Econ midterm 2

price as an aggregate

A good example of this is prediction markets where payoffs are linked to whether an uncertain event occurs. For example, there are prediction markets where you can buy a share that'll be worth $1 if a Democrat wins the next election. The price communicates a prediction. If the price of Democratic stock is $0.60, the Democrat has a roughly 60% chance of winning.

strategies for solving externalities 6: assigning ownership rights for common resource problems

Common resources: goods that are rival but non excludable

consequences of allowing imports

Competition from foreign sellers causes the price of goods imported to fall, buyers respond by raising the quantity they demand while sellers respond by reducing the quantity they supply with imports filling the difference, lower price increases the consumer surplus of buyers and decreases the producer surplus of sellers, because buyers amplify their gains and sellers minimize their losses, the net effect is to boost total economic surplus

strategy 2 to solving externalities: corrective taxes and subsidies

Corrective taxes: a tax designed to induce people to take account of the negative externalities they cause. Imposing a per unit tax equal to the marginal external cost will lead people to make choices as if they're accounting for the marginal external costs of their actions. On the other hand, imposing a marginal external cost leads suppliers to make choices based on their new marginal cost which coincides with the marginal social cost. Corrective subsidies can fix positive externalities: a subsidy designed to induce people to take account of the positive externalities they cause. E.g. insurance companies subsidizing your purchase of an alarm system. A subsidy can act as the incentive spurring people to do more of an action that has positive externalities. Lawsuits, norms, and social sanctions are like corrective taxes. The threat of a lawsuit provides an incentive for people to consider the consequences of their actions on bystanders, thereby internalizing the externality. Damages t

labor shifter 1: changes in demand for product

Demand for labor is not based on the desire to consume labor. Instead, it's a result of the demand that your customers have for the end result of your workers' efforts.

determining comparative advantage

Determine how long each task would take each person, measuring the cost of producing each good in hours Convert this into a measure of opportunity cost by calculating how much of the alternative good you could have produced in that time Evaluate who has a comparative advantage at each task by assessing who can produce each good at the lowest opportunity cost

evaluating how imports shape domestic markets

Determine new price: when you buy goods abroad, you have new options to consider. For traded goods, the price is equal to the world price Determine quantities demanded and supplied by domestic buyers and sellers at the new price: consult the domestic demand and domestic supply curves. Assess the quantity that will be traded: international trade makes up the gap between the quantity demanded by domestic buyers and the quantity supplied by domestic sellers.

effects of adding a tariff

Find out the new price. Determine the world price plus the tariff. Determine the quantities demanded and supplied by domestic buyers and sellers at this new price using the domestic supply and demand curves Assess the quantity that will be traded. Recall that imports make up the gap between the quantities demanded and supplied. Because this gap shrinks, imports fall.

price as an incentive

High prices are incentives for buyers to cut back, just as it's an incentive for suppliers to expand production and vice versa. For suppliers, higher prices incentivize increased production, people changing careers, and innovation. For potential buyers, a high price raises the opportunity cost and creates an incentive to consume less. Price also provides an incentive for strangers to cooperate.

labor shifter 3: better management and productivity gains

Improved management and technological changes that increase the productivity of labor mean that each worker can produce more per week. Since labor demand = marginal revenue product of workers, an increase in workers' marginal product will increase your demand for labor as long as the price is unchanged. As each additional worker generates more revenue, you want to hire more.

insights to solving externalities

Insight 1: don't intervene if you don't need to. If they can, let people use private bargains to solve an externality problem. Insight 2: complementing market forces is better than hindering them Insight 3: the best tool depends on what you're uncertain about. Use corrective taxes/subsidies when you know the marginal external costs or benefits, but use cap and trade when you're more confident about the socially optimal quantity Insight 4: consider costs and benefits of regulations or public goods Insight 5: target outcomes, not specific processes Insight 6: ensure there's an incentive to innovate

labor shifter 4: non wage benefits, subsidies, and taxes

Many workers receive health insurance, retirement benefits, paid days off, and other benefits. Employers often have to pay taxes for each worker. Also, some government programs provide subsidies/tax cuts when they hire more workers. If any of these costs change, the labor demand curve shifts

price as a message

Price acts as a messenger communicating the sharp increase in demand. A skyrocketing price creates a communication line between buyers and sellers. A price tells potential suppliers how much buyers value their products because it reveals the buyer's marginal benefit or WTP. Price also tells potential buyers about how expensive it is for sellers to produce more of a product as it reveals the seller's marginal cost. If the price rises, buyers perceive that the product is more scarce. Prices make global coordination possible.

effects of a wage increase

Raises the marginal benefit of working another hour (substitution effect) Raises the marginal benefit of an extra hour of leisure (income effect) work against each other

why market labor supply curves are upward sloping

Reason 1: new people may be induced to join the workforce rather than pursue alternatives Reason 2: existing workers may put in more hours. As wages go up, people already working in that occupation may increase the number of hours they work. However, the effect is small because while higher wages provide a greater incentive to work (substitution), they also increase the demand for leisure (income). Reason 3: some people may switch occupations

labor supply shifts

Shifter 1: changing wages in other occupations Shifter 2: changing the number of potential workers. When the population grows, so does the potential labor supply. Age distribution also matters. As age shifts toward retirement age, the labor supply curve shifts left Shifter 3: changing benefits of not working. E.g. a government program making college more affordable leads to a decrease in labor supply among young workers. E.g. a decrease in the cost of child care will increase the labor supply of parents. Shifter 4: non wage benefits, subsidies, and income taxes. These depend on whether the income or substitution effect dominates. Increase in benefits or subsidies or an decrease in income taxes leads to an increase in labor supply → rightward shift Decrease in non wage benefits, decrease in subsidies, or an increase in income taxes causes a decrease in the labor supply → leftward shift

analyzing the labor market

Step 1: determine which curve is shifting: labor supply, labor demand, or both. Labor demand is about marginal revenue. Anything that shifts the productivity of workers or the value of their output shifts labor demand Labor supply is about opportunity costs. Step 2: determine if the shift is an increase or a decrease Step 3: determine how wages and the number of jobs will change in the new equilibrium

four steps to analyze externalities

Step 1: predict the equilibrium quantity to forecast what could happen Step 2: assess what externalities are involved Step 3: find the socially optimal quantity in society's best interest Step 4: compare your forecast of the equilibrium quantity with the socially optimal quantity

strategy 5 for solving externalities: government supports public goods

The government purchases public goods for everyone to use paid for from tax revenues.

when domestic sellers export goods

The price rises to the world price, the higher price leads to a higher quantity supplied by domestic sellers but a lower quantity demanded by domestic buyers, exports fill the gap between the quantity supplied and quantity demanded

signal

a costly action that you take to credibly convey information that would otherwise be hard for someone else to verify

rival good

a good for which your use of it comes at someone else's expense. E.g. eating a cookie on the table. Free rider problem is never an issue. Businesses can easily exclude those who don't pay from benefiting from their goods.

club good

a good that is excludable but nonrival in consumption. Businesses try to turn public goods into club goods. The ability to keep out non paying customers means that they can now force people to pay to join the "club" of customers.

efficiency wage

a higher wage paid to encourage greater worker productivity by increasing worker effort and reducing worker turnover

economic efficiency

a market outcome in which the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production and in which the sum of consumer surplus and producer surplus is at a maximum

public good

a nonrival good that is nonexcludable and subject to the free rider problem. E.g. the military. Markets underproduce public goods. Just because the government provides it doesn't mean that it is a public good. Just because something is a public good doesn't mean that the government should fund it. Policymakers apply the cost-benefit principle when making public investments. Just because the government should fund a public good doesn't mean that the government should provide it

externality

a side effect on bystanders whose interests aren't fully taken into account

compensating differential

a wage required to offset the undesirable aspects of a job. It's compensating because it compensates you for certain attributes of a job and it's a differential because it leads people with similar human capital to earn different wages Jobs with undesirable attributes pay more Jobs with desirable attributes pay less Compensating differentials depend on the preferences of other workers.

producer surplus on a graph

area above the supply curve, below the price, out to the quantity

total consumer surplus on a graph

area below the demand curve, above the price, out to quantity sold

fair trade advocates

argue that we should pay higher prices for imports to ensure a reasonable standard of living for the workers involved and include minimum labor standards as a part of new trade agreements. It's likely that the higher prices for fair-trade goods would reduce quantity demanded which would destroy the jobs of the people they aim to help.

internal prediction markets

can improve forecasts by allowing employees to bet on the outcome which yields more estimate forecasts.

exchange rate manipulatuion

changes the price of goods in foreign markets

economic surplus equation

consumer surplus + producer surplus (marginal benefit - price) + (price - marginal cost) area between the demand and supply curves

substitution effect

counters the scale effect. There are many tasks that can be done by either workers or machines. When the price of a machine falls, the demand for workers to do tasks decreases. If substitution effect dominates, labor and capital are substitutes

substitution effect with labor

describes how people respond to a change in relative prices. Says that the higher wages make work relatively more attractive. When your wage goes up, the opportunity cost of an hour of leisure goes up. Leisure becomes more expensive. If this is dominant, individual labor supply curve is upward-sloping

income effect

describes how people's choices change when they have more income. Since leisure is a normal good, a rise in income means an increase in the marginal benefit of leisure. (demand curve = marginal benefit curve). Therefore, a higher wage which boosts workers' incomes will lead them to choose more leisure which means working fewer hours. If this is dominant, then individual labor supply curve may be downward sloping When your hourly wage rate rises, you don't need to work as many hours to buy the things you were purchasing before. Rather than spending the pay increase buying more items, you may spend it buying more leisure time.

deadweight loss

difference between the largest possible economic surplus and the actual level of economic surplus Deadweight loss = economic surplus at efficient quantity - actual economic surplus. Looks like an arrowhead pointed toward the efficient quantity

critiques of economic efficiency

distribution matters, WTP reflects ability to pay, not just MC, and the means matter.

Voluntary exchange

ensures that both buyer and seller enjoy gains from trade. As a buyer follows the cost-benefit principle, they will buy a pair of jeans if the marginal benefit is at least as large as the price they pay. They will only buy something if it yields consumer surplus. Likewise, a supplier following the cost-benefit principle will sell jeans if the price is at least as large as their marginal cost. They will only produce if they expect to gain producer surplus.

labor demand

equal to the marginal revenue product of labor. The labor demand curve = marginal revenue product curve The curve is downward-sloping because of diminishing marginal product.

marginal private cost curve

equal to the supply curve

strategy 4 for solving externalities: laws, rules, and regulations

exist to help solve problems caused by negative externalities Workplace rules also target externalities. E.g. banning intra-office dating, requiring antivirus software, and requirements to work in the office. Rules often lead to better outcomes, but they can also blunt the forces of competition

marginal external benefit

extra benefit enjoyed by bystanders.

marginal private benefit

extra benefit enjoyed by the buyer from one extra unit. Equal to the demand curve

trade costs

extra costs aside from the price that are incurred as a result of buying or selling goods internationally rather than domestically. E.g. shipping costs. They are not just financial out-of-pocket expenses, but also shipping delays, language barriers, time zones, foreign laws, etc. Cost benefit principle says that you should only import a good if the foreign price offsets the associated trade costs. Only export a good if the price you'll get exceeds the local price enough to offset the export-related trade costs They limit how important international trade is in the sector. If a product has high trade costs, then it's unlikely that importing/exporting the goods will pass the cost-benefit test and vice versa.

marginal benefit

extra revenue you will earn

world trade organization

facilitates global agreements to reduce trade barriers through more favored nation status (requires member nations to treat all members equally-at least as well as the most favored nation.) and national treatment principle (imported goods and locally produced goods must be treated equally once they've entered a country)

producer surplus

gaining economic surplus from selling something at a higher price than the marginal cost. price - marginal cost

import quotas

have similar effects to tariffs but don't raise revenue

rational rule for employers

hire an additional worker if their marginal revenue is greater than (or equal to) the wage

MF4: irrationality

if buyers don't follow the Rational Rule for Buyers, their demand decisions may no longer reflect their marginal benefits, so efficient allocation is unlikely. If suppliers don't follow the same rule, their supply decisions may not be driven by their marginal costs, so efficient production is unlikely

strategy 3 for solving externalities: cap and trade

involves changing the quantity of the harmful activity directly by imposing a quantity regulation. The system works by raising the opportunity cost: if you emit pollution, you'll need to use one of your permits rather than selling that permit. The forgone revenue is an important opportunity cost like a corrective tax

MF1: market power undermines competitive pressures

market power arises when markets don't meet the perfectly competitive ideal of many sellers selling identical products. For example, most markets are dominated by only a handful of companies. Sellers exploit limited competition by charging higher prices, leading consumers to buy a smaller quantity. This results in underproduction as businesses with market power tend to produce less than the efficient quantity.

internal markets

markets that managers set up within their organization so that different divisions can buy and sell scarce resources to harness more power of market forces to help businesses grow and become more profitable

power of prices

message, incentive, aggregator

five counterarguments against trade restraints

national security is only relevant to a few industries, many infant industries don't grow up, it is difficult to determine if it's unfair competition or fierce competition, rich-country standards may not help poor countries, trade changes what workers do, but not how many people work.

intensive margin

number of hours each worker supplies-measuring how intensively existing workers supply labor

extensive margin

number of people in a workforce-measure of the extent of work

efficient allocation

occurs when goods are allocated to create the largest economic surplus from the allocation, which requires that each good goes to the person who gets the highest marginal benefit from it. Efficient allocation maximizes benefits.

market failure

occurs when the forces of supply and demand lead to an inefficient outcome.

efficient production

occurs when we produce a given level of output at the lowest possible cost. Efficient production minimizes cost.

nonrival

one person's enjoyment or use doesn't subtract from another person's enjoyment or use. free riders enjoy positive externalities without harming others

nonexcludable product

other people cannot easily be excluded from using it. E.g. beautiful architecture, clean breathing air, eradication of disease

MF3: Information problems undermine trust

private or hidden information can undermine trust, leading people to buy or sell less than the efficient quantity

rational rule for society

produce more of an item as long as its marginal social benefit is at least as large as the marginal social cost

five arguments for limiting international trade

protecting national security, helping infant industries, anti-dumping laws should prevent unfair competition, trade used to skirt regulations (enforcing minimum standards), saving jobs.

red tape

raises costs like a tariff but doesn't raise revenue

MF5: government

regulations and taxes can impede market forces

3 factors that shape comparative advantage

relatively abundant inputs, specialized skills, and benefits of mass production

positive externality

side effect that benefits bystanders. E.g. taking a vaccine or planting a tree

negative externality

side effect that harms bystanders like driving a car or standing up at a concert

strategy 1 to solving externalities: private bargaining

side payments, coase theorem (if people can bargain costlessly and legal rights are clear and enforced, externality problems can be solved by private bargaining), strategic investments, and mergers.

marginal social benefit

sum of the marginal private benefit and the marginal external benefit

tariffs

tax imported on goods that increase trade costs

tragedy of the commons

tendency to over consume a common resource. Occurs when rival goods are nonexcludable.

absolute advantage

the ability of one person to do a task using fewer inputs than someone else. Absolute advantage tells us who's best at the task, but not who should do the task. Solely focusing on absolute advantage ignores opportunity cost

comparative advantage

the ability to do a task at a lower opportunity cost. To get the most output with your given inputs, you should allocate each task to the person with the lowest opportunity cost. Comparative advantage is all about opportunity cost. Opportunity cost principle reminds us that the true cost of something is what you must give up to get it.

human capital

the accumulated knowledge and skills that make a worker more productive

derived demand

the demand for an input derives from the demand for the stuff that the input produces If the demand for what you sell increases. It leads the price of the product to rise → the marginal revenue product of all of your workers is higher. Marginal revenue product = marginal product x price

marginal external cost

the extra cost imposed on bystanders from producing one more unit

marginal private costs

the extra cost that the seller incurs to produce one more unit

marginal product of labor

the extra output you produce from hiring an extra worker Businesses experience diminishing marginal product

marginal cost of another worker

the increase in your business's costs due to hiring one more worker (the wage you pay that worker)

globalization

the increasing global integration of economies, cultures, political institutions, and ideas. As trade costs have declined, our lives have become increasingly connected.

marginal revenue product

the marginal product of labor multiplied by the price she can sell the output for.

marginal social cost

the sum of the marginal private costs paid by the seller and the marginal external costs borne by bystanders. lies above the supply curve with the wedge between them equal to the marginal external cost

labor supply

time spent working in the market. All about the marginal benefit of leisure

rational rule for markets

to increase economic surplus, produce more of an item if the marginal benefit of one more is greater than or equal to its marginal cost.

world demand

total quantity of a product demanded across all buyers in the world at each price

world supply

total quantity of a product produced by all manufacturers in the world at each price

government failure

when government policies lead to worse outcomes

scale effect

when the price of capital goods (or any inputs) declines, your business can produce output at a lower cost, so at a given price you will sell a larger quantity. You'll produce at a larger scale which may require more workers, increasing your business's labor demand If scale effect dominates, labor and capital are complements

consumer surplus

when you gain economic surplus from buying something in the role as a consumer. You receive this when you buy something for a cheaper price than the marginal benefit you get from it. marginal benefit - price

MF2: externalities create side effects

whenever the choices that buyers and sellers make have side effects on others, the problem of externalities arise. Generally, businesses tend to produce more than the efficient quantity of products with negative side effects (e.g. pollution.) Not all externalities are bad (e.g. getting a flu shot). However, they interfere with the ability of the market to produce the efficient quantity

social optimal quantity

where marginal social benefit = marginal social cost. the quantity most efficient for society as a whole taking into account all the costs and all the benefits of buyers, sellers, or bystanders. This means determining the quantity of goods will yield the largest possible economic surplus. Marginal principle: will society be better off if it produces one more gallon of gas? Cost-benefit principle: the benefit to society of producing one more gallon of gas is the marginal social benefit and the cost is the marginal social cost. Opportunity cost principle: marginal social cost is the marginal private cost plus the marginal external cost. Produce until marginal social benefit equals marginal social cost.

rational rule for workers

work one more hour as long as the wage is at least as large as the marginal benefit of another hour of leisure

efficient outcome

yields the largest possible economic surplus