Incentives and Economic Systems: A Classroom Exercise.

Author:Bruehler, James R.
Position:EDUCATIONAL NOTE
 
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  1. Introduction

    In most introductory economics courses, students learn the three basic questions that must be answered in setting up an economic system: What is produced? How is it produced? And who receives the goods and services once they are produced? This lesson is generally followed by a discussion comparing market-based economies and command-type systems. Students enter economics courses believing that they know what capitalism and communism are and how each system impacts the individuals living within it. However, a 2016 survey by the global public opinion and data company YouGov for the Victims of Communism Memorial Foundation, a nonprofit educational and human rights organization, shows that most Americans (especially those considered to be millennials or part of Generation Z) cannot recognize the definitions of socialism and communism; they do a better job with capitalism. Moreover, while 58 percent of the entire sample held an unfavorable view of communism, only 37 percent of millennials and 38 percent of those in Generation Z viewed communism negatively (Victims of Communism Memorial Foundation 2016). (1)

    These results indicate that economists may need to do more to educate students about capitalism and communism, yet few articles in the economics literature suggest how to cover this important topic. Zygmont (2014) describes a written assignment where students must choose and read a novel based in a Soviet bloc nation and then describe how their understanding of the economics of central planning affected their reading of the book. Zygmont (2006) and McCutcheon (2015) use a series of readings about the merits of socialism and capitalism and then have their students participate in debates. To our knowledge, no published papers describe classroom experiments or simulations letting students experience firsthand the impacts of alternative economic systems on living standards. This paper fills that gap. The simulation it describes can also teach students about marginal reasoning, deadweight loss, and game theory.

  2. The Model Economy

    These simulations are all modeled on a single, simple economy where residents produce a single good, pie (denoted [pi]). Completed pies are collected by a government agent, the Minister of Distribution. The Minister of Distribution, in turn, distributes all the pies to residents for consumption. In the simulation, working brings residents displeasure (denoted sadness, S), and consumption brings residents pleasure (denoted happiness, H). Participants are incentivized to maximize the net of happiness over sadness (denoted well-being, W). Figure 1 illustrates these key features of the economy, which are common to each simulation.

    Participants in each simulation face one straightforward task: choosing the level of effort to expend producing pie. Participants may choose any effort level from zero through ten, with zero denoting no effort and ten denoting maximum effort.

    1. Production

      Individual production depends only on labor input and is given by [[pi].sub.i] = 25 x [E.sub.i.sup.0.75], where [[pi].sub.i] denotes pie produced by individual i and [E.sub.i] denotes that individual's effort. This production function displays diminishing marginal returns to labor input. Overall production for the entire economy, 17, is the sum of individual production:

      [PI] = [summation over (term)] [[pi].sub.i].

    2. Happiness

      Individual happiness, [H.sub.i], depends only on how much pie individual i consumes, [C.sub.i]. Happiness for individual i displays diminishing marginal returns to consumption. Specifically, [H.sub.i] = 5 x [C.sub.i.sup.0.75]

    3. Sadness

      Individual sadness, [S.sub.i], depends only on how much effort individual i expends working to produce pie, [E.sub.i]. Sadness grows exponentially with effort. Because sadness rises as leisure falls ([E.sub.i] grows), sadness can be viewed as incorporating the disutility of work along with the cost of foregone leisure. Specifically, [S.sub.i] = [E.sub.i.sup.2].

    4. Weil-Being

      Well-being for individual i, [W.sub.i], is simply the difference between that individual's happiness and sadness. Specifically, [W.sub.i] = [H.sub.i] - [S.sub.i]. Aggregate well-being, denoted A, is the sum of individual well-being: A = [summation over (term)][W.sub.r]. These four essential elements--production, happiness, sadness, and well-being--are common to all of the economic systems that this set of simulations compares and contrasts.

  3. Comparative Systems

    The model economy outlined in section 2 is the foundation for three distinct simulations. These simulations vary only in the manner in which pie is distributed for consumption.

    1. Capitalism

      What exactly is capitalism? According to Merriam-Webster (2003), capitalism is "an economic system characterized by private or corporate ownership of capital goods, by investments that are determined by private decision, and by prices, production, and the distribution of goods that are determined mainly by competition in a free market." In this simulation, each participant may consume every pie he or she produces so that [C.sub.i] = [[pi].sub.i]. In this way, the simulation captures the essence of capitalism. Workers in this simulation can be viewed as worker-entrepreneurs who control both their own labor services and the capital necessary to utilize those services.

    2. Communism

      Communism is defined as a "theory advocating elimination of private property" resulting in "a system in which goods are owned in common and are available to all as needed" (Merriam-Webster 2003). Communism can also be thought of as "an ideology of economic equality" (Dhar 2014). In the communism simulation, a Minister of Distribution collects the pie produced by each participant. Then, the minister divides the total production equally and allocates each participant an equal share. For a group of n participants, individual i's consumption is given by: [C.sub.i = (1/n) x [summation over (term)][[pi].sub.i] In this way, the simulation captures the essence of communism in that each worker owns an equal share of society's production.

    3. Mixed Economy

      A mixed economy is a blend of capitalism and communism. Our simulation represents a mix where the government (through the Minister of Distribution) collects part of the workers' output for equal redistribution, but the workers also get to keep some of their individual production for themselves. In the mixed-economy simulation, the Minister of Distribution collects 20 percent of the pie produced by each participant. Then, the minister divides the pie collected by the number of...

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