Naked Economics - Video Flashcards (Key Vocabulary)
Introduction and Core Ideas
Naked Economics argues that economics is about intuitive, powerful ideas that govern everyday life, not just abstractions.
Key message: Incentives, information, and institutions shape what we do, often more than ideology.
Economics is seen as a set of tools to analyze real-world problems: trade-offs, costs, benefits, and unintended consequences.
Central metaphor: Markets align self-interest with social outcomes when properly designed; government should fix market failures, not replace markets.
Core aims across chapters: explain how markets work, where they fail, and how policy can improve outcomes without stifling innovation or growth.
Chapter 1 recap: The Power of Markets (highlights from intro and early chapters)
Markets allocate scarce resources via prices; prices coordinate supply and demand and convey information efficiently.
Prices act as signals, guiding resource use to where they are valued most and enabling creative destruction.
The basic forces: supply, demand, price, and incentives; individuals act to maximize utility given constraints.
Market success does not imply markets are perfect; government is needed to address externalities, public goods, and information problems.
Examples illustrating market dynamics: supply shocks, price signals, and how individuals respond to incentives (e.g., how a small price change can shift behavior).
The book emphasizes that economics should be accessible to smart non-specialists and framed by intuitive ideas rather than equations alone.
Key Concepts and Formulas (Chapter 1 overview)
Utility and preferences: individuals maximize utility subject to constraints; utility can be non-material and time-dependent.
Opportunity cost: the true cost of any choice includes the next best alternative foregone.
Prices as signals: guide consumption, production, investment, and innovation.
Creative destruction: market competition forces old industries to adapt or die; this drives long-run productivity gains.
Externalities and public goods: market failures where private costs/benefits diverge from social costs/benefits; government intervention can help.
Price discrimination (Chapter 2 discussion): charging different prices to different customers for the same good to capture more consumer surplus.
Laffer curve (briefly discussed): tax rates and revenues have a non-linear relationship; optimal taxation cannot be assumed to always rise with higher rates.
Rule of 72: ext{doubling time (years)}
oughly rac{72}{r} where r is the annual growth rate (in percent).Purchasing Power Parity (PPP): currencies should adjust so that identical baskets of goods cost the same across countries; formalized as exchange rates aligning with relative price levels.
Gini index: a measure of income inequality, with 0 = perfect equality and 100 = maximal inequality. Examples: US ~0.45 in 2007; France ~0.28; Sweden ~0.23; Brazil ~0.57.
HDI (Human Development Index): broader measure of development including life expectancy, literacy, and education; US ranked 13th in 2009.
Chapter 2: Incentives Matter
Core idea: Incentives drive behavior; people respond to price signals, payoffs, and perceived benefits/costs.
Affermative action example ( Glenn Loury): nuances show how policies can create perceptions of unfairness and unintended consequences in group relations.
Healthcare cost mandates illustrate tradeoffs: expanding benefits raises costs (premiums) and can reduce coverage for some on the margin; design must balance comprehensive care with cost containment.
Behavioral economics introduces limits to strictly rational models; heuristics and biases affect decision making (cashew example from Thaler).
Bounded rationality and risk perception: people overweight rare, dramatic outcomes; underweight long-term risks.
Rational decisions vs. actual behavior: individuals may make choices that maximize perceived utility given imperfect information.
Environment and development implications: rich nations’ consumption choices affect poorer countries; enviro-externalities require careful policy design and funding to address global costs.
Blind auditions in orchestras improved female success, illustrating how information and signaling affect outcomes.
Key practical lesson: experts may disagree about policies (e.g., minimum wage, health reform) but policy analysis should frame tradeoffs clearly.
Economic incentives behind major crises: moral hazard in financial markets, misaligned incentives for mortgage brokers and banks; the crisis is tied to incentives for risk-taking and offloading risk via securitization.
Behavioral economics integrates psychology with economics to explain why people deviate from “rational agent” assumptions.
Chapter 2: Key Concepts and Formulas
Utility maximization under constraints; incentives shape choices.
Perverse incentives and unintended consequences: policies may produce outcomes opposite to intended goals.
Coase theorem (policy relevance): when property rights are well-defined and transaction costs are low, private bargaining can internalize externalities; government intervention may be unnecessary in some cases.
Externalities (negative and positive) and the role of Pigouvian-style policies (taxes or subsidies) to align private incentives with social costs/benefits.
Price discrimination: $p1 eq p2$ across consumer groups; airlines, entertainment, and online pricing illustrate this in practice.
Market power and price setting: imperfect competition allows firms to charge above marginal cost; pricing strategies aim to maximize profits, often via segmentation.
Information problems: adverse selection and moral hazard; signaling (e.g., deductible in insurance) helps to separate and price-risk pools.
Monopoly/competition trade-offs: competition reduces prices and spurs innovation, but some markets require regulation to prevent abuse.
Okun’s law (policy relevance): rac{ ext{change in unemployment}}{ ext{change in GDP}} ext{ rough rule}
ightarrow ext{about } -0.5 \
ext{to } -0.3 per percentage point change in GDP growth (illustrative timescale).PPP and exchange rates: floating vs fixed rates; currency values reflect relative price levels and trade balances over time.
The Rule of 72 and risk/return tradeoffs in finance; compounding effects.
Chapter 3: Government and the Economy (I)
Externalities explained via examples (gasoline consumption, pollution, congestion) and the need for policy to reflect true social costs.
Role of government: define and enforce property rights; provide public goods; regulate externalities; stabilize the economy via macro policies.
Taxation and public finance: taxes affect behavior; deadweight loss occurs when taxation distorts economic decisions; broad, simple, fair taxes are preferred.
Green taxes and “sin taxes” (cigarettes) as tools to align private incentives with social policy goals.
Public goods: non-excludable and non-rival, leading to free-rider problems; examples include national defense, public parks, and basic R&D.
Bank and financial regulation: central bank independence matters for credibility and low inflation.
Technology, innovation, and government role: defense and scientific research funding; government procurement can spur private sector innovation (In-Q-It example).
Health policy and insurance design: cost-sharing, moral hazard, adverse selection; mandates may be needed to pool risk.
Protectionism vs. liberalization: trade openness generally raises living standards, but political economy creates winners and losers; policies should counteract displacement with retraining and safety nets.
Coase-type negotiations vs. regulation: private settlements can internalize externalities when transaction costs are low; many externalities require government action due to high transaction costs.
The economics of regulation: licensure and entry barriers can protect incumbents; regulation can be both helpful and harmful depending on design and enforcement.
Earmarks and political economy: the persistence of political incentives that favor small, organized groups over broad constituencies; policy must consider political economy.
The role of democratic governance in market outcomes: institutions shape long-run growth; rule of law, property rights, and accountability are crucial.
Chapter 3: Key Concepts and Formulas
Externalities: social cost vs. private cost; Pigouvian taxes/subsidies to align incentives.
Public goods: non-excludable, non-rival; free-rider problem; market provision underprovision without government.
Deadweight loss of taxation: efficiency costs from tax distortions; broad, low-rate taxes minimize deadweight loss.
GDP and macro policy: fiscal policy (taxes/spending) and monetary policy (money supply/interest rates).
Laffer curve (conceptual): tax rates and revenue relationship; not a universal predictor of revenue bumps.
Okun’s law (as noted in Chapter 3 context): approximate link between GDP growth and unemployment.
Nash/Coase ideas: private bargaining vs. regulation under varying transaction costs; property rights and enforcement matter.
Chapter 4: Government and the Economy II
Public choice and political economy: regulation often serves incumbents' interests; the mohair subsidy example shows how political incentives shape policy outcomes.
The costs and benefits of macro policy in crisis: the 2008-09 stimulus as a response to a financial crisis; debate over timing and composition.
The role of regulation in fostering or hampering growth: too much regulation can stifle entry and innovation; too little can enable fraud and externalities.
The role of international institutions (IMF, World Bank) and the politics of global finance.
The idea that governments should fix externalities but avoid micro-managing markets in ways that reduce efficiency or adaptability.
The importance of institutions in development: property rights, rule of law, regulatory quality, and governance.
Chapter 4: Key Concepts and Formulas
Regulations and entry barriers: e.g., licensure, zoning; the Becker insight that small but organized interest groups can capture political power.
Policy design and incentives: how to structure unemployment insurance or safety nets to avoid distorting incentives (the EITC example comes later in Chapter 12).
Laffer curve in practice caveat: extreme tax cuts may not raise revenue in modern economies; political constraints matter.
Chapter 5: Economics of Information
Information asymmetry is central to many markets (health care, used cars, insurance).
Market signaling and screening: deducing private information through actions (deductibles, tests, and signals of risk).
Adverse selection and pooling: insurance markets fail when high-risk individuals are more likely to buy; the personal mandate is one approach to mitigate adverse selection.
Principal-agent problems: misaligned incentives within firms (CEO incentives, stock options) and within buyer-seller relationships (real estate agents; brokers).
Behavioral economics: bounded rationality, heuristics, and systematic biases (e.g., overconfidence, “hot hand” belief in sports analytics).
Information problems in health care: misaligned incentives among patients, doctors, insurers, and tech; cost/quality trade-offs and the role of HMOs.
The rise of signaling in education and credentials; Harvard premium vs. actual value added (signaling vs. human capital argument).
Chapter 5: Key Concepts and Formulas
Adverse selection model concept: adverse selection occurs when one party has more information than the other about a transaction’s risk.
Signaling and screening math is often qualitative; formal models use Bayesian updating and pooling/separating equilibria (not fully written here but underlying concept).
The “Lemons” problem: market for used cars where quality is uncertain; information asymmetry drives quality down.
The role of deductibles as a screening mechanism in insurance: higher deductibles attract lower-risk individuals, lowering average payout.
Chapter 6: Productivity and Human Capital
Human capital is the stock of skills, education, health, and capabilities individuals hold; it drives productivity and growth.
The 75% claim: Becker argues human capital is the dominant component of wealth in a modern economy.
Education and fertility: higher female education correlates with lower infant mortality and better health outcomes; education enables better health practices and productivity.
The wage premium for high-skill workers reflects scarcity and marginal productivity; superstar earnings reflect unique value additions (e.g., athletes and entertainers).
International comparisons show that natural resources are not the main determinant of growth; human capital and institutions matter more.
The concept of a “brain drain” and the importance of domestic human capital formation; urban density effects on productivity.
The role of geography in development: climate and tropical environments can hamper agricultural productivity and disease burden, but human capital and technology can overcome many barriers.
Chapter 6: Key Concepts and Formulas
Return on investment in education: typical ROI estimates around ext{ROI}_{education}
oughly 10 ext{%} per year (illustrative from Wheelan’s discussion of college ROI).Human capital shares of wealth: Becker argues human capital accounts for roughly 75% of wealth in a modern economy (conceptual figure).
Productivity growth rates: historical US productivity growth ranges cited: 2.7 ext{% per year (1947-1975)}; 1.4 ext{% (1975-mid-1990s)}; 2.5 ext{% (2000-2008)} with long-run implications for living standards.
The Law of Diminishing Returns and the role of technology in lifting output per worker over time.
Chapter 7: Financial Markets
Financial markets perform four broad tasks: raising capital, enabling credit, storing value, and spreading risk.
The case for diversified portfolios: diversification lowers risk without reducing expected return; index funds beat many active managers over long horizons due to costs and competition.
Efficient markets hypothesis caveats: markets can be irrational in the short run, but prices tend to reflect all available information in the long run; behavioral finance explores deviations.
The rise of complex financial instruments (CDOs, CDS) and the systemic risks they posed when mispriced and poorly understood.
The role of incentives in finance: risk-taking by bankers and the misalignment with shareholders’ interests; executive compensation (stock options) as a double-edged sword—potential misalignment and accounting manipulation risk.
The 2007-08 crisis overview: mispricing of mortgage-backed securities, securitization, rating agencies’ conflicts of interest, and the moral hazard embedded in bailout expectations.
The concept of liquidity, risk, and the function of Treasury/government guarantees in stabilizing markets during crises.
The endowment example: Harvard/Yale and the role of risk/return trade-offs in investment policy; diversification and long-horizon institutions.
Chapter 7: Key Concepts and Formulas
Rule of 72 (finance context): ext{doubling time} rac{72}{r} where r is the annual growth rate or return (percent).
Expected return vs. risk trade-off: riskier assets offer higher expected returns, but with higher variance and the chance of large losses.
Diversification math (illustrative): splitting $100k into 10 independent bets reduces the probability of total loss drastically; independent events.
Securitization and CDS mechanics: risk transfer as a mechanism to distribute credit risk; not inherently bad, but dangerous when mispriced or when counterparty risk is high.
Index funds vs. active funds: after costs, many active funds fail to outperform a broad market index over long horizons.
Chapter 8: The Power of Organized Interests
Politics and economics interact; small, well-organized interest groups can capture benefits at the expense of the many.
Mohair subsidy example and pork-barrel politics demonstrate the drift toward rent-seeking in government; votes often hinge on narrow, well-organized groups rather than broad public good.
The “policy tunnel”: once a policy is enacted, it often persists due to political incentives, even if the broader economy would be better off without it.
Refundable and targeted policies can mitigate adverse effects; the need for humility and policy diversity in development.
The importance of transparency and public accountability to counteract corruption and ensure efficient policy outcomes.
Chapter 8: Key Concepts and Formulas
The “mohair problem” as an emblem of special-interest politics; the need for sunset clauses and evaluation to prevent perpetual subsidies.
The Coasean view on transaction costs: private bargains can solve some externalities if costs are small and rights well-defined; otherwise government intervention is required.
The concept of regulatory capture: industries influencing the very rules meant to govern them.
Chapter 9: Keeping Score
GDP as a measure of market activity; not a complete measure of welfare or well-being.
Alternative metrics: HDI (life expectancy, literacy, education) and other indicators to supplement GDP.
Happiness and welfare economics: evidence that rising GDP does not automatically translate into higher reported happiness; the importance of non-material factors and experiences.
The role of innovation, technology, and human capital in long-term growth; the trade-offs between consumption today and investment for the future.
The Great Moderation and mechanisms to manage recessions: consensus that monetary policy, prudent fiscal policy, and credible institutions reduce economic pain over cycles.
Chapter 9: Key Concepts and Formulas
Okun’s law (contextual): relationship between GDP growth and unemployment (policy relevance).
The GDP growth–unemployment linkage is not a strict law but a robust empirical regularity observed over decades.
The Happiness literature: correlation between life satisfaction and income vs. non-income determinants (e.g., family, health, relationships).
Chapter 10: The Federal Reserve
The Fed’s core tools: monetary policy via open market operations, discount rate, and reserve requirements; setting target federal funds rate.
The money multiplier mechanism: central bank creates money by swapping bonds for cash in banks’ reserves; loans out reserves, increasing money supply and stimulating activity.
Independence in policy: credibility matters; political interference can undermine inflation control; evidence from international cases.
Inflation vs. deflation dynamics: deflation can be dangerous; inflation control is critical for stable growth; inflation can erode debt values in the short run but cause distortions if not managed.
The role of unconventional monetary tools during crises (e.g., liquidity facilities, bailouts, and unconventional lending): necessity during crises but potential long-run risks.
The debate about long-term growth potential, the “speed limit” of growth, and the interaction between monetary and fiscal policy.
Chapter 10: Key Concepts and Formulas
The money supply and monetary base concepts; the money multiplier is not constant in crises but illustrates how central banks influence liquidity.
The inflation tax concept: inflation erodes the real value of money and outstanding debts; governments can use inflation to reduce real debt burden, with societal costs.
The relationship between inflation expectations and actual inflation; the role of credible policy in anchoring expectations.
The Fed’s independence and its impact on inflation, growth, and expectations.
Chapter 11: International Economics
Capital flows and exchange rates: foreign investment flows determine currency valuations; trade balances influence current accounts.
Soros’ pound bet (Black Wednesday) illustrates currency speculation and the risk of fixed/managed exchange-rate regimes.
The ERM and currency crises illustrate how pegs invite speculative attacks if markets doubt the defender’s resolve or capacity.
Floating vs fixed exchange rate regimes: each has advantages and vulnerabilities; many economies use floating rates with hedging to manage risk.
The role of the IMF and World Bank in stabilizing crises; conditional lending tied to reforms.
The Big Mac Index as a playful PPP indicator: demonstrates differences between official exchange rates and PPP-based valuations; illustrates how markets reflect real purchasing power across currencies.
Trade and growth: empirical evidence suggests trade openness correlates with higher per-capita income; causal links still debated, but the consensus supports free trade as a long-run growth engine.
The “Dutch disease” phenomenon: resource booms can hurt other tradable sectors by appreciating the currency; the need for policies to diversify and invest in human capital and institutions.
Currency misalignment and the politics of exchange-rate policy: currency valuations reflect macro fundamentals and policy stance; misalignment can trigger tensions in international relations.
Chapter 11: Key Concepts and Formulas
PPP (Purchasing Power Parity): exchange rate aligns with relative price levels: E imes P^{domestic} ext{ vs } P^{foreign} (conceptual).
Big Mac PPP: cross-country price comparisons for tradables vs. nontradables; the Big Mac index shows deviations from official exchange rates.
Current account balance: reflects net exports and cross-border income flows; persistent deficits imply the need to borrow from abroad or run down assets.
Chapter 12: Trade and Globalization
Core claim: Trade raises overall welfare by allowing countries to specialize in what they do best (comparative advantage) and trade for what they do less efficiently.
Comparative advantage: even if Bangladeshis are not more productive at every task, they can benefit from specializing in labor-intensive goods and importing capital-intensive goods from others.
Globalization and growth: export-led growth linked to poverty reduction when coupled with good governance and investment in human capital.
Sweatshops debate: arguments that sweatshops may lift households out of poverty by providing working opportunities; the counterpoints emphasize the need for better conditions and gradual upgrading rather than outright bans.
The environmental dimension: trade can enable capital to flow toward cleaner technologies; mitigation of environmental harms through global standards and cooperation.
The Doha Round and the politics of trade negotiations: the balancing act between liberalization, development, and domestic political interests.
The Africa Growth and Opportunity Act (AGOA) as a case study showing how trade preferences can stimulate growth in developing countries.
Trade-offs of liberalization: while trade reduces prices and increases consumer welfare, it may displace workers; policy should emphasize retraining and safety nets to cushion transitions.
Chapter 12: Key Concepts and Formulas
Absolute vs. comparative advantage: formal concept; trade improves overall welfare via specialization and exchange.
Trade balances and capital flows: deficits can be financed by asset sales or borrowing; long-run sustainability depends on productive investment.
The World Trade Organization (WTO) and multilateral agreements: institutional arrangements to facilitate trade, reduce protectionism, and enforce rules.
The infant industry and protectionism critique: temporary protections may hinder efficiency if they persist too long; the design of transitional arrangements matters.
Chapter 13: Development Economics
Major puzzle: why are some countries rich while others are poor? The focus is on institutions, governance, human capital, and open markets.
Effective government institutions (rule of law, contract enforcement, property rights) are critical determinants of long-run growth; extractive vs. inclusive institutions matter.
The colonization literature (Acemoglu, Johnson, Robinson) links the origins of institutions to colonial settlement patterns; extractive institutions persist where settlement was difficult.
Property rights: formal titles unlock access to credit and investment; de Soto’s work on informal property demonstrates vast untapped capital in developing countries.
The problem of “dead capital” and the potential for growth through better property rights regimes.
Corruption and governance quality: governance metrics (World Bank governance indicators) correlate with development outcomes.
The role of public health, education, and human capital accumulation: investments in health and education yield long-run growth via productivity improvements and demographic changes.
Aid effectiveness and policy advice: aid works best where there are good policies; aid alone is insufficient to spur growth without governance reforms.
The development policy debate contrasts two camps: Sachs’s growth-led development with large-scale aid vs. Easterly’s humility and evidence-based, context-sensitive interventions.
The concept of poverty traps: some countries face persistent constraints (e.g., geography, governance) that require targeted, well-designed interventions to jump-start growth.
Demographic transitions: education and family planning influence population growth and long-run development trajectories.
Chapter 13: Key Concepts and Formulas
Growth accounting highlights: capital deepening (physical and human capital) and total factor productivity (TFP) as drivers of long-run growth.
The role of human capital: investments in education and health essential for sustained development; Becker’s emphasis on human capital as wealth driver.
Institutions and governance indices: use of World Bank governance indicators to assess development potential.
Comparative development literature: Acemoglu et al. link institutions with development outcomes; the colonial origin thesis explains cross-country divergence.
The core policy implication: aid without good governance is less effective; reforms in institutions, property rights, and governance are prerequisites for sustainable development.
Epilogue: Life in 2050 – Seven Questions
Question 1: How many minutes of work will a loaf of bread cost? Productivity is central; with sustained growth, real incomes and living standards rise, altering the time-cost of everyday items.
Question 2: Will wealth be distributed more evenly? Relative income and happiness depend on distribution as well as absolute growth; policy can influence both through taxes, transfers, and investments in human capital.
Question 3: How much of a safety net is desirable? Balancing incentives for work with social protection remains contentious; findings from EITC and other programs illustrate trade-offs.
Question 4: What share of the pie should be allocated to consumption vs. investment? Growth requires savings and investment but immediate welfare may require consumption.
Question 5: How should government intervene in markets? The right amount of intervention depends on institutions, incentives, and the political economy of each country.
Question 6: Will technology and globalization continue to raise living standards? Yes, but policy must adapt to distributional consequences and the need for inclusive growth.
Question 7: What is the role of happiness and well-being in policy? Economists increasingly study well-being metrics alongside GDP to capture broader social progress.
Notes on Key Equations and Concepts Used in the Book (selected)
Utility and choice: maximize utility U(x) subject to budget constraint; decisions reflect preferences and trade-offs.
Demand and supply: Qd = f(P), Qs = g(P); equilibrium when Qd=Qs.
Price discrimination: charging different prices to different consumers based on willingness to pay; examples include airline tickets, online pricing, etc.
Public goods and externalities: definitions and policy responses via taxes or subsidies to correct market failures.
PPP and exchange rates: E ext{ (PPP)}
ightarrow rac{P{ ext{domestic}}}{P{ ext{foreign}}} ext{ approximates } E_{ ext{nominal}}; Big Mac PPP as an illustrative proxy.Rule of 72: ext{doubling time}
oughly rac{72}{r}.GDP growth and unemployment (Okun’s law): rough relationship; used to discuss macro policy.
Laffer curve (conceptual): tax rates and revenue relationship; not a universal predictive rule.
Inflation and interest rates: monetary policy to manage inflation; inflation affects real debt values; inflation expectations influence behavior.
Current account and savings: deficits/surpluses reflect intertemporal choices and capital flows; savings behavior influences the current account balance.
Comparative and absolute advantage: trade improves welfare by allocating resources to their most productive uses; specialization and exchange raise total output.
Human capital ROI: ext{ROI}_{education} ext{ often cited around } 10 ext{%}; human capital as a driver of growth.
Endowment vs. growth: natural resources less predictive of long-run wealth than institutions and human capital.
Signaling vs. productivity in education and credentials; the debate over value-added vs. signaling effects of college.
The Bayesian framework (information economics) underpins adverse selection and screening in insurance, as well as signaling in labor markets.
Real-World Connections and Implications
Global crises (2008): incentives in the financial system, risk-taking, and misaligned compensation contributed to the crisis; reform emphasizes better incentives, transparency, and regulation.
Climate and externalities: carbon taxes, environmental policy, and green growth strategies reflect market-based approaches to externalities.
Health care reform debates: balancing insurance coverage, adverse selection, and costs; the role of mandates and subsidies in risk pooling.
Education and inequality: human capital development is central to growth and to reducing poverty; policies favoring universal access to education yield long-run benefits.
Trade and poverty: globalization raises overall welfare but requires safety nets for displaced workers; aid effectiveness hinges on governance and policy reform.
Institutional development: governance quality and property rights are foundational; without them, inflows (capital, aid) may fail to raise living standards.
Policy design principles: align incentives, minimize deadweight loss, design policies that can be rolled back or sunset; beware of political economy dynamics that sustain inefficient arrangements.
Ethical and Philosophical Relevance
Debates over redistribution reflect ethical choices about fairness vs. efficiency; economists provide frameworks, not moral prescriptions.
Libertarian paternalism (Nudge) suggests steering choices through defaults while preserving freedom; organ donation examples illustrate policy design consequences.
Global justice concerns: the balance between aiding the poor and promoting long-run growth through open markets and investment in human capital.
The role of government in shaping a “good life” includes considerations beyond GDP: health, education, environment, and social cohesion.