ECON 110 Exam 3

Equity-efficiency trade-off

Trying to distribute wealth more fairly (equity) can reduce productivity needed to maximize economic wealth (efficiency)

Utilitarianism

Everyone has their own level of utility ands we want to maximize everyone’s utility

Utility

Total satisfaction a person gets from consuming a good or service

Diminishing marginal utility

As a person consumes more units of a good or service, the additional satisfaction gained from each unit decreases

Case for redistribution

Redistribution can raise total utility

• a dollar means more to a poor person than rich person, so gain for poor person is higher than loss for rich person

• We can maximize social satisfaction

Veil of ignorance

Imagine you have to make a society, but you don’t know who you’ll be in it. You’d want equity to reduce risk.

• strongest argument for utilitarianism

Rowls

• critic of utilitarianism

• Judge society by welfare of worst off

• Maximize minimum

Utilitarian viewpoints

• maximize sum of societal utility

• One person’s gain can offset another’s loss

• Risk-averse behind the veil

Lorenz curve

• x axis percent population

• Y axis percent income

• Perfect equality 45 deg line

• Real, always bowed below diagonal

Lorenz curve Gini coefficient

• 0 = perfect equality

• 1 = perfect inequality (one person’s gain earns everything)

Federal poverty level (FPL)

• set annually by Us dept. of health and human services

• Cost of food x 3

Aid to families with dependent children (AFDC)

• set minimum income level

• If working more adds no additional benefit, you won’t

Earned Income Tax Credit

• trapezoid design

  • Phase in: earn more get more

  • Flat: credit stays at max

  • Phase out: earn more, credit decreases

• Must work to receive benefit

Quintile ratio

Income of the highest (of 5) quintiles divided by the income of lowest quintiles

Poverty rate

% of population whose family income falls below an absolute level called the poverty line

Poverty line

Absolute level of income set by the federal government for each family size below which they are deemed to be in poverty

• US sets this as 3x cost of diet

Liberal contractarianism

government should choose policies that are fair

• concerned abt worst off

Maximum criterion

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

Social insurance

Government policy aimed at protecting people against risk of adverse events

Libertarianism

government should only stop crime and enforce voluntary deals, not redistribute wealth

Why are minimum wage laws controversial?

• creates DWL

• Causes more unemployment

• Might not actually help the poor

Welfare

Government programs that supplement people of low incomes

Welfare programs

• TANF

• SSI

Supplemental security income

Helps people that have low incomes because of age, disability, sickness, etc.

Negative income tax

Tax system that collects some revenue from high-income households and gives subsidies to low income households

• universal base income

In-kind transfers

government provides assistance in the form of specific goods or services rather than cash

Product possibility frontier

Shows the maximum possible output combinations of two different goods or services when all resources are fully and efficiently used

Absolute advantage

The ability to produce a good using fewer inputs than another producer

Comparative advantage

The ability to produce a good at a lower opportunity cost than another producer

Gains from specialization and trade are based on ____ advantage

Comparative

Price of trade for both parties to benefit

Must lie between their opportunity costs

Exports

Goods produced domestically and sold abroad

Exports

Goods produced domestically and sold abroad

When does a country import a good?

When the world price is lower than the domestic price to produce it

Why do people trade?

access to wider variety of goods and maximize production

Why do people trade?

access to wider variety of goods and maximize production

PPF Format

• axes have goods

• Only points on the curve are efficient

• Outside of curve is not feasible

How to calculate if trade will be beneficial?

1. Compare opportunity costs

2. Find comparative advantage

3. Each firm specializes in comparative advantage

4. If price is between OCs, its beneficial

World price

The price that prevails in the world market for that good

Tariff

A tax on an imported good (increases world price)

Quota

Restricts amount of imports

• creates a wedge between supply and demand

Benefits of free trade

• flow of ideas

• More variety of goods

• Lower costs due to economies of scale

• Increased competitions

• Increased productivity

Arguments against free trade

• protect jobs

• National security

• Infant industries

• Unfair competition

• Protection as a bargaining chip

Factors of production

Inputs into production process

Derived demand

Demand derived from the firm’s desire to supply goods to the market

Assumptions in factors of production

Firm is competitive and profit-maximizing

Production function

Relationship between quantity of inputs and output produced

Marginal product of labor

Additional output created from an additional worker

Diminishing marginal product

Additional output declines as we increase the number of workers, ceteris paribus

Eqn MPL

Change in Q divided by change in labor

Eqn VMPL

price times MPL

Eqn Value of marginal profit

VMPL minus W

Value of the marginal product of labor

Value of the additional output created by hiring that worker

In a perfectly competitive market, a firm’s derived demand equals

VMPL

Firms hire until…

Market wage = VMPL

Derivation VMPL = Wage

P x MPL = W

P = (W / MPL)

P = MC

Factors that shift labor demand

• price of the good

• Technological change

• Cost of the other factors of production

Labor saving technological change

Replaces workers and decreases demand for labor

Labor augmenting technological change

Tech is used in combination with workers and would increase labor demand

Labor supply: leisure

Non-working time

• leisure-labor tradeoff

Labor supply: Income vs substitution effect

• Income effect: mean wage goes up, have more leisure, buy more expensive goods

• Sub effect: work more bc opportunity costs is larger with higher wage, buy cheaper goods

Which effect dominates?

Substitution

Factors that shift labor supply

• preferences / discrimination

  • Cultural norms

• Outside opportunities

  • Change in wages

• Immigration

  • Increases labor supply

Other factors of production

• land

• Capital

• Rental price

Confounding variables

Omitted variables that can skew data

Randomized control trials

An experiment in which the researcher randomly assigns ppl to treated and control groups

Problems with observational data

• confounding variables

• Reverse causality

Data observation

Single record in data set

Variable in Data

Characteristics of observation

Cross sectional data

Data that represents info about multiple subjects at a given time

Time series data

Data that present info about a single subject over time

Panel data

Data that present info about multiple subjects at various times

Statistical model eqn

Exam score = Bo + B1 hours studying + Ei

Error term Ei

Difference between observed value and true relationship

Gross domestic product GDP

The market value of all final goods and services produced within a country during a given period of time

• best measure of well-being

Approaches to calculating GDP

• final goods

  • Value of the final goods produced

• Value added

  • Sum of the value of each individual product

Components of GDP

Y = C + I + G + NX

C in GDP

Consumption

Goods or services purchased for personal use in households

I in GDP

Investment

Machines and structures firms/businesses use and residential investment

G in GDP

Government spending

Roads, bridges, national defense

• doesn’t include taxes

NX in GDP

Net exports

Exports minus imports

Nominal GDP

Current prices x current quantities

Real GDP

Base year prices x current quantities

GDP Deflator

(Nominal GDP / Real GDP) x 100

Percent change

((New - old) / old) x 100

Consumer Price Index (CPI)

A measure of the cost of the goods and services bought by a typical household

• BASKET

Computing the CPI steps

1. Fix the basket

   1. Use basket Qs not current Qs

2. Find the prices

   1. Current year prices

3. Compute cost of basket

   1. Sum of price times Qs

4. Choose a base year and compute index

CPI Eqn

CPI = ((cost of basket in year x) / (cost of basket in base year)) x 100

Problems with CPI

• substitution bias

  • Changes in relative prices

• Introduction of new goods

  • More options

• Unmeasured quality changes

  • Prices change w changing quality

How do CPI and GDP differ?

• Investment goods

  • Machines count for GDP but not CPI

• Basket of goods

  • CPI basket is fixed GDP isn’t

• Imports

  • Included in CPI not GDP

Converting dollars from different times

T$ = T$ x (CPI T / CPI t)

Nominal interest rate

Interest rate without correction for inflation

Real interest rate

Interest rate that’s corrected for inflation

Nominal rate— inflation rate

global change in GDP over time

Mostly increasing but changes by country

Production function

Y = AF(L,K,H,N)

Y = output of GDP

L = labor

K+ capital

H = human capital

N = natural resources

A = technological knowledge

Productivity

Quantity of goods and services produced from each unit of labor input

Productivity EQN

Output of worker [ Y / L ]

= AF (1, (K,H,N)/L)

Determinants of productivity

• capital per worker

• Human capital per worker

• Natural resources per worker

• Technological knowledge

Physical capital per worker

• capital or physical

  • Machines and equipment

• Consumption vs. saving tradeoff

• Investment from abroad

• Diminishing returns

• Catch up effect

Catch up effect

Countries that have less capital per worker and lower GDP will grow at faster rates

• growth rate decreases over time