maximize their own utility or profit, respectively. It is used to model economics to explain and predict the behavior of economic agents.

Households

Function: Consumer target

Objective: Maximize their own welfare by choosing goods that satisfy them according to their preferences and their limited budget.

Businesses

Function: Production

Objective: Maximize profits through effective utilization of available resources to produce goods and services as profitably as possible.

Public Sector

Function: Regulation system

Objective: Maximize the general welfare by using available resources to produce required public goods and services and reducing inequalities.

Supply and Demand

Businesses offer goods and services in product markets and demand labor in factor markets.

Basic economic problems:

1. What goods and quantities to produce (what needs will we meet with our scarce resources)?
2. How will these assets be produced (with what resources and techniques will we produce)?
3. Who will these assets be produced for (distribution)?

Economic Systems

An economic system is the way a society organizes itself to solve its economic problems.

Market Economy System

Decision-makers: Businesses and consumers through the price system.

State: Ensure the free functioning of the market.

• What to produce: Decided by the consumer market.
• How to produce: Maximize profits.
• For whom to produce: Those who can afford it.

Advantages: Operational efficiency and economic freedom.

Disadvantages: Unequal incomes, not always efficient, unstable with periods of crisis, creates artificial needs, questionable economic freedom.

Central Planning (Socialism)

Decision-maker: The state through a central planning agency.

Operators: Consumers, state-owned enterprises, and workers.

Goods production: The state sets decisions on what and for whom to produce.

Advantages: Work, health, and free education for all, and equal income.

Disadvantages: No incentives, excessive bureaucracy, and inefficiency of the system.

Mixed Economy System

Combines the virtues of the market with state intervention and correction of its faults.

Market Failures

• Cyclical crises
• Unequal income and wealth distribution
• Public goods (non-rival consumption, impossibility of exclusion in consumption: e.g., national defense)
• Externalities (effects on the environment, e.g., education, pollution)

Economic Theories

• Economic Liberalism: Reduce government intervention (Adam Smith).
• Marxism: The state must intervene to ensure the basic needs of society. The state should consider ecological and social values, not just cost.
• Neoclassical or Marginalist: Price formation according to supply and demand.
• Keynesian Theory: State intervention to prevent falling demand by increasing public spending.
• Neoliberal Trend: Trust in and continuation of market liberalism.
• Neo-Keynesians: Followers of Keynes, focusing on unemployment. To improve employment, it is necessary to reactivate the economy with public investment.
• Monetarists: Propose liberalization or abolition of state regulations to allow the market to work more freely.