Test 1 Flashcards
Define the features of the Great Depression
- period of severe economic contraction and high unemployment that began in 1929, throughout the 1930s
- started off with the stock market crash of 1929. Over the next 10 years, around 9,000 banks went bust, resulting in huge unemployment levels. Protectionism (the SH tariff act) worsened these conditions.
What was the problem with simple classical models when explaining the Great Depression’s high unemployment?
classical economics couldn’t explain how goods could go unsold and workers could be left unemployed.
In classical economics, the prices and waged would fall until the market cleared, and all goods and labour were sold. Keynes = offered new theory that explained why markets might not clear.
Keynes’ theory was that the classical quantity theory broke down because people and businesses tend to hold on to their cash in difficult economic times.
What did Keynes believe governments could do in response to the Great Depression etc?
intervene in the economy and affect the level of output and unemployment.
During periods of low private demand, the gov can stimulate aggregate demand to lift the economy out recession.
Define the term “Inflation”
The rate of change of the general price level
Define the term “Unemployment”
A measure of the number of people looking for work, but who are without jobs
Define the term “Output”
Real GDP of an economy
Define the term “Economic Growth”
Its shown by increases in real GDP. It’s an indication of the expansion of the economy’s total output
Define the term “Macroeconomic Policy”
A variety of policy measures used by the gov and central bank to affect the overall performance of the economy
Define the term “International Trade”
How does being a part of a global economic system affect nations’ economies?
What are the 2 traits of economic powerhouse economies?
1/ They grow their level of output fast
2/ They manage the problems of unemployment and inflation well by undertaking appropriate macro policies
Why is the PPF negatively sloped and concave?
It’s negatively sloped because of scarcity.
It’s concave because of the inadaptability of resources –as the production of one good rises, the opportunity cost of producing that good also increases. Not all factor inputs are equally suited to producing items
Define the term “Inefficiency”
If more output could be produced from a given quantity of inputs, or the same output from less inputs
Define the term “Allocative Efficiency”
Achieved when production represents consumer preferences i.e. where MR = MC (demand = supply)
Why might the PPF shift outwards?
- Discovery of new resources
- Increase in work force i.e. migration
What might shift the demand curve?
- Price of substitute
- Price of a complement
- Consumer income
What might shift the supply curve rightwards?
- Falling costs
- Technological improvements
Define the term “Consumer Surplus”
Difference between the total amount that consumers are willing to pay and the total amount that they actually pay (i.e. market price)
Define the term “Producer Surplus”
The difference between the amount at which they are willing to supply and the price that they actually receive
What are the 3 reasons why governments exist?
- Establish and maintain property rights = markets rely on property rights to function
- Provide non-market mechanisms for allocating scarce resources = choices made pursuing self-interest may not always be in the social interest and governments may reallocate resources
- Redistribute income and wealth = the market economy delivers a distribution of income and wealth that many people regard as unfair.
What are signs of an appropriate policy intervention?
- Corrects failure
- Raises social value/welfare i.e. controlling/breaking up monopolies
- The benefits gained are higher than the costs of intervention
- Does not cause other failures
- Minimises conflict with other policy aims
What are the reasons for market failure?
- Price and quantity regulations
- Monopoly
- Externalities
- Public goods
- Asymmetric information
What are the features of monopoly power?
- P>MC
- Low production, surplus loss and lower social value
What are potential policy responses to a monopoly?
- Limit pricing
- Break-up monopoly
- Regulate price discrimination
- Control merges
- Limit barriers to entry
- Regulate natural monopoly
Define the term “External Costs”
Costs imposed on 3rd parties not priced in markets i.e. pollution, road congestion, health hazards etc
What are some policy responses to externalities?
- Create a market for externalities i.e. pollution permits
- Tax production of good creating external cost
Define the term “Public choice”
A decision that has consequences for many people, maybe even a society
2 traits of public goods?
1/ Non-rivalrous
2/ Non-excludable
Explain the “Free-rider problem”
- The non-exclusivity of a public good means there is incentive for people to avoid paying for what they consume. Leads the private market to under-produce a public good.
Non-excludable and non-rival + free rider problem => the MC of provision = 0, P = 0, Profit = 0
No private supply = underproduction => MSB > 0, so value is lost. - Policy response:
→ Gov supply at point of demand
→ Total cost financed through tax
Define the term “Moral Hazard”
Incentive one party to an agreement has to act in a manner that brings additional benefits to themselves at the expense of the other party. i.e. insuring and then taking less avoidance care
Define the term “Adverse Selection”
Tendency for people to enter into agreements in which they can use their private information to their own advantage and to the disadvantage of the less informed party. i.e. insurance company and its high-risk clients, or bank and risky borrowers
Explain the “Market for Loans”
- Private info on credit risk:
- Low-risk borrowers likely will repay their loans
- High-risk borrowers likely will default on their loans
- Adverse selection – banks cannot distinguish between 2 classes of borrowers and will treat them the same.
- Banks use proxies to screen borrowers =
- The length of time on the job, marital status, age and other factors correlated with low-risk borrowers to try and determine the risk
- Banks also ration the sizes of the loans they are willing to make
Explain the “Market for Used Cars”
- Used-car seller has private information = cars may be good quality or “lemons”
= adverse selection and moral hazard occur if the seller claims all cars are high quality but in truth only offers “lemons” for sale - consumer unable to distinguish between a “lemon” and a good vehicle, so assumes that all used vehicles for sale are potential “lemons”.
- As a result = used car dealers must price their cars at the highest price that consumers will pay for a “lemon”.
- Private solution = warranties. Used car dealers can offer a warranty on the vehicle = if the dealer gives a warranty on a lemon vehicle, the dealer will face expensive repair costs.
Explain the “Market for Insurance”
- Moral hazard = insured people have less incentive to be careful and avoid risky behaviour
- Adverse selection = mainly high risks want insurance
- Insurance companies need signals to limit the extent of adverse selection problem. i.e. auto insurer looking at an individual’s driving record, or a health insurer looking at an individual’s medical records
