Micro Exam 3

Axiom

Markets are usually a good way to organize economic activity

Externality

the uncompensated impact of one person’s actions on the well-being of a bystander

when there is an additional cost or benefit from producing or consuming a good which is NOT included in the marginal cost (MC) or marginal benefit (MB)

can be negative or positive, depending on whether impact on bystander is adverse or beneficial

the true cost or benefit to society is different then the cost or benefit to the individual consumer or producer

Negative Externality

when there is an additional cost from producing or consuming a good which is NOT included in the marginal private cost (MPC)

The cost of the externality is not included in the supply curve

Marginal Private Cost and Marginal Social Cost

Marginal Private Cost

cost borne by producer of a good or service

Marginal Social Cost

total cost of producing a good

Marginal Social Cost (MSC) = Marginal Private Cost (MPC) + external cost (EC)

Examples of Negative Externalities

Air pollution from a factory

The neighbor’s barking dog

Late-night stereo blasting from the dorm room next to yours

Noise pollution from construction projects

Health risk to others from second-hand smoke

Drugs in your neighborhood

Talking on cell phone while driving makes the roads less safe for others

Government Intervention

Problem: Markets produce “too much”

Goal: Make them internalize the external costs

Take the full costs to society into account

Make a Tax = external cost

Coase Theorem

if transaction costs are low, then private bargaining will result in an efficient allocation of resources and hence solve the externality problem

Private Bargaining Example

you have a party and play loud music, which disrupts your neighbor who is busy studying microeconomics

External cost to your neighborhood that you are not considering when you decide how much music to play

if you have the right to play music, then your neighbor could pay you to turn it down

if your neighbor has right to silence, then you can pay your neighbor to play music for your party

Positive Externality

situation when there is an external benefit to society from producing or consuming the good but it is not factored into your Marginal Private Benefit (MPB)

Marginal Private Benefit and Marginal Social Benefit

Marginal Private Benefit

benefit received by consumer of a good or service

Marginal Social Benefit

total benefit from consuming a good, including both private benefit and external benefit

MSB = MPB + external benefit

Example of Positive Externality

Being vaccinated against contagious diseases protects not only you, but people who visit the salad bar or produce section after you.

Also protects others in your class and your professor!

However, you do not get paid to get vaccinated, instead by getting vaccinated you create an external benefit to society

Set Subsidy

EB to internalize the externality and now get Q* instead of Qc

Good Excludable

if a person can be prevented from using it

A person can be prevented from consuming the good

Excludable: fish tacos, wireless internet access

Not excludable: FM radio signals, national defense

Good Rival in Consumption (Rivalry)

if one person’s use of it diminishes others’ use

Only one person can consume the good

Rival: fish tacos

Not rival: An MP3 file of Taylor Swift’s latest single

Private Goods

excludable, rival in consumption

Example: food

Public Goods

not excludable, not rival

Example: national defense

Common Resources

rival but not excludable

Example: fish in the ocean

Natural Monopolies

excludable but not rival

Example: cable TV

Free Rider

a person who receives the benefit of a good but avoids paying for it

If good is not excludable, people have incentive to be free riders, because firms cannot prevent non-payers from consuming the good

Who Supplies Labor?

We do as workers

Leisure

home, sleep, with friends, movies, parties, etc

While we are having leisure time we are NOT working

Who Demands Labor and How Much do They Demand?

The firms that need labor to make their products

It depends on the wage

They must pay their workers a wage to work

Derived Demand

derived from a firm’s decision to supply a good in another market

A firm’s demand for labor depends on the demand for the product they are making

If there is a large demand for their product, then they will demand more labor - More labor helps them make more of their product

Shifters of Labor Supply

1. Wealth: If wealth goes up, you will work less (supply shifts left)

2. Increase in Population: Shifts market labor supply to the right (more workers)

Example: Immigration

Decrease in wage, increase in number of workers

3. Changing Demographics

4. Changing Alternatives

When labor supply increases (shifts right)

Equilibrium Wage decreases

Equilibrium Number of Workers increases

When labor supply decreases (shifts left)

Equilibrium Wage increases

Equilibrium Number of Workers decreases

Shifters of Labor Demand

1. Anything that affects the Price of the Product good (not price of labor (wage) or anything that affects MPL

2. Anything that increases P or MPL will shift demand to the right

Workers are better trained (i.e. more education) – increases in human capital

Technological change (affects MPL)

The supply of other factors (affects MPL)

Ex: If firm gets more equipment (capital), then workers will be more productive

3. More firms in the market

When Labor Demand increases (shifts right),

Equilibrium Wage increases

Equilibrium Number of Workers increases

When Labor demand decreases (shifts left),

Equilibrium Wage decreases

Equilibrium Number of Workers (L) decreases

The Minimum Wage

Min wage laws do not affect highly skilled workers.

They do affect teen workers.

Studies: A 10% increase in the min wage raises teen unemployment by 1-3%

Asymmetric Information

one party in an economic transaction has less information than the other party

Ex: Buyers have more information (car insurance market), Sellers have more information (financial markets, used cars)

Adverse Selection

a situation in which one party to an economic transaction has more information and exploits this information

Moral Hazard

after the transaction, people will often act in a way that makes the other party worse off

Taxes

The government levies taxes on many goods and services to raise revenue to pay for national defense, public schools, etc

The government can make buyers or sellers pay the tax

The tax can be a % of the good’s price or a specific amount for each unit sold

Tax Incidence

the manner in which the burden of a tax is shared among participants in a market

Transfers

money given to individuals without work or goods given back in return

Cash or in-kind (service, good) benefit given to parts of the population

Ex: Food Stamps

Equity

refers to fairness

How big is each person's slice of the pie

Efficiency

refers to using resources in the best possible way

Maximize the size of the economic pie

Gov and Taxes

relies on taxes to raise revenue to pay for the actions and programs it needs to finance

can also place a tax on a good to discourage consumption (and demand) of the good

Ex: Excise tax on cigarettes and alcohol

Individual Income Taxes

federal, state, and local governments tax wages, salaries, income, and profits

Largest source of revenue

2018: Average U.S. taxpayer earned $74,664 and paid

$8,367 in federal income taxes (total of $10,489 in taxes)

Social Insurance Taxes

federal government also taxes wages and salaries to raise funds for Social Security and Medicare system (“payroll taxes”)

Social Security – payments to retired and disabled

Medicare – health insurance for those over 65

2009: 75% of taxpayers pay more in payroll taxes than federal income taxes

Sales Taxes

state and local governments tax sales of most retail products

50% of states exempt food

Property Taxes

local governments tax homes, offices, factories, land

Largest source of funding for public schools

Excise Taxes

federal government (and some state governments) have excise taxes on specific goods

Examples: Beer, gasoline, cigarettes

Regressive Taxes

a tax for which people with a lower income pay a higher percentage of their income in taxes than do people with higher incomes

Example: sales tax

Progressive Taxes

a tax for which people with lower incomes pay a lower percentage of their income in taxes than people with higher incomes

Proportional Taxes

a tax for which people with lower incomes pay the same percentage of their income in taxes as do people with higher incomes

Example: if there was a tax where everyone paid 20% of their income

Taxable Income (Federal Income Tax)

the amount of income you have that is eligible for taxation, this is your total income minus exemptions and deductions

Exemptions (Federal Income Tax)

deductions for each member of your family

Deductions (Federal Income Tax)

other things that can be deducted from total income

Examples: mortgage interest, contributions to charity

Tax Rate (Personal Income Tax)

percentage of income paid in taxes

Tax Bracket (Personal Income Tax)

income range within which a tax rate applies

Marginal Tax Rate (Personal Income Tax)

the percentage that income in a particular tax bracket is taxed.

Fraction of each additional dollar of income that must be paid in taxes

Average Tax Rate (Personal Income Tax)

total tax paid divided by total income

Income Taxes

distort behavior

reduces the incentive to work

Can result in workers actually deciding to work less

put a Deadweight Loss (DWL) on society

Lump-Sum Tax

a tax that is the same amount for every person

Benefit: More efficient

Can’t decrease your taxes by working less, etc

Cost: Regressive

The poor pay a higher proportion of their income in taxes

Mortgage Interest Deduction (MID)

Allows you to deduct interest paid on your mortgage from your taxable income

Every dollar of mortgage interest deducts tax liability by household marginal tax rate

Provides an incentive to buy “too much” house

Benefits households with higher income more

Means-Tested

your benefit (amount you receive) depends on your income

Social Insurance

benefits offered to everyone in a group

Means-Tested Transfers

Food Stamps (in-kind)

Medicaid (in-kind): Health insurance for families with low income

Provides long-term care (nursing homes) for elderly with low enough income

Earned Income Tax Credit: Refundable tax credit for families with a low enough income

Reason why some households don’t pay any taxes or get money back

“Welfare”: Transfers money to low income families with kids

Social Insurance Programs

Unemployment Insurance: pays workers an income for a certain amount of time when they are laid off

Medicare: health insurance for the elderly

Social Security: payments to retired workers or disabled 

Disability: pays workers when they are disabled, can get health insurance too

Social Security Problems 1

It can reduce the incentive to save

Know you get a social security transfer payment from the government when you retire, so you may not save as much for retirement

Distorts behavior

Social Security Problems 2

It is a pay-as-you-go system

The payroll taxes you pay to Social Security today are financing TODAY’S retirees, not your retirement

People are having fewer kids

There are more elderly

Fewer people paying into a system providing benefits to more people

Social Security Problems 3

Babyboomers are getting ready to retire, so we will have even more elderly

1970, 9% of population over 65

5.9 workers/retiree

2030, 20% of population over 65

3.0 workers/retiree

More elderly and less people paying into the system

Need to make the system “solvent”

Social Security Proposed Changes

Get rid of it

Problem: people have paid in for their entire life and are counting on it

Stop pay-as-you-go: President Bush wanted to set up individual retirement accounts

Problem: What happens if stock market crashes?

Lower benefits: Lowers costs

Increase age needed to receive Social Security

Life expectancy has dramatically increased since 1935 when it was created

Increase age to 68, etc