unit 5 Flashcards
what are institutions (4)
Institutions: both unwritten and written rules that governed the interactions among players (rules of the game)
Institutions provide both constraints and incentives
- Institutions are the “rules of the game”.
- They govern the interactions between individuals.
- They provide the constraints and the incentives.
- They specify who can do what, when they can do it, and how
the actions of players (in game theory terminology) affect
their payoffs.
what is power
Power is the ability to do and get the things we want in opposition to the intentions of others.
what are the two forms of power
Structural power
Bargaining power
what is structural power
a person’s structural power is the value of their next best alternative.
A person’s structural power is limited by the structural power of the other.
what is bargaining power
A person exercising bargaining power may set
the terms of an exchange and/or impose, or threaten to impose,
heavy costs.
how can you evaluate institutions and outcomes
assess the allocation according to the Pareto criterion and Pareto
efficiency.
A second important criterion is fairness.
why may an allocation be seen as unfair?
How unequal the allocations are: In terms of income, for example, or subjective wellbeing. These are called substantive judgements of fairness.
How the allocations came about: For example, by force, or by competition on a level playing field. These are called procedural judgements of fairness.
in what aspects may the rules of the game be evaluated?
Legitimacy of voluntary exchange: Were the actions resulting in the allocation the result of freely chosen actions by the individuals involved? Or was fraud or force involved?
Equal opportunity: Did people have an equal opportunity to acquire a large share
of the total to be divided up?
Deservingness: Did the rules of the game that determined the allocation take account of the extent to which an individual worked hard, or otherwise upheld social norms?
what is the Rawlsian approach to evaluate institutions fairness
Justice is impartial: fairness applies to all people
Imagine a veil of ignorance
From behind the veil of ignorance we can make a judgement
why may the ultimatum game be judged as procedurally fair? (4)
The prospers are chosen at random
The game is played anonymously
Discrimination is not possible
All actions are voluntary
what remains the same in the Angela and Bruno situation as institutions differ
preferences and technology used to produce grain
what does angel want
The best-for-her feasible combination of grain and free time, according to her preferences
what does bruno want
As much grain as possible
facts about angels indifference curves/ preferences
her indifference curves are vertical shifts of each other this means:
- that the vertical distance between two curves is the same whatever her amount of free time
- for each level of free time, the slope is the same on every indifference curve: Angela’s MRS depends on the amount of free time she has, but does not change if she receives more or less grain
what is the production function
the input (x-axis) creates the output (y-axis)
it has a concave shape: the average product for an hour’s work diminishes as the number of hours increases. This happens because the amount of land is fixed and becomes overworked.
what is the feasible frontier
The feasible frontier is the mirror image of the production function in the figure above.
The slope of the feasible frontier is the MRT of free time into grain
Each point on the frontier tells us the trade off Angela faces: how much grain Angela would have to give up to get one more unit of free time.
what do we identify in each case (3)
- grain produced
- hours Angela works
- the distribution of grain produced
what are the 3 cases
- forced labour
- take it or leave it contract
- bargaining in a democracy
what happens in case 1: forced labour
Bruno forces Angela to work
Bruno decides how much Angela works and how much grain she consumes
Angela can disobey or try to escape both cases risking death
what happens in case 2
bruno offers Angela an employment or tenancy contract which she can accept or reject
bruno cannot threaten Angela and Angela can go elsewhere
Angela has greater structural power
government protects Angela from being forced to work, as well as Bruno’s property rights as a landowner.
what happens in case 3
bruno offers angela a contract
angela can accept, reject or negotiate for an alternative contract
angela and other farmers are able to vote so they can push the governemtn to make a contract that limits work hours and sets a minimum wage (what angela earns in case 2) she has democratic political rights
what is the base case
Angela owns the land and produces independently.
Angela chooses 16 hours of free time
what is economic rent
Economic rent is the benefit someone gets compared to their next best alternative.
Direct benefit - opportunity cost
what is an employment contract
Bruno can specify Angela’s work hours and wage that she will be paid.
Bruno gets the most grain where the slope of Angela’s reservation indifference curve (her MRS) is the same as the slope of the feasible frontier, he will offer at this quantity
how does the graph show the total amount of rent available
its the vertical distance between the feasible frontier and Angela’s reservation indifference curve.
what is a tenancy contract
bruno specifies the rent she must pay him to use the land and leaves it to her to decide how to use it.
how can the allocation be pareto efficient
The MRT on the feasible frontier=MRS on Angela’s indifference curve
No grain is wasted: all the grain produced is consumed by angela or bruno
what is the pareto efficiency curve
The set of all pareto efficient allocations
what are the 3 lessons learned from Angela and bruno situation
When one person has the power to decide how resources are divided, as long as they ensure the other party isn’t worse off than their fallback option, the powerful party will take the entire surplus. In this case, no improvements can be made for either side without harming the other, making it Pareto efficient. However, this outcome is typically seen as unfair, as one side takes all the benefits.
If people who feel they’re treated unfairly can push for change through laws and politics, the outcome might shift to a fairer distribution . However, this new outcome may not be Pareto efficient (referred to as contract N). Societies often face a trade-off between outcomes that are Pareto efficient but feel unfair and those that are fairer but not Pareto efficient.
When institutions allow people to discuss, agree on, and enforce different allocations together, it’s possible to avoid choosing between efficiency and fairness. Instead, they can achieve both
what are endowments
A person’s endowments are the things they have that enable them to receive income
examples of endowments (6)
Financial wealth: savings, stocks, bonds in which they receive interest or dividends
Physical assets: land, buildings, machinery
Intellectual property e.g. copyrights or patents
Knowledge, skills and other personal attributes that affect their value to an employer and hence labour earnings
Race,gender,age may affect wealth, access to credit
Citizenship and if they have a visa, which determines if they are legally allowed to work
what does an individuals income depend on (2)
Their set of endowments
The income derived from each endowment, which depends on technology, institutions and political arrangements
how do endowments, technology and inequality interact over time?
endowments are constantly changing. a wealthier person has more influence on what the government does than a poor person.
a greater gap between rich and poor could increase the political advantage of the wealthy resulting in income inequality
use the endowment model to describe the inequality in bruno and angela case
Their endowments: Owning the land meant Bruno could decide whether Angela could work on it.
Angela’s productivity as a worker: This is determined by her endowment of skills and capacities, and the agricultural technology.
Angela’s reservation option: What Angela would get if she were (in Case 1) to attempt to escape from Bruno’s domination, or (in Cases 2 and 3) to refuse to work for him and seek employment or land to farm elsewhere. This is an important influence on her power to increase her income relative to Bruno’s. It is determined by her endowments and the institutions or policies in place.
what is the gini coefficient
it measures income inequality
the gini coefficient gives information about everyone and not just the rich and the poor but also those in the middle
how the gini coefficient calculated
(1/2)(average difference between people income) / (average income of people)
what is disposable income
Disposable income = market income (income from wages salaries, self employment, business and investment) - direct taxes and cash transfers
when ordering countries from most unequal to equal based on their disposable income what are the main trends
The differences between countries in disposable income inequality are much greater than the difference in inequality of market incomes
The US and the UK are among the most unequal of the high income economies
