American Economy Final

Capitalism

private ownership of means or production, market allocation of goods and services, compare Laissez faire capitalism with welfare capitalism

Communism

means of production are public (belong to state). Centralized decision-making, state decides things

Hybrid/mixed systems

very heavy state ownership, market allocation adopted, think China or Cuba

Main goals of Economic Policy

1. Economic Growth → long-run increases in output, productivity, and living standards

2. Efficiency (microeconomic principle) → allocating resources to highest-value, minimising waste, and avoiding DWL

3. Fairness / Equity → politically contested concept, who deserves what, how resources should be distributed, and what counts as equality

4. Liberty → balance freedom with state intervention. Positive liberty: freedom to pursue opportunities. Negative liberty: freedom from government interference

5. National Security → protecting nation’s stability and resilience, includes defense spending, supply chains, energy independence, cybersecurity, and infrastructure

6. Ethics → moral constraints on markets, e.g. bans on organ markets, child labour laws, workplace safety standards

Stone Reading/theories of fairness/efficiency-equity tradeoff

problem—equality = sameness, equity = fairness. Three dimensions of equity (defining the recipients, defining the item, defining the process).

Nozick theory of fairness

Nozick: Fairness as Process

A distribution is fair if the process by which people acquired holdings was fair, e.g. justice in transfer, justice in acquisition, no need to examine results

Key Points:

Distributions reflect voluntary exchange

Redistribution violates liberty because it takes legitimately acquired holdings

Property is individually created

Liberty = freedom from interference

Policy implication: fix unfair process, but do not redistribute

outcomes

Rawls theory of fairness

Rawks: Fairness as End-Result

Asks what rules people would choose behind a veil of ignorance

An experiment used to determine what fair social rules would look like. Behind the veil, individuals designing society do not know their own position. Because personal advantages or disadvantages are hidden, people cannot rig the rules in their own favor and they must choose institutions that are fair to every position, including the most vulnerable.

Maxmin principle:

society should choose an arrangement where worst-off group is as well off as possible.

Provision of primary goods (essential things rational people want no matter circumstance) and social safety net, agreed behind the veil of ignorance.

Fairness disagreements

Process vs end-result, two concepts of liberty, individual vs collective creation of value, motivation

Free rider problem

When individuals benefit from a good without contributing to a cost

. Appears in government interventions/solutions to market failures: public goods (national defense, parks, lighthouses) → markets under provide and government must tax and provide goods because voluntary contributions are insufficient. In regulation, people may demand stricter standards but avoid personal cost (eg environmental regulation). In redistribution, people may support redistribution but minimize tax payments

Appears in political economics. Voteres free-ride on being informed, lobbying , etc

Main economic features of labor markets

Productivity, LFPR, unemployment, wages, per capita income, etc

Reasons for government interventions in labor markets

Labor determines a large aspect of a person’s life

Bargaining power of individual sellers is weaker than those of individual buyers

Voluntary effort required for optimal production

Workers enter authoritarian relationship with their employers

Large scale unemployment can lead to social upheaval

Rent-seeking

Pursuit of excess profit above the normal market payoff that the government can create through legislation and regulation.

Connection to government involvement in economy

1. capture regulatory benefits

2. influence distribution of public funds

3. shape rules to disadvantage competitiors

4. Causes issues with govenrment intervention, such as with externalities and cap and trade.

Downsian model

Explains democratic political behavior—parties are vote-maximizers and thus converge on the median voter.

Median voter preferences impact government intervention in the economy in two ways: swing states, legislative committees

Key institutions

CBO - legislative, congressional budget office. provide crucial objective analysis for Congress on budgets and economics, helping lawmakers make informed fiscal policy (nonpartisan)

OMB - executive, office of management and budget, oversees federal budget, manages agency performance, develops regulations, and helps implement presidential priorities across the government.

Treasury - manages fiscal policy (government spending, revenue, debt)

Fed - handles monetary policy (money supply, interest rates)

3 big roles of state

1. Setting the rules of market and enforcing/defining property rights

2. Fixing market failures (when not Pareto efficient)

3. Efficiency-equity tradeoff (when Pareto efficient)

Inequality, main things to measure

Income (labor income, capital income), consumption, wealth

Inequality, ways to measure

Mean-median divergence, gini coefficient, percentages of quantiles, desciles etc

Big episodes of regulation in US

Progressive era, new deal, great society, deregulation, covid, trump 2nd term

Progressive era

Late 1800s

-It happened because rapid industrialisation created monopolies, unsafe products, labour exploitation, and political corruption

-Major Problems: railroads and oil monopolies, price-fixing and cartels, child labour / unsafe workplaces, food and drug safety issues, lack ofcompetition

- Key Policies: Sherman AntiTrust Act (1890), Clayton ACt (1914), Federal Trade Commission, Pure Food and DRug Act (1906)

-Logic: gov intervened to restore competition, break monopolies, andestablish baseline consumer protections

New Deal

(1933-1950s)

- Happened because Great Depression exposed systemic financial failures, mass unemployment, and collapse of private insurance and banking systems

- Major Problems: bank runs, mass unemployment, financial market instability, collapse of farm prices, lack of social insurance, and safety nets

- Key Policies / Agencies: Glass-Steagall Act (bank separation), FDIC (deposit insurance), SEC (securities regulation), NLRB (labour rights and unions), Social Security Act (1935)

- Logic: gov took on a major role in financial stabilisation, labour regulation, and created American welfare state

Great society

Happened because continued poverty, racial inequality, and lack of universal access to healthcare and education drove demand for social expansion

- Major Problems: persistent poverty, racial discrimination, elderly lacking health coverage, urban crisis, and expanding corporate power

- Key Policies / Agencies: Medicare and Medicaid (1965), Civil Rights Act (1964), Voting Rights Act (1965), Environmental Protection Agency (EPA)

- Medicare, Medicaid

-War on Poverty

-Logic: gov shifted towards ensuring equity, civil rights, health care access, and environmental

Deregulation

(1970s-1990s)

-Happened because stagflation, inefficiency, and belief that regulation stifled competition fueled a move toward markets

- Major Problems being Addressed: high inflation, slow growth, overly rigid industry regulation, airline, telecom, and trucking monopolies undera regulatory regime

-Key Deregulatory Actions: Airline Deregulation Act (1978), Deregulation of trucking and railroads, Telecom deregulation, Financial deregulation,

Energy markets deregulation

-Logic: belief that market competition would achieve lower prices, more choice, and higher efficiency

Pandemic-era regulation

(mix of macroeconomic stabilisation measures and efficiency-equity tradeoff) massive fiscal stimulus, expanded safety net

- Key elements: PPP loans, trillions in stimulus, eviction moratoriums, direct payments, emergency unemployment insurance

Trump 2

deregulation and industrial policy mix

- Characteristics: aggressive deregulation in energy/environment / labour, trade tariffs and protectionism, industrial policy resurgence, debate over “big tech” regulation

Market failures - list 3 types

incomplete markets, imperfect competition, incomplete information/asymmetry

Incomplete markets

Externalities, public goods

Externalities

a cost or benefit that affects a third party not directly involved in transaction, production, or consumption of a good or service

Private cost ≠ Social cost

Types: positive and negative externalities

- Examples: taxes (carbon tax, congestion pricing), subsidies (vaccines, solar panels), cap-and-trade (pollution permits)

Solutions: market creation, financial (dis)incentives, regulation, authority-based instruments, info spreading, etc

-

Cap-and-Trade:

Hybrid system combining government-set limits with market trading, designed to achieve pollution reduction at lowest total cost.

How it works: Gov sets a cap on total emissions for an industry or region. It issues permits (allowances) equal to that cap. Each permit allows one unit of pollution. Firms must hold enough permits to cover their emissions. There is then a secondary market for this. This is an example of market creation

Issues: knowing what is Pareto efficient, monitoring/enforcement costs, rent-seeking, MVT

Coase Theorem

Situation where market fixes externalities itself. With 0 transaction cost, affected parties of an externality will agree on an allocation of resources that is both Pareto efficient and independent of any prior assignment of property rights

Assumptions: rationality, property rights well-defined, transaction costs are 0, no strategic misrepresentation, efficiency as goal

Public Goods

A public good is a non-rivalrous and non-excludable product or service available to everyone, meaning one person's usedoesn't diminish another's, and no one can be easily prevented from using it

Why is it a MF: private firms have no incentive to provide these goods because they cannot charge users → FRP

Examples: national defense, street lighting, clean air

Solutions: direct provision, respecification of property rights, market design

Issues: free-riding, misallocation, political inefficiency

Imperfect competition

Monopoly (industry w single firm, produces products for which there are no close substitutes, significant barriers to entry)

Natural monopoly: characteristisc: large economies of scale, having fewer # of firms is more Pareto efficient

Solutions: government provision, heavy regulation

Artificial monopolies: formed throguh anti-competitive parties in the market, like undercutting competitors, buying out competitoors

Solutions: antitrust legislation, regulation

Common measures:

HHI, share of revenue going to top X firms, abnormal profits, prices of products relative to those of similar countries

Other causes:

changes in antitrust legislation/enforcement, potentially network effects, rent-seeking

Antitrust policy in the US

implemented by Antitrust division of DOJ, FTC. Private firms are more likely to bring cases against each other. Sherman Antitrust 1890, Clayton Act 1914, FTC Act 1914, etc

Pareto efficiency

type of equilibrium outcome, allocation such that no one can be made better without someone else worse (prisoner’s dilemma).

This means all resources are going to highest value usage, economic growth is maximized, all gains from trade are exhausted, everybody doing their best interest creates an outcome that makes everyone the best off they can be (invisible hand)

Conditions: perfect info, complete market, perfect competition

Market failure

systematic misallocation of resources

Issues with government intervention

knowing what is Pareto efficient, rent seeking, relevant median voter, monitoring and enforcement costs

Incomplete Information

Incomplete info / Information asymmetry: situations where one party in an economic transaction or interaction possesses more or better knowledge than the other, leading to potential unfairness, market inefficiencies, and poor decisions

Government Solutions -

Mandates (e.g., individual mandate in Affirmative Care Act) - Forces healthy people into a pool - Prevents adverse selection - Stabilises risk pools -

Subsidies - Makes insurance affordable - Encourages participation by low-income / healthy individuals - Helps maintain balanced insurance pools -

Risk adjustment - Transfers money across insurers so they do not cherry-pick healthy patients - Keeps insurers neutral about attracting sick individuals - Essential when non-discriminatory rules exist -

Issues with Solutions - Rent-seeking: firms capture regulators - Misaligned incentives: private insurers maximise profit, not welfare - Regulatory capture: agencies dominated by industry - Measurement problem: difficult to quantify externalities or risk - Enforcement dficiultires - Political incentives: lobbying pressure, short-termism

Adverse selection

Buyers and sellers have asymmetric information about the quality of the good.

Assume a good comes in different qualities and only one of the parties knows the true quality of the product

• A market is created in the inferior product without the requisite price adjustment; creates a pooling of the inferior product

• This will lead to a smaller mkt for the good compared to what is Pareto efficient

Solutions

• (non-state) Signaling and price discrimination

• E.g. medical check-ups, initial gap in coverage, different premiums based on relevant sub-population variables (vectors) like age, gender, etc.

• (state) Forcing the participation of the superior good

• E.g. individual mandate, mandatory driver’s insurance

Moral Hazard

Not protecting against risk because one is protected from the consequences; lack of incentive to take care

• The quality of the good changes once the product is provided without the requisite price adjustment

Solutions

• Structuring incentives to discourage risky behavior

• E.g.: deductibles, co-pays, monitoring, rewarding good behavior/punishing bad behavior

ACA/Healthcare

ACA

Design features (Jonathan Gruber MIT)

• Guaranteed issue: no one can be denied based on pre-existing conditions

• No price discrimination among most vectors (ok for age, tobacco use…)

• Subsidies for low-income individuals

• Parental coverage up to age 26

• Individual mandate (solves adverse selection problem and should lower premiums)

• Congress passed a law in 2017 that made the penalty for not being covered $0

• Created exchanges to shop of insurance coverage

• Established essential benefits insurance companies must provide

• Employers with more than 50 employees were required to provide it

Medicare: Single-payer system for Americans 65+ and for those with disabilities

Medicaid: Joint federal and state program to provide insurance for low-income individuals; means-tested