NAKED ECONOMICS

(1) market allocation

schemes/agreements in which competitors divide markets (types of customers) among themselves

(1) assumption of rational utility-maximizers

individuals act to make themselves as well off as possible

(1) opportunity costs

more than just money-the REAL cost of something is what you must give up in order to get it: time, effort, gas, quality, anything there is to sacrifice

(1) profit maximization

firms attempt to maximize profits by taking inputs and combining them in a way that adds value

(1) prices allocate resources

profit opportunities attract firms // because there is a finite amount of everything worth having, the most basic function of any economic system is to decide who gets what, which we do with prices in the US

(1) barriers to entry

barriers can be physical or natural (truffles can't be cultivated), the political process, network effects (value of some goods rises with the # of people using them)

(1) market price // pricing decision // price discrimination

the price will settle at the point where the # of products for sale exactly matches the # of products the consumer wants to buy // stores will attempt to pick a price that leads to the quantity of sales that earn the company the most money // when a firm attempts to sell the same item to different people at different prices

(1) lessons of markets

the market economy is a powerful force for making our lives better yet it is amoral; our system uses prices to allocate scarce resources; b/c we use price to allocate goods, most markets are self-correcting; if we fix prices in a market system, private firms will find other ways to compete; every market transaction makes all parties better off

(2) wrong incentives → undesirable outcomes

people kill (endangered) black rhinos b/c they make a lot of $ relative to the risk of getting caught → black rhino market cannot correct itself → rhino becomes more imperiled and its price tag skyrockets (incentive for poachers)

(2) principal-agent problem

the principal employs an agent who has an incentive to do a lot of things that aren't necessarily in the best interest of the firm

(2) prisoners' dilemma

essentially, two men are arrested and have to deal with the decision on whether or not they keep silent, confess, or rat the other one out

(2) creative destruction

i.e. the opening of a Wal-Mart with exceptionally cheaper prices puts Mom + Pops out of business

(2) tax/gov. program disincentives

mechanisms such as fees, policies, procedures, rules, taxes, that (un)intentionally (in)directly discourage/prevent (un)desirable actions, behavior, or decisions

(3) externalities

the private costs of one's behavior are different than the social costs; when an externality is large, individuals have an incentive to do things that make them better off at the expense of others

(3) gov. solutions to externalities

federal gov. issues heaps of regulations per year on a plethora of things; states have their own regulatory structures; taxing the offending behavior rather than banning it

(3) gov. makes market economy possible: rights, laws, regulations

gov. sets rules: defines + protects property rights, lowers the cost of doing business in the private sector, builds + maintains infrastructure

(3) public goods

gov. provides us with a wide array of "public goods" that make us better off but wouldn't otherwise be provided by the private sector

(3) redistribution

gov. redistributes wealth: we collect taxes from some citizens + provide benefits to others (middle class in the form of Medicare + Social Security)

(4) gov. inefficiency

gov. operations function exactly as we would expect given their incentives; because we depend on their functions, they have no incentive to treat people nicely, clean facilities, stay open longer, etc.

(4) gov. allocation vs. private allocation

gov. allocation = gov. shouldn't be the sole provider of a good/service unless there is a compelling reason to believe that the private sector will fail in that role (the gov. allocates resources wherever the political process takes them) // private allocation = gov. employees don't have to be the ones actually doing work when they can plan/finance then solicit bids from the private sector (the private sector allocates resources where they will earn the highest return)

(4) effects of regulation

regulation can disrupt the movement of capital and labor, raise the cost of goods and services, inhibit innovation, and otherwise shackle the economy at BEST // at WORST, it can become a powerful tool for self-interest as firms work the political system to their own benefit

(4) effects of taxation

when gov. is doing things it's theoretically supposed to do, gov. spending must be financed by levying taxes, causing individuals to change their behavior in ways that make the economy worse off without necessarily providing any revenue for the gov. // taxes discourage work + investment

(5) adverse selection

in terms of Bill Clinton's Hope Scholarships, future graduates sort themselves in/out of the program based on private information about their career plans // aspiring Wall Street barons would avoid the program because it's a bad deal for them → program attracts predominantly low earners who wouldn't be able to give back as much to fund the scholarship in the future

(5) firm screening

screening mechanisms elicit information from their potential customers (i.e. deductibles)

(5) branding provides info

companies spend enormous sums of $$ to build an identity for their products; branding helps to provide an element of trust that is necessary for a complex economy to function

(5) branding vs. commodities

branding can be a very profitable strategy-prices are driven relentlessly towards the cost of production

(5) signaling mechanisms

firms will do whatever they can to "signal" their own quality to the market (aesthetics, interior decor, etc.)

(6) human capital

in essence, skills; natural talent or acquired skills through specialized training and education

(6) job creation

jobs are created anytime an individual provides a new good/service or finds a better/cheaper way of providing an old one

(6) effects of human capital on standard of living

our total stock of human capital defines how well off we are as a society // the stock of education, training, skills, and even the health of people constitutes ~75% of the wealth of a modern economy in which human capital is by far the most important form of capital in creating wealth and growth

(6) productivity

the efficiency with which we convert inputs into outputs; inextricably linked to human capital

(6) income inequality

our economy is evolving in ways that favor skilled workers // tech makes smart workers more productive while making low-skilled workers redundant // causes: unions are less powerful; high-wage workers log more hours than low-wage workers; more and more industries are linking pay to performance → increases wage gap between those who are more/less productive

(7) purposes of financial instruments

like every other good or service in a market economy, they must create some value; both the buyer and seller must perceive themselves as better off by entering into the deal // all financial instruments based on 4 simple needs: raising capital; storing, protecting, and making profitable use of excess capital; insuring against risk; speculation (bet on short-term price movements)

(7) efficient markets + index funds

financial markets do for capital what other markets do for everything else: allocate it in a highly productive, albeit imperfect, way // capital flows to where it can get the highest return // index funds = mutual funds that do not purport to pick winners but instead buy and hold a predetermined basket of stocks

(7) investment guidelines

save, invest, repeat; take risk, earn reward; diversify; invest for the long run

(8) interest groups + politicians' incentives

it pays to be small: an adept politician would probably improve his/her career prospects by voting/siding with the more motivated underdogs → the large group subsidizes the small group

(8) some regulations benefit business

firms + industries benefit from regulation by using the political process to generate regulation that either helps them or hobbles their competitors

(8) tyranny of the status quo

if small groups get what they want out of the legislative process, they can also stop what they don't want, or at least try

(9) importance of GDP

gross domestic product; the total value of all goods and services produced in an economy

(9) real vs. nominal GDP

real GDP: the GDP figure has been adjusted to account for inflation // nominal GDP: nominal figures haven't been adjusted for inflation

(9) GDP per capita

a nation's GDP divided by its population

(9) GDP growth + wage growth

the average American is 5x as rich as (s)he would have been in 1940 because we're more productive // on wage growth: because of the dramatic increase in productivity over the years, both prices and wages have increased

(9) GDP misses social progress

GDP is an imperfect measure of how well off we really consider ourselves to be

(9) recessions

when GDP turns negative, the damage is real: jobs lost, businesses closed, productive capacity turned idle

(9) fiscal policy

fiscal policy: uses gov.'s capacity to tax and spend as a lever for prying the economy from reverse into forward-if nervous consumers won't spend, the gov. will do it for them, which could create a positive cycle

(9) monetary policy

has the potential to affect the economy very quickly: the chairman of the Federal Reserve can raise/lower short-term interest rates with one phone call

(9) other "vital signs" policymakers would ask for upon waking from a coma: unemployment, poverty, income inequality, gov. budget, deficit, current account, national savings, demographics

- unemployment: GDP growth of 3%/year will leave unemployment rate unchanged; faster/slower growth will move the employment rate up/down by 1/2 a % point for each % point change in GDP

- poverty: poverty line = arbitrary definition of the amount of income necessary to buy the basic necessities; poverty level remains as the statistical threshold for who (isn't) poor in America

- income inequality: the Gini index (0 = total equality, 100 = total inequality)

- gov. budget

- deficit/surplus

- current amount

- nat'l. savings

- demographics: bulk of gov. benefits (Medicare, Social Security) are bestowed upon retired Americans and funded by payroll taxes imposed on younger, working Americans

(10) importance of the Fed

the Federal Reserve has tools with more direct impact on the global economy than any other institution in the world, private or public: it controls the money supply + therefore the credit tap for the economy

(10) easy money → inflation

low interest rates/"easy money" → consumers demand more of a product than before → company can't make enough to satisfy demand without expanding production → raises prices to fund expansion → workers realize company's desperate for workers → union demands higher wages

(10) FOMC + monetary policy tools

Federal Open Market Committee = a committee within the Fed that makes monetary decisions (the determination whether interest rates need to go up/down/stay the same) // if the FOMC wants to stimulate the economy by lowering the cost of borrowing, the committee has 2 primary tools at its disposal: the discount rate (the interest rate at which commercial banks can borrow funds directly from the Fed) and the federal funds rate (the rate that banks charge other banks for short-term loans) // done right, monetary policy facilitates economic growth + cushions the economy from shocks that might otherwise wreak havoc

(10) difficulty of policy decision-making

while the Fed is trying to use monetary policy to hit a particular economic target, Congress may be doing things with fiscal policy that have a different effect entirely (or the same effect, causing Fed policy to overshoot) // the Fed must facilitate a rate of economic growth that is neither too fast nor slow

(10) money

money is a tiny subset of wealth that is merely a medium of exchange, something that facilitates trade and commerce

(10) inflation + effects

avg. prices rise // massive inflation distorts the economy massively: workers must rush to spend their cash before it becomes worthless; a culture emerges in which workers rush out to spend their paychecks at lunch because prices will have gone up by dinner; fixed-rate loans become impossible b/c no financial institution will agree to be repaid a fixed quantity of money when that money is at risk of becoming worthless // inflation distributes wealth arbitrarily and distorts taxes

(10) political pressure to allow inflation

shortsighted/corrupt/desperate govs. can buy themselves some time by stoking inflation; can cut their own debts with inflation: (1) owe large debt, (2) inflation erodes value of payback money, (3) govs. control inflation rate // benefit in the short run from inflation tax: gov. workers demand to be paid, gov, begins runing the printing press at the national mint and new dollars (with lower value) are used to pay the workers (tax is from the devalue)

(10) deflation

steadily falling prices; begets a dangerous economic cycle: falling prices → consumers postpone purchases (it'll be cheaper later) → asset prices fall → consumers feel poorer, less inclined to spend → economy grows less

(11) exchange rates

the rate at which one currency can be exchanged for another; determined by supply relative to demand // as demand for one currency falls, so does qthe value of the currency on currency markets

(11) purchasing power parity (PPP)

if a bundle of everyday goods costs $25 in the US, and a comparable bundle of goods costs 750 rubles in Russia, then we would expect $25 ≈ 750 rubles ($1 ≈ 30 rubles) // tool used by official agencies to make comparisons across countries as it presents the most accurate snapshot of a nation's standard of living

(11) official exchange rates

the rate at which you can actually trade one currency from another-deviates widely and for long stretches from what the PPP would predict

(11) IMF

International Monetary Fund; responsible for dousing international financial crises

(12) benefits of trade

our standard of living is high b/c we are able to focus on the tasks we do best and trade for everything else, globalization (the increase in the internat'l. flow of goods + services), trade makes us richer

(12) comparative advantage + specialization

when different countries are better at producing different things, they can both consume more by specializing at what they do best and trading for the rest // comparative advantage: workers in Bangladesh don't have to do better than American workers at producing anything for there to be gains from trade

(12) losers from trade

trade, like tech, can destroy (low-skilled) jobs-if a worker in the US earns $14/hour for something that can be made in Vietnam for $1/hour, then US had better be 14x as productive or else a profit-maximizing company will choose Vietnam

(12) protectionism

saves jobs in the short run and slows economic growth; global trade turns the specialization clock forward, whereas protectionism stops that from happening

(12) trade raises real incomes

trade lowers the cost of goods for consumers, which is the same as raising their incomes (lowering trade barriers has the same impact on consumers as cutting taxes)

(12) trade benefits for poor countries

trade gives poor countries access to markets in the developed world, where most of the world's consumers are

(12) cultural homogenization

trade is based on voluntary exchange (individuals do things that make them better off); the threat of "cultural homogenization" is a common knock against globalization

(12) sweatshops

it doesn't make sense that we can make sweatshop workers better off by refusing to buy their products-industrialization sets in motion a process that can make poor countries richer // the simplest way to help workers is to buy more from sweatshops, not less

(13) importance of policies vs. resources

every country has resources, but resources aren't what make a country economically function/successful-good policies are

(13) effective development policies

laws, law enforcement, courts, basic infrastructure, a gov. capable of collecting taxes, and a healthy respect among the citizenship for each of these things-good governance matters; (formal) property rights; no excessive regulation; human capital; geography; openness to trade; responsible fiscal/monetary policy; natural resources matter less than you think; democracy; war is bad; woman power