Economics for political scientists

What are finished goods

Goods that will not be sold again as part of another good

What causes economic growth

- Natural resource discovery

- Physical capital or infrastructure

- Population

- Human capital

- Technology

- Law

What are intermediate goods

Goods that will be used to make something else that will be sold

What are capital goods

Goods that are used to produce other goods but are not a part of other

What is capitalism

An economic system in which private property, markets, and firms play an important role

What does capitalism "give us"

- Division of labor

- Specialization

- Entrepreneurial innovators

- New technology

What is specialization

This takes place when an individual, country, or some other entity produces a more narrow range of goods and services than it consumers, acquiring the goods and services that it does not produce by trade

What is division of labor

The specialization of producers to carry out different tasks in the production process

Democracy definition(s)

- Gives equal political power to all citizens:

This power is defined by individual rights such as freedom of speech, assembly and the press

- Selects political leaders by means of election:

In these elections, virtually all adults are eligible to vote, and the governing party leaves office if it loses

Elements of a game

- Players: who is involved in the interaction

- Feasible strategies: actions each player can take

- Information: what each players knows when choosing their action

- Payoffs: outcomes for every possible combination of actions

What is a payoff matrix

A table of the payoffs associated with every possible combination of strategies chosen by two or more players in a game

Dominant strategy equilibrium (game theory)

An outcome of a game in which every player play his or her dominant strategy

Invisible hand (game theory)

When following your personal self interest leads to a better society

Prisoner's dilemma

- Shows that individual incentives often make cooperation difficult

- Individual incentives to defect undermine the collective interest to cooperate

- Selfish behavior can lead to suboptimal outcomes

- Simple model with strong implications for economics and social behavior

Public goods

- Non-rivalrous

- Non-excludable

The collective action problem

A scenario in which there is conflict between the individual interest and the group interest

Common property good (common access resource /

- Rivalrous

- Non-excludable

Ways to overcome public goods / collective action / tragedy of the commons problems?

- Repeated interactions: Using sanctions to punish those who defect in later rounds (or vice versa)

- Number of players: It is easier to cooperation to emerge when there are fewer actors

- Selective incentives: Goods given only to those who participate

- Institutions: Use government to change the rules or act as enforcers

Nash equilibrium

A set of strategies, one for each player in the game, such that each player's strategy is a best response to the strategies chosen by everyone else

The best response (game theory)

The strategy which produces the most favorable outcome for a player, taking other players' actions as a given

Three key ideas of economic modelling

- Ceteris paribus

- Incentives

- Relative prices

Ceteris paribus (key ideas of econ modelling)

"All other things constant" when analyzing the variables and effects of interest

Incentives (key ideas of econ modelling)

Rewards or punishments that affect the costs and benefits of taking one action as opposed to another

Relative prices (key ideas of econ modelling)

We often focus on ratios of things to help us compare different courses of action and explain individual choices

What do production functions do

Production functions show how inputs translate into outputs holding other factors constant

Marginal product

Change in output per unit change in input

Diminishing marginal product

The marginal product decreases over time (as input increases)

Opportunity cost

The net benefit of the next best alternative action

Marginal rate of transformation (MRT)

The MRT is the slope of the feasible frontier, and it represents the tradeoffs an individual faces

Utility

Total satisfaction received from consuming a good

Marginal rate of substitution (MRS)

The MRS is the slope of the indifference curve

Economic rent definition

A payment or other benefit received above and beyond what the individual would have received in their next best alternative

Joint surplus definition

The sum of the economic rents of all involved in the interaction

Pareto improvement definition

An improvement that makes at least one person better off without leaving another worse off

What is a firm

A business organization which:

- Employs people

- Purchases inputs to produce market goods and services

- Set prices greater than the cost of production

- Is profit maximizing

Transaction costs definition

Costs that impede the bargaining process or the agreement of a contract. They include the cost of acquiring information about the good to be traded, and costs of enforcing a contract. Additionally, enforcement costs

Search and information costs (transaction costs)

Costs incurred in identifying possibilities for mutual gains

Policing and enforcement costs (transaction costs)

Costs involved in making sure parties stick to the agreement

What can incomplete contracts cause

Incomplete contracts lead to principle-agent problems (firm is the principle, worker is the agent)

- Rational agents have the incentive to shirk / mismanage a firm's assets

Employment rent

The cost of job loss, including:

- Lost income while searching for a job

- Costs required to start a new job

- Loss of non-wage benefits

- Social costs

Reservation wage

Value of next best option (other employment opportunity or unemployment benefits)

Best response curve

Shows the optimal amount of effort workers will exert for each wage offered. It represents the firm's feasible frontier for wages and effort

When determining wages at what point are profits maximized

Profits are maximized at the steepest isocost line

Efficiency wage

Wages set higher than the reservation wage so workers will care about losing the job and provide more effort

What is a cooperative

A firm that is mostly or entirely owned by its worker, who hire and fire the managers

What is a gig economy

An economy made up of people performing services matched by means of a computer platform with those paying for the service

Economies of scale

Where the average cost per unit decreases as the number of units produced increases

Diseconomies of scale

When cost per unit increases with the number of units produced

Economies of scale examples

- Cost advantages (bulk discount): Large firms can purchase inputs on more favorable terms due to their bargaining power

- Fixed costs: Some industries require fixed costs. These costs are the same no matter how big the firm is or how many units you produce

- Demand advantages (network effects): Value rises with number of users

Quantity demanded

The quantity that buyers are willing (and able) to purchase at a particular price

What is a monopoly

A firm that is the only seller of a product without close substitutions

Deadweight loss definition

A loss of total surplus relative to a Pareto efficient allocation (unexploited gains from trade)

Structural unemployment

Long term and persistent unemployment, a long term mismatch between skills demanded and skills possessed

Frictional unemployment

Unemployment due to "friction" in the matching employers with the employees (it takes time to find a job that you want and who wants you)

Aggregate demand

Sum of the demand for all of the goods and services produced in the economy

Whats bad about deflation

Deflation increases the real debt burden, which may lead households to cut consumption to return to their target wealth (people stop buying things, sellers of things are out of work)

Demand pull inflation is caused by

Excess aggregate demand (more money chasing the same amount of goods)

Limitations of markets

- Repugnant markets: creating a market for certain goods/services would violate ethical social norms

- Market mechanisms may crowd out norms of social preferences

- Merit goods may be under consumed

- Public goods suffer from collective action problem

Nominal GDP

- Gross domestic produce measure in current currency amount

- Does not account for inflation or differences in purchasing power across countries

Real GDP

- Growth adjusted for changes in inflation

- We translate current nominal prices to a consistent baseline

- Important for measuring changes over time

Purchasing power parity

- Growth adjusted for differences in currency and what those currencies purchase

What does GDP measure?

GDP measure the market value of all finished goods produced within a country (usually measure yearly)

3 elements of capitalism

- Private property:

People can keep the gains of their labor and are protected from others

They can also own capital goods

- Markets:

The allocation of goods and services are determined by buying and selling, not government

- Firms (privately run an organized):

A business organization which pays wages and salaries to employ people, and purchases inputs, to produce and market goods and services with the intention of making a profit

Best response strategy (game theory)

The strategy that will give a player the highest payoff, given the strategies that the other players select

Dominant strategy (game theory)

Action that yields the highest payoff for a player, no matter what the other player does

Tragedy of the commons

Is an economic problem of overconsumption, under investment and ultimately a depletion of common pool resources

Properties of indifference curves

- Indifference curves slope downwards due to trade-offs

- Higher indifference curves correspond to higher utility levels

- Indifference curves are usually smooth

- Indifference curves do not cross

- Diminishing MRS: As you move to the right along an indifference curve, it becomes flatter

Optimal choice

The utility-maximizing choice is where the amount of one good the individual is willing to trade off for the other good (MRS) equals the actual tradeoff between the two goods (MRT)

MRS = MRT

Institutions definition

- Set of rules known and shared by the community, that structure political ineractions in specific ways

- The laws and social customs governing the way people interact in society

Importance of institutions

- Institutions shape incentives

- Institutions influence growth and influence the distribution of wealth within society

- Institutions shape who has bargaining power

Pareto efficient definition

An allocation where no individual or preference criterion can be made better off without at least making one individual or preference criterion worse off

Bargaining and decision costs (transaction costs)

All costs associated with negotiating and agreement

Producer surplus

The producers gain from a transaction. The difference between market price at which producer would be willing to sell at a given quantity

What can cause deadweight loss

- Monopoly/oligopoly

- Taxes

- Artificial scarcity

- Externalities

- Subsidies

- Price controls

Market power definition

An attribute of a firm that can sell its product at a range of feasible prices by acting as a price setter

Criteria to be considered unemployed

- Are not in paid employment or self-employed

- Are available for work

- Are actively seeking work

Cyclical unemployment

Short term changes in unemployment due to changes in economic demand

Nominal wage

The actual amount received in payment for work, in a particular currency

Real wage

The nominal wage, adjusted to take account of changes in prices between different time periods. It measures the amount of goods and services the worker can buy

What affects the cost of goods (and in turn the real wages)

- Inflation

- Unemployment level

- Productivity

- Monopoly power of firms

How interest rates are determined by demand

- # of people that have access to credit markets

- Attractiveness of making new investments

- Uncertainty of making new investments

How interest rates are determined by supply

- Amount of money in circulation (monetary policy, increased savings)

- Openness to foreign capital (if you can borrow from more lenders, interest rates fall)

- Uncertainty over the state of the economy

What three functions does money serve?

- A medium of exchange

- Store of value

- Unit of account

Intrinsic value (the values of money)

Market value of the currency's constituent material when used for non-monetary purposes

Exchange value (the values of money)

Market value of the currency when used as currency in trade

Extrinsic / Nominal value (the values of money)

"Official" value and/or units

Whats wrong with inflation

- Causes uncertainty

- Harder to distinguish between changes in relative price and inflation

- Menu costs as firms have to update their prices more frequently

Cost push inflation is caused by

- Rising cost of labor, raw materials

- Rising import costs due to a failing exchange rate

What does the phillips curve do?

Assumes that trade-off exists between inflation and unemployment

What is a market failure

When markets allocate resources in a pareto inefficient way

Coase Theorem

Private bargaining can (sometimes) address market failures and reach the most efficient outcome if property rights are assigned to one of the parties

Pigouvian tax

A tax on a good with external costs

Solutions to externalities

- Pigouvian taxes

- Regulation

Moral hazards

Moral hazards are generated because one party cannot easily monitor the other due to asymmetric information

How governments try to solve market failures

- Incentives: altering the costs/benefits of activities through taxes, subsidies, and other expenditure

- Regulation

- Persuasion or information: altering available information or expectations about what others will do, to promote coordination

- Public provisions: includes merit goods and transfers

Political rents

An economic gain due to political interference greater than what would arise under natural market conditions OR gain relative to what an actor would receive if it were not for their political position

How do markets help solve an information problem

- The market price provides all relevant information about scarcity and demand

- Governments don't have the capacity to necessary information outside markets

How do markets help solve an incentive problem

- Prices provides an incentive to produce more (for profit) or substitute to preserve goods for those with high value for them

- What incentives are there for individuals to produce under a planned economy or even for the government to try hard to allocate goods efficiently?

What limitations do governments face in controlling markets?

- Economic feasibility

- Administrative feasibility

- Political feasibility

Roving bandit

Move from village to village ransacking and pillaging, they take 100% tax, they have no incentive to leave anything behind