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What kind of economy do we have?
A market economy
Give the names of the two market economists that we pay attention to for fundamental description of market and welfare econmics.
- Adam Smith
- Wilfredo Pareto
What does Adam Smith's book An Inquiry into the Nature and Causes of the Wealth of Nations explain?
The "rational economic man"- he looks out for his own self interest in a rational way,
Describe the Neoclassical Economic Theory.
- The economic problem is the problem of allocating scarce resources among competing ends (choice and allocation)
- a simplified model of reality
- power derives with what you can do with model results
- model describes human activities in terms of market interactions
What are the several critical assumptions of the Neoclassical Economic Theory?
- value = human utility, which consists of human preferences of goods and services, expressed in terms of WTP
- all decision makers are economically rational
- all resources and goods are individually owned
- all markets are competitive- free entry and free exit
- there exists perfect information
What are the collararies of the assumptions of the Neoclassical Economic Theory?
- Price is a measure of value (from 1 to 4)
- All possible beneficial transactions take place, this society could not be better off
- State and nonmarket social relationships are irrleevant
- equity is not relevant
What is the Pareto Optimality?
No transaction remains that would benefit anyone without hurting someone else more
What does the Tragedy of the Commons explain?
It explains the critical assumption that all resources are individually owned.
What is asymmetric information?
When one party to a transaction has information not possessed by the other, that party has an advantage (ex. Martha Stewart)
What is Adverse Selection?
The Circumstances that arise in financial markets when borrowers with the worse credit are the ones most likely to seek loans
What is a moral hazard?
An asymmetric infomation after a transaction; in financial markets, a person to whom money has been lent may engage in riskier behavior increasing the probability of default (ex. Enron)
What are the two kinds of monopolies?
- market capture by private business (ex. Standard Oil)
- natural monopoly (ex. utility-large economy of scale p.536)
What are the problems of social functions?
- materialistic bias
- fails to be sufficiently inclusive
- promotes decisions that increase wealth
What are the problems of individual welfare?
- Not pure competition
- Not full private ownership
- Information scarcity
What are the three conditions for an economy to be economically efficient?
- be on its production possibilities froniter
- exchange efficiency
- product-mix efficiency
What is the marginal rate of transformation and substitution?
- The amount of good B that must be given up to produce good A
- The amount of good B that must be given to people so they willingly give up a unit of A
What are the effects of efficiency when scarce resporces appear to be free?
- less will be produced than could be produced with other resource allocations
- the wrong "mix" of goods and services will be produced
What does "non-rival" mean? Non-excludable?
- additional users do not deprive others of the goods
- once the good has been provideed, it is not feasible to prevent people from using it
What is the significance of impure public goods?
These kinds of goods that become "rival" with congestion are also called "club goods" (Lexus lanes)
Who is Tony Downs?
He explains the Public Choice Theory though the median voter theory. As long as all preferences aresingle peaked, the outcome of majority voting reflects the preferences of the median voter
What is the motivation of those serving in public office according to Downs?
Income, prestige and power
What are political parties' existence for?
- not to carry our a precoonceived set of policies or serve specific interest groups
- form policies to serve interest groups, gain their support, and stay in office
- any social function is a by-product of efforts to gain office
- In essence, they sell policies for VOTES.
Explain the Median Voter Theory.
It is the outcome of majority voting where the winner takes all according to Downs
Explain Arrow's Impossibility Theorem?
- Arrow demonstrated mathematically that it is impossible to find a voting that can produce a decision
- able to rank all possible outcomes
- Responsive to individual preferences
- Preferences are transitive
- social rankings are responsive to individual rankings
- no dictatorship
What are the three parties in the Iron Triangle?
- Representative Government
- Interest Groups
What does Niskanin argue about the self-interests of bureaucrats?
- There are no market consraints
- Leads to overspending and oversupply of public goods
- Bureaucrats argue for spending on basis of total cost and benefit
How is public choice different from welfare economics?
- Public choice is openly critical to government failure
- extremely suspicious of decision-making process in government and perfers market mechanism for everything
What were some criticisms of Hunter's experiment?
- Original panels based on hunches
- no way to know why the powerful are powerful
- unable to gauge relative power
- reputation and actual power are not the same thing
- equates overall power with power on different issues
- static analysis