American Economy Final

📘 ECONOMIC PRINCIPLES

5⃣ Goals/Principles of Economic Policy

• Definition: The key goals of economic policy are efficiency, equity, economic growth, and stability.

• Relevance: Determines government intervention in taxation, welfare, and monetary policy.

• How It Works: Policies like fiscal policy (taxes) and monetary policy (interest rates) are designed to achieve these goals.

• Who/When/Why/How:

  • Who: Policymakers, governments, and central banks.

  • When: Used in response to economic shocks and recessions.

  • Why: To ensure sustainable economic growth, fairness, and stability.

  • How: Trade-offs are made between equity and efficiency in policies like welfare.

• Example: COVID-19 stimulus checks promoted stability but increased debt, showing a trade-off.

6⃣ Pareto Efficiency

• Definition: An allocation of resources where no one can be made better off without making someone else worse off.

• Relevance: Serves as a benchmark for economic efficiency.

• How It Works: In perfect competition, markets achieve Pareto efficiency.

• Who/When/Why/How:

  • Who: Used by policymakers and economists.

  • When: Used to judge market outcomes and resource allocation.

  • Why: To ensure resources are used optimally.

  • How: Markets must have perfect information, perfect competition, and no externalities.

• Example: A perfectly competitive market is Pareto efficient.

7⃣ Role of the State

• Definition: The government's role in setting rules, protecting property rights, and fixing market failures.

• Relevance: Justifies welfare, taxes, public goods, and market regulation.

• How It Works: The state intervenes when markets fail or when public goods are under-supplied.

• Who/When/Why/How:

  • Who: Government agencies like the EPA, CBO, and Federal Reserve.

  • When: During market failures (like the 2008 financial crisis).

  • Why: To ensure efficiency, equity, and public welfare.

  • How: Uses laws, regulations, and taxes to achieve social goals.

• Example: EPA regulations reduce pollution and address externalities.

8⃣ Efficiency-Equity Tradeoff

• Definition: The idea that improving fairness (equity) reduces economic efficiency.

• Relevance: Justifies welfare programs and progressive taxation.

• How It Works: Redistribution (like welfare) reduces efficiency by introducing deadweight loss.

• Who/When/Why/How:

  • Who: Policymakers debate tradeoffs when designing tax systems.

  • When: Used to analyze programs like welfare and unemployment benefits.

  • Why: To balance fairness (equity) with efficiency in policy.

  • How: Governments impose progressive taxes to improve fairness.

• Example: Minimum wage laws improve fairness but reduce efficiency by increasing costs for firms.

📘 FAIRNESS AND INEQUALITY

9⃣ Rawls' Veil of Ignorance

• Definition: Decision-makers create fair rules as if they didn't know their social position.

• Relevance: Justifies welfare programs and redistribution to protect the vulnerable.

• How It Works: By imagining themselves as the "worst-off," decision-makers create rules that maximize fairness.

• Who/When/Why/How:

  • Who: Used in social contract theory by John Rawls.

  • When: Used to support welfare policies.

  • Why: To ensure fairness and redistributive justice.

  • How: Encourages progressive tax policies and universal healthcare.

• Example: Justifies universal healthcare and programs like food stamps (SNAP).

🔟 Rawls' Maxi-Min Principle

• Definition: Maximize the welfare of the least-advantaged members of society.

• Relevance: Supports policies that reduce inequality.

• Example: Progressive taxation benefits low-income households.

1⃣1⃣ Nozick's Libertarian Principle

• Definition: Emphasizes minimal government intervention and protection of property rights.

• Relevance: Opposes redistributive taxation and supports a "minimal state."

• Example: Opposition to welfare and support for low taxes.

1⃣2⃣ Inequality in the U.S.

• Definition: The unequal distribution of income, wealth, and opportunity.

• Methods to Measure:

  • Gini Coefficient

  • Quintiles/Deciles

  • Income/Wealth Disparity

• Target of Measures: Labor Income, Capital Income.

• Example: The top 1% controls 40% of wealth in the U.S.

📘 INCOME, INEQUALITY, AND PIKETTY & SAEZ

1⃣ Income (Labor Income + Capital Income)

• Definition: Total income from two primary sources:

  • Labor Income: Wages, salaries, and employment-related earnings.

  • Capital Income: Income from ownership of assets like dividends, interest, capital gains, and rents.

• Relevance: The split between labor income and capital income determines income inequality and wealth inequality.

• How It Works: Labor income is earned through work, while capital income comes from returns on investments.

• Who/When/Why/How:

  • Who: Workers receive labor income, while investors receive capital income.

  • When: Capital income becomes more relevant as wealth accumulates.

  • Why: High-income individuals receive most of their income from capital, while low-income individuals rely on labor.

  • How: Policies like taxes on capital gains affect income inequality.

• Examples:

  • Labor Income: Wages earned from a 9-5 job.

  • Capital Income: Dividends from owning stocks or rental income from property ownership.

2⃣ Inequality in the U.S.

• Definition: The growing gap between high-income and low-income individuals.

• Relevance: Drives debates on progressive taxation, wealth taxes, and wage increases.

• How It Works: Increases in capital income for the wealthy drive inequality, while wages (labor income) remain stagnant.

• Who/When/Why/How:

  • Who: Wealthiest 1% receive the majority of capital income.

  • When: Inequality grew after the 1980s due to lower taxes on capital gains and less unionization.

  • Why: The rich earn more capital income than the poor.

  • How: Government intervention can reduce inequality via progressive taxation and welfare.

• Example: The top 1% of U.S. households control 40% of the nation's wealth, while most of the bottom 50% rely on labor income.

3⃣ Piketty & Saez Main Idea

• Definition: The key argument is that in low-growth economies, returns on capital (r) exceed returns on labor (g), leading to rising inequality.

• Relevance: Explains the increasing gap between capital owners and wage earners in the U.S.

• How It Works: If the rate of return on wealth (r) is greater than the economic growth rate (g), then wealth becomes more concentrated.

• Who/When/Why/How:

  • Who: Wealth holders grow richer while workers stay stagnant.

  • When: Post-1980s, after tax cuts on capital gains.

  • Why: Wealth grows faster than wages, causing inequality.

  • How: Capitalists gain from returns on stocks, dividends, and rents.

• Example: Billionaires like Jeff Bezos and Elon Musk grow wealthier due to returns on stock, while workers' wages barely increase.

📘 REGULATIONS AND GOVERNMENT INTERVENTION

4⃣ Regulations

• Definition: Rules or laws set by the government to control market activity.

• Relevance: Reduces market failures like monopolies and externalities.

• How It Works: Governments pass laws, rules, and standards to control market behavior.

• Who/When/Why/How:

  • Who: EPA (environmental regulations), FTC (anti-monopoly), SEC (financial regulations).

  • When: Often passed after crises (e.g., after the 2008 financial crisis).

  • Why: To protect consumers, reduce externalities, and prevent monopolies.

  • How: Laws like the Clean Air Act and Sherman Antitrust Act.

• Example: Clean Air Act regulates pollution to reduce environmental harm.

5⃣ Waves of Regulation (Cohen's Key Features)

• Definition: Different periods of intense regulatory action in U.S. history.

• Key Waves:

  • Progressive Era (1890-1920): Sherman Antitrust Act (break up monopolies).

  • New Deal (1930s): SEC created to regulate stock markets after the Great Depression.

  • Great Society (1960s): Focused on civil rights, health, and environmental issues (created the EPA).

  • Reagan Era (1980s): Deregulation of banking, airlines, and telecom.

• Relevance: Each era of regulation responded to a major crisis or need.

• Example: The 2008 financial crisis led to the Dodd-Frank Act to regulate Wall Street.

📘 MARKET FAILURES AND PUBLIC GOODS

6⃣ Market Failure

• Definition: When the market fails to allocate resources efficiently.

• Causes: Monopolies, externalities, and public goods.

• Relevance: Justifies government intervention in the market.

• Example: Monopolies increase prices, and externalities (pollution) reduce social welfare.

7⃣ Externalities

• Definition: Costs or benefits that affect third parties.

  • Negative Externality: Pollution (cost to society).

  • Positive Externality: Education (benefit to society).

• How It Works: Externalities cause misallocation of resources, leading to market failure.

• Solution: Taxes on negative externalities (like pollution taxes) or subsidies for positive externalities (like education grants).

• Example: Carbon taxes reduce emissions and address climate change.

8⃣ Cap-and-Trade (RGGI)

• Definition: A market-based system to reduce pollution by issuing permits to polluters.

• Relevance: Limits total pollution and allows firms to trade permits, creating incentives to reduce emissions.

• How It Works: Firms receive permits for emissions, but they can buy/sell them based on need.

• Who/When/Why/How:

  • Who: Used in the Regional Greenhouse Gas Initiative (RGGI).

  • When: Introduced in the U.S. in the 2000s to address climate change.

  • Why: To limit greenhouse gas emissions.

  • How: Caps total emissions and allows firms to buy/sell pollution permits.

• Example: RGGI (Regional Greenhouse Gas Initiative) is a U.S. cap-and-trade program to reduce CO2 emissions.

9⃣ Public Goods

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

• Examples: Clean air, public parks, national defense.

• How It Works: Markets fail to provide public goods because of the free-rider problem.

• Solution: Government intervention (taxes) is required to fund public goods.

• Relevance: Justifies taxes to pay for goods like national defense and public health.

• Example: The U.S. military is funded by taxes and provides defense for all citizens.

🔟 Public vs Private Prisons

• Definition:

  • Public Prisons: Run by the government.

  • Private Prisons: Run by private firms under contracts with the government.

• Relevance: Raises issues of accountability, cost-cutting, and profit motives in criminal justice.

• How It Works: Private prisons reduce costs by cutting staffing and services.

• Criticism: Private prisons have incentives to increase incarceration rates.

• Example: GEO Group and CoreCivic run for-profit private prisons.

• Public vs Private:

  • Public Prisons: Focus on rehabilitation and reducing recidivism.

  • Private Prisons: Focus on cost reduction and profit maximization.

📘 INCOMPLETE INFORMATION AND HEALTHCARE IN THE U.S.

1⃣ Adverse Selection

• Definition: 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 It Works: 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 It's a Market Failure:

  • Low-risk people (healthy people) leave the market, leaving only high-risk (sick) people, which raises insurance premiums.

  • This leads to an under-provision of health insurance.

• Relevance: Explains why health insurance markets fail without mandates or risk pooling.

• Who/When/Why/How:

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

  • When: Occurs in health insurance markets and used car markets.

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

  • How: Mandatory insurance requirements (like the ACA individual mandate) fix this problem.

• Example: 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.

2⃣ Moral Hazard

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

• How It Works: If people have health insurance, they might use more healthcare services than necessary (since they're not paying the full cost).

• Why It Matters: It causes overuse of healthcare services, leading to higher insurance premiums.

• Relevance: Explains why insurers use deductibles, co-pays, and co-insurance to reduce overuse.

• Who/When/Why/How:

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

  • When: Happens in any market where risk is transferred from the buyer to the insurer.

  • Why: People behave more recklessly when they don’t have to bear the full cost of their actions.

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

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

3⃣ 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

4⃣ Features of Healthcare Markets

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

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

• 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.

• Who/When/Why/How:

  • Who: Buyers (patients) and sellers (doctors, hospitals, and insurers).

  • When: Happens in every healthcare market.

  • Why: People have different health risks, so they don't all face the same healthcare costs.

  • How: Governments intervene with regulation and subsidies to address these failures.

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

📘 MEDICARE, MEDICAID, AND THE ACA

5⃣ 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.

• Parts of Medicare:

  • Part A: Covers hospital stays (funded by payroll taxes).

  • Part B: Covers doctor visits and outpatient care.

  • Part C: Medicare Advantage (allows private insurance plans to offer Medicare benefits).

  • Part D: Covers prescription drugs.

• Who/When/Why/How:

  • Who: People aged 65+ and people with certain disabilities.

  • When: Became law in 1965 as part of Lyndon B. Johnson's Great Society.

  • Why: To reduce poverty among seniors and improve access to healthcare.

  • How: Funded through payroll taxes, general revenues, and premiums.

• Example: Seniors 65+ receive hospital coverage under Medicare Part A.

6⃣ Medicaid

• Definition: A state and federal program that provides healthcare to low-income individuals and families.

• Relevance: Reduces poverty and improves healthcare for vulnerable populations.

• How It Works: Funded by both the federal government and states. Each state sets its eligibility rules.

• Who/When/Why/How:

  • Who: Low-income families, pregnant women, children, and people with disabilities.

  • When: Established in 1965 under President Lyndon B. Johnson.

  • Why: To provide healthcare for vulnerable populations.

  • How: States manage Medicaid with federal matching funds.

• Example: Medicaid expansion under the ACA increased coverage for low-income adults.

7⃣ Affordable Care Act (ACA)

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

• Relevance: Reduced the number of uninsured Americans and fixed adverse selection issues.

• How It Works:

  • Guaranteed Issue: Insurers can't deny coverage due to pre-existing conditions.

  • Subsidies: Provides financial aid for low-income families to buy insurance.

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

  • Individual Mandate: Required people to buy insurance or face a penalty (later eliminated in 2017).

• Who/When/Why/How:

  • Who: Everyone in the U.S. is affected (especially the uninsured).

  • When: Became law in 2010 under President Barack Obama.

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

  • How: Combines subsidies, mandates, and regulations to reduce market failures.

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

8⃣ Key Features of the ACA

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

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

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

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

• 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.

📘 IMPERFECT COMPETITION

1⃣ Imperfect Competition

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

• Relevance: Explains monopolies, oligopolies, and rent-seeking behavior in markets.

• Types of Imperfect Competition:

  • Monopoly: One seller, no close substitutes.

  • Oligopoly: Few sellers, firms influence price (like airlines).

  • Monopolistic Competition: Many firms selling slightly differentiated products (like restaurants).

• Example: The U.S. airline industry operates as an oligopoly since only a few large firms dominate.

2⃣ Types of Monopolies

• Natural Monopoly: A monopoly that arises when high fixed costs make it more efficient to have one firm (like utilities).

• Artificial Monopoly: A monopoly created by anti-competitive practices or government-granted rights.

• Relevance: Natural monopolies justify government regulation, while artificial monopolies are targeted by antitrust policies.

• Examples:

  • Natural Monopoly: Electric utilities (only one set of power lines is needed for efficiency).

  • Artificial Monopoly: Microsoft was accused of monopolistic behavior for controlling web browsers (Internet Explorer).

3⃣ 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.

4⃣ Solutions to Imperfect Competition

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

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

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

• 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

5⃣ 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.

6⃣ 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.

7⃣ 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).

8⃣ 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 AND MONETARY POLICY

9⃣ 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.

1⃣0⃣ 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.

1⃣1⃣ 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.

1⃣2⃣ Goals of Monetary Policy

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

• Full Employment: Keep unemployment at a natural rate.

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

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

1⃣3⃣ Monetary Policy Tools

• Open Market Operations: Buying/selling government securities to influence the money supply.

• Discount Rate: The interest rate at which banks borrow from the Federal Reserve.

• Reserve Requirement: The fraction of deposits banks must hold as reserves.

• Relevance: The Federal Reserve uses these tools to manage inflation, employment, and liquidity.

1⃣4⃣ 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.

1⃣5⃣ 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.

1⃣6⃣ 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.

1⃣7⃣ 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.

1⃣8⃣ 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.

1⃣9⃣ 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.

2⃣0⃣ 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.