1.

PRINCIPAL, AGENT, & ASYMMETRIC INFORMATION

o The principal is the person who needs help to achieve a goal. They rely on someone else to do the work for
them.
o The agent is the person who is hired or assigned to do the work for the principal. They are supposed to act
in the principal’s best interest.
o A contract is an agreement between two or more parties that defines their roles, responsibilities, and
obligations and even penalties if they don’t fulfill their obligations.
o Information asymmetry happens when one party in a relationship has more or better information than the
other. In a principal-agent context - The agent usually knows more about their actions, abilities, or effort than
the principal.

This imbalance creates problems:

Moral Hazard: The agent might take advantage of the principal’s lack of information by working less or making
decisions that benefit themselves but not the principal.

Adverse Selection: The principal might choose the wrong agent if they don’t have enough information about the
agent’s true skills or intentions before hiring.

Human Behavior

Self-interest means people prioritize their own needs, desires, and benefits when making decisions or taking actions.

Bounded rationality refers to the idea that humans try to make rational decisions but are limited by their cognitive
abilities, access to information, and the time available to process it.

Risk aversion means people prefer outcomes with lower risk, than taking riskier option might lead to a higher reward.

The "too big to fail" concept refers to the idea that certain businesses, particularly large financial institutions, are so
critical to the economy that their failure would have devastating effects on the broader financial system and society.
As a result, governments often intervene to prevent such institutions from collapsing.

When there is a contract from the principal there is an ideal behavior that will come from agents.

Multiple Principals Multiple Agents

- Diverging objectives Coordination Problems

- Coordination Problem Competition and Rivalry
- Favoritism Collective action and Free riding

✓ Information is a commodity, purchasable, and has a cost.

✓ Example of Principal has more knowledge than the agent
- A patient (principal) might have detailed knowledge about their own medical history, symptoms, or lifestyle
that a doctor (agent) does not immediately know. The doctor relies on the patient to provide accurate
information for diagnosis.
 2. INSTITUTIONAL THEORY: THE “RULES OF THE GAME”
- Douglass North, a prominent economist proposed the concept of "rules of the game" in institutionalism
theory.
- Institutions are the "rules of the game" in a society consisting of formal and informal rules that shape human
behavior, structure interactions and govern relationship within a society.

Where institutions do not exist?

-Tribal societies

Importance of Institutions
- They create order and reduce uncertainty in exchanges, lowering transaction costs and influencing
production efficiency.
- They facilitate cooperation, define agreements, and manage self-interested behavior in complex economies.

Types of Institutions

Formal Institutions:
Codified and written rules like laws, policies, and regulations enforced by governments.

Informal Institutions:
Unwritten norms, traditions, and customs maintained through shared social understandings.

Difference Between Traditional and New Institutionalism

1. Focus:
o Traditional: Focuses on fixed, formal structures like laws and governments.
o New: Examines both formal and informal institutions, including culture and norms, and how they
change over time.
2. Analysis:
o Traditional: Treats institutions as unchanging structures that shape behavior.
o New: Studies how people and groups interact with and how they influence institutions.

New Institutionalism

Rational Choice Institutionalism: People act based on interest (what benefits them).
Sociological Institutionalism: People act based on appropriateness (what fits norms).
Historical Institutionalism: People's actions are shaped by path dependency (past decisions).

Why Nations Fail?

Nations fail because their political and economic systems are unfair and only benefit a small group of powerful
people, leaving the majority of the population excluded from opportunities. To succeed, a country needs systems that
allow everyone to participate and prosper.

INFORMAL INSTITUTIONS SHOULD NOT DOMINATE FORMAL INSTITUTIONS

When informal institutions dominate over formal ones, it often signals systemic dysfunction, with informal norms and
practices replacing or undermining official rules and structures. While informal institutions can sometimes provide
flexibility and cohesion, their dominance generally leads to inefficiencies, inequality, and lack of accountability, making
it difficult to maintain a fair, transparent, and effective system.
Why Formal Institutions Should Lead

• Fair for Everyone: They ensure everyone is treated equally under the same rules.

• Accountable: They can be monitored and improved if they fail.

• Efficient and Transparent: They work for the whole society, not just a few people.
RADICAL POLITICAL ECONOMY

Class Conflict and Power Dynamics: Radical political economy assumes that capitalist societies are inherently
divided into social classes—primarily labor (workers) and capital (owners of production)—with conflicting interests.

Exploitation as a Core Mechanism: It posits that capitalism relies on the exploitation of labor, where workers are
paid less than the value they produce. This creates profits (or surplus value) for capitalists, leading to wealth
accumulation and economic inequality.

Role of the State: The state is viewed as an instrument that supports capitalist interests, managing the economy in
ways that uphold property rights and facilitate capital accumulation.

Market Critique: Turn everything into something that should be bought and paid

Environmental degradation: Destroying the environment and depletion of natural resources.

Economic Crisis: In capitalist systems, firms aim to maximize profits by producing more goods and services.
However, since workers’ wages are kept relatively low (to increase profit margins), they often lack the purchasing
power to buy back all the goods produced. This creates a demand shortfall, where the capacity to produce goods
exceeds the market's ability to consume them. This contradiction leads to overproduction, resulting in unsold goods,
lowered profits, and eventually production cuts, layoffs, or business closures.

Alternative Economic Systems: Finally, radical political economists advocate for exploring alternative systems (like
socialism or communism) where resources are owned collectively, and production is organized around social needs
rather than profit.

Theoretical Foundations - Radical political economy draws from various theories and methods like feminism,
whereas Marxian political economy is rooted in Marx's writings and concepts.

Approach to Change - Radical political economy advocates for grassroots movements and social justice, while
Marxian political economy focuses on the necessity of class struggle leading to revolutionary change
MARKET FAILURE AND PUBLIC GOODS

It is the inability of market mechanisms to allocate resources efficiently or equitably, leading to

suboptimal outcomes for society, such as externalities, public goods under-provision, or
monopolistic dominance.

Why market fail?

Because of externalities
Positive Externalities: Activities that benefit others (like education) but aren't rewarded in
the market, leading to too little of that activity.
Negative Externalities: Activities that harm others (like pollution) but aren’t penalized in
the market, leading to too much harm.
Market Power (Concentration) - When one or a few companies control the market, they can
set high prices or offer fewer choices.
3. Asymmetric Information - When one party knows more than the other, leading to unfair
deals.
4. Public Goods - Public goods are things everyone needs, but businesses won’t provide
enough because they can’t make a profit from them.

In simple terms, excludable means that someone can be prevented from using or enjoying
something unless they pay for it or meet certain conditions.
Non-excludable means that no one can be prevented from using or enjoying something, even
if they don't pay for it or don't have permission.
Rivalrous means that when one person uses or consumes something, it reduces the amount
available for others to use.
Non-rivalrous means that when one person uses or consumes something, it doesn't reduce
the amount available for others to use.

Private Goods - Goods that belong to an individual, and the individual can control who gets to
use them. They are owned and used privately.
Common Goods - Goods that are shared by everyone, but their use by one person can reduce
the availability for others. They are available to the public but are limited.
Club Goods - Goods that are available to a specific group of people (like members of a club),
but one person’s use doesn’t take away from others. They are shared within a group but only
accessible to those who belong to the group.
Public Goods - Goods that are available for everyone to use, and one person’s use does not
reduce the ability of others to use it. They are non-exclusive and non-rivalrous.

In short, public goods are shared by everyone, but the free-rider problem happens when
people take advantage of these goods without paying for them, which can lead to the goods
being under-provided or overused. Ex Street Lighting: Everyone benefits from street lighting,
but not everyone contributes to the cost (through taxes, for example). Some people "ride for
free" and don’t pay, but they still enjoy the light.

Rent seeking is when a company or person tries to make money by using influence or power to
get special benefits, instead of creating value or competing fairly.
Example: A company lobbies the government for a law that prevents others from competing
with them, allowing them to make money without improving their product.
GOVERNMENT FAILURE
Government failure arises when government intervention aimed at correcting market failure or achieving
societal goals is counterproductive or mismanaged

Special Interest Effect - The special interest effect happens when small, powerful groups of
people or businesses push for laws or policies that benefit them, even though it might hurt the
larger public. These groups often have a lot of influence, so their interests are prioritized.
Short-sightedness Effect (Political Myopia) - Short-sightedness Effect (Political Myopia) refers
to politicians focusing on immediate, short-term benefits to win votes, while ignoring long-term
consequences or future problems.
Rent-seeking - It’s when people or organizations try to make money or gain advantages by
using political or legal systems, rather than by creating or producing something useful.
Example: A company might spend money lobbying politicians to pass laws that give them
special benefits, like tax breaks or protection from competition, instead of improving their
products or services to earn money through regular business activities.
Regulatory Capture - Regulatory Capture happens when a government agency, meant to
regulate an industry, is influenced or controlled by the very companies or groups it’s supposed
to oversee. This leads to the agency acting in the interests of those companies rather than the
public.
Example: A government agency that regulates the oil industry might be influenced by oil
companies to pass laws that benefit the companies, such as loosening environmental
regulations, instead of enforcing rules that protect the environment.
Government Favoritism - Government favoritism refers to the practice where government
officials or institutions show preferential treatment to certain individuals, businesses, or groups
over others, often through favorable policies, contracts, or access to resources.
Bureaucratic Inefficiency - This refers to when government agencies struggle to implement
policies or provide services because of issues within their structure, processes, or organization.
Example: A government health agency may struggle to distribute vaccines efficiently due to
poor planning, outdated technology, or mismanagement, leading to delays and confusion,
despite having the resources to do so.
Rational Ignorance - Rational Ignorance is when people choose not to learn about something
because they believe the effort or cost of learning is greater than the benefits of knowing.
Example: A voter might not spend time researching all the candidates in an election because
they feel that their single vote won’t make much of a difference, so the time and effort spent
learning about the candidates isn’t worth it.
I Pencil
"I, Pencil" is an essay written by economist Leonard E. Read in 1958 that illustrates the
complexity of how goods are produced in a market economy. The story is told from the
perspective of a pencil, which emphasizes that no single person knows how to make a pencil
from start to finish. Instead, it’s the result of countless people working together across the world,
each contributing their specialized knowledge and skills.
Meaning:
The essay shows how spontaneous order works in markets. This means that many people,
each working on their own goals, come together to create products and services without anyone
being in charge or knowing the whole process. It shows how free markets can lead to
cooperation, where things are made efficiently even without anyone planning it all.
Example:
In the case of a pencil, the wood comes from trees harvested by people who specialize in
logging. The graphite is mined by workers in different countries. The rubber eraser is produced
by another set of experts, and the metal ferrule is made in factories that produce metal goods.
All these people, without knowing each other or the full process, contribute to making a pencil.
Each individual plays a small but essential part in the larger system that makes the pencil
possible.

Broken Window Fallacy

The broken window fallacy is the idea that breaking something, like a window, can actually be
good for the economy because it creates work for the person who repairs it. However, this is a
mistake because it ignores the fact that the money spent on repairs could have been used for
something else, like buying new goods or services. In reality, breaking a window wastes
resources that could have been used more productively.
Example: If a person’s car window is broken and they have to spend money to fix it, some might
think this is good for the economy because the mechanic earns money. However, this ignores
the fact that the person could have used that money to buy something else, like a new phone or
clothes, which would have created more value. Fixing the window only replaces something that
was already there, instead of improving something new.
The Civil War in Syria started in 2011 when protests broke out against the government, led by
President Bashar al-Assad. People were unhappy with his rule, demanding more freedom and
better living conditions. The government responded by using force to stop the protests, which
led to violence and anger.
Over time, the situation escalated into a full-scale war, with different groups fighting for control.
Some were against Assad's government, while others supported it. Many other countries also
got involved, either supporting the government or the opposition, making the conflict even more
complicated.
The war caused a lot of destruction, with cities damaged and millions of people forced to flee
their homes. It also led to a humanitarian crisis, as people struggled with food shortages, lack of
medical care, and violence.
The war is still ongoing, with no clear winner, and the country is divided among various groups
and regions controlled by different forces.

President Ferdinand Marcos Jr. has signed two important laws aimed at boosting the
Philippines' economy and tourism sector. The first law expands the Rice Competitiveness
Enhancement Fund (RCEF), which will provide more resources to help improve rice production
and reduce the cost of rice for consumers. This expansion is expected to assist local farmers,
enhance agricultural productivity, and stabilize rice prices
The second law introduces a VAT (Value Added Tax) refund for foreign tourists, encouraging
more international visitors to shop in the Philippines. Under the new law, tourists can claim
refunds on VAT for goods purchased in the country, provided the goods are taken out within 60
days. This initiative is designed to position the Philippines as a leading shopping destination and
is expected to significantly increase tourist spending and support local businesses