Public Policy Flashcards
when should the government intervene
when it can increase social welfare
social welfare
level of well being in society - determined by how much gets produced and how its distributed
when will government intervention increase social welfare
when it can increase social efficiency or when it can achieve a more preferred distribution of resources
social efficiency
net gains to society from all activity in a market - sum of consumer and producer surplus
consumer surplus
benefit that consumers derive form consuming a good
producer surplus
benefit that producers derive from selling a good
market demand curve
sum of buyers demands
market supply curve
sum of sellers supply
market equilibrium
where demand and supply intersect
social efficiency is maximised at
the competitive equilibirum
market failures examples
imperfect competitive, imperfect or asymmetric information, individual failures, externalities
2nd fundamental theorem of welfare economics
society can attain any efficient outcome by suitable redistributing resources among individuals and then allowing them to freely trade
equity-efficiency trade-off
we have to trade of social efficiency (total size of economic pie) with increased equity (how the pie is distributed among individuals)
how does the government intervene
provision of cash benefits, direct spending or financing of public provision, taxes and subsidies, restrict or mandate private sale or purchase
direct effects of intervention
the effects in individuals did not change their behaviour in response to interventions
indirect effects of intervention
the effects that arise because individuals change their behaviour in response to interventions
positive statement
object statements that can be tested, amended or rejected based on evidence
normative statements
subjective statements that involve a value judgement or opinion
what is insurance
the future is uncertain. insurance allows you to smooth consumption, so you get the same amount whether you end up in a good or bad state of the world
expected utility def
weighted sum of utilities across state of the world - weights are probability of each state occuring
expected utility equation words
(prob adverse event doesnt occur)x(utility from consumption when adverse event doesnt occur) + (prob adverse event occurs)x(utility from consumption when adverse event occurs)
how can you smooth consumption
by saving, borrowing or purchasing insurance
expected utility equation algebra
EU = (1-q)U(w-p) + (q)U(w-p-d+b) where: q is probability, w is income, p is insurance premium, d is cost (e.g. medical cost when sick), b is pay-out
if insurance market is competitive and works well, firm charges and insurance premium of
p = q * b, where q is probability, b is payout
heterogeneity in risks across individuals
people dont all have the same probability of adverse events affecting them
asymmetric information
occurs when individuals know their own probability but insurance companies don’t
situation where the market will unravel due to asymmetric information
insurance companies can’t see who’s sickly and who’s healthy, everyone buys the healthy insurance as it’s cheaper, insurance company makes bigger payouts than they received and so make a loss
situation of adverse selection
insurance companies offer fair price or average of healthy and sickly price, low risk people wont buy insurance but high risk people will, insurers make losses and so raise prices, this drives more low risk people out the market, so insurers make losses and raise prices. Continues on until market unravels, and no insurance is offered
how can the government address adverse selection and improve market efficiency
directly provide the insurance (NHS), mandate that everyone is required to purchase insurance (car insurance)
