Before Midterm (end at cost benefit) Flashcards
1
Q
what are the roles of government in terms of business & society (5) & Examples
A
- Provides a stable trading environment, ie rule of law, macroeconomic policy, interest rates.
- Provides certain goods & services, i.e. National defence, education & health care
- Regulations: Labour laws, finances, competition
- Taxes & Subsidies: Funding, reduce unwanted behaviour
- Redistribution of wealth & provides funding for under privileged sectors
2
Q
Economic Rational Agent means
A
Selfishly maximizing my own anticipated utility
3
Q
Surplus Transaction
A
The extra benefit that arises feom the difference between the utility of having the good & the utility of the transaction price
4
Q
Social Welfare
A
The sum of everyone’s utility
5
Q
A free Market is one where transactions are
A
Voluntary
6
Q
The outcome from trade will not be Pareto-Efficient when (4)
A
- Imperfect competition
- Asymmetrical info
- Externalities
- Public Goods
7
Q
What is a problem associated with rational agents participating in a free market
A
They may fail to maximize social welfare
8
Q
Why do we create institutions?
A
Govern how transactions take place
9
Q
What are the drawbacks of institutions and policies
A
Costly & we need to make trade-offs against gains we get from fixing market failures against the costs.
We have to be wary that they may be serving the special interests of certain groups or bureaucrats
10
Q
What are policies?
A
A set of rules creates and enforced by a governing body.
11
Q
Normative Analysis
A
What policy should do
12
Q
Positive Analysis
A
What policy actually does
13
Q
What type of rules do we want to design and what does that mean?
A
We want them to be “fair” and “efficient”, this means we often need to make trade-offs between adding additional welfare with the cost of implementing the policy
14
Q
Incentives
A
Linking an agent’s utility to some action or outcome
15
Q
Opportunity Cost
A
The utility an agent gets by doing the next best alternative with their time/effort
16
Q
Willingness-to-pay
A
The total utility an agent gets from a good, expressed in dollars
17
Q
Being a rational agent, I get paid a flat wage for teaching this class. How hard should I work?
A
Bare minimum to collect your pay cheque due to opportunity costs & incentives
18
Q
I decide to sell you your grades. I know your willingness-to-pay (for each of you). I can name one price for everyone. How much should I charge?
A
You should charge everyone a price above the minimum of our willingness-to-pay. “Imperfect competition” & “monopoly pricing”
19
Q
I assign you all to groups and say that I’ll assign you a collective grade for the debates based solely on your collective performance. You value an A more than a B, and so on, down the grade scale, but failing means your parents will yell at you forever (so
you experience −∞ utility). Effort is costly to you. How much effort should you exert in your group?
A
Some effort but not enough to do my fair-share to get my group an A. There is a problem in regards to information, externalities & an incentive to free-ride
20
Q
Opportunity Cost
A
The opportunity cost of X is the amount of Y given up to get X, where Y is the best alternative to X.
21
Q
Opportunity versus “accounting” costs. (3)
A
- Units of measurement (opportunity costs might not be express in $)
- Opportunity costs EXCLUDE sunk costs.
- Opportunity costs INCLUDE costs for which there is no observed outlay.
22
Q
Your rich aunt gives you $200 to spend in NYC. Broadway shows cost $98. Movies cost $14. What is the
opportunity cost of the Broadway show?
A
7 movies
23
Q
Suppose you spend $98 on a ticket. Upon arriving at the theatre, you
realize you forgot the ticket at home. There is no time to get it.
Someone offers to sell you a ticket for $126. Movies (at $14 each) are
still your next best alternative. What is the opportunity cost
of the show?
A
9 movies
24
Q
Marginalist Principle definition.
A
Any policy should be carried out as long as the marginal benefit exceeds the marginal cost.
25
If a scare resource has more than one use what would the Marginalist Principle suggest?
It should be divided among it's potential uses such that the marginal benefits are equal.
26
Draw a graph of Marginalism applied to budgets
Two mirrored graphs where MB of A and MB of B intersect at point Q*, X axis is total budget divided by spending on B and Spending on A. Y axis is dollars. See photo album on phone for references
27
What is the paradox of value? How does it relate to the marganalist principal.
Water vs diamonds, prices are determined on marginal utility not at the unit of utility.
28
What is the marginalist principal? (4)
Most activities are subject to diminishing marginal benefits and rising marginal costs
Any policy should be carried out as long as the benefits>Cost
Funding should be provided up to the point where MB=MC
Scare resource = dividing up among potential uses such that MBa=MBb
29
Incentives & Example
Definition: When an agent’s utility is dependent on some action or outcome
Incentives: people do more of something that is rewarded and less of something that is penalized
30
An example of incentive effect
The demand curve, as an item gets more expensive people buy less of it
31
What is a problem with incentives and regulations?
They can lead to unintended consequences, or that people can adjust their behaviour to avoid the intended affect of the regulations
32
Limitations of financial incentives
Can lead out intrinsic motivations
33
The Invisible Hand
The public interest is promoted when entrepreneurs are acting in their own self-gain by creating high value products
34
What were Adam Smith's Conclusions? (3)
1. Very Little role for government intervention in competitive business
2. Why can't the private sector do it?
3. Government intervention is needed to reduce monopoly power and provide public goods
35
What is the first welfare theorem?
Under perfect competition, markets achieve Pareto efficiency.
36
What is “perfect competition”? (3)
1. Prices are set by the market (No one has the power to “set prices”)
2. Entry of new firms (or exit of unprofitable firms) drives profits to zero.
3. Buyers and sellers have all relevant information.
37
Efficiency
The general meaning of efficiency is the absence of waste, i.e. “getting the most out of what you put in”
38
What are the two kinds of efficiencies?
1. Is a given level of output being produced at lowest input usage (and therefore lowest cost)? If yes, then we have “management efficiency”
or“production efficiency.”
2. Is the appropriate amount of each good being produced? If yes then we have “allocational” or “Pareto efficiency.”
39
Economists have given much more emphasis to allocational (or Pareto) efficiency than management efficiency. Why?
The assumption was that market competition would be enough to ensure that most firms minimize costs & the ones who don’t manage efficiently go out of business
40
a Harvard economist, argued in 1966 that there were many examples where management efficiency was NOT achieved. He called this what?
X-inefficiency
41
What are the two applications of Pareto Efficiency?
Markets and goods
42
Explain how markets and goods can achieve Pareto Efficiency?
Goods: allocated efficiently
Markets: no market failure & no deadweight loss
43
What is Pareto (Allocational) Efficiency?
Pareto efficiency is attained when it is impossible to re-allocate the resources among a group of people in such a way as to make at least one person better off without making anybody else worse off.
There is no dead weight loss
44
What is a Pareto improvement
A Pareto improvement occurs when at least *one* person is made better off while *no one* is made worse off.
45
Potential Pareto-improvement
A potential Pareto-improvement is said to exist if it a re-allocation of resources allows those individuals who are net gainers to fully compensate the net losers, and still be better off.
46
There are three people with respective utilities:
Xavier = 10 Yong = 70 Zac = 200
Following a policy implementation their utilities are:
Xavier = 20 Yong = 80 Zac = 200
What describes this policy?
Pareto improvement
47
There are three people with respective utilities:
Xavier = 10 Yong = 70 Zac = 200
Following a policy implementation their utilities are:
Xavier = 20 Yong = 80 Zac = 185
What describes this policy?
Potential Pareto improvement, increase of welfare by 20 pts and a decrease of 15pts
48
Pareto Efficiency in Markets as shown on a graph
Supply = MC and Demand = MB and the intersection of the two is the Pareto efficient point
49
Dead Weight Loss in relation to Pareto Efficiency
DWL is the term we use to measure the deviation from Pareto efficiency.
50
DWL is what?
DWL is “wasteful” because it means “money was left on the table.” Mutually beneficial transactions were not realized.
51
Benevolent Social Planners
They try to maximize social welfare.
52
what is the relationship between social welfare and Pareto optimal allocations?
1. Social welfare is the sum of everyone’s utility
2. A Pareto improvement must increase social welfare, but a net increase in social welfare isn’t necessarily a Pareto improvement
3. Given many different Pareto improvements, we could chose the one that maximizes social welfare
53
Game
consists of players, actions and pay-offs
54
strategy
A complete contingent plan. For every action of another player (and state-of-the-world etc), you know in advance what action you would take.
55
outcome
Specified in terms of the strategies of the players
56
Nash equilibrium
Each player chooses the action that maximizes his utility, taking the other players action as given. Strategies are in equilibrium when every strategy
is a best-response to every other strategy.
57
The Prisoner’s Dilemma
When the welfare maximizing solution isn't chosen because players can't reach it without cooperating. Therefore they chose their selfish incentives and lose.
58
What is an example of a firm that has X-inefficency but still manages to stay in business?
Telecommunications companies
59
Markets can fail to achieve Pareto efficiency as the result of the following 4 issues:
1. Imperfect competition
2. Public goods
3. Externalities
4. Informational market failure
60
Imperfect competition. Definition, 2 examples
Definition: Market structures where the assumptions of perfect competition breakdown.
- Sellers and/or buyers exert some control over prices.
- Entry and/or exit is blocked.
61
In imperfect competition some sellers or buyers are said to have
“market power”
62
The general defect associated with most types of imperfect competition is that firms produce _______ and that prices are _____
too little & too high.
63
Types of imperfect competition (5)
Monopoly: markets with a single seller.
Cartels: multiple sellers who collude on price.
Oligopoly: a small number of sellers compete, recognizing they are large enough to affect the price.
Monopolistic competition: a large number of sellers of differentiated varieties of the same product.
Monopsony: markets where there is a single buyer.
64
What are the two policy responses to Natural Monopolies?
There are two policy responses to natural monopoly: Public corporation (e.g. BC Hydro) or regulation (e.g. Fortis)
65
monopsony leads to prices that are_____ than _______
Lower than competitive equilibrium
66
Examples of monopsony (5)
Labour markets with a single (major) employer. e.g. rural town with a sawmill or mine.
Single-payer health insurance systems (e.g. Canadian MSP): All nurses are paid by the health authority.
Air Force is sole buyer for military aircraft.
Wal-mart, Amazon, Starbucks are not a true monopsonists but they appear to have significant bargaining power with suppliers.
67
Market failure type 2: Public goods
Defining characteristics:
- non-rival: the benefits obtained by one “consumer” are not subtracted from benefits available to others.
- non-excludable: it is prohibitively costly to selectively prevent people from using it.
Note: some goods are non-rival up to a congestion
point.
*Caution: it’s not a “public good” just because it is provided free to the public or provided by publicly owned enterprise.
68
4 types of goods
Private good: Excludable & Revival in use
Commons good: Not Excludable & Revival in use
Public good: Not Excludable & No Revival in use
Club good: Yes Excludable & No Revival in use
69
Policy responses to the 4 types of goods?
private and club goods are mainly left to the market, public goods are often provided by government.
70
Market failure type 3: Externalities
(Real) Externalities are activity by-products that generate “non-priced” costs or benefits affecting 3rd parties.
71
What does “priced” mean?
A priced interaction is the normal bids and asks of buyers and sellers in a market. Benefits are paid for and costs are incurred voluntarily.
72
Pecuniary externalities
(as opposed to real externalities) are those where the externality is incorporated into the price
73
Mkt. failure type 4: Imperfect Information
Exchange is guaranteed to be mutually beneficial only if both parties are rational and well-informed.
When both parties have the same amount of uncertainty there is not necessarily a market failure.
Buyers can't tell bad from good, driving the good out of the market
74
Explain the Lemon Market, such that the seller’s value of a good used car is VG = $1500 and a lemon is VL = $1000.
Expected value is [50% * $1001] + [50% * $1501] = $1251
The presence of lemons leads to underpricing on the good cars
75
Adverse selection
occurs when the 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. Arises from *asymmetrical information*
76
You are a potential buyer of health insurance. The seller (Steve) offers to pay up to $1000 in medical expenses if you buy the policy and require medical attention in the next period
Bad types (lemon):
You are already sick and will require $1000 of medical attention in the next period
Good types (good):
You are have a 1:10 chance of getting sick and requiring $1000 of medical attention in the next period.
What is your expected payoff as an insurance seller?
If I offer to sell insurance at more than $100, only lemon types will buy from me, and I’ll get lemons for sure.
If I offer to sell insurance at less than $100, both types will want to buy but my expected payoff is:
$100 - [50% * 100% * $1000] - [50% * 10% * $1000] = -$450
77
How does adverse selection work in insurance policy?
The worst types have the greatest incentive to buy the policy, which leads to adverse selection.
Insurance firms are risk neutral and clients (policy-holders) are risk-averse
The point is that adverse selection problem *pushes the price of policies up*
78
Suppose the seller’s value of a ‘good’ used car is VG = $1500 and a
‘lemon’ is VL = $1000. But now the buyer’s values are going to be $1700 and $1100, respectively.
Honest Steve: When I sell a good used car I get up to $200. When I sell a lemon I get up to $100. People believe me when I say a car is good, because I have a reputation for honesty
Dishonest Steve: I can sell one lemon at up to $1700 and make up to $700. But from then on, I’m never going to be able to sell another good used car
Economists assume that rational agents tell the truth only if falsehood is costly to them
In the reputation game:
The used car dealer got a cost from lying - the cost of not being able to sell another good used car and making $200
The used car dealer also got a benefit (the one period game)
Reputations work on the relative continuation value of the game
Reputations can mitigate information asymmetries and lead to pareto-optimal allocations
79
Markets for information can mitigate what?
information asymmetry problems!
80
moral hazard + example
Occurs when an an agent’s behaviour changes because they don’t bear all the costs of their actions. In many cases agents take more risk than they would do otherwise. e.g.
Drivers taking less care on the roads due to increased safety of motor vehicles (Peltzman effect)
81
What are the imperfect remedies to imperfect information problems? (5)
1. Markets for information
2. Reputation
3. Labeling/disclosure requirements
4. Warranties and guarantees
5. Standards (set and enforced by government, business, or professional organizations)
82
What are the efficiency losses due to market failure (5)
In the presence of market failure, the market gets quantities wrong, leading to inefficiency
1. With imperfect competition there is too little output produced (monopoly) and too little labour employed (monopsony).
2. Public goods are under-provided by the market.
3. Negative externalities are over-provided.
4. Positive externalities are under-provided.
5. Bad products are over-provided when their quality is not known, good products are under-provided (because consumers have lower willingness to pay when quality is uncertain).
83
Distributive fairness:
the final allocation of benefits (or goods) across individuals (or groups) is just (or morally acceptable).
84
Procedural fairness
T he “rules of the game”are just (morally defensible)—regardless of the final allocation that results.
85
Non-coercion
No individual forced to take an action he or she does not want to take
86
Policies to address inequality in outcomes (4)
- Free medical care (Brander p. 68)
- Unemployment insurance (Brander p. 69)
- Disaster relief programs
- Progressive taxation
87
Policies that promote distributional fairness generally come at a cost of
Reduced Efficiency
88
What causes the trade-off from distributional fairness
1. Evening out the outcomes removes or distorts incentives.
2. People who make different levels of effort (broadly interpreted) still get same payoffs, so less reason to exert effort.
3. If prices moved away from competitive equilibrium to benefit buyers (price ceilings, such as rent control) or sellers (price floors, e.g. for farmers) there will be DWL.
89
Stiglitz’s main points in “The Price of Inequality” (4)
1. Main cause of inequality is through “rent seeking” by the wealthy
2. Wealthy wield political power that shapes monopolies, obtains favorable treatment (e.g . regulation) and ensures low taxes
3. Inequality is therefore self-perpetuating, and transfers across generations since wealth is inherited
4. Not only unfair but also hurts productivity
90
If capital and labour are inputs, assuming substitution between labour and capital, what are the two policy responses?
Which is preferable and why?
1. Direct redistribution (increasing wages)
2. Fiscal redistribution (tax on capital)
Fiscal redistribution preferable since increasing cost of labour through direct distribution increases unemployment
Capital to labour elasticicity found to be low from empirical findings (taxing capital does not have a large effect of reducing employment)
91
Two options for fiscal redistribution
either tax capital or labour income
92
The problem with taxing capital
Capital is internationally mobile and tax competition makes capital highly elastic
93
Problems with redistributing wealth (2)
1. If wealth inequalities get too large there are *negative externalities* (a public bad?): labor shortages, crime, revolution, etc.
2. If we redistribute we *dull incentives*: Total redistribution (to equality) gives no incentives
94
Rawls
Veil of ignorance, should design rules that take into account how the rules would affect your well-being in any possible state you might find yourself in.
95
Maximin principle
Preference for the welfare of the least advantaged.
96
Individual sovereignty
Is a philsophical construct that is widely embraced in the Western world. It is
key to the notion of private enterprise.
97
What two concepts does Individual sovereignty include
Economic Freedom: The freedom to enter into voluntary economic agreements
Consumer sovereignty: The right to one’s own tastes and preferences
98
Paternalism
Is placing limits on a person’s liberty or automony for their own good.
From the Latin Pater, meaning ‘father’
The limits may be placed against the person’s will
Examples:
Restrictions on narcotics
Restrictions on the activity of minors
Safety requirements: Wear a seat-belt, motorcycle helmets, etc.
99
How does out utility functions fail us?
They may not be as rational as we would like. Due to the fact we may not consider our own long-term/life time utility
100
What are the 4 "isms"
Relativism
Consequentialism
Egoism
Utilitarianism
101
Relativism
There is no absolute right or wrong but we can say acts are morally acceptable so long as they conform to my society’s approved practices.
102
Consequentialism
Acts are good if they have good consequences.
103
Egoism
Acts are good if they benefit me.
104
Utilitarianism
Acts are good if they can be expected to raise the sum of all human welfare.
105
What are the three rules?
1. Golden Rule: Do unto others as you would have other do unto you.
2. Kant’s 1st Rule, the Categorical Imperative:
Act according to principles that are universalizable.
3. Kant’s 2nd Rule, the Practical Imperative: Do not treat people purely as a means.
106
What are the two main versions of consequentialism
Utilitarianism:
I Whose good? Everyone’s.
I What is good? utility/happiness/pleasure
Egoism:
I Whose good? The individual’s own.
I What is good? Up to him or her to decide.
107
Two different types of egoism
Ethical egoism: moral agents should do what is in their self-interest
Psychological egoism: self-interest is what motivates people in fact
108
objectivism
Objectivism claims that the only social system which fully recognizes individual rights is capitalism, specifically what Rand described as "full, pure, uncontrolled, unregulated laissez-faire capitalism".
109
The two possible justifications for ethical egoism
Smith: When we each pursue our own self-interest, we are collectively better off. When we try to help others it is unsatisfactory because a) we invasively impose our own preferences, b) charity is degrading and debilitating.
Rand (Atlas Shrugged): Egoism recognizes the supreme value of each individual life. The alternative, altruism, requires sacrificing the individual for the good of others, thus destroying the highest value.
110
Normative analysis of the two types of egoism
So that’s ethical egoism: the view that moral agents should do what is in their self-interest.
Now let’s consider psychological egoism: the claim that self-interest is what motivates people in fact. Are we selfish by nature?
111
In terms of the trolly problem how would each ism react to:
- Switch
- Fat man
- Evil man
- Father
Egoism: No for all of the above
Utilitarianism: Yes for all of the above
Relativism: No for father and Yes for Evil man
Consequentialism: TBD
112
The basic idea is that you should follow principles or rules that you would want all people to follow.
Two key concepts:
1. Universality: I want everyone to follow that rule
2, Reversibility: The rule should apply to me
113
Always deal with people honestly
The ____ to follow this moral rule establishes a ___ to expect honest dealings
duty, right
114
The Social Contract
Individuals consent, either explicitly or tacitly, to surrender some of their freedoms and submit to the authority of the state, in exchange for protection of their remaining rights
115
How to apply the Categorical Imperative
1. Start by stating the action I am considering
2. Devise a general guiding principle that would underlie my decision
3. Imagine a universal law that requires everyone in all circumstances to act according to this principle.
4. If no rational person would ever want to impose such a universal law, then I have a moral duty not to do the action—no matter what the consequences.
116
Rule utilitarianism
Rule utilitarianism is a more practical approach: Obey moral rules, which if universally followed, would maximize social welfare.
117
Rule utilitarianism examples & explanation
Why I vote in national elections, even knowing I won’t influence the outcome
Why some people sign up for HBO to watch Game of Thrones instead of downloading a torrent
In each cases the consequences of the ACT might be to lower total utility but everyone following the rule raises utility.
118
Principle of autonomy
"informed consent” (no deception, no coercion)
119
Reformulated practical imperative
Never treat other human beings in a way that violates their autonomy.
120
Generally speaking, take actions that add to the sum of human happiness
act utilitarianism
121
Obey rules, that if followed by others, would maximize human happiness
rule utilitarianism
122
Do not make self-serving moral exceptions
Golden Rule, Categorical imperative
123
Respect the autonomy of others. No coercion, no deception.
Reformulated Practical Imperative
124
Why must we put a dollar amount on the value of life
We cannot treat the value of life as infinite!
Practical implications of perfectly safe cars.
Opportunity costs of lives saved: resources used for safety could save lives elsewhere.
125
Assumption on valuing life
No frictions in transferring between industries, we can equate utilities
126
Value of life formula via occupational risks
V=w1-w2/r1-r2
wages, Fatality risk
127
Utility of working in an industry
```
U=w-rV
Utility
Wages
Risk of Fatality
Value of life
```
128
What is the estimated value of life
$5-$10 million.
129
The value of a statistical life
Economists generally value life using everything earned and accumulated by an average person - the grand total value of all of their economic activity
130
Economists value a life at
CAN$8.16m
131
What does are have to do with on the value of life?
Increased age means lower value of life
132
some philosophers say the value of a life should be measured by what as oppose to age
Victim’s emotional investment in the world and its future.
133
Formula for the VSL
Value of a statistical life:
| Median wage x Average years
