econ2010 notes; block 3

8/8/2019 ECON2010 Notes; Block 3

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November 17, 2009

Microeconomics

Lecture 22: Pegs

-Income Distribution: Who gets what?-Measuring and mis-measuring income

-The cash equivalent concept (and two applications)-Income versus Wealth (or net worth)-Your wealth and Human Capital

Lecture Notes:-Side-note: Advertising leads to market dominance? While he said that he doubts advertising cancreate a dominate position in the market, do not misunderstand and think that advertising does not havethe power to move markets.

-Clicker:-Concentrated industry means most sales in the industry are made by only a few sellers. Not

necessarily high barriers to entry.-In economics, a network effect means the value one consumer places upon a good is in part a

function of the number of other consumers using that good.

-Remember the 3 fundamental economic problems. What goods? How goods produced? Who gets toconsume?

-In a market economy, the who gets to consume question is largely a function of one's income;see dollar votes.-With income distribution data, remember to be skeptical of economic data. Firstly, there may be anagenda to that data => some bias, but also, data on income distribution can be very hard to get. Whenyou look at income data, you have to think, could there be a theory, an economic theory, that couldexplain all these different salaries? Perhaps a template like supply/demand? Perhaps a sociologicaltheory relating power and money?

What is Income?-Income from labor (wages)-Income from investments and savings (interest and dividends)-Income from entrepreneurial talent (profit)-In-kind income (from government, charity, or business firms)-taxes-Post-tax income

What's you income?1). None of your business!2). In kind income too? (valued at cash equivalent)

-Tricky. Let's say the government gives an individual food stamps. What's the value of thosefood stamps? Well, do you look at the value of the food stamps themselves (ex. $100 worth of food)?No, you look at the cash equivalent of the transfer to get the true value of those food stamps. Forexample, $100 worth of food stamps is not worth $100 cash, because $100 worth of cash would not bespent only on food.

-Key point to take from this: sometimes you have the choice of a good/service or the cashequivalent. Depending on the individual's utility function, one choice will be better than the other.


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Example: a nice date versus the cash equivalent of that date.3). What's the time period?

-What a person earns in 2009 might be very different what they earn in 2015.4). Adjusted for leisure?

-Say you have two people who both make 50K a year. Let's say one of them works 40hrs/weekfor 6 months of a year. Compare this to 50hrs/week 50 weeks of the year. Nominal statistics will show

the same income, but in an economic sense, these two obviously not equivalent in their income.5). Do you mean income, orwealth?

-These two are not synonyms!-Wealth = Net wealth or Wealth = Assets -Debt-Income is things that come from wages, profit, interest, etc.-Think of income as a flow; something you make over the course of a year. Think of a movie,

constantly flowing.-Wealth is a stock concept. Think of a snapshot.-Example: Who is wealthier? A 26 year old with a medical degree but no stocks/bonds, or a 26

year old with no higher education, but a million dollars worth of bonds? Answer: First girl, because ofhuman capital.

November 19 and 24, 2009

(unfortunately lost notes when whilst in the process of installing Windows 7, the HP Recovery discwiped out Ubuntu partition)

December 1, 2009

Lecture 25: Pegs-Finish Rent & Odds and Ends-Stock: owning a part of the company-Bonds: loaning money to a company-Both stocks and bonds are traded in the market-Stock price = present value of future stream of profits-Theory of Financial Markets

-Using experts vs. Using Darts-Efficient Market Hypothesis (EMH and cousin RWH)

-Mutual Funds (actively managed)-Index Funds (passively managed)

Exam: Next Saturday, 7PM, Wilson 402; No class next Tuesday-75 multiple choice questions-Objective test-3 hours; shouldn't take all 3 hours; should take about an hour and a half-Wrong answers do not count against you more than blank answers-Go to his homepage for multiple choice practice-Test is comprehensive, but has a slight tilt to the new material

Lecture Notes:-Rent (review of what we went over last class)

-Example, Jimmie Johnson, the NASCAR driver. He would gladly drive for 100K, but hemakes millions. Rent is that differential. Much of his income is rent, a payment which is over andabove what is necessary to induce him to provide his services.

-So the question is, if you are going to tax the rent that comes from owning land, then do you


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tax these celebrities? Almost every other tax that you can think of affects the level of economic activityto some degree, for example, the income tax. When you tax income, you can tax productive activity.That could be a bad thing; there's a trade-off. Or if you tax restaurants, you have more income for thegovernment, but you get less restaurants. Interestingly, rent tax does not work the same way. If youtax just the rent, you still get the celebrities.

-Not just celebrities can have income rent. See Fig. 1. The market clears at $36,000. Notice on

the demand curve, 516 people are willing to work for $32,000. The area, or wedge, is the surplus. Itis the rent-Query, how do you actually find out people's rent? If the IRS came along and asked you, how

much would you be willing to do your job for so I can tax away the differential? Clearly, most peoplewould not be honest. Therefore, rent taxes are pretty much theoretical.-Moving on to Odd's and Ends...

-Public policy with price discrimination-Public colleges charge different prices to different students?

-ex. Higher paying majors => different tuition fees-ex. First-years pay more than upper class students-ex. Lower tuition for earlier classes

-Environmental Kuznets Curve (see fig. 2)-Relationship b/t national income vs. negative externalities-As GDP increases, pollution increases, but after a certain point, the negative

externalities decrease-Economic freedoms

-Different countries with different economic freedoms

Clicker:-The demand for labor: is a derived demand, derived from the ultimate demand for goods andservices-The supply curve for labor:

-is a function of the wage rate-can be backward bending-is affected by population demographics-will be greater (i.e., farther to the right) if more 18-60 year olds have a 24-7 work ethic-(it's all of the above)

-Lecture on Financial Markets-Financial Markets on stocks and bonds-Stocks are ownership rights in a corporation. Shares of a stock are a piece of property in the

assets of that corporation.-Bonds are debt instruments. Someone agrees to pay you so much interest on that bond. When

it matures, you will be paid the face value of that bond. Company owes you money with corporatebonds.

-Stocks/bonds can be sold almost instantly. Compare this to how long it can take to sell land.-J. Crew example. A stock is worth 4x as much now than at the beginning of the year, but for a

regular shopper, nothing has changed. The merchandise is the same, and the prices are the same.-Economic theory: stock prices are forward looking. The share price on any given day

reflects the present value of the future stream of income. If investors believe that the future stream ofprofits from J. Crew will go up, the stock prices with go up because investors want that stock.

-The Efficient Market Hypothesis, EMH. Note: The Random Walk Hypothesis (RWH)is related to EMH, but it goes beyond the scope of this class


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-The stock market is so efficient at processing information, that a random pick ofstocks should do as well or better as following the financial advisors

-If markets develop efficiently, than the experts can't to any better than randomlydrawn stocks

December 3, 2009

Lecture 26: Pegs-Getting Rich the Econ Way1). Save (starting young)2). Invest3). Diversify (suggestion: index fund)

-Inverse Relationship: Bond Prices and Interest Rates-Investment Mistake

EMH:Semistrong form: all public information about publicly traded corporate stocks will be reflected

in their current share pricesimplication: no investment strategy based on publicly available information can beat the market

because all the information is rapidly reflected in share prices after becoming public. too late, *bythe time we learn something that info is already embedded into the market

Price changes also have random characteristics-Think about flipping coins in a big class

-Statistic probability: 1 person flips 5 heads-Same idea with stocks-doesn't mean they're good at it, just random

-Combine EMH/RWH with PPC that shifts to right you get share prices that are random walk with anupward drift

-You can't pick specific stocks that will make you rich-Instead pick diverse strategy realizing stocks move up/down

1). mutual funds1. manager diverse portfolio and asks you to buy a part of it2. actively managed3. diversified4. index fund (type of mutual fund)

1. fund buys shares of an array-rejecting EMHS buying into a part though (diverse)-index funds outperform mutual funds

-ex. Vangaurd, charles schwab, fidelity, t. rowe price, TIAA-CREF-Read: A Random Walk Down Wallstreet by Burton Malkiel-Econ: science of choice

-consume more or save more-Work more; save more > aggressive saving-Bonds vs. Interestingly

-Debt instruments-You buy 20 year bond for $1000, which pays interest/coupon rate of 10%. Phillips pays you $100each year in interest for 20 years, then the bond matures and you get the $1000 back


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-When interests rates go up to 20% a couple of years after you bought the bond. A newly issued bondnow pays 20% ($200 per year in interest)-What could you get for your Phillips bond? Bond price will fall to $500 (yearly $100, not $200)-Bond prices and interest rates have an inverse relationship

-Investment Pitfalls:

-Max out on your employer's 401K or 403B plan (for upfront tax deduction + tax deferredgrowth)-Pay down credit card debt (quickest way to 12% + ROR)

1). Do nothing2). Choosing an investment opportunity that arrives by phone, internet, or mail3). Buying last year's hot investments4). Believing you can outsmart the market

econ2010 notes; block 3

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