Econ Midterm 1 Study Guide PDF

Econ Midterm 1 Study Guide: Econ 1 Notes: Inequality Lecture #1: 1/7/25 Income Distribution: ​ 39% of households earned less than $25K a year in 2014 ​ The top 1% of earners in the united states gave an average household income of 2.7M a year in 2014 ​ Percentiles are added up and aver...

Econ Midterm 1 Study Guide: Econ 1 Notes: Inequality Lecture #1: 1/7/25 Income Distribution: ​ 39% of households earned less than $25K a year in 2014 ​ The top 1% of earners in the united states gave an average household income of 2.7M a year in 2014 ​ Percentiles are added up and averaged (numbers are not precise) ​ The income distribution graph is incredibly steeper showing the wealth gap between the rich and poor ​ Gap between the top 1% and the top 99% is millions of dollars ​ Economists looking at how well income taxes alleviate the income gap ​ Top 1% of earners in 2017 made 21.5% of total income in the US ​ Tax laws and what income needs to be reported to the IRS change over time so the numbers we have from the IRS have changed over time ​ There have been increase in inequality in recent years but due to factors such as changes in tax law the amount inequality has increased is debated ​ Income is a flow (money earned per year) wealth is the total amount of wealth/assets you have accumulated over your lifetime Wealth Distribution: ​ Top 10% of individuals control 70% of wealth in the US ​ Top 1% holds about 40% of wealth in the US ​ Inequality in wealth is much more drastic than inequality in income ​ Generally worldwide, income and wealth are highly concentrated in the top 10% Income Mobility: ​ Inequality can be shown in the average of a child's rank in the income distribution compared to their parents ​ Income mobility is shown by the difference in a child's income rank compared to thief parents  ​ The US has worse income mobility than other countries ​ Race plays a substantial role in income mobility ​ The mobility is relatively consistent across major US cities ​ Factors correlated with high income mobility include: ○​ Low segregation ○​ Low income inequality ○​ Good K-12 education/schools ○​ High social capital (having a lot of good relationships with people within your community) ○​ Family stability ​ There is a positive relationship between intergenerational mobility and inequality (ie. more unequal countries have lower levels of intergenerational mobility) Poverty: ​ The poverty rate is the fraction of people whose family income is less than the official poverty line, normalised by the size of their family ​ Absolute poverty: the fraction of the population with disposable income below a fixed poverty threshold (Word Bank counts this as $1.90/day) ○​ Takes into account the effects of both growth and inequality ​ Relative poverty: the fraction of the population with disposable income below a poverty threshold fixed relative to median (EU used 60% of median income) ○​ Takes into account only the effects of inequality ​ It is possible to be impoverished according to relative terms, but not in absolute poverty ​ In the long run, absolute poverty rates fall but relative poverty rates do not ​ No one in the US is World Bank Poor ​ Poverty line: the income level, below which a family is defined to be in poverty ○​ 1 person household: $14,580 ○​ 2 person household: $19,720 ○​ 3 person household: $24,860 ​ The poverty line is adjusted for inflation ​ The rate of poverty in the US has barely fallen since 1970 despite huge growth in the economy ​ Some groups are more likely to experience poverty including: ○​ Children ○​ Single parent households ○​ Single mothers ○​ Racial/ethnic minorities ​ People less exposed to poverty include: ○​ Elders (social security) ○​ Full time workers ○​ Multi income families ○​ Multi income households without kids  ​ Few people are in poverty at any given time (approx. 1-in-7), but many experience poverty as some point ​ Common factors that contribute to poverty include but are not limited to: ○​ Divorce ○​ Childbirth ○​ Losing a job ○​ Medical issues ​ The median spell of poverty is around half a year unless you are from the currently poor population, in which case the median spell is 8 years ​ Long term poor are a small share of those entering poverty and a large share of those in poverty at any given time ​ More than 50% of those who escape poverty will end up impoverished again within 5 years Summary: ​ Inequality is high, rising, and linked to low levels of intergenerational mobility ​ Long-term poverty is large among those who are born into one currently in poverty, poverty is a recurrent state ​ Upward mobility is not equally likely for everyone Lecture #2: 1/10/25 Government Intervention in Inequality: ​ There are two main reasons why the government should intervene in inequality ○​ Redistribution: society may want a different outcome from a situation that is provided by the market (ex. The government collects revenue via taxes and redistributes to even out the wealth gap) ​ Can be thought of as a “social insurance” ​ Insuring against being born into unlucky situations (you get support) ​ If you are born wealthy you have to pay a tax ○​ Market Failure: when market economies fail to provide efficient outcomes the government can intervene to prevent economic collapse, this can be caused by… ​ Externalities: a side effect of one activities on others ​ Individual failures: people who are not rational individuals (those who don’t save for retirement) ​ Imperfect or asymmetric information: when one party in a transaction knows something the others don't (insider trading, hidden health conditions when applying for health insurance) ​ Safety net programs like social security are one way the government redistributes ○​ Rich people pay more money in and don't get as much back ○​ Poor people pay less in and get more back  ​ Majority of money redistributed comes from the top 10% of taxpayers ​ Social insurance: insurance provided by the government that covers, job loss, disability, old age, etc ​ There are two main reasons that the private insurance market may not provide social insurance because of imperfect or asymmetric information: ○​ Adverse selection: the greater the likelihood of something happening is higher than the likelihood you will buy insurance for it (predisposed health conditions you are more likely to buy health insurance, clumsy with your phone you are more likely to buy applecare insurance) ○​ Moral hazard: people making riskier choices once they are insured because they now have a fall back ​ Insurance Death Spiral: only people with more risk get insurance → insurance companies take on more risk and have higher payouts per policy → insurance companies raise prices for all clients ○​ This can be remedied by the maximin principle social insurance, all individuals regardless of risk type are required to buy riskier and less risky people are forced to participate ​ Downsides of government intervention: ○​ Taxing people's income reduces their incentive to work ○​ Taxation leads to tax avoidance, tax evasion, and fraud ○​ Insuring people against unemployment/poverty/disability/etc leads to moral hazard ​ The leaky bucket analogy: imagining redistribution as taking water from some and giving it to others, how worth it this is depends on “how leaky the bucket is” (how large are the efficiency costs) Equity VS Efficiency: ​ Equity vs. Efficiency: every time the government intervenes there are equity vs efficiency trade offs ​ Equity: an additional $1 a year of income to a family making $10,000 a year is worth more to them than a family making $1,000,000 a year, this idea leads to higher tax rates on the rich/high income earners ○​ If we only care about equity then money (communism) is redistributed so that everyone makes an equal amount (equal pieces of a smaller pie) ​ Everyone gets paid the same but output in the economy falls ​ Efficiency: a person who earns $1,000,000 a year and is taxed heavily may choose to work less to avoid high taxes, this idea leads to lower tax rates on the rich/high income earners ○​ If we care about efficiency more than equality (capitalism) there is no redistribution of funds and everyone gets only what they work for and save ​ Lots of incentives to work and grow capital but anyone with a disadvantage (low income, disables, old) would suffer ​ The optimal tax system balances gains from equity against efficiency costs Summary: ​ The most common reasons for government interventions in the economy are redistribution and market failures ​ Redistribution gives additional resources to those who need it most (unemployment, low income housing, social security) ​ Government interventions are costly and can distort incentives and diminish efficiency ​ Economists can help understand why the economies result in certain outcomes and what can be done to fix/improve those outcomes Econ 1 Notes: Decision Making Lecture #3: 1/13/25 Cost-Benefit Principle: ​ Decision rule: pursue the choice if the benefits are at least as large as the costs ○​ Willingness to pay > the cost ​ Economic surplus: the total benefits minus the total costs from an economic activity ​ Buyers perspective: say a pair of shoes is $180 and the buyer is willing to pay $200, the benefit ($200) minus the actual cost ($180) makes the buyers economic surplus $20 ​ Sellers perspective: it costs the seller $100 to make a pair of shoes they are going to sell for $180, the benefit ($180) minus the costs of manufacturing ($100) makes the sellers economic surplus $80 Opportunity Cost Principle: ​ The opportunity cost: the most valuable alternative you are giving up to get the thing you want ​ Limited resources means with every decision you make you are giving something else up ○​ Limited money ○​ Limited time ○​ Limited attention ○​ Limited production capacity in a business ​ The decision rule applies here too, only take the action is the benefit is at least as large as the actions opportunity cost  ​ The opportunity cost of going to the store to buy a new pair of shoes means not spending that money/time/attention on something possibly more valuable that would have a more positive impact on your life ​ Not all costs are opportunity costs… ○​ Sunk costs are costs that have already incurred and can not be reversed ​ Let bygones be bygones, sunk costs are not relevant for decision making Marginal Principle: ​ Instead of either/or decisions, we are now going to consider “how many” decisions ​ As opposed to deciding whether or not to buy something you ask, should I do this again/should I buy more ​ The marginal principle can be combined with the cost-benefit principle ○​ Should i buy this → yes, if the benefit of ONE MORE UNIT is at least as great as the cost of ONE MORE UNIT ​ Marginal benefit: the “extra benefit” from the additional unit ​ Marginal cost: the “extra cost” of the additional unit ​ The decision rule applies here too, the marginal benefit must be greater than or equal to the marginal cost ​ The rational rule: (marginal principle+cost-benefit/opportunity cost principals) ○​ If something is worth doing, keep doing it over again until marginal benefit is less than marginal cost Interdependence Principle: ​ The choices made in an economy are not fully independent/isolated ​ In order to understand the consequences of these decisions we have to account for: ○​ How one decision impacts other choices you make ​ Your own choices are interdependent, you have limited resources and allocating one resource towards one thing makes you unable to use it for another ○​ How other people's decisions impact your decision making process ​ Other people who are knowledgeable about the stock market all buy into one stock, you are inclined to follow their lead and buy the same stock ​ Trends (clothing, hair, slang, etc.) ○​ How decisions in one market depend on other markets ​ Minimum wage for factory workers is raised by $3 an hour and the price of goods goes up a significant amount ○​ How the decisions we make today depend on past and future choices  ​ You are saving up for a car in the future so you decide not to buy concert tickets not ​ You spent half of your monthly budget on a shopping spree last week and now you can’t go out to eat this month Summary: ​ Marginal principle: one more? ○​ Is it worth it to get another unit? ​ Cost-benefit principle: is the benefit greater than or equal to the cost? ○​ Only chose something if it yields at least as much benefit as it costs ​ Opportunity cost principle: or what instead? ○​ What are you giving up to make this decision? ○​ Decisions reflect all costs and actions not just financial ones ​ Interdependence principle: what else? ○​ Decisions in one market are connected to other choices you make, other decisions, past and future decisions, and decisions in other markets Econ 1 Notes: Demand Lecture #5: 1/17/25 Individual demand: ​ An individual demand curve is just a set of plans ○​ The “plan” will remain the same if nothing else changes (factors) ○​ If other things change (cost of product, taste, quality) the demand curve will change ​ The individual demand is always downward sloping ○​ The lower the price, the higher the quantity demanded ​ The cheaper a product is, the more people will buy ○​ The demand curve always slopes downward because each additional item yields a smaller marginal benefit than the previous one ​ Since the price you are willing to pay is equal to the marginal benefit there is a negative relationship between price and quantity ​ Law of demand: quantity demanded is higher when prices are lower ​ The rational rule applies to the formation of the demand curve  ○​ Insured your decisions will always increase your economic surplus ​ Marginal principal (should I buy one more?) → cost benefit principal (does the benefit of the product outweigh the cost) → opportunity cost principal (what am i giving up to get/do this) → interdependence principle (how will this decision affect my future choices) ​ Marginal benefits: benefit of the extra unit compared to the next best alternative quantified as the willingness to pay (monetary value) ​ Demand is all about marginal benefits Market demand: ​ To calculate market demand you add individual demands at each given price ○​ In reality it is hard to know every individual customer's willingness to pay ​ The four steps to estimate market demand are: ○​ Survey customers ​ Ask a portion of customers about the amount of an item they will buy (demand) at each price point ○​ Add up the total amount of “demanded” items ​ This gives us the total quantity demanded at each price point ○​ Scale up the quantities to represent the whole market and not just the portion of customers you surveyed (the sample group) ○​ Plot the market demand curve ​ Use your calculations of total demand and willingness to pay at each increment to plot points on the graph ​ Plot the total quantity demanded by the market at each price ​ The market demand curve plots the total quantity demanded by the market at each price ​ Extensive vs intensive margin: ○​ The law of demand applies to market demand too ​ The lower the prices the higher the demand ​ The higher the prices the lower the demand ​ Why is the quantity demanded higher when the price is lower? ○​ Intensive margin: the cheaper something is, the more each consumer buys (costco business plan) ​ Each consumer in the market buys more → market demand increases ○​ Extensive margin: the cheaper something is, the more consumers you get ​ The prices drop and more consumers join the market → market demand increases ​ We need to consider the demand of all potential consumers when estimating demand since the changes in prices can change who the consumers are ​ When more consumers join the market the demand curve shifts Demand shifts: ​ Movement along the demand curve VS shifts of the curve itself  ○​ The demand curve shows the set of consumption plans/predictions ○​ Increases and decreases in price will raise or lower the quantity demanded along the original demand curve ○​ Increases and decreases in the demand change the curve ​ Increases in demand will shift the curve to a higher quantity for every pricepoint ​ Decreases in the demand will shift the curve to a lower quantity for every pricepoint ​ Decreases in demand: ○​ Shifts the demand curve to the left ○​ Decreases the quantity demanded at each and every price ○​ Decreased number of customers ​ What can shift the demand curve: ○​ Income of the customers ○​ Shifts in tastes and preferences ○​ The price of other goods and services ○​ Expectations for the product can shift ○​ Network and congestion ○​ The number and type of buyers in the market ○​ Price changes DO NOT shift the demand curve ​ Shifts in income: ○​ Depending on the type of goods, changes in income will affect their demand differently ​ Normal goods: higher incomes cause an increase in demand for normal goods (quantity demanded increases) ​ When you make more money you are more likely to take an uber to work ​ When you have more money you buy more ​ Inferior goods: higher income causes decrease in demand for inferior goods (quantity demanded decreases) ​ When you make less money you are more likely to take the bus to work ​ Inferior goods are things you buy when your income is constrained but when you have higher income you substitute them ​ Changing tastes: ○​ Changes in trends with change demand for clothing, shoes, accessories, etc ○​ Increased environmental awareness had reduced demand for certain goods and increased for others ​ Less demand for SUV’s ​ More demand for hybrid/electric cars ○​ The main goal of advertising is to shift the demand curve to the right! ​ Price of other goods: ○​ Substitute goods: ​ Goods that replace each other (you buy one or the other)  ​ Demand increases when the price of a substitute good rises ○​ Complimentary goods: ​ Goods that go together ​ Demand decreases when the price of a complimentary good increases ​ Shifts in expectations: ○​ INTERDEPENDENCE PRINCIPAL (choices are linked through time) ○​ Buying tomorrow is a substitute for buying today ​ Ex. if you expect the price of an item to go down next month, you will wait until then to buy it → demand for that item today will decrease ​ Network and congestion effects: ○​ Interdependence principal also applies to this ○​ Network effects: ​ When a product becomes more useful because more people start using it ​ Ex. social networks, messaging software, speaking more common languages (english, chinese), microsoft word, etc. ​ Increased use by others will increase demand ○​ Congestion effects: ​ When a good becomes less useful because a lot of people use it ​ Ex. driving, something becoming too popular so it's not worth it anymore ​ Increased use by others decreases demand ​ Network goods (facebook, whatsapp) are more valuable when other people use them ​ Congestion goods (busy restaurant, traffic on main roads) are less valuable when other people use them ​ Number and type of buyers: ○​ Individuals in the market are changing ​ DOESN’T change individual demands ​ DOES change market demand ○​ Remember that market demand is the sum of individual demands ○​ More buyers increase market demand, less buyers reduce it