American Economy Final set 3

How does Cap-and-Trade limit emissions?

It caps total emissions and allows firms to buy or sell pollution permits.

What is an example of a Cap-and-Trade program in the U.S.?

The Regional Greenhouse Gas Initiative (RGGI) to reduce CO2 emissions.

What is the definition of public goods?

Non-rival, non-excludable goods (meaning one person's use doesn't reduce availability for others).

What are some examples of public goods?

Clean air, public parks, national defense.

Why do markets fail to provide public goods?

Because of the free-rider problem.

What is required to fund public goods?

Government intervention (taxes).

How do public goods justify taxes?

They justify taxes to pay for goods like national defense and public health.

How is the U.S. military funded?

By taxes, providing defense for all citizens.

What is the definition of public prisons?

Public prisons are run by the government.

What is the definition of private prisons?

Private prisons are run by private firms under contracts with the government.

What issues are raised by private prisons?

Accountability, cost-cutting, and profit motives in criminal justice.

How do private prisons reduce costs?

By cutting staffing and services.

What is a criticism of private prisons?

They have incentives to increase incarceration rates.

Name two companies that run for-profit private prisons.

GEO Group and CoreCivic.

What is the focus of public prisons?

Rehabilitation and reducing recidivism.

What is the focus of private prisons?

Cost reduction and profit maximization.

What is the definition of adverse selection?

A situation where one party (usually the buyer) has more information about the quality of a product than the other party (usually the seller), causing higher-quality sellers to exit the market.

How does adverse selection work in health insurance?

People with pre-existing conditions are more likely to buy health insurance, but insurers can't perfectly identify who is a high-risk customer.

Why is adverse selection considered a market failure?

Low-risk people (healthy people) leave the market, leaving only high-risk (sick) people, which raises insurance premiums and leads to an under-provision of health insurance.

What is the relevance of adverse selection in health insurance markets?

It explains why health insurance markets fail without mandates or risk pooling.

Who has more information in an adverse selection scenario?

Buyers (patients) have more information about their health than insurance companies.

In which markets does adverse selection occur?

It occurs in health insurance markets and used car markets.

Why do insurers raise premiums in the context of adverse selection?

Insurers can't perfectly predict who will be sick, so they raise premiums.

How can mandatory insurance requirements address adverse selection?

They help fix the problem by ensuring a mix of healthy and sick individuals in the insurance pool.

What was an example of adverse selection before the Affordable Care Act (ACA)?

People with pre-existing conditions could be denied health insurance because insurers feared that only the sick would sign up.

What is the definition of Moral Hazard?

When people change their behavior and take on more risk because they are protected from the consequences.

How does Moral Hazard work in healthcare?

If people have health insurance, they might use more healthcare services than necessary since they're not paying the full cost.

Why does Moral Hazard matter?

It causes overuse of healthcare services, leading to higher insurance premiums.

What measures do insurers use to reduce Moral Hazard?

Insurers use deductibles, co-pays, and co-insurance.

Who is affected by Moral Hazard?

Insurance policyholders (people with health, auto, or homeowners insurance).

When does Moral Hazard occur?

It happens in any market where risk is transferred from the buyer to the insurer.

Why do people exhibit Moral Hazard behavior?

People behave more recklessly when they don't have to bear the full cost of their actions.

How do insurers mitigate the effects of Moral Hazard?

Insurers use deductibles and co-pays to force customers to pay a portion of the cost.

Give an example of Moral Hazard in healthcare.

People might visit the doctor for minor ailments more frequently if their health insurance has no co-pay.

Deductible

Definition: The amount you must pay out of pocket before insurance begins to cover costs.
Relevance: Reduces moral hazard by making individuals responsible for some costs.

Who/When/Why/How:
Who: Anyone with health, car, or homeowners insurance.
When: Deductibles are paid annually or per-incident, depending on the insurance type.
Why: To reduce moral hazard and limit overuse of services.
How: Insurance doesn't pay until the deductible is met.

Example: If your deductible is $500, you pay the first $500 in medical expenses before the insurance company pays.

Features of Healthcare Markets

1. Uncertainty of Demand: You don't know when you'll need healthcare (like an emergency).

2. Asymmetric Information: Patients know more about their health than insurers.

3. Market Failures: Caused by adverse selection, moral hazard, and public good aspects of healthcare.

Relevance: These features explain why healthcare is not like other markets.

Example: Because of asymmetric information, people with undiagnosed health conditions may buy insurance at standard rates, raising costs for insurers.

Medicare

Definition: A U.S. federal health insurance program for seniors (65+), younger people with disabilities, and certain illnesses.

Relevance: Reduces elderly poverty by covering healthcare for seniors.

What is the Affordable Care Act (ACA)?

A 2010 law that reformed the U.S. healthcare system by expanding Medicaid, creating health insurance exchanges, and eliminating pre-existing condition exclusions.

What was the relevance of the Affordable Care Act?

It reduced the number of uninsured Americans and fixed adverse selection issues.

What is the Guaranteed Issue provision in the ACA?

Insurers can't deny coverage due to pre-existing conditions.

What type of financial aid does the ACA provide?

Subsidies for low-income families to buy insurance.

What does Medicaid Expansion under the ACA allow?

States can expand Medicaid to cover more low-income people.

What was the Individual Mandate in the ACA?

It required people to buy insurance or face a penalty, which was later eliminated in 2017.

Who is affected by the Affordable Care Act?

Everyone in the U.S., especially the uninsured.

When did the Affordable Care Act become law?

In 2010 under President Barack Obama.

What was the purpose of the Affordable Care Act?

To reduce the number of uninsured people and control healthcare costs.

How does the ACA aim to reduce market failures?

By combining subsidies, mandates, and regulations.

What is an example of a provision in the ACA?

The ACA prevented insurers from denying coverage for pre-existing conditions.

Key Features of the ACA

1. Guaranteed Issue: Insurance companies must offer policies to everyone, regardless of pre-existing conditions.

2. No Price Discrimination: Insurers cannot charge different premiums based on health status.

3. Individual Mandate: People must buy health insurance or pay a tax penalty (until 2017).

4. Subsidies: Low-income individuals receive federal subsidies to buy insurance.

5. Medicaid Expansion: States can expand Medicaid to cover more people.

Relevance: Reduced uninsured rates and fixed the adverse selection problem.

Example: People with pre-existing conditions like diabetes could no longer be denied coverage.

What is the definition of imperfect competition?

A market structure where firms have market power, unlike in perfect competition where no firm can control the price.

What market structures are explained by imperfect competition?

Monopolies, oligopolies, and rent-seeking behavior in markets.

What is a monopoly?

A market structure with one seller and no close substitutes.

What is an oligopoly?

A market structure with few sellers where firms influence price.

What is monopolistic competition?

A market structure with many firms selling slightly differentiated products.

Which industry in the U.S. operates as an oligopoly?

The U.S. airline industry.

What is a Natural Monopoly?

A monopoly that arises when high fixed costs make it more efficient to have one firm, such as utilities.

What is an Artificial Monopoly?

A monopoly created by anti-competitive practices or government-granted rights.

Why do Natural Monopolies justify government regulation?

Because they arise from conditions that make it more efficient for one firm to operate.

What type of monopoly is targeted by antitrust policies?

Artificial Monopoly.

Give an example of a Natural Monopoly.

Electric utilities, as only one set of power lines is needed for efficiency.

Give an example of an Artificial Monopoly.

Microsoft was accused of monopolistic behavior for controlling web browsers, specifically Internet Explorer.

Monopoly

Definition: A single firm controls an entire market and faces no competition.

Relevance: Monopolies cause higher prices, lower output, and deadweight loss.

Example: Standard Oil was a monopoly until it was broken up under antitrust laws.

Solutions to Imperfect Competition

1. Government Regulation: Government regulates natural monopolies (like utilities) to ensure fair pricing.

2. Antitrust Policy: Break up or prevent monopolies (like the Sherman Antitrust Act).

3. Price Controls: Governments impose price ceilings to limit consumer costs.

4. Subsidies/Taxes: Subsidies encourage new entrants, and taxes can reduce market power.

Example: Sherman Antitrust Act led to the breakup of Standard Oil.

Antitrust Policy

Definition: Laws and regulations designed to prevent monopolies and promote competition.

Relevance: Promotes competition, lowers prices, and increases consumer welfare.

Example: The Sherman Antitrust Act (1890) prohibits anti-competitive practices, price-fixing, and monopolization.

Sherman Antitrust Act (1890)

Definition: First U.S. federal law to prevent monopolies and anti-competitive behavior.

Relevance: Breaks up monopolies, encourages competition, and prevents abuse of power.

Example: Used to break up Standard Oil into multiple smaller companies.

Clayton Antitrust Act (1914)

Definition: Strengthened the Sherman Antitrust Act, outlawed price discrimination and mergers that reduce competition.

Relevance: Helps prevent large firms from consolidating market power.

Example: Used to block mergers between companies that would reduce competition (like AT&T/Time Warner merger).

Federal Trade Commission (FTC)

Definition: Federal agency that enforces antitrust laws and promotes competition.

Relevance: Prevents anti-competitive mergers and stops deceptive business practices.

Example: The FTC sued Facebook for anti-competitive behavior regarding its acquisitions of Instagram and WhatsApp.

Macroeconomy

Definition: The economy as a whole, focusing on GDP, inflation, unemployment, and growth.

Relevance: Used to assess the health of the economy and guide government policies.

Example: The 2008 Great Recession was a major macroeconomic event that required stimulus spending and monetary policy intervention.

Fiscal Policy

Definition: Government use of taxes and spending to influence the economy.

Relevance: Helps reduce unemployment, control inflation, and stimulate growth.

Example: COVID-19 stimulus checks were part of a fiscal policy response to increase demand during the pandemic.

Monetary Policy

Definition: Central bank policy to control money supply and interest rates.

Relevance: Used to stabilize inflation, promote growth, and reduce unemployment.

Example: The Federal Reserve lowers interest rates to stimulate the economy during recessions.

Goals of Monetary Policy

1. Price Stability: Control inflation to ensure stable purchasing power.

2. Full Employment: Keep unemployment at a natural rate.

3. Economic Growth: Ensure the economy grows steadily over time.


Relevance: Central banks use interest rate changes to meet these goals.

What are Open Market Operations?

Buying/selling government securities to influence the money supply.

What is the Discount Rate?

The interest rate at which banks borrow from the Federal Reserve.

What is the Reserve Requirement?

The fraction of deposits banks must hold as reserves.

Why does the Federal Reserve use monetary policy tools?

To manage inflation, employment, and liquidity.

Federal Reserve Structure

Definition: Centralized but independent structure to manage U.S. monetary policy.

Main Components:
Board of Governors: 7 members appointed for 14-year terms.
Federal Open Market Committee (FOMC): Controls open market operations.
12 Regional Federal Reserve Banks: Implement policy at the local level.

Relevance: Ensures monetary policy is independent of political influence.

Independence of the Federal Reserve

Definition: The Federal Reserve operates independently of direct political control.

Relevance: Prevents short-term political motives from influencing long-term monetary policy.

How: Governors serve staggered 14-year terms and cannot be fired by the president.

Example: During the COVID-19 pandemic, the Federal Reserve independently decided to lower interest rates to boost the economy.

Federal Open Market Committee (FOMC)

Definition: The body that sets U.S. monetary policy by controlling open market operations.

Relevance: Directly influences interest rates, which affects the entire economy.

Example: If the FOMC lowers interest rates, borrowing increases and economic activity rises.

Quantitative Easing (QE)

Definition: The Federal Reserve buys government bonds to increase the money supply.

Relevance: Used during financial crises to inject liquidity into the economy.

Example: QE was used after the 2008 financial crisis to stabilize the economy.

Dual Mandate of the Federal Reserve

Definition: The Fed's goal to promote maximum employment and price stability.

Relevance: Guides every decision the Federal Reserve makes.

Example: The Fed may lower interest rates to reduce unemployment but risks increasing inflation.

Reserve Requirement

Definition: The percentage of deposits that banks must keep in reserve.

Relevance: Regulates how much banks can lend, controlling the money supply.

Example: During COVID-19, the reserve requirement was set to 0% to increase liquidity.

Open Market Operations (OMO)

Definition: The buying and selling of government bonds by the Federal Reserve.

Relevance: Used to increase or decrease the money supply.

Example: To increase the money supply, the Fed buys bonds from banks, putting more money into circulation.