Midterm

Question 1

Role of government

Answer 1

Criminal justice system:
* rule of law - disincentivizes harmful behaviour and protects property rights
Provides a stable trading environment:
* rule of law - enables enforcement of contracts
* macroeconomic policy - setitng interest rates and making spending decisions
Provides certain goods and services
* national defence
* education
* healthcare
* infrastructure
* utilities
Makes regulations (rules enforced by law)
* labour law to protect workers and provide benefits
* environment regulations to reduce pollution
* financial regulation to reduce fraud and protect investors
* Competition law to maintain competition in markets and to reduce unfair trading practices
Taxes and subsidies
* required to find government policies, and can be used to reduce unwanted behaviour
*subsidies given to encourage firms or individuals to do beneficial things
Redistribute wealth and provide for the underprivileged
* progressive tax system
* benefits from redistribution, costs: administration, loss to those taxed, incentives

Question 2

Economically rational agent

Answer 2

selfishly maximize own anticipated utility

Question 3

Social welfare

Answer 3

Maximizing the sum of everyone’s utility

Question 4

Surplus

Answer 4

The difference between the utility of having the good and the utility of transaction price

Question 5

Free market

Answer 5

transactions are voluntary

Question 6

Pareto efficiency

Answer 6

Resources are allocated so that it is impossible to make one person better off without making at least one other person worse off

Outcome is not pareto-efficient when there is:
* imperfect competition
* information provlems
* externalities
* public goods

Can still redistrivute the surplus if pareto-efficient

Question 7

Externalities

Answer 7

indirect costs or benefits from an economic activity that affect a third party not involved in the transaction

Question 8

Maximizing social welfare

Answer 8

• role of the government to maximize the sum of everyone’s utility* can happen through redistribution as the marginal utility of wealth decreases and the amount of wealth increases
• trade in free markets will generally increase social welfare
• with market failure, we need institutions to fix them

Question 9

Institutions

Answer 9

• used to govern how transactions take place and to redistribute wealth
• creating institutions and implementing policies are both constly, and we have to trade-off the gains that we get from fixing market failures against these costs
• we have to be wary that institutions and policies may serve special interest groups or self-serving bureaucrats

Question 10

Policy

Answer 10

a set of rules, created and enforced by a governing body.

Question 11

Normative analysis

Answer 11

what policy makers should do, sometimes different from what policy makers actially do.

Question 12

cost benefit analysis

Answer 12

We want to design rules that are both “fair” and “efficient”. This will mean making a trade-off between gaining additional social welfare against the costs of implrmeneting polocy

Question 13

incentives

Answer 13

link agents utility to some action or outcome

Question 14

opportunity cost

Answer 14

the utility an agent gets by doing (the best) something else with their time/effort

Question 15

Willingness-to-pay

Answer 15

the total utility an agent gets from a good, expressed in dollars

Question 16

transfer seeking

Answer 16

any activity that tries to increase one’s share of wealth without creating new wealth

Question 17

perfect competition

Question 18

imperfect competition

Question 19

monopoly

Question 20

moral hazard

Question 21

Team’s problem

Answer 21

If everyone was marked separately, they’d have an incentive to work hard. But if there was on person providing a positive externality by working hard, there is an incentive to free-ride on your peers

Question 22

transfer seeking

Answer 22

The act of seeking to transfer wealth or resources to oneself, without creating new wealth for society

Question 23

Disaster relief economics

Answer 23

The main point of Paul Krugman’s “Disaster Relief Economics” (2011) is that it’s bad economics to demand immediate spending cuts to “offset” disaster relief.

Krugman argues:

Government spending should focus on marginal benefits and costs — after a disaster, the marginal benefit of relief spending rises sharply, so shifting resources toward it makes sense.

However, trying to fully offset that spending elsewhere right away (by cutting other programs) is misguided because it ignores that the government can borrow temporarily.

Disasters are temporary events, and it’s economically sound to finance them with a short-term increase in the deficit, not by slashing other areas of spending in the moment.

In short: Krugman’s thesis → Disaster relief shouldn’t be offset by immediate spending cuts; it should be paid for over time through future adjustments, since the costs and benefits are temporary and the government can borrow responsibly.

Question 24

opportunity cost

Answer 24

the value of the best foregone alternative. The OC of X is the amount of Y given up to get X, where Y is the best alternative to C.

exclude sunk costs
include costs for which there is no observed outlay

OC of broadway show (98/per)vs. movie (14/per) (chosing show) = 98/14 -> one broadway show is the OC of 7 movies

Question 25

Sunk cost

Answer 25

expense already incurred

Question 26

Marginalist Principle

Answer 26

* most acitivies are subject to diminshing marginal benefits and rising margnal cost * any polcy should be carried our as long as the overall benefits exceed the costs (MB=MC) * If a resource (such as gov. budget) had more than one potential usem then it should be deicided among those uses such that the marginal benefits are equal * Ex. careful of things being "more important": Even though healthcare is “more important” in general, the marginal benefit from an additional dollar might be higher for parks.

Question 27

paradox of value