Economic Analysis of Public Policy

Vocabulary practice flashcards covering fundamental concepts across Modules 01 through 05 of the Economic Analysis of Public Policy course, including price theory, market failures, game theory, and firm structure.

Peltzman Effect

The behavioral tendency of individuals to react to a safety regulation by engaging in riskier behavior, resulting in an offset where safer cars reduce injury risk per crash while increased risky driving increases the total number of accidents.

Economic Rationality

The foundational economic assumption that, given an individual's objectives, economic theory explains individual behaviors as the actions chosen to best achieve those objectives, imposing no technical restrictions on what those objectives may be.

Correlation vs. Causation

The empirical principle stating that two variables moving simultaneously does not indicate that one causes the other; both may be driven by an underlying common factor, such as warm weather driving both ice cream sales and shark encounters.

Price as an Information Aggregator

The market function whereby prices summarize and communicate dispersed information across buyers and sellers, coordinating production and consumption without requiring a centralized planner or costly information collection.

Anti-Price Gouging Laws

Government legal prohibitions against raising prices during emergency shortages, which suppress incentives for suppliers to expand output or import goods, discourage newcomers, induce hoarding, and often cause severe shortages or black markets.

Circular Flow Model

A visual framework depicting how households provide productive inputs like labor to firms in the resource market in exchange for income, and then use that income to buy goods and services produced by firms in the goods and services market.

Talent Allocation via Prices

The market process where high sustained demand pushes up wages in a given profession, incentivizing individuals to invest time and resources into building that specific human capital and establishing a stable supply.

Negative Commerce Clause

A legal principle prohibiting state governments from passing legislation that discriminates against out-of-state economic activities or shields local markets from interstate competition.

Internal Affairs Doctrine

A corporate law conflict-of-laws principle mandating that matters internal to a corporation are governed exclusively by the laws of the state or jurisdiction in which it is incorporated.

Pareto Efficiency

A condition in resource or output allocation under which it is impossible to make any individual better off without making at least one other individual worse off.

Capital Asset Pricing Model (CAPM)

A financial model illustrating the relationship between systematic risk and expected return for assets, depicting individual assets plotted against an efficient frontier and the capital allocation line (CAL) tangent to the optimal portfolio.

Arrow's Theorem (Competitive Equilibrium Benchmark)

The theoretical benchmark demonstrating that in an economy free of market imperfections, competitive markets and price mechanisms allocate resources efficiently, serving as an origin point from which real-world market failures deviate along dimensions $x$, $y$, and $z$.

Public Good

A good that can be consumed by any person without diminishing its availability to others, whose total societal value is the sum of the valuations that all consumers place on each unit, typically troubled by the inability to exclude non-payers.

Externalities

The external costs or benefits that an individual's or firm's actions impose on third parties without negotiated compensation or market exchange, exemplified by pollution.

Information Asymmetry

A market condition occurring when different transacting parties possess unequal information regarding product quality, risks, or actions, analyzed by economists George Akerlof, James Mirrlees, and Joseph Stiglitz.

Nash Equilibrium

A state in game theory where each player selects a strategy that maximizes their payoff given the strategies chosen by all other players, leaving no player with a unilateral incentive to alter their choice.

Focal Point

A concept introduced by Thomas C. Schelling describing a Nash equilibrium that players naturally converge on in the absence of communication because it appears prominent, conspicuous, or self-evident.

Option Value of Waiting

The economic principle formulated by Avinash Dixit and Robert Pindyck establishing that when investments involve irreversibility under uncertainty, delaying commitment has value because time brings new information that would be forfeited upon immediate expenditure.

Firm

A specialized form of business organization legally established by individuals with the clear evolutionary objective of adapting to its economic environment to generate profit.

Principle of Organizational Separation

The organizational rule dictating that entities created for one specific purpose should not be redirected toward another, ensuring personal affairs are distinct from business affairs, and separating profit-seeking firms from trusts, schools, and hospitals.

The Golden Rule of Demand

The market principle stating that businesses earn zero revenue unless they create goods or services that consumers value and are willing to pay for, directly or indirectly.

Limited Liability

A corporate characteristic that restricts an investor's or owner's financial loss to the amount of capital contributed to the firm, shielding personal assets from company debts and legal claims.

Transferable Shares

A legal feature of publicly traded corporations permitting ownership stakes to be exchanged smoothly on secondary markets, substantially lowering the firm's financing costs and required risk premium.

Double Taxation

A corporate tax structure where business profits are taxed first at the entity level as corporate income tax and subsequently at the owner level when distributed as dividends.

Sands in the Gear

A metaphor for regulatory and bureaucratic frictions—such as complex registration steps, burdensome permits, licensing rules, fire safety mandates, and labor restrictions—that slow down business entry, operation, and resource reallocation.