Up to Final Flashcards
Taxation
-Changes individual behaviour of firms and consumers.
-Reduction in CS and PS exceeds government revenue (DWL).
-Used to mitigate inefficiencies created by externalities.
Principle of Taxation
The policymakers’ objectives when designing a tax system:
-Efficiency
-Equity
-Primary aim for it is to raise money for government services. It is also used to influence behaviour (e.g., sin taxes, externalities.)
Efficiency (Taxation)
A tax system is more efficient if it raises the same amount of revenue at a smaller cost to taxpayers.
Cost to Taxpayers:
-Tax payments
-DWL
-Administrative costs
Efficiency signifies that these would be smaller.
Average Tax Rate
Taxes paid / total income.
Captures cost paid by taxpayer.
Marginal Tax Rate
Additional tax paid on additional dollar.
Captures degree of behavioural distortion in the tax system.
Lump-Sum Taxation:
The same amount taxed to every taxpayer. (Such as fees to the city.)
Equity Principles (Taxation)
-Benefits principle
-Ability to pay principle
Benefits Principle (Taxation)
People should pay taxes based on the benefits they receive from the government services.
-Gasoline taxes –> fixing the roads.
Ability-to-Pay Principle (Taxation)
Taxes should be levied (imposed) according to how well a taxpayer can shoulder the burden (equal sacrifice).
-Progressive taxation
-Public goods
Horizontal and Vertical Equity (Taxation)
Horizontal: taxpayers with similar abilities pay similar amounts.
Vertical: if taxes are based on ability to pay, then wealthier taxpayers should pay more than the poorer taxpayers.
Proportional Tax
A tax for which high-income and low-income taxpayers pay the same fraction of income.
Regressive Tax
A tax for which high-income taxpayers pay a smaller fraction of their income than do low-income taxpayers.
Progressive Tax
A tax for which high-income taxpayers pay a larger fraction of their income than do low-income taxpayers.
Adverse Selection
Participation in a market (e.g. used cars) or contract (e.g. insurance) by those with unobserved and undesirable attributes that are costly to the other party.
-Arises in markets where sellers more about the attributes of the good being sold more than the buyer.
Primitives of a Market (Market Economy)
-Preferences
-Institutions
-Private information
Utilitarianism
Government should choose policies to maximize the total utility of all in society.
-It is based on assumption of diminishing marginal utility.
Liberalism
Government should choose policies deemed to be just, as evaluated by an impartial observer behind a “veil of ignorance.” (Rawls)
-Raise welfare to those worse-off in society in order to maximize minimum utility (maximin).
Libertarianism
Government should punish crimes and enforce voluntary agreements but not redistribute income.
Property Rights
Key institution for a market economy is to secure property rights.
They secure the incentives to trade:
-Patents provide incentive to invest in R&D.
-Income security provides incentives to invest in human capital.
Without it, it can lead to collapse:
-Atlantic cod fishery
-Tragedy of the commons
Tragedy of the Commons
Common pool resources get overused because individuals do not recognize the external costs their use puts on others (e.g. congestion).
Government solutions include:
-Reducing use of resource through regulation or taxes
-Turning resource into a private good.
Dictator Game
Individual is given a sum of money $X and asked to allocation a proportion to another person (between $0 and $X).
-Typically people will give on average of 20%.
Condorcet Paradox
Majority voting may to intransitive (not having objective) preferences at societal level.
Arrow’s Impossibility Theorem
There is no method for aggregating presences that satisfies all conditions in society.
The Median Voter Theorem
When a policy is chosen based on majority voting, the option preferred by the median voter will be chosen.
Social Preferences
Fairness: people care about outcomes relative to others.
Reciprocity: many people seem to desire reciprocity (if someone is kind/unkind to me then I should be the same to them).
Overall Biases
-People are influences by baselines (inertia: or tendency to remain unchanged)
-People have limited attention and make mistakes as result of simplifying complex problems
-People aren’t very good at sophisticated math
Price/Valuation Biases
-People have trouble doing present value calculations
-How choices are framed heavily influences decisions
-The presence of other options can bias choices
-People reject all choices if there are too many
Expectation and Preference Biases
-People are overconfident in ability to stick to plans such as saving
-People are overly optimistic about themselves and their futures
-People “live for today” expecting to be more patient tomorrow but tomorrow is today
-People place more value of items in their possession than the same item not in their possession
Choice Architecture
Central Idea: How to sequence or lay out decisions to encourage efficient decisions that counteract other biases.
Rationality
Studies of human decision-making have tried to detect systematic mistakes the people make:
-People are overconfident
-People give too much weight to a small number of vivid observations
-People are reluctant to change their minds
-Time inconsistency
