Economics for Political Scientists PDF (2021/2022) - Leiden University

EFPS João Bazelga Economics for Political Scientists IRO (2021/2022) - Leiden University Block 2 1  EFPS...

EFPS João Bazelga Economics for Political Scientists IRO (2021/2022) - Leiden University Block 2 1  EFPS João Bazelga Economic growth and inequality INEQUALITIES WITHIN AND BETWEEN COUNTRIES Using statistics, we can measure inequality in many ways, the most powerful way to do it is to rank everyone in the world by income, from the richest to the poorest. Di erences between the rich and the poor are huge within every country; Between states, this inequalities are rather big (Norway is the most equal country but the poorest 10% in Norway receive on average almost twice the income of the richest 10% in Nigeria). MEASURING INCOMES (GDP) Gross domestic product (GDP): the total/market value of all nished goods and services produced in a country in a given period, such as a year (doesn’t include capital goods). Net exports (NX) To make meaningful comparisons we need to: - Divide a country’s total GDP by its population (GDP per capita); - Correct for changes in spending power, in uenced by in ation, within the country (real/ constant GDP, rather then nominal GDP); - Measure in a common unit like the US dollar; - Use Purchasing power parity (PPP) to re ect the changes across countries and time; 2 ff fl fl fi fl EFPS João Bazelga ECONOMIC GROWTH Annual growth rate of real GDP (in year t): ‘Hockey Stick’ diagram shows a booming of the economy since 1800s. This led atmospheric CO2 to also grow exponentially. When we see growth reported, it is often reported as the average rate during a period of years. This is the case whether it is the growth of the economy (real GDP growth) or the growth of incomes (real GDP per capita). Economic growth increases in: natural resource discovery, physical capital/infrastructure; population; human capital; technology; law. | on short therm, this can cause… | |—> External shocks; |—> Government monetary or scal policy; |—> Consumer/business sentiment; CAPITALISM The explosion in growth rates correlates with the adoption of di erent economic systems, predominantly capitalism. This allied with the permanent technological revolution that the Enlightenment brought, enhanced the a uence in the world. Capitalism: An economic system in which private property, markets, and rms play an important role. Elements of capitalism: Private property (the right and expectation that one can enjoy one’s possessions in ways of one’s own choosing, exclude others from their use, and dispose of them by gi or sale to others who then become their owners); 3 ff fi ffl fi  EFPS João Bazelga Markets (a reciprocated, voluntary and competitive way of connecting people who may mutually bene t by exchanging goods or services through a process of buying and selling and not trough governments); Private rms (business organization which pays wages and salaries to employ people, and purchases inputs, to produce and market goods and services with the intention of making a pro t). What does capitalism give us? Division of labour (The specialisation of producers to carry out di erent tasks in the production process); Specialisation (This takes place when an individual, country or some other entity produces a more narrow range of goods and services than it consumes, acquiring the goods and services that it does not produce by trade - concerning that self su ciency is the road to poverty); Entrepreneurial innovators; New technology (improves economies and living standards); Creative destruction: old technologies and the rms that do not adapt are swept away by the new, because they cannot compete in the market by selling goods at a price that covers the cost of production. Incentivises cost-reducing innovation. Leads to greater inequalities —> Capitalism is a system of winners and losers. DEMOCRACY Democracy has many de nitions, but generally and ideally it includes: Gives equal political power to all citizens: this power is de ned by individual rights such as freedom of speech, assembly, and the press; Selects political leaders by means of elections: in these elections, virtually all adults are eligible to vote, and the governing party leaves o ce if it loses; By giving individuals power to choose their economic system, they generally opt to secure property rights and prevent non-competitive forces. In a nutshell, capitalism can be a dynamic economic system when it combines: 4 fi fi fi fi ffi fi ffi fi ff  EFPS João Bazelga Private incentives for cost-reducing innovation: these are derived from market competition and secure private property; Public policy supporting these conditions: governments enforce laws and provide regulation; Public policy that supplies essential goods and services: these may not be provided in su cient quantities by private rms, and include education and basic research; Social interactions and economic outcomes SOCIAL INTERACTION Interaction: Economic and political actors don’t act in isolation; Our actions impact others and vice-versa; This produces opportunity (gains) and con ict (losses); GAME THEORY This interactions can be explain by a framework labelled as “Game Theory” (an analytical tool of social science used to examine strategic interaction between rational individuals or groups); Assumes that rational individuals act strategically (self-help) People don’t act rationally all the time; This way of modelling how people interact with each other includes: Strategic Interaction- A situation in which my optimal decision depends on what others do, and vice versa. Game- Is a formal model of strategic interaction. It accounts for: - Player - A participant in the game. - Strategy- A detailed plan of action (it may even plan for reactions to others’ actions in dynamic settings) for strategic interactions. - Payo - The nal utility the player obtains in the game as a consequence of all the players’ strategies. Equilibrium- The analysts’ prediction for a solution of the game. 5 ff fi fi fl ffi  EFPS João Bazelga To understand social dilemmas, and how they might be avoided, we distinguish between two classes of preferences: Self-interested preferences: When a person with self-interested preferences chooses to take some action, she only takes account of how it a ects her personally, ignoring the a ects on others; Social preferences: A person with these preferences cares not only about how her action a ects her personally, but also about how it a ects other people; Social dilemmas can be avoided or minimised if people care su ciently about how their actions a ect others (social preferences), or if society is organised so that people are constrained or motivated to act as if they did. Social dilemmas can also be resolved by government policies. TRAGEDY OF THE COMMONS “Tragedy of the commons”, Hardin: resources that are not owned by anyone (‘common property’/‘common-pool resources’), such as the earth’s atmosphere or stocks, are easily overexploited unless we control their access in some way. Social dilemma: Even if you try to help it, you will bear the costs, while others will enjoy the bene ts today and in the future, since the goods are rival in consumption; Elinor Ostrom: Social preferences like altruism partly explain why some communities avoid Garrett Hardin’s tragedy o the commons, but communities may also nd ways of deterring free-riding behaviour by punishing those who do not contribute (since it may have unpleasant consequences tomorrow or years from now). Adam Smith: Individuals pursuing their own interest, without regard for the interests of others, can be consistent with the common good (socially desirable). Under the right laws and economic institutions (private property, and competition among many economic actors), the economy would be guided, as if by an ‘invisible hand’ towards a socially bene cial outcome. THE INVISIBLE HAND Dominant strategy: action that yields the highest payo for a player, no In the game shown in matter what the other players do; the book, Anil choosing Cassava and Bala Dominant strategy equilibrium: an outcome of a game in which every choosing Rice is an player plays his or her dominant strategy; equilibrium because neither of them would Dominated strategy: a strategy that is not a best response independently want to change their of other player’s strategy; decision after seeing what the other player Equilibrium: self perpetuating situation in which an outcome that does not chose; change unless outside forces a change; 6 ff ff fi ff fi ff ff ff ffi fi ff EFPS João Bazelga This goes to show that the pursuit of self-interest without regard for others is sometimes considered to be morally bad, but the study of economics has identi ed cases in which it can lead to outcomes that are socially desirable, due to an “invisible hand”. Problems: Individual incentives and following your self interest can lead to a better society, but this is not always the case; Sometimes following your self interest, absent government interferences, can lead to sub- optimal, really bad or indeterminate outcomes; Self interested behaviour produces externalities PRISIONER’S DILEMMA 2 criminals are caught robbing a bank and the government o ers both of them the same deal: snitch on the other and get o fee, if both smith you get 5 years and if you remain silent you get 20 years if your partner snitches; | |—> Collectively, they both would do better by staying silent; | |—> Individually, the payo s in the dominant strategy equilibrium are lower for each player then if neither player played the dominant strategy; | | Yet, each has an incentive to defect (or turn in) his accomplice; | This shows that individual incentives often make cooperation di cult and that sel sh behaviour can lead to suboptimal outcomes; | |—> There are cases in which the pursuit of self-interest leads to results that are not in the self- interest of any of the players. PUBLIC GOODS Public goods (national defence, public radio, roads, bridges, common currency, etc.): - Socially desirable products de ned by two qualities; - Non-excludable (can’t prevent consumption by others); - Non-rival (consumption by one doesn’t hinder consumption by others); Private goods (dinner at a restaurant, airplane ride, cellphone): - Can be excluded from others; The public goods game: there is something to gain for everyone by engaging with others in a common project such as pest control, maintaining an irrigation system, or controlling carbon emissions. But there is also something to lose when others free ride; 7 ff ff fi ff ffi fi fi EFPS João Bazelga Free ride: Bene ting from the contributions of others to some cooperative project without contributing oneself (even if this brings problems in the future); | | Example: 10 houses live on a lake they use for water and waste; Dirty water costs €500 per house/year (each share of pollution is $50); A sewage system costs €250 per house/year; Everyone is better o if they purchase a sewage system; However, not everyone is needed to make the system pro table for all players; If only one house doesn’t install a sewer, cost of pollution is €50 year for each house; Everyone has incentive to free ride (€50 Coercion; |—> Ability to set the agenda; |—> Create a credible commitment; |—> Availability of outside options (leave the game and join another one); However, all of this can be challenged by the deviations from rationality that people sometimes showcase, like their bias (loss aversion, discounting behaviour) or there concern with social preferences (altruism, reciprocity to those who acted well and inequality aversion); Even Nash equilibrium can sometimes be challenged: | Hawk-dove game: represents the idea that no one wants to see a negative outcome (catastrophic climate change), but each is waiting in order to see if others will move rst to prevent it since there are two Nash equilibria (di er on which country bears the cost of restricting emissions); ECONOMIC OUTCOMES E ciency and fairness help us evaluate di erent allocations (outcome of an economic interaction): E ciency: an allocation is Pareto e cient if there is no other outcome that would be preferred by everyone a ected (or at least preferred by some, and not opposed by any) - If the allocation A, compared to B, leads to at least one party being better o (than in B), and nobody worse o than A dominates allocation B (there can be multiple Pareto e cient points); | |—> This doesn’t take fairness in consideration; Fairness: An evaluation of an outcome based on how the allocation came about, and not on the characteristics of the outcome itself, taking in consideration the principles of equality (to assess this is necessary to apply this principle to all people under a veil of ignorance); Modelling economic decisions ECONOMIC MODELS In order to make sense of the world, we need to simplify its complexity. This simpli cation is called modelling (if we are interested in a car’s aerodynamics, we build a model to test how air ows around the car). 9 fl ffi ffi ff ff ff ffi ff fi ff ffi fi  EFPS João Bazelga | |—> the model needs to be clear, identify important relationships, be useful, improve communication, make accurate predictions and include our tradeo s/other options (but it doesn’t and it shouldn’t re ect 100% o the reality). Three keys of economic modelling: Ceteris Paribus: held other things constant when analysing the variables and e ects of interest; Incentives: rewards or punishments that a ect the costs and bene ts of taking one action as opposed to another; Relative price: we often focus on ratio of things to help us compare di erent courses of action and explain individual choices; THE PRODUCTION FUNCTION Production functions, represented in the curve, show how inputs (e.g.: work hours) translate into outputs (e.g.: GPA), holding other factors constant (e.g.: study environment). Marginal products: change in output per unit change in input; Diminishing marginal products: studying becomes less productive the more you study (the marginal product of an additional hour falls as we move along the curve); OPPORTUNITY COSTS Since choices are limited by constraints and involve tradeo s, when we gain something, we lose something (e.g.: when we spend time studying, we loose free time); | creating | |—> The opportunity cost of an action is the next bene t of the next best alternative action; Economic cost = monetary costs + subjective costs (personal preferences) Economic rent = Bene t of an action - Economic cost FEASIBLE FRONTIER The feasible frontier (curve) shows the maximum output that can be achieved with a given amount of input. This tells us which options are possible, impossible and e cient. Feasible set: All the combinations of the things under consideration that a decision-maker could choose given the economic, physical, or other constraints that he faces; 10 ffi fl fi ff ff fi ff fi ff ff ff  EFPS João Bazelga | |—> Outside the frontier set the combinations are infeasible; |—> Inside the frontier set the combinations are feasible (however, in combination D, for example, Alexei is wasting time or points in the exam and therefore is not optimal/e cient). Marginal rate of transformation (MRT): the slope of the feasible frontier, and it represents the tradeo s an individual faces (opportunity costs). Preferences determine where in the feasible frontier you want to stand. | |—> This is measured in terms of utility (total satisfaction received from consuming a good); DECISION-MAKING AND SCARCITY Indi erence curves: joins points that cannot be ordered to show all combinations that give the | same utility. | |—> Slopes downwards (due to trade-o s); | |—> Higher indi erence curves correspond to higher utility level (we get more); | |—> Usually smooth; | |—> Indi erence curves do not cross (the points on the lines that cross would be equivalent); | |—> perfect sustainability would be a at line; | |—> diminishing MRS - as you move to the right along an indi erence curve, it becomes atter (the more free time and the lower the grade he has, the less willing he will be to sacri ce further percentage points in return for free time, so his MRS will be lower); Marginal rate of substitution (MRS): slope of the indi erence curve that represents the trade-o s an individual is willing to make. Constrained choice problem: a decision-maker (Alexei) pursues an objective (utility maximisation in this case) subject to a constraint (his feasible frontier). | Optimal choice (MRT=MRS): where the amount of one good the individual is willing to trade o for other good (MRS) equals the actual tradeo between the two goods (MRT); | |—> In this case it’s E, where the feasible frontier and the highest attainable indi erence curve IC3 touch but do not cross. This is a point of tangency. 11 ff ff ff ff ff ff fl ff ff ff ff ffi fi fl ff  EFPS João Bazelga TECHNOLOGICAL PROGRESS Technological progress, and other factors such has labour experience, increases the amount of grain produced in a given number of hours. | |—> Technological progress raises the standard by making it feasible to both consume more and have more free time. Be careful, because this mindset can lead us to a sunk cost fallacy (false tendency that we have to follow trough on an endeavour if we haver already invested time, e ort, or money into it, whether to not the current costs outweigh the bene ts); Institutions and power INSTITUTIONS Set of written and unwritten rules known and shared by the community, that structure political interactions in speci c ways and regulate how people interact - “rules of the game”; The laws and social customs governing the way people interact in society (the text book); Can be categorised as formal (Dutch Constitution, labor laws, Schengen Agreement) and informal (actions that we have no reason to deviate from - norms of behaviour); Shape incentives; In uence growth, the balance of power and in uence the distribution of wealth within society; Shapes who has bargaining power (the extent of a person’s advantage in securing a larger share of the economic rents); Can be a source of good (they can reduce inequality by redistributing wealth); THE ROLE OF POWER IN PRODUCTION Power: The ability to do and get the things we want in opposition to the intentions of others; | |—> Bargaining Power: The extent of a person’s advantage in securing a larger share of the economic rents made possible by an interaction (this is in uenced by coercion, institutions and alternative options). To understand bargaining power, we can learn about two di erent games: Dictator game: a proposer dictates how a pie is to be divided - authoritarian regimes (democratic institutions can undermine this); Ultimatum game: a proposer is given 100€ and the opportunity to make a take-it-or-leave-it o er to the respondent of a part of that money, while the respondent, knowing how much he o ered and took for himself, has the chance to accept it or reject it which would lead to both getting nothing (although the proposer’s bargaining power is limited because of the responder’s power to refuse, he still has more since he is the one making the o er) - labour market; 12 ff ff fl fi fl fi ff fl ff ff  EFPS João Bazelga Production with no interference: Both the worker (controlled) and the boss (controller) are entrepreneurs and have the same bargaining power - ideal world; The hours of free time will be determined by the intersection between the feasible frontier and the indi erence curve; Production under absolute power: Worker and boss spilt the output of the worker; Worker needs a certain amount to survive (biological/ survival constraint - green line); The money made o of land will be within the technically feasible area (all the allocations that are possible within the limitations of the technology - the production function - and biology - the biologically feasibility); Within this area, the boss will pick where their share of production is largest while giving the Worker only the amount they need to survivor (the boss has all of the bargaining power); This will be where: slope of the biological constraint = slope of the feasible frontier (MRS=MRT); Production with property rights: The worker rents land and agrees, by contract, with the land owner on the rent payment; The worker has the opportunity to say “NO” to any distribution he doesn’t prefer; Reservation indi erence curve: below a certain level (above the biological constraint) the worker will not work - blue line; Reservation price/point/option: a person’s next best alternative among all options in a particular transaction - point z, where the survival constraint is assured but the worker won’t accept the contract (anything above reservation prices is a Pareto improvement); The economically feasible set shows all possible allocation that bene t both parties; Economic rent (a payment or other bene t received above and beyond what the individual would have received in his or her next best alternative); Joint surplus (the sum of the economic rents of all involved in the interaction); The landlord will o er where the MRT=MRS on the reservation indi erence curve (which is where they get most from their land); Pareto E ciency curve: all points in the feasible set in which MRS=MRT (E-F); The landlord has all the bargaining power so you must take the deal at your lowest reservation point; 13 ffi fi ff ff ff ff fi ff EFPS João Bazelga Production with labor laws and property rights: A government passes a law that restricts working day to 3 hours and the same pay that they used to get (30$); The worker might be better o but there is still room for a more productive allocation (MRT > MRS) - “deadweight loss” (a loss of total surplus relative to a Pareto-e cient allocation); If allowed, the worker can bargain to work at the point x because both him and the landlord will be better o ; This types of interventions are “fairer” but don’t qualify as a Pareto improvement (change that bene ts at least one person without making anyone else worse o ). This previous examples proves that if we have institutions under which people can jointly deliberate, agree on, and enforce alternative allocations, then it may be possible to achieve a fairer outcome that is also Pareto e cient. Angela and Bruno did this through a combination of legislation and bargaining between themselves. The outcome of an interaction depends on people’s preferences, as well as the institutions that provide their bargaining power, and hence how the surplus is distributed. Measuring inequality INEQUALITY Important criterion for assessing if an allocation is fairness. Creative destruction and Institutions, via bargaining power and endowment (what each person owns), can lead to inequality; The Gini, rich/poor ratio and the 90/10 ratio are widely used to measure income inequality. THE LORENZ CURVE Shows the % of a country’s income held by each cumulative percentiles of the population; A useful tool for looking at the entire distribution of income or wealth representing and comparing distributions of income or wealth across countries; It indicates how much disparity there is in income, or any other measure, across the population; The Lorenz curve shows the entire population lined up along the horizontal axis from the poorest to the richest. 14 ff ff fi ffi ffi ff  EFPS João Bazelga The height of the curve at any point on the horizontal axis indicates the fraction of total income received by the fraction of the population given by that point on the horizontal axis. The Lorenz curve allows us to see how far a distribution departs from this line of perfect equality; GINI COEFFICIENT/RATIO Calculated as the ratio of the are between the Lorenz curve to the perfect equality line to the area of the whole triangle under the 45-degree line; This graphical method of calculating the Gini gives only an approximation (To calculate it precisely, we need to work out the average di erence in income between every pair of individuals in the population); Values vary between 0 (perfectly equal) and 1 (extreme inequality, one person/group has all the wealth); The more unequally resources are distributed amongst the members of the population, the larger is the Gini coe cient. | Problem | |—> It doesn’t properly assess if a society is highly unequal because there is a small number of exceptionally rich people—everyone else being moderately well o — or, instead, there are a small number of very poor people—everyone else being better o (since they could have same values). GOVERNMENT ROLE IN INEQUALITY Disposable income: what a household can spend without borrowing money, after paying tax and receiving transfers (such as unemployment bene t and pensions) from the government. | |—> The di erences between countries in disposable income inequality (the top of the lower bars) are much greater than the di erences in inequality of market incomes (the top of the upper bars). Firms FIRMS VS MARKETS (CAPITALIST ECONOMY) Division of labour (in a capitalist economy) is coordinated in two di erent ways: - Firms (the components of goods are produced by di erent people in di erent departments of the rm and assembled to produce a nished shirt or iPhone); 15 ffi fi ff ff ff fi fi ff ff ff ff ff  EFPS João Bazelga | |—> concentration of economic power: this is placed in the hands of the owners and managers, who regularly issue directives with the expectation that their employees will carry them out. - Markets (components produced by groups of workers in di erent rms may be brought together through market interactions between rms); | |—>decentralisation of power: purchases and sales result from the buyers’ and sellers’ autonomous decisions. WHAT IS A FIRM? Firm: a business organization which employs people, purchases inputs to produce market goods and services, sets prices greater than the cost of production and is pro t maximising (when they aren’t, they end in bankrupt); | |—> “The rm in a capitalist economy is a miniature, privately owned, centrally planned economy” (Ronald Coast); The people making up the rm — employees, managers, and owners — are united in their common interest in the rm’s success because all of them would su er if it were to fail. | |—>However, they have con icting interests about how to distribute the pro ts from the rm’s success among themselves, about the rm’s policies and who makes the key decisions; WHY DO FIRMS EXIST? There are not very e cient alternatives to rms; Markets often have a high cost (it is cheaper to order someone to do something than negotiate with a private actor to carry out a task); Firms are useful when tasks are not clearly de ned and breaking short-term contracts come with large transaction costs; Firms need to hire on long term contracts (which leads to Principal-Agent problems); Transaction costs Transaction costs: costs that impede the bargaining process or the agreement of a contract; they include costs of acquiring information about the good to be traded and costs of enforcing a contract; | |—> Search and information costs | (Costs incurred in identifying possibilities for mutual gains - cost of gathering information); | 16 fi ffi fi fi ff fi fl fi fi fi fi fi ff fi fi  EFPS João Bazelga |—> Bargaining and Decision costs | (All costs associated with negotiating and agreement - time spent at meetings); | |—> Policing and Enforcement Costs (Costs involved in making sure parties stick to the agreement - time and e ort spent jjjjjjjjjjjmonitoring others informally); -Market transactions allow for constant price changes in response to supply and demand (this creates transaction costs in production); Although the government can tax and regulate private property, the idea of private property speci cally limits the things a government or anyone else can do with your possessions. AGENCY DILEMMA Incomplete contracts | | Principal-agent problems, in which the worker is the agent and the principal is the rm ( rms are useful when services or goods are not standardized and output/performance is di cult to monitor - since employers can’t specify everything they need the worker to do during that time); | Rational agents have an incentive to neglect/mismanage the rm’s assets. | however | The contracts usually work because their failure would hurt both parts; | |—> Firm would have a cost of nding a new employee; |—> Employee would have cost of nding a new job; | | A solution for this agency dilemma is… | INCREASE | Employment rent = cost of job loss: - Money besides the reservation option (employees fear getting red when they are paid more than their reservation option); - Lost income while searching for a job; - Costs required to start a new job (e.g. relocation); - Loss of non-wage bene ts (e.g. medical insurance); - Social costs (stigma of being unemployed); This way, the worker puts in more e ort to reduce the chance of getting re. | |—> However, there still are some costs of working: employee waste time that they could invest on something that they like (disutility of work) or the cost of travelling to work every day - this costs increased during COVID-19 (especially for health care ones) which led to unemployment; 17 fi fi fi fi fi fi ff fi fi fi ff ffi  EFPS João Bazelga Employment rent= wage - reservation wage - disutility of e ort Reservation of wage = value of the next best option UNEMPLOYMENT If nding a new job was costless, how hard would you work? | | If everyone had a job, you could easily nd a new job if you lost your current one; | You have little incentive to work hard and put in e ort; | |—> Employers increase wages and look for fewer employees —-leads to——>Unemployment WORKER’S BEST RESPONSE CURVE Best response curve shows the optimal amount of e ort workers will exert for each wage o ered. It represents the rm’s feasible frontier for wages and e ort. Worker payo s = Employment rent (employment game); Slope of best response curve = MRT FIRM’S BEST RESPONSE CURVE (ISOCOST LINES) To maximise pro ts, rms want to minimise the costs of production. Because there is a trade-o between wages and e ort, the employer should nd a feasible combination of e ort and wage that minimises the cost per unit of e ort. Isocost lines (for e ort): the cost (of e ort) is the same in the points o the isocost line.. Firm payo s = Pro t = Worker output - wage Slope of isocost curve = MRS = the rate at which the employer is willing to increase wages to get higher e ort; DETERMINING WAGES Pro ts are maximised at the steepest isocost lime, subject to the worker’s best response curve. | |—> MRT = MRS E ciency wage = wages set higher than the reservation wage so workers will care about losing the job and provide more e ort. 18 ff ffi fi fi ff ff ff ff fi fi ff ff fi ff ff fi fi ff ff ff ff fi ff ff ff  EFPS João Bazelga If rms don’t want to spend much money in wages but still need worker’s to work for them that can opt for other forms of compensation: - Bonuses; - Pro t sharing (useful for rms); - High barriers to o ering compensation in the form of equity (company stock); ALTERNATIVES TO FIRMS Cooperatives (a rm that is mostly or entirely owned by its workers, who hire and re the managers - because pro ts are paid out to workers, there is less need for supervision and monitoring; collective action problem stands as a issue); The gig economy (an economy made up of people performing services matched by means of a computer platform with those paying for the service - because the tasks performed are su ciently well-de ned, a virtually complete contract is possible; much of the risk is placed on the employee): Public sector rms (by public sector we mean government employment; they become particularly di cult because you can’t provide direct stake in the pro t; nor is there a pro t motive for management in providing incentives; jobs are often protected by political patronage; thus principals have a harder time getting their agent not to shrink); Supply & Demand FIRM SIZE Economies of scale: where the average cost per unit decrease as the number of units produced increases; Cost advantages (large rms can purchase inputs on more favourable terms due to their bargaining power or even take advantage of labor specialisation); Fixed costs (some industries require xed costs, costs that are the same no matter how big the rm is or how many units you produce); Demand advantages (network e ects); Diseconomies of scale: when cost per unit increases with the number of units produced; DEMAND CURVE A function that shows the quantity demanded at di erent prices; Slopes down; 19 fi fi ffi fi ffi fi fi ff fi fi fi fi ff fi ff fi fi fi EFPS João Bazelga Represent how much people are willing to give for a certain quantity of a good; Horizontally is the quantity buyers are willing and able to purchase at a given price; Vertically is the maximum price that buyers are willing to pay for a given unit of CTC produced; Increase in demand (increase in quantity demanded at all given prices or an increase in the maximum willingness to pay for each given quantity) can be due to: - Income (growing income leads to bigger demand in normal goods, most of them, and less in inferior goods, like Instant Ramen Noodles); - Population; - Expectations; - Tastes; - Price of substitutes (wind energy and oil/gas energy); - Price of compliments (hot dogs and buns); Elasticity of demand: a measure of how responsive the quantity demand is to the price; Demand is elastic when an increase in price reduces the quantity demanded a lot OR when a decrease in price increases the quantity of demanded a lot; Demand is inelastic when the same increase in price reduces quantity demanded a little OR when the same decrease in price increases the quantity demanded a little; Inelastic goods: goods that have few competitive substitutes, that usually take time to obtain - if oil prices increase, you might think on getting an electric car on the long term, but on the short term this will probably not happen; Consumer surplus: consumer gain from the transaction - di erence between maximum price a consumer is willing to pay for a given quantity and the market price; | | |—>Total consumer surplus is the surplus of all buyers and all units of the good; SUPPLY CURVE A function that shows how much sellers are willing to supply at di erent prices; Slopes up; 20 ff ff EFPS João Bazelga Ex: When oil has a low price only those who can extract it at a low price do so, when the price of oil is high, other suppliers nd to pro table to extract oil; Horizontally represents how much suppliers are willing and able to sell at each price level; Vertically represents the minimum price at which suppliers will sell at each quantity; Increase in supply (producers willing to take a lower price or greater quantity supplied at the same price) due to: - Technology advancements; - Input prices; Reduction in production costs - Taxes and subsidies; Producer surplus: the producers gain from a transaction - di erence between market prices and minimum price at which producers would be willing to sell at a given quantity; | | |—> Total producer surplus is the sum of producer surplus for all unit of the good; PRICES IN COMPETITIVE MARKETS Under competitive markets, the market price (where they are stable) is where supply and demand meet, in the equilibrium price. If producers supply above the maximum price consumers are willing to pay at that quantity | |—> Suppliers would compete (they would have an incentive to reduce prices to get rid of their supply) If the supply is lower than the equilibrium | |—> Buyers compete to purchase the good (they would bid up the price incentivising suppliers to raise prices) A free market maximises the gains from trade (which are split by consumers and producers). 21 fi fi ff  EFPS João Bazelga Demand curve = rm’s feasible frontier (slope = MRT) Firm’s maximises pro ts by choosing point where MRS=MRT; Isopro t curves = rm’s indi erence curves (slope = MRS); Maximising pro t requires that rms gure out where Marginal Revenue (MR)=Marginal Costs (MC). | |—> If MR > MC, you are not pro t maximising (producing more will make you more money); | |—>If MC > MR, you are losing money (each additional unit costs you more than you’re making in revenue); PRICES IN NON-COMPETITIVE MARKETS Monopoly: a rm that is the only seller of a product without close substitutes - when rms have monopolies they can set prices above the market rate in where it maximises there pro t the most; Oligopoly: a market with a small number of sellers producing the same good; Market power: an attribute of a rm that can sell its product at a range of feasible prices by acting as a price setter. Monopoly rents: pro ts resulting from a lack of competition (are the highest when demand is relatively inelastic). DEADWEIGHT LOSS Deadweight loss (DWL) = a loss of total surplus relative to a Pareto e cient allocation (unexploited gains from trade, when consumers and producers didn't make the best out of their resources); - Imagine your mom o ers you a 75€ jeans that you only value 5€, because you can’t spend that 70€ on other things | Can be caused by: - Monopoly/oligopoly; - Taxes; - Arti cial scarcity; - Externalities; - Subsidies; - Price controls; Total surplus is highest when Demand = Marginal Cost (Pareto e cient allocation). Monopoly markup: the less sensitive people are to the price, the greater this is; 22 ffi fi fi fi fi fi fi fi fi ff ff fi fi fi fi ffi fi fi  EFPS João Bazelga The Macro Labor Market UNEMPLOYMENT Unemployed: people who are not in paid employment or self-employment but are available and actively seeking for work; Why does unemployment exist? The cost of losing a job is close to zero if there is no unemployment (workers are not motivated to work under a fully employed labor force); A healthy economy dynamic (creative destruction); Government policies; Demand for labor. TYPES OF UNEMPLOYMENT Structural - Happens when people don’t nd a job that ts them; - Long term and persistent unemployment; - Mismatch between skills demanded and skills possessed; - Changes in the skills demanded due to large economic forces, government policies (that a ect the attractiveness of work) and cultural attitudes towards working are some causes for this unemployment; Cyclical - Happens when there are jobs that t you but because the demand is not enough, someone got the job rst; - Short term changes in unemployment due to changes in economic demand; - The rm’s demand for labour depends on the demand for their goods and services; - Aggregate demand = sum of the demand for all of the goods and services produced in the economy; Frictional - The time that you are taking while nding a job; - Unemployment due to “frictions” in the matching employers with the employees; - Is not a big concern for people since it is a normal part of a healthy dynamic economy; 23 fi fi fi fi fi fi ff EFPS João Bazelga The natural rate of unemployment = frictional + structural unemployment UNEMPLOYMENT FACTORS Labor regulations can a ect incentives to hire and not try so hard to seek work. Elections can lead politics to try to decrease unemployment in the short run; Employers are reluctant to reduce wages of current employees for fear of retaliation; Taking a lower paying job might come with a stigma or makes it more di cult to nd the job that you want; MINIMUM WAGE Leads to Dead Weight Loss; It’s harder to establish causality ; There is little evidence that a minimum wage leads to less jobs; LABOR UNIONS Unions certainly raise the wages of some workers by reducing supply of labor (like a cartel); Can lower wages overall (workers who don’t get in the union, go work elsewhere, pushing wages down); Empirically, there is not a clear relationship between union rates and wages across countries (weak relationship with inequality); Unions do other things beside setting wages (they advocate for workers safety and against arbitrary abuses, which might have spillover e ect); Unions are more prevalent than you think; Finance Finance is crucial for a functioning economy. When we study this theme of economics, it’s useful to treat money as another type of good since it responds to supply and demand and we can measure its price in the interest rate. BORROWING Borrowing allow us to buy more now, at the cost of buying less later which can be economically optimal. | this depends on… 24 ff ff ffi fi  EFPS João Bazelga | |—> Interest rate (r) = price of bringing some buying power forward in time Tradeo between current and future consumption (MRT) = (1 + r) Real interest rate: (nominal) interest rate corrected to in ation which makes it more useful for comparisons; Interest rates are determined by: - Demand: number of people that have access to credit markers; attractiveness of making new investments; uncertainty of making new investments; - Supply: amount of money in circulation; openness to foreign capital; uncertainty over the state of the economy; Borrowing money leads borrowers to debt (money that is owed to a di erent entity, usually banks). Bene ts of debt/borrowing: - To make an investment today that will hopefully pay o in the future (transportation, education and housing); - To avoid liquidating assets to make payments (provide a social safety net, ght wars); - Leads to consumption smoothing during your lifetime (provides a stable standard live on a long term). - Leads to tax smoothing (it helps governments overcome gaps in taxes and revenues- without it, states would have to raise taxes, cut spending and sell assets to raise revenue); Harms of debt/borrowing: - Fluctuations in taxation increases market uncertainty; - Spending cuts can increase unemployment and reduce growth; - Once assets are gone, they are not easily replaced; DISCOUNT RATES Discount rates (ρ): measure of a person’s impatience (value of an additional unit now relative to an additional unit at a future period). Some people and governments are concerned about the future than others; | |—> This is explained by rational and irrational reasons; 25 fi ff fi ff fl ff  EFPS João Bazelga Individual borrows at the point where: discount rate=interest rate —> 1+R = 1+ρ (MRT=MRS); Experimental and neurological evidence nds that people tend to exhibit hyperbolic or exponential discounting for their own income. There is considerable variation across individuals in how much we discount SUPPLY OF CREDIT Interest rates are determined by supply and demand; While borrowers determine the demand for borrowing, the supply of money is driven by a few factors such as: - Monetary supply; - Willingness of banks to lend; - Capital ow cycle; - When more capital is available, lender will often seek riskier and riskier borrowers (or projects); When setting an interest rate, con icts between borrowers and lenders emerge (while the borrowers have an interest to set a lower interest rate, lenders have for a higher one); Principal agent problem: Borrowing is another incomplete contract; Asymmetric information (borrowers know the risks of projects fund uses better than lenders); Under most circumstance lenders wouldn’t lend; | | |—>To resolve the con ict of interest between the principal (lender) and the agent (borrower) its necessary to ha e secured credit, which includes: - Equity (the lender may require the borrower to put some of her wealth into the project); - Collateral (the borrower has to set aside property that will be transferred to the lender if the loan in not repaid) | However | Those with less wealth nd it more di cult to provide equity or collateral; | Credit rationing = when those with less wealth borrow on unfavourable terms compared with those with more wealth (credit-constrained) or are refused loans entirely (credit-excluded); | |—>There are still cases of unsecured credit: - Credit still exists without collateral or equity (credit cards); - For countries to borrow, there is not credible way to provide collateral; - Once you or a country spend borrowed funds, it is hard for debtors to recoup their investment; - The principal agent problem is a bit harder to solve under these conditions; 26 fl fl fi fl ffi fi  EFPS João Bazelga Time inconstancy problem: At time (t) borrow wants to signal to the lender that it will repay loans at time (t+1,2,3,4,..) However, the lender knows that the borrowers preferences will change once the loan is disbursed; | | Default/Credit risk: the risk a borrower will miss a payment or not repay a loan; | |—> Creditors can use the legal system to recoup defaulted funds (this is di cult to do internationally); FINANCIAL INTERMEDIARIES Banks; - Attract deposits by paying interest; - Make loans by charging interest; - Help overcome the collective action problem by evaluating the credit risk of potential borrowers; - Do not own the assets they invest in; Stock market; - Represent ownership in a rm; - Buyers are entitled to a “share” of the rms pro ts; - These pro ts are given out in dividends or reinvested in the company to increase future pro ts; - This trading doesn’t increase nancial resources; - More risky then banks; Bond market, - Traded on markets (but the market is much bigger and risky then the stock market); - Bonds (IOUs - I owe you) are traded in this market; - Buyers get a promise that you’ll get a return (interest) on your funds in the future; - Investors lend to creditors directly; - Governments turn to this to overcome gaps in spending and taxes; Money FUNCTIONS OF MONEY Medium of exchange: money, by being a common good generally accepted as a common mean of exchange, evolved as a mean to resolve the “double coincidence of wants problem”; Store of value: allows individuals to convert perishable goods into more durable goods, allowing us to store value between transactions and saving for the future; 27 fi fi fi fi fi fi ffi  EFPS João Bazelga Unit of account: money provides a standard relationship between various goods in the economy, which simpli es account and transactions); Essentially, money is a public good because its non-excludable (anyone can use a currency) and non-rival (the use of it by someone doesn’t decrease the amount of it that others could use it); THE VALUES OF MONEY Across time, money has taken a lot of forms like cows, beans, paper currency, digital money and online coins. This makes us distinguish di erent types of values that money can have: Intrinsic value (market value of the currency’s constituent material when used for non-monetary purposes - the value of gold in gold coins); Exchange value (market value of the currency value when used as currency in trade - using gold coin to buy jewellery); Extrinsic/Nominal value (o cial stated value - 1 dollar); MONETARY EXCHANGE Monetary systems: groups along a continuum according to the gap between the intrinsic and the exchange values of the currency; | |—> Commodity money (value as a good additional to its value as a money - gold, shells, jewerly) | Historically, it has been leaning more to… | |—> Fiat money (completely based on your faith, usually by a government - dollar bill) Seigniorage = nominal value of money - cost of production The seignorage of money currently is really high, which gives revenues to governments and leads to fewer market constraints. Money is more and more dependent of faith and expectations that governments won’t devalue the currency, that others will continue valuing their currency and that the institutions that emit money won’t abuse their power concerning it. INFLATION In ation: an increase in the general price level; Zero in ation: A constant price level from year to year; De ation: A decrease in the general price level; Disin ation: A decrease in the rate of in ation; Hyperin ation: A period of extremely high in ation; 28 fl fl fl fl fl fi ffi fl ff fl  EFPS João Bazelga In ation is measured by the Percent Change in the Consumer Price Index (CPI), measured in a basket of goods, over a period of time. Whats wrong with in ation? In ation reduces the real value of debt (good for borrowers, bad for creditors); For people on xed nominal income (like pensioners), higher in ation means lower real value of income; High rate of in ation makes the economy work less well (this volatile status makes it harder to distinguish between changes in relative prices and in ation); This slows growth in the long run (since fewer investments are made due to the volatile status of the economy) Raises uncertainty among rms and unions; Raises the natural rate of unemployment in the long term; | |—> If people continue to believe that prices will continue to rise, they will keep consuming more now, making the problem worse; Whats wrong with de ation? When prices are falling, households will postpone consumption because they expect goods will be cheaper in the future; Increases the real debt burden, which may lead households to cut consumption to return to their target wealth; Sellers are a ected by this which can cause a recession/depression; In ation comes from… | |—> Money Supply (long run of sustained in ation results from government policies to print more money - the greater the supply of money, the cheaper the price is); | |—> Demand (excess of aggregate demand leads to a money or credit boom); Demand and Cost push | result in short term changes in prices (the |—> Cost Push (rising import costs or costs of labour due to a falling market usually adjusts exchange rate); quickly); 29 fl fl fl ff fl fi fl fl fi fl fl fl  EFPS João Bazelga Central banks: Usually mandated to target price stability | |—> by changing interest rates indirectly trough increasing/decreasing the money supply; Sets an in ation target (that gives banks room to not accidentally create de ation); Central bank’s policy rate a ects the level of spending in the economy, because households and rms borrow to spend: - Higher interest rate —> Lower spending today; - Lower interest rate —> More spending today; Because politicians have a strong incentive to manipulate the economy, monetary policy is usually controlled by individuals who are distanced from electoral incentives; The Phillips Curve: if you want to have lower unemployment, this necessitates an high on in ation; | newer macroeconomic theories disagree | |—> they assume that there is only short term trade-o s between this two variables; Governments, when they have control over the monetary policy (depends on their exchange rate regime), can fool workers with a unexpected reduction/increase of the interest rate; | |—> Reduction of interest rate —> Unexpected increase in in ation —> Lower REAL wage —> Decreased unemployment (below natural rate); | |—> Increase of interest rate —> Unexpected decrease in in ation —> Increased REAL wages —> Increased unemployment; Governments can also fool their population by arti cially reducing unemployment; | | Increased money supply —> In ation growth (A—>B) —> Short term lowering of real wages —> Workers demand more income —> Employers have to pay higher wages —> Cost of labor increases —> Demand decreases —> Unemployment returns to its natural level (E); 30 fl fl ff fl fl fi fi fl ff fl EFPS João Bazelga Because markets readjust, governments must continually use monetary policy to keep unemployment below the natural rate by continually increasing the rate of in ation (slows the economy down on the long run); Market failures WHAT IS A MARKET FAILURE? Market Failure: when markets allocate resources in a Pareto ine cient way (e.g.: asymmetric information, externalities, monopoly); EXTERNALITIES Externalities: cost/bene t to society not borne by the producer or consumer (once this is taken into account we have the Social Cost Curve); Positive externalities Negative externalities (this costs bring the supply curve down) (this costs bring the supply curve up) Economic decisions have societal costs (costs that are not transmitted through a price signal) that can be considered as Deadweight loss (units that are not socially e cient); Example: Steal factory pollutes a local river that some use to sh in; | How can we resolve this? | | |—> Property Rights - Give property rights to the shermen (for them to seek for reparations on the river which the factory would pay) or to the factory (for them to look after the cleanliness on the river) | Coase theorem: the market will internalise externalities if the appropriate property rights are established; | Limitations of the Case Theorem: 31 fi fi fi ffi ffi fl  EFPS João Bazelga Assignment problem (it is often di cult to tell who has the property rights); Enforcement power (weak state capacity or uncertain legal basis); Holdout problem (property right held by parties leads di erent owners to try to hold out to get a better deal for themselves); Free rider problem (some actors will try to avoid paying their fair share); It’s hard to assign property rights to some goods (water in rivers for example); It’s hard to enforce solutions; It’s hard to negotiate/bargain since there are so many parties involved (in come cases); | | Given vague property rights and high transaction costs, we often turn to the government to solve problems | | |—> Pigouvian Tax: tax on a good with external costs (usually to compensate for the di erence between private gain and societal costs) - gas tax, cigarette tax; | Limitations od Pigouvian Taxes: Often hard to calculate the social cost; Easier for rms to over come collective action problems in lobbying for government policy; | | |—> State’s regulations: legislate and limit the quantity of a good produced; | Limitations of state’s regulations: Di culty collecting information and measuring social costs; Costly to enforce this regulations (especially in international markets); Unintended consequences (might push people in to more harmful substitutes); Subject to imperfect government ( rms have an advantage in lobbying) ASYMMETRIC INFORMATION Asymmetric information: economic transaction and societal bene ts often fail to take place because of problems actors have because of di erent levels of information they each possess (and they know it); | |—> Hidden Action (leads to moral hazard - employers can’t observe work e ort of employees and creditors can’t observe actions of borrowers); | |—> Hidden Attributes (leads too adverse selection - the quality of a used car is only known to one party) Those that would sell are driven out of the market because others won’t disclose the true value of their asserts. So the market cannot produce an e cient equilibrium. 32 ffi fi ff ffi fi ffi ff ff fi ff EFPS João Bazelga Solutions to Asymmetric information: Market solutions can be found in incentives to gather information; Firms can counter buyer apprehension; Insurance companies high actuaries to estimate your health care costs based on location behaviour demographics; Governments also play a role (have the ability to mandate, sanction and punishment); Example: When you ask to get your car repaid, the xer has an incentive to exploit the client, knowing the fact that this client doesn’t have the same information that he does (the client doesn’t understand nothing about cars); | | This creates an incentive to exploit the other party, which is named… | |—> Moral Hazard: people with insurance may take greater risks than they would do without it because they know they are protected, so the insurer may get more claims than it bargained fo (if they do take place, asymmetric information generates moral hazard because one part cannot easily monitor the other - knowing this ahead of time, voluntary transaction might be avoided); | | Solutions for Moral Hazard: Balancing information; Reducing incentives for exploitation; Sharing information between consumers (online reviews); Separate diagnosis and repair; Signaling: producers signal what type they are (honest or dishonest); | |—> they could just tell you they are honest but is still hard to believe them; Governments & Markets SOCIETAL BENEFITS OF MARKETS Market generated prices send signals (about the scarcity of goods and services) and provide incentives (they deliver information that incentives behaviour and coordinate the actions of strangers); | |—> This arranges production and behaviour (of producers and consumers); “The pricing system is a scienti c mystery, as deep, fundamental, and inspiring as that of the expanding universe or the forces that bind matter.” – Vernon Smith (Nobel Prize Winner) 33 fi fi EFPS João Bazelga Example: Oil price goes up —> Prices tell them what is valuable and incentives our producers to act because they are self-interested —> Goods get to where they are valued highly and actors are incentivised to produce more —> Prices come down What if we didn’t have markets? It would be very di cult for centralised governments to allocate goods and services (to identify scarcity/surplus and give the right mix to respond to it); It would be hard for governments to produce more substitutes and nd the right amount to produce; It’s incredibly di cult to gather information on all the vents that determine supply and demand; This will probably lead to shortages and unnecessary waste; Example: How can we bring down rental prices in Den Haag? Initial market price If the government puts a price If the government gives subsidies for (Without government intervention) ceiling, then demand will decrease people to rent houses, the demand will which decreases the quality of the increase, in the long run, since there are incentives for people to construct houses but, in the short run, prices will rise; LIMITATIONS OF MARKETS Repugnant markets (creating a market for certain goods/services would violate ethical/social norms); Market mechanisms may crowd out norms of social preferences; Merit goods (goods that should be available to everyone, independently of their ability to pay - education, vaccines, emergency care); Public goods (that su er from the collective action problem - roads, ports, national defense): GOVERNMENTS SOLUTIONS FOR MARKET FAILURES Provided the right political institutions and incentives, governments can work to solve market failures to maximize social welfare; They can give incentives (by altering the costs/bene ts of activities trough taxes, subsidies, etc) Put out regulations; 34 ffi ffi ff fi fi  EFPS João Bazelga Persuasion or information (altering available information or expectations about what others will do, promote coordination) Public provision (includes merit goods and transfers); Alleviating or inducing (BREXIT) uncertainty; | | However | |—> A government strong enough to enact/enforce regulations, taxes and property rights is strong | enough to also do great harm; | |—> These decisions always have winners and losers; | |—> Administrative feasibility (the government might not have the capacity to successfully carry it | out); | |—> Political feasibility (the voters/elites can impact negatively governments goals); | |—> Economists often neglect the feasibility as they are often concerned with optimal policy and | e ciency; | |—> The uncertainty that governments put out often leads rms to hold back on investment which | slows economic growth; | |—> Allows privileged actors to produce political rents; Political rents (An economic gain, due to political interference, greater than what would arise under natural market conditions or gain relative to what an actor would receive if it were not for their political position - Property owners, that prefer the value of their properties to remain high, lobby against the construction of high occupancy buildings and transportation to their less dense areas). | | Some argue that this, by leading to the lack of competition, is the real cause of inequality Governments and Markets have always existed together and are impossible to separate. | |—> Democracies are more likely to adopt pro-market reforms. | However | | China has had a very high economic growth since it adopted market reforms, while not adopting democratic reforms (however this might be because it was a very poor economy); 35 ffi fi  EFPS João Bazelga The Roving and Stationary Bandit Analogy: imagine a world in which those who have the most coercive capacity can use the threat of violence for economic gain and then consider the incentives of two di erent types of warlords: one that moves from town to town (doesn’t have incentive to leave anything behind so he takes 100%) and one that stays put (he doesn’t take everything because no one would have any incentive to produce if he did); | |—> Policy makers decisions depends how long they think they can stick around; Globalization ECONOMIC GLOBALIZATION Economic globalization: a process by which the economies of the world become more integrated by the freer ow across national boundaries of goods, services, investments, nances, and labour; | |—> First era of globalization (before 1870 - 1914): trade costs fell dramatically; |—> Second era of globalization (end of WW2 - now): trade costs fell and migration ows | boomed, especially after the Bretton Woods conference; | | International trade | |—> Generates aggregate economic gains (even though it creates winners and losers); |—> Gives a solution to self-su ciency that has been proven to lead to poverty; |—> Avoids waste and loss in production; | A country can export what is good (most e cient) at producing and import what is bad (least e cient) at producing; | This doesn’t have to do just with the division of labour but also about what you choose to produce (after evaluating the opportunity costs). COMPARATIVE ADVANTAGE Absolute advantage: uses fewer inputs to produce a good; Comparative advantage: greatest absolute advantage, or least productivity disadvantage (comparatively better) - based on opportunity costs; Trade can be mutually bene cial when both parties specialise in the good in which they have a comparative (not absolute) advantage. Example: Greta lives on wheat island and has absolute advantage in producing apples and wheat, while Carlos lives on apple island and has comparative advantage in producing apples; 36 ffi fi fl ff fi ffi ffi fl  EFPS João Bazelga A. Self-su ciency (absence of trade): the feasible consumption frontier = feasible production frontier; B. With trade: Carlos specialises in producing apples and Greta specialises in producing wheat | |—> Both of their consumption frontiers are above their production frontiers, so they are both better o ; | | Even though Greta doesn’t produce above her PPF she ends up on consuming more then she would with no trade; TRADE PROTECTION Focusing on comparative advantages, like capitalism economic model does, each side ends up being better o ; | |—> But trade protection is the rule and trade liberalisation is the exception; Types of trade protection: - Tari s (a tax on imported good); - Quotas (a limit on the amount of goods that can be imported by a nation or globally); - Non-Tari Barriers (industry subsidies, industry insurance programs, laws to protect regional products); With trade, prices of goods get lower; Tari s increase prices and which leads do deadweight loss; 37 ff ff ffi ff ff ff  EFPS João Bazelga Example: In the late 2000s US tire workers lost jobs as consumers bought cheaper tires from China and in an attempt to save jobs, the Obama Administration imposed a tax on Chinese tires. After, Obama claimed a thousand Americans are working today because we stopped a surge in Chinese tires. | However | |—> Tire prices rose by 30% which meant that consumers had less money to spend on other goods which led to other lost jobs (2,500 estimated) This means that, trade protection can also impact other sectors of economy. EXPLAINING PATTERNS OF TRADE The Gravity Model of Trade: bilateral trade is a function of distance, population and the size of two countries economies; Hecksher-Ohlin Trade Theory: scarcity and abundance of factors of production - land, skilled labour, unskilled