EC10a Final

Match-specific surplus (Institutional Labor Model)

- $50000: Least worker will accept - $60000: Most firm will pay - The $10000 in between will be split amongst the two depending on relative bargaining power - Wedge between the two because it costs the firm to pass on the worker and it costs the worker to find a new job - Results in a match-specific surplus the two divide

Minimum wage in monopsony model

- A higher wage increases the amount of labor supplied - Employers make a smaller profit, but is still below their VMPL so they are willing to hire people at that level - But, if minimum wage exceeds market clearing wage, employment losses

Argument for a tax rate below the Laffer peak

- A person who contribute more to society deserves a higher income that reflects those greater contributions - Income is rightfully his

Monopsony Model

- A single buyer of a product (in case of labor markets, a company town with one employer) - IE: town in America with only one hospital, so nurses have one choice More generally think about monopsony: - Hard to find out about job - Costly to integrate into a new job - Potentially small number of employers hiring - Every job is different - Every worker is different - The MC curve is 2x as steep as the supply curve - VMPL/D intersection with MC down to S =.the lowest wage possible, as it is below VMPL - VMPL/D intersection with MC = the quantity of labor determined by setting MC = VMPL (the most the employer is WTP) - Past this point, even though VMPL > Wage, you will not hire more people because it will drive the wages up - All the points in the triangle created to the left of S and VMPL intersection are above what a worker needs to work and less than what an employee is willing to pay - Employer surplus is above wage to intersection of VMPL/D = MC - Emp

Statistical discrimination (models of labor market discrimination)

- Accurate on average - Occurs when employers use an observable variable (such as race or gender) to help determine whether the person will be a good employe. It occurs when expectations cause people to discriminate against a certain group- may be conscious or unconscious - IE: An employer might expect that a woman in her twenties will be more likely to leave work to have a child than a man (accurate on average because woman in her 20s is more likely to get pregnant that a man in his 60s) - May reflect a self-fulfilling prophecy - Statistical discrimination can increase profits if an employer is implicitly or explicitly using a predictive statistical model - Would not expect the market to eliminate statistical discrimination. It is illegal under employment law, whether or not it is accurate, but it is hard to detect

Signaling

- Actions taken by someone who has private information to convince others about their information - A doctor displays their Harvard Medical School diploma in their office waiting room

Different constraints firms face

- All firms try to optimize, whether in perfect competition or monopoly. Optimal behavior depends on what market allows them to do: - Perfect competition: firms would like to sell their goods at a higher price but they can't - Monopoly: choose price (which results in a quantity) or quantity (which results in a price) but still faces a constraint, as it cannot sell an unlimited quantity at an unlimited price

Competitive model (inequality & SBTC)

- An innovation that raises the demand for skilled workers - D shifts to right due to skill-biased technological change and wages increase - Now there is more inequality because you have a greater increase in the return to skills - Workers are paid their VMPL and inequality is the natural result of differences in skill - Education policy can affect market wages - Tax/transfer can change post market incomes Cannot be the entire story: - Inequality fell in past despite technology complementing skills - Technological trends same in different countries, but inequality varies (IE: France had narrowing college premium, but similar technology) - Cannot test empirically

Lead as a determinant of crime

- Analyzing trends in lead pollution and assault rates in Chicago, found that children exposed to lead are more likely to develop behavioral issues that might lead them to commit crime - Decrease in lead correlates with decrease in aggravated assault years later

Competition policy

- Antitrust should protect competition, not competitors - Assessed using the consumer welfare standard → in theory corresponds to maximizing consumer surplus rather than social surplus - Includes: price (& quantity), variety, quality, and innovation (which improves all of this) - Can be difficult to balance pro-competitive benefits and anti-competitive harms - IE: McDonalds causes other restaurants to innovate better food, but it also causes all the small restaurants to close Strive to avoid two types of errors: 1. Underenforcement, where anti-competitive harms are not stopped 2. Overenforcement, which inadvertently stops competitive benefits

US Taxes in a historical perspective

- Around 35% of GDP goes towards taxes, with roughly 20% of that being federal taxes - This is lower than most other first world countries

The Black-white pay gap (mechanical decompositions and their interpretations)

- As education level rises, the wage gap between Black and white people increases (there are more white people with higher education) - As educational attainment rises, the differences in hourly wage grow larger - Difference in population shares within educational attainment categories account for 26% of the difference in hourly wages - If education shares were the same, there is as $6.83 disparity → $1.75 is explained by the disparity on broad educational attainment categories, while $5.08 is the result of other factors - Finer gradations explains more/all of the gap, especially if test scores are used (consistent with the competitive labor market model and its emphasis on skills)

What happens to revenue when the monopolist lowers the price?

- Assumption that monopolist sells everything at one price - To sell more units, it has to lower the price for everyone who was buying it before at the higher price as well Example: Monopolist is selling 200m units at $5. To sell 400m units, it has to lower the price to $4. Quantity effect (source of additional revenue): selling 200m more units at $4 = $800m Price effect (source of decreased revenue): selling 200m units for $1 less than before = -$200m Marginal thinking: when you lower the price you gain sales but get less for inframarginal sales Marginal revenue = [Quantity effect - Price effect]/Change in Quantity - When it is positive, you will want to make the change because QE > PE

1. Mandates/prohibitions (command and control)

- Ban sale of anything other than very energy efficient appliances - Pick appliances so that average household cuts its electricity usage to the socially optimal quantity - Is this done in a socially optimal manner? New dishwashers take much longer Why command and control can be inefficient: - Could hurt some more than others when the cost is much higher for one person (say someone had a higher marginal benefit from old washer) - Policymakers do not know everyone's tastes and preferences - Socially efficient policy should get everyone to make the best choice for them to get the socially efficient quantity

The distributional impact of a carbon tax & dividend

- Before rebates, regressive tax - With rebate, tax is actually paid by the highest quintile - Cannot avoid some winners and losers within income groups - For example, no way to compensate someone who drives much more than average without undoing the incentive effects - The carbon tax, by itself, could cause concentrated losses for some communities (need policies to help the most affected regions and workers transition into new jobs)

Gambler's Fallacy

- Believing that the wheel somehow tends to avoid repeats and somehow evens out from one spin to the next - If the ball just landed on 64, less than a 1/100 chance for it to land on 64 again on the next spin

Structural dominance (models of labor market discrimination)

- Benefit one group by hurting others through institutions/violence - One group benefits at the expense of another, enforced in a coordinated manner by institutions or violence that redistribute from a subordinate group to a dominant group - In the context of an institutional model for labor markets with monopsony → violence is used to lower the wage (and restrict employment)- could even lower it below the supply curve - Examples are Jim Crow and Apartheid - Structural dominance increases profits by effectively taking from one group and giving to another → it will last unless there is political change

Buying a firm

- Bidding on Jason's company, with value uniformly distributed from $0 to $100 million - Jason knows true value → worth 50% more to you - If you bid greater than Jason's value, he will sell - If you bid less, he'll keep it - If Jason accepts bid b, then Jason's value is v ≤ b - Jason's value is uniformly distributed over [0, b] - The expected value of the company to Jason is b/2 - Expected value to me is (1.5)(b/2)=(3/4)b - I should expect profits of (3/4)b - b = -(1/4)b - To maximize profits (minimize losses), set b = 0

Social surplus with taxes

- CS is the triangle between demand curve and the price paid by consumers - PS is the triangle between price received by producers and Supply(MC) - Lost consumer surplus is area between old equilibrium price and new price paid by consumers (now part of transfer) - Lost producer surplus is area between old equilibrium price and price received by producers (now part of transfer) - DWL is the triangle between old equilibrium price and the line between price paid by consumers to price received by producers (alternatively triangle between market quantity and tax quantity)

The International Dimension (Carbon)

- Carbon emitted in Cambridge is the same as in Beijing - A costly effort to reduce emissions in Cambridge aids Beijing too - This leads to the free rider or global commons problem - If all countries act in their own narrowly-defined interest, they will do very little to reduce emissions because they bear the full cost of emissions reductions but receive only a small fraction of the benefit - Countries have tried to address the global commons issue with global agreements (IE: The Paris Agreement) - Many countries have carbon taxes or cap and trade, but often at low prices/coverage below thee social cost of carbon - Richer countries generally emit more carbon per capita, but poorer countries are the source of emissions growth

2. Pigouvian taxes

- Charge a tax of $0.14 per hour of electricity - Gets people to take into account the cost of their actions on society, internalizing the externality - Reduction of quantity will happen in the most efficient way possible → Jaden will cut back 9000 hours, but Zhen will only cut back to 11000 hours - Pigouvian tax = MEC - The price paid to producers is less than market equilibrium and the price consumers pay is more than the market price - Fix what is worst about the invisible hand but use what is best about it - Agents do not need much info to make decisions, just prices - Agents optimize, doing what is best for them, but these decentralized choices will lead to socially optimal outcome

"Predatory pricing" (below-cost pricing)

- Charge low prices not, but as soon as other businesses are driven out, the company raises prices - Does not happen often - Companies can: charge prices below their cost in order to gain market share - Companies cannot: do this when there is a high likelihood that they will successfully become a monopoly- but this is very rare. Rationale: - Low prices are good for consumers, do not want discourage businesses from lowering prices because they are afraid they'll end up in court - Rarely seen in practice because it requires strong assumptions (ability to sustain large losses and inability of competition to return)

David Card and Alan Krueger Natural Experiment

- Compared New Jersey after it raised minimum wage and Pennsylvania - Found employment rose

Summary of competitive and institutional explanations of inequality trends

- Competitive model: explains why college graduates are paid more (skills matter in wages) - Institutional model: employers have some wage setting power and bargaining matters - Wages determined by competitive equilibrium plus or minus some amount determined by institutions (magnitude is debated... 20% is reasonable)

Unionization and inequality (institutional explanations)

- Correlated with inequality - As union membership decreased, so did the share of income going to the bottom 90% - Less unions, less bargaining power Limits: - Uncertainty about the effect of unions on non-union workers - Unionization caused by same factors that affect inequality (reduction in manufacturing since 50s might have reduced both wages and unionization) - Unionization has declined for men but not women (but inequality increased for both) - Studies found that reduced unionization explains 10 to 20% rise in inequality

Minimum wage and inequality (institutional explanations)

- Correlated with some facets of inequality - Min wage matters at the lower percentiles, but not at the higher where people don't make that

Unions in institutional model

- Could raise wages without hurting employment - Increases wage from where MC = VMPL down to S to a little bit above S. - DWL past that wage to the intersection where S = VMPL - Involuntary unemployment from higher wage to S curve because more people want to work at higher wage - Do unions lower VMPL by producing inefficiently due to work rules or raise VMPL by improving workplace functioning

Hispanic-white pay gap (mechanical decompositions and their interpretations)

- Crude education explain 53% of the gap (differences in population shares within broad educational attainment categories account for 53% of the difference in hourly wages)

Asian-white pay gap (mechanical decompositions and their interpretations)

- Crude education explain 80% of the gap (differences in population shares within broad educational attainment categories account for 80% of the difference in hourly wages) - Higher wages for Asians due to the fact that they are more likely to have a bachelor's degree+

What if the tax was on consumers?

- Demand (Tax) = Marginal Benefit - Tax (so left shift of demand) - New intersection with supply is the benefit received → moved up to old demand is the amount paid - Consumers pay the difference between old equilibrium and amount paid, while producers pay the difference between old equilibrium and benefit received

US competition policy enforcers

- Department of Justice (Antitrust Division) - Federal Trade Commission Main competition laws: - The Sherman Act (1890) - The Clayton Act (1914)

Summary and implications (discrimination and disparities)

- Discrimination/disparities at many stages of life from birth to entering the job market - Substantial but incomplete progress in reducing discrimination at the job market stage - For black-white differential, educational differences are especially important - For male-female differential, compensating differentials (schedule flexibility) are very important → need institutional;/cultural changes

How the government handles growth and mergers

- Does not stop companies from growing very large (Walmart) - Does sometimes stop companies from merging to become very large (AT&T) Companies can: - Grow organically Companies cannot: - Merge with another company if the effect "may be substantially to lessen competition, or to tend to create a monopoly" (Clayton Act) Rationale: - Organic growth is more likely to reflect efficiencies that benefit consumers - Mergers are a combination of efficiencies (which benefit consumers) and increased market power (which hurts consumers) - DoJ/FTC weigh these two considerations on a case-by-case basis, with the courts ultimately deciding - Government can agree to mergers with conditions, like selling some business units or promising certain conduct

Economists advise households to avoid taking big risks.

- Economists advise households to avoid taking big risks. - Economists believe that the marginal value of a dollar goes up when your resources fall. - A family with a disabled worker who is out of the labor force greatly values an extra $1,000, whereas a family with two healthy working adults (and total household income of $80,000 per year) won't value the extra $1,000 as much. - This is called diminishing marginal utility. - By implication, households should worry about making sure that they have money in bad times, (when total household income is low), even if it means sacrificing a greater amount in expectation during good times. So, how to avoid risk: - Medical costs: health insurance - Loss of income due to illness: life insurance, disability insurance - Loss of income due to unemployment: unemployment insurance - Outliving your retirement savings: annuitization - Home theft/fire/flood: home insurance - Car theft/accident: car insurance

Economic Policymaking Solutions for Climate Change

- Economists like carbon taxing, but the public does not - First Option: Persuasion - Second Option: Bundling together policies - Last Resort: Adopting a less-than-perfect policy

Economics Application #1: Uncovering Discrimination

- Economists study and uncover the disparate treatment of white and minority individuals by actors in the criminal justice system, such as police - Goncalves and Mello examine how individual police officers in Florida act in the context of issuing speeding tickets - Results show that minorities are less likely to receive a discount on speeding tickets than white drivers (white drivers more likely to be charged with inly 9 mph to avoid high fines) - Can use 'non-lenient' officers' ticketed speeds to benchmark the true distribution of speeds and still find substantial evidence of leniency for white drivers - About 40% of officers explain all the racial differences - Hoekstra and Sloan (2021) study 2 large cities where police officers are assigned to 911 calls based on immediate availability/geographic proximity - this means that black and white officers areas-good-as-randomly sent to otherwise similar situation - In each type of neighborhood, white officers where more likely to use force → gap grows even larger in neighborhoods with high share of Black citizens - Application to prosecutors (Tuttle 2020): a subset of federal prosecutors use their discretion to charge some defendants with drug amounts that will trigger mandatory minimum sentences, and that they do this disproportionately for black and Hispanic defendants

Economics Application #4: Behavioral Insights to Reduce Crime

- Efforts at crime reduction have traditionally focused on how to increase the cost (through enhanced punishment or increasing the probability of apprehension), or how to decrease the benefits (such as investing in academic/vocational skills of young people) → very costly and ineffective - Heller et al. (2017) explore how lack of self-control and"automaticity" may impact the behavior of young men - Randomized BAM to male 7th - 10th graders in Chicago public schools (teaches them to think differently and nonviolently) - In the 1-2 years of the study, participation in BAM was found to reduce total arrests by 28% relative to control group and violent-crime arrests by 45% Behavioral Nudges: - Fishbane et al. (2020) conducted two RCTs in New York City to make critical information salient by redesigning the summons form and providing text message reminders - Find that these interventions reduce failures to appear by 13 to 21% and lead to 30,000 fewer arrest warrants over a 3-year period - Criminal justice policies can be made more effective and humane by anticipating human error in unintentional offenses

Benefits

- Employers provide benefits because it will increase their profits to provide them, since they can offer a lower wage - When government mandates benefits, the equilibrium compensation does not change, so wages decrease

Hospital mergers

- Evidence on impacts of hospital mergers on quality are mixed, with many studies finding negative outcomes, especially in Medicare, which sets price so competition is largely based on quality - Hospital mergers have led to higher prices

Household income inequality

- Exacerbated by assortative mating of similar income spouses - People with high wages marry each other - Household incomes were growing together from 1947 to 1979, but are not growing apart

The production technology of a monopoly

- Example of monopoly with a large fixed cost and a flat/low marginal cost (means firm has economies of scale) - IE: pay a lot to build a factory, but once you have the factory it is easy to make product (after innovation, production is cheap) Natural market power: - Network externalities with Facebook having to pay high cost to set up their system but a very low cost to operate for an additional user - Natural monopolies like a water treatment company that has to pay a lot to build a treatment plant and pipes but then needs to pay only a low cost to treat and deliver each additional gallon of water - Average total cost (ATC) is exponentially downward slopping and marginal cost (MC) is a horizontal line

Application: Black-White Pay Disparities

- Explicit racial discrimination was legal and common (Jim Crow) - Employment discrimination outlawed by the Civil Rights Act of 1964 → unlawful to discriminate on bases of race, color, religion, sex, national origin, and sexual orientation/gender identity - Taste-based discrimination continued after the Civil Rights Act (estimates find that a meaningful fraction of the racial wage gap is due to prejudice) - Statistical discrimination can be a self-fulfilling prophecy → highly biased managers oversaw minority workers that has lower performances - "Ban the box" meant to prevent questions that asked whether job applicant had a criminal record because worry that it was hurting Black men → actually helped whites with a criminal background, but hurt Black individuals without one - Employers overestimated the degree to which race predicted criminal background and ignored more statistically predictive information, such as education level (implicit bias) - The black-white pay gap fell then rose: - Between the 40s and 70s, massive racial differences in schooling were reduced and more Civil Rights protections came into place - After the 80s, continued progress was outweighed by growing returns to skill across the board which magnified black-white skill differences (declining discrimination on the basis of race, but importance of college grew and so did inequality)

Minimum wage

- Federal has fallen in real terms but state minimums have risen - Even if employment falls due to a raise, total wages might rise (employed for less hours but paid more) - Even if employment does not fall, employers might make workers pay in other ways (less benefits), higher prices, etc

3. Cap-and-trade

- Flexible quantity regulation - Can get to the same place as a Pigouvian tax

Implications of inequality facts

- For policy, level matters more than trend Are there desirable policy interventions? - It is possible inequality is rising/high but there is nothing fair or efficient to do about it. - It is possible inequality is stable but there are fair and efficient opportunities to address it. - Normative issue

Third rule of positive tax analysis

- Framing and psychological considerations might qualify rules 1 and 2 - Consumers can under-react to taxes that are not salient to them - The price shoppers see when they put an item in their cart does not include taxes → posting tax inclusive prices has been shown to reduce demand, even though consumers are not paying more

Hot hand fallacy

- Gamblers mistakenly believe in streaks → if they got lucky on the last spin they believe they have a higher chance of winning on the next spin - With independent draw, each even has no bearing on the likelihood of future events - Need to remember that roulette wheels have no memory → the spins are independent of one another

Taste-based discrimination → aka personal bigotry (models of labor market discrimination)

- Gary Becker - Occurs when people's preferences cause them to discriminate against a certain group - For example, if an employer is a bigot, he might prefer to not work with certain types of people - Employers pay a cost (lower profits) in order to buy something they like (indulging in their bigotry) → they would hire an incompetent white male because of bigotry against women - Can reduce profits, such as if any employer is unwilling to hire good workers even at a competitive or below competitive wage - Competition may drive out businesses that discriminate based on taste, but this might take a long time or not happen at all if consumers have bigoted taste

Can increasing health spending reduce spending?

- Generally no - In the Oregon RCT, people who got Medicaid coverage went to the emergency 40 percent more annually → Insurance lowers the price of emergency room visits, resulting in more of them (outweighing any substitution effect from lower prices for care in other settings, like doctor's offices) - Most prevention does not save money due to direct costs, cost of more follow-ups and the financial cost of a longer life - But prevention is often a cost-effective way to improve health (big benefit for a small net cost) - IE: flu shots for toddlers may save money but many other immunizations cost money on net (e.g., for hepatitis B for children)

Second rule of positive tax analysis

- Generally, marginal tax rates matter for choices (quantities change) - As tax rate increases, the incentive to work decreases - As marginal tax rate goes up that makes you less likely to want to work and you will be less likely to take an additional hour of overtime - Labor supply of women decreases more when taxes increase than for men (same for high income household labor versus average income)

Wage inequality

- Gone up within men and within women but narrowed between them - Fastest wage growth is at the 90% percentile - Earning gaps by race and ethnicity have persisted (Asian → White → Black → Hispanic)

Chicago School (Competition Policy)

- Government should not do a whole lot - Policy should be focused narrowly (eg on cartels) - Government intervention risks chilling innovation and growth

Moral Hazard Myth Myth

- Health demand curves are indeed downward sloping - The RAND Health Insurance Experiment randomized people into different health plans. People in less generous plans were given more cash so they could afford health care as easily as people in more generous plans - When they had to pay for their own visits, doctor visits and hospitalizations decreased - The researchers summarized as an elasticity of demand of -0.2

Is pay completely determined by worker's skills (Institutional Labor Model)

- Identically skilled workers are paid more at more profitable firms - Workers switching between jobs experience variation in pay. Employers pay workers that switch to them systematically more

Adverse selection and health insurance death spirals (like the market for lemons)

- If everyone had the same forecasted health status then health spending is like a coin toss. Everyone would purchase health insurance and there is no adverse selection. - Some people have private information that means they are relatively more likely to incur greater health costs (e.g they are planning to get pregnant) and then they would be more likely to want to buy insurance - A health insurance company might raise the premium, but then only "expensive types" (who know they need insurance) will buy insurance - So then they raise the premium more, leading people less likely to incur health costs to drop out, leading to higher premiums ... leading to a death spiral where insurance ceases to exist

Institutional Model (Labor Markets)

- Imperfect competition (IE a price maker) - Firms face an upward sloping supply analogous to monopolies (residual supply curve of labor is relatively elastic, but not completely elastic as assumed in the competitive model)

Different assumptions under Institutional Labors Models

- Imperfect information → Can get "efficiency wages" where workers are paid more to motivate them and retain them - Friction in labor markets → Match generates a surplus to be divided based on relative bargaining power. It is costly for employer/employee to find someone else or leave job, which results in match-specific surplus that is divided based on bargaining power - Monopsony (single buyer) in labor markets → Can pay workers below the marginal product. If wages are forced up (minimum wage, unions), still would be worth hiring people

Application: Female-Male Pay Disparities

- Implicit bias in women's work - Rouse and Golding: put musicians behind screens (impartial hiring) and orchestras ended up with better violinists and a greater proportion of women because they no longer assumed women were bad violinists - Physicians reduce referrals to female surgeons after death, but not for men Source of the gender wage gap - Occupation, industry, experience, age, education, and other factors (only 5¢ or less remains after observables) - How much do the observables themselves reflect inequality of opportunity (premarket disparities/discrimination)? - How much do they reflect compensating differentials/different choices or culture/institutions? Notable factors: 1. Women with children earn less than those without children. 2. Earning gaps increase with age and with events (marriage, birth). 3. Gaps are greater t the upper end of male earning and education (if husband makes a lot of $, wife is more likely to stop working). 4. Gender gaps in earnings are greater for occupations with more time demands and client relationships.

Labor supply of a monpsonist

- In a competitive model, a firm faces an infinitely elastic supply curve of labor. It can hire as many workers as it wants at $600 a week. So the marginal cost of an additional worker is $600 = the wage - In monopsony, the firm faces an upward-sloping labor supply curve. If it wants to hire a new worker, it must pay more to do so ($610/week) and has to pay all its old workers a new higher wage. The MC of an additional worker is the wage of the new worker + the extra money for all the previous workers, which is greater the wage - When MC > wage it is more costly to hire new people, so the monpsonist will hire less people. Similar to monopoly where MR < P, so you sell less.

Surplus allocation under monopoly

- In monopoly, quantity is inefficiently low, so it leaves people that would buy good without it - MC = MR < P = MP

Implicit bias (models of labor market discrimination)

- Inaccurate on average - Occurs when employers unconsciously and inaccurately discriminate in hiring or wage setting based on inaccurate stereotypes and bias - Training might address it, but the evidence that it works is mixed - Changing hiring practices and structures to eliminate the impact implicit bias has on outcomes may be more effective (IE: collect resumes and interview in a certain way → blind auditions, structured interviews to avoid bonding with someone with similar characteristics) - Reduces profits because employers will not get the best workers. - Firms that figure out how to address this bias will eventually drive out firms that don't, but it is a slow process

Education and the supply of skills

- Inequality started to rise in the 70s when the generation where education slowed down entered the workforce Why the growth educational attainment slowed: - High School Movement from 1910s to 40s saw enrollment drastically increase - After WWII, GI Bill boosted college enrollment (to avoid draft) - Women became increasingly educated

How do we get the innovation needed for major decarbonization?

- Innovation is critical to effectively combatting climate change—like we've seen in solar - Carbon tax increases incentive to innovate. Potentially a big return to ideas to produce energy with less carbon or consume energy more efficiently - Research subsidies can address the positive externality from innovation - Widespread support for increased funding for basic research on energy issues.

Top 1% in Continental Europe and Japan

- Japan, Germany, France, Italy - L-Shaped inequality (high in early 1900s and then decreased)

Other institutional explanations for rise in inequality

- Labor market rules (non-compete agreements, no-poaching agreements, and collusion in wage setting) - Increased concentration in industries (monopolization makes power of employers at a bargain higher) - Deregulation of financial markets - Increased barriers to moving jobs (occupational licenses, high rents in desirable areas, high health insurance costs) - Lower tax rates (encourage higher paid people to seek even higher pay)

Cecilia Rouse's views on Build Back Better

- Legislation aimed at climate and investments in children - Universal Pre-K, affordable childcare, child tax credit - Investments in children pay back in the long run

Legalized abortion as a means to explain decrease in crime

- Less children who were likely to grow up in situations that lead to crime were born - But correlation does not imply causation

Health (the outcome)

- Life expectancy is correlated with income (although causation likely somewhat smaller) - Behavior and local conditions highly correlated with life expectancy → healthy behaviors and characteristics of the local area like home values and college graduates - Little support for impact of: access to health care, environment (although poorly measured), inequality, and local economy

Consumption inequality

- Lower and has risen less

Estimating the Social Cost of Carbon

- Measures how much one ton of carbon dioxide (often abbreviated as "carbon") costs society

Wealth inequality

- Most measures show it rising, but the magnitude of the rise is highly debated - Counting social security as wealth, wealth inequality has been stable or falling - More generally, wealth inequality is affected by public policies. If policy includes support for retirement, college, health, then lower and middle income households will accumulate less wealth and society will have more inequality - Expected returns are lower so a given amount of wealth can buy less

Inequality Facts

- Most of the increase in inequality happened from the 80s to the 2000s - Substantial inequality in economic and non-economic outcomes - Ranking economic outcomes by extent of inequality: 1. Wealth (greatest) 2. Income before taxes/transfers 3. Income after taxes/transfers 4. Consumption - Most measures of inequality increased since 70s - Less clear if still increasing - CEO pay has been stable since 2000 - Gender pay disparities have fallen but remain - Racial gaps are persistent - Wealth inequality has not risen (including social security) - Debate over whether consumption inequality is increasing

Economics Application #2: Incentives Matter

- Municipalities can use the criminal justice system in a variety of ways to raise revenueI - Arrests and traffic citations often generate some amount of revenue, be it through fines, fees, or the seizing of property (criminal justice system is profitable) - Makowsky and Stratmann (2009) show that speeding tickets are not only determined by the speed of driver but also incentives of police → More tickets for drivers who have a higher opportunity cost of contesting a ticket → More tickets for out-of-town drivers → More tickets when fiscal conditions are tight and in municipalities where revenues from property taxes are low - Prison is paid for at the state level, but sentences are determined by at county - The costs of incarceration may not be fully internalized by the relevant decision-makers because the state is effectively subsidizes it - Ouss (2020) studies a major law change in CA which change cost structures for incarcerating juveniles between states and counties - As soon as county internalizes costs, it began incarcerating less juveniles - Suggests that prison subsidizing led to over-reliance on confinement relative to when costs are borne directly - Berdejo and Yuchtman (2013) find that WA judges respond to political pressure by sentencing serious crimes more severely

Black-white male pay gap

- Narrowed but has stop improving and is still very large

Female-male wage gap

- Narrowed but remains large

Neo-Brandeisians (Competition Policy)

- Need more aggressive competition policy with more of a presumption that big is inherently bad (especially for democracy) - BIG IS BAD - Antitrust should pursue broader goals - No judge has this attitude right now

What makes digital markets "winner takes most?"

- Network externalities (the demand for a product is dependent on the demand of others buying that product) - Economies of scale - Data as a barrier to entry - Capital and brands - Behavioral features (consumers do not switch)

Different estimates of the Social Cost of Carbon

- Obama valued it much more, from $50 to $82 - Trump from $1 to $2 - Germany from $218 to $291 - If you want net 0, cost is around $140 - Lower discount means you pay more now to avoid the issue in the future

Can institutions change wage disparities?

- Obstetrics was historically for males, since they needed to be readily available to deliver a baby - Now shifted to team practice with different people on call, so now a female specialty - For this to be seen in other professions, need to reduce the premium for "always on"

Pecuniary externality

- Occurs when a market transaction affects other people only through market prices - Not an externality in our sense → not a market failure

Standard Oil

- Owned by John D. Rockefeller - Used aggressive tactics to maintain its very high market share, many related to railroad pricing (told railroads they could only transport his oil → once company could not transport their oil, he would buy it) - Broken into 34 companies; many have since recombined as ExxonMobil, Chevron, Marathon, etc.

Adverse selection

- Parties with adverse hidden information tend to enter markets and conduct transactions IE: Jason is entering the market when he knows things adverse to your interest as a buyer - The situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction IE: Medical insurance → the insured knows more about their health and are more likely to think they need insurance → the less healthy people cost more to insurance company, so they begin charging a higher premium and healthy people begin not getting insurance IE: House sales → house owners know more about hidden issues (information asymmetry) and will enter the house market to sell their home - By these standards, critical to think contingently → why would someone who knows a lot about a used car be willing to sell it to me at a given price? - When people willingly enter trade, tells you about the hidden characteristics of what they are trying to buy

Behavioral hazard" in health insurance

- People cut back both low- and high-value care - People do not rationally cut back on care when prices are higher, with similar percentage reductions in "high value" (such as preventative care) and "low value" care and drugs

College wage premium

- People with less than a college degree have seen their earnings decline or have increasing trouble finding good jobs

Surplus allocation under perfect competition

- Perfect competition maximizes consumer surplus - MC = MB = D = P

Pink tax

- Pink tax: some retailers charge more for products or services marketed towards women (haircuts, dry cleaning, etc) - Not due to marginal cost differences, but rather due to different WTP

Malaria Control (example of positive externality)

- Positive consumption externality from insecticide treated bed nets - If 1/2 of an area used bed nets, dramatically reduces the ability of malaria to spread - Giving out free bed nets is a very cost-effective way to save lives since they are only $6

Inequality of opportunity

- Predominantly Black neighborhoods in Boston have more lead in pipes and blood samples → lifelong effects on development, IQ, and success - Education is unequal by income and race/ethnicity → poor districts get more state funding, but lots of aid is local so state funding is not enough to offset disparities - Large differences in racial disparities in school discipline and treatment (IE: suspension, AP course taking, etc.) - Incarceration rates vary dramatically by education/income and race/ethnicity (Black male high school dropouts have greatest %) - This all means that when you get to your employer, your different experiences put you in a disadvantaged position

Firms with market power

- Price makers: have the ability to affect price (does not mean that you can force people to pay any price as there are consequences) Characteristics of markets with market power: - Many buyers - 1 or a few sellers AND/OR varied goods What happens: - The firm wants to sell more but now has to worry that this will drive the price down - The firm can choose its price OR its quantity - A firm's choices may affect decisions by other firms- if so, game theory is needed (strategic analysis) - Example 1: Books from Harvard Book Store come with a unique experience (varied good). If HBS discounts their books, more people would buy from them. - Example 2: Apple makes iPhones. If they charge more, sales do not go to 0. If they charge less, sales do not go to infinity because you can only buy one iPhone. - Residual Demand Curve: slightly downward sloping & elastic demand.

Health spending increases are buying more health

- Price: how much you have to pay for a unit. - Spending: price x quantity - Health spending has gone up a lot, but we are buying something very different: outpatient surgeries with faster recovery times, drugs with fewer side effects, more effective treatments for heart attacks, more treatable cancers, vaccines for more diseases, etc - What has happened to the price of "health"? - One recent study found the cost of treating a heart attack—adjusting for improved outcomes—has fallen about 10% annually from 2001-14 - Health spending has increased as a share of the economy (GDP) - What we spend money on (in order): hospital care, professional services, home health nursing and other residential/personal care, prescription drugs, other

Tax progressivity

- Progressive tax system: goes up on a percentage basis with income - Proportional tax system: everyone pays the same fraction of their income - Regressive tax system: a tax for which the percentage of income paid in taxes decreases as income increases - Income taxes are progressive (tax rate increases as income increases) - Other federal taxes are not progressive (roughly proportional) - State and local taxes are not progressive, but rather sightly regressive since low-income households spend more of their income - The overall tax system is progressive → adding government programs, tax and transfer system is very progressive (lower incomes get more from the government than they pay, so effectively have a negative tax rate) - Average tax rates at the top have fallen over time, but not as much as top marginal rates - Government spending has changed, making the fiscal system more progressive (increase from 13 to 67% spending on insurance/redistribution)

Current child tax credit proposal

- RN, if you make no money, no child credit → offers no help to those most in need - New American Rescue Plan (ARPA) provides more broad assistance that is thereafter phased out

Major Monopolization cases

- Rare - American Tobacco - IBM (case dropped) - AT&T - Microsoft - Digital Giants (lawsuit against Google and Facebook)

Avoiding taxes does not avoid costs—it just hides them

- Regulatory approaches also impose costs, they are just more hidden - Regulatory approaches do not generate a revenue stream that can be used to compensate losers - Fiscal approaches (e.g., subsidies) have costs that are borne by all taxpayers in the form of higher taxes or opportunity costs of other uses of the money

CEO Pay

- Risen enormously since 1990 but stabilized since 200 (current CEO-to-Worker ratio of 350, initially 50) - CEO pay cannot be explained by competitive model - CEOs are paid their VMPL and it's just really high - Pay rise mirrors other occupations they might have chosen (hedge funds, law partners, consultants) - Fired for underperformance more than ever before, so do not control board - Small difference in CEO's skill can be large difference for company, so worth paying for

A carbon tax to "mitigate" climate change

- Set a carbon tax based on what is needed to achieve a given goal or following the Pigouvian approach of using the social cost of carbon - Make the coverage broad (covering as many emissions sources as administratively feasible) and neutral (policymakers do not care where the emissions reductions come from) - Unleashes the invisible hand so hundreds of millions of people and millions of businesses make the best choices for themselves consistent with a lower emissions trajectory. Also, effectively rewards emissions-reducing innovations.

Some of what antitrust does not do

- Should not try to achieve broader social goals Can't: - Allow a tobacco company to monopolize because it will raise prices and improve health by reducing deaths - Allow AT&T and T-Mobile to merge because they will add jobs - Prevent American Airlines from merging with US Airways because a smaller number of big companies is bad for democracy - Antitrust does not focus on issues like the impact of conduct on privacy, human rights, local media diversity, etc.

information asymmetries

- Situations in which one party is more informed than another, because of the possession of private information - Arise when economic actors have different information and/or inferences about the world - Need to work your way through the decision tree and think about each contingency (economists call these contingencies 'states of nature' or 'states of the world') - You need to think about what everyone else knows in each contingency (i.e., state of nature)

Risk preferences

- Small risks with a positive expected payoff appeal more if you frame them as part of a large portfolio of identical (independent) gambles

Marginal tax rate

- Tax rate that applies to the next dollar of taxable income Couple with a $37000 income: - 39% marginal tax rate - 10% income, 7.65% social security + medicare, 21& losing EITC

Skill-biased technological change

- Technological change that affects the marginal products of higher-skilled workers differently from those of lower-skilled workers - When the VMPL rises for a given amount of labor for higher-skilled households - Complements skilled people IE: Computers complement people engaged in analyzing data but substitute people engaged in entering data

Health care in the US

- The US spends more on health expenditures but has a lower life expectancy - We pay for our healthcare, even if we do not notice it: - What family sees: employee contribution to health insurance and out of pocket spending - Total premium: lower wages due to employer contributions, taxes for healthcare, and the above - The uninsured rate has fallen over time but remains substantial

Positive externality of consumption

- The external benefits to a third party that occur when a product is consumed - Wearing a mask

Negative externality of consumption

- The external costs to a third party that occur when a product is consumed - Secondhand smoke

Negative externality of production

- The external costs to third party that occur when a product is produced - Making electricity, making new Kissing Booth movies

Antitrust

- The government ensures that there are multiple competitors - Combatting the "robber barons" who ran trusts in the Gilded Age (late 19th century) - Until the Civil War, US had lots of small businesses that couldn't affect price, but with industrialization, larger businesses (trusts) formed - Premise of US competition policy: antitrust should protect competition, not competitors

Downsides to government provision/regulated price

- The government might be less efficient at making a produce, so cost of $1 might end up being $2 for the government - Government might charge or set a regulation with the wrong price based on lobbying, so will not result in perfect efficiency - Government regulators might set prices in a way that deters investment and innovation - In the case of natural monopolies, cannot set the socially efficient P = MC because when MC < ATC, the company would lose money and go out of business (would not be able to pay for the initial costs)

Progressive Economists School (Competition Policy)

- The government should do more and be more aggressive, as monopolization and anticompetitive mergers are more common that previously thought

Impact of carbon tax on households

- The impact of a carbon tax on household well being depends on what you do with the money - Carbon tax is bore by consumers, but money is given back in rebates - Rebate will be the same for everyone, so depends on how much money spent on carbon

Internalities

- The long-term benefit or cost to an individual that they do not consider when making the decision to consume a good or service - Tax smoking so you internalize cost to your own health in the future

What is the socially optimal top marginal tax rate from a utilitarian or Rawlsian perspective?

- The marginal utility of the very highest income households is so low compared to the middle/poor class that it is effectively negligible (money taken from the top is trivial because it does not give them much utility) - This implies that you should choose the top marginal tax rate that is at the top of the Laffer curve, potentially around 60%

Negative production externality model

- The regular supply curve (MC) does not reflect all costs - With negative production externality, MSC is higher than MC - MSC > MSB - Would be better from a social perspective if less units of a good (such as electricity) were produced - The DWL is the triangle formed between the Market equilibrium and the optimal equilibrium (smaller quantity) → the DWL is the total cost of externality to society due to too high quantity → the further away market is from optimal equilibrium, the more DWL - The DWL is the marginal external cost times the quantity produced in excess

How government eliminates DWL (monopoly)

- Through government provision or government regulated price - The government could take over the company and sell the good at the price where demand = MC - The government could require the company to sell the good at the price where demand = MC - This makes the entire triangle above MC consumer surplus

Michael Strain's views on Build Back Better

- Too much focus on demand and too little focus on supply - Not enough focus on fundamentally restructuring programs - Possible room for discrimination against younger women because of need to pay for maternity leave - Failure to correct for market externalities - Deficit (too expensive)

Positive production externality model

- Total cost of externality to society is negative because quantity is too low - Trades that would be beneficial to society do not happen because they do not benefit individuals

Average tax rate

- Total taxes paid divided by total taxable income

Globalization & inequality

- Trade share of US economy grown from 13% in 1973 to 26% in 2019 - Trade plays some role but skeptical over large impact: - Most increase in trade is with other rich countries - Globalization increased in Japan and continental Europe without inequality - Majority of economy is services, which is not exposed to trade - Studies find it explains less than 10% of increase

Climate change facts

- Transportation and electricity are biggest sources of U.S. emissions - Coal accounts for one-fifth of electricity but more than half of emissions - Impact of a $50/ton carbon tax: huge price increase for coal, relatively little for gasoline - The medium-term emissions reductions from a carbon tax mostly come from electricity (if you tell people that carbon has x cost, easier to change behavior with electricity than with transportation)

Auction (coin-filled vase)

- True value of coins in the vase: $31.74 - 38% of the "90% confidence intervals" include $31.74 - If people made confidence intervals that were wide enough (on average), 90% of the 90% confidence intervals would include $31.74. - People tend to generate confidence intervals that are too narrow. - Median bid: $25 - Thick "right tail" of bids: 18% of the bids exceed $31.74. - The person who wins the auction, tends to be a bidder who has one of the highest estimations of the value of the coins in the jar. - If you are the "winner", that implies that hundreds of other students all think the coins have lower value than you do. - Auction winners are selected from the set of bidders with mistakenly high valuations. - The winners are adversely selected (with respect to the accuracy of their beliefs) - The winners are the ones with the most upwardly biased beliefs about the value of the coins in the vase. - Oil companies made the same mistakes: bidding for offshore oil drilling rights in the Gulf of Mexico in the 1960's and 1970's → overbid

The Marginal Revenue Curve

- Twice as steep as the demand curve (twice the slope)

What does the government spend money on?

- US federal spending has generally outpace revenues (the difference is the deficit) - US government spends less than other advanced economies (the US has a bigger budget deficit that the countries below it though) US Spending: 1. Insurance/redistribution 2. Defense 3. Other Major social insurance/redistribution programs: 1. Social security (old age) 2. Medicare (elderly) 2. Medicaid (poor) 3. Social security: disability 4. Supplemental nutrition assistance program 5. Supplemental security income (support for low income disabled) 6. Unemployment insurance

The Economics of Criminal Justice

- US has 5% of population, but 25% of prison population - 1/100 US adults imprisoned → 1/15 Black adults imprisoned - 1/3 US adults has a prior arrest/conviction - Crime rate has fallen, but incarceration has rises - US has the highest incarceration rates amongst OECD countries - Black children are much more likely to have a parent in jail/prison

Immigration & inequality

- US workers born abroad have disproportionately lower wages (no high school degree) and higher levels of eduction attainment with fewer in the middle - Increased immigration may account for up to 10% of increase in inequality - But other studies have found no impact of large increases in low-wage immigration on native-born wages

Top 1% in English speaking countries

- US, Canada, UK - U-shaped inequality - Pattern of inequality rising after 1970s shared by Anglo-Saxon countries

Unions in competitive market

- Unions reduce labor supply leading to higher wages - Labor unions restrict quantities (prevent employers from hiring more people at lower wages, even if the people are willing to work) - The number of people that want to work at the higher negotiated union wage is greater than the wage/job number negotiated by unions & employers

Long run effects of the social safety net

- Using a natural experiment: slow rollout of SNAP - Chatham Georgia versus Fulton Georgia - Adults from families that got social safety net payments as children saw improvement in metabolic syndrome (diabetes, obesity, etc) and economic self sufficiency (women only) Other studies: - Preschool increases school completion, eventual earnings, reduces crime and mortality - Medicaid received as a child leaves to increased high school and college graduation and higher earnings for women - Housing vouchers lead to higher college attendance and earnings - EITC increases college enrollment - Are studies still valid or do they show what happens when you go from very low safety net to modest one?

Argument for a tax rate above the Laffer peak

- Wealth as a negative externality - Higher top rates are about regulating inequality and the market economy and safeguarding democracy against oligarchy - Lose money for a more equal world

Trucking example (competitive labor model)

- When COVID hit initially, the VMPL of truck drivers went down due to lower delivery prices - Since D = VMPL, demand shifted to the left - Lately, the VMPL of drivers is much higher, so demand is shifter right - supply is inelastic after a certain point

Moral Hazard

- When hidden actions on the part of one agent influence another agent's payoffs - IE: People who have flood insurance taking risks with their homes - In the case of health care → the choice to spend more on health treatments, which imposes a cost on the insurance company

Risk neutral

- When people are risk neutral, they don't care about the level of risk and are therefore indifferent between the two investments.

Risk seeking

- When people are risk seeking, they prefer the investment with the risky payoff.

Positive externality of production

- When the production of a good or service creates a benefit to third parties - Innovative research

Minimum wage in competitive model

- When you raise minimum wage, the number of people employers are willing to hire is less than the number of people who want to work at higher wage, so involuntary employment

Assumption underlying the demand curve (competitive labor model)

- Workers are paid the value marginal product of their labor: the amount that an additional worker adds to the value of output - Diminishing VMPL → Hiring additional workers will reduce the marginal amount produced by each new worker. As you hire more workers, each does less. The employer keeps hiring people until they get to a person who just produces as much as the wage. Hiring any fewer people leaves money on the table and hiring more people means you would lose money. - Perfect competition in the labor market (firms are price takers, not makers) → Employers cannot pay less than the VMPL because another employer would outbid them and they would not be able to hire any workers (competition). - Perfect information → The quality of workers/effort is perfectly observable. For example, if an employer offer a higher/lower wage, it does not affect work effort. - Frictionless labor markets → Costless matching of workers and jobs.

Inequality in the competitive labor model

- Workers who are paid more have a higher VMPL, due to having higher educational attainment and skills - Not about good/bad jobs or good/bad employees - About higher skilled/lower skilled workers → a "good" employer who tried to pay above VMPL would go out of business and a "bad" employer who tried to pay below VMPL would be unable to hire

Determinants of criminal activity

- Years and quality of schooling - Neighborhoods - Poverty and unemployment - Studies involve establishing causation over correlation

Why people pay for insurance

- You pay a premium (directly or indirectly) - If something bad happens you get a payout (could be paid directly to health provider) - If you are lucky, you lose money because premium > payout - If you are unlucky, you make money because payout > premium (IE: if house burns down) - Ex ante insurance (based on forecast) is attractive because people are risk averse. - Getting money has higher marginal utility when you are unlucky than when you are lucky. People will pay, on average, for this benefit. - Health spending varies a lot, ex post you mostly "lose" on insurance but sometimes "win" big

P-Beauty experiment

0 is the Nash equilibrium. But, for this to be the best response: No one can misread the instructions or assume someone else will. No one can fail to think perfectly rationally. No one throws a wrench in the works. No one assumes someone will throw a wrench in the works. Behavioral economists predict that people will not act in this manner and guess in the range of 22. Called P-Beauty because in the General Theory of Employment, Keynes describes newspaper beauty contest in which readers guess which published photo other readers will pick as the most handsome. The challenge is to select a number/photo that is your best guess of what other players will do.

1. Monopoly is not illegal, monopolization is illegal

1. Being a monopoly is not illegal (you are allowed to be the only company) Companies can: - Make very high profits - Charge very high prices - Be lazy about changing and innovating Rationale: - Firms generally grow because they offer a better product or a lower price, which benefits consumers - High profits, high prices, and laziness are the opposite of the conduct that maintains a monopoly- they invite entry/competition 2. Monopolization is illegal Companies that have monopoly power cannot: - Engage in exclusionary and predatory practices: - Cannot require suppliers not to sell to competitors - Cannot require stores to not sell competitors's goods - Use monopoly power in one industry to gain it in another (IE: the government argued that Microsoft was using its monopoly in the Windows operating system to require people to use the Internet Explorer browser) Rationale: - These behaviors harm consumers with no countervailing benefit - Part of why monopoly is legal is that it is not permanent, but monopolization threatens permanence - These rules do not apply to companies that are not monopolies

Two ways to price carbon

1. Carbon tax - Set a price based on the Pigouvian value or what is needed to hit a given quantity goal 2. Cap and trade - Set a quantity and auction/trade permits, which will have a price - Can be designed to effectively match a carbon tax

Social benefits of trade

1. Comparative advantage and specialization shift out PPC and raise overall social welfare. 2. Specialization generates additional expertise. 3. Transfer of technology from more advanced to less advanced economies (foreign direct investment).

Explanations for wage differences

1. Compensating differentials - Workers are paid different amounts because the unpleasantness/pleasantness of jobs varies - A person might be indifferent between coal miner ($26) and freight hand-mover ($18) - Coal miners compensated for risks involved with job - Some people care more about money, others fun, others benefits 2. Competitive model - Wages determined by supply of labor and demand for labor 3. Institutional models - Wages determined by relative bargaining power and other institutional factors like the minimum wage, labor unions, and discrimination

Two approaches to setting climate policy

1. Cost-benefit analysis that results in an outcome that balances both sides - Take measures until the marginal social benefit of reducing emissions (social cost of carbon) equals the marginal cost of undertaking those measures 2. Set an absolute goal - Limit the rise in temperature to 1.5 celsius - Cut emissions by 100 percent by 2050

Government failures

1. Direct cost of bureaucracies 2. Corruption 3. Underground economy 4. Irrational/bad/uninformed choices by government (not just consumers are behavioral) 5. Government capture— acts for various powerful groups rather than the public good

Private solutions to externalities

1. Do the right thing - People may increasingly value knowing they are conserving energy - Corporations increasingly claim to take the impact of their actions on the community into account - Some externalities may only be addressed through norms (hateful social media posts make it worse for other so don't, wearing masks even if not mandated) 2. Bargaining - Sometimes parties can work it out themselves - Movie theater would lose $20000 if reopened, but Lizzy's would make $50000. Lizzy's can give movie theater anywhere from $20001 to $49999 to reopen movie theater- this surplus is divided based on bargaining

Four overarching questions in health reform

1. Evolution or revolution? - How conservative to be about how large/abrupt a change to make from the status quo 2. Role of the market? - Can private competition—potentially appropriately regulated—play a useful role as it does elsewhere in the economy? - Or are market failures too serious to trust substantial portions of health care to the market? 3. Financing/progressivity? - Financing/progressivity issues can be separated from insurance/delivery issues. - For example, could pay for single payer with a per household tax or have an entirely private system with very progressive subsidies. 4. How to say no? - How can people make educated tradeoffs about benefits vs. costs? - How can they understand they pay for care?

Health has all the major types of market failures (and equity considerations)

1. Externalities (e.g flu or COVID) 2. Imperfect competition (e.g hospital concentration and drug monopolies) 3. Imperfect information (e.g adverse selection and moral hazard) 4. Imperfect rationality (e.g people overoptimistic) 5.Unfair outcomes (e.g widespread belief something special about health, maybe even a right)

Why do we have taxes?

1. Fund government (schools, military, etc) 2. Redistribute 3. Implement broader policies (tax benefits for health, education, adoption, electric cards, etc) 4. Correct market failures (Pigouvian taxes)

How to improve social welfare when it is reduced by monopoly?

1. Government provision - The government produces and sells the good (subways and municipal water) 2. Government-regulated price - The government sets the price a private entity can charge (the price a local electricity company can charge is set by law) 3. Legal monopoly reform - The government shortens patent lives, weakens copyright protections, increases openness to foreign competition - in action, the government strengthens and lengthens 4. Antitrust - The government ensures that there are multiple competitors

Horizontal Mergers v. Vertical Mergers

1. Horizontal: - Companies selling similar goods or services - Some efficiencies, such as smaller HR - Fewer choices IE: Ford + GM 2. Vertical: - Companies that are part of the same supply chain - Much larger benefits due to higher efficiency IE: Automaker (GM) + Supplier (GoodYear) IE: Seatbelts are part of car, not a post addition bought separately Companies can: - Merge vertically in almost all cases (controversial) Companies cannot: - Merge horizontally if it substantially lessens competition Rationale: - Vertical mergers likely have efficiencies in terms of lower transaction costs and improved coordination - Some economic theories predict that vertical suppliers will still have an incentive to sell to competitors - Horizontal mergers raise more of a balance of concerns, with potentially smaller efficiencies and potentially larger expansions of market power

Two major reasons that estimates of the Social Cost of Carbon differ

1. How much to count future costs - This is called the "discount rate" - The three estimates shown assume that $1,000 lost in 2100 is as if we lost: Trump administration: $5 today Obama administration: $100 today Germany: $190 today 2. How to treat the impact on the rest of the world - The Obama administration and Germany estimate counted the cost of climate damage globally - The Trump administration counted only the U.S. impact of a U.S. carbon policy

Some arguments for command-and-control

1. Huge externality so ban is equivalent to optimal tax 2. Psychological issues may lead a tax to be counterproductive (licensing or encouraging use) 3. Tax/subsidy might be politically/administratively infeasible

Policy responses to CEO pay

1. If you think they are paid more than marginal products: - Institutional reforms like giving shareholders more say on pay - Proposals to penalize firms with high CEO to worker ration would act as a disincentive to hire less-skilled workers and an incentive to outsource low-paid jobs 2. If you think they are paid their marginal product: - Do nothing, it is efficient - Higher taxes on high-income households

Application of the first rule to major taxes

1. Income taxes → paid by individuals writing check since the labor supply is completely inelastic 2. Payroll taxes → both employer and employee payroll taxes are paid by workers (labor supply is close to inelastic and taxes are paid on the inelastic side... Harvard pays Jason less due to payroll taxes) 3. Corporate taxes → 75% paid by owners of stocks and other capital and 25% paid by workers in lower wages (very debated) - These are assumptions used by Congress's Joint Committee on Taxation

Three broad reform approaches (healthcare)

1. Incremental - Fill gaps in the current system - Expand subsidies for low/moderate income households - Public option - Trim payments for drugs/hospitals 2. Single Payer (aka "Medicare for All") - New system for all - Government insures everyone, no private insurance - Private hospitals, doctors and drugs—but reduce prices 3. Market Oriented - Consumers make more choices - Reduce public subsidies - Replace tax subsidy for employer insurance with a flat subsidy for private insurance - Government role in high-risk pool/catastrophic costs

Why might wages differ across different groups?

1. Inequality of opportunity (premarket disparities/discrimination including systemic racism) - Historical experience - Childhood experience - School funding/quality - Neighborhoods - Criminal justice system 2. Labor market discrimination 3. Different preferences (compensating differentials that are not counted in wages)

Shifts in supply curve

1. Input prices (cost of capital) 2. Technology (IE: shale fracking) 3. Number and scale of sellers 4. Sellers' expectations about the future 5. Goals of stockholders/board (IE: Engine No. 1's activist owners pushed oil company to be more climate-mindful)

Approaches to reducing gross health spending

1. Lower quantities - Demand side: reduce moral hazard (earlier section) - Supply side: reduce use of expensive specialists/surgeries 2. Lower prices (but do these result in lower quantities??) - Hospitals - Drugs 3. Reduce waste and increase efficiency—but how?? - Single payer focuses on prices and administrative costs, while market focuses on the demand side of lower quantities

Government solutions for externalities

1. Mandates/prohibitions (command and control) 2. Pigouvian taxes or subsidies (tax/subsidy = MEC to get people to internalize externality) 3. Cap-and-trade 4. Public provision (only for positive externalities...healthcare/primary education)

Why is employer-sponsored insurance so important in the United States?

1. Mitigates adverse selection problem - Employers are a pool of people selected on an attribute other than health status (and may be a reasonably healthy group) 2. Tax subsidy - If an employer pays workers cash, workers have to pay tax on it → Employer contributions to health insurance are tax free 3. Helping less informed agents - Employers can screen/design/pick good plans

Competition Policy Rules/Practices

1. Monopoly is not illegal, monopolization is illegal 2. Low price are not unfair, they are generally good 3. Cartels and collusion are per se illegal 4. Organic growth is generally viewed favorably, growth by merger depends on the results 5. Horizontal mergers can raise more concerns than vertical mergers 6. Antitrust should not try to achieve broader social goals

Social costs of trade

1. National security concerns. IE: over-reliance on other countries 2. Desire to protect culture from dilution or infringement of other values (due to creation of global culture). 3. Environmental and resource concerns. Countries vary by stringency of their environmental policies. Free trade can lead to greater pollution and resource depletion in those countries with lax standards because of the increase in demand. 4. Potential negative effects on local wages and jobs. 5. Infant industry argument: When industries are first getting started, they want/need government protection from free trade until they get established.

Types of market structures

1. Perfect Competition (homogeneous products, many firms) - corn, apples 2. Monopolistic Competition (differentiated products, many firms) - books, music 3. Oligopoly (few firms) - oil, cement, cigarettes, cars 4. Monopoly (one firm) - patented drugs, tap water

Monopolist's profit maximizing decision

1. Pick the quantity that sets MC = MR 2. Set the price according to the demand curve - This sets the price at where the demand curve is at the best quantity - If you sell below where MC = MR, you could still make more revenue since MR is still positive - If you sell above where MC = MR, you are making less profit on the additional units that what you are losing on the initial units due to the lower price - MC = MR maximizes revenue without decreasing price too much

What makes the invisible hand work?

1. Self-interest (optimization) Good can come for society from people acting in their own interest. If you ignore that people optimize according to what they believe is best, bad consequences. 2. Competition Otherwise, self interest would face few constraints. 3. Trust Costly and inefficient to engage in commerce without some basic level of trust. Need to trust that other party will deliver. 4. Rules/Institutions Need property rights, roads/education, etc.

Does spending increase health?

1. Some spending makes health worse—unnecessary and dangerous procedures 2. Some health spending makes health slightly better, but not worth the cost. (e.g $100m per life.) 3. Some health spending makes health much better, worth the cost. (e.g. $1m per life)

Shifts in demand curve

1. Tastes and preferences 2. Income and wealth 3. Availability and price of related goods 4. Number and scale of buyers 5. Buyers' expectations about the future

Marginal Revenue

= (Change in Revenue)(Change in Quantity) - Always below price, but as you sell more, you suffer more from lowering price - Can turn negative (additional sales drive down price by more than sales increase) - Price and revenue diverge more as you go down the demand curve

Compensation

= wages + benefits - Total value of what you're being paid on the job by employer - Wages and salaries, health insurance, paid leave, etc. - Different workers are paid very different amounts ($19 is median wage) - Wages have risen a lot in the 95% percentile, but not in the 10% (inequality)

Rule of thumb on comparing utility across incomes

A 10% increase in incomes results in about the same increase in utility across the income spectrum.

Budget constraints

A budget constraint is an equation representing the goods or activities that a consumer can choose given their limited budget. IE: exam with two parts, A & B, and total examination time of 50 minutes → 50 minutes = (minutes on Part A) + (minutes on Part B) Leads to tradeoffs.

Pareto improvement

A description of a change on the way to Pareto efficiency where some individuals are made better off while no one is made worse off. A change that benefits at least one person without making anyone else worse off. If it is impossible to make a "Pareto improvement" then the equilibrium is "Pareto efficient." Weakest welfare concept. Any Pareto improvement is a Rawlsian improvement.

Price ceiling

A legal maximum on the price at which a good can be sold IE: In the market for gasoline, there is often shortages due to price caps. People are willing to pay more, but the government won't let them. Consequences: People who want/need a good cannot get it Difficulty over how to ration limited supply Potential for resale in unregulated underground markets Productivity loss

Price floor

A legal minimum on the price at which a good can be sold An example of how government policy can keep us from reaching equilibrium.

Price elasticity of demand

A measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price. ED = (%Change in Quantity)/(%Change in Demand) A product with a lot of substitutes would have elastic demand. Elasticity increases as quantity increases on the x-axis.

Homo economicus

A model of humans as agents who are: 1. perfectly rational 2. narrowly self-interested 3. have perfect self-control Benchmark/dominant framework to guide analysis from 1950 - 2000

Natural experiment

A natural event that acts as an experimental treatment in an ecosystem. Some natural process assigns subjects into treatment and control groups in a random or nearly random way. IE: When policies are implemented and you can compare a before/after IE: Employment and wage study in Pennsylvania and New Jersey

Agents

A person, but also families, firms, organizations, communities, governments, etc.

Price taker

A price taker is a buyer or seller small enough to take the market price as given and buy/sell as many units of the good as they desire without affecting the market pr

Laffer Curve

A relationship between the tax rates and tax revenues that illustrates that high tax rates could lead to lower tax revenues if economic activity is severely discouraged - The equilibrium point depends on what elasticity you believe the labor supply curve has → more elastic, lower equilibrium max tax rate - The top of the Laffer curve depends on how much taxable income responds to tax changes - Taxable income responds because: people work less, hide more income, contribute more to charity, more aggressively reduce taxes

Shortage

A situation in which quantity demanded is greater than quantity supplied— not in equilibrium. There is an incentive for suppliers to increase the price. The willingness to pay is higher than the price.

Surplus

A situation in which quantity supplied is greater than quantity demanded— not in equilibrium. There is an incentive for suppliers to decrease the price. The willingness to pay is lower than the price.

Prediction Markets

A speculative market designed so that prices can be interpreted as probabilities and used to make predictions - In this case used for politics - If everyone is rational and risk neural this works

Nash Equilibrium

A strategy combination where each player's strategy is a best response to the strategies of other players (optimization) In equilibrium, every agent is simultaneously choosing the best feasible option, so no one would benefit personally by changing their own behavior, given the choices of others. Not necessarily Pareto efficient. No Nash equilibrium in pure strategy.

Optimization

A theory about how choices are made- Trying to pick the best feasible option, given whatever limited information, knowledge, training, and experience the economic agent has. Optimization is how we allocate scare resources.

Reverse causality

A two-way causal relationship in, as it were, a loop. Wealth can lead to better medical care which can lead to health. Health can also lead to wealth which can lead to better medical care.

Behavioral game theory

About what real people (and other economic agents) actual do in games: they try to optimize and sometimes fail in predictable ways.

Market failure

Allocation of goods and services under free markets is not socially efficient. A situation in which the free market does not distribute resources efficiently. Does not mean the market actually literally fails— lots of buyers and sellers, supply equals demand, but the result is not socially efficient. Government intervention MAY increase social efficiency.

Externalities (Market failure 2)

An agent's actions hurt or help others in ways other than through prices. IE: Using oil increases CO2 emissions, warming the planet and harming others.

Tradeoffs

An economic agent faces a tradeoff when the agent needs to give up one thing to get something else. IE: Money v. human health

Field Experiment

An experiment conducted in the participants' natural environment

Externality

An externality occurs when an economic activity has either a spillover cost to or a spillover benefit for a bystander - Direct effects that result from the production or consumption of a good Negative externality: - Consumers/producers do not take into account the costs they impose on society - Benefits are smaller than social costs at the margin so there is DWL - Reducing quantity is socially efficient, increasing marginal benefits and lowering marginal social costs

Marginal analysis

Analysis that involves comparing marginal benefits and marginal costs (how total points change as you make a local change to your time allocation). A cost-benefit calculation that studies the difference between one feasible alternative and the next feasible alternative. Keep allocating more time to something so long as MB > MC.

Perfect Competition

Assumes buyers and sellers are price takers Characteristics: - Many buyers - Many sellers - Identical good What happens: - A firm can sell as much as it wants (pick Q) - If a firm sells more or less it does not affect the market price - Firms are price takers Residual Demand Curve (from the perspective of your firm) - Infinitely elastic demand (horizontal line) - If the price is $7, you can sell as much or as little of the good as you want - If you charge $7.50, will not sell any goods because everyone will buy from suppliers selling at equilibrium price - If you sold at $6, it would be a mistake because you could sell as much as you want at $7 - the market demand curve is still downward sloping

The Competitive Inequality Model

Assumptions: - Market outcomes, not post tax/transfer - Individual earnings, not household - Labor income, not capital income too - Looking primarily at wages for bottom 99% - Focused on relative wages by education - College has become more rewarded and >HS less rewarded (so earnings by education have become increasingly unequal)

Economics Application #3: Less Information is Not Always Better

Ban the Box - Many cities and states have passed Ban the Box (BTB) policies forbid employers from asking on an initial job application whether an individual has been convicted of a crime, but can ask later in the hiring process - Agan and Starr(2017) designed a randomized field experiment:I Sent applications from fictitious men in matched pairs based on race( Black and white) by assigning distinctly black or distinctly white names to the fictitious applicants - Before BTB, white applicants received 7 percent more callbacks than matched Black applicants → increased dramatically to 43 percent - When employers lack individualized information, they tend to generalize that black applicants, but not white applicants, are likely to have record (implicit bias) - Common assumption is that the rise of drug testing among U.S.employers must have had negative consequences for black employment - Wozniak (2015) looks at the timing and nature of drug testing regulation and finds that drug testing laws increases black employment in the testing sector by 7% to 30%, especially among low-skilled black men

Sources of market power (barriers to entry)

Barriers to entry mean that lots of new firms cannot enter the market 1. Legal market power - Patents (Claritin), copyrights (authors for books), licensing (medical boards), trade protectionism (foreign airlines cannot fly domestic routes) - Laws that make new entrance to market harder 2. Natural market power - a) Controls a key resource (all diamond mines), has network externalities (Facebook, eBay, Uber/Lyft, etc), expertise of founder (Google, at least originally) - b) Economies of scale (natural monopoly): large fixed costs and low variable costs, like electricity or water distribution, subway systems, or highways (only one water pipe to my house, so it would be difficult for another company to come and build pipe)

Welfare

Based on how people judge their own well-being. Optimization is one principle of economics, with agents making the best choices for themselves (need not be selfish and could care about others). Welfarist approaches to ethics put what people value at the center of moral calculus. Most economic models take a welfarist approach— within this, you can care more/less about redistribution. Consequentialist and based on outcomes (Pareto efficient, utilitarian, rawlsian)

Does being altruistic make you irrational/suboptimal?

Being altruistic or pro-social does not mean you are irrational or suboptimal. You can have a preference for spending resources in any way that gives you meaning or satisfaction.

Example of first rule of positive tax analysis

Cambridge Hamburger Tax - Cambridge is considering imposing a 50¢ tax per hamburger sold by fast food chains. - Proponents of tax: McDonalds and Shake Shack are rich and can afford to pay tax. - McDonalds and Shake Shack counter: We will just pass the tax on to our customers, many who will suffer from increased cost in food. - Impact on supply curve: taxes are an additional cost of production, so supply would shift left (old supply = MC, but new supply = MC + tax) - Demand is drawn → intersection with Supply(tax) is the amount charged to the customer, down to Supply(MC) is the amount received by the company, intersection with Supply(MC) is the old equilibrium price - Difference between old equilibrium and amount charged in the consumer incidence; difference between amount received and old equilibrium price is company incidence

Advantages of procedural fairness approaches

Can accord with our moral intuitions and the way people actually judge what is right and wrong in practice. Can be derived in a philosophically-consistent manner. Can provide a clear answer to a wide range of questions.

Coase Theorem

Can get socially efficient outcome through bargaining if 1) property rights are fully assigned and 2) no transaction costs - If private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own - In many cases, transaction costs are too high for the Coase theorem to work → cannot get everyone in the world who is hurt by carbon emissions together to pay everyone in the world who emits carbon

Causation

Causation occurs when one variable directly affects another through a cause and effect relationship.

Implementing a carbon tax in the United States

Collect taxes on specific fossil fuels at one stage: Coal: - At the mine (1,109 mines) - Natural gas: at the processing plant (551 plants) - Oil: at the refinery (139 refineries) - Imports/exports: Tax imported but not exported carbon - Credits for carbon capture/storage: For example, carbon permanently put into asphalt or carbon capture and storage - Regulation where a tax is administratively infeasible: For example, cannot measure methane emissions associated with oil and gas extraction so would need to regulate those.

Cartels and collusion are per se illegal

Companies cannot get together and: - Fix prices - Limit quantities - Divide markets geographically or otherwise (Per se means the government does not need to prove anyone was harmed, it is automatically illegal to do this) Rationale: - With a cartel you get all of the harms of a monopoly (higher prices and lower quantities) without any benefits (such as the efficiency you might get with one large form) - Agreeing to divide the labor market with competitors is illegal wage fixing

Risk averse

Consider a person choosing between two investments with the same expected payoff but one investment has a fixed payoff and the other investment has a risky payoff: - When people are risk averse, they prefer the investment with the fixed payoff.

First degree price discrimination

Consumers charged the maximum price they are willing to pay (charging each individual customer a different price based on their willingness to pay) Examples: car sales, street markets - Eliminates DWL by raising the quantity sold - Maximizes social surplus - Completely producer surplus; no consumer surplus and no equilibrium price - Requires lots of information about consumers and no cross-selling -Unrealistic because you do not know everyone's WTP

Imperfect rationality (Market failure 4)

Consumers who are worse off because they make systematic errors. IE: People that do not save enough for retirement because they are myopic.

The fundamental tradeoff in health insurance

Consumption smoothing - Health insurance reduces financial risk by paying most/all of major medical costs Moral Hazard (or incentive effects) - Health insurance encourages more spending by lowering the marginal cost of health services below the actual cost to society of providing them

Costs & benefits of mitigating climate change

Cost of reducing carbon emissions: Shifting to power sources that might not otherwise make sense, using less power, and engaging in activities that prevent the release of carbon Benefits of reducing carbon emissions: Less atmospheric concentration of carbon over time, smaller temperature increases, and less of all the problems associated with those

Cost-benefit analysis

Cost-benefit analysis is a calculation that combines costs (subtraction) and benefits (addition) using a common unit of measurement, like dollar value. Cost-benefit analysis is the same as optimization. Economists and policy makers apply cost-benefit analysis to almost every domain of human decision-making, including domains that are controversial, like marriage, fertility, and safety. IE: In class, we calculated the value of investing in airbags based on the value of human life.

Other-sacrifice game

Decider chooses one of the following allocations between Passive 1 and Passive 2: - $4 for Passive 1 and $4 for Passive 2 - $3.75 for Passive 1 and $7.50 for Passive 2 Rawlsian: Choice of $4, $4 (makes the person worse off, the decider, better) Social efficiency (utilitarian): Choice of $3.75, $7.50

Self-sacrifice game

Decider chooses one of the following allocations: - $4 for Decider and $4 for Passive - $3.75 for Decider and $7.50 for Passive Self-interest: Choice of $4, $4 Rawlsian: Choice of $4, $4 (makes the person worse off, the decider, better) Social efficiency (utilitarian): Choice of $3.75, $7.50

Psychology matters when...

Decision makers are inexperienced Transactions are person-to-person Stakes are low Transact with professional salesperson Advisers have perverse incentives Third-party arbitrage is difficult Rewards are imminent Procrastination is possible

Pareto efficiency

Describes an allocation in which the only way to make any individual or group of individuals better off would require making at least one other person worse off. A state where no individual can be made better off without making someone else worse off.

Positive

Describes what people actually do. Aspires to objectivity, can be tested.

Normative

Describes what people, including society, ought to do. Inherently subjective and dependent on your values. Economics policy recommendations reflect a combination of positive and normative views.

The Competitive Model (Labor Markets)

Description: Downward sloping demand and upward sloping supply (slightly exponential, as past a certain point workers will not be willing to supply more labor even if the wage is really high) - Demand for labor is based on the value of the marginal product of labor (VMPL) - Employers hire workers until the cost of hiring them equal the amount they can produce with their labor - Employers do not pay more out of kindness, but rather lack of choice - If they pay below market wage no one will accept a job - If they pay above will be overwhelmed by applicants and cannot produce enough to pay wages - If VMPL goes up, employer has to pass the gains to workers because otherwise competitors with similar increases would bid those workers away (if productivity goes up, wages rise) - Residual supply curve is perfectly elastic (horizontal) → if firm pays less than market wage, it will lose all workers

Third degree price discrimination

Different groups of consumers are charged different prices based on their own attributes (age, gender, location, etc) - Different buyer characteristics Examples: - Surcharge for someone age 13-59 to see a movie (demand is more elastic for young and old, so this is revenue maxing) - Charge more Harvard tuition for families with high income - Charge more for groceries in low income neighborhoods (no car so demand is inelastic for close grocery stores)

Disadvantages of welfarist approaches

Difficulties comparing utility across people. Too strict: requires everyone to give a lot to the worst off. Not strict enough: does not have absolute prohibitions against slavery and murder, only if they are shown to decrease utility. Distasteful implications: like should we tax people with genes for high IQ and give more money to gourmands. Violates many people's moral intuitions by according no moral relevance to whether income is earned through talent, hard work, luck, or theft.

What are games in economics?

Domains in which economic agents make decisions with payoffs dependent on the (potentially unobserved) actions of other economics agents. Games require strategic decision-making, which essentially means having a prediction of how other agents will play the game.

Elasticity Cutoffs

ED > 1 elastic (no incentive to increase price) ED = 1 unit elastic ED < 1 inelastic (incentive to increase price until you reach unit elastic)

What is economics?

Economics is the study of how agents allocate scarce resources and how those choices affect society. The study of choices.

Do economists agree?

Economists agree on positive issues more than you think. Differences still remain on many positive issues, but further research can narrow down these differences. Economists have widely varying normative views.

Overview of equity

Economists can aspire to describe the cause and effect of different policies (positive analysis) To decide which of these policies is the best we need a notion of justice or equity (normative analysis) Notions of equity and deciding whether something is equitable is normative analysis. Encounter the question of distribution of income (and how policy should or should not affect it)

The efficient solution and the fair solution (climate change)

Efficient solution: - Emissions reductions should take place wherever in the world it is cheapest to reduce emissions—which is often poorer countries - Can then have bargaining to divide the surplus from the more efficient solution. Fair solution: - Rich countries benefit from the large emissions reductions in poorer countries - They should be willing to pay them for this with large transfers.

Empiricism

Empiricism is analysis that uses data from the world. Such data is used to test scientific models, including models developed by economists. Economics test their ideas with empirical analysis— they use data to test their (positive) theories. Economists use data to build models to understand the world around them. Interested in understanding what is causing things to happen in the world.

Equilibrium

Equilibrium is the special situation in which everyone is simultaneously optimizing, so nobody perceives that changing their own behavior would benefit them personally, given the choices of others. All economic agents are simultaneously optimizing.

Expected value

Expected value is a probability weighted value - Can calculate this average payoff by multiplying the probability of each possible outcome by the expected winnings associated with each outcome IE: You put up $X. If the wheel spins any number from 1 through 47, you get your bet back and you win an extra $X. If the wheel spins on any number from 48 through 100, you lose your bet. What is your expected winning from playing once? 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑤𝑖𝑛𝑛𝑖𝑛𝑔 = 47/100($𝑋) + 53100(−$𝑋)= -6% of $𝑋

Short run effects of anti-poverty programs (incentives at the margin)

Families making around $20000 can face a marginal tax rate of 80% based on phaseout of EITC, SNAP, and other benefits

Health insurance reduces...

Financial risk - It is effective at consumption smoothing Mortality - The IRS conducted a randomized trial in 2016. There were 4.5 million households who did not have insurance and paid a penalty. They randomly selected 3.9 million to receive a letter telling them about their insurance options and 600,000 did not get a letter. Getting a letter increased coverage and reduced mortality

Strategic analysis

Games involve strategic analysis: needing to have a prediction of how other players will play the game. Strategic: If the owner of Pinocchio's raises their prices, will the owner of Otto respond by also raising their prices? (two actors need to predict the actions of the other) Dribble past another soccer player (you trick them into going left while you go right) Non-strategic: Can the owner of Pinocchio's make a profit if they sell 200 pizzas per day at the market price (taking the market price as given)? Surfing a wave (the wave is not trying to optimize/work against you)

Rawlsian preference

Give resources to the person who is the least well off

Increased concentration

Good/Natural Causes: More competition - Superstar firms - Globalization Bad/Unnatural Causes: Less competition - Reductions in merger and antitrust enforcement - Increased regulatory barriers to entry Hospital concentration: - Not more efficiency as a result of the mergers, just higher prices

Kantian

Grounded in procedural fairness. Act towards others the way you would want them to act towards you.

Equality of opportunity

Grounded in procedural fairness. Everyone should get the same shot, like education, on a level playing field.

Long-term effects of taxation

Higher tax rates could discourage: - Education/training motivated by higher future earnings - Entrepreneurial risks to earn more - Taking more productive jobs that pay more but are less pleasant - Moving to areas where they can be more productive and have higher wages

Advantageous selection

Highly risk averse people buy life insurance and these are people who actually have low rates of mortality, in part due to risk aversion . A situation in which less risky customers seek more insurance.

Movements along the demand curve

Holding all else equal (ceteris paribus), change the price of the good/service, and identify the change in quantity demanded.

Inequity aversion

Holding my own payoff fixed, I'm made better off the more equal consumption is in my reference group (I am particularly upset when I am the one who was less).

Marginal social benefit (MSB) → for consumption externalities

How much it benefits everyone in society (the consumers and others) when an additional unit is consumed MSB = MB + MEB

Marginal external benefit (MEB) → for consumption externalities

How much it benefits others in society when an additional unit is consumed (can be positive or negative)

Marginal (private) benefit (MB) → for consumption externalities

How much it benefits users to consume an additional unit

Marginal social cost (MSC) → for production externalities

How much it costs everyone in society (the producers and others) when an additional unit is produced MSC = MC + MEC

Marginal external cost (MEC) → for production externalities

How much it costs others in society when an additional unit is produced (can be positive or negative)

Marginal (private) cost (MC) → for production externalities

How much it costs producers to make an additional unit

Impure altruism (warm glow)

I feel better when I 'give' A motivation solely to help oneself feel good

Relative consumption

I judge the adequacy of my consumption relative to the level of others' consumption. Evaluate personal well-being in regards to others'.

Altruism

I'm made better off when someone else is made better off. Unselfish regard for the welfare of others.

Negative reciprocity

I'm made better off when someone who has tried to harm me is harmed

Reciprocal altruism

I'm made better off when someone who has tried to help me is made better off. Helping others with the expectation that they will probably return the favor in the future.

Present bias

Immediate events get full psychological weight while everything else (future) gets half psychological weight. There are differences in how we handle tradeoffs in the immediate present versus the future.

Oil optimization

In the oil market, we see private optimization. Lots of social costs are bore by society but not the oil company (IE: climate change)

How do the activities of so many people get organized so efficiently?

Individuals act in their own rational self-interest led by an invisible hand to promote an end that was no part of their intention. The workers of Campbell just wanted a job & money, but collaborated unknowingly through the invisible hand.

When education is winning the race...

Inequality falls (college premium falls) - SBTC shifts D right, but then S shifts to the right too because people are going to college and becoming skilled (so wage doesn't increase much or at all for labor of skilled workers)

When education is losing the race...

Inequality rises (college premium rises) - SBTC shifts D right and S shifts right, but less, because people are not going to college and becoming skilled as much (so wage increases for labor of skilled workers)

Why do people share in the dictator game but not outside the lab?

Inequity is salient in the game. Group identity. Worried about opinion of experimenter. Willing to share windfalls by not "my money."

Dynamic analysis of monopolies

Innovation through investment in R&D: - Developing new products (a new drug) - Producing existing products more cheaply - If you have a longer patent length, encourages people to go through all the strenuous steps to produce a drug, because they know they will see the benefits Policies that trade off patents against innovation: - Grant longer patents to drugs for children's cancers: higher prices but more innovation - Negotiate drug prices: lower prices but less innovation

What else are we planning to do tomorrow?

Invest in financial capital Invest in human capital Invest in social capital Invest in health capital

Welfare (consequentialist)

Judge a policy based in its impact on the well-being of people

Procedural fairness (deontological)

Judge a policy based on ideas of justice, rights, liberty, community norms, etc. Focuses on the process (IE: libertarianism)

Well-designed tax policy

Little tradeoff Makes one person a lot better off while taking relatively little from the other (taxes hurt economy a little)

Free rider problem

Making choices that benefit the individual at the expense of the group. If you do not protect a public resource, private interest will destroy it (The Tragedy of the Commons) IE: Fossil fuel emitter gets energy, while community experiences the consequences of climate change (hotter summers, drought, etc.) IE: Jumping the subway far, but the community loses the jumper's financial contribution to the public transport system. IE: Wearing a mask damages your public interest, but is good for the public interest.

Willingness to accept

Marginal Cost If Willem is willing to accept $34 for a mug that means his marginal cost is $34.

Willingness to pay

Marginal benefit If Carissa is willing to pay $28 for a mug, that means her marginal benefit from that mug is $28.

market equilibrium is inefficient when there are externalities

Market equilibrium balances the (private) costs to producers and benefits to consumers: - MC = MB Socially efficient equilibrium takes into account the marginal extra cost to society: - MSC = MSB - MC + MEC = MB + MEB When there are externalities (strictly speaking MEC ≠ MEB), then if the economy is in market equilibrium (MC = MB) that market equilibrium is socially inefficient (MSC ≠ MSB)

Behavioral economists share many things with mainstream economists

Markets & incentives play an important role in shaping behavior Decision makers are often highly sophisticated Ideas are mathematically formalized Parsimony (modeling simplicity) is valued

Game theory

Mathematical theory of game playing. Based on the principles of rationality and deductive reasoning, which assume that people are perfect optimizers. Invented in the 1940's (John Nash was a key contributor)

Utilitarianism

Maximize the sum of everyone's utility. The greatest total well-being, calculated by adding up well-being of each person in society. IE: Take money from Alice and give to Bob if it reduces Alice's utility be less than it raises Bob's utility.

Social efficiency (utilitarian)

Maximize the total social surplus

Rawlsianism

Maximize the utility of the worst-off person in society. Pick the outcome in which Bob is as well off as possible (assuming not better than Alice).

Utility

Measure of well-being (in utils). Cannot be observed or measured, but it is a concept that is useful when thinking about equity. Someone very well off/happy has a high utility and vice versa. On average, self-reported well-being (and also life satisfaction) rises with income. Each additional dollar matter less for happiness with richer people. 10% of your income matters the same to both rich & poor people in terms of increasing/decreasing utility.

Behavioral economics (psychology & economics)

Methodological principles: Identify the basic foundations of behavior (preferences, beliefs, cognition) Study the psychological and economic factors that influence behavior Analyze impact of choice architecture Often conclude that Homo economicus is an exaggerated version of human behavior Unrealistically rational (game theory) Unrealistically selfish (social preferences) Unrealistically self-controlled

Unemployment insurance

Normally: replacement of 50% of previous wages with a cap, involuntary job losers actively looking for a job, six months Economic tradeoff: 1. Consumption smoothing: larger benefits help families maintain standard of living 2. Work incentives: lower benefits would encourage workers to find job faster - unemployment designed to trade these off - when unemployment is really high, work incentives do not matter as much because there are not enough jobs for motivated job seekers (optimal replacement rates are higher) Under American Rescue Plan: replacement of 50% of previous wages with a cap + $300 weekly, involuntary job losers, self employed, people who had to leave job due to virus, 39 weeks, states can waive job search reqs

Why do people differ on health reform?

Normative Differences - How much redistribution based on income? - How much redistribution based on health status? (man cannot get pregnant, should he pay more than a woman that can) - Should people be allowed to make their own choices? Positive Differences - How much of the problem with healthcare is that ½ of it is government and governments make mistakes? - How much of the problem that ½ of it is markets and markets fail? - What types of changes are politically feasible?

Lab experiment

Occurs in a lab setting (lots of control), but participants might not act as as naturally as in a field experiment. IE: Dictator Game

Second degree price discrimination

Occurs when consumers are charged different prices based on characteristics of their purchase - Different purchase characteristics Examples: - Charge more for last-minute plane ticket (the seat is the same) - Charge more for an Uber in front of Goldman Sachs versus across the street - Discount for larger purchases

Liberterianism

One procedural fairness approach. Protect people from infringement on their rights. Key concepts: Individualism Individual rights Spontaneous order Rule of law Free markets Limited government Virtue of production Peace Do not believe in redistribution. Support taxes to pay for some purposes, like national defense and public works, but not for redistribution.

How are rebates price discrimination?

Only people who are price sensitive fill out the form for a rebate.

Slope of PPC

Opportunity cost Negative because it represents a tradeoff. Absolute magnitude of the slope is the opportunity cost of producing the food plotted on the x-axis.

Enrollment types

Opt-in enrollment (40% effective) Opt-out enrollment (90% effective) Active choice (70% effective) Quick enrollment (50% effective)

Unfair outcomes (Market failure 5)

Outcomes that violate society's views of what is fair. IE: In a pure free market, education would be unaffordable for many. Dependent on your views of justice.

Top 5%

Own: - 22% of labor income - 33% of labor, capital, and other income - 25% of post-tax and transfer income - 65% wealth - 21% of consumption

Monopoly efficiency problem

Perfect competition gives rise to two types of efficiency that result from MC = MB = P: 1. Efficient production: still true under monopoly (by assumption, in practice there are lazy monopolists) 2. Efficient allocation: violated under monopoly because MC < MB = P. So some people do not buy product even though it would be worth it for society. The quantity is inefficiently low because the monopolist is worried that if they sell more, it will drive down the price of other transactions. - From the price set on, those individuals have a WTP above the marginal cost, but they are still not getting a product

Economists generally prefer...

Pigouvian taxes (or Cap-and-trade) - Most efficient because it redirects the invisible hand, letting people/firms make choices that will lead to efficient outcomes - Can be the most fair because: 1. regulation imposes costs (consumer has to pay more for a dishwasher) 2. Pigouvian taxes also impose costs, but these costs are transparent and the tax also raises revenue that can be used to compensate people

Formal definition of a game (three elements)

Players (and the information they have) Strategies: the actions that each player chooses (can be deterministic or random ie coin flip) Payoffs: received by players as a function of the strategy that each player adopts

Up-Down Game

Players that choose "UP" receive a base payment of $15. Players that choose "DOWN" receive a base payment of $10. Payment reduced by number of players who play up. Equilibrium if everyone cares only about their own material payoffs: everyone play s up and all 10 people get $6. Private maximization can lead to societal harm— if everyone played down, then we would all get $10. When people act in their own personal self-interest to maximize private payoff, costs are created for the larger group that lower everyone's payoff.

Sequential move games

Players' choices are revealed and made sequentially IE: Tic tac toe

Simultaneous move games

Players' choices are revealed simultaneously IE: Rock, paper, scissors

Demand curve

Plots the quantity demanded at different prices. Inverse relationship between price and quantity demanded. Optimizing buyers trade off the private costs and benefits of buying a good. Makes the quantity demanded a function of price.

Supply curve

Plots the quantity supplied at different prices. Optimizing sellers trade off the private costs and benefits of producing a good to sell.

Correlation

Positive correlation implies that the two variables tend to move in the same direction. Negative correlation implies that the two variables move in opposite directions. When the variable have movements that are not related, it is zero correlation.

The Direct Effect of Government Programs on Poverty

Poverty rates fell sharply in 2020 (measured inclusive of taxes and transfers) - Unemployment rose, so Congress passed stimulus checks. Income went down, but government aid increased. - Taxes and transfers bring a family below the poverty level above the poverty level - Tax and transfer system has increasingly reduced poverty (most progress on poverty has not been in the market)

How to prevent death spirals

Private solutions - Insurers ban people with pre-existing conditions from coverage or charge them more (no longer allowed) - Insurance has specific features, like deductibles and copays Public solutions - Government pays for insurance Public/private solutions - Government mandates people get insurance (penalty in effect from 2014-18, penalty is now $0 so not enforced) - Tax subsidy for employer-provided insurance

Partial solutions to adverse selection

Private solutions: - More information (e.g., inspect a used car) - Warranties (e.g., can return defective product) Public solutions: - Public provision of social insurance (e.g., unemployment insurance and Medicare) - Mandate the purchase of private insurance (e.g., you "must" purchase health insurance)

Campbell soup

Producing Campbell soup requires the coordinated effort of millions of people spread all over the world— requires a massive "division of labor" that does not rely primarily on altruism or command-and-control. Alternatively, it takes $1. Typically less than 3 minutes of work, compared to hunter gatherers who worked all day for their food.

Implications of Utilitarianism & Rawlsianism

Redistribution can make society better off by taking from people that will not miss the money as much as it will benefit the people who get it. Judge policies solely based on their consequences. Policymakers should not care about how the high-income person made the money or what the lower-income person does to deserve the money.

Shortcomings of procedural fairness approaches

Requires us to choose between different theories based on philosophical introspection, unrelated to how people view their own wellbeing. Might suggest adopting policies that make everyone worse off. Not all the procedural fairness frameworks as rigorously worked out in the philosophical literature.

The First Fundamental Theorem of Welfare Economics

Result stating that, under certain conditions, the economy will have a competitive equilibrium is Pareto efficient.

The sufficient conditions for theorem

Satisfied if the theorem holds: Effective property rights Perfect competition Individual actions do not affect others except through prices Perfect information Perfect rationality

Shape of utility possibilities curve for safety net programs

Short run: possibly a tradeoff (might discourage work) Long run: possibly no tradeoff in some cases

Production possibilities curve

Shows the relationship between the maximum production of one good for a given level of production of another good. A curve showing the different combinations of two goods or services that can be produced in a full-employment, full-production economy where the available supplies of resources and technology are fixed. Point D is inefficient. Point E is not possible.

Randomized Control Trial (Gold Standard: Randomized Experiment)

Situation in which randomized assignment creates multiple groups that are identical except for some element randomly assigned by the experiment. A controlled method of investigating causal relationships: Participants are assigned randomly to treatment and control group.

Ways to minimize moral hazard

Skin in the game: People can choose how much care to get but pay some of the costs themselves - Across-the-board cost sharing - "Value-based" cost sharing with behavioral motivation• (preventative care is free, but ridiculous treatments are not) Impose limits on what insurance will cover - Prior authorization for specialist care - Not covering certain drugs or procedures - Limit what doctors a person can see - The less skin in the game or limits, the higher the premium

Imperfect competition (Market failure 1)

Smaller number of sellers or buyers in a market.

Social surplus

Social surplus is the difference between willingness to pay (demand curve) and willingness to accept (supply curve). The sum of consumer surplus and producer surplus

Short run effects of anti-poverty programs (Incentives to work or not to work)

Some anti-poverty programs give household money if they are not working, which might discourage work - Whether this is good or bas is a matter of judgement (someone might work one job instead of time, spending more time with their children) - In practice most anti-poverty programs require work Some programs only give households money if they work, so encourages work (EITC) Payments for many programs go down when you earn more, so could discourage working more

Compensated Pareto improvement

Some individuals are made sufficiently better off that they could compensate others so that no one is made worse off. Limitation: In reality, the compensation often doesn't occur (and difficult to even see how it could happen). You often see this in trade. Some wins are big enough that the losers can be compensated; however, in practice, losers are rarely compensated.

The Damages Module for the Social Cost of Carbon

Some of the costs that could be included are: - Premature deaths - Reduced worker productivity - Reduced agricultural yields - Dislocation from sea level rises - Lost outdoor recreation - Loss of biodiversity (often not included in numerical estimates)

Principle of Optimization at the Margin

States that an optimal feasible alternative has the property that moving to it makes you better off and moving away from it makes you worse off.

Industrialized countries tariffs

Tariffs are generally low but can be quite high for agricultural goods.

Developing countries tariffs

Tariffs are used to raise revenue and protect domestic producers.

Invisible Hand

Term economists use to describe the self-regulating nature of the marketplace.

Absolute advantage

The ability of an economic agent to produce more output than another agent with the same resources. You still specialize and trade, as someone will have comparative advantage.

Comparative advantage

The ability of one economic agent to produce at a lower opportunity cost than another. Key to determining CA is to compare individual opportunity costs. Different CA is the basis for trade. If you each specialize and trade, social surplus (along with output) will rise. By exploiting comparative advantage, international trade increases overall economic efficiency.

Quantity demanded

The amount of a good that buyers are willing to purchase at a given price

Quantity supplied

The amount of a good that sellers are willing to sell at a given price.

Opportunity cost

The best alternative use of a resource. What you are giving up to use the resource. If talking about time, it's the next best use of your time. If you are a successful optimizer, you value what you're doing more than what you gave up.

Can you do better than equilibrium?

The concept of an equilibrium that maximizes social surplus is grounded in the idea that you have an allocation that cannot be compensated Pareto improved because total surplus is maximized. This is a stronger statement than cannot be Pareto improved because many more equilibria cannot be Pareto improved.

Competitive equilibrium

The crossing point in the supply and demand curves. Competitive equilibrium price equates quantity supplied and quantity demanded. Competitive equilibrium quantity equates willingness to pay and willingness to accept. Every agent (buyers & sellers) is simultaneously optimizing, so no one wants to change behavior. At this price, every producer is profiting and every consumer's WTP is equal or greater than the price. Social surplus is maximized, but not necessarily producer/consumer surplus.

Consumer surplus

The difference between a consumer's willingness to pay and the price actually paid for the good/service. If market prices increase, consumer surplus decreases. You lose both surplus on transactions still taking place at a higher price and transactions no longer occurring. If market prices fall, consumer surplus increases.

What do these mechanical decompositions tell us about discrimination?

The explained portion: - Explained by differences in education, occupation, experience - May reflect: choices (like choice of job or taking time off to have a child) or pre-market discrimination/disparities (unequal opportunity) The unexplained portion: - What the economic model cannot explain based on what the economist can observe - May reflect: differences in factors economists cannot observe but employers can (skills shown in interviews) or labor market discrimination

Producer surplus

The extra benefit that producers receive from selling a good over and above their willingness to accept. The difference between a producer's willingness to accept and the price of the good/service.

Willingness to pay (WTP)

The highest price that a buyer is willing to pay for an extra unit of a good

Willingness to accept

The lowest price that a seller is willing to receive to supply an extra unit of a good. The cost of production is a company's willingness to accept.

Efficient Equilibrium

The price and quantity that maximizes social surplus MC = MB

Law of Demand

The quantity demanded rises as the price falls, ceteris paribus.

Law of Supply

The quantity supplied rises when the price rises, ceteris paribus.

Elasticity

The sensitivity of one economic variable to change in another.

Protectionism

The view that government should control trade due to the harmful effects of free trade. The theory or practice of shielding a country's domestic industries from foreign competition by taxing imports.

Trade

Through trade, you and the other will always both be made strictly better off than you would be without trade, assuming you are not buying faulty goods.

IQ, time, learning, and stakes (game theory)

Time makes a small difference: More time reduces mean slightly and reduces variability a lot. Stakes make a small difference: High stakes reduce means slightly and reduce variability. Learning makes a large difference: No games where subjects reach predicted equilibrium immediately → no games where subjects do not converge in the direction of equilibrium with enough experience in the lab. The average guess for P-Beauty falls as contestants play multiple rounds in the lab.

Resources

Time, physical health, mental health, financial wealth, physical capital, social network

Optimization toolbox

Tradeoffs Budget constraints Opportunity Cost Cost-benefit analysis

Lessons from P-Beauty

Traditional game theory predicts that everyone is equally and perfectly rational, but real players are heterogeneous and imperfectly rational. - Different levels of experience - Different cognitive starting points - Different types of thinking - Different intensity of thinking In traditional game theory, it is impossible to consistently be one step ahead of the competition, because everyone anticipates everyone else's moves (assuming everyone is rational). But in real life, it is possible. Blindly applying rational game theory is almost never the best strategy in practice. Still useful, as it gives us information about some behavioral propensities, especially outcomes in repeated play. Successful strategies combine rational game theory and an understanding about the imperfect rationality of your opponents.

Normative analysis of taxation

Two normative approaches: 1. Welfare (eg ability to pay) - Focuses on outcomes - Could use a utilitarian, Rawlsian, or other framework - If you have a lot of money, you have more ability to pay 2. Process Fairness (eg benefits principle) - Benefits principle → do not pay for redistribution, more of a user fee (IE for military) - Some versions say you should pay taxes for what you get from the system, but not pay taxes for redistribution

Dictator game

Two subjects randomly assigned either decider or passive role. Decider divides $10 and money is allocated as proposed. Average allocation to passive in lab: $2 Average allocation to passive in EC10a: $2.57 A lot of people are materialistically focused on their own wellbeing, but some degree of pro-sociality is seen. Rawlsian preference leads decider to give something to passive. Reflects narrow bracketing, however: fail to consider bigger picture where you could take all of the $10 and donated to a targetable charitable donation.

Ultimatum game

Two subjects randomly assigned either proposer or recipient role. Proposer divides $10 between the two; recipient can accept or reject the proposal. Average proposal is $4. Average recipient cutoff is $2.50. Fear of social repercussions make us more generous. Is it prosocial or driven by strategy? Game theory says we need to be strategic and think through the actions of the other player. Negative reciprocity leads recipients to reject "unfairly" low offers. Anticipating this, proposers make more generous offers than they did in the dictator game. Lesson: some apparent sharing is actually motivated by self-interested considerations.

Universal Basic Income

Typical proposal: $12000 per year, remove certain benefits (IE cash welfare, unemployment, etc), keep others (social security retirement, medicare/aid) - Would cost $1.5 trillion, so need to increase taxes by a lot

Narrow Bracketing

We seem to focus on the task and people that are salient/present and fail to consider the bigger picture. IE: Events that occur later in time or outsiders who are deserving but escape our altruistic attention

How does government decide what goods to provide or regulate prices of?

Weigh the costs of high price and restricted quantity versus the cost of trying to regulate the monopoly - Highways and subways versus books

Philosophical (normative) approaches to equity

Welfare (consequentialist) Procedural fairness (deontological)

Way to measure the value of statistical life

What do people actually do to reduce risks of mortality? Buy a bicycle helmet, purchase car safety features, buy houses not near air pollution sources, etc.

Imperfect information (Market failure 3)

When not all relevant information is known, especially if one party does not know it. IE: Purchaser of insurance knows if they are clumsy more than the seller.

Export

When the world price is above domestic price In exporting nation, suppliers gain producer surplus while consumers lose consumer surplus, as they now pay the higher world cost. In net, society surplus increases.

Import

When the world price is below domestic price In importing nation, suppliers lose producer surplus while consumers gain consumer surplus, as they now pay the lower world cost. In net, society surplus increases.

Independent outcomes

When two random outcomes are independent, knowing about one outcome does not help you predict the other outcome - Roulette spins, coin tosses, dice throws, stock returns

First rule of positive tax analysis

Writing the check does not mean paying the tax (ie prices change) - Statutory incidence (what the law says) ≠ economic incidence (who ultimately bears cost of tax) - The ultimate incidence is the same whether the tax is levied on the producer or consumer - Generally, the cost of the tax is shared between the two parties - The more inelastic side fo the market pays more of the tax (more inelastic side is less price sensitive so in equilibrium will be willing to pay more of the tax)

Two PPCs

Y intercept: production of Y of both people added X intercept: production of X of both people added Meet at the point where the production of the people with comp. adv. ends

Procedural fairness

You cannot answer the question based on just looking at the outcomes, you need to have a view on the process.

Graph of perfectly elastic demand

horizontal line ED = ∞ slope is 0 (opposite of ∞)

Economists assume most people are risk...

risk neutral or risk averse - An appetite for risk is easy to satisfy - Just gamble (with fair odds) until you no longer want any more risk - At that point you are risk neutral or risk averse - Alternative argument: you can get paid to take risk (e.g., in the stock market), so why would you take risk for free? - This implies that everyone is risk averse - If you are compensated for taking risks, more likely to do it

Graph of perfectly inelastic demand

vertical line ED = 0 slope is ∞ (opposite of 0, since the formula is the opposite of slope)