Posts Tagged ‘econ’

Game Theory: Nash Equilibrium

In game theory, the Nash equilibrium is a solution concept of a non-cooperative game involving two or more players, in which each player is assumed to know the equilibrium strategies of the other players, and no player has anything to gain by changing only their own strategy.[1] If each player has chosen a strategy and no player can benefit by changing strategies while the other players keep theirs unchanged, then the current set of strategy choices and the corresponding payoffs constitutes a Nash equilibrium.

Stated simply, Amy and Will are in Nash equilibrium if Amy is making the best decision she can, taking into account Will’s decision, and Will is making the best decision he can, taking into account Amy’s decision. Likewise, a group of players are in Nash equilibrium if each one is making the best decision that he or she can, taking into account the decisions of the others in the game.

Macro: Capital Deepening, Capital Widening

Capital deepening is an economic scenario wherein capital per worker is increasing in the economy. This is also referred to as increase in the capital intensity. Capital deepening is often measured by the capital stock per labour hour. Overall, the economy will expand, and productivity per worker will increase. However, according to some economic models, such as the Solow model, economic expansion will not continue indefinitely through capital deepening alone. This is partly due to diminishing returns and wear & tear (depreciation). Investment is also required to increase the amount of capital available to each worker in the system and thus increase the ratio of capital to labor. In other economic models, for example, the AK model or some models in endogenous growth theory, capital deepening can lead to sustained economic growth even without technological progress. Traditionally, in development economics, capital deepening is seen as a necessary but not sufficient condition for economic development of a country.

Capital widening on the other hand is the economic scenario wherein capital stock is increasing at the same rate as the labor force and the depreciation rate, thus the capital per worker ratio remains constant. The economy will expand in terms of aggregate outputbut productivity per worker will remain constant.

Micro: Types of Inefficiency — X, Allocative, Dynamic, Social, Productive, Pareto, and Distributive

‘X’ inefficiency is a concept that was originally associated specifically with management inefficiencies, but can also be applied more widely.

X inefficiency occurs when the output of firms is not the greatest it could be. It is likely to arise when firms operate in highly uncompetitive markets where there is no incentive for managers to maximize output.

Allocative inefficiency occurs when the consumer does not pay aefficient price.

An efficient price is one that just covers the costs of production incurred in supplying the good or service.

Allocative efficiency occurs when the firm’s price, P, equals the extra (marginalcost of supplyMC. This is efficient because the revenue received is just enough to ensure that all the resources used in the making of a product are sufficiently rewarded to encourage them to continue supplying.

Dynamic inefficiency occurs when firms have no incentive to become technologically progressive. This is associated with a lack of innovation, which leads to higher production costs, inferior products, and less choice for consumers.

There are two ways in which firms can innovate:

  1. New production methods, such as when applying new technology to an existing process.
  2. New products, which are a feature of markets with highly competitive firms, such as those in the consumer electronics.

Innovation, researchand development are expensive and risky, so firms will expect a fair level of profits in return. However, because the price mechanism may not generate profits for the supply of public and merit goodsthere is often an absence of dynamic efficiency in these markets.

Social inefficiency occurs when the price mechanism does not take into account all the costs and benefits associated with economic exchange.

The price mechanism will only take into account private costs and benefits arising directly from production and consumption, not the external costs and benefits incurred by thirdparties.

Social costs refer to the total costs borne by society as a result of an economic transaction, and include private costs plus external costs. Social benefits are the private benefits plus external benefits resulting from a transaction.

A transaction is socially efficient if it takes into account costs and benefits associated with the transaction – that is, the social costs and benefits.

Productive inefficiency occurs when a firm is not producing at its lowest unit cost. Unit cost is the average cost of production, which is found by dividing total costs of production by the number of units produced.

It is possible that in markets where there is little competition, the output of firms will be low, and average costs will be relatively high. This is likely to occur if a few firms, or just one, dominate the market, as in the case of oligopoly and monopoly.

Pareto inefficiency is associated with economist Vilfredo Pareto, and occurs when an economy is not operating on the edge of its PPF and is, therefore, not fully exploiting its scarce resources.

This means that the economy is producing less than the maximum possible output of goods and services, from its resources.

Distributive inefficiency occurs when goods and services are not received by those who have the greatest need for them. Abba Lerner first proposed the idea of distributive efficiency in his 1944 book The Economics of Control.

Macro: Discretionary Policy

In macroeconomicsdiscretionary policy is an economic policy based on the ad hoc judgment of policymakers as opposed to policy set by predetermined rules. For instance, a central banker could make decisions on interest rates on a case-by-case basis instead of allowing a set rule, such as the Taylor rule or Friedman’s k-percent rule, to determine interest rates or the money supply. In practice most policy actions are discretionary in nature.

Macro: Slow Growth Causes (United States, 2000s)

  1. Wars in Iraq and Afghanistan
  2. Collapse of a housing bubble
  3. China’s entry into the World Trade Organization

Macro: Equation of the exchange; Money Velocity (compilation)

The above link is the best overall, but the stuff below is from elsewhere and is almost as good (but lacks Q and pi…)
To do: clean this up and properly cite sources
MV = nominal GDP

The equation of exchange shows that the money supply M times its velocity Vequals nominal GDP. Velocity is the number of times the money supply is spent to obtain the goods and services that make up GDP during a particular time period.

To see that nominal GDP is the price level multiplied by real GDP, recall from an earlier chapter that the implicit price deflator P equals nominal GDP divided by real GDP:

Equation 11.2. 

P = Nominal GDP / Real GDP

Multiplying both sides by real GDP, we have

Equation 11.3. 

Nominal GDP = P × real GDP

Letting Y equal real GDP, we can rewrite the equation of exchange as

Equation 11.4. 


We shall use the equation of exchange to see how it represents spending in a hypothetical economy that consists of 50 people, each of whom has a car. Each person has $10 in cash and no other money. The money supply of this economy is thus $500. Now suppose that the sole economic activity in this economy is car washing. Each person in the economy washes one other person’s car once a month, and the price of a car wash is $10. In one month, then, a total of 50 car washes are produced at a price of $10 each. During that month, the money supply is spent once.

Applying the equation of exchange to this economy, we have a money supply Mof $500 and a velocity V of 1. Because the only good or service produced is car washing, we can measure real GDP as the number of car washes. Thus Y equals 50 car washes. The price level P is the price of a car wash: $10. The equation of exchange for a period of 1 month is

$500 × 1 = $10 × 50

Now suppose that in the second month everyone washes someone else’s car again. Over the full two-month period, the money supply has been spent twice—the velocity over a period of two months is 2. The total output in the economy is $1,000—100 car washes have been produced over a two-month period at a price of $10 each. Inserting these values into the equation of exchange, we have

$500 × 2 = $10 × 100

Suppose this process continues for one more month. For the three-month period, the money supply of $500 has been spent three times, for a velocity of 3. We have

$500 × 3 = $10 × 150

The essential thing to note about the equation of exchange is that it always holds. That should come as no surprise. The left side, MV, gives the money supply times the number of times that money is spent on goods and services during a period. It thus measures total spending. The right side is nominal GDP. But that is a measure of total spending on goods and services as well. Nominal GDP is the value of all final goods and services produced during a particular period. Those goods and services are either sold or added to inventory. If they are sold, then they must be part of total spending. If they are added to inventory, then some firm must have either purchased them or paid for their production; they thus represent a portion of total spending. In effect, the equation of exchange says simply that total spending on goods and services, measured as MV, equals total spending on goods and services, measured as PY (or nominal GDP). The equation of exchange is thus an identity, a mathematical expression that is true by definition.

To apply the equation of exchange to a real economy, we need measures of each of the variables in it. Three of these variables are readily available. The Department of Commerce reports the price level (that is, the implicit price deflator) and real GDP. The Federal Reserve Board reports M2, a measure of the money supply. For the second quarter of 2008, the values of these variables at an annual rate were

M = $7,635.4 billion

P = 1.22

Y = 11,727.4 billion

To solve for the velocity of money, V, we divide both sides of Equation 11.4 byM:

Equation 11.5. 

$$V = {{PY} \over M}$$

Using the data for the second quarter of 2008 to compute velocity, we find that Vis equal to 1.87. A velocity of 1.87 means that the money supply was spent 1.87 times in the purchase of goods and services in the second quarter of 2008.

Money, Nominal GDP, and Price-Level Changes

Assume for the moment that velocity is constant, expressed as $$\overline V $$. Our equation of exchange is now written as

Equation 11.6. 

$$M\overline V = PY$$

A constant value for velocity would have two important implications:

  1. Nominal GDP could change only if there were a change in the money supply. Other kinds of changes, such as a change in government purchases or a change in investment, could have no effect on nominal GDP.
  2. A change in the money supply would always change nominal GDP, and by an equal percentage.

In short, if velocity were constant, a course in macroeconomics would be quite simple. The quantity of money would determine nominal GDP; nothing else would matter.

Macro: Say’s Law Overiew

Say’s Law is a cornerstone of economic theory, particularly that which is given the loaded label of “Classical” economic theory.

Supply creates its own demand

When an economy produces a certain level of real GDP, it also generates the income needed to purchase that level of real GDP. In other words, the economy is always capable of demanding all of the output that its workers and firms choose to produce. Hence, the economy is always capable of achieving the natural level of real GDP.


Economics: Oken’s Law

Okun’s law (named after Arthur Melvin Okun, who published this thesis in 1962) is an empirically observed relationship between unemployment and losses in a country’s production.

The gap version states that for every 1% increase in the unemployment rate, a country’s GDP will be approximately 2% marginally lower than its potential GDP.

The difference version describes the relationship between quarterly changes in unemployment and quarterly changes in real GDP.

Like much of economic theory, Okun’s law has been challenged by many economists.

Economics: Laffer Curve (Stub)

In economics, the Laffer curve is one possible representation of the relationship between rates of taxation and the hypothetical resulting levels of government revenue.

Micro: Perf Comp Conditions/Equations

P     = MC

P     = MR

P = Price
MC = Marginal Cost
MR = Marginal Revenue