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10.1 Chapter Overview

Learning Objective

  1. Understand the motivations of a government in determining the policies that affect international trade.

In most economic models, it is assumed that consumers maximize utility, firms maximize profit, and governments maximize national welfare. Although one can reasonably object to any one of these assumptions, perhaps the one least likely to hold is the assumption about a government’s behavior. Governments are rarely comprised of a solitary decision maker whose primary interest is the maximum well-being of the nation’s constituents. Such a person, if he or she existed, could be labeled a “benevolent dictator.” Although historically some nations have been ruled almost single-handedly by dictators, most dictators could hardly be called benevolent.

The assumption that governments behave as if they had a benevolent dictator may have developed out of the philosophical traditions of utilitarianism. Utilitarianism, whose roots date to writings by Jeremy Bentham in the early 1800s, suggests that the objective of society should be to produce the greatest good for the greatest number. The objective of individuals is to obtain utility (happiness, satisfaction, well-being, etc.). In economic analysis, we presume that individuals obtain all their utility from the consumption of goods and services, and this motivates the behavioral assumption that consumers maximize utility. The assumption that firms maximize profit is based on the same logic. Profit affects the income of firm owners. The greater one’s income, the greater will be one’s consumption possibilities and thus the higher will be one’s utility. Thus profit is merely a means to an end, the end being greater utility. It is not unreasonable, then, that if the objective of individuals and firms is maximum utility, then the objective of a government might be to maximize utility for everyone.

But even if governments do not seek to maximize national welfare, it is still a valid exercise to investigate which policies would lead to maximum utility. Indeed, most of the analysis of trade policies does just this. Policy analysis identifies the differential welfare effects of various policies and points out which of these will lead to the greatest overall utility or welfare.

If one prescribes policies that also maximize national welfare, then one is making the value judgment that maximum national welfare is the appropriate goal for a government. If one presumes that governments do indeed seek to maximize national welfare, then the task is to explain why the choices that governments make are explainable as the outcome of a national welfare maximization exercise. An alternative approach is to consider other reasons for the choices made by governments. This is essentially the task of political economy models.

Political economyA term used to describe the interaction between the economic system and the political system. is a term that reflects the interaction between the economic system and the political system. Many traditional models of the economy make simplifying assumptions about the behavior of governments. Keeping the model simple is one reason for the assumption of a benevolent dictator. Political economy models attempt to explain more carefully the decision-making process of governments. Today, most governments can be best described as representative democracies. This means that government officials are elected, through some voting procedure, to “represent” the interests of their constituents in making government decisions.

The key issue in political economy and trade models is to explain how political features in democratic economies affect the choice of a trade policy. Among the key questions are the following:

  1. Why do countries choose protection so often, especially given that economists have been emphasizing the advantages of free trade for three hundred or more years? In other words, if free trade is as good as economists say, then why do nations choose to protect?
  2. In discussions of trade policies, why is so much attention seemingly given to a policy’s effects on businesses or firms and so little attention given to the effects on consumers?
  3. Why do political discussions, even today, have a mercantilist spirit, wherein exports are hailed as beneficial, while imports are treated as harmful to the country?

Key Takeaways

  • Economic modelers often seem to assume that governments will choose policies to maximize the nation’s welfare.
  • Instead, most government policies arise from complex decision making in a representative democracy.
  • “Political economy” is a term used to describe the process of government decisions on economic policies.

Exercise

  1. Jeopardy Questions. As in the popular television game show, you are given an answer to a question and you must respond with the question. For example, if the answer is “a tax on imports,” then the correct question is “What is a tariff?”

    1. The name for the philosophical ideas suggesting that the purpose of society is to create the greatest good for the greatest number.
    2. The name for a solitary leader of a country whose intention is to maximize the well-being of the nation’s constituents.
    3. The term used to describe the interaction of the political system and the economic system.
    4. The term used to describe a contention that exports are good and imports are bad for a country.