Positive Economics

• (positive economics)- U.S. GDP approx $14 trillion, unemployment =9.5%, little or no disagreement, Test Question: Ernie the economist told me that “the Unemployment rate is currently 9.7%. Ernie is making a an (Positive) economic statement

Sunk Costs

• “I paid for it”, time and money, shouldn’t factor into future decisions. You go to a movie and you don’t like it but you stay because that money is gone

Normative Economics

• (Normative economics)- “health care plan will…”, we should or should not

·         the value or satisfaction that people derive from the goods and services they consume and the activities they pursue

Nominal variables

Real variables

• (Real variables)- inflation adjusted, Test Question: If I want to know about the purchasing power of my income relative to ten years ago I should study how my real wage has changed as opposed to studying what my nominal wage has change (True)  

Markets

Opportunity Cost

• what you give up to do something buy something or make something

·         is the condition of having to choose among alternatives, 1. What should be produces, 2. How should goods and services be produced, 3. For whom should goods and services be produced

Ceteris Paribus

·         All other things equal (an increase in the price of peanut butter will decrease the demand for jelly

• Test Question: Ceteris Paribus means that we should (Hold all relevant factors constant when looking at how one economic variable affects another)

• (equity)-distribution who ends up with it

What does it mean to think at the margin?

(All you can eat buffet?)

• is a decision to do a little more or a little less of something
• This does not figure into future decisions, $8 Buffet is a sunk cost, cost of benefits marginal cost vs. benefits           
  

Understand the “fallacy of false cause”

• the incorrect assumption that one event causes another because the two events tend to occur together
• Test Question: The incorrect presumption that because two events tend to occur together, one must cause the other is that (fallacy of false cause)

types of jobs economists may perform

government agencies, business firms, colleagues and universities

What is the current unemployment rate in the U.S.? 

Is that high or low relative to the last twenty years?

• Overall (9.8% from October 2010)

• That is high

Productive Efficiency

• (productive)-shows the combination of output a society can effectively produce given the factors of production

Allocative Efficiency

• (allocative)-all the points are on the line
• Test Question: Any point on the PPF represents an output combination that achieves allocative efficiency but not necessarily productive efficiency (False)

• (Only one point achieves Allocative efficiency, many points may achieve productive efficiency)

  PPF and Opportunity Cost (As slope of PPF and in general)

Why does the PPF shift?

  When does it NOT shift?

• is shifts because of a natural disaster or something else that is economy changing, Test Question: If you are in charge of Econland and you want to create the best situation for the economy to grow in the long term what situations would you like to see occur, You must choose the best option, think about the importance of the PPF (Have a new discovery of fertile land in Econland)
• it doesn’t shift because there were no disasters

Understanding what the factors of production are and why they are important

• they are land, labor, capital and entrepreneurial ability

What are externalities?   

• Effects that happen outside of the market pollution

Goals of Macroeconomics (Efficiency, Equity, Stability and Growth)

• (Efficiency)-that we produce on the frontier
• (Equity)-fairness
• (Stability)-price levels that are predictable, market economies do well with it, no inflation
• (Growth)-free markets do better than command because we save more
  • Test Question: Economic evidence suggests that over the (Free market) economies tend to experience the most economic growth and that (Free market) economies tend to have greater economic stability (well defined property rights, stable currencies etc.)
  • Test Question: Which of the following will not lead to economic growth? (restrictions on international trade)

Types of Economic Systems:

• (Market)- United States is not a pure economy, what should you produce: interaction of supply and demand: how to produce: low cost most efficient, how to divide well: people keep what they earn
• Command Economy (centrally planned or socialist)- what to produce: what the economy wants to, how to produce: full employment, how to divide well: equally, everyone gets something,
• Test Question: In a command economy the question of “what to produce” is answered by (a central planner) and in a market economy it is answered by (the interaction of supply and demand)

Laissez Faire

• French for “hands off” or “to leave alone” This term is often used to describe a free market attitude about government. While most economics believe that the government should enforce property rights and provide a national defense the idea behind a free market belief in economics is that government intervention in markets should be as limited as possible.

• It is in between the market economy and command economy

Three Fundamental Questions of Macroeconomics

• what to produce, how to produce and how to divide well?

Who was Adam Smith?

What did he contribute to the history of economic thought?

• how people’s selfishness can work in society’s best interests when he talked about the invisible hand in the Wealth of Nations (1776)
• When people wish to buy a good it’s price goes up; that encourages firms to produce a good

Comparative Advantage

• (Comparative Advantage)- we should specialize in producing the good we producing the good we produce at the lower opportunity cost. Test Question: Given the information in the graph which nation has the comparative advantage in producing automobiles? Which nation has the comparative advantage in producing wheat? (South Korea, United States)

Absolute Advantage

• (Absolute Advantage)- the ability to produce a good more efficiently at a lower cost. Test Question: Given the information is the graph which nation has the Absolute advantage in producing automobiles? Which nation has the Absolute advantage in producing wheat (United States, United States)

 What are the potential gains from trade? 

Does anyone lose because of trade?

The people can work together

• They might if the person doesn’t want to trade

Supply and Demand

• makes up markets, determines prices and amounts of goods that are sold

Law of Demand

• shows that as the price of a good falls the (quantity demanded) of the amount of that good consumers are willing and able to buy and increase
• Test Question: When the price of a good falls the demand for that good will be expected to increase all other things equal (True)
• Test Question: If the demand for housing increase and the supply of housing decreases (price will increase, but the quantity change is indeterminate)

Law of Supply

• taste and preferences, price substitutes, complements, income (increase in demand function), expected future price by consumers and population

Supply Determinants

• Input costs decrease, supply increases, improved technology supply increases, number of producers, opportunity cost of producing the good falls supply increases

Shifts in Supply/Demand, What happens to price and quantity?

• supply- change is the supply curve a change increases the quantity of a good or service supplied at each price shifts the supply curve to the right, decrease in supply (input price increase, lost technology and fewer producers), supply decreases price increases and quantity decreases, supply increases price decreases and quantity increases. Test Question: As a result of consumers expecting the price of computers to fall next month we expect the price today of computers to (Decrease) and the amount sold today to (decrease)
• Demand- a movement along the demand curve that results from a change in price increase in demand is caused by increase price of a substitute, increase in income, decrease of a price complement, Demand increases price increase and quantity increase, demand decreases price decreases and quantity decreases Test Question: As a result of the government taxing the production of a good we except the price of that good to (Increase) and the amount sold to (decrease)

Price Ceilings

• Price Ceilings- maximum legally allowed price by the government this can create a shortage. An example “free highways”, donated organs, rent controlled apartments 
• Test Question: A price ceiling enforced by the government would create a shortage in a market when the ceiling is placed below the equilibrium price (True)
• Test Question: A binding price ceiling in the market for K-State basketball tickets will create a situation where are many more tickets for sale than people wish to purchase (False)

• (price floor- minimum legally allowed price by the government this can create a situation where there is a surplus, if the floor is set to high. An example is minimum wage

Understand the issues we study in macroeconomics

• Macroeconomics- the study of national and international economic issues. We study supply and demand of money, influences interest rates, monetary policy (U.S. Central Bank FED), GDP or GNP size of the U.S. Economy Test Question: Which of the following is not a topic of study in macroeconomics (The market for apples and why the price of apples has gone up or down)

What makes up the supply and demand in markets for goods and services, what about the factors of production

• Markets for good and services, consumers-demand, firms-supply, factors of production (land, labor, capital) consumers-supply and firm-demand

What is GDP (including size of GDP)?

• Gross domestic product represents all new, final, legally produced output produced in the USA in a calendar year 14.6 trillion

What is GNP?

• GNP goods and services and GDP doesn’t mention goods and services

Expenditure approach to GDP/Importance of each component

• Consumption (71%) plus Investment (11%) plus Government (21%) plus Net Exports (negative 3 %) equals Y (GDP Output Income)

• Consumption
  • 71%, spending on durable goods lasts more than 3 year (car, furniture, TV), no durable goods everyday purchases (food, gas, several purchases), it’s the biggest part and rapidly growing services

• Investment
  • 11% spending by firm on capital goods (plant and equipment, machinery used to produce the output, consumer spending on homes)

• Government
  • 21% spending both federal and state local which is larger and rapidly growing, spending on good and services, not transfer payment

What makes up net exports?

• Net Exports
  • -3% value of all exports minus the value of all imports

Durable vs. non-durable goods.

• durable goods (lasts more than 3 years, car, furniture and TV’s) non-durable goods (everyday purchases, food, gas and several purchases)

What is not included in GDP?

• no illegal goods/ underground economy, alcohol, cigarettes, gas-electric, demand function, no intermediate goods (tires on a car) no transfer payments (welfare and social security)

Why is National income < GDP?

• Payments, factor of production, wage profits, labor 57% (wages) + land 1% (rent) + capital 60% (interest) + entrepreneurial activity 15% (profits)

What makes up national income/importance of each component?

• Employee Compensation (wages, salaries and benefits) Profits (households) Rental income (rental income, rental housing or payments of the natural resources) net interest (business both receive and pay interest) depreciation (capital that wears out, machinery and buildings) Indirect taxes (indirect businesses taxes)

GDP Deflator-Why is it the “best” measure of inflation but what measure of inflation is used most often?

• (GDP deflator)-includes everything
• (consumer price index)-doesn’t include everything

• expansion,, then contraction, then expansion again and at the growth of real GDP, expansion- in which real GDP is rising, recession- is when GDP is falling, peak- the point of business cycle at which an expansion ends and recession begins, trough- the point of the business cycle at which recession ends an expansion begins

Recession

• a period of six months or more where real output produced in the U.S. is falling

How does this recession compare to the recessions of 2001, 1990 and 1982?

• In 2001 it was 1.1%, in 1990 it was 1.9% and in 1982 it was 4.5%

We need to understand why hyperinflation might occur and why it is a real concern

• extremely high inflation occurs when prices double or increase by more on an annual base, money loses value and people may lose faith in the monetary system, there would be a need for batter and lost economy activity

Ways of measuring inflation?

• Consumer Price Index

• CPI may overestimate inflation, quality bias- assume no technology changes and substitution bias- changes in tastes and preferences

How do CPI and PPI relate?

• an increase in the PPI (higher cost) is a good indicator of increases in the CPI in about 6 months, Test Question: We know that when the (Producer Price Index) increase in about three to 6 months we expect the (Consumer Price Index) to increase

Understand the GDP Deflator.

• nominal divided by real GDP, this has an advantage of including all types of goods

What is deflation?

• decline in the overall price level

How can it be bad?

• the who lose are the people on a fixed income and lender with a fixed rate of return

What is the real interest rate?

• Real GDP is the value of output produced today at a constant price level. This lets us know how output produced today compares to the past % change Price Output = % change price plus % change output

Be able to convert nominal wages into “real” or inflation adjusted wages.  Why would we want to do that?

• real wage = nominal wage divided by the price level

What is unemployment?

• people who aren’t working anymore or they can’t find jobs since people are losing their jobs           

Why might the unemployment rate underestimate the true problem with unemployment?

• because of the discouraged workers, if someone is a discouraged worker they are not in the numerator or denominator

Who did Stephen Colbert call the “Hopeless Heroes”?  Why would he say that?

• He was talking about the discouraged workers           

What are the current unemployment and inflation rates?

• 9.6 % unemployment, Inflation rate is about 1%

What was the SPI this year?

• Student Price Index 5% increase

• Structural Unemployment- companies downsize because improve technology or a cheaper labor source overseas has made someone’s job not necessary, Test Question: Which type of unemployment is the most likely to be caused by a technological innovation making someone’s skill not sent as important than it used to be. This is what might happen to an accountant if all the jobs they used to do become automated on a Blackberry, This must be a real type of unemployment
• Frictional/ Search unemployment- seeking a new or better job fit (take this job and shove it)
• Cyclical unemployment- focus of the FED, due to an economic slow down

What is the “natural rate” of unemployment?

• It is currently at 4.8% approximately

Why might the inflation rate overestimate the problem of inflation?

• bias with CPI overestimate the inflation rate

Understand Okun’s Law and why a 1% increase in the unemployment rate correlates with a 2% decline in GDP.

• It is called a GDP or recessionary gap

Why are some nations wealthy while others are not? 

• they know how to better handle their money

What is the relationship between economic freedom and economic growth?  How does this relate to North and South Korea?

• north and south Korea more economic growth than command economies

Understand the short run aggregate supply and aggregate demand framework with an upward sloping AS and downward sloping AD curve.

• short run increase AD increase output decrease unemployment, increase price, increase in inflation, if short run in AS increases, land increases, labor increases, capital increase and technology increases

Why is the AD curve downward sloping?

• wealth effects, interest effect and foreign good effects along with changes in trade patterns based on the price level, Test Question: The aggregate demand curve slopes downward (because as the price level falls, the net export component of aggregate demand increase)  

 What causes the AD curve to shift and how does that affect the price level, the level of output and the unemployment rate other things equal.

• AD increase at any time when a component of C, I, G, NX increases, consumer confidence increases, business confidence increases, health of trading increases, interest rates decreases, health of trading payments (NX increases), government increases and technology decreases

What causes the AS curve to shift and how does that affect the price level, the level of output and the unemployment rate other things equal

 What does cause the economy to grow according to this model?  Why do shifts in AD “not matter” according to this model. 

• looks at what is true in the long run, imports are variable, wages and prices are perfectly feasible

• AS it’s vertical and AD is diagonal

Why is the AS curve vertical and what does that mean in this model?’

• Increase in classical model, this level of output is on the PPF

• Increasing the aggregate demand we can fix the economy, Keynesian came about in the 1930’s in the Great Depression, suggests that under certain circumstances an increases in AG demand can increase real GDP in the short run by a large amount, if wages and prices are fixed then full multiplier will need, Keynesian model assumes- fixed prices plus that spending equals output C plus I plus G plus NX equals Y

Who was Keynes? 

What was his most famous work?

What was his most famous saying?

• John Maynard Keynes, developed a new framework in Britain of macroeconomics analysis one that suggested that for Ricardo were “temporary effects” cold persist for a long time at a terrible cost

• a book called The General Theory of Employment Interest and Money
• In the long run “we are all dead”
• dismissed the notion that the economy would achieve full employment in the long run as irrelevant

What does this (Keynesian) AS/AD graph look like? 

What does that mean?

• It’s in the shape of a cross
• AD equals Consumption plus Investment plus Government spending plus net exports equals output

What caused the Great Depression according to Keynes?

• asserts the changes in AD can create gaps between the actual and potential levels of output, and that such gaps can be prolonged Test Question- According to Keynes the Great Depression was primarily caused by a lack of aggregate demand

What did Keynes assume about wages and prices?

• if wages and prices are fixed then the full multiplier will had, can create gaps between the actual and potential levels of output and that such gaps can be prolonged

Be able to differentiate between the classical model and the Keynesian model?  What happens when aggregate demand increases according to each model?

• Keynesian economies- increasing the aggregate demand we can fix the economy, Classical Model- aggregate demand doesn’t matter, only AG supply matters

Humphrey Hawkins Act

• FED has a dual mandate of low inflation and low unemployment, the FED recently have been fighting unemployment by increasing the money supply Test Question: The Humphrey Hawkins Act dictates the FED should focus on preventing (Inflation and Unemployment equally)

• which declared that the federal government should use all practical means to promote maximum employment, production and purchasing power 

What are the three functions of money (understand the importance of each function)?

• Medium of exchange- prevents the need for batter and avoids double coincidence of wants, need money to facilitate exchanges with the barter, Test Question: What function on money is best expressed by the fact that money prevents a double coincidence of wants. We believe that as long as there is a willing buyer (who is able to pay for a good) and a willing seller that a mutually beneficial transaction will take place (Medium of Exchange)
• Unit of Account- prices must convey easily understood information we all know what money is worth, $20 buys a consistent number of goods and services we can easily express value in term of prices Test Question: When people realize that they can express the value of goods in services in prices that other consumers easily understand and can relate to money is functioning best as a (Unit of Account)
• Store of Value- money should be able to buy something today and in the future, not subject to high inflation and it will buy a similar bundle of goods in the future

What determines the demand for money?

• MD increases when intrinsic value decreases speculates demand for money at lower interest rates the opportunity cost of having money as opposed to say a bond falls, as income rises, people demand for “walking around” and “rainy day” can be called precautionary demand, money increases- transactions demand for money            

What is liquidity?

• ease of purchasing things with money, the ease with which an asset can be converted into currency

Hyperinflation (how it affects the functions of money)        

• This is when a central bank prints too much money and hyperinflation occurs

Where has this occurred historically and today?

• Zimbabwe, Yugoslavia, Germany after WWI

Commodity Money

• using an actual product with intrinsic value as money, Example: cigarettes or mackerel or gold or sliver coins Test Question: Cigarettes are a good form of commodity money because there are many cigarettes you can trade within each package of cigarettes, Test Question: What is a form of money that we have not talked about in class (Elvis records)

Fiat Money

• money by decree of that U.S. Government hot by an actual product

Intrinsic Value           

• is printed on each bill “this note is legal tender for all debts, public and private.”

M1 (what is it and how large is it)

• most liquid from of money, currency demand deposits (checking account) and traveler’s checks, debit cards- 1.6 trillion

• M1 savings accounts and money market accounts and Certificate of Deposite(CD)- 8.2 trillion

Are credit cards a part of M1 or M2?

• NO (all of M1 is included in M2)

Reserve Requirement Ratio

• 1/ Reserve Requirement, what percentage of deposits must banks hold on to

HOW IS MONEY CREATED/MONEY MULTIPLER

• shows the potential increase or decrease in the money supply, when the FED buys or sells bonds

What can weaken the money multiplier?

• people hold on to currency outside of banks, banks don’t loan excess reserves

What are assets and liabilities for a commercial bank?

• Assets what the bank owns loans, cash on hand bonds, cash deposited by the FED
• liabilities and owners equity, what the bank owes, demand deposit

THE FED

• formed in 1913 to be the central bank of U.S., and to determine monetary policies for the country and protect the currency, FED governors are appointed by the president and the FED must be politically independent, have to be approved by congress, goal to look out for the long term concerns of the U.S. Economy, the FED may have to be “the bad guy” and fight inflation, FED has a dual mandate of low inflation ad low unemployment, FED keep interest rates to low for too long, housing market got out of control not enough regulate banks, the more politically independent the central bank of a nation is he lower inflation rates are jobs of the FED

Makeup of the FOMC

• meets 8 times a year to discuss changes to in monetary policies typically the discount and fed funds rate, the central banks of the FED help perform the duties of the fed, located in the New York City

Makeup of the Board of Governors

• the president always serves as a voting FOMC member, they are appointed every 2 years, 7 governors appointed by the president for 14 year terms

• Atlanta, Boston, Dallas, Cleveland, Philly, Chicago, San Fran, Richmond VA, Minneapolis MN, St Louis, Kansas City Missouri ( 10^th Bank) New York, there are 12 central banks, all on east coast because we trade more, formed in 1913

• Banker’s Banks, the FED loans money at the discount rate, commercial one bank lends to another at the FEDS fund rate, slightly lower than the discount rate Federal funds rage= 0% to 0.25%, Momentary policy, expansionary decrease Interest rates which increase investment spending which increasing aggregate demand, open market operations daily, FED buys bonds increase MS decrease IR, Lower discount rate/FED funds rate, FOMC meetings 8 times a year, lower reserve rate increase money supply, regulate banks

• designed to fight inflation, these are primary designed to reduce investment spending by increasing the interest rate, interest rates will increase other things are equal when the FED reduces the money supply, 1. FED sell bonds, 2. FOMC raise discount/FED funds rate, 3 raise reserve requirement

What is the relationship between the money supply and aggregate demand? Why is this the case?

• increase money supply will increase AD which increases money supply which decreases interest rates which decreases AD government spending

• tighten money supply is contrationary policy and loosening is trying to put money into the monetary system

What makes up the federal budget (both spending and revenue sides)?

• (revenue)-43% Personal Income Taxes, 14% Corporate Income Taxes, 34% Social Security and Payroll taxes, 7% other

 Is the budget balanced?  Why or why not?  What policies can be used to reduce the budget deficit?  Are those policies popular?

• The Federal budge Deficit is currently about 10% of GDP (highest since WW II) That makes it more difficult to implement expansionary fiscal policies, A budget deficit occurs when the government spends more than it collects, the national debt is the accumulation of deficits or how much the U.S. owes in total. That is currently just over 80% of GDP Test Question: The current budget deficit is about 10% of GDP which is very low relative to the average budget deficit since World War II (False)

Understand EXPANSIONARY VS. CONTRACTIONARY POLICY!

• expansionary monetary policy, Fed buy bonds-daily basis, open market operations, FED lower discount/FED funds rates, 8 or more times a year FOMC meetings, Lower reserve requirements, rarely, Contrationary- increase taxes, decrease government, reduce deficit 

Understand FISCAL VS. MONETARY POLICY!

• Fiscal Policies deal with, taxes and or government spending and come from president and congress, monetary policies deal with, money supply and interest rate, comes from central bank the FED

What are expansionary fiscal policies?

What do they do to the debt/deficit?

• are lowering taxes and increasing government spending
• expansionary fiscal policies are designed to stimulate spending, increase demand for output and fight unemployment, taxes decrease and government spending increase,
•  National Debit- total amount the U.S. owes or accumulated deficits

Is the U.S. Government running a deficit or a surplus currently?

• we are in a deficit of 10%

Has the U.S. experienced any surpluses in the past 25 years?

• yes there was a surplus in the 19560’s and a brief period between 1998-2001

What is a budget deficit?

• occurs when the government spends more than it collects, how much the U.S. owes during one year

How does the current deficit compare to historical norms?

• Highest since WWII (10%)

What will a stimulus plan be expected to do to our budget deficit?  Why is this the case?

• Stimulus plan must go through the Department of Energy. One division of the department focus on approving loan guarantees for energy saving industrial projects, in 2007 as part of another effect to stimulate the economy activity

Understand Demand pull vs. Cost push inflation.

• (cost push)-decrease in aggregate supply
• (demand pull)-decrease in aggregate supply

What polices did Kennedy try?

• Kennedy-Used Keynesian model of cutting taxes during periods of high unemployment.  This is believed to have been effective.

What polices did Reagan try?

• Reagan-(Supply Side Economics) --Decreased taxes with the idea that it would increase aggregate supply.  The immediate effect of these policies was however to increase aggregate demand but this was during a time of high budget deficits.  Whether or not these policies were effective in stimulating aggregate supply is a subject of much debate amongst economists.

What polices did Obama try?

• Obama-Major increases in government spending have been implemented along with tax rebates (stimulus checks: $787 Billion Stimulus)

What is the idea behind supply side economics?

• Laffer said we were on one spot on the curve and most economists think we are on another spot in the curve

What is the Laffer Curve?

• Art Laffer created it, lower tax rate, people would have to work more Test Question: Art Laffer and the Laffer curve suggest that the best economic policy to stimulate economic growth is (Lowering Marginal Tax rates)
• Under what type of a tax plan would this curve possibly be the most useful to use for policy formation? the tax rate

 Why are we concerned about the national debt?

What suggestions does the Bowles/Simpson plan make?

• Because is relative to its GDP is about average among developed nations
• deep cuts in domestic and military spending, a gradual 15 cents a gallon increase in the federal gasoline tax, limiting or eliminating popular tax breaks in return for lower rates, and benefit cuts and an increased retirement age for social security

What are the problems with Lags in both fiscal and monetary policy?

• lags are period of time between a policy being necessary and when it actually takes effect, problems, inside lags- policy makers, recognition log- collect and analyze data

What types of lags are the “worst”?

• (implementation lag)- policy must act- big problem for fiscal policy not a big problem for momentary policy, Outside lags- consumers and firms, response lag- bigger problem for monetary policy

Understand the “fool in the shower” story

• Milton Friedman said this, he said economist don’t know what they are doing, Test Question: What is the main idea behind Milton Friedman’s “Fool in the Shower story (The lags associated with discretionary polices are unpredictable and therefore a predictable set of fiscal and monetary policies are the best way to manage the economy)
•  Monetarist Model- policies can have a harmful effect because they can’t be controlled (lags. Timing issues) he created lags

What is stagflation?

Why does it occur?

-higher inflation and higher unemployment occurring at the same time

-between 1960’s and 1970’s to describe a sluggish economy

What does it mean for a currency to appreciate or depreciate? 

• (appreciates)-becomes more valuable or worth more foreign currency, FED decreases the relative money supply or if the relative demand for U.S., goods and therefore dollars increase
• (depreciates)-it becomes less value so we as Americans tend to buy fewer imports, dollar depreciates when supply of dollars increase or demand for dollars decrease

• it lowers the trade deficit

• (game theory)-this is a type of model economists use to make assumptions about how people, firms or even nations will behave. It is assumed that economic agents will behave in their own best interests.
• (Nash equilibrium)-occurs when neither player has any incentive to change his/her decision.  You may have heard about John Nash in the film “A Beautiful Mind”.

What was the Nash Equilibrium for the games we discussed in class?

• In this game “Prisoner’s Dilemma” you and a friend have been caught doing something wrong.  If neither of you confess you will both suffer a mild penalty.  (Let’s say you suffer a “cost of $2” but this could be two years in prison, two minutes in timeout if you are my nephew, etc.).  If you both confess you will suffer a stronger penalty (let’s say a cost of $5) but if one person confesses while the other person does not the confessor suffers no penalty while the person who does not confess suffers a cost of both parties ($10) [dominant strategy – confess)

What is moral hazard?

• exists when one party in a transaction has both the incentive and the ability to shift costs onto the other party
• Ex ante moral hazard- good decision before something happens
• Ex post moral hazard- really good decision that turned bad
  •  You ask the insurer to cover medical expenses you would have never incurred if you were not insured
  • This leads to overconsumption

• Government help pay insurance

• Tax credits for individuals and families likely making up to 400% of the federal poverty level, or $88,000 for a family of four to purchase insurance through the Exchanges
  • Tax credits to buy health coverage available to small employers with up to 25 workers and average wage of $40,000 or less