ECON midterm 2 terms

Human Capital

the capacity to perform productive work

Flow vs Stock

Flow = instantaneous changes in stock actual work (capped by stock)

Stock = Capacity (can be contributed to)

Investment vs Disinvestment

Investment = increasing stock (buying canned goods for future apocolypse)

Disinvestment = depleting stock (eating the canned goods)

How to invest in human capital

education

experience

health

matching (job search, migration)

Why young people have highest marginal time on investment

they have the longest potential work life after completion of the investment

General Vs Firm-Specific Skills

General - skills that make you more productive everywhere

Firm-specific skills - unique to firms, the employer needs you to learn the

Deming, 4 facts about Human Capital

1. Human Capital Strongly determines earnings

2. Investing in human capital pays off at many stages of life

3. We know how to build basic skills

4. We don’t know yet how to build higher-order skills well

we need incentives bc

productivity is a choice

The Principal-Agent Problem

• Hard to get someone to do what you want them to do

• Agent -- the one trying to execute the bosses intentions

• Principal -- the boss

Incentives

encourage worker to behave more like how principal wants them to behave

Incentives to create the possibility of inequality

Individuals will make different choices when faced with the same incentive (inequality across people)

Fundamental challenge 1 - Principle-Agent Problem

Positive and Negative reinforcement

Fundamental Challenge 2 - Risk and how people respond to risk

alternatives

!! If you've got diminishing marginal utility

You’ve got risk aversion

!! Who has diminishing marginal utility?

everyone

I!! Incentives create

Risk

Nobody Likes Risk

!! B/c of diminishing marginal utility…

everyone is risk averse

!!! The natural response to risk is always …

Insurance

!! Insurance is…

Compensation for risk

Stock vs Flow

Stock = Capacity

Flow = Use of that Capacity

Human capital vs work itself

Human Capital = capacity to do work

Work itself = flow

Health Stock and Flow

Stock = Health Capital - the capacity to experience healthiness

Flow = Health Services - flow of health services

Endowment

Natural - given - out of control

IQ

Age

Genes

!! When you insure a choice

you encourage that choice

!! Inequality starts young and is to some degree heritable

Parents with more human capital engage in activities that help their children more

!! economic status across generations

there is a persistence in economic status across generations

!! It is easy to make a place better,

It’s hard to make people in that place better off

!! the market is like water

the actions of individuals trying to make their lives better is really hard to resist and aggregating the community is very hard to resist

!! as the cohort ages

inequality evolves/gets bigger

What determines the price of labor?

Productivity

Wealth Inequality stock and flow

Wealth = stock

Income (recurring) = flow

What is wealth

stocks, bonds, real estate, human capital

!! we want consumption to be

SMOOTH

Defined contiribution

the amount of income, labor, capital, or taxes an individual or group adds to the economy.

What is equalizing and what is disequalizing

Defined benefit (such as pension) = dis-equalizing (but is fading out of our economy)

Medicare (health insurance for 65 + = equalizing

two main domains of production

1. formal workplace

2. Household

Economic reasons people form groups

1. Economies to Scale

2. Specialization —> Commitment (RECIPROCITY) cook for fam they cook back (not roommate tho)

economies of scale

cost advantages a firm gains when it increases production, leading to a lower average cost per unit

The marginal cost of adding another person to the family decreases

Do we want to make these equivalence scale adjustments?

yes

!! Consumption Smoothing

if your income varies your consumption is not going to vary directly with it because of diminishing marginal utility

If no binging and no deprivation

!!!!!!! Permanent Income Hypothesis

• We spend out of permanent income!

• Permanent income is your expected income not your reliable income

• Permanent Income leads to spending

• Transitory Income (short-term such as bonus) leads to saving

People base consumption on their long-term expected income, not short-term income changes.

Transitory income

short-term earning such as bonus or lottery - Leads to saving.