Micro Economics [Maltzev]

8/2/2019 Micro Economics [Maltzev]

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1/18/11

Introduction:

Micro is the study of people assuming people are rational

Rich and poor countries are faced with scarcity-

Choice is freedom

The action of choice is based in scarcity-

Based on time preferences

Time is a part of scarcity-

The study of allocation of scarce resources

The science of choice- the science that explains the choices that we make how those choices

change as we cope with scarcity

Micro Economics:

What, who when, where, for whom?

All answers are provided with pricesGreed is not the only thing that drives private interest, i t can be compassion and love for

others or other various things.

Price theory

Production: land, capitol, & labor

Comparative vs. Absolute advantage

5 big economic questions:

A choice is a trade off - we give up something to get something to get something else- and the

highest valued alternative we give up is the opportunity cost of the activity chosen .

Value is in the eye of the beholder-

Value is highly subjective

Value is objective-

There is no capital

This leads to the idea: why do we need capitalists?

Labor is the only source of wealth

-Dangers to this theory:

This theory is not true because values are subjective to the consumer (Yuri would not

purchase a projector for a dollar, but someone else would buy it for more.) There are

different value interpretations between people

Labor Value Theory, the value is equal to the amount of labor put into the thing

Adam Smith:

Economists attempt to discover an exploration for how economic systems work.Economists distinguish between Positive Statements(What is) and Normative

Statement(What aught to be)

Positive and Normative Economics:

Observation and measurement-

Model Building-

Testing-

Steps: to Economic Science

Opportunity Cost:

HW: Read Ch.1

1/20/10

Key Assumptions to Economic Science

MicroTuesday, January 18, 2011

10:55 AM

Micro Economics Page 1


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People are self interested

People are rational

Robinson Crusoe has a set of needs on the isolated island however the more people you

interact with the more resources you need to satisfy the unl imited possibilities of

desires/needs

People have unlimited desires but limited resources

More than greed, it can take different forms

It encompasses anything that makes a person happy

Most human behavior is motivated by self interest

Consider consequences of their actions

Take action to promote self interest

Respond to incentives

Rational People

Their views of human activity was new

Daniel Kaheman and Vernon Smith

Did experimental economics-

Experimented on his students and came up with general conclusions-

Vernon

The study of economics is moving from logic positivism and field observation one of

experimentation under controlled conditions

One of the problems with substantial institutional change is that modification and irreversibility

makes the process slow, cautions and costly to society

Experimental economics yields a formal and replicable system for analysis alternative market

structures before they are actually implemented

Market experiments

Game experiments

Individual choice experiments

Historical

Chamberlin's Theory of Monopolistic Competition-

Smith 1962; Double auction experiments-

Market Experiments

Replicable-Control-

If theory doesnt work under ideal conditions in the lab, it wil l certainly not work in reality-

Communication between theorists and experimentalists (particularly in game theory

experiments)

-

Ex. Case with the dead roof man who died from a disease

Opportunity costs is uncertain

Can be used in l itigation to shift burden of proof-

Benefits of Experimental Economics

Non-realists-

Insufficient incentives-

Subjects not sophisticated enough-

Problems:

Policy: pharmaceutical companies have to sell l ifesaving drugs at lower prices to

reduce cost of medical care

Indirect effect: pharmaceutical companies spend less money on research and

development of new drugs

Example:Incentives to rational people can create indirect effects of government policies

Indirect effects:

PPF is a line that shows combinations of goods a country can make using all of its productive

resources

It shows tradeoffs a country has to face

By moving from one point to another on PPF, a country has to give up production of one

Production Possibility frontier

Experimental Economics



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good for another

Million Computers

10

6

5 12

Million televisions

Not using all resouces

Can rpoduce more of both

Buchanan-Everything Else

Inside PPF

Outside PPF

Innovation

Increasing Wealth

Voluntary exchange of goods services money and resources

Creates wealth by providing incentives for trade and specialization

Markets

Used because the "real world" is too complicated to describe in detail-

While they fail to show every detail (such as houses on a map) they provided

enough structure to solve the problem (such as how a map provides you with a

way to solve how to drive to a new location)

Models tend to be "unrealistic" but useful-

Simple theoretical description that capture the essentials of how the economy works

Economic Models

1-25-11

Personal Choice

Voluntary exchange

Protection of Persons and Property

What is Economic Freedom?

-no property rights, everything is nationalized and owned by the government .

Its not even economic, its more about management. People only work because

they are told to work not because they want to.

Russia communism

Normally preserves private ownership or markets, prices, wages, and interests

rates. There are however no longer entrepreneurs but only shop managers. The

owners of businesses were more like shop managers for the government. Theyhad to answer to the government at all times. Sociali sm is mixed with

nationalism.

Nazi Socialism

Because of the lack of incentives they had to murder people to install fear in the

hearts of the people to work

Two types:

Socialism

Economic freedom leads to economic growth and higher per capita income

Economic freedoms and property rights is the source of freedom

Private Property

They should be well defined

Restrictions on property rights:

Property rights



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In as much as we do not destruct others property rights

[economics of crime and punishment- Gary Becker(paper***)]

Say someone sells you chalk instead of cocain you cant call the police to

enforce them to get your money back so you have to go with guns and enforce

it yourself

Economics of a prohibited good leads to violence-

46% of people in prison are on charges of drugs

How consumers make choices under income constraints

They can be a place; walmart, world trade center, monster.com, etc.-

Market= where supply meets demand, where buyers and sellers are exchanging

Consumer theory is a mirror for production theory

The Consumer Theory

Idea that utility is something we are looking for in consumption

The value a consumer places on a unity of good or service depends on the pleasure

Consumers are utility maximizers

Consumers prefer more of a good thing than less of it

Diminishing marginal Utility: as more and more of a good is consumed by a consumer,

ceteris paribus, beyond a certain point the util ity of each additional unit starts to fall

Utility:

Money becomes our comparative measure of uti lity because we use it for trade.

Transfer Utility into money:

Utility can trickle down in society-

It starts with human desire and trickles down to society-

Ex. Consumers endorce what is to be sold, if people buy product from china they endorce

production in china

-

"Trickle Down" Economics

Chapter 3

The utility a consumer derives from the last unit of a consumer good she or he consumes during a

consumption period. (coke in airport vs. tom thumb)

Marginal Utility:

Utility a consumer derives from the

The aggregate level of satisfaction or fulfillment that a consumer receives through the

consumption of a specific good or service.

Total Util ity:

Total utili ty

Marginal Utility

Marginal UtilityD/ PriceD > MUH/PH

Hamburgers vs. hotdogsOne dollar's worth of hotdogs would be worth more to theis

person than one dollars worth of hamburgers

Price is a determinant of how much utility we are getting

Constrained by consumer's income

Consumers maximize their utility according to their income

Consumer Spending



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Normal good (-)

Ex. Used car's (the richer you are the less used cars you will buy)

Inferior goods (+)

Income effects:

If two goods are substitutes you can switch from one to another because

they give you the same utility

Buying less X and substituting it with Y until the optimizing condition is

restored (- )

As Px increases, Qx decreases

Substitution effect

Two effects of Price change:

Labor supply curve

Labor Markets:

Labor

Wages People trade leisure for Labor

The higher your income the more you demand leisure

All great countries at a certain point slow down because their wealth increases so they can afford leisure

The difference between equilibrium price and the price one is wil ling to pay

Consumer Surplus

P

Qx

D

Price

0

P'

If Pv then the demand will increase and shift

out thus increasing consumer surplus

Budget line versus the price

Comparing the purchases of two goods

Indifference curve analysis

1/27/11

Indifference curves for two goods are generally negatively sloped

Has to do with opportunity cost

How do we make choices with a constrained budget.

Everything inside the budget line is attainable

If there is an increase in income we can afford more

Price change effects the line the same way

Budget line and what is attainable

Properties of Indifference curves

We had deflation with an increase of production-

Prices decrease as standard of living increases-

With a fixed rate with a gold standard

GOOD SUBSTITUTES INFLUENCE CONSUMERS VERY MUCH-

The higher the price the lower the quantity demanded

Change in price effects quantity demanded

Elasticity of Demand-

Consumer choice theory

Bc I dont like the

job=micro (human

reaction)

Unemployment= macro-

Difference btw micro& macro



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Kiwi

Addictive substance

It depends

how much

you value

the good.

Demand curve

Elasticity

The more substitutes the lower prices and demand for particular goods is elastic

Substitutesalso effect the demand of an object

Demand for food is less elastic because it doesnt have any substitutes

On different levels of the market the demand is getting less elastic

-if you have time constraints then you will end up spending more

The more time you have the more elastic it is

Time:

If gas is high people wi ll buy different kinds of cars-

Gas and cars

Complements

Romin noodles and hotdogs vs. a nice meal (depending on income) the higher our income isthe less we wi ll buy an inferior good

Inferior goods

Price, income

Demand effected by:

Ink and printers

-change in the complement effects the elasticity of the good

Cross elasticity of demand

Eating tons of doughnuts - good then ok then bad

As quantity goes up utility goes down

Diminishing Marginal Utility

Borrow shares at beginning of the day, sel l right away-

Short saleStock:

Rationality assumption

Scarcity

Opportunity cost

Incentives

Marginal Decisions

Property rights

Supply and demand

Consumer demand

Markets:

Marginal production and diminishing returns

Average and marginal costs and revenues

Long run cost and economies of scale

Firm Production, costs and revenues

Quiz topics:

Price ceilings cause shortages

p

D

S



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Long run cost and economies of scale

Price ceil ings cause shortages

p

q

D

S

The more middle men we have the lower our transaction cost

Transaction cost= justification of the middle man

A person who comes up with ideas for production and services

Builds production facil ity, buy raw materials, hires workers

Takes risks for profit

Entrpreneur

An institution that hires productive resources and that organizes those factors to produce and sell goods

and services

-

A firms goal is to maximize profit-

Firm:

Opportunity cost of producing-- the best alternative action that the firm foregoes to produce a good or

service

Costs which you pay through invoices

The amounts paid for factors of production

Direct costs

Explicit costs:

Using own capital-

Uses owners time or financial resources-

Time-

Forgone opportunities

Implicit costs:

Firms opportunity costs:

Implicit rental rate is the income that the firm forgoes by using the assets itself and not renting them toanother firm.

The rental income foregone is the opportunity cost of the firm using its own capital

Opportunity Cost:

The economic depreciation

Interest foregone

(using an old computer)

Implicit rental rate of capital:

Economic depreciation is the change in the market price of a piece of capital over a given period of time

The income that the owner could have earned in the best alternative job

Normal profit is the expected return of supplying entrepreneurial ability

Owners Resources:

Production and the Firm

The whole history of human kind is a history of class warfare

Communist Manifesto

An institution that hires productive resources and that organizes those factors to

produce and sell goods and services

A firm's goal is to maximize profit

Firm:

The Firm and Its Economic problem:

Firms and Markets



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Economic & Accounting profit

Opportunity Cost-

Economic:

Measuring a firm's profit:

Technological efficiency

Efficiency

The problem of devising compensation rules that induce an agent to act in the

best interest of principal

The principal-agent problem

Ownership

Incentive pay

Long term contracts

Three methods of copying

The principle agent problem

A firm with a single owner

Proprietorship

A firm with two or more owners who have unlimited l iabilityPartnership

A firm owned by one or more limited liability stockholders

Double taxation: initial tax then personal tax-

Corporation

Types of Business

They generate the most legal lawsuits than anyone else

Cons

Economy of scale

Specialization

Pros

Partnerships

# of firms

Nature of product

Barriers of entry

Extent of control over price

Economists use market struture analysis to categorize industires based on a few key

characteristics:

Market Structure

Competition-

Monopolistic competition-

Oligopoly-

Monopoly-

Four major market types:

They have many buyers and sellers each one so small that none can individually

influence the price

Firms in the industry produce a homogeneous or standardized product

Buyers and sellers have all the information about prices and product quality that need

to make informed decisions

Characteristics of competitive markets;-

You are a price taker not a price maker

Deman curve is horizontal-

Competitive Markets:



9/19

Barriers to entry or exit are insignificant in the long run; new fi rms are free to enter the industry if so

doing appears profitable, while fi rms are free to exit if they anticipate losses

Arises when there are many firms each sell ing an identical product, many buyers, and no

restrictions on the entry of new firms into the industry

i.

Perfect competitionI.

A market structure in which a large number of firms compete by making similar buy slightly

different products

Product differentiation

Monopolistic competitionII.

A market structure in which a small number of fi rms compete

OligopolyIII.

Market with one seller

An industry produces a good or service for which no close substitutes exists and in which

there is one supplier that is protected from competition by a barrier preventing the entry of

new firms

This doesnt happen because of economy of scale - when economies or companies become

too big they become unmanageable so companies will split themselves to make themselves

more manageable

MonopolyIV.

Competition:

The Four Firm Concentration Ratio

The square of the percentage market share of each firm summed over the largest 50 firms (or thenumber of firms if there are less than 50)

Range from approximately .5% to 10,000

Herfindahl Hirchman Index

Monopoly does not have any substitutes

Oligopolies have the most brutal competition

Barriers to Entry

Regional vs Global markets

Regional markets versus global markets

Geographical scope of market

Barriers to entry and turnover

Limitations of concentration measures

Limitations:

Organizing Production

Josef Alois,

creative destruction: Netflix coming out with a new innovation destroys the old movie market -

Karl Marx came up with it.

New technologies destroy old technology. Super profits in new technology is justified - this is the

engine of change.

Business cycles:



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Long waves- revolutionary changes at the end of the wave the lenghts of the waves change

with the creation of new technology.

Expansion of credit creates easy money so people borrow a lot and interest rates are too

low and cheap money causes many projects that would not have been put together

otherwise

Artificial expansion increases the length of the depression. There needs to be a cleansing of

bad companies and projects through innovation and creativity

Bubble theory:

Labor, capital, land, and entrepreneurship

The opportunity cost of working is the amount of leisure time that mmust be given up in

order to work

The marginal utility of income may decline as you earn more

Increasing opp cost of labor as leisure

People supply more labor when wages rise

Labor supply curve:

The upward slope of an individual labor supply curve is reflectiopn of 2 things:

Income Vs Leisure

Labor Supply

Income effectsDominate

Substitute effects dominate

A worker might respond to higher wage by working less and not more

This negative supply response to increase wage rates is referred to as the income of a wage increase

Taste- for leisure income and work

Income and wealthExpectations-for income/ consumption

Prices -consumer goods

Taxes- the higher the tax the less incentive there is to work

The labor supply curve shifts when the determinates of labor supply change

Market Supply

People work hard until they become wealthy then they slow down

A rise in living standards

Income transfer programs that provide economic security when not working

Increased diversity and attractiveness of le isure activities

Over time, the labor supply cure has shifted leftward

Shifts in market supply

The percentage of change in quantity of labor supply divided by the percentage change in wage

rate

Elasticity of laor supply

Workers responsiveness to wage i s often constrained by the institutional constraints such as

specifies work hours such as 8-5 shifts

Institutional constraints:

People are only able to work 8-10 hours per day

Labor Demans

derived demand

rate

$Per hour



11/19

The quantity of resources purchased by a business depends on the firms expected sales and

outputs

Demand for final good services land and labor all materials

The principle of derived demand suggests that one way to increase someone's wages is to

increase the demand fo the goods he or she produces

The number of workers hired is not completely dependent upon the demand for the product

The quantity of labor demanded also depends on its price (the wage rate)

The higher the wage the higher the incentive to invent new technologies

Labor demand curve

Demand for Labor

Wage rate

Quantity of labor

Labor economics and the distribution of income

Interest within the company is different than outside. Conflict between managers and owners.

Principle agent problem

The agent usually has more information about his or her actions or intentions than the principal

does, because the principal usually cannot completely monitor the agent

The agent may have an incentive to act inappropriately (from the viewpoint of the principal) if the

interests of the agent and the principal are not aligned

Give the manager some stock options so that they will put more effort into the work

Some way to get around this:

The residual claimant of a company- the share holders (people who have risk in the company)

They pursue personal interests rather than those of the public

Elected officials given public trust cannot usually be monitored much of the time

Principal is the owner of the company

National income is the sum of all incomes

Income- total amount of money received by a person or household during a given time

period

Property income such as rents interest and dividends

Transfer payments

Wealth-value of assets owned at one point in timeTangible items like houses, cars, durable goods, financial assets

Income is flow and wealth is stock

Income Distribution

Abilities and skills

Intensity of work

Differences among occupations

Education

Discrimination and exclusion from certain occupations

People are not equal:

Moral Hazard

Measurment of inequality



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Depicts the relationship between complete equality and absolute inequality and actual

inequality

Lorenze Curve

GINI Coefficient

A/(A+B)

Further tool for measuring of inequality is so called Gini coefficient, which compares actual lorenz curvewith the ideal curve

Gini Coefficient can vary from 0-1

G=1 corresponds to extreme case of absolute inequality in incomes

G=0 case of absolute equality in income distribution

Primary distribution- income distribution through economic activities (wages, interests,profits,

rent)

Income distribution is final distribution of income- income was increased by transfer payments

(social security, unemployment insurance, pensions for elderly) and decrased by taxes, f ines and

other payments to state budget and other funds

Redistribution

Administrative costs- costs in distribution

The impact of working effort and entrepreneurship

Costs

Positive externality: walking by a bakery and it smells good (no transaction and there is

something you receive that you like)

-

Negative externality: cost paid by people other than the buyer or seller of a good: pollution-

Without government assistance, Adam smiths invi sible hand does li ttle to reduce

pollutionAs pollution i s created by imperfect markets and regulated by imperfect governments,

there is no ul timate pollution solution (because you cannot privatize everything)

Property rights are the biggest protection to pollution

Pollution Problem

Major thing for economists: how to internali ze external costs

Subsidi ze positive externalities and tax negative externalities

Learning objectives:

Governments should tax goods that create negative externalities

Pigouvian taxes reduces individuals incentives to use such goods

Pigouvian Taxes:

Market Externalities and Environment



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Taxation allows firms to pick their own level of pollution

Firms have an incentive to reduce their own pollution

It will give an incentive to create technology to reduce pollution

The advantages:

polution-

Negative Externalities

Positive externalities

Externalities are used to justi fy government intervention

Market Failure: Externalities

Under this system firms are given permits to pollute only up to the asmount covered by the

permits

A firm can use its permit buy permits from other firms or sel l its permits to others

The advantages of tradeavle permits are identical to those of Pigouvian taxes

They give tremendous flexibility to firms in deciding how to combat pollution

They create market for pollution-reduction innovations

Tradable Permits:

What is the optimal level of pollution: its on a cost based analysis

Tradable permits vs. Pigouvian Taxes:

Only tradable permits allow the government to set the total amount of pollution that wil l be generated

If the government can determine the optimal level of pollution, then tradable permits are socially

superior to Pigouvian taxes

If the gov doesnt know the optimal level of pollution then the gov should use pigouvian taxes to allow

the market to set the optimal level of pollution

Tradable permits allows environmentalists to buy permits and not use them.

The richer you are the more you demand a clean environment

Maybe a good solution i s to outsource. Rich countries should outsource their industries outside of

their country to remove pollution from their cities.

Poor countries

If you dont have transaction cost then all environmental problems can be solved by

negotiation between two parties-- no government intervention necessary

Cose Theory:Environment of Externalities and Cost Theory :

Distribution of income

What determines income?

Labor Economics

Different MRP's

High skilled workers can perform more tasks than low skilled workers

The demand for high skil led and low skil led labor-

Its costly

Cost paid prior to receiving higher wages

Acquisition of a skil l in an investmenr in human capital:

Human Capital is the accumulated skil l and knowledge of human beings

Wage is higher for high skilled labor

The equilibrium wage

5%-10% average return/year on high school and college education

The supply of high skilled and low skil led labor-

The minimum wage may exceed the equilibrium wage of unskilled wokers especially

teenagers

Labor Unions

Minimum wage-

Skill Differentials



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Unions exersise monopoly power to secure higher wages for their members

When union wage exceeds the equilibrium wage unemployment results

Insiders: Employed union workers whose interest is to keep wages high

Outsiders: unemployed non union workers who prefer equilibrium wages, so there

would be enough jobs for them

Attracting higher quality job applicants

Increasing worker effort, reducing "shirking"

Reducing turnover, which is costly to firms

Improving health of workers (in developing countries)

Theories in which higher wages increase workers productivity by:

Firms wil lingly pay above equilibrium wages to raise productivity

Efficiency Wage Theory-

Craft unions

Industrial unions

Two types:

Most unions are members of the AFL-CIO

Union membership has declined from 35 percent in 1950 to 12 percent today

Unions-

Local is a subunit of a union that organizes the individual workers

Negotiations about wages , working conditions etc.

Collective barganing

Group decision to stop working for prevail ing conditions

Strike

Firms refusal to operate plant or employ workers

Lockout

Binding arbitration- process which a third party and arbitrator determines wages and other

employment conditions on behalf of negotiating parties

These act similar to unions

Professional associations -organized group of professionals workers such as lawyers,

dentists, or physicians

Union -Nonunion Wage differentials-

Increase compensation

Improve working condition

Expand job opportunities

Objectives of Unions:-

Limited y how wel l it can restrict nonunion workers from offering their labor in the same

market

Higher wages result in decrease in quantity demanded of labor

World economy makes i t difficult for unions to demand too much because of the

competition with labor in other countries

This puts pressure on employers

The older your labor force the more costs a company will have

Union pensions and Healthcare

Constraints:-

Increase marginal product of union members

Encourage import restrictionsSupport minimum wage laws

Methods to increase demand for labor-

On average union wage rates are 30% higher than nonunion wage rates

Some areas have a major employer

The employer wi ll pay the last worker hired an amount equal to the extra total

revenue

A monopsony is a market with a single buyer

Decrease the level of employment

Monopsony:



15/19

Job types

Discrimination

Differences in human capital

Differences in the degree of specialization

Differences in sexes for wage earnings:

Labor stats: www.bls.gov

Production function: capital labor and land

There is something important to skills and education (human capital)

Human Capital:

Education-

Health-

Nutrition-

On-job training-

Experience-

Skills-

Migration-

Components:

Young people

Those with Lower mortality rates

Those with Likely to remain in labor force

Those with Lower and direct opportunity cost

Those with greater certainty of the future

Those with lower discount rates

Greater Incentives to invest for:

Tax laws discriminate agianst human capital

Human capital deteriorates when it is idle

Human capital has certain public good characteristics

Public investment in human capital can reduce income inequality

People would stay educated until marginal utility of getting education would be higher than costs

Theory of education:

This determines the wage rate

MRP=Firms labor demand

Derived demand for goods or services

Demand for labor

is the change in total output associated with one additional product of input

Eventually declines as the quantity of labor employed increases

Marginal Physical output

MRP

Marginal revenue product of labor

Determines the wage rate

Real wages: wages todayNominal wages: combination of all money

In the 19th century when we were on a gold standard, when there was an increase in productivity there

was deflation.

Gender-

Race-

Employee-

Consumer-

Age/disability-

In the labor market:

Discrimination:

http://www.bls.gov/http://www.bls.gov/


16/19

"looks"-

This form is based on treating an individual on the basis of membership in a group and

knowledge of that groups history

Statistical discrimination:

Labor market discrimination has a direct connection to poverty

Earnings= hours * wage rate

Piece rate- give a lump sum instead of getting paid hourly

Work organization theory

Psychology

Basic human need= security

People are motivated by the need coming after the need just satisfied

Money and total compensation is something that is neutral. The only thing that

motivates people is content of work.

Motivation theory-

Hierarchy of needs

A federal agency will issue carbon credit to companies

Corps in europe issue debit cards that can be used when purchasing "green" things

and it gives them credit to use carbon-- redistribution of income btween people who

consume more energy and those who do not

Carbon Permits:

Work Content

Cose theory: private solution to pollution can be possible if there is low transaction cost

Pigovian taxes: subsidizing positive externalities and taxing negative externalities

Command and control: tell each firm how much pollution they are allowed to use. It when companies

are told what to do

Temporary vs. Hardcore poverty

Family structure

Age

Race and ethnicity

Regional differences

Poverty:

Inequality-measured in micro economics

In most cases poverty is relative

Relative vs absolute poverty:

Inequality, Income, Redistribution, and Health Care

The Lorenz Curve- degree of inequality

% of

income

The measure of inequality of distribution

The Gini Coefficient

a

b

Income



17/19

The higher the gini inequality the higher the differentiation

The higher the income the higher percentage the tax is on income

Progressive

Brains and brawn

Skill levels

Capacity Utilization rate

Causes of differences in labor resource ownership

Inheritance

Luck

Propensities to accumulate

Causes of dif ferences in capital resource ownership

Determinants of income distribution

Income support

Health care

Food and nutrition assistance- food stamps

Housing assistance

Training and employment

Work incentiveFamily structure incentives

Welfare dependency

Problems:

Federal Welfare System: 57% of federal budget

Education-

Legislation-

Reduces tastes for discrimination

Taxes distort behavior

Income: (flow)

Wealth: anything you value (stock)

Income vs Wealth

A state in which a families income is too low to be able to buy the quantites of food, shelter, and

clothing that are deemed necessary. Poverty is a relative concept

Poverty measurement:

Two major areas:

Health care costs-

Health Care:

Collective Decision Making

Self interest

Opportunity cost

Competition

Similarity of individuals, but dif ferent incentive structures

Simmilarities in market and public sector decision making

The Theory of Public Choice

Government failure in reforming market failure--The role of government because there is market

failure. You need government to correct this failure

Government Failure refers to situations where allocative efficiency may have been reduced

Correct shortages or surpluses

Provide when market cannor

Regulate when there is inefiecency or inequality

Government steps in when:-

Does government intervene-

Public Choice Theory



18/19

Taxation-redistrubution and provide incentive or disincentive effects

Subsidies-to encourage production/consumption

Regulation-guides, codes of practice, legislation, independent regulators

Property rights- ownership of property ex. Intellectual prperty, granting of patents etc.

Direct provision- health education etc.

Poli ticians, beurocrates ands others acting on behalf of publ ic may act in their own self

interest as util ity maximisers

The invisible hand may not work in the provision of public goods

Rent seeking or log rolling two important concepts

Calculus of consent-- Smith, Hijack

Politics involve a series of trad offs in public policy making

Traditional theoyr would suggest that the decisions will be made that give the greatest

utility to the maximum number of people

Rent seeking- where decisions are made leading to resource allocation that maximises

the benefi t to the decision maker that the expense of another party or parties

Log rolling- where decisions may be made n resource allocation to projects that have

less importance in return for the support of the interested party in other decision

making areas

Rent seeking or log rolling

Eg- decisions on genetically modified crops- were they made on the basis pf public

interest at large or to satisfy the farming lobby, the health lobby, the enviornemtal

lobby or the GM business lobby?

Government Policy:

Distortion of markets- rent control, minimum wage, agriculture subsidies, taxes on

fuel

Welfare impact- erosion of consumer surplus and producer surplus--eg. EU tariff

support for manufactured goods and food

How does government failure manifest itself?

High taxes hampering business expansion or enterprise-

Welfare benefits reducing the incentive to find work-

Disincentive Effects:

Short termism- solving the hot topics of the day rather than the long term important issues--

eg. Id cards vs pension crisis

Desire to get elected and pass popular policies to capture votes-

Spending on publ ic services at the risk of higher inflation and futures interest rates-

Electoral pressure:

Build new motorways

Impact on the enviornmet

Regulatory agencies become dominated by firms they are supposed to be regulating

Regulatory capture

Imperfect info

Price-

Value-

Costs-

Benefits-

Long term effects-

Behavioral changes-

External costs and benefits-

Value of producers and consumer surplus-

Lack of knowledge

All means less efficient allocation may result from government intervention

Government failure

Public choice theory:



19/19

Collective decision making

Benefit= (probability of the vote to make a difference)*(actual benefits receive if

candidate wins)

Costs=Driving+Waiting time+ voting effort

The cost and benefit of voting- individual maked decisions based on their own cost benefit

analysis

Concept of concentrated costs and diffuse benefits. Social benefits from not havingpolicy exceeds cast. Trade restriction is a common example

-

Benefits are diffusely spread out through entire population-

Costs are consentrated on a few individuals or firms-

Information content and lobbyng efforts

Rent=part of the payment to owner of resources over and above the amount those

resources could command in any alternative use, over the opp cost

-

Rent vs Profit

Profit=when rent results from satisfaction of new demand or increase the value of resources

it is profit

Backbone of public choice theory-

Provide majority of legislation-

Interest groups

Resource allocation on the most important projects-

Political logrolling

Statistically one vote does not matter-

Politicians do ignore groups who do not vote-

Paradox of Voting

Median-voter Model

Public Choice Theory:

Progressive

Sales taxt-

The lower your income the higher the percentage the tax you pay of your income-

Regressive

Flat tax-

Proportional

Taxation:

Tarrifs on steal-

Rent controls in some cities-

Sugar quotas-

Milk prices-

Farm subsidies-

Ethanol subsidies-

Interest group effects:

Documents

Micro Economics [Maltzev]