Economics, Welfare and Distribution

Assumptions in Microeconomics

agents pursue self-interest, completeness of alternatives, transitivity of alternatives

Completeness of alternatives

a<b or b<a or a=b

Transitivity of alternatives

if a<b and b<c then a<c

Marginal Thinking

cost or benefit of one more

Efficiency

completing tasks with minimum waste of time, energy or resources

effectiveness

significancy of achieving the desired outcomes with precision and quality

demand

amount of good or service that costumers are wiling and able to buy

law of demand

inverse relationship exists between the price of a good and the quantity demanded

what causes movement amongst the curve

changes in price

reasons for shift of demand curve

changes in income, tastes, preferences, price and availability of related goods, number of consumers and expectations

supply

amount of good or service that producers are willing and able to supply

law of supply

quantity supplied of a good rises when the prices of a good rises

causes for movement along the supply curve

changes in price

reason for a shift in the supply curve

changing resource prices, technology, taxes + subsidies, prices of other related goods, natural costs, number of sellers

elasticity

measure of changes in demand when there are changes in a determinant

price elasticity of demand

how much demand changes if price changes

elastic

price changes affects demand

inelastic

price change doesn’t affect demand

perfectly inelastic

e=0, example insulin

relatively inelastic

-1<e<0, necessary products with no substitutes, electricity

unit elastic

e=-1, close substitutes, clothing brands

relatively elastic

e < -1, luxury products with many substitutes, iPad

Perfectly elastic

e = - infinity, theoretical concept

assumptions consumer choice theory

goods a and goods b, prices are given, all goods are homogenous, perfect information on price quality and location of supply

Marginal rate of substitution

rate at which a consumer is willing to trade one good for another

budget constraint

limit on the consumption bundles that a consumer can afford

law of diminishing marginal returns

diminishing marginal product is the property whereby the marginal product of an inout declines as the quantity of an input increases

isoquants

all possible combinations of labour and capital that used to produce a given level of output

calculation MRTS

marginal product of labour : marginal product of capital

calculation ATC

Total cost : quantity

calculation AFC

fixed cost : quantity

calculation AVC

variable cost : quantity

calculation MC

change in TC when producing one more unit

maximising profit rule

MR = MC

Perfect competition

many sellers and buyers, homogeneous product, no buyer or seller can influence the market, no restrictions on entering and exiting, all products sold at market price

Monopolistic competition

slightly different products that are highly substitutable, however distinguished by branding, heterogenous products

oligopoly

few firms, some barriers of entry, firms can collude or compete, heterogenous or homogenous product

Monopoly

one firm producing all goods, no close substitutes and major barriers of entry, homogenous product

optimal production for a price taking firm (P=MR)

MR=MC, determine quantity, determine price, determine TR, determine TC, TR-TC

break even point

MC=ATC

shut down point

point below AVC

overt collusion (oligopoly)

open collusion

covert (oligopoly)

agreements are reached in secret

tacit collusion (oligopoly)

unspoken/implied collusion

reasons for government to intervene in free-market economy

common property resources, externalities, provision of public goods, merit or demerit goods, unequal distribution of income

price ceiling

legal maximum price

price floor

legal minimum price

public policies toward monopolies/oligopolies

anti-trust laws, regulation like MC pricing, public ownership

Pareto criterium

social improvements are possible as long as welfare of at least one individual can increase, without decreasing the welfare of another

Pareto efficiency

the outcome when no further Pareto improvements are possible

how can we recognise the optimal allocation of resources?

Pareto efficiency, social optimum

what are the key characteristics of a social optimum?

Utility possibility curve, social indifference curve

how do we get at social optimum?

first and second welfare theorem

what if the first best world assumptions don’t apply?

incentive distortion, efficiency-equity tradeoff, market failures and deviations from the first best world

first best world criteria

everyone is a rational actors with perfect information, everyone is a price-taker, there are no externalities/barriers to enter/ leave the market

first welfare theorem

if certain conditions are fulfilled, the operation of perfect competition will lead to a Pareto efficient allocation of resources

second welfare theorem

you can achieve any pareto optimum outcome by changing the initial endowments only and then allowing perfect competition

Social indifference curve

shows all possible combinations of individual welfare for which total societal welfare remains the same

utilitarian approach

social welfare is the sum of each person’s individual welfare, indifferent as to who gains

rawlsian approach

total welfare cannot be improved without first improving the welfare of the person who’s worse off, extreme aversion to inequality

creating welfare

role of the markets

redistributing welfare

role of the state

market distortions- shrinking the size of the pie

most taxes interfere with decisions people make disturbing markets and optimal allocation of resources, resulting in less production and smaller pie to share

Okun and the leaky bucket metaphor

redistributing money between people is like carrying water with a bucket that leaks

why does the bucket leak?

taxes distort incentives administering taxes and transfers is costly, complying with tay law is costly and not productive

market failure

when first best conditions aren’t fulfilled

bounded rationality

when the complexity of choices makes it difficult to process information rationally

bounded willpower

when people take actions that they know to be in conflict with their own long-term interests

governments toolbox

regulation - nudging behaviour, public finance - taxes or subsidies, public provision - using public resources

actuarial insurance (market-based insurance)

price of your insurance reflects your expected loss

Premium calculation

probability of loss x value of what you have

Adverse selection

buyer of insurance knows more bao their risks than the insurer and may be able to conceal this, so insurer can’t always differentiate between high-risk and low-risk when setting premiums

result/solution adverse selection

adverse selection either results in undersupply of actuarial insurance yet insurer tries hard to recruit only the clearly good risks and avoid potentially bad risks through cream-skimming

Moral hazard - when there’s hidden knowledge after buying insurance

idea is that you start behaving more risky once you’re insured

missing insurance markets (supply side problems)

adverse selection, moral hazard, correlated risks, uncertainties

insufficient demand - social risks

behavioural issues ex. bounded rationality, bounded willpower

traditional solution for negative externalities

pigouvian tax to internalise negative externalities

problem pigouvian tax

if you only know aggregate pollution, uniform taxes doesn’t incentivise abetment

output tax

tracks the average rate of damage amongst those choosing not to participate in the certification programme

goal of healthcare system

equity and efficiency

equity - healthcare

what is a fair way to distribute healthcare, equality of outcome vs equality of opportunity, everyone should be able to benefit from healthcare system

efficiency - healthcare

is spending more on healthcare always better

Macro-efficiency healthcare

how much to spend on healthcare, choose between different fields/policy areas

Micro efficiency healthcare

how to allocate resources within healthcare, what stage to implement/who specifically gets money

Allocative efficiency healthcare

where to spend your resources

Productive efficiency healthcare e

how to spend your resources

challenges private provision

imperfect information, bounded rationality/willpower

challenges private insurance

certainty rather than risk, adverse selection, moral hazard

third party payment problem

insurance company has imperfect information about decisions made by doctor and patient, doctors are paid fee for service by insurer, with more insurance consuming healthcare feels free to patients whilst doctors don’t have to care about patients ability to pay

3 main reasons for rising healthcare spending

medical technology advances, demographic change, third party payment problem

USA healthcare system

healthcare is a service like any other, price mechanism as key to efficient resource allocation, spending is high but quality is low, health insurance is rare

USA healthcare system pre 1960s

fully private provisions and finance, medicare and medicaid programme introduced, problem: rising healthcare expenditure, public finance but still private provision

UK public health system

healthcare is freely available through public hospitals, coverage is universal, treatment is free, no one is derived access, but long waiting lists, low wages and limited consumer choice

UK public health system development

pre 1990s NHS organised through centralised top-down planning, then introducing more choice for patients and more competition in the supply side

Netherlands and mixed healthcare system

market based competition to increase efficiency yet public intervention to reduce problems with market failures, private provision and fee for service

Netherlands and mixed healthcare system development

dekker commission said system to inefficient and inflexible, insufficient incentives to reduce costs, recommended market based form; 2006 health insurance act managed competition in healthcare provision as well as in healthcare insurance, introducing market-elements