ECO100 Term Test 3 Study Notes

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18. Markets for Factors of Production
Economys income distributed in markets for factors of production: labour, land & capital
Demand for factors is derived demand (comes from firms that use factors to produce goods
& services). Competitive, profit-maximizing firms hire each factor up to point @ which
value of marginal product of factor = its price
Supply of labour arises from individuals’ trade-off between work & leisure. Upward-sloping
labour supply curve means ppl respond to increase in wage by enjoying less leisure &
working more
Price paid to each factor adjusts to balance supply & demand for that factor. [Factor
demand reflects value of marginal product of that factor; in equilibrium, each is
compensated according to its marginal contribution to the production of g&s
Because factors of production are used together, marginal product of any one factor
depends on quantities of all factors available. { change in supply of one factor alters
equilibrium earnings of all factors}
Capital equipment & structures used to produce g&s
Diminishing marginal product property whereby marginal product of an input as quantity
of input
Factors of production inputs used to produce g&s
Marginal product of labour increase in amount of output from additional unit of labour
Production function relationship between quantity of inputs used to make a good & quantity
of output
Value of the marginal product marginal product of input X price of output
19. Earnings & Discrimination
To some extent, wage differentials compensate workers for job attributes
Workers with more human capital get paid > workers with less human capital. Return to
accumulating human capital is high & has increased over past 2 decades
Although years of education, experience & job characteristics affect earnings as theory
predicts, much variation in earnings that cannot be explain by things economists measure
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by unexplained variation in earnings largely attributable to natural ability, effort &
Some economists have suggested that more educated workers earn higher w ages not
because education raises productivity but bec workers with high natural ability used edu
as way to signal to employers. {If this theory is correct, then increasing edu attainment of
all workers wouldnt raise overall level of wages}
Wages are sometimes pushed above level that brings supply & demand into balance
because: minimum wage laws, unions & efficiency wages
Some differences in earnings are attributable to discrimination on basis of race, sex, etc.
Competitive markets tend to limit impact of discrimination on wages {Profit-maximizing
behaviour can reduce discriminatory wage differentials}
Compensating differential difference in wages that arises to offset nonmonetary
characteristics of different jobs
Efficiency wages above-equilibrium wages paid by firms in order to increase worker
Human capital accumulation of investments in people, such as education and on-the-job
Strike organized withdrawl of labour from a firm by a union
Union worker association that bargains with employers over wages & working conditions
20. Income Inequality & Poverty
Data on distribution of income show wide disparity in society; richest fifth earn 8x poorest
Because in-kind transfers, economic life cycle, transitory income & economic mobility are
so important for understanding variation in income, difficult to gauge degree of inequality
in our society using data in a single year. When these other factors taken into account,
tend to suggest that economic well-being is more equally distributed than annual income
Political philosophers differ in views re: role of govt in altering distribution of income.
oUtilitarians would choose distribution of income to max sum of utility of everyone in
oLiberals would determine distribution of income as if behind a veil of ignorance
that prevented us from knowing stations in life
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oLibertarians would have the govt enforce individual rights to ensure fair process
but not be concerned re: inequality in resulting distribution of income
Various policies aim to help the poor minimum-wage laws, welfare, negative income
taxes, in-kind transfers. Although each help escape poverty, also unintended side effects:
bec financial assistance declines as income rises, poor often face effective marginal tax
rates that are very high, which discourages poor families from escaping poverty on their
In-kind transfers transfers given in form of goods & services rather than cash
Life cycle regular pattern of income variation over a persons life
Maximin criterion claim that govt should aim to maximize well-being of worst-off person in
Negative income tax tax system that collects revenue from high income households & gives
transfers to low-income households
Permanent income a persons normal income
Poverty rate % of popl whose family income falls below an absolute level called the poverty
Poverty line absolute lvl of income set by federal govt for each family size, below which
deemed in poverty
Utility a measure of happiness or satisfaction
Welfare govt programs that supplement incomes of the needy
Liberalism political philosophy according to which govt should choose policies deemed to be
just, as evaluated by an impartial observer behind a veil of ignorance
Libertarianism political philosophy according to which govt should punish crimes & enforce
voluntary agreements but not redistribute income
Utilitarianism political philosophy according to which govt should choose policies to max
total utility of everyone in society
10. Externalities
When a transaction between buyer & seller directly affects 3rd party, effect is called an
oNegative externalities (e.g. pollution) cause socially optimal quantity in market to
be < equilibrium quantity
oPositive externalities (e.g. tech spillovers) cause socially optimal quantity to be >
equilibrium quantity
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