Econ Exam Three: FINAL

Definition of Income and Wealth

1. Income is the flow of money earned by and individual during a period of time. Eg., week, month, or year. Income comes from "selling" labor, natural resources, or capital in the market for factors of production. 2. Wealth is the current stock of money and other valuable assets net of debt that has been accumulated by an individual to a particular point in time. Wealth comes from saving, capital gains, and debt retirement

Solutions to the Externality Problem

1.) Private Solutions Private Solutions are also known as Market Solutions or Coasian Solutions, after Prof. Ronald Coase. Coasian Soultion: involves clearly and fully define the property rights; make individuals pay compensation if they infringe upon the property rights of others; and allow parties to negotiate with one another regarding infringements upon property rights cause by externalities Consist of better property rights that let people bargain toward the social equilibrium. Eg., homeowners associations, privatizing common property, etc. 2.) Public Solutions Public Solutions are also known as governmental solutions. 1.Command and Control e.g., direct regulation 2. Govt. Sponsored Market Solutions: A. Taxes and Subsidies B.Cap and Trade

Of the following list of factors that affect income, which one does a person not have control over?

Business Cycle downturn

Externality Problem

Externalities are situations where third parties to a market transaction are affected by the activities of others. Negative Externality: Third party - negatively affected by others - Not compensated Eg., pollution Positive Externality: positive externalities are what not only benefit a company but benefit society as a whole Third party - positively affected by others - Does not pay (free-rides) Eg., flue vaccine

Gini Coefficient

The Gini Coefficient is a numerical measure of income inequality defined as the ration of the lens shaped area between the Lorenz Curve and the 45-degree line to the entire area below the 45-degree line. It is the ratio of the area inside the Lorenz Curve to the area of the blue bounded triangle. The Gini Coefficient runs from 0 to 1, with 0 = perfect income equality and 1 = perfect income inequality

Which of the following factors that affect a person's income is under the control of the individual:

degree of studiousness at school

The War on Poverty:

was started by President Johnson in the mid 1960's. He got legislation passed to create government programs with the intention to help the poor escape poverty.

List of Market Failures

1.) Problem of "Market Power" or Monopoly: - Monopoly refers to a market structure in which there is a single seller of a unique good for which there are no close substitutes - Market Power refers to a firm's ability to charge more than the competitive market price for a good or service. A. Some firms have none. Eg., farmers selling a standardized product like wheat, corn, cotton, etc. No firm can charge more than the market price. B. Some firms have a little. Eg., branded gas stations charge more for gas than discount gas stations. C. Some firms have a lot. Eg., a Monopoly like the electric power company or water utility Pricing under Monopoly: Firm reduces output below market level in order to create the ability to raise price 2.) Problem of Public Goods and Common Property 3.Problem of Market generated Externalities 4. Problem of lack of information . How easy is it to gain a monopoly in a capitalist system? A. Resource based B. Technology based C. Politically based 2. What do we do about monopoly if one arises? A. Anti-trust Law B. Government ownership and provision C. Price Regulation D. Do nothing, and let market solve over the long-run

7 Most Common Specific Government "Failures"

1.Informational Problems 2.Cost of Compliance Problems 3.Corruption or Kleptocracy - 'Corruption' present if regulations are not enforced and decisions are not made evenly and without bias - 'Kleptocracy' is when corruption becomes so pervasive that government officals unabashedly seek personal gain at the expense of the public interest 4.Regulatory Capture: a situation in which firms in a regulared industry influence a regulatory agency to the point where the agency enacts policies that are in the best interest of the regulated firms, even if the policies are not in the best interest of the general public 5.Rent Seeking: refers to attempts by people to manipulate government action of influence government decisions in order to make themselves better off at the expense of others 6.Logrolling and Rational Ignorance: - 'Logrolling' refers to a process of vote trading in which an individual agrees to vote in favor of one proposal in exchange for favorable votes from others on different proposals - 'Rational Ignorance' in a representative democracy, becoming informed on matters of public policy has high costs and low benefits to individual voters, it is rational for them to remain ignorant and uninformed Deadweight loss of Taxation - 'Per Unit Tax' a requirement for a fixes dollar amount to be paid to the government for each unit of a good traded - A Per Unit Tax Legally Imposed on Sellers - In practice most per unit taxes are imposed on sellers, meaning that sellers are the ones legally responsible for paying the tax. Ex.) the imposition of a $1 per unit tax on sellers in the market - A Per Unit Tax Legally Imposed on Buyers - What is this $1 per unit tax were intead leggaly imposed on buyers? - indidence of a tax: a measure of who bears the burden of the tax in terms of decreased economic surplus

Government Failure due to Deadweight Loss from Taxes

A Deadweight loss is a loss to one party without simultaneously being a gain to another party. A deadweight loss is imposed whenever taxes are imposed because they reduce the size of the market for the good taxed. Eg., suppose we put a $1 tax per slice of pizza in order to fund a government program. Original P = $3.50 and Q = 10,000 New P = $4.15 and Q = 5,750 due to tax

Economic Arguments For and Against Redistribution

A.For Redistribution: Overcoming the Free Rider Problem A final argument in favor of government redistribution is that having the government mandate redistribution in this manner essentially allows members of society to overcome a free rider problem. Assume everyone agreed that reducing poverty is a good thing. Would enough people contribute to charity to eliminate poverty? If I don't contribute, but you do, I can free ride on your contribution. If everyone took this attitude, not enough contributions. Eg., pledge breaks on PBS. B.Against Redistribution: Disincentive Effects of Redistribution If the government redistributes too much from higher income to lower income then the incentive to work hard and study hard are diminished, leading to lower overall levels of productivity and income.

Cost of Compliance with Government Bureaucracy

All government bureaucracies impose costs on citizens in carrying out their mandates. Some governments impose extraordinarily high costs. Eg. Cost of starting a business: 1. in New Zeeland: a. there is only one procedure b. it takes half a day to complete c. It costs 0.3% of annual per capita income 2. in Venezuela: a. There are 17 procedures b. It takes 144 days to complete c. It costs 88.7% of the annual per capita income As an exercise, go back to table 3.5 on page 61 to compare countries

Utilitarian Income Redistribution

Argument for Utilitarian Redistribution of Income: 1. Diminishing Marginal Benefit of Income As income rises, total benefit rises, but at a diminishing rate. Eg., eating oysters Numerical example: Joe Poor goes from $10,000 to $11,000 in income when Richie Rich goes from $100,000 to $101,000. Who gets more benefit from the extra $1,000? 2. Redistribution increases the sum total of benefit or happiness. If govt. transfers $5,000 from Richie to Joe, will the net benefit rise? Why? Problems: Interpersonal comparisons of Utility: is it possible?

Example of Positive Externality

Assume that the use of flue vaccines by buyers reduces the flue for third parties as well. 1.Market price and output are determined by demand and supply, or private benefit and private cost at market equilibrium. 2.The benefit to the third parties from the private expenditure of others is an external benefit, or a positive externality. 3.The true value of flue vaccine is the Social Benefit which is equal to Private Benefit + External Benefit. 4.Society should produce more vaccine, even though costs are higher. Government needs to subsidize the extra vaccine.

Example of Negative Externality

Assume that the use of gasoline by drivers causes smog pollution that causes respiratory problems in the population. 1.Market price and output are determined by demand and supply, or private benefit and private cost at market equilibrium. 2.The cost in respiratory problems is not paid for by neither drivers nor gasoline suppliers, making it an external cost, or a negative externality. 3.The true cost of gasoline is the Social Cost which is equal to Private Cost + External Cost 4.Society should produce less gasoline at higher prices.

Rawlsian Income Redistribution (cont.)

Chart on 12.2 Slide 6: According to Rawls, which set of laws or institutions, A or B, would everyone pick if they were behind the "veil-of-ignorance"? (remember, random assignment) Which would you pick? Is Rawls right? Which would a Utilitarian choose?

EXCLUDABLE VS NON-EXCLUDABLE GOOD

Excludable: a good is this if it is easy for a provider to prevent consumption by those who do not pay, whereas a good is non-excusable if it difficult (or very costly) to prevent consumption

Public Goods Problem

Goods can be classified as either: 1.) Private Goods: refers to a good that is rival and excludable Goods that are: - Rival in Consumption -Excludable Eg. Cars, houses, clothing, food, health care, etc. Production is just right! 2.) Public Goods: refers to a good that is non-rival and non-excusable Goods that are: - Non-rival in Consumption - Non-Excludable Eg., light house, tornado siren, missile defense, etc. Problem is underproduction by private parties 3.) Common Goods, or Common Property: Common Goods: is an interesting hybrid good that is simultaneously rival and non-excludable, sharing one characteristic each with both a private good and a public good Goods that are: - Rival in Consumption - Non-Excludable Eg., rivers, oceans, the atmosphere (air), etc. Problem is overconsumption by private parties

Government Failure due to Corruption or Kleptocracy

Government Corruption refers to government officials deliberately making the "wrong" decision in order to get bribes or other forms of compensation. Eg., Two qualified road building firms are competing to widen Interstate I-75. Contactor A submits a bid of $20,000,000 and contractor B submits a bid of $23,000,000. Economic Efficiency (and morality!) requires that the government award the contract to contractor A. In many countries government officials will grant the contract to contractor B in return for a bribe. Bribes can be initiated by either the contractor or the government official. If bribe taking becomes the norm, the country is a Kleptocracy.

Concept of Government Failure

Government Failure exists when a government fails to generate a "perfect" economic outcome. This is also known as being economically inefficient. Situation in which "Total Social Surplus" is decreased by government intervention in a market. Definition of a "Perfect Outcome" 1. Productive Efficiency Whatever Government is producing, it is doing it for the lowest possible cost (is the govt. doing things well?) The concept that whatever we are producing is being produced at the lowest possible cost with the least amount of waste 2. Allocative Efficiency Government produces only those goods that people value more than it costs to produce them (is the govt. doing the right things?) The concept that we are allocating our scarce resources to the production of goods that are most highly valued

What does it mean to be poor today?

Graph on 12.1 Slide 7

Moral Argument Against Redistribution: Libertarian Justice

Libertarian Justice, also known as Natural Rights, posits that the distribution of income is morally irrelevant, as long as the procedures for distribution are morally just. Argues that the fairest distribution of income and consumption is that which results when he government established and enforces a legal code which respects all voluntary economic interactions between individuals in society 1. Property Rights 2. Contracts Government should do nothing more than act as "referee", and punish those who violate property rights and contracts. Eg., Since some students are born smarter than others, and/or have better and richer parents who made school a priority, should Mr. Patrono re-arrange the grades to get a "fairer" distribution?

Government Failure due to Logrolling and Rational Ignorance

Logrolling refers to a process of vote trading between representatives in a political system. In logrolling: a. Rep. A votes for a project that Rep. B is in favor of even though it hurts the constituents of Rep. A b. In return, Rep. B votes for a project favored by Rep. A, even though it hurts the constituents of Rep. B Requires Rational Ignorance for this process to work. Rational Ignorance is ignorance among voters as to what their representatives are doing, and the voter is rational for being ignorant. due to costs of information being higher than benefit of information. One voter cannot remove bad representative.

Concept of Market Failure

Market Failure exists when a market system fails to generate a "perfect" outcome. This is also known as being economically inefficient. "Market Failure" refers to situations in which the free market outcome is inefficient, in that there is a positive Dead weight Loss at the free market level of trade (the level of trade that emerges from the interaction of self-interested buyers and sellers) Definition of a "Perfect Outcome" 1. Productive Efficiency Whatever firms are producing, they are doing it for the lowest possible cost in resources 2. Allocative Efficiency Firms produce only those goods that people value more than it costs to produce them if 1 & 2 are done PERFECTLY then you are efficient. Even a tiny mistake (99/100) would qualify as inefficient

Poverty Rate in the U.S.

Poverty is the condition of having very limited access to goods and services. A person (or household) in poverty does not have enough income to pay for necessities, such as food, clothing, shelter, etc. It is usually defined as having an income below the Poverty Threshold, or minimum amount of income necessary to escape poverty. In 2015, in the U.S., the Poverty Threshold was $24,036 for a family of 4. The Poverty Rate is the percentage of the population that has an income so low that they are categorized as being in poverty Poverty thresholds: based on the number of and the ages of individuals in the households defined as income levels below which the household is deemed to be living in poverty. Poverty Rate: refers to the percentage of the population living below the poverty line

Public Goods Problem (cont.)

Private markets cannot provide Public Goods due to Free-Rider problem caused by non-excludability: A Free-Rider consumes the good but does not pay since: - He is self-interested - the good is non-excludable Can markets provide schools, hospitals, interstate highways, private security, etc.? Can markets provide national defense, tornado sirens, general policing, flood control dams and levees? Can markets provide the correct amount of fishing on a fishing ground?

Public Choice Model of Voting

Public Choice is the subfield of economics that studies issues dealing with government. Normally these are addressed in Political Science. The academic sub-field which uses the tools and framework of economics to analyze issues that historically fall within the domain of political science. Problem: Does the voting process always lead to rational decisions in a democracy? Condorcet Paradox: A series of pair-wise majority votes over more than two options leads to a cycling of winners. See the opening example of Hillary, Ted, and Donald running for President. It is possible in runoff elections for: Hillary to be preferred to Donald, Ted to be preferred to Hillary, and then have Donald preferred to Ted. This leads to no clear rational choice to make a social decision.

Social Justice Argument for Redistribution: Rawlsian Justice

Rawlsian Justice (named for Philosopher John Rawls) is a version of the Social Contract Theory of Justice, which claims that each individual has entered into a contract (implicitly) with the other members of society in order to create civilized life. In this contract we surrender some of our natural rights in order to gain the benefits of civilization. It is a second argument for redistribution built upon Rawl's book "A Theory of Justice" in 1971. It argues that the morally best distribution of society's income is the one which maximizes the well-being of the worse-off member of society. Rawlsian Justice is based on the concept of the veil-of-ignorance, wherein we do not know if we are going to be born rich or poor, gifted or slow, etc. If we were to make a social contract before we were born, would we all agree to have redistribution from the rich to the poor? The Maximin Criterion says yes. Due to risk-aversion, rational, self-interested people would vote to make sure that the worst possible outcome would not happen to them.

Arguments for and Against Coercive Redistribution

Redistribution: refers to policies designed to alter the levels of income or consumption of households within a society (usually from rich to poor). It also refers to government policies to alter the distribution of income, usually by transferring income from rich to poor. When done through the government this redistribution is non-voluntary, or coercive. Moral Arguments for Redistribution: Social Justice: 1. Utilitarian Justice 2. Rawlsian Justice 3. Labor Theory of Value Moral Arguments Against Redistribution: Natural Rights: 1. Libertarian Justice or Property Rights

Poverty Trap

Reducing incentive for the individual to take the initiative in earning their own income. Ex.) Welfare Abuse

Government Failure due to Rent Seeking

Rent Seeking is the attempt by people to manipulate the government in such a way that they collect more than competitive levels of income. This extra income comes at the expense of others. Eg. California wine growers convince Congress to pass a tariff of $10 per bottle against French wine. a. This artificially benefits the California wineries because they can now sell more wine at higher prices (without having to improve the quality of their wine) since the French now have an extra burden in the market. b. This benefit comes at the expense of wine drinkers across the country.

Rival vs. Non-Rival

Rival: if consumption by one person diminishes the quantity of the good available for others to consume Non-Rival: if consumption by one person does not diminish the quantity of the good available for others to consume.

Social Justice Argument for Redistribution: The Labor Theory of Value

The Labor Theory of Value (from Karl Marx)*posits that the entire value of a good that is sold in a market system is due to the labor used in production. Therefore, neither Capitalists nor land owners have any moral right to benefit from the production of their workers. It is an assesment of the production process which attributes all economic surplus generated from production to labor. Under this mindset, the value of a produced good is measured by the amount of labor used to produce the good. Redistribution is not only morally ok, but is mandatory in a just society. Is Marx correct that the Capitalist and the land owner contribute nothing to production and therefore have no right to benefit from it? Should all income from production be transferred to the workers?

Measuring Income Inequality

The Lorenz Curve: developed by economist Max Lorenz graphically illustrates income inequality within a society by focusing on every larger segments of the population and plotting the relation between the cumulative fraction of the population (with people ordered from lowest income to highest) and their cumulative fraction of total income earned. Measures the cumulative percentage of a group's income as fraction of the population. The more "bowed out" the curve, the more income inequality

Informational Problems

To make an economically efficient choice the decision maker must know the true marginal cost and marginal benefit of a decision. 1. In Private Markets this information is revealed by the participants 2. In Government this information is often distorted or unavailable. Eg. What is the right number of miles of interstate highways? What is the right number of places in college for students? What is the right level of pollution control in Atlanta? What is the right level of noise control at the Atlanta Airport? Ludwig Von Mises and the Economic Calculation Problem: posits that a system of planning can never achieve efficient outcomes precisely because the planners do not have the information generated by market transactions available to them.

Redistribution Policies

Two Classes of Redistribution Policies: Redistribution in-kind & Income Support Redistribution in-kind: Government transfers a good or service to the poor to increase their wellbeing, rather than give them income. (Also cash transfer with restrictions). A transfer of a good or service to someone which directly increases their consumption of the item. Eg., food stamps, WIC, In-State Tuition, Grady Hospital, Medicare, etc. Income Support: Government transfers money income to the poor and lets the poor make their own decisions about how to spend the money to increase well-being. Refers to the transfer of money to someone which indirectly increases their consumption of goods and services. Eg., Social Security, Earned Income Tax Credit, Negative Income Tax, Guaranteed Minimum Income, Unemployment Compensation, etc.

Social Justice Argument for Redistribution: Utilitarian Justice

Utilitarian Justice: is an argument in favor of redistribution, which posits that total social welfare can be increased by transferring income/wealth from the rich to the poor, so lonf as people have a diminishing marginal utility for money. It is the notion that the morally best outcome is the one which maximizes a society's overall utility or well-being. It is derived from the philosophy of Utilitarianism. Utilitarianism is a moral principle that it is the duty of society to maximize the sum total of utility for all members of society. Utility is the benefit a person receives from a good or service. (so, maximize benefits on net for everyone) Utilitarianism is a consequentialist theory, which judges rightness or wrongness based only the consequences of actions, not on an inherent quality. 1. If the sum of all the consequences for all the population nets out positive, it is a good and moral thing, and justice demands that it be done. 2. If the sum of all the consequences for all the population nets out negative, it is a bad and immoral thing, and justice demands that it be prohibited.

Determinants of Income and Wealth in a Market Economy

Wealth refers to the current stock of money and otehr valuable assets that an individual owns at a point in time. Income refers to the flow of money earned by an individual during a period of time. Income is determined by economic productivity Personal Determinants of Productivity: 1.Natural Talent and Ability 2.Acquired Skills 3.Effort 4.Location 5.Inheritance 6.Health Market Based Determinants of Productivity 1.Market Supply and Demand 2.Compensating Differentials: refers to the differences in labor market wage rates that are due to differences in working conditions. Such differences can work in either direction 3.Technological Change 4.Immigration 5.Luck

An example of a positive externality is a situation where:

a factory hires an engineering firm to help it reduce its fuel consumption in order to save money. In the process the neighbors get cleaner air.

Rawlsian Justice refers to:

a form of Social Contract Theory which states that the government has a contract with each person not to interfere with them when they are following normal laws of property rights and contracts.

Utilitarian Justice refers to:

a moral philosophy which states that society is morally obligated to maximize the sum of each person's utility or benefit, or in other words, to maximize the benefit to all of society.

An example of a negative externality is a situation where:

a nightclub opens near a residential neighborhood. The neighborhood suffers from noise at late hours, but is not compensated by the club owner.

Whether the current degree of income inequality in the U.S. is right or wrong is:

a normative question since we have to address this issue using moral principles of fairness.

When comparing societies, it is always best to be in one with a lower degree of income inequality. This is:

a normative statement, but cannot be proved to be true scientifically.

Guaranteed Minimum Income

a program which would provide each person in society with a large lump-sum payment every period.

a light house is an example of:

a public good because if one boat sees the light it does not reduce the ability of other boats to see the light, and there is no way for a lighthouse owner to turn off the light for a non-payer but still leave it on for those who do pay.

Market Failure is:

a situation where a market outcome is economically inefficient due to productive or allocative inefficiency.

Means Tested

a testing to determine eligibility for receiving benefits the recipient must have an income below a certain level

an externality in Economics is a situation where:

a third party is being affected by the market activity of others, and either does npt pay for benefits received nor is compensated for harms suffered.

By one measure, the poor are doing:

better economically today. When we measure ownership rates of televisions, air conditioning, and washing machines, for instance, we find that the poor in 1997 had a higher ownership rate than did the average of the U.S. population did in 1950.

As concepts, Income and wealth:

differ in that income is a flow of money while wealth is a stock of valuable assets (including money).

Income Redistribution refers to:

government programs that are designed to transfer income from wealthier people to poorer people.

Free Rider Problem

if a public good were provided in a free market, the amount traded would be less than the efficient quantity, since many people would attempt to enjoy the benefits of units purchased by others, while not purchasing any units themselves.

Under the Anti-Trust laws of the United States:

it is illegal for a private firm to have a monopoly without government permission.

When a firm is able to become a monopoly:

it will tend to charge a higher price and produce a lower quantity than would a competitive market.

If a country's Lorenz Curve fell on the 45* line:

it would mean the country's income was distributed equally across the population.

Which of the following items does not represent a market failure?

market price and output in a competitive market.

Voters tend to support redistribution to the "deserving" poor, which:

means transferring through income support programs only. The undeserving poor get their redistribution through in-kind programs where their consumption can be more closely monitored.

In a monopoly

one firm controls the supply of a good and has a lot of market power.

Positive Externality

or, external benefit, refers to a gain realized by someone other than the buyer or seller of a good.

Negative Externality

or, external cost, refers to a burden borne by someone other than the buyer or seller of a good.

We have two different goods. When one of the goods is characterized as a public good and the other as a common good:

private firms will under-produce the former and over-utilize the latter.

Fish raised on a catfish farm are:

private goods since the catfish are rival in consumption and private property rights give the farmer who owns the pond the right to restrict access.

Marginal Revenue

refers to the amount by which revenue changes as the firm's quantity of output is increased by a unit and marginal costs of production refers to the amount by which production costs change as the firm's quantity of output is increased by a unit.

Using Mean Household Income for the decades from 1974 to 2014, we find:

that every fifth of the population except the lowest fifth has had an increase in real household income over the period.

The poverty threshold is:

the amount of money a family needs to earn to just escape being in poverty by the government's definition.

One economic argument against government redistributing income from rich to poor is:

the free-rider problem in funding, which states that when the government offers welfare, individuals free-ride on the program.

When the production of a good generates a negative externality:

the government could increase economic efficiency by taxing the good producing of the negative externality.

Whenever a negative externality exists in the production of a good:

we expect that the firms will produce too much of the good at too low a price compared to the economically efficient amounts.