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.
Pareto inefficiency:
Difference from Pareto efficiency.
Mutually beneficial transactions were not realized.
Pareto improvement:
Somebody was made better off without making someone worse off.
Second welfare theorem:
Any desired efficient allocation of resources (Pareto efficient) can be achieved by redistributing wealth and then allowing markets to operate freely.
Social welfare can be maximized through…
Redistribution of endowments (resources, assets, wealth) to create a more equitable playing field, before the market forces kick in.
The goal is to address inequalities and create a fairer starting point, which can help achieve desired economic outcomes such as reducing poverty or increasing economic opportunity.
Used for programs etc that could bring more social utility than what an individual person would use the money for.
Benevolent social planners:
Economists who try to maximize social welfare.
Nash equilibrium:
Where each players has chosen strategies that maximizes their utility. Nobody can improve by changing their strategy given that others don’t change theirs.
Every strategy (action) is a best-response to the strategy (action) of the other,
Strategy:
For every action of another player, you know in advance what action you would take.
Prisoner’s dilemma:
Two individuals acting in their own self-interests does not produce the optimal outcome.
Solutions to prisoner’s dilemma: Tit-for-that:
If the opponent cooperates, the player continues to cooperate; if the opponent defects, the player retaliates by defecting in the next round.
Solutions to prisoner’s dilemma: Grim:
Once the opponent defects, the player defects forever, creating a severe punishment.
Solutions to prisoner’s dilemma: Institutions Enforcing Rules:
Institutions establish rules and enforce penalties for non-compliance, creating incentives for cooperation and discouraging defection.
Solutions to prisoner’s dilemma: Outside Intervention to Restructure Payoffs:
Restructuring the payoffs by making defection (talking to authorities) highly costly, incentivizing cooperation (remaining silent)
Ex: A mob boss who eliminates anyone who talks to the authorities.
Solutions to prisoner’s dilemma: Signalling:
By signaling their intentions (to steal or cooperate), players can build trust and coordinate their actions, leading to mutually beneficial outcomes.
Trust or Social Conventions
Cultural and social norms can help people coordinate, doing the best choice for everyone.
Perfect competition:
- No one has market power.
- Lots of sellers and buyers.
- Homogeneous products.
- Access to all relevant information for their production and consumption decisions and low transaction costs (can transact easily).
- Free entry and exit in the long run.
General problem with imperfect competition:
Firms produce too light and price too high (losing surplus).
Monopolistic competition:
- Large number of sellers selling differentiated versions of the same product.
- Ability to set their own prices (market power).
- Free entry & exit.
Monopsony:
There’s a single buyer, tends to have power of the price it wants to buy at.
Policy responses: Minimum wages, and unions (so companies who have high power over their suppliers don’t take advantage of them).
Two policy responses to monopolies:
- Public corporations (ex: BC Hydro).
- Regulations (ex: Fortis).
Public goods:
- Non-rival: When one benefits from a good, it doesn’t reduce the benefits of othera. Everyone benefits.
- Some goods are non-rival until a congestion point (consumption by one individual reduce the benefits available to others).
- Non-exclusive: Costly or impossible to exclude others from consuming it.
Private goods:
- Rival: If one consumes it/ benefits from the good, no one else can benefit.
- Exclusive: Gotta pay to get it (can exclude others).
Ex: An apple
Commons good:
- Rival
- Non-exclusive
Ex: Fisheries
Club good:
- Non-rival
- Excludable
Ex: Toll roads, private parks, exclusive clubs
Imperfect information:
The less informed party is unsure about the true marginal benefit from a transaction -> can lead to market failure (goods not being purchased for ex)
Market failures come primarily from assymmetric information.
Expected value:
(prob. of condition)(prob.of event)($)+(prob.) of condition)(prob.of event)($)=
Adverse selection:
When one party knows more information then the other leading to ineffeciency (surplus isn’t maximized).
Pushes price of policies up
Solutions for Adverse Selection/ Imperfect Information:
- Markets for information.
- Labeling/ disclosing requirements.
- Warranties and guaranties.
- Standards (set by the government, business, or professional organizations).
Moral hazard:
Moral hazard occurs when one party takes on riskier behavior because they do not bear the full consequences of that risk, often due to some form of protection.
Peltzman effect:
When people feel safer due to safety measures or regulations, they might take more risks, potentially offsetting the intended benefits of those safety measures.
Ex: Drivers being less safe while driving due to increased safety of vehicles.
Distributive fairness:
Fair allocation of resources among individuals or groups.
Complete equal shares/ allocation is not efficient -> incentive costs.
Can disrupt the natural balance of supply and demand -> leading to deadweight loss (ex: rent).
Procedural fairness:
Fair processes and decision-making (ensure that everyone has an equal change of participating and being heard).
Rent-seeking:
Invidiuals/ business use their resources to gain economic benefits without creating new wealth for others.
Ex: lobbying favorable regulations that benefits themselves but not necessarily the broader economy).
Direct redistribution:
Increasing wages
Increases unemployment
Fiscal redistribution:
Taxing capital (internationally mobile, tax competition) or labour income.
Reducing economic inequalities among citizens.
Capital to labour elasticity is low (taxing capital does not have a large effect on reducing employment).
“Capital highly elastic” = easily movable to other countries.
Fiscal federalism:
Each level of government taxes it citizens and uses the resources and responsibility to efficiently meet its citizens needs.
Thomas Piketty:
- Inequality will increase since return on capital growth > economic growth.
- Two options for fiscal redistribution: income or capital.
- Taxation has problems: money is internationally mobile, and tax competition.
- Solution: fiscal federalism
Social contract:
An agreement where individuals give up some of their freedoms to form a government (protecting the rest of their rights, security and stability) and society.
State of nature:
Where there’s no government.
Hobbes: Constant fear of violence and death.
Horizontal equity (John Rawls):
People with are alike in relevant ways should be treated the same.
Vertical equity (John Rawls):
People who different in relevant ways should be treated differently.
“Unequals should be treated unequally.”
- Wealth redistribution (taxation %), crime (punishment intensity), participation grades (varying grades).
Veil of ignorance:
Used to design rules that benefit everyone regardless of their background (social status, religion, personal attributes) that everyone would agree to regardless of their eventual position in society.
Maximin principle:
A rule for decision making that prioritizes the well-being of the least advantaged members of society.
Individual sovereignty:
- Economic freedom (voluntary exchanges).
- Consumer sovereignty (the right to one’s preferences and tastes).
Paternalism:
Limiting someone’s liberty for their own wellbeing/ with their long-term utility in mind.
- Restriction of narcotics, safety requirements.
Utility functions:
Assume that people make rational decisions to maximize their utility.
Internality:
People fail to consider costs (and benefits) when making decisions about consumption.
Failing to see the cost of eating lots of junk food for their long-term utility.
