SSC 220 Closing Comments

1
SSC 220Closing Comments

• Classifying Goods and Resources
• The Stock Market
• Measuring Economic Inequality
• The Economic Theory of Government

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Classifying Goods and Resources

• What is the essential difference between
• A city police department and Brinks security
• Fish in the Atlantic Ocean and fish in a fish
  farm
• A live concert and a concert on television
• These and all goods and services can be
  classified according to whether they are
  excludable or nonexcludable and rival or nonrival.

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Classifying Goods and Resources

• Excludable
• A good is excludable if only the people who pay
  for it are able to enjoy its benefits.
• Brinkss security services, East Point Seafoods
  fish, and a Coldplay concert are examples.
• Nonexcludable
• A good is nonexcludable if everyone benefits from
  it regardless of whether they pay for it.
• The services of the LAPD, fish in the Pacific
  Ocean, and a concert on network television are
  examples.

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Classifying Goods and Resources

• Rival
• A good is rival if one persons use of it
  decreases the quantity available for someone
  else.
• A Brinkss truck cant deliver cash to two banks
  at the same time. A fish can be consumed only
  once.
• Nonrival
• A good is nonrival if one persons use of it does
  not decrease the quantity available for someone
  else.
• The services of the LAPD and a concert on network
  television are nonrival.

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Classifying Goods and Resources

• Figure 16.1 shows this four-fold classification
  of goods and services.

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Classifying Goods and Resources

• Two Problems
• Public goods create a free-rider problemthe
  absence of an incentive for people to pay for
  what they consume.
• Common resources create a problem called the
  tragedy of the commonsthe absence of incentives
  to prevent the overuse and depletion of a
  resource.

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Managing Risk in Financial Markets

• The Stock Market
• The prices of the stocks are determined by demand
  and supply.
• Demand and supply in the stock market are
  dominated by the expected future price.
• If the price of a stock today is higher than the
  expected price tomorrow, people will sell the
  stock today.
• If the price of a stock today is less than its
  expected price tomorrow, people will buy the
  stock today.

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Managing Risk in Financial Markets

• Todays price equals tomorrows expected price.
• Todays price embodies all the information that
  is available about the stock.
• A market in which the actual price embodies all
  currently available relevant information is
  called an efficient market.
• In an efficient market, it is impossible to
  forecast changes in price.

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Managing Risk in Financial Markets
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Managing Risk in Financial Markets

• So an efficient market has two features
• 1. Its price equals the expected future price and
  embodies all the available information.
• 2. No forecastable profit opportunities are
  available.
• The key thing to understand about an efficient
  market is that
• If something can be anticipated, it will be, and
  the anticipation of a future event will affect
  the current price.

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Measuring Economic Inequality

• In 2005
• The poorest 20 of households received only 3.4
  of the total income.
• The middle 20 received 14.6 of total income.
• The richest 20 received 50.4 of total income.

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Measuring Economic Inequality

• The Income Lorenz Curve
• The income Lorenz curve graphs the cumulative
  percentage of income earned against the
  cumulative percentage of households.
• Figure 18.3 shows the income Lorenz curve for the
  income shares in Figure 18.2.

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Measuring Economic Inequality

• If everyone has the same income,
• the income Lorenz curve is a 45 degree line from
  the lower left corner to the upper right corner.
  This line is called the line of equality.
• The Lorenz curve shows the cumulative
  distribution of income.

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Measuring Economic Inequality

• The Distribution of Wealth
• A households wealth is the value of all the
  things that it owns at a point in time.
• The distribution of wealth is another way of
  examining the degree of economic inequality.

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Measuring Economic Inequality

• A wealth Lorenz curve measures the distribution
  of wealth in the same way an income Lorenz curve
  measures the distribution of income.
• The distribution of wealth is even more unequally
  distributed than income.

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Measuring Economic Inequality

• Wealth Versus Income
• Wealth is a stock of assets and income is a flow
  of earnings that result from a given stock of
  wealth.
• The reason that wealth is more unequally
  distributed than income is that wealth does not
  measure the quantity of human capitalonly income
  reflects the quantity of human capital.
• Because wealth does not reflect potential for
  income from human capital, income is a more
  accurate measure of economic inequality.

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Measuring Economic Inequality

• Annual or Lifetime Income and Wealth?
• A households income and wealth change over time.
• A household headed by a young person starts out
  with moderate income and accumulates wealth for
  retirement years.
• A middle-age headed household is in its highest
  earning years and enjoys the highest level of
  wealth.
• A households headed by an older, retired person
  has lower earning and is consuming, rather than
  accumulating, its wealth.

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Measuring Economic Inequality

• Trends in Inequality
• To measure inequality as an index number, we use
  the Gini ratio, which equals the ratio of blue
  area to the red area in the two figures below.

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Measuring Economic Inequality

• With perfect equality, the Lorenz curve is the
  line of equality and the Gini ratio is zero.

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Measuring Economic Inequality

• With the most extreme inequalityone person has
  all the incomethe Lorenz curve runs along the
  axes and the Gini ratio is one.

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Measuring Economic Inequality

• The closer the Gini ratio is to one, the more
  unequal is the distribution of income. In 2005,
  the U.S. Gini ratio was 0.47.

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Measuring Economic Inequality

• Figure 18.5 shows the U.S. Gini ratio from 1970
  to 2005.
• The Gini ratio shows that the distribution of
  income in the United States has become more
  unequal.
• Despite the change in the definition in 1992, the
  trend is still visible.

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Measuring Economic Inequality

• Who Are the Rich and the Poor?
• Figure 18.6 on the next slide identifies the five
  characteristics that appear to influence the
  amount of income earned by a household.
• These characteristics are
• Education
• Type of household
• Age of householder
• Race

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Measuring Economic Inequality
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The Economic Theory of Government

• The economic theory of government explains the
  purpose of governments, the economic choices that
  governments make, and the consequences of those
  choices.
• Governments exist for two main economic reasons
• 1. To establish property rights and set the rules
  for the redistribution of income and wealth.
• 2. To provide a nonmarket mechanism for
  allocating scarce resources when the market
  economy results in inefficiencya situation
  called a market failure.

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The Economic Theory of Government

• Governments and public choices deal with five
  economic problems
• Monopoly and oligopoly regulation
• Externalities regulation
• The provision of public goods
• The use of common resources
• Income redistribution

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The Economic Theory of Government

• Externalities Regulation
• External costs and external benefits are
  consequences of an economic transaction between
  two parties that are borne or enjoyed by a third
  party.
• A chemical factory that dumps waste into a river
  that kills the fish downstream imposes an
  external cost.
• A bank that builds a beautiful office building
  creates an external benefit.
• External costs and external benefits prevent the
  market allocation of resources from being
  efficient.

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Externalities in Our Lives

• An externality is a cost or benefit that arises
  from production and falls on someone other than
  the producer, or a cost or benefit that arises
  from consumption and falls on someone other than
  the consumer.
• A negative externality imposes a cost and a
  positive externality creates a benefit.

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The Economic Theory of Government

• Provision of Public Goods
• A public good is a good that is consumed by
  everyone and from which no one can be excluded
• Examples are national defense, law and order, and
  sewage and waste disposal services.
• The market economy underproduces these goods
  because it is impossible to exclude those who
  choose not to pay from enjoying themcalled the
  free-rider problem.

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The Economic Theory of Government

• The Use of Common Resources
• Some resources are owned by no one and used by
  everyone.
• Examples are fish in the ocean and the lakes and
  rivers.
• The market economy overuses these resources
  because no one has an incentive to conserve
  themcalled the tragedy of the commons.

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The Economic Theory of Government

• Income Redistribution
• The market economy delivers an unequal
  distribution of income and wealth.
• Progressive income taxes pay for public goods and
  redistribute income.

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The Economic Theory of Government

• Public Choice and the Political Marketplace
• Public choice theory applies the economic way of
  thinking to the choices that people and
  governments make in a political marketplace.
• The actors in the political marketplace are
• Voters
• Firms
• Politicians
• Bureaucrats

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The Economic Theory of Government

• Figure 14.1 illustrates the political market
  place.
• Voters and firms are the consumers in the
  political marketplace.
• Politicians are the entrepreneurs of the
  political marketplace.
• Bureaucrats are the producers, or firms, of the
  political marketplace.

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The Economic Theory of Government

• The objective of politicians is to get elected to
  office and remain in office.
• Votes to a politician are like profits to a firm,
  so they propose policies that they expect to
  attract enough votes to get elected.
• Bureaucrats produce the public goods and services.

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The Economic Theory of Government

• Political Equilibrium
• A political equilibrium is the outcome of the
  choices of voters, firms, politicians, and
  bureaucrats.
• It is a situation in which the choices of the
  three groups are compatible and no group can
  improve its own situation by making a different
  choice.