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Study Notes eco100 Test 3.pdf

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James Pesando

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Microeconomics 18. Markets for Factors of Production Economy’s 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 by – unexplained variation in earnings largely attributable to natural ability, effort & chance 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 wouldn’t 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 productivity Human capital – accumulation of investments in people, such as education and on-the-job training 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 fifth 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 gov’t in altering distribution of income. o Utilitarians would choose distribution of income to max sum of utility of everyone in society o Liberals would determine distribution of income as if behind a “veil of ignorance” that prevented us from knowing stations in life o Libertarians would have the gov’t 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 own In-kind transfers – transfers given in form of goods & services rather than cash Life cycle – regular pattern of income variation over a person’s life Maximin criterion – claim that gov’t should aim to maximize well-being of worst-off person in society Negative income tax – tax system that collects revenue from high income households & gives transfers to low-income households Permanent income – a person’s normal income Poverty rate – % of pop’l whose family income falls below an absolute level called the poverty line Poverty line – absolute lvl of income set by federal gov’t for each family size, below which deemed in poverty Utility – a measure of happiness or satisfaction Welfare – gov’t programs that supplement incomes of the needy Liberalism – political philosophy according to which gov’t should choosepolicies deemed to be just, as evaluated by an impartial observer behind a “veil of ignorance” Libertarianism – political philosophy according to which gov’t should punish crimes & enforce voluntary agreements but not redistribute income Utilitarianism – political philosophy according to which gov’t should choosepolicies to max total utility of everyone in society 10. Externalities When a transaction between buyer & seller directly affects 3 party, effect is called an externality. o Negative externalities (e.g. pollution) cause socially optimal quantity in market to be < equilibrium quantity o Positive externalities (e.g. tech spillovers) cause socially optimal quantity to be > equilibrium quantity Those affected can sometimes solve problem privately; can internalize externality by merging; can negotiate a contract Coase Theorem: if people can bargain without cost, then can always reach an agreement in which resources are allocated efficiently. {does not often apply} When private parties can’t adequately deal with external effects, gov’t steps in ‘ prevents socially inefficient activity by regulating behaviour ‘ internalizes an externality using Pigovian taxes ‘ public policy issuing permits Coase Theorem – proposition that if private parties can bargain without cost over allocation of resources, can solve problem of externalities on their own Externality – uncompensated impact of one person’s actions on the well-being of a bystander Internalize the externality – alter incentives so that people take account of the external effects of their actions Pigovian taxes – taxes enacted to correct effects of negative externalities Transaction costs – costs that parties incur in the process of agreeing & following through on a bargain 11. Public Goods & Common Resources Goods differ in whether excludable or rival o Excludable if possible to prevent someone from using it o Rival if one person’s use of the good reduces other people’s ability to use same unit of good Markets work best for private goods, which are both excludable & rival (markets don’t work as well for other types of goods) Public goods are neither rival nor excludable (e.g. fireworks, national defence, fundamental knowledge) Bec ppl aren’t charged for use of public good, incentive to free-ride when provided privately (∴gov’t provide public goods, making decision about quantity based on cost-benefit analysis) Common resources are rival but not excludable (e.g. common grazing land, clean air, congested roads) ‘ bec ppl aren’t charged for use of common resources, tend to use excessively →∴gov’t try to limit use of common resources Common resources – goods that are rival but not excludable Cost-benefit analysis – study that compares costs & benefits to society of providing a public good Excludability – property of a good whereby a person can be prevented from using it Free rider – person who receives benefit of a good but avoids paying for it Private goods – goods that are both excludable & rival Public goods – goods that are neither excludable nor rival Rival – property of a good whereby one person’s use diminishes other ppl’s use Tragedy of the Commons – a parable that illustrates why common resources get used more than is desirable from standpoint of society as a whole Macroeconomics 19. What is Macroeconomics? Macroeconomics – study of determination of economic aggregates, such as total output, total employment, price level, & rate of economic growth Business cycle – fluctuations of national income around its trend value that follow ~wave-like pattern Nominal national income – total national income measured in current dollars aka current- dollar income Real national income – national income measured in constant (base-period) dollars; changes only when quantities change Potential output (YP) – real GDP that economy would produce if its productive resources were employed @normal levels of utilization (aka potential GDP) Output gap – actual national income – potential national income [Y – YP] Recessionary gap – situation in which actual output is less than potential output [Y P Y ] Inflationary gap – situation in which actual output exceeds potential output [Y > Y ] P Recession – downturn in level of economic activity; often defined precisely as 2 consecutive quarters in which real GDP falls Price level – average level of all prices in the economy, expressed as an index number Consumer Price Index (CPI) – index of the average prices of goods & services commonly bought by households Purchasing power of money – amount of goods & services that can be purchased with a unit of money Interest rate – price paid per dollar borrowed per period of time, expressed either as a proportion (e.g. 0.06) or as a percentage (e.g. 6%) Nominal interest rate – price pai
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