Minor - Week 1 Flashcards
10 Economic principles categories
- How people make decisions
- How people interact
- How the economy as a whole works
How people make desicions
- People face trade offs
- The cost of something is what you give up getting it (opportunity costs)
- Rational People think in margin (cost and benefits)
- People respond to incentives
How people interact
- Trade can make everyone better of (specilazation, lower costs)
- Markets are a good way to organize economic activity (adam Smith invisable hand and allocation resources)
- Goverments can sometimes improve market outcomes
How the economy as a whole works
- A country’s standard of living depends on its ability to produce goods and services
- Prices rise when the government prints too much money
- Society faces a short run trade off between inflation and unemployment
Efficiency
the property of society getting the most it can from its scare resources
Equality
the property of distributing economic prosperity uniformly
among the members of society
Production possibilities frontier
We must choose between to goods, cars and covid 19 medicines
- Changes as oppertunity costs increases
Incentives
Something that induces a person to act
- Policymakers can influence the incentives (costs and benefits) and can change behavior
Higher price
Buyers – consume less o
Sellers – produce more
Public policy > government
o Change costs or benefits
o Change people’s behavior
First law of supply
High price the grater the quantity of supplies
- Aanbodlijn is stijgend
First law of demand
the higher the price the lower the quantity is demanded
Governments can sometimes improve market outcomes
We need the government to
o Enforce rules
o Maintain institutions (your company or mine) – key to market economy
o Enforce property rights
Can change outcomes with
- Intervention
- Promote efficiency
- Avoid market failure
- To promote equality
- Avoid differences in economic well being
Enforce property rights
Ability of an individual to own and exercise control over scarce resources
Market failure
Fails to produce an efficient allocation of resources
- externality
- Market power
Utility maximization theory
consumers maximize their utility subject to a budget constraint
- Marginal utility is assumed to
decrease with consumption
MRS
Marginal rate of subsitution; equal to the negative slope of the indifference curve
Supply and demand
- Demand as result of utility maximization
- Supplies derived from cost
- Equilibrium price and quantity
Traditional assumptions of economics
- Always want to maximize utility for lifetime
- Needs and desire are infinite, yet resources are scare ->
- Scarcity creates choice
- opportunity costs must be taken in to account
Homo economicus
Is able to understand, predict and prescribe rational desicions in life.
- Rational
- Self interested
- Utility maximization (own utility)
Indifference curve
- Higher curves is more utility
- What is possible with the indifference curve and the frontier?
Formula utility maximization
(MUx / Px) = (MUy / Py)
Preferences & utility
- A> B (strong preference)
- A gelijk of groter dan B (weak preference)
- A ~ B (indifferent)
If you prefer A over B, then your utility is higher with A U(A) > U(B)
Ordinal and cardinal utility
- Cardinal is numerical
- Ordinal (more than…)
Rational choice axioms (basic components of rationality)
- Completeness
- Transitivity
- Monotonic
- Self interest
Completeness
Either A or B, all alternatives can be compared.
- Preferences for all options
- Information and ordening
Transitivity
logical and consistent ordening of goods
- Constant steps
- A over B, B over C etc.
Monotonic
Utility rises with more goods
Sorts of monotonic
- Weakly monotonic; Preferences to have more of a bundle (goods X and Y, gas and cars)
- Stronly monotonic; more of one (happy with X more), if given a bundle, that has at least more of one good; leads to more utility
instrumental rationality
- Consistent proces of making choices
Rational behavior, two elements
- internal consistency; (instrumental rationality; completeness, monotonicy and transivity)
- Reasoned pursuit of self interest
Lottery 1: 10% chance of U=15, 90% chance of U=5
Under risk or uncertainty will try to maximize our utility
- Cardinal utility you can calculate
Example: Lottery 1: 10% chance of U=15, 90% chance of U=5
EU = 0.115 + 0.95 = 1.5 + 4.5 = 6]
Rational behavior has two elements
- Internal consistency (instrumental rationality; completeness, monotonicy and transitvity)
- Reasond persuit of self interest
Critisism on traditional model
- Rational choices; informed
- Stable preferences
- Independent
- Content
Rational choices, can we make when?
Only when we are truly informed
- Cardinal
- Calculate risk and utility
Stable preferences
Preferences are stable and do not change over time, between whealty and poor or cultures
- Not the product of social system
But it is not the case!
Independent
Decisions are independent
- Not affect each other
- Not comparing utility
Not the case!
Without content
- Only cares about what preferences and consistancy
- Not Why
- No matters on if preferenceses are good or meaningfull
Procedural in variance
Preferences are consisent and independent of the method used to elicit
Preference reversals
Lottery to see how the preferences changed
- First say A > B, then when asked again B > A (YOU COMPARE!)
Laissez faire thinking
You know your own preferences and government should not intervene in what is meaningful and good
Alternative models to traditional, that take in to account the not rational part
- Simon’s bounded rationality: incomplete info, time constraints and cognitive limitations satisficing behavior (happy when we get to certain utility level)
- Prospect theory: relative positions rather than absolute ones
o Mill: ‘Men do not desire to be rich, but to be richer than other men’
Why not lose the rational utility maximizer?
- People try do maximize in many situations; determined by the capacity of explaining and predicting
- Natural selection;
Violation of rationality will flip you out of the market
Deviate, not maximize utility and pushed out of market system
Positive economics
Understand and describe observed choices
- Descriptive
- Why a to high weightening?
Normative
Prescriptive
- Define and prescrive optimal choices
- Calculate
allocation
Redistribute scares recourses
Scarcity
Never enough resources to satify all human needs –> choices
Welfare economics
normatieve judging whether state a or B is better in terms of social welfare
How to determinate if A is better than B welfare wise?
Ethical framework
- Utility principe
- Individual sovereignty;individuals are themselves the best judges of what
contributes to their utility and how much that contribution is.
-Consequentialism; utility oly derived from outcomes and not process itself
- Welfarism; goodness judged by utility levels in that situation
Utility maximizers
- Self interest
- Given; income and prices
Income effect
Lotto effect
reflects the change in consumers real income as result of a price change
(purchasing power)
Subsitution effect
The effect when a relative price change occurs and the shift in quantity demanded of a good
- Shift to more expensive or cheaper products
- Lead to new preferences of bundle
- What is then the highest attainable
Total Price effect (PE)
The change in prices influence the overall quantity demanded of a good or service
Determants demand good X
- Price of commodity
- rices of other commodities (compliment or subsitutes)
- Preferences
- Income
What you are willing to pay reflexts?
- Also oppertunity costs
Demand curve
- Indicates Marginal benefit
- Ceteris paribus
- All people on market; aggregation
- stronger preference for good or they have a higher income
perfect market, firms have ?
No market power
- P=Mc
Supply curve
- Indicates Mc
- Firms seek for maximize profits
Equilibrium:
demand and supply are perfectly balanced
Example: Qd > Qs
- More demand than supply
- People will offer higher
prices (resulting, ideally, in
more supply)
Resulting in equilibrium again
Any distortion will be fixed through price signals
- Too much supply lower price more demand and lower supply
- Too much demand higher price lower demand and higher supply
consumer surplus
The amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. They gained happiness
producer surplus
The amount a seller is paid for a good minus the seller’s cost of providing it
Total surplus
Total surplus = (Value to buyers – Amount paid by buyers) + (Amount received by sellers Cost to sellers).
pareto optimallity
An allocation is Pareto-optimal if you cannot reallocate (e.g. through exchange
on a market) in such a way that at least one person is better off and none is
worse off
Pareto aspects
- Measure and compare utility (sum )
- Utility is not comparable, but handy in pareto, when no one is worse off
potential pareto
- Gains must be lagere enough for winners to possibly compensate for losers
- Not compensation is not needed
- Assumption; : utility value of money equal
–> essential for CBA; benefits higher than losses
Competitive markets
Results in Pareto optimallity even without government intervention
- Complete information
- No market powers
- enter en exit market
- no externalities (bear full costs and benefits)
Pareto en efficiency
Pareto can lead to efficiency but not to equity
- Income is fixed (not how income is distributed)
- pareto optimal; one has evertything and one has nothing, one is always worse of is it’s more equity
Marketoutcome is not optimal for healthcare (arrow 1963)
- Uncertainty and consequences of insurance
- Information asymmetry
- Existence of externalities
- Market power
- Uncertainty - Moral hazard and adverse selection
- Uncertainty when you can yet a disease of illness (we dont no the chances of getting sick)
- Risk aversion
Insurance market; why not voluntary?
- adverse selection (high risks, that is profitable); premium higher in future
- Cream skimming; attract good profitable risks
Mandatory insurance how risks pooled
- Income related in stead of risk related
- Risk solidarity and income solidarity –> risk equalisation
Risk equalisation
Competing healthcare insurancers execute risk and income solidarity
Consumer moral hazard
Full insurance customer feels no costs –> will overconsume
- incentive overconsumption; consuming beyond the
point where benefits exceed costs:
welfare loss
consuming beyond the point of benefits;
- Costs are ultra high
- Consumer pays nothing
Ex ante moral hazard
Less prevention and more risk
- You have insurance so why a healthy lifestyle?
Ex post moral hazard
Demand increases and take more expensive healthcare
- Dont have to pay anayway
How to reduce moral hazard?
- instance cost sharing
(incentive to not overconsume, because you have to pay, decrease demand).
Problem cost sharing
- Poor react stronger to such incentives
- Pushed out of the market; efficiency comes to a premium that is average with the risks, but poor can’t afford even
Jeopardize efficiency
Some people pushed out of the market of efficiency thinking
Denk aan plaatje welfare loss, rechter hoekje
Supplier induced demand or producer moral hazard (assymetric information)
Supplier more knowlegde (agent)
- Agent must formulate her demand
- serves own well being as well (self interested)
- Can influence demand
Producer moral hazard
behavior that might lead to more consumption
because the producer might be maximizing his/her profits
Externalities
An (often unintended) impact (positive or negative, cost or benefit) of an action of one party on another party not involved in that action
- Costs or benefits not percieved by the costumer
Externalities and optimum vaccinations (subsidy)
Social desirable is higer
- Subsidy will increase demand curve will be less steeper and Qs is reached (more vaccinations)
- Relative price has changed
Market power in healthcare
- Not easy to step in and out
- ## Much market power of existing suppliers (insurers and suppliers)
equity in healthcare
- Willingness and ability to pay inadequate to distribute health care?
- Poor would then consume less care (and be sicker and poorer from that..)
Goverment has to intervene! (subsidies, quality control, accesability and solidarity)
Is health only outcome for utility?
- NO!
utility is also derived from other things
Made a trade of between health and hapiness
Rational addiction - Becker and murphy
People maximize utility and may
still enter into addictive behavior
- They may take full account of
future costs and consequences
(subjectively assessed) - Time and time preference
important
Becker and murphy formula
U(t) = U[c(t) * S(t) * y(t)]
C= consumption of addictible stock
S= addictive capital stock (depends on C) - accumulatie verslavingsgedrag
Y= inkomen
Reinforcement:
greater past consumption of addictive goods increases
desire for present consumption (dc/dS > 0)
Tolerance
utility from a given amount of consumption is lower when past
consumption is greater
Addictions
- More likely with higer discount rates
- Respond to price changes such as taxes
- Taxes to correct for externalities
Timing and costs and effects
- Health behavior involves current costs and future health benefits
- People discount hyperbolicly; lead to time inconsistenciesTi
Time inconsistencies
You value X on time 1 other than on time 2.
- Not in line with traditional economics; where preferences are the same and consistent
Positional concerns
Comparing to others
- Less prominent in healthcare, because it is about absolute concerns
Adaptation
People become less healthy due to a shock, their utility will decrease
significantly, however after a while their utility level might adapt and increase again
