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172 Cards in this Set
- Front
- Back
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Product markets
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markets in which firms sell goods and services to households
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Factor markets
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markets in which resources--labor, capital, land and natural resources, and entrepreneurship--are sold to firms
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Derived demand
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the demand for a resource that arises from, and varies with, the demand for the product it helps to produce
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Perfectly competitive labor market
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1. Many buyers and sellers (wage takers)
2. Standardized labor quality 3. Easy Entry and Exit 4. Well-Informed Buyers and Sellers |
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Market labor demand
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Demand by all firms for the type of labor being traded in that market
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Labor demand curve
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curve indicating the total number of workers all firms in a labor market want to employ at each wage rate
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Output effect
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a change in the wage rate alters the profit-maximizing output level, and therefore changes the quantity of labor demanded
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Input-substitution effect
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a change in the wage rate alters the price of labor relative to the costs of other inputs, and therefore changes the quantity of labor demanded
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Why does the market labor demand curve slope downward?
(a rise in the wage rate has what 2 effects?) |
1. increases the firm's marginal costs, causing them to decrease production and employ fewer workers (output effect)
2. it increases the relative cost of labor from that market, causing firms to substitute other inputs, such as capital or other types of labor (input-substitution effect) |
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What shifts the Labor Demand Curve
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1. Changes in demand for the product
2. Changes involving other inputs |
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Complementary input
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an input that is used by a particular type of labor, making it more productive (new or cheaper complementary goods = demand shifts right)
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Substitutable input
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an input that can be used instead of a particular type of labor (new or cheaper substitutable goods = demand shifts left)
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Labor supply curve
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A curve indicating the number of people who want jobs in a labor market at each wage rate
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The short-run supply of labor curves upward because...
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a rise in the wage rate causes some additional people--already qualified but previously not working in that labor market-- to want to work there
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What shifts the labor supply curve?
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1. Changes in the number of qualified people
2. Changes in other labor markets 3. Changes in tastes |
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Wage rate above equilibrium
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excess supply
wage rate decreases |
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Wage rate below equilibrium
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excess demand
wage rate increases |
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Increase in labor demand
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higher equilibrium wage rate and level of employment
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Increase in supply
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lower equilibrium wage rate and level of employment
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Imaginary world
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1. all labor markets are perfectly competitive
2. all jobs are equally attractive to all workers 3. in the long run, all workers can costlessly acquire the qualifications for any job |
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Compensating wage differential
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a difference in wages that makes two jobs equally attractive to a worker
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Nonwage job characteristic
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any aspect of a job--other than the wage-- that matters to a potential or current employee.
less attractive jobs pay more. |
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Differences in human capital requirements
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jobs that require more costly training tend to pay higher wages.
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Differences in ability to become qualified
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jobs that require skills that relatively few people have the ability to acquire will pay persistently higher wages
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Differences in ability among those qualified
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those with greater ability to perform a job better--based on talent, experience, motivation, or perseverance-- will be more valuable to employers, and will generally be able to command a higher wage rate.
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Superstar
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an individual widely viewed as among the top few in his or her profession
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Labor markets for talented professionals
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require: mass-distribution of product and substantial agreement about ranking
Small differences in ability can lead to disproportionate differences in pay |
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Barriers to entry of a labor market
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1. Occupational licensing - higher cost of acquiring human capital
2. Union wage setting - negotiate higher wage than equilibrium |
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Effect of Unions
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by raising the wage firms must pay, it decreases total employment in the union sector. Thus, wages in nonunion sector drop.
Creates a differential between union and nonunion wages |
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Discrimination
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When a group of people have different opportunities because of personal characteristics that have nothing to do with their abilities
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Employer Prejudice
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competitive labor markets work to discourage discrimination
work to reduce or eliminate any wage gaps b/w favored and disfavored group |
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Employee and customer prejudice
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market forces may encourage, rather than discourage, discrimination and can lead to a permanent wage gap between the favored and disfavored groups
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Statistical discrimination
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Individuals are excluded based on the statistical probability of behavior in their group rather than their own personal traits
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Discrimination and wage differentials
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The simple wage gap b/w 2 groups tends to overstate the impact of job-market discrimination on earnings, because it fails to account for differences in worker skill, experience, and job choice.
However, controlling for these characteristics may understate the impact of discrimination, since these characteristics may in part result from discrimination |
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Who pays for a higher minimum wage?
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consumers because of higher prices
short run - consumer and firm |
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Who benefits from a higher minimum wage?
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poor
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Higher minimum wage benefits...
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1. unskilled workers - maintain their jobs
2. skilled workers - raises equilibrium wage |
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Higher minimum wage harms...
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1. unskilled workers without work
2. unskilled workers not in the covered sector - wages decrease |
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EITC (Earned income tax credit)
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Supplements those of low income
Supported by progressive tax Tends to increase employment |
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Capital
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resource: human/physical
rented/purchased |
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Marginal approach to profit
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a firm should take any action that adds more to its revenue than it adds to costs
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Value of future dollars
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because dollars can earn interest, always better to receive money earlier than later
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Present value
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the value, in today's dollars, of a sum of money to be received or paid at a specific date in the future with certainty
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Present value equation
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PV = Y/ ((1+r)^n)
Y = sum of money r = interest rate n = # of years |
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Discounting
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the act of converting a future value into its present-day equivalent
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Discount rate
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the interest rate used in computing present values
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Determinants of PV
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Y,r,n
Y - payment received later has a lower PV than payment received earlier r - the PV of a future payment is lower when the interest rate is higher n - the more years the less PV |
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Principle of asset valuation
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the idea that the value of an asset is equal to the total present value of all future benefits it generates.
Starting point |
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Risk
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The greater the uncertainty or the greater one’s aversion to risk, the more the value of a risky asset will fall short of its present value
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Investment
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firms' purchases of new capital over some period of time
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When interest rate rises...
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firms (using the principle of asset valuation) will place a lower value on additional capital, and decide to purchase less of it.
economy as a whole - rise in interest rate causes decrease in investment expenditures |
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When the interest rate falls...
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increase firms' investment in physical capital
capital stock - larger overall standard of living - higher |
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Financial asset
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a promise to pay future income in some form, such as future profits or future interest payments
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Primary market
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the market in which newly issued financial assets are sold for the first time
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Secondary market
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the market in which previously issued financial assets are sold
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Why do firms care about secondary market trading?
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Price changes in secondary market – similar price changes in primary market
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Bond
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a promise to pay back borrowed funds, issued by a corporation or government agency
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Principal (face value)
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the amount of money a bond promises to pay when it matures
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Maturity date
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the date at which a bond's principal amount will be paid by the bond owner
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Pure discount rate
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a bond that promises no payments except for the principal it pays at maturity
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Yield
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the annual rate of return a bond earns for its owner.
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Coupon payments
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a series of periodic payments that a bond promises before maturity
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The value of a bond is measured in...
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sum of PV
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Bond prices and Bond yields
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inverse relationship. The higher the price of any given bond, the lower the yield on the bond
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Bond yields and Interest rates
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a riskless bond will have a yield equal to the interest rate on other riskless loans (interest rate used to calculate PV)
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Default risk
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Bonds with default risk sell for less than the present value of their promised payments
Greater risk of default, lower the bond's price, and the higher the yield |
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Why do bond yields differ?
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1. Default risk
2. Differences in - maturity date, frequency of coupon payments, how the interest is taxed |
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Bond prices are determined by...
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supply - vertical
demand - downward sloping change in demand changes price |
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Demand for bonds decrease because
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1. An increase in the (riskless) interest rate
2. An increase in the attractiveness of other assets (stocks, real estate, other bonds) 3. An increase in the perceived riskiness of the bond 4. Expectations of any of the above |
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Stock prices are determined by
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Supply - vertical
Demand - downward sloping change in demand changes price |
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Demand for stock increases because
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1. Release of new information
2. Drop in interest rates 3. Other assets less attractive 4. Decrease in risk 5. Expectations of any of the above |
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Efficient market
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a market that instantaneously incorporates all available information relevant to a stock's price
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Efficient market theory
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Any helpful information that predicts future price is instantly incorporated in stock prices.
only ones who benefit are those who are lucky enough to be holding the stock before the information is available |
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Economic efficiency
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a situation in which every possible Pareto improvement is being exploited
all activities that came make at least one person better off without making anybody else worse off are taking place |
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Pareto improvement
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an action that makes at least one person better off, and harms no one
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Side payments
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if any action creates greater total gains for some than total losses to others, a side payment exists, which if transferred from the gainers to the losers, would make the action a Pareto improvement
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Market demand curve
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the height of the market demand curve at any quantity shows us the value--to someone--of the last unit of the good consumed
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Market supply curve
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the height of the market supply curve at any quantity shows us the additional cost--to someone--of the last unit of the good supplied
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If D is higher than S curve
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the value of one more unit to some consumer is greater than its additional cost to some producer
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Efficient quantity of a good
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quantity at which the market demand curve and market supply curve intersect
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Efficiency of perfect competition
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perfectly competitive market will automatically achieve the efficient quantity.
the equilibrium quantity maximizes total benefits. equilibrium under PC is efficient. |
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Consumer surplus
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the difference b/w its value to the buyer and what the buyer actually pays for that unit
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Market consumer surplus
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the total consumer surplus enjoyed by all consumers in a market.
measured, in dollars per period, as the toal area under the market demand curve and above the market price |
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Producer surplus
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the difference b/w the price the seller gets and the additional cost of providing it
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Market producer surplus
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the total producer surplus gained by all sellers in a market
measured, in dollars per period, as the total area above the market supply curve and below the market price |
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Total benefits
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the sum of consumer and producer surplus in a particular market
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A market is efficient when...
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total benefits--the sum of consumer and producer surplus--are maximized in that market
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Deadweight loss
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the dollar value of potential benefits not achieved due to inefficiency in a particular market
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Price floor
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above the equilibrium price
total benefit falls - consumer surplus declines, producer surplus may increase/decrease. results in deadweight loss |
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Monopoly and imperfectly competitive markets
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Cannot maximize total benefits in the market
Price is too high Output is too low |
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Market producer surplus
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the total producer surplus gained by all sellers in a market
measured, in dollars per period, as the total area above the market supply curve and below the market price |
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Total benefits
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the sum of consumer and producer surplus in a particular market
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A market is efficient when...
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total benefits--the sum of consumer and producer surplus--are maximized in that market
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Deadweight loss
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the dollar value of potential benefits not achieved due to inefficiency in a particular market
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Price floor
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above the equilibrium price
total benefit falls - consumer surplus declines, producer surplus may increase/decrease. results in deadweight loss |
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Monopoly and imperfectly competitive markets
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Cannot maximize total benefits in the market
Price is too high Output is too low |
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Physical infrastructure
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roads, bridges, airports, waterways
often provided by the government |
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Institutional infrastructure
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legal and regulatory framework
provided by the government |
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Legal system
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1. Protects us from many kinds of physical and emotional harm
2. Guarantees us freedom of speech and other vital civil liberties 3. Helps provide a sense of security and dignity in our lives 4. Imposes fines or other penalties when a business violates the law 5. Economic role of law: supports markets and helps us achieve economic efficiency |
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Criminal law
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illegal to engage in many types of involuntary exchange in which one party is harmed
ex. robbery encourages Pareto improvements |
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Property law
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enables society to assign ownership to assets and determine who is entitled to the rewards
encourages people to make best use of property |
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Contract law
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enables parties to exchange promises involving future activities
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Tort law
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Defines obligation among people who are not linked by contracts
helps businesses from unreasonable liabilities |
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Antitrust law
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prevents businesses from engaging in behavior that limits competition and harms consumers
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Regulation
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directs businesses to take a specific action by prohibiting other actions
contributes to efficiency |
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Infrastructure is important because...
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Pareto improvements rely on them
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Market failure
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a market that operates inefficiently without government intervention
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Types of market failure
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1. monopoly markets
2. externalities 3. public goods 4. information asymmetry |
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Potential remedy for monopoly power
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break up the monopoly
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Breaking up a monopoly causes...
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patents/copyrights: closer-to-efficient quantity of that drug but reduces incentives to develop future drugs
network externalities: offers benefits hard to achieve under more competitive conditions |
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Natural monopoly forms due to
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economies of scale
one firm can produce for the entire market at a lower cost per unit than could two or more firms. |
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If an anti-trust law breaks up a monopoly
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Higher cost per unit, Higher price, Lower quantity
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If government intervenes in a natural monopoly...
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there is public ownership and regulation
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Regulators
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tell firms what price it can charge
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Marginal cost pricing
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setting a monopoly's regulated price equal to marginal cost where the marginal cost curve crosses the market demand curve
causes a problem where P<LRATC. often corrected by subsidy |
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Average cost pricing
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setting a monopoly's regulated price equal to long-run average cost where the LRATC curve crosses the market demand curve
higher quantity but not totally efficient reduces incentive to control costs |
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Externality
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a by-product of consuming or producing a good that affects someone other than the buyer or seller
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Negative externality
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causes harm to others
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Positive externality
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creates benefits for others
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Coase theorem
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when a side payment can be arranged without cost, the market will solve an externality problem--and create the efficient outcome--on its own
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Side payments arranged without cost if...
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1. Legal rights are clearly established
2. Legal rights can be easily transferred 3. # of people involved is very small |
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Free rider problem
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when the efficient outcome requires a side payment but some individuals will not contribute
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Marginal social cost
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the full cost of producing another unit of a good, including the marginal cost to the producer and any harm caused to third parties
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Market with a negative externality...
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will produce more than the efficient quantity of the good (and therefore, more than the efficient quantity of the harmful byproduct), creating a deadweight loss
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Regulation of negative externality
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Limit amounts of certain pollutants released into the water and air by individual firms
Inefficient in allocating production and consumption among market participants |
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Taxes to regulate negative externality
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Impose a tax on each unit of a good = negative externality created by each unit of the good
Creates efficient quantity Encourages technological change that reduces the harm from each unit of the good produced or consumed |
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Tradable permit
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A license that allows a company to release a unit of pollution into the environment over some period of time.
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Tradable permits to regulate negative externality
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Efficient market quantity
Number is fixed Firms can sell their government-issued permits to other firms in an organized market Pollution reduction efforts increase |
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Market with a positive externality
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produces less than efficient quantity
creates deadweight loss |
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Marginal social benefit
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the full benefit provided by another unit of a good, including the benefit to the consumer and any benefits enjoyed by third parties
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Government subsidies
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A subsidy on each unit of a good = external benefits it creates
Subsidy – shifted the D curve until = MSB curve is at an efficient output level |
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Rivalry
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a situation in which one person's consumption of a unit of a good or service means that no one else can consume that unit
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Excludability
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the ability to exclude those who do not pay for a good from consuming it
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Pure private good
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a good that is both rivalrous and excludable
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Pure public good
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a good that is both nonrival and nonexcludable
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Nonrival good
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Firm should not provide it
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Nonexcludable good
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Free rider problem
Firm will not provide it |
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Marketable public good
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an excludable and non-rival good. generally provided by the market for a price, though efficiency would require a price of zero
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Common resource
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a non-excludable and rival good. generally available free of charge, though efficiency would require a positive price
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Tragedy of the commons
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problem of overuse when a good is rivalrous but non-excludable
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Asymmetric information
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a situation in which one party to a transaction has relevant information not known by the other party.
reduce total benefits prevents transactions |
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Adverse selection
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a situation in which asymmetric information about quality eliminates high-quality goods from a market
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Moral hazard
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when someone is protected from paying the full costs of their harmful actions and acts irresponsibly, making the harmful consequences more likely
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Principal-agent problem
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when one party (the principal) hires another (the agent), who in turn can pursue goals that conflict with the principal's because of asymmetric information
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Market solutions to problems with Asymmetric information
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Adverse selection – establish a reputation
Moral hazard – charged higher rates for riskier behavior Principal-agent problem – offering agents incentives for good performance |
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Government failure
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same types of problems that cause market failures in the private economy
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Equity
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government is concerned with efficiency, equity, fairness, justice, and more
efficiency – equity trade-off |
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National specialization and exchange
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can expand world living standards through free international trade
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Exports
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goods and services produced domestically, but sold abroad
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Imports
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goods and services produced abroad, but consumed domestically
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When a country has an absolute advantage in a good
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produce it using fewer resources than another country
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When a nation has comparative advantage in producing a good
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produce it at a lower opportunity cost than some other country
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When world specializes according to comparative advantage
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world's resources are used more effectively
greater production of every good |
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When International trade is based on comparative advantage
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greater total consumption of goods and services
higher standard of living |
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Terms of trade
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the ratio at which a country can trade domestically produced products for foreign produced products
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Distribution on world gains depend on
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terms of trade
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Reduced trade or incomplete specialization
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1. Costs of trading
2. Sizes of countries 3. Increasing opportunity cost 4. Government barriers to trade |
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Source of comparative advantage
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country with a large amount of a particular resource will tend to have a comparative advantage in goods that make heavy us of that resource
Natural resources and climate |
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Countries have strong comparative advantage in goods that
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they have produced in the past, regardless of why they began producing those goods in the first place
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Cheap imports from abroad benefit and harm who?
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benefit domestic consumers
harm domestic producers |
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Anti-trade bias
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costs from expanded trade are concentrated on few, while benefits are dispersed, so those affected tend to lobby and mobilize against free trade more
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Antidotes to anti-trade bias
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WTO
All or nothing trade agreements Industries as importers |
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Tariffs
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tax on an import
reduces volume of trade raises domestic price of import |
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Effects of tariffs
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domestic producers gain
consumers lose less trade/ less gain from trade |
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Quota
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a limit on the physical quantity of imports
reduces imports raises domestic price helps domestic producers |
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Tariffs vs. Quota
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Same, but tariffs create government revenue
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Protectionism
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the belief that a nation's industries should be protected from foreign competition
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Protectionism Myths
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1. A high-wage country cannot afford free trade with a low-wage country
2. A low-productivity country cannot afford free trade with a high-productivity country 3. International trade decreases the total number of jobs in a country 4. In recent times the declining wages of America’s unskilled workers are due to ever-expanding trade between the US and other countries |
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Strategic trade policy
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protectionist policies designed to capture social benefits, such as greater tax revenue, from having an industry in the domestic country
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Infant industry argument
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the argument that a new industry in which a country has a comparative advantage might need protection from foreign competition in order to flourish
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Free trade without gov. intervention
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works best when market is doing well
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Production most likely to reflect the principle of comparative advantage
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When firms can obtain funds for investment projects
When they can freely enter industries that are profitable |
