Normative Analysis Flashcards
4 similarities between law and econimics
- Human interaction is object of study
- Strongly influenced by (moral) philosophy
- Method of deduction (general principles yield specific conclusions)
- Storytelling is used to persuade the audience
What is the definition of law?
The system of rules which a particular country or community recognizes as regulating the actions of its members and which it may enforce by the imposition of penalties
E.g., defining the rules of the game
Why do we have law?
The law protects people by constraining the state
Law versus economics: ex-post vs. ex-ante and top-down vs. bottom-up
Most laywers are in the ex-post (facts happened; studying the law that already exists) and bottom-up (specific cases to general rules) box
Most economists are in the ex-ante (behavior can change in the future; context is not given) and top-down box
What is consequentialism?
Something is good when its effect is good
E.g., when a tax policy has been changed and its effect was desirable, this change in policy is desirable
What is efficiency?
A change in the allocation of outcomes in the economy that potentially makes at least one individual better off without making anyone worse off
Exchange efficiency
A market with no production, only preferences
Example: Angela and Bruno both owns apples and bread -> where their indifference curve meets each other, they trade so that Angela gets a few more apples and Bruno a bit more bread
This makes one of them better off without making the other worse off -> parto-efficient point
What is Pareto-improvement?
A change that makes at least one individual better off without making any other individual worse off
What is pareto-efficiency?
A situation where the welfare of an individual cannot be improved without reducing the welfare of others (e.g., no pareto improvement is possible anymore)
2 assumptions behind pareto-criterion
- Welfare consists out of individual utility only
- Individuals are the best judge of their own utility
Is there only one pareto-efficient outcome?
No, there are several depending on negotiation power, and some are more desirable for society than others
What is production efficiency?
The “cheapest” way to achieve a certain combination of produced goods -> the least amount of money or material being wasted
First welfare theorem
Every competitive economy is pareto-efficient (all resources are being used efficiently)
What is a Hicks-Kaldor improvement?
A change where gainers are able to compensate losers (a potential pareto improvement)
What is Hicks-Kaldor efficiency?
A situation where no adjustment can be made that benefits some individuals more than costs to other - the loss of the others cannot be compensated fully
Name 5 market failures
- Public goods with no market (free-riding)
- Externalities: consumption of a good hurts others
- Information asymmetry
- Market power: firms or consumers determine the price, so it does not reflect the production costs
- Business cycles
What is utilitarianism?
Creating the greatest happiness to the greatest number of individuals -> welfare is the sum of individual utility
Reactive vs. proactive economist strategies
Reactive: let society define specific policy goals with reveal true welfare objective of society
Proactive: explicitly formulating a social welfare function that reveals a demand for a desired good that is insufficiently supplied by the market
What do lawyers almost never do?
Explain the way a social objective can be achieved in the most efficient way
Why is the total burden of a tax larger than the tax payment?
It also includes the social cost of taxation - people work less, buy less, firms relocate etc. This causes an excess burden/welfare loss
Which market should be taxed?
The one with the steepest demand curve -> less change in the quantity bought so less welfare loss
What is a surplus technically?
For consumers, the difference between what they pay for the product and how they value it
For suppliers, the difference between the price they get and what they are willing to produce it for
What is the transfer-effect?
When introducing a tax, the part of the consumer surplus that goes to the tax revenue is not welfare loss, because it is assumed that the government spends the money in a socially desired way that benefits people
What is deadweight loss/welfare burden on a graph?
Red triangle that describes the number of transactions that would have happened without the tax but does not happen now
What is the income effect of a tax?
The tax reduces net income -> consumers buy less of all products/services
What is the substitution effect of a tax?
The taxed product becomes more expensive -> buy different product/services instead
Does income effect or substitution effect create a welfare loss?
Substitution effect -> a change in behavior that is not the purpose of the tax
What is a lump-sum tax?
Taxes that are independent of behavior and only have an income effect
How to measure income and substitution effect on a graph?
Parallel line from budget constraint that just touches on the indifference curve after tax.
Income effect is the move from the original equilibrium to equilibrium on parallel budget constraint -> less of both goods
Substitution effect is the move from the equilibrium on the parallel budget constraint to the new equilibrium with the tax -> one good substituted for the other
The distance between the budget constraint and the parallel budget constraint that reflects income effect is…
Potential revenues from a lump-sum tax
The difference between the potential revenues from a lump-sum tax and the actual revenues from the tax is…
The welfare loss due to substitution
Is it desirable to choose the highest possible tax on the upward slope of the Laffer Curve?
Political choice -> it maximizes revenues but also creates large welfare loss
The larger the tax base elasticity…
The larger the welfare loss of taxation
What is the most elastic vs. inelastic tax bases?
Wealth, interest, and dividends are vert elastic
Property is practically immobile
What are 4 direct benefits of tax?
- Equitable taxation helps equlize after-tax income
- Correcting market failures
- Stabilization (macro-economic)
- Paternalism
Strengths and weaknesses of an economist
Strenghts: developing objective models, alternative policies, and evaluating efficiency
Weaknesses: narrow focus on rationality, oversimplification, failure to explain assumptions behind models,
Strengths and weaknesses of a lawyer/policymaker
Strengths: understanding legal doctrine, understanding transactions, flexibility, normative ordering
Weaknesses: fondness for anecdote, inability to understand economic models, tendency to consider statistics and models the truth
Does a reduction in the excess burden of taxation (deadweight loss) relate most to a Pareto Improvement or an Hicks-Kaldor improvement?
It is a Hicks-Kaldor improvement: it is not guaranteed that nobody is not worse off - there is no way to be sure; on average, we expect that the gains from those who gain is bigger than those who might have a loss.
