Pre-Midterm Content Flashcards
2 elements that the government does that benefits society:
- Criminal justice system (protects citizens and property from harmful behaviour)
- Provides a stable trading environment (enables enforcements of contracts [ensures agreements between parties are legally binding and can be enforced if one party fails to fulfill its obligations]), and macroeconomic policies sets interest rates and influences spending decisions)
Economically rational agent:
Selfishly maximizing one’s own utility.
Surplus:
Difference between the utility of having the good and the utility of the transaction price.
Maximizing social welfare:
Maximizing everyone’s welfare.
Free market
Where transactions are voluntary.
Outcome from trade won’t be pareto-efficient when there’s:
- Imperfect competition
- Information problems
- Externalities
- Public goods
- Some other situations (coordination problems, etc)
How to maximize social welfare:
- Redistribution
- Trade (market failure can affect this).
- Institutions to fix market failures (so utility isn’t lost)
Policy:
Set of rules, created and enforced by the government.
Normative analysis & policy:
What policy makers SHOULD do.
Cost-Benefit analysis & policy:
Analyzing the trade-off between gaining additional social welfare against the costs of implementing the policy.
Incentives:
An action/ outcome is linked with utility for someone.
Opportunity cost:
The foregone benefit (utility) of the next best alternative.
Willingness-to-pay:
The total utility an agent gets from a good, expressed in dollar terms.
Transfer seeking:
Getting a bigger share of what’s already been created (not putting any effort to create more).
Ex: Stealing.
Imperfect competition:
- Market Power: Firms can influence prices rather than just accept the market price.
- Product Differentiation: Products are not identical, and firms try to make their products stand out through branding, quality, or features.
- Barriers to Entry: New firms may face obstacles that prevent them from entering the market easily, such as high startup costs, strong brand loyalty for existing firms, or regulatory hurdles.
- Non-Price Competition: Firms often compete using methods other than price, such as advertising, product quality, and customer service.
Monopolistic competition: Many firms sell similar but not identical products. Each firm has a small degree of market power, meaning they can influence prices to some extent.
Oligopoly
Monopoly
Moral hazard:
Moral hazard occurs when one party takes more risks because they know another party will bear the consequences if things go wrong.
Any policy should be carried out as long as…
Marginal benefits exceed marginal costs.
The amount of money spent on the policy should be until the last dollar spent…
is where MB=MC.
Paradox of value:
Things that are vital for life are inexpensive, whereas things that are not essential to survive are expensive.
The paradox of value, also known as the diamond-water paradox, refers to the observation that while water, which is essential for life, is abundant and inexpensive, diamonds, which are not essential for life, are scarce and expensive.
Price is based on the Marginal Unit of the last unit supplied.
- Prices reflect the value of the last unit bought or sold. This is because consumers and producers make decisions based on the additional benefit or cost of consuming or producing one more unit.
Incentive effects:
Changes in people’s behaviours based on rewards and punishments, or changes in benefits and costs.
Peltzman effect:
The tendency of individuals to take additional risks when they feel safer due to the presence of safety measures.
Law of Unintended Consequences:
When people or organizations take actions to achieve a particular goal, there may be unexpected and unintended outcomes that result.
Ex: The cobra effect.
Limitations of Financial Incentives:
- When incentives overpower intrinsic motivation.
Ex: Israeli day care late fees, paying for blood instead of voluntary donations (that feeling of “being good”).
Invisible Hand Theory:
The invisible hand theory suggests that when individuals act in their own self-interest, they unintentionally contribute to the overall good of society through their actions.
- Spiritually connected.
Perfect Competition:
- Prices set by the market.
- No barriers to entry.
- In the long term, profits go to zero due to new entrants.
- Buyers and sellers have all relevant information (sellers and buyers can feel confident about their decision and that they’ll get the benefits they are promised).
What are the names of the two different concepts of efficiency?
- Management efficiency/ production efficiency
- Allocational efficiency/ Pareto efficiency
Management efficiency/ Production efficiency:
Using resources (time, money, people) effectively and productively to achieve goals.
Question: Is the given level output being produced with the lowest amount of inputs (at the lowest price)?
When there is management inefficiency = called X-inefficiency.
Allocational efficiency/ Pareto efficiency:
Where resources are allocated in a way where someone can’t be better off without making someone worse off
It is assumed that all firms have management efficiency (lowest costs):
Due to competition in the market…
- Most firms minimize costs to get the highest profits possible).
- The one who don’t manage efficiently go out of business.
Potential Pareto-improvement:
Where social welfare for everyone can increase by making someone worse off. The net benefit can compensate the net loss, and still be better off than before.