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Terms in this set (87)
An indicator of inequality that gives weight to what happens in the middle of the distribution. It's an average of how far people's income is from that of everyone else.
G = 2A, where A = area between 45° line & Lorenz curve.
Perfect equality: G = 0
Perfect inequality: G = 1
A plot of the cumulative shares of income over the cumulative shares of population. Perfect equality: y = x
Perfect inequality: top quintile takes all
Dalton's Principle of Transfer for Income Redistribution
When 2 Lorenz curves don't intersect, you can derive one curve from the other via transfer from richer to poorer people, provided it doesn't alter the relative ranks of the two (e.g. richer becomes poorer than the poor guy).
If income distributions A & B have Lorenz curves that don't cross over, the income distribution associated with the Lorenz curve closer to the 45° line is more equal.
Being able to produce more than someone else
Being able to produce something with a lower relative loss than someone else
OC of X = Px/Py
What we lose when we choose to use our resources to do one thing instead of something else.
e.g. # pizzas you give up for 1 more ramen
Income at 90th percentile / income at 10th percentile. Gives attention to income at the extremes among the very poor and very rich.
Most equal: lowest 90/10
Least equal: highest 90/10
Labor Equipment Diagrams
NE is dominated by SW.
The closer an isocost line is to the origin, the lower the cost of production.
Indifference Curves & Their Properties
All bundles the consumer equally likes. When preferences are complete, transitive, and monotonic, IC's are:
1. Downward sloping
2. Do not cross
3. Higher welfare on higher curves
If consumer also prefers bundles with more balanced amounts of the two items, IC's are bowed into the origin.
Items we're willing to exchange at the same rate regardless of how much we have of each.
Items we want to consume in exact proportions.
Types of Analysis
Positive Analysis: better understanding of how the economy works. Descriptive; "this is the worst recession ever".
Normative Analysis: evaluate if the economy is working well; "good", "bad".
Policy Analysis: support design of policies that would enhance economic outcomes.
The Consumer Choice Model
1. Circumstances: budget constraint
2. Goals: preferences & IC's
3. Outcome: the optimal choice
4. When things change: income & substitution effect
Budget Set / Opportunity Set
The set of all affordable bundles.
e.g. Combos of ramen and pizza the student can afford
Budget Constraint / Budget Line
The set of all bundles that exactly exhaust the consumer's budget.
e.g. Combos of ramen and pizza that cost exactly the student's budget
Slope of Budget Constraint
Given M = monetary budget:
Qy/Qx = -M/Py // M/Px = -Px/Py
When the consumer's budget changes
The budget constraint maintains the same slope, but moves further form the origin.
When the consumer faces new prices
The budget constraint rotates inward or outward depending on the price change.
If price decreases, rotates outward.
A description of a consumer's tastes. Follows three simple rules:
1. Completeness: if there are two options A & B, we can rank them so A is preferred to B or vice versa or indifferent.
2. Transitivity: if A > B and B > C, then A > C
3. Monotonicity: any increase in consumption of goods is welcome.
Marginal Rate of Substitution (MRS)
1. The highest amount of Y a consumer's willing to give up for one more X.
2. The slope of an IC at a given bundle.
3. The MRS declines as we move rightward along an indifference curve.
Marginal Utility of X (MUx)
The increase in welfare from consuming one more X, all else kept the same.
Diminishing Marginal utility
The idea that, typically a consumer's marginal utility from a product declines the more the consumer already has of that product.
Items that we'd rather consume in balanced amounts.
1. Optimal Choice: MRS = Px/Py and MUx/Px = MUy/Py
2. Optimal Allocation: MRS = MRT
3. Firm: MR = MC
The change in consumption resulting from a change in real income.
Normal goods: income increases, buy more.
Necessities: income increases, buy more but expenditure share decreases.
Luxuries: incomes increases, buy more and expenditure share increases.
Inferior goods: income increases, buy less.
The change in the quantity demanded of a good that results from a change in price (opportunity cost).
Own effect: Px decreases, buy more X.
Giffen effect: Px decreases, buy less X.
Cross effect: how price of X affects others
Gross complement: Px decreases, buy more X and Y.
Gross substitute: Px decreases, buy less Y.
How output varies with input; how economic agents can transform its resources into something else.
Change in output / change in input
Marginal Rate of Transformation (MRT)
1. Slope of the feasible frontier
2. Related to supply
Components of Game
Players, feasible strategies, payoffs, information
When do people coordinate and cooperate?
1. Repeated interactions
2. Social norms change payoffs
1. Resources move around following orders that are commands.
2. Power is centralized
3. Where production takes place
4. Actors that compete
5. More defined
6. Goal: maximize profit
1. Resources move around following orders that are requests.
2. Power is decentralized
3. Where products are exchanged
4. Space where actors compete
5. More abstract; larger
6. Goal: maximize welfare
What level of control do economic agents within a firm have?
The board: good amount
Executives: a lot of control
Management: a lot of control
Rank and file: limited
Economic Rewards of the Firm
Ownership: profit = revenue - cost
The board: compensation
Rank and file: compensation
Tools to Re-Align Incentives
1. Monitoring, but costly and imperfect
Isoquant / Isocost Model: Assumptions
1. It's a price-taking firm (firm can't influence market wage or rental cost of capital)
2. Wages and rental cost of capital don't influence productivity
What can be done
Labor Discipline Model: Assumptions
Firm offers a wage rate while workers choose an effort level. Employer/worker relationship can be modeled as a sequential interaction where employer offers wage rate and then worker chooses an effort level.
1. Labor contracts are incomplete
2. Firms find it hard or too expensive to fully monitor their workers
Worker's Payoffs & Assumptions
1. Workers prefer higher wages
2. Workers prefer to exert lower effort
3. Employers can't fully monitor workers, but if the worker is caught slacking, they could lose their job
4. Higher effort reduces the chances of losing the job
5. If the worker loses the current job, they can eventually find another job/might be covered by UI (formal risk sharing)/fam & friends can help (informal risk sharing)
6. Employment rent: how much the worker values keeping the job over losing it
Result: The higher the worker's employment rent, the higher the worker's desired level of effort
(Wage - Cost of Effort) x 40 hrs/wk
(Job utility - UI utility) x # of weeks
The greater the UI, the lower the employment rent and the lower they effort they exert at each level.
If the labor market tightens and the unemployment spells become shorter
Employment rent decreases (lower but same period as before)
If unemployment insurance becomes more generous
Employment rent decreases and is delayed
Employer Isocost Lines
Cost = Labor x wage
Labor = Output quantity / effort level
Cost = Quantity x wage rate / effort
Effort = (Quantity / cost) x wage rate
Ownership = management (control)
Ownership's financial reward: profit
Large Firms & Corporations
1. Ownership is not equal to management (control)
2. Management's labor contracts are designed to realign management's incentives to ownership's
3. Competition among firms creates market discipline that wipes out unprofitable firms
Firms with Market Power & Price Schemes
When a firm can control its sale prices; when raising your price loses you some but not all customers.
Firms can choose among various price schemes:
1. Same price on all units
2. Nonlinear pricing
3. Market segmentation
Profit = R - TC
Profit = PQ - ACQ, where AC = TC/Q
Profit = (Price - AC) x Q
1. ΔTC / ΔQ
2. Represents individual supply curve of the firm.
3. MC = P in terms of Q
Total Cost = Recurring Fixed Cost (FC) + Variable Cost (VC) = AC x Q
Average Cost = FC/Q + VC/Q
Price Taking Firms
Some firms that sell a highly homogenous product in a highly competitive market cannot freely pick their price. If they set a price higher than their competitors', they lose all customers. Entry and exit is cheap. At going price, can sell any level of output. Infinitely elastic, flat demand curve.
(Profit/Quantity) + AC
Economies & Diseconomies of Scale
1. Occurs when increasing output lowers the unit cost of production.
2. Firms with large recurring FC's are more likely to experience economies of scale (e.g. from intense use of equipment)
3. When firms can benefit from economies of scale, they tend to merge in large conglomerates since raising output allows them to lower the unit cost of production and the sale price.
4. Diseconomy: increasing scale raises unit cost of production
Variable Cost (VC)
Cost that varies with level of output
e.g. labor cost, power
Recurring Fixed Cost
Cost that doesn't vary with level of output
MC & AC
When MC < AC, MC pulls AC down.
MC = AC when AC lowest
When MC > AC, MC pulls AC up.
Demand and MR: Equation
If Demand is P = A - bQ:
MR = A - 2bQ
Price Elasticity of Demand
Coefficient that measure the % decline in quantity demanded d/t a 1% increase in a product's price; measure of buyer's price sensitivity.
PE = % ΔQ / % ΔP
% ΔQ = (Q2-Q1) // (Q2+Q1) / 2
% ΔP = (P2-P1) // (P2+P1) / 2
Above midpoint, |ε| > 1 = price elastic
Below midpoint, |ε| < 1 = price inelastic
MR = ΔR/ΔQ
1. Profit is __ given demand and cost.
2. The firm chooses the price/quantity combo on the __ curve that lies on the highest __ curve.
3. The firm matches the slope of its __ curve (MRS) to the slope of the __ curve (MRT)
4. The firm's __ revenue matches the firms marginal __
5. The firm charges a price that is __ than the marginal cost.
2. Demand, isocost
3. Isoprofit, demand
4. MR, MC
Where unit cost is the lowest
Total Willingness to Pay
Sum of marginal WTP
Demand & Its Properties
1. The relationship between a product's price and the quantity folks and firms want to buy.
2. Downward sloping d/t substitution and income effects.
3. Price elasticity of demand is related to MR. When MR +, demand = elastic. When MR -, demand = inelastic.
4. Captures buyer's marginal WTP
Willingness to Accept
Marginal opportunity cost
Supply & Its Properties
1. The relationship between a product's price and the quantity folks and firms want to sell.
2. Upward sloping d/t diminishing marginal returns and diseconomies of scale.
3. Affected by by cost of labor
4. When firms sell a very homogenous product, they face a highly price elastic demand (flat). Illustrates firms' marginal cost from producing an extra unit.
No XS demand or supply; every buyer finds a seller and every seller finds a buyer. Market price in time adjusts to level where quantity demanded matches supplied and the market clears.
Above the equilibrium point
Below the equilibrium point
Area below demand and above market price
Area below market price and above supply
Socially Valuable Units
Output units that buyers value more than it costs society to produce, distribute and consume them.
Socially Optimal Quantity
The quantity where all socially valuable units are produced and exchanged
No other way to use resources that would make one person better off without hurting any other people
A game in which pursuing dominant strategies results in noncooperation that leaves everyone worse off
Returns to Scale
Quantitative change in output of a firm or industry resulting from a proportionate increase in all inputs
A unit cost is a total expenditure incurred by a company to produce, store, and sell one unit of a particular product or service.
Price caps below the equilibrium price causes the quantity demanded to rise and the quantity supplied to fall.
Base of the triangle: supply at price ceiling quantity to demand at price ceiling quantity.
Height of triangle: market quantity at price ceiling to quantity at equilibrium
Analyzing Economic Policy: Purpose & Steps
Purpose: models are used to help understand what drives the behavior of all stakeholders (what they care about, tradeoffs, variables that affect behavior, interactions bw stakeholders), and to figure out how policy would impact this behavior, the economic outcome, and economic agents' welfare.
1. We construct a simplified description of the conditions under which people take actions.
2. Then we describe in simple terms what determines the actions that people take.
3. We determine how each of their actions affects each other.
4. We determine the outcome of these actions. This is often an equilibrium (something is constant).
5. Finally, we try to get more insight by studying what happens to certain variables when conditions change.
Ceteris Paribus Assumption
Economists often use simplifying assumptions to get a better idea of the relationships between variables of interest. The ceteris paribus condition (all else equal condition) means that when studying how one variable affects another, economists assume that all else remains the same.
Marginal Willingness to Pay (MWTP)
How much a consumer in the market would be willing to pay for an extra unit of a good considering the quantity of the product that is already being sold
List an event or change that could lead to higher prices for automatic weapons and fewer weapons sold each year
We would have higher prices but fewer sales if the supply of weapons declined. This decline could be due to higher cost of production (higher input prices) or stricter regulatory environment or taxes on weapons...
List an event or change that could lead to higher prices for automatic weapons and more weapons sold each year
An increase in demand for automatic weapons would lead to higher prices and higher sales.Events that could lead to a higher demand include: higher income and wealth (if weapons are a normal good) or an increase in folks' fear and anxiety.
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