PRIN MICROECONOMICS ECON 2000
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This 21 page Class Notes was uploaded by Bethany Conn on Tuesday October 13, 2015. The Class Notes belongs to ECON 2000 at Louisiana State University taught by Bernard Sharkey in Fall. Since its upload, it has received 49 views. For similar materials see /class/223036/econ-2000-louisiana-state-university in Economcs at Louisiana State University.
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Date Created: 10/13/15
Economics Fall 2011 Exam 1 Read Chapter 1 by Friday and do chapter 1 homework over weekend Friday Read Chapter 2 for Monday An Economic system must solve 3 problems 1 What and how much to produce 2 How to produce it 3 For whom to produce it Making Rational Decisions 0 Clarify goal or objective 0 Identify all alternative paths to help you get there 0 Evaluate the payoffs from each alternative 0 Select the best alternative and implement your decision Net Benefit considering benefit and cost Sunk cost money you can t get back water under the bridge example 0 Cost that has already been incurred and can t get back Ice Fishing image rational decisions are different based on interests Opportunity cost highest value of next alternative the one that you didn t choose 0 Highest alternative that must be given up to engage in an activity 0 Making a decision and what are you losing when the choice is made 0 Ex Football or Party What will I get out of either Pick the one with the greatest level of satisfaction or benefit 0 0C is what is forfeited when a choice is made what you give up Cost is always less than the benefit of what you have chosen It is the basis of costbenefit economics 0 Individual decisions the DC of college includes the items you could have purchased with the money you spent on tuition and books or loss of the income from a full time job Government decisions the DC of money spent on the war on terrorism is less spending on health care and education 0 Decisions are made at the Margin weighing the additional marginal benefits of a change and the additional marginal cost of a change with respect to current conditions 0 Marginal benefits additional benefits the benefits connected 0 Marginal costs cost connected to consuming additional unit of a good or undertaking one or more unit of an activity 0 Additional benefits are benefits that come along Economics Fall 2011 Exam 1 0 Example Three bridges have been built and a study was done that said they cost 30 million and the benefit is 42 million dollars A politician hears this and says let s build another bridge He s wrong because he doesn t know the price per bridge or the benefit from each bridge Politician was comparing averages Must determine decisions by margin Question what will be the cost and what will be the benefit of the next bridge 0 Bridge cost bridge 1 8 mill Bridge 2 10 mill Bridge 3 12 mill 0 Bridge benefit bridge 1 16 mill Bridge 2 14 mill Bridge 3 12 mill 0 The cost of bridge 4 14 mill would exceed the benefit 10 mill 0 Marginal changes are small incremental adjustments to an existing plan of action People make decisions by comparing costs and benefits at the margin Marginal changes in cost or benefit motivate people to respond The decision to choose one benefit over another occurs when that alternative s marginal benefit exceeds its marginal cost Economic decision rule if the marginal benefits of doing something are greater than the cost you do it If marginal costs exceed benefits don t do it Maslow s Hierarchy of Needs 0 Physiological eating health sleeping survival 0 Safety shelter protection from danger 0 Love affection belonging o Esteem self esteem esteem from others 0 Selfactualization achieving individual potential DevilAngel Shaker Marginal analysis additional cost andor benefit Marginal reasoning what we had to use to determine the amount of salt in the pepper shaker and pepper in the salt shaker o Teaspoon additional change concentrate on teaspoon instead of shaker where we began Marginal value is not fixed it changes depending on where you are Efficient market a market in which profit opportunities are eliminated almost instantaneously o Efficiency marginal benefit equals marginal cost Industrial Revolution late 18th 19th century when increases of agriculture manufacturing technologies and the development of more efficient modes oftransportation led people in Britain to move from the country side to the city Economics Fall 2011 Exam 1 Microeconomics the branch of economics that examines the functioning of individual industries and the behavior of individual decision making units business firms and households Labor economics deals with wage rates employment and unemployment Economic development deals with problems faced by low income countries Normative Economic Analysis approach to economics that analyzes outcomes of economic behavior Involves judgment and prescription for course of action Positive Economic Analysis seeks to understand behavior and the operation of systems without makingjudgments Describes what exists and how it works without making judgment Model a formal statement of theory usually a mathematical statement of a presumed relationship between two or more variables Variable can change over time or across observations Ceteris paribus all else equal to isolate the impact of one single variable we use this assumption 0 Helps simplify reality to focus on the relationship that interest us 0 We are able to isolate one single factor Post hoc ergo propter hoc quotafter this therefore because of thisquot A common error made in thinking about causation Equity refers to fairness Trade off idea that because of scarcity producing more of one good or service means producing less of another good or service 0 Tradeoffs force society to make choices 0 1 What goods will be produced 0 2 How will the goods be produced 0 3 Who will receive the goods produced Scarcity condition in which our wants are greater than the limited resources available to satisfy those wants goods are wanted more than they are produced 0 The science of Scarcity o The science of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those wants 0 The limited amount to satisfy wants 0 Scarcity exists because individuals want more than can be produced Economics Fall 2011 Exam 1 o It is constantly changing o The quantity of goods services and usable resources depends on human technology 0 The goods available are too few to satisfy individuals desires Economics and Market Forces 0 When goods are scarce they must be rationed by some mechanism 0 Economic forces are the necessary reactions to scarcity o A market force is an economic circumstance that is given relatively free reign by society to work through the market 0 Markets are a good way to organize economic activity Market Economy 0 Economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services 0 Households decide what they buy and who to work for 0 Firms decide who to hire and what they produce 0 Market forces ration by changing prices 0 The quotinvisible hand is the price mechanism that guides price markets 0 When there is a shortage the price increases when there is a surplus the price decreases 0 Adam Smith made the observation that that households and firms interacting in markets act as if they are being guided by an invisible hand 0 What happens in society can be seen as a reaction to the interaction of economic forces invisible hand social forces and historical forces 0 Social political and cultural forces influence market forces 0 Social and political forces often work against the political hand The Invisible hand theory 0 Price has a tendency to fall when the quantity supplied is greater than the quantity demanded 0 Price has a tendency to rise when the quantity demanded is greater than the quantity suppHed 0 Quantity supplied a change in quantity the producer is willing to supply based on a change in price 0 According to the invisible hand theory a market economy through price mechanism will allocate resources efficiently o Efficiency achieving a goal as cheaply as possible Policy Analysis 0 To make clear the distinction between objective and subjective analysis economics is devided into 3 categories Positive Economics Normative Economics and Art of Economics 0 Positive Economics Study of what is how the economy works 0 Normative Economics Study of what the goals of the economy should be 0 Art of Economics the application of knowledge learned in positive economics to achieve the goals learned in normative economics Economics Fall 2011 Exam 1 Positive Statements Statements that attempt to describe the world as is descriptive analysis 0 Studies economic behavior without making judgment 0 Describes what exists and how it works Normative Statements Statements about what the world should be prescriptive analysis 0 Also called POLICY OF ECONOMICS analyzes outcomes of economic behavior 0 Evaluates them as good or bad and may provide courses of actions Unintended affects positive or negative outcome that was not anticipated The production possibility curve 0 Illustrates opportunity cost by showing trade off among choices we make 0 It measures the maximum number of outputs from a given number of inputs 0 An output is a result of an activity 0 An input is what you put in production process to achieve an output 0 Can be presented in a table or a graph 0 There is a limit to what you can achieve given the existing institutions resources and technology 0 Every choice made has an opportunity cost you can get more of something only by giving up something else 0 Opportunity cost units of goods forgonelostunits of goods produced I See notes for Elizabeth and Bryan example 0 Law of increasing Opportunity cost I As more ofa good is produced the opportunity of producing that good increases 0 The PPC is bowed outward so that reflects that it is increasing 0 Any point with in the PPC represents inefficiency 0 Any point outside the PPC is unattainable given present resources and technology Shifts in PPC 0 Society can produce more output if 0 Technology is improved 0 More resources are discovered 0 Economic institutions are improved 0 More output is represented by an outward shift in the curve 0 MThese could shift the curve 0 Possible Shifts in the PPC Curve 0 Increase production of all goods gt shift in curve outward Decrease in production of all goods gtshift in curve inward Improvement in one vs the other gt shift outward on the one axis Decrease in Production in one vs the other gt shift inward on the one axis One good improves and the other decreases gt shift outward along one axis shift inward along the other Productive Efficiency 0 Achieving as much output as possible from a given amount of resources 0 Occurs at any point on the ppc O O O O Economics Fall 2011 Exam 1 Increasing Marginal Opportunity Cost states that the opportunity costs increase as you produce more of one product Productive Efficiency and Inefficiency o Productive Efficiency The condition where the maximum output is produced with given resources and technology Achieving as much output as possible from given amount of resources occurs at any point PPC o Productive Inefficiency The condition where less than the maximum output is produced with given resources and technology Productive inefficiency implies that more of one good can be produced without any less of another good being produced Any point within the PPC 0 Any point outside the PPC is unattainable given present resources and technology Comparative Advantagewhen the resource has an advantage because the resources are better suited for producing a certain thing 0 The reason the opportunity cost of guns increases as we produce more guns is that some resources have comparative over other resources 0 A resource has comparative advantage if it has the ability to be better suited to the production of one good than another Efficiency and Inefficiency o Productive Efficiency 0 o Achieving as much output as possible from a given amount of resources or inputs 0 Occurs at any point of the PPC o Inefficiency o The condition where less than the maximum output is produced with given resources and technology Productive inefficiency implies that more of one good can be produced without any less of another good being produced 0 Any point within the curve 0 Unattainable 0 Any point outside of the PPC given present resources and technology Economic Growth 0 An increase in resources or an advance in technology can increase the production capabilities of an economy leading to economic growth and shift outward in the production possibilities frontier o The ability of the economy to produce increasing quantities of goods and services Advance in technology 0 An advance in technology commonly refers to the ability to produce more output with a fixed amount of resources or the ability to produce the same output with fewer resources 0 PPF can illustrate 7 economic concepts 0 Scarcity 0 Choice 0 Opportunity cost 0 Productive Efficiency 0 Productive inefficiency Economics Fall 2011 Exam 1 o Unemployment 0 Economic growth Trade and comparative advantage 0 The PPC is bowed because individuals specialize in the production of goods for which they have a comparative advantage 0 For a society to produce on its PPC individuals most produce those goods for which they have a comparative advantage and trade for other goods 0 According to Adam Smith humankind s proclivity to trade leads to individuals using their comparative advantages Exchange or Trade 0 Exchange 0 The process of giving up one thing for another 0 Terms of Trade 0 How much of one thing is given up for how much of something else 0 Transaction Costs Costnegative effects of the trade 0 The costs associated with the time and effort needed to search out negotiate and consummate and exchange 0 Comparative advantage 0 Ability to produce a good at a lower opportunity cost than another producer 0 Benefits of Trade Benefitpositive effect of the trade I Allows people to specialize in activities in which they have a comparative advantage 0 Absolute advantage 0 Producer can produce that product using fewer resources than another producer Economics Fall 2011 Exam 1 Scarcity and Choice in an Economy of Two or More 0 A producer has an absolute advantage over another in the production ofa good or service if it can be produced that product using fewer resources 0 A producer has a comparative advantage in the production of a good or service over another if it can produce that product at a lower opportunity cost Specialization Exchange and Comparative Advantage 0 According to the theory of competitive advantage specialization and free trade will benefit all trading parties even those that may be absolutely more efficient producers Opportunity Cost and Comparative Advantage o Compares producers ofa good according to their opportunity cost 0 Whatever must be given up to obtain some item 0 The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good 0 Opportunity cost of a good or service Units of good or service forgone Units of good or service produced 0 Opportunity cost of Elizabeth making apples going from 20 bread to 10 bread 10 apples 10 loafs of bread forgone 10 apples produced 1 Comparative Advantage and Trade 0 Comparative Advantage and the Gains from Trade 0 The basis for trade is comparative advantage not absolute advantage I Absolute 0 Individuals firms and countries are better off if they specialize in producing goods and services for which they have a comparative advantage and obtain the other goods and services they need by trading 0 Example You all time picking apples 20 LBS neighbor 30 LBS o All time picking cherries 20 BS 60 LBS o Neighbor has absolute advantage Neighbor has comparative advantage in picking cherries You have comparative advantage in apples Can still benefit from trade 0 Example Thelma can produce 1000 bars and 500 sandwiches Louise can produce 750 bars and 500 sandwiches 0 Louise has a I 39 39 t in for every 2 Thelma gives up Louise gives up 1 Gains of Trading 0 Suppose Pakistan has a comparative advantage in producing fabric and Belgium has a comparative advantage in producing chocolate 0 Pakistan can produce either 4000 yards of fabric 1 ton of chocolate or any proportional combination of the two 0 Belgium can produce either 1000 yards of fabric 4 tons of chocolate or any proportional combination of the two Comparative Advantage and the PPC 0 Another way to show trade is to combine both PPC into one curve o If both countries produce only fabric they can produce 5000 yards and Thelma s in bars because Economics Fall 2011 Exam 1 o If both countries produce only chocolate they can produce 5 tons o If each country specialized they can produce 4000 yards of fabric and 4 tons of chocolate 0 Combined PPC is way out in the unattainable region if they both produce each Outsourcing Trade and Comparative Advantage o Outsourcing I The relocation of production once done in the United States to foreign countries I Occurs because many other countries have a comparative advantage in labor costs I The US hasa I 39 J U in 39 39 U 39 39 39 39structureand specialized knowledge Globalization 0 The increasing integration of economics cultures and institutions across the world 0 A positive effect of globalization is that it provides larger markets that the domestic economy 0 The global economy increases the number of competitors and this increases competition can be a negative effect of globalization Exchange Rates and Comparative Advantage o The US comparative advantage in innovation results in higher wages in the US 0 As industries mature they move to lower wage countries 0 In order to regain our comparative advantage the US exchange rate will decline and foreign wages will increase to make US exports cheaper and imports to the US more expensive The Law of One Price 0 The law of one price is the wages of equal workers in one country will not differ significantly from the wages of workers in another institutionally similar country The US Economy The US economy is a market economy which is an economic system based on private property and the markets in which individuals decide how what and for whom to produce 0 Markets work through a system of rewards and payments 0 Individuals are free to do whatever they want as long as it is legal 0 Fluctuations in prices play a central role in coordinating individuals wants in a market economy Most economists believe the market is a good way to coordinate economic activity Capitalism and Socialism Capitalism is an economic system based on the market in which the ownership of the means of production resides with a small group of individuals capitalists Socialism is an economic system based on individuals goodwill towards others not on their own self interest and in which in principle society decides what how and for whom to produce Evolving Economic Systems Feudalism is an economic system based on tradition and dominated the western world from the 8 h to the 15 h century 9 Mercantilism is an economic system in which the government controls economic Economics Fall 2011 Exam 1 activity by doling out the rights to undertake economic activities and was dominant until the 18 h century 9 During the industrial revolution technology and machines rapidly modernized industrial production 9 Capitalism 0 Businesses I Businesses are private producing units in our society I Businesses in the US decide what to produce how much to produce and for whom to produce it I Businesses produce what they believe will sell and make a profit By channeling the desire to make a profit for the general good of society the US economic system allows the invisible hand to work Although businesses decide what to produce they are guided by consumer sovereignty Types of business 0 Proprietorship direct control by owner unlimited personal liability o Advantage minimum bureaucratic hassle direct control by owner 0 Disadvantages limited ability to get funds unlimited personal liability o Partnership share work and risk limited ability to get funds unlimited personal liability o Advantage Ability to share work and risk relatively easy to form 0 Disadvantages Limited ability to get funds unlimited personal liability even for a partner s blunder o Corporation no personal liability increase ability to get funds legal hassle to organize 0 Advantages No personal liability increasing ability to get funds ability to avoid personal income taxes 0 Disadvantages Legal hassle to organize possible double taxation monitoring problems I ECommerce and the Digital Economy 0 Business to Business B2B 0 Firms exchanging goods and services through online sales and auctions 0 Business to Consumer BZC 0 Firms selling goods and services to consumer through online catalogs 0 Consumer to Business 0 An individual offering goods 0 Consumer to Consumer o Households I Groups of individuals living together making joint decisions Supply the labor with which businesses produce and government governs I Largest source of income is wages and salaries I Households vote with their dollars to determine what businesses produce 0 Economics Fall 2011 Exam 1 Make a significant number of decisions in the economy Government The government plays two general roles in the economy 0 1 An actor who collects money in taxes and spend that money on projects such as defense and education 0 2 A referee who sets the rules that determine relations between businesses and households Various levels of government each with its own powers Consume about 15 of the country s total output and employ over 22 million Government as a referee 0 Equal opp And labor laws 0 Safety and overtime 0 Prices they will charge 0 Unions 6 Roles of a Government in a Market 0 Providing Stable set of institutions and rules 0 Promoting Effective and workable competition 0 Correcting for externalities 3rd party impacted 0 Ensuring economic stability and growth 0 Providing public goods 0 Adjusting for undesirable market results Economics Fall 2011 Exam 1 I Government and Choice Architecture 0 Economists are hesitant to have government tell people what is best for them but behavioral economists suggest that government might be able to quotnudgequot people s choices in a positive way 0 How choices are presented affect the choices people make and nudges take this into account 0 An example is the default option bias people tend to choose whatever is presented as the default option Market Failures and Government Failures 0 Market failures are situations in which the market does not leas to a desired result 0 Government failures are situations in which the government intervenes and make things worse 0 Policy makers must decide which failure is the least problematic a market or government failure Global Institutions and Corporations 0 The US economy makes up 20 of the worlds output and consumption but only 6 of the worlds land mass and less than 5 of the worlds population 0 US economic institutions are integrated with the world s economy 0 Global corporations are corporations with substantial operations in both productions and sales in more than one country 0 Global corporations create jobs bring new technologies and provide competition or domestic companies Coordinating Global Issues 0 There is no global government to regulate global corporations but government have developed international institutions to promote negotiations and coordinate economic relations among countries 0 Some examples of international institutions 0 The united nations is an organization designed to achieve international cooperation but it has no ability to tax or enforce its policies on its members 0 The world bank is a multinational international financial institution that world to secure loans for developing countries 0 Markets and Competition 0 Market I Is where a group of buyers and sellers of a particular good 0 The terms supply and demand refer to the behavior of people as they interact with one another in markets I Buyers determine demand I Seller determine supply 0 A competitive market I A market in which there are many buyers and sellers so that each has a negligible impact on the market price 0 Demand I The willingness and ability of buyers to purchase different quantities of a good at different prices during a specific time period 0 The Law of Demand I The quantity ofa good demanded is inversely related to the good s price I Quantity demanded rises as price falls Economics Fall 2011 Exam 1 I Quantity demanded falls and price rises As prices change people change how much they re willing to buy I Based on the fact that when prices for a good rise people substitute away from that good to other goods I As the price of a good rises the quantity demanded of the good falls and as the price of a good falls the quantity demanded of the goo rises ceteris paribus I Price and quantity demanded have an inverse relationship I Demand curve slopes downward Ceteris Paribus O O A Latin term meaning llall other things constantquot or llnothing else changesquot An assumption used to examine the effect ofone influence on an outcome while holding all other influences constant Other Things Constant I Other things constant places a limitation on the application on the law of demand I All other factors such as changing tastes prices of other goods income and even the weather are assumed to remain constant weather they actually remain constant on not Demand Schedule I The numerical tabulation of the quantity demanded of a good at different prices I The numerical representation of the law of demand I Demand curve 0 A graph of the relationship between price and quantity demanded o Slopes downward and to the right 0 As price goes up the quantity demanded goes down and vice versa Market demand vs individual demand I The sum ofall individual demands for a particular good or service I Individual demand curves are summed horizontally to obtain the market demand curve Sift in the demand vs movements along a demand curve I Quantity demanded specific amount that will be demanded per unit of time at a specific price other things constant 0 Specific point on the demand curve 0 Change in price changes quantity demanded o A change in price causes a change in quantity demanded o A change in price causes a movement along the demand curve 0 The demand does not change the quantity demanded changes I Demand refers to the entire schedule of quantities of a good that will be bought per unit of time at various prices 0 Entire demand curve 0 Tells us how much will be bought at various prices 0 A change in anything other that price that affects the demand curve changes the entire demand curve 0 A change in the entire demand curve is a shift in demand Economics Fall 2011 Exam 1 The Demand Side of the Market What explains the Law of Demand 0 Substitution effect the change in the quantity demanded of a good that results from a change in price making the good more or less expensive relative to other goods that are substitutes 0 Income effect the change in the quantity demanded of a good that results from the effect of a change in the good s price on consumers purchasing power Variables that shift market demand 0 Income 0 Normal good a good for which the demand increases as income rises and decreased as income falls 0 Inferior good a good for which the demand increases as income falls and decreases as income rises Price of related goods 0 Substitutes goods and services that can be used for the same purpose 0 Complements goods and services that are used together Tastes Consumers can be influenced by an advertising campaign for a product Population and demographics 0 Demographics the characteristics of a population which respect to age race and gender Expected Future Prices Consumers choose not only which products to buy but also when to buy them 0 Shift Factors in Demand I Factors that cause changes in demand 0 Society s income 0 An increase in income will increase demand for normal goods 0 An increase in income will decrease demand for inferior goods Price of other goods 0 When the price ofa substitute good falls Demand falls for the good whose price has not changed 0 When the price of a complement good falls demand rises for the good whose price has not changed Tastes o A change in taste will change demand with no change in price Expectations 0 If you expect your income to rise you may consume more now 0 If you expect prices to fall in the future you may put off purchase today Taxes and subsidies to consumers 0 Taxes increase the cost of goods thereby reducing demand 0 Subsidies have an opposite effect 0 Substitute goods I Two goods that satisfy similar needs or desires I If two goods are substitutes the demand for one rises as the prices of the other falls 0 Complement goods Economics Fall 2011 Exam 1 I Two goods that are used jointly in consumption I If two goods are complements the demand for one rises as the price of the other falls 0 The Law of Supply I The quantity of a good supplied is directly related to the good s price I Quantity supplied rises as the prices rises I Quantity supplied falls as the price falls I When the price rises firms substitute production of one good for another I Assuming a firms cost are constant a higher price means higher profit 0 Shifts in Supply vs Movements along a Supply Curve I Quantity supplied refers to a specific amount that will be supplied per unit of time at a specific price other things constant 0 A change in price changes quantity supplied 0 A change in price causes a movement along the supply curve I Supply refers to a schedule of quantities of a good a seller is willing to sell per unit of time at various prices 0 A change in anything other than price that affects the supply curve changes the entire supply curve 0 A change in the entire supply curve is a shift in supply 0 Refers to the entire supply curve 0 Supply tells us how much will be sold at various prices I Shift Factors in Supply 0 Price of inputs 0 Technology 0 Expectations 0 Taxes and subsidies 0 Interaction of Supply and Demand I Equilibrium o Opposing dynamic forces cancel each other out I In the free market the forces of supply and demand interact to determine 0 Equilibrium quantity is the amount bought and sold at equilibrium prices 0 Equilibrium price is the price toward which the invisible hand drives the market I If there is an excess supply quantity supplied is greater then the quantity demanded I If there is excess demand quantity demanded is greater than quantity supplied I Prices adjust and tend to rise when there is excess demand and fall when there is excess supply ECON 2000 NOTES FINAL EXAM Externalities Externalities are the effects of a decision on a third party that are not taken into account by the decision maker 0 Negative Externalities occur when the effects are detrimental to others I Ex Secondhand smoke and carbon monoxide emissions 0 Positive Externalities occur when the effects are beneficial to others I Ex Education Effect of Externalities on Market Outcomes When either negative or positive externalities exist the market output is different from the socially optimal output In the case of a negative externality the market is said to overproduce the good connected with the negative externality the socially optimal output is less than the market output In the case of a positive externality the market is said to under produce the good connected with the positive externality the socially optimal output is greater than the market output A Negative Externality Example When there are negative externalities the marginal social cost differs from the marginal private cost The marginal social cost includes the marginal private costs of production plus the cost of negative externalities associated with that production 0 It includes all the marginal costs that society bears Marginal Social Costs MSC and Benefits MSB The sum ofmarginal private costs MPC and marginal external costs MEC MSCMPCMEC The sum ofmarginal private benefits MPB and marginal external benefits MEB MSBMPBMEB Socially Optimal Amount Output An amount that takes into account and adjusts for all benefits external and private and all costs external and private The socially optimal amount is the amount at which MSBMSC Sometimes the socially optimal amount is referred to as the efficient amount Internalizing Externalities I An externality is internalized ifthe persons or group that generated the externality incorporate into their own private or internal costbenefit calculations the external benefits in the case ofa positive externality or the external costs in the case ofa negative externality that third parties bear Methods of Dealing with Externalities Direct regulation is when the government directly limits the amount ofa good people are allowed to use Incentive Policies 0 Tax Incentives are programs using a tax to create incentives for individuals to structure their activities in a way that is consistent with the desired ends 0 Market Incentives are plans requiring market participants to certify that they have reduced total consumption by a certain amount Voluntary solutions The Environment Some pollution is likely to be a better situation than no pollution The reason is that people derive utility from things that cause pollution such as cars to drive There is more than one way to tackle environmental problems For example both setting standards and selling pollution permits can be used to deal with pollution The economists is interested in finding the cheapest way to solve environmental problems Often this tends to be through some measure of market environmentalism Why Income Equality Exists Income inequality exists because individuals differ in 0 Their innate abilities and attributes Their choices of work and leisure Their education and other training human capital Their attitudes about risk taking The luck they experience 0 The amount ofwage discrimination directed against them Some income inequality is the result ofvoluntary choices and some is not 0 O O 0 Human Capital Education development of skills and anything else that is particular to the individual and increases his or her productivity Wage Discrimination The situation that exists when individuals of equal ability and productivity as measured by their contribution to output are paid different wage rates Transfer Payments Payments to persons that are not made in return for goods and services currently supplied InKind Transfer Payments Transfer payments such as food stamps medical assistance and subsidized housing that are made in a specific good or service rather than in cash The Lorenz Curve A Lorenz curve is a geometric representation ofthe share distribution ofincome among families in a given country at a given time o It measures the cumulative percentage offamill39es on the horizontal axis arranged from poorest to richest and the cumulative percentage offaml39ly income on the vertical axis 0 Both axes start at zero and end at 100 Poverty and Data The income poverty threshold or poverty line is the income level below which a family or person is considered poor and living in poverty Limitations ofpoverty income statistics The statistics are usually not adjusted for o Inkind benefits 0 Unreported and illegal income and 0 Regional differences in the cost of living and The statistics do not count the poor who exist but are out of sight such as some ofthe homeless The Distribution of Wealth Wealth is the value of assets individuals own less the value of what they owe o It is a stock concept representing the value of assets such as houses buildings and machines Income is payments received plus or minus changes in value of a person assets in a specified time period 0 It is a ow concept a stream through time In the US wealth is significantly more unequally distributed than is income The Gini Coefficient A Gini coefficient ofO means perfect income equality a Gini coefficient of 1 means complete income inequality The larger the Gini coefficient the greater the income inequality The smaller the Gini coefficient the lower the income inequality Fairness and Equality Most Americans see fairness as equality of opportunity There are great differences of opinion as to what constitutes equal opportunityquot There are three problems in determining whether an equal income distribution is fair 1 People do not start from equivalent positions 2 People39s needs differ 3 People39s efforts differ Income Redistribution Policies The government redistributes income through direct and indirect methods The direct methods include o Taxation which are policies that tax the rich more than the poor 0 Expenditures which are programs that help the poor more than the rich The indirect method involves the establishment and protection of property rights Government Redistribution of IncomeSocial Insurance The socialinsurance justification holds that individuals not currently receiving redistributed monies may one day find themselves in a position where they will need to so they are willing to take out a form of insurance In essence they are willing to support redistribution programs today so that these programs exist ifthey should need them in the future Taxation to Redistribute Income 0 A progressive tax is a one in which the average tax rate increases with income 0 It redistributes income from the rich to the poor 0 A proportional tax is a one in which the average tax rate is constant regardless ofincome 0 It is neutral in regard to income redistribution o A regressive tax is a one in which the average tax rate decreases as income increases 0 It redistributes income from poor to rich Expenditure Programs to Redistribute Income 0 Expenditure programs have been more successful than taxation for redistributing income 0 Example of Expenditure programs 0 O 0 Social Security is a social insurance program that provides financial benefits to the elderly and disabled and to their eligible dependents andor survivors Medicare is a medical insurance system for retired people Public assistance programs are meanstested social programs that provide financial nutritional medical and housing assistance and include I Temporary Assistance for Needy Families TANF I Supplemental Nutritional Assistance Program SNAP I Medicaid I General assistance Supplemental Security Income SSI is a federal program that pays benefits based on need to the elderly blind and disabled Unemployment Compensation is shortterm financial assistance regardless of need to eligible individuals who are temporarily out ofwork Housing Programs are federal and state programs to improve housing or to provide affordable housing
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