1
Q
What does gov do for members of society?
A
criminal justice system
rule of law = disincentivizes harmful behavior and protects property rights
provides certain goods and services
- national defense
- education
- healthcare
- infrastructure
- utilities
make regulations
- labour laws to protect workers/provide benefits
- environmental regulations to reduce pollution
- financial regulation to reduce fraud and protect investors
- competition law to maintain competition in markets and reduce unfair trading prices
Redistribute wealth and provide for the under-privileged
- progressive tax system (your tax amount depends on how much you make)
- HAS COSTS!!
2
Q
What does gov do for businesses
A
Provides a stable trading environment
rule of law = enables enforcement of contracts
Macroeconomic policy = setting interest rates and making spending decisions
Tax and subsidies
- taxes required to fund gov polices and also reduce unwanted behaviors (smoking/drinking)
- given to encourage firms/individuals to do beneficial things (innovate)
3
Q
Economically rational agent
A
selfishly maximizes their own anticipated utility (utility = happiness/absence of suffering)
- everyone has different utilities for different things
4
Q
What is the argument of Adam Smith and the Invisible Hand?
A
Individuals/firms/businesses act in their own self interest, and in doing so they provide social welfare for the economy when doing transactions (SW is increased b/c they are better off after)
- e.g. Steve Jobs didn’t develop the iPhone to make consumers happy, he did it to make a huge profit. Since the smartphone business was so competitive, he had to make an insanely good product to compete
- markets are very effective at providing sophisticated goods which give significant utility, there is very little role for gov intervention in competitive markets –> question with respect to any public policy proposal is “why can’t the private sector do it?” –> gov needs to reduce monopoly power and provide public goods
5
Q
Surplus (consumer/producer)
A
The difference between the utility of having the good and the utility of the transaction price
6
Q
Social welfare
A
The sum of everyone’s utility (maximizing social welfare is usually gov. objective)
7
Q
Free market
A
market where transactions are voluntary
8
Q
Reasons for non-pareto efficiency/ non-maximized pareto efficiency
A
- imperfect competition
- information problems
- externalities
- public goods
- OCCASIONAL: coordination problems
All of these make it so rational agents participating in a free market may fail to maximize social welfare
9
Q
How can social welfare be maximized?
A
- redistribution –> marginal utility of wealth decreases as the amount of wealth increases (taxes) –> downside = decreased incentives to work hard (don’t assume everyone has same MU curve)
- trade in free markets since buyers and sellers will be better off, otherwise transaction would not occur (everyone is rational)
10
Q
Why do we create institutions
A
- To govern how transactions take place and to redistribute wealth
- creating institutions and implementing policies are both costly –> trade-off the gains we get from fixing market against the costs
- BE WARY institutions and policies may serve groups of special interest
11
Q
What are policy’s and why do we create them
A
set of rules created and enforced by a governing body
- want to design rules that are fair and efficient –> tradeoffs between gaining additional social welfare and cost of implementing policy
12
Q
incentives
A
linking an agent’s utility to some action or outcome (e.g. sales commissions, bonus, etc.)
13
Q
opportunity cost
A
utility an agent gets by doing something else with their time/effort (best alternative) (e.g. time playing games vs time studying)
- exclude sunk costs
- include costs with no observed outlay (e.g. letting uni student live at home VS renting out their room)
14
Q
willingness to pay
A
total utility an agent gets from a good (expressed in dollars)
15
Q
transfer seeking
A
any activity that tries to increase one’s share of wealth without creating new wealth
- non productive, spend resources on getting more SW without increasing it (e.g. fraud, charity, fundraising, lobbying)
16
Q
Marginalist principle
A
any policy should be carried out as long as the overall benefits exceed the costs
- amt spent on policy should be such that the benefit from the last dollar spent should be equal to the cost of raising that dollar (MB = MC)
- resource with multiple potential usages should be divided among those uses such that MB is equal between all (MBa and MBb form an X, the budget should be applied at Q* where they intersect)
17
Q
Paradox of value (marginalist principle)
A
price of anything is determined based on the margin and not absolute value
- in areas where something is scarce, it will cost more, whilst in areas in which it is abundant, it will cost less (if its scarce, you get more MU from it)
- this is one argument for why free trade should happen –> better distribution = more balanced prices
- if something is abundant, it will intersect with demand in bottom right to show high quantity, low price
- if something is scarce, it will intersect with demand in middle/top left to show low quantity, high price
18
Q
READING: Disaster Relief Economics
A
Paul Krugman = nobel prize winning economist
Eric Cantor = politician
Article: Cantor states that he can only help those affected by the hurricane if the gov budget in other areas are reduced (but he didn’t bring this up during any America waging wars). Krugman agrees on budget cuts and recommends to increases taxes and borrowing money since every dollar spent on disaster relief will have immense increases in SW. However, America has high levels of debt and borrowing more would bring the debt level to a concerning level –> if anything, America should increase taxes and decrease spending to pay back debt. Printing more money would only increase the inflation rate
19
Q
incentives
A
people do more of something that is rewarded and less of something that is penalized (e.g. R&D tax credits, demand curve, Germany stopping Russian gas imports)
20
Q
Peltzman Effect
A
people adjust their behavior to a regulation in ways that counteract the intended effect of the regulation (perverse incentives ((incentives act against intended idea) –> make cars safer = ppl drive more recklessly)
21
Q
What are the limitations of financial incentives
A
it crowds out intrinsic motivations (e.g. late fee for daycare centre –> resulted in even more lates b/c getting there on time became an option, if they were late they didn’t need to rush, they just had to pay a fine)
22
Q
Perfect competition
A
- prices set by market
- entry of new firms (or exit of unprofitable firms) drives profit to zero
- buyers and sellers have perfect information
- homogenous goods
- lots of buyers and sellers
23
Q
What are the two kinds of efficiency
A
general meaning = absence of waste
- management/production efficiency = if a given level of output is being produced at lowest input usage –> focus on waste/absence of waste
- pareto efficiency = appropriate amount of each good bring produced (good allocation of resources) –> in markets and allocations of resources
24
Q
management efficiency cons
A
- assumes most firms minimize costs and those who don’t efficiently go out of business
- however mgmt inefficiency does occur sometimes (X-inefficiency)
25
X-inefficiency
- incompetent management
- scared of sunk costs (psychological reasons)
- company growing too fast to organize workers well
- lack of motivators (financial/psychological)
- lack of competition
- luxury/differentiated goods (higher costs to differentiate good --> marketing, materials, etc.)
- subsidies (e.g. saving jobs --> inefficient usage of money b/c if the economy is strong the workers can find other jobs)
26
Pareto Efficiency
attained when it is impossible to re-allocate resources among a group of people in a way that would make at least one person better off without making anyone else worse off (doesn't mean this is always the best allocation)
- no DWL
27
Pareto Improvement
at least 1+ person is made better off while no one is made worse off (increase SW)
28
Potential Pareto Improvement
reallocation of resources allows individuals who are net gainers to fully compensate the net losers --> overall better off
- e.g. regulate price of cheese = increase prices = increase farmer welfare, decrease consumer welfare, but overall farmer gain > consumer loss
- lobbying --> farmers will vote for whoever does the cheese policy the best (single issue voters) meanwhile consumers aren't going to change their vote just because one party is adding a cheese regulation
- maximize social welfare
29
Deadweight loss (DWL)
Term used to measure the deviation from Pareto efficiency --> DWL is wasteful because it means not all mutually beneficial transactions were realized by both parties
- usually triangle shaped
30
Game
consists of players, actions, pay-offs
31
Strategy
complete contingent plan --> for every action of another player, you know in advance what action you would take
32
Outcome
Specified in terms of the strategies of the players
33
Nash-Equilibrium
each player chooses the action that maximizes their utility given the other players action
- strategies are in equilibrium when every strategy is a best-response to every other strategy (each player has a best response to another player's best response)
34
Dominant strategy
when there is one action a player should always take no matter what action the other player does
35
Prisoner's dilemma game
because everyone is selfish, the outcome for both groups is the worst possible outcome. If they were not selfish they could get the welfare maximizing result (e.g. nuclear weapons, commitment to decreasing greenhouse gases, trade wars, etc.)
36
Coordination game
there are two equilibriums, and each one benefits one player more than the other. However, the benefit it still greater than the other possible results that are not equilibrium. Players must work together to avoid the bad results
37
Tit-for-tat strategy
if one person breaks the cooperation and gains an advantage, they are punished the next round by the other player
38
Grim strategy
when one person breaks the cooperation, the other one punishes them forever
39
Other solutions to PD
- institutions enforce rules (e.g. Olympic committee ban drug usage)
- outside intervention to restructure payoffs (e.g. mob boss threatens to kill anyone who talks)
- signalling (split or steal)
- trust/social conventions (informal institutions)
40
Market failure
market structures where the assumptions of perfect competition break down
41
Imperfect competition
firms produce too little and prices are too high
- monopoly = single seller
- cartel = multiple sellers collude on price
- oligopoly = small # of sellers compete, and are aware they can affect the price
- monopolistic competition = large # of sellers selling differentiated product, exit/entry costs low, each firm has monopoly on their version of the product (horizontal differentiation = appeal to different tastes, vertical = quality differences)
- monopsony = single buyer
42
Natural monopoly
The goods are homogenous and there are economies of scale
- firms that are bigger have lower costs, so they're able to sell at cheaper price and capture the entire market --> leads to 1 firm in the market
- cost of two firms producing is greater than just having one firm produce
43
Policy responses to natural monopoly
- public corporation --> BC Hydro is government owned and managed
- regulation --> Fortis BC is private company but allowed by gov to sell as long as they're regulated
44
Monopsony
leads to prices that are lower than competitive equilibrium
- e.g. labour market with single major employer in rural town (mine) --> wages are so low that an inefficient amount of ppl might be employed (not enough bc they don't want to work for such low wages)
- super big firms can also be partially monopsony --> Amazon, Walmart, etc. have significant bargaining power with suppliers
45
Policy responses to monopsony
- minimum wage = pushes wages to efficient level for # of people employed
- unions = push for better wages
- fair trade = employers feel bad for taking advantage (?)
46
Public goods
- non rival = benefits obtained by 1 consumer does not subtract from benefits available to others
- non excludable = very hard and expensive to selectively prevent people from using it
- underprovided by private sector, public good doesn't necessarily mean provided free to the public or provided by publicly owned enterprise
- issues of free riding (ppl don't pay their fair share for usage) + lack of incentive to provide
- NOTE: some goods are non-rival up to a congestion point (e.g. bridge at normal traffic VS traffic jam)
47
Types of goods
- private good = excludable and rival (left to mkt)
- club good = excludable not rival (left to the mkt)
- common good = non excludable and rival
- public good = non excludable and non rival (usually provided by gov)
48
Externalities
activity by-products that generate "non-Priced" costs/benefits affecting 3rd parties
- 3rd party = anyone that is not buyer/seller
- e.g. factory polluting river --> negative externalities to fishermen who fish in the river for a living --> causes DWL = produce less
- e.g. vaccines --> positive externalities to those around us bc they have less chance of getting sick --> causes DWL = produce more
49
Pecuniary externalities
externality is incorporated into the price
50
READING: Externalities
Summary: Davidson suggests putting a tax on gas so drivers have to bear the cost of the negative externality --> encourage ppl to drive less, pollute less, crash less, lower country dependency on foreign oil, make cities more livable. However there are arguments that a tax for using gas is already being paid by overcrowding roads (wasting time), higher insurance premiums and smog + global warming. There is also the issue of who to tax and when to stop introduces taxes on externalities. Do we tax buyers, sellers, companies? Do we put taxes on dropping out of highschool which is linked to increases in crime? do we tax obese people who increase the costs of the healthcare system? There are also arguments around things such as guns, which for 99% of gun owners will never have any sort of externality, but the 1% that uses them negatively causes huge externalities. Also any form of tax will be politically unpopular
51
Imperfect information
type of market failure where both parties do not have equal information (asymmetric information) --> seller/buyer knows product characteristics that the other does not know
- consumers cannot distinguish before buying, the existence of bad products can drive good ones out of the market
- e.g. market for lemons (50/50 lemon: good car --> presence of lemons leads to underpricing of good cars which drives them out of the market since seller won't sell good car at a price below their value = inefficient # of good cars sold and only lemons are sold)
52
Expected value calculation
P1 x V1 + P2 x V2
- P = probability
- V = value
53
Adverse selection
seller doesn't know the buyer's "type" and is unable to correctly screen the types so that it is much more likely to select the bad types
- takes place before a "contract" has been made
- e.g. insurance market = worst types have greatest incentive to buy the insurance --> insurance firms are risk neutral and clients are risk adverse, this pushes the price of policies up, leading to only worst types to buy the insurance
54
Why can reputation be important and mitigate information asymmetries?
- e.g. market for lemons/good cars --> acting deceitful can gain you more value than selling at the price of lemons, however you will not get any future repeated transactions and will never be able to sell another good used car
- however if you act honest and sell a good car for good car price, and lemon for lemon price, people will believe you since you have a reputation of being honest, leading to more future sales/revenue than acting dishonest and only selling a few lemons for good car price
- work on the relative continuation value of the game
55
Other remedies to imperfect information problems
- markets for info --> formal and informal (approaching company for info VS asking a friend)
- labeling/disclosure requirements --> legal requirement (e.g. processed foods)
- warranties/guarantees --> company provides warranty on their product as a way to signal quality b/c only good quality products would have insurance since the company believes they are worth the price
- standards (set/enforced by gov/business/professional orgs) --> e.g. professional engineer joins an institution, signals to potential clients that the engineer is at a certain standard
56
Moral Hazard
occurs when an agent's behavior changes because they don't want to bear all the costs of their actions
- in many cases, agents take more risk than they would do otherwise
- e.g. bankers undertake high risk investments knowing gov will bail them out, ppl take more risks if they're insured
57
READING: Moral Hazard of Naxolone in the Opioid Crisis
Summary: The Peltzman effect is showcased through the usage of Naxolone. In cities where Naxolone is publicly available and free for usage as a way to reverse overdoses and save people's lives, there has actually been an increase in opioid-related emergency room visits and more opioid-related theft, with no reduction in opioid-related mortality. This is because drugs rewire the brains reward system, meaning they do drug-seeking even at high personal risk. With the addition of Naxolone which could save their life, they are highly likely to recalibrate their risk taking so the risk of death remains a constant.
58
Why is fairness hard to decide?
- the value of certain things may be worth more to some than others --> is it fair to discriminate based off willingness to pay?
- people often judge things based on how they're framed (group discrimination, discount VS premium, etc.), and think of fairness based on how it affects us
59
Distributive fairness
The final allocation of benefits across individuals/groups is just/morally acceptable --> any policy that looks to redistribute is a distributive fairness policy
- complete equality of outcomes (equal shares) is not always optimal --> some ppl value the share of something more than others
- incentive costs --> if everyone gets an equal share, ppl don't want to work hard if others are going to get the share they worked hard for (e.g. redistribution of money thru taxes lowers incentive for those who earn more to work hard, and you never want to completely redistribute wealth equally or else there is no incentive to work hard or do hard jobs at all
60
Procedural fairness
the rules of the game are just/morally defensible regardless of the final allocation that results --> don't expect outcomes to be equal for everyone
- non-coercion --> no individual is forced to take an action they do not want to take (we expect outcomes to be unequal bc ppl make their own decisions about how much effort to put in)
- equality of opportunity is required (everyone starts at the same point)
61
What are policies to address inequality in outcomes?
- free medical care
- unemployment insurance
- disaster relief programs
- progressive taxation
62
What are incentive issues associated with policies to address inequality of outcomes?
- evening out the outcomes removes/distorts incentives
- ppl who make different levels of effort get the same payoff, so there's less reason to exert effort/ do less desirable activities
- if prices moved away from competitive equilibrium to benefit buyers or sellers, there will be DWL (e.g. if workers and capital are interchangeable and there is a minimum wage increase = decreased # workers, increased # capital = increased unemployment)
63
How has income inequality in Canada changed from 1980-2005?
- Top 20 percentile earnings grew 16.4%
- Bottom 20 percentile earnings fell 20.6%
- ~3% more individuals earn over 100,000 compared to1980
- median income for individuals stagnated
TLDR: All these points show how inequality has been exacerbated because wealth carries over between generations
64
General comments on the income inequality in North America
Income concentration of total before-tax income flowing into households within the top 1% has fluctuated over the years but remains high because things have structurally changed --> things have become more unfair. Students these days graduate with debt and still find it hard to find a job or ever afford a home. Back in 1980, graduating from post-secondary guaranteed a stable income, future house down-payment, etc.
Inequality is a public bad, it causes increases in crime, gated communities and a decrease in community solidarity
65
What is Joseph Stiglitz's main point in "The Price of Inequality"
- a significant cause of inequality is through rent seeking by the wealthy
- the wealthy wield political power that shapes monopolies and are able to obtain favourable treatment and ensure low taxes
- inequality is self perpetuating --> it transfers across generations since wealth is inherited. It is not self correcting
- Large differences in starting allocation of resources is not only arguable unfair but also hurts productivity by suppressing aggregate demand --> less to spend = decreased economy spending
66
What are Thomas Piketty's main points in "Capital in the Twenty-First Century"
- clear evidence of high levels of inequality --> something should be done to balance it out
- if capital and labour are inputs, assuming substitution between labour and capital there are two policy responses --> direct redistribution (increasing wages) and fiscal redistribution (tax on capital)
- fiscal redistribution is preferable since increasing cost of labour through direct redistribution increases unemployment
- taxing capital does not have a large effect of reducing employment (capital to labour elasticity found to be low)
- inequality will increase since return on capital growth will outstrip growth in the economy, so we should tax wealth (capital) rather than labour
- two options for fiscal redistribution --> tax capital or labour income
- problems with taxing capital = capital is internationally mobile and tax competition makes it highly elastic --> if one country has strict capital regulations, ppl will simply move their capital to another country with more lax taxations
- solution is fiscal federalism --> a progressive global tax on wealth - issue = countries incentivized to reject bc then the capital will flow into their revenue distribution
67
How much should we redistribute?
- some degree of redistribution is inevitable. If wealth inequalities get too large they become a public bad, however if we redistribute we dull incentives --> degree of redistribution depends on your political view
- e.g. more funding in public goods, make things more equally accessible, multinational corp's pay their fair share of tax --> decrease tax burden on individuals
68
The social contract
- Idea developed by 17th-18th century philosophers concerning the legitimacy of the state over the individual
- explicitly or tacitly, individuals consent to surrender some of their freedoms and submit to the authority of the state (e.g. pay taxes, follow the law) for protection of their remaining rights
TLDR: individuals voluntarily give up their natural freedom to obtain benefits of political order
- Rousseau argued that democracy was the best way of ensuring the general welfare while maintaining individual freedom under the rule of law
69
What was John Rawls' point in "Theory of Justice"
- horizontal equity = ppl that are alike should be treated the same (e.g. treat ppl the same at the workplace)
- vertical equity = ppl who differ in relevant ways should be treated differently (e.g. need, deservedness, contribution, effort) --> wealth redistribution, crime, participation grades
70
What is the "veil of ignorance" Rawls talks about?
To decide what is fair, you must put yourself in the original position behind a veil of ignorance --> imagine you could have been born as anyone. Healthy, sick, tall, black, white, christian, etc. --> design rules that take into account how they would affect your well-being in any possible state you may find yourself in
- results in the maximin principle = preference for the welfare of the least advantaged (rules end up favouring less advantaged)
71
Individual Sovereignty
Philosophical construct widely embraced in the Western world and is key to the notion of private enterprises --> implies the ultimate determiner of what will be made, sold and consumed is the consumer (economic activity driven by consumer preference)
- economic freedom = freedom to enter into voluntary economic agreements
- consumer sovereignty = right to one's own tastes and preferences
72
Paternalism
Placing limits on a person's liberty or autonomy for their own good --> limits may be placed against the person's will
e.g. restriction on narcotics, activity of minors, safety requirements
73
What are issues with our utility functions
Often times people's utility functions are not as rational as we would like to think --> e.g. narcotics are addictive and bad for you, fattening foods taste good
- internality = individuals do not consider long term cost/benefit when they make a decision to consume a good --> might not be able to trust people to maximize their own long-run utility (they only consider short term benefits)
74
What are problems with maximizing social welfare?
question of whether to maximize the social welfare of people alive right now or all of humanity (incl. future generations)
- we tend to undervalue humanity's future --> we might want to be paternalistic about the whole of humanity (individual sovereignty is so central that wanting to be sustainable for future generations restricts current ppl's rights)
- challenges = psychological, government narratives (global warming = individuals need to do more = lets firms off the hook)
COMM 394
flashcards
Decks in class (2)
# Cards
