Econ 1000 Chapters 10-12

distribution function

government policies aimed at changing the final distribution of goods/services across consumers, usually with the intention of realizing a “fairer” apportionment of consumption/income/wealth

redistribution

government policies designed to alter the distribution of income/wealth/consumption across members of society

income

the flow of money earned by an individual during a period of time

wealth

the current stock of money (and other valuable goods) that an individual owns at a point in time

income support

monetary payments (such as unemployment benefits and social security payments) made to certain individuals, which directly alter the distribution of income within a society

redistribution in-kind

public provision of goods/services (such as healthcare, education, housing, food) for certain individuals, which alter the consumption of goods/services within society

poverty

the condition of having very limited access to goods and services

poverty thresholds

income levels (based upon the number of and ages of individuals in a household) below which a household is deemed to be living in poverty

poverty rate

the percentage of the population that is living in poverty

7 determinants of productivity, income, and wealth

(1) natural talent and ability, (2) acquired skills, (3) effort, (4) compensating differentials, (5) inherited wealth, (6) accumulated savings, (7) seemingly unrelated market conditions

natural talent and ability

ability is not distributed equally at birth; some people possess attributes (e.g., intelligence, strength) that make them more productive

acquired skills

individual productivity depends in large part upon skills and experiences acquired during education, training, and work experience

effort

productivity is often largely dependent upon effort (“workers” are more productive than “shirkers”)

compensating differentials

differences in wage rates that are due to differences in working conditions (e.g., risky jobs pay more; “glamour jobs” pay less)

inherited wealth

wealth is distributed less evenly than income (due partly to differences in inheritances)

accumulated savings

the stock of wealth that a person has at any point in time is partly determined by previous consumption/savings decisions

seemingly unrelated market conditions

income depends in part upon economic conditions beyond our control; a worker’s value depends greatly upon the price of the product he helps produce (e.g., wage of a coal miner would increase if we ran out of oil)

Lorenz curve

Max Lorenz - a graph which illustrates income inequality within a society by plotting the relation between cumulative fraction of the population (with people ordered from lowest income to highest) and corresponding cumulative fraction of total income earned

gini-coefficient

a quantitative measure of income inequality based upon the Lorenz curve, defined as the ratio of “the area between 45-degree line and the Lorenz curve” to “the entire area below 45-degree line”

4 arguments in favor of coercive redistribution

(1) utilitarian justice, (2) Rawlsian justice (social contract theory), (3) labor theory of value, (4) overcoming the free rider problem

utilitarian justice

Jeremy Bentham and John Stuart - total social welfare can be increased by transferring income/wealth from the rich to the poor, so long as people have a diminishing marginal utility for money

Rawlsian justice (social contract theory)

John Rawls - the socially best income distribution is the one which maximizes the well-being of the worst-off member of society

maximum criterion

a claim that the government should aim to maximize the well-being of the worst off person in society

labor theory of value

an assessment of the production process which attributes all economic surplus generated from production to labor

overcoming the free rider problem

if society prefers a more equal distribution of income/wealth, relying upon private charity to reduce inequality will result in too little redistribution

argument against coercive redistribution

libertarian justice

libertarian justice

the argument that the fairest distribution of income and consumption is the one realized when the government establishes and enforces a legal code which respects all voluntary economic interactions between individuals in society

average tax rate (ATR)

the amount of total taxes paid divided by income

progressive tax

tax structure for which ATR increases as the level of income is increased (e.g., U.S federal income tax)

proportional tax

tax structure for which ATR remains constant as the level of income is increased (e.g., “flat tax” with no deductions whatsoever)

regressive tax

tax structure for which ATR decreases as the level of income is increased (e.g., U.S social security payroll tax)

marginal tax rate (MTR)

the percentage of the next dollar earned that must be paid in taxes

government failure

a situation in which total social surplus is decreased by government intervention in a market

public choice

academic subfield which uses the tools and framework of economics to analyze issues that historically fall within the domain of political science

Condorcet paradox

Nicolas de Condorcet - a situation in which a series of pair-wise majority votes over more than two options, leading to a cycling of winners

7 specific sources of government failture

(1) informational problems, (2) costs of complying with government bureaucracy, (3) corruption or kleptocracy, (4) regulatory capture, (5) rent-seeking, (6) logrolling and rational ignorance, and (7) deadweight-loss from taxes

economic calculation problem

the argument that a system of planning will never be able to achieve efficient outcomes, precisely because under such a system, the planners do not have the information generated by market activities available to them

costs of complying which government bureaucracy

when governments impose rules/regulations, individual households and firms need to expend resources to comply with the policies

corruption

an environment in which regulations are not enforced and decisions are not made evenly and without bias → corruption leads to inefficient decisions

kleptocracy

an environment of extreme corruption in which government officials unabashedly seek personal gain at the expense of the public interest

regulatory capture

a situation in which firms in a regulated industry influence a regulatory agency to the point where the agency enacts policies that are in the best interest of the regulated firms (even if the decisions are not in the best interest of the public)

rent seeking

attempts by people to manipulate government action or influence government decisions in order to make themselves better off at the expense of others

logrolling

the process by which a legislator votes to approve one bill in exchange for favorable votes from other members on other bills

rational ignorance

since becoming informed on matters of public policy has high costs and low benefits for individual voters, it is rational for them to remain uninformed

incidence of a tax

a measure of who bears the burden of a tax in terms of decreased welfare

allocation function

government production of goods or regulation of business, aimed at improving the allocative efficiency of the economy (i.e., getting the “right mix” of products produced, each in the “ideal quantity” and at the “ideal quality”)

distribution function

government policies aimed at changing the final distribution of goods/services across consumers, usually with the intention of realizing a “fairer” apportionment of consumption/income/wealth

stabilization function

attempts by government to minimize fluctuations in overall macroeconomic activity

market failure

a situation in which the “free market outcome” is inefficient, in that there is a positive deadweight-loss as the resulting “free market level of trade”

4 common sources of market failure

(1) profit maximization by a firm with market power, (2) market provision of public goods, (3) market provision of goods generating externalities, and (4) lack of information by market participants

market power

A firm has market power if they have some “control over the price
of their output,” in that they: (i) can increase price without losing all customers and (ii) must decrease price in order to increase sales

monopoly

market structure in which there is one single seller of a unique good with no close substitutes

profit

the difference between revenues and costs of production

marginal revenue

the amount by which revenue changes as the firm’s quantity of output is increased by a unit

marginal costs of production

the amount by which production costs change as the firm’s quantity of output is increased by a unit

non-rival good

a good for which consumption by one person does not diminish the quantity or quality of consumption by others

rival good

a good for which consumption by one person does diminish the quantity or quality of consumption by others

non-excludable good

a good for which it is difficult (or very costly) to prevent consumption by those who do not pay

excludable good

a good for which it is easy to prevent consumption by those who do not pay

private good

a good that is excludable and rival in consumption (e.g., a Big Mac from McDonald’s)

public good

a good that is non-excludable and non-rival in consumption (e.g., national defense)

club good

a good that is excludable and non-rival in consumption (e.g., satellite radio or television broadcast)

common good

a good that is non-excludable and rival in consumption (e.g., stock of fish in the ocean)

free rider problem

if a public good were supplied in a free market, the amount traded would be less than the efficient quantity, since many people would attempt to enjoy the benefits of units purchased by others, while not purchasing any units themselves

externality

a benefit or cost that is realized by someone who is not directly engaging in an activity

negative externality

a cost of an activity borne by someone not engaging in the activity (e.g., pollution, noise from low-flying aircraft, speeding on a highway)

positive externality

a benefit from an activity realized by someone not engaging in the activity (e.g., vaccines, installation of smoke detector in an “attached apartment”)

internalizing an externality

policies which introduce a cost (or foregone gain) that is realized if the person continues to generate a negative externality

Coasian solution to the problem of externalities

Ronald Coase - problems of externalities are at their core due to undefined property rights and can be addressed by the following approach:
i. clearly and fully define property rights
ii. make individuals pay compensation if they infringe upon the property rights of others
iii. allow parties to negotiate with one another regarding infringements on
property rights caused by the externality

market failure due to lack of information

when consumers lack accurate information about costs or benefits of consuming a good, they may fail to make efficient choices in the marketplace