10/9/2003 Econ

Role of government:

What are some of the benefits and what are some of the problems with allowing the market to allocate resources?

Government involvement v. markets (she draws a classic S&D curve graph & points out equilibrium.) At equilibrium, the additional cost of producing equals the additional benefit gained from producing. Marginal cost = marginal benefit, which means that no more deals can be made = "Pareto efficiency." Nothing gets made that's more costly than someone is willing to buy it for. It might seem trivial, but it would be hugely time-consuming for government to regulate value & supply decisions.

Benefits of Markets:

- They are Pareto Efficient. (nothing is produced that people don't want)

- Respond rapidly to changes (as compared to governments – Eastern Europe as brilliant example of government allocation gone wrong.)

- Profit motive tend to spur innovation

Problems with Markets:

You can group markets into two groups:

Market Failures

- Externalities (benefits don't just go to the individual making the decision, they accrue to society as a whole. eg: less use of gov't resources (Medicaid, welfare), better citizenship, part of additional productivity goes to society.

- Public good: main example of this is defense. Few individuals would choose to pay for it, it's SO expensive, and individual need is nil, societal need is huge.

- Capital market failures – can't buy human capital (invest in own potential) on credit because there is no collateral to repo. This is the thing that is universally recognized as important.

Distribution

- Equilibrium says absolutely nothing about how resources should be distributed in society. But how do you decide?

- Benefits (societal good)

- Difficulties

o How to decide

o fraud/corruption

o redistribution itself leads to market problems

§ welfare (lack of incentive to work) – this is the argument for the fall of socialism.

§ trick is to balance benefits and costs

Redistribution as applied to education:

Why is redistribution an important thing to think about when you are thinking about education?

Nara: government funds education, government controls education. All funding has strings.

SLoeb: This is part of a larger issue: why should the government tell anyone how to spend their money? It's like food stamps, restricted funding. It's the problem of paternalism. What are some positives?

- Adds to the labor force (externalities)

- Equalizes the population, raises the bottom

- People can't get around or remove the redistribution because it's internal, it's human capital, fraud-proof?

- It goes directly to children (monetary redistribution goes to parents/adults)

- Meritocracy makes us happy.

Individual benefits of education

- Income (private good, though taxes give some public)

- Employment options

- Research and development (spillovers)

- Cultural distinction (the cachet of being an educated person)

- Social capital (connections, resources)

- Social groups that lead to public good

- Population reduction (either good or bad)

- Inculcate shared sultural values (morality, civic duty)

- Healthier households

- Next generation gets benefits/resources

- Less crime/less juvenile crime

When we model, we'll be looking solely at income, because it's simpler.

Investment in education

Human capital: "All the acquired characteristics from education (OC – and experience) that provide benefits. Gary Becker wrote a book called "Human Capital" that applied physical capital concepts to humans.

When we talk about why or how much school, we're talking about whether the benefits are greater than the costs. Benefits and costs are different for different people. You also have to be able to make cost/benefit judgments and comparisons in terms of time.

We need ways of comparing dollars over time. $1K now and $1K 20 years from now are very different because:

- inflation

o What you can buy with a dollar today is different than what you could buy in the past/future. Value changes over time.

o Consumer Price Index (CPI) indicates HOW MUCH different a dollar is today than at a given point in the past. There is a general CPI, as well as regional- and industry-specific CPIs.

Year	CPI
1960	29.6
1970	38.8
1980	82.4
1990	130.7
1996	156.9

So, let's say you had $1K in 1990. What's that worth in 1996?

$1000 in 1990 130.7

------------------- = ---------- = X=$1200.46

$X in 1996 156.9

Same equation for 1980 gives you $630.45

This is the difference between turning something from nominal to real

§ Nominal - $1K in 1990, $1K in 1996

§ Real (When you put everything into the same year's dollars)= $2246 1996 dollars.

- investment potential/present value

o How much you could make if you had that money now vs. how much you could make if you had it in the future.

§ Assumptions about how much you can make on your investments (interest rate = r)

§ Example $IK in the bank for 1 year at an r of 5%

§ next year $1000+1000(.05) = $1000(1+.05

§ D₁=D₀(1+r)

§ D₀=D₁/(1+r)

§ In two years D₂ = 1000(1+.05) (1+.05)

§ D₂=D₀(1+r)²

§ D₃=D₀(1+r)³

o Example: You are a school thinking about buying a Xerox machine that costs $980 today. The alternative is to rent for the next five years @ $200/year at the end of each year. The machine lasts 5 years before you sell it for junk for $100.

o If r=.04

Year	Benefit in future of buying	Divide by	Present Value (PV
0	-$980	1	-$980
1	200	(1+.04)	192
2	200	(1+.04)²	185
3	200	(1+.04)³	178
4	200	(1+.04)⁴	171
5	200	(1+.04)⁵	164
	100	(1+.04)⁵	82

o =-980+972=-8. You should rent the machine.

- risk /discounting the future