Theory

Question 1

Pareto efficiency

Answer 1

no one can be made better off without
making at least one person worse off

Question 2

Productive efficiency

Answer 2

: no additional output without
increasing inputs

Question 3

Consider 2 people A and B. There is $100 to share between
the two. What is Pareto efficient?

Answer 3

(50, 50) and (99,1), and (1,99) are all Pareto efficient

Question 4

You have $100 to distibute between A and B (70 - 25) Efficient?

Utility function:

Answer 4

A mathematical function representing
an individual’s set of preferences, which translates her
well-being (=utility) from different consumption
bundles (=set of goods & services they consume) into
units that can be compared in order to determine
choice

Question 5

First fundamental Welfare Theorem

Answer 5

A market delivers Pareto efficient outcomes if:
* Perfect information of market participants
* Perfect competition: no monopolies, or price fixing of any
kind, easy entry and exit from market
* Complete markets with no transaction costs: the complete
set of possible bets on future states of the world can be
constructed with existing assets without friction (e.g.
insurance)
* Implications: “invisible hand”, perfect markets deliver Pareto
efficient outcomes without government intervention.

Question 6

Market failure:

Answer 6

Market failure: A problem that causes the market economy to deliver an outcome that does not maximize efficiency

Question 7

When Should the Government Intervene in the Economy?

Answer 7

redistribution, efficinecy

Question 8

Equity-efficiency tradeoff

Answer 8

Re-cutting the pie (redistribution) may reduce the size of the pie (efficiency loss).

Question 9

price mechanism

Answer 9

price mechanism, changing the price of a good to encourage or discourage use.

Question 10

Ways to discourage consumption vs encourage

Answer 10

taxes v quota and public financing

Question 11

Direct effects:

Answer 11

The effects of government interventions that would arise if individuals did not change their behavior in response to the interventions.

Question 12

Indirect effects:

Answer 12

The effects of government interventions that arise only because individuals change their behavior in response to the interventions

Question 13

payroll v income tax

Answer 13

Payroll taxes: The taxes on worker earnings that typically fund social insurance programs.

Individual income tax: A tax levied on the income of U.S. residents.

Question 14

Example of public provision v public financing

Answer 14

provision: public education
finances: medicare

Question 15

what are three ways the government intervenes

Answer 15

price mechanisms (taxes/subsidies)
regulations/mandates
public provision

Question 16

What are rationales for gover

Question 17

When should public provision be used?

Answer 17

Fully funds and provides service
Should be used for goods that have positive externalities or public goods

Question 18

what are public goods

Answer 18

non-rival and non-excludable

Question 19

example of govt intervention in regulation/mandate

Answer 19

Clean Air Act
Affordable Care Act

Question 20

Constrained utility maximization

Answer 20

he process of
maximizing the well-being (utility) of an individual,
subject to her resources (budget constraint)

Question 21

payroll v income taxes

Answer 21

income taxes are progressive, payroll are automatically deducted

Question 22

What is the equity-efficiency trade-off?

Question 23

What is the leaky bucket?

Answer 23

There can be a loss of efficiency when redistributing

Question 24

What is economic efficiency and what are the two types?

Answer 24

when goods distributed
Pareto
productive: producing goods at lowest possible costs

Question 25

What are the four questions of public finance?

Answer 25

When the govt intervene? Why? How? What are the effects?

Question 26

How has US funding - sources and payment changed?

Question 27

What is the first welfare theorem?

Answer 27

The competitive equilibrium, where supply equals demand, maximizes social efficiency.

Question 28

what are the effects of govt intervention

Answer 28

indirect - happens when behavior change once intervention is in place (people leaving private market because of govt insurance)
direct - effects without behavior change

Question 29

total social surplus

Answer 29

also known as social efficiency
represents the net gains to society from all trades that are made in a market, and it consists of the sum of two components: consumer and producer surplus

Question 30

what is the indifference curve? What are two key properties?

Answer 30

graph of all goods bundles that make someone equally well-off

Because these bundles
have equal utility, an individual is indifferent as to
which bundle they consume

consumers prefer higher indifference curves: more
is better, downward sloping

Question 31

producer surplus

Answer 31

profit; The benefit that producers derive from selling a good, above and beyond the cost of producing that good.

Question 32

consumer surplus

Answer 32

The benefit that consumers derive from consuming a good, above and beyond the price they paid for the good.

Question 32

market equilibrium

Answer 32

consumer and producer surplus are both maximixed

Question 33

income effect

Answer 33

spend less money on goods overall because feel poorer

Question 33

substitution effect

Answer 33

when price of one good increases we are more likely to choose another

Question 34

when does

Answer 34

when marginal rate

Question 35

what is a budget constraint

Answer 35

mathematical representation of all the combinations of goods an individual can afford to buy if she spends her entire income.

slope = relative price to trade goods for each other, trade-off rate = -Pgood1/Pgood2

Question 36

How does TANF impact labor supply?

Answer 36

Assume that, without TANF, the labor market is in competitive equilibrium.
When TANF is introduced, labor supply falls, which creates a deadweight loss in the labor market, i.e. some people who would have worked without TANF no longer work so these jobs (trades) are lost.
When TANF benefits are reduced, labor supply increases and social efficiency in the labor market rises, i.e. number of jobs increases closer to competitive equilibrium (but single mothers are worse off due to income effect).

Question 37

marginal utility

Answer 37

additional increment to utility by consuming additional unit

Question 38

diminishing marginal utility

Answer 38

consumption of additional unit gives the individual less utility than the previous

Question 39

marginal rate of substitution

Answer 39

rate at which consumer is willing to trade one good for another
= slope of indifference curve
MRS = -MUgood1 / MUgood2 = Pgood1/Pgood2

price trade of = utility trade off

Question 40

Opportunity cost:

Answer 40

The cost of any purchase is the next best alternative use of that money, or the forgone opportunity.

Question 41

Substitution effect:

Answer 41

Holding utility constant, a relative rise in the price of a good will always cause an individual to choose less of that good (substitute away from more expensive goods).

Question 42

Income effect:

Answer 42

A rise in the price of a good will typically cause an individual to choose less of all goods because her income can purchase less than before (poor consume less overall).

Question 43

Market equilibrium

Answer 43

The combination of price and quantity that satisfies both demand and supply, determined by the interaction of the supply and demand curves.

Question 44

deadweight loss

Answer 44

The reduction in social efficiency from preventing trades for which benefits exceed costs.
Reduction of social efficiency can be justified by some social welfare functions: e.g. Rawlsian, which gives priority to the worst off.

Price ceiling (e.g. rent control) decreases social surplus by creating deadweight loss DE. Some producers no longer sell (E) and some consumers can no longer buy (D).

Question 45

A market delivers Pareto efficient outcomes if:

Answer 45

Perfect information of market participants
Perfect competition: no monopolies, or price fixing of any kind, easy entry and exit from market
Complete markets with no transaction costs: the complete set of possible bets on future states of the world can be constructed with existing assets without friction (e.g. insurance)