Curriculum for the Twenty-First Century: Recent Advances in Economic Theory and Undergraduate Economics

Abstract

Undergraduate economics lags behind cutting-edge economic theory. The author briefly reviews six related advances that profoundly extend and deepen economic analysis: game-theoretic modeling, collective-action problems, information economics and contracting, social preference theory, conceptualizing rationality, and institutional theory. He offers suggestions for incorporating these into the undergraduate classes at various levels. He argues that game-theoretic representation of collective-action problems offers a unifying framework, on par with supply and demand, for political economy. Blending in the other developments deepens our micro-level understanding of internal and external contract enforcement, with implications on nonclearing markets, power, and distribution. At the macro level, these concepts illuminate the role of institutions in economic development and long-term growth. Undergraduate curricula should incorporate these new approaches.

Keywords:

• contemporary economic theory
• undergraduate curriculum

JEL codes:

• A10
• A22
• B52

The author thanks Janet Seiz and Lee Hansen for encouragement, Mark Montgomery and three anonymous referees for useful comments, and Jelal Younes for editing assistance.

Notes

1. Related discussions appeared in Colander, Holt, and Rosser (2005), Colander (2006), and Becker (2007). I focus on theory; I mention, but do not analyze important new empirical work in experimental and behavioral economics.

2. The transformative implications of game theory are reflected by recent Nobel Prize awards to Nash, Schelling, Maskin, and Myerson, among others.

3. Table 1 and this example closely parallel discussion in chapters 11 and 12 of Dixit and Skeath (2004).

4. Large group example: society is better off if shoplifters are apprehended, yet without an external enforcement, honest shoppers face a CAP: who would risk confronting a shoplifter?

5. In table 1 we have a symmetric game of assurance when C > D > H = L and a symmetric game of chicken when H > C and L > D. In symmetric battle, add subscripts for players, CA = DB > DA = CB > H = L. Obviously instructors may wish to adjust notation. See Dixit and Skeath (2004, chap. 4, chap. 12) for an intuitive discussion.

6. Stable equilibria in typical supply/demand models arise from negative feedback.

7. Indeed one could argue that the assumption of perfect information is inconsistent with rational pursuit of self-interest: why rule out potential gains from concealing information?

8. In these models, a principal contracts with an agent to perform costly services, which subsequently the principal can observe only imperfectly.

9. A power law distribution more accurately represents complex phenomenon (Miller and Page 2007).

10. This quotation appeared in Bowles and Gintis (2004, 1430).

11. Bowles (2004, 249–57) discussed P–A models with implications. Colander (2008, 325–30) discussed monitoring and incentive compatibility. See Dixit and Skeath (2004, 277–80) for a managerial incentive model. See Ferguson (1994) for a link between efficiency wages and bargaining accessible to postintermediate labor economics. Maskin (2008) discussed mechanism design and eliciting information: implementation theory.

12. A limited exception: direct offspring in intergenerational models.

13. Bowles (2004, 97) treated violations of assumption 3 as a separate departure from traditional models. Bowles (1998) discussed violations of assumption 3 in detail.

14. Other types of social preference: pure altruism or spite—unconditional willingness to sacrifice absolute payoffs to help or harm others (Fehr and Fischbacher 2002).

15. Fehr and Schmidt (1999) also modeled inequality aversion.

16. Earlier examples of reciprocity appeared in Akerlof (1982), Akerlof and Yellen (1990), and Fehr and Gächter (1998). Bowles (2004, 111) distinguished between strong reciprocity and weak reciprocity. Weak reciprocity connotes a self-interest motivation for reciprocal behavior, as in tit-for-tat in repeated PD games.

17. Economic approaches to social exchange focus on relations to incentives and scarcity, typically with formal modeling, whereas sociologists focus on relations to social standing. Sociological works include Blau (1964) and Molm (1997). Economic works include Barron and Paulson Gjerde (1997), Fehr and Fischbacher (2002), Gächter and Fehr (1999), Holländer (1990), and Kandel and Lazear (1992).

18. See Akerlof and Yellen (1990), Akerlof and Kranton (2005). Bewley (1999) and Howitt (2002) reviewed survey evidence on managerial concern for morale. Ferguson (2005) applied social exchange to implicit bargaining power in segmented labor markets.

19. Related arguments appeared in Fehr, Kirchsteiger, and Riedl (1993), Fehr and Falk (1999), Fehr and Gächter (2002).

20. See Schelling (1978, 91–110). For a review of literature on endogenous preferences, see Bowles (1998).

21. I will not attempt to summarize network economics. Miller and Page (2007) discussed network effects as complex social phenomena. Colander (2006) addressed complexity and UG economics. Page (2007) discussed problem-solving network effects of diverse group membership. For a comprehensive text, see Jackson (2008).

22. This is free at http://ccl.northwestern.edu/netlogo/. The site offers tutorials and intuitive examples.

23. Dixit and Skeath (2004) used essentially the same definition without the modifier “substantive.” Thus, game payoffs may reflect reciprocity, altruism, or spite in addition to standard material rewards.

24. North (1990, chap. 3) offered a scathing critique of traditional assumptions of rational calculation.

25. Spitzer et al. (2007) offered neuroscientific foundations for social norm enforcement. Since many UGs have some exposure to neuroscience from core classes in science or psychology, it is not unreasonable to introduce neural economics, despite an inability to go into depth.

26. See John Maynard Smith (1989). For an insightful recent text, see Gintis (2008). For simulations, see Epstein (2006).

27. For Bowles, strategies (not individuals) are the “personae dramatis” of evolutionary game theory (2004, 60).

28. As in biological evolution, selection need not generate any form of social optimum (North 1990, 20–21).

29. Acemoglu, Johnson, and Robinson (2004) do not explicitly discuss evolutionary game theory, but because payoffs influence future configurations, evolutionary modeling could apply.

30. An intuitive summary of evolutionary game theory appears in Dixit and Skeath (2004, chap. 13).

31. Necessary conditions for Coasian bargaining: (1) relevant property rights must be defined; (2) rights must be transferable; and (3) a small number of involved parties (Hall and Lieberman 2008, 473). Example: compared to other CAPs related to externalities or public goods, oligopoly bargaining has a small number of players, definable property rights (limiting output), easy monitoring, and a norm of negotiation over business transactions (how many people pay neighbors to turn down music?). Yet, we often consider oligopoly collusion difficult.

32. Organizations are actors (players), institutions are rules; this distinction is important and often unclear.

33. Basu (2000) discussed types of norms. Ostrom (2000) related norms to social enforcement. See also Akerlof (1982), Akerlof and Yellen (1990), and Fehr and Gächter (2000) for economics of social norms.

34. Fudenberg and Maskin (1986) called this proposition the Folk Theorem; see Gintis (2008, 213–19) for examples.

35. Grief, Milgrom, and Weingast (1994) discussed the role of institutional enforcement mechanisms in advancing medieval trade. Grief (1994) similarly stressed the importance of social organization.

36. “But the fact that growth has been more exceptional than stagnation or decline suggests that ‘efficient’ property rights are unusual in history” (North 1981, 6).

37. Laswell's (1935) definition of politics: “who gets what, when and how,” is instructive: property rights are social mechanisms that partially address these political questions. Definitions are contested.

38. A move designed to alter the expectations of other players in a subsequent game to one's advantage, such as altering an agenda to a subsequent meeting. See Dixit and Skeath (2004, chapter 10).

39. Mountains of lawsuits testify to the contested nature of property right definitions.

40. For endogenous growth, dynamic comparative advantage, and distribution: see Aghion, Caroli, and García-Peñalosa (1999). For development and spatial location theory, see Krugman (1997).

41. With commentary, one could teach this chapter by itself after an intermediate micro treatment of game theory.

42. Chapter 11 of Dixit and Skeath (2004) presents repeated PD games.