AP Econ Mia Bettino
1) Chapter one. In a paragraph, summarize the main points of the chapter. Note that simply listing the bolded statements will get you zero points. There are key ideas and assumptions in this chapter.
This chapter explains the basic ways which the American market economy works, especially compared to other forms of economies, such as communisms. In a market economy, competition keeps incentives alive, whereas in a communist economy, all similar businesses sell the same products or services for the same for the same price. The market economy system pushes individuals to work harder to better themselves, as opposed to making a fixed amount regardless of their effort. Author Charles Wheelan explains that the market economy system is consistent with basic human nature, as competition and the want to better one’s self and life is something that we do naturally. This chapter also discusses the idea of maximizing one’s utility: making choices that betters one’s life. Wheelan is quick to point out that maximizing utility does not necessarily mean selfishness. Wheelan also explains the basics of cost and demand: as cost increases, demand falls; as cost falls, demand increases. This chapter also emphasizes that every market transaction leaves all the parties involved better off, even if it does not appear that way. The consumer is receiving something that it needs, and the business or firm is paid for it. Finally, Wheelan briefly discusses risks. He explains that if an individual does not understand the risks when he makes a transaction, he may not be maximizing his utility.
2) Chapter 2 (one paragraph). Explain why incentives matter. What do you think about the author’s ideas on black rhino conservation? Explain what perverse incentives are and give examples from a high school student’s life.
Incentives matter because they push us to work harder in order to reach our goals. In a communism, there are no incentives – nothing better to strive toward – because the quality of work done does not benefit the worker. Thus, individuals have no motivation to work harder. One example of this communist-esque system takes place in American public education. Teachers are paid not based on skill but on experience combined with their own education. This has actually pushed some of the most skilled teachers into other professions. Wheelan explains the problem issue in Africa: poaches hunt down black rhinos that have valuable horns, kill the animals, and take their horns for profit. Although this is an illegal practice, there is an extensive black market that supports it. As the black rhino becomes more and more endangered, the price of black rhino horn increases, giving poachers all the more incentive to hunt them. I agree with Wheelan that helping to conserve black rhinos will help with the issue, because it will save some, and then cause the black market prices to drop, giving poaches less of an incentive to hunt the rhinos. A perverse incentive is an incentive accidentally created when an individual sets out towards a particular goal. The follow situation displays a perverse incentive. A student’s parents give him a weekly allowance with which to buy lunch. However, if the parents see that their child has his own money to spend, then they will not give him the allowance. So the student spends most or all of his money elsewhere so that his parents will continue paying for his lunch. Although saving his money would have been more responsible, the perverse incentive created in this situation pushed him to spend it.
3) Chapter three. Summarize this chapter in 1-2 paragraphs. Why might government regulation and lawyers be a good thing? Include specific examples.
This chapter discusses externalities and the government’s role in them. An externality is defined as “a consequence of an economic activity experienced by unrelated third parties; it can be either positive or negative” (Investopedia.com). Someone falls victim to an externality when they are not involved in a transaction but are still affected by it. One of the most prevalent examples of this in today’s world is global warming and pollution. While a manufacturing company might be made better off by increasing its production and generating more revenue, the emissions from its factories may be polluting nearby waterways, pumping smog into the surrounding air, and negatively affecting the everyday lives of people that don’t have any involvement in the company or its products. Thus, an externality is something generally not taken into account when a transaction is made. Although they are not always obvious, externalities arise in some way from every transaction – even from every activity. The government is in charge of dealing with externalities that a private firm or company will not take care of. This includes banning and taxing certain behaviors that negatively affect the general public, such as smoking cigarettes. The government getting involved is a good thing because otherwise, externalities will not be dealt with.
Government regulation of externalities and lawyers that deal with these cases are a good thing in many situations, like in the above-mentioned situation: smoking cigarettes. Smokers negatively affect the public. Even if you have never smoked a cigarette in your life, you can succumb to smoking-related diseases due to secondhand smoke. If the government bans smoking, at least in certain places, it can help make the public a safer and cleaner, healthier place. An even better solution would be to tax smokers through increased tax on cigarettes. This will not only get rid of smokers in certain areas, but incentivise smokers to give up smoking altogether because the cost for them to continue their behavior is rising. However, Wheelan presents a downside of regulating this activity. Almost half a million people die from tobacco use each year in the US. If the government incentivises more people, then these people will live longer, leaving less money to go around among the public because of the sheer number of people that would not be dying at relatively early ages. This would especially be a problem as a generation moves into old age when the government is paying for elderly care. Clearly, there are advantages and disadvantages to the regulation of certain activities that generate obvious externalities. Another example of how government regulation can be a good thing is a tax on gas-guzzling cars like SUVs. If the government were to tax the use of such cars, the money made from the tax could go to the issues such cars contribute towards such as global warming and pollution.
4) Chapter four. Summarize this chapter in one paragraph. Include specific examples of government involvement as needed. In another paragraph, be sure to discuss the government’s “grabbing hand” as it licenses and regulates businesses in third world countries versus Capitalist nations.
In this chapter, Wheelan really emphasizes that the “Government can deal with significant externalities – or it can regulate an economy to the point of ruin” (80). The government controls some large organizations such as the DMV, where people must go and have no other options. Because the government controls this, the DMV has no incentive to run efficiently. This is exactly why communism doesn’t work. In addition to the Department of Motor Vehicles, the US government has centralized things like healthcare and national security and defense. In important areas where a private sector would likely fail, especially due to competition, government regulation is generally seen as a good thing. However, too much government regulation is almost always viewed as a bad thing. It can cause prices to rise. It can keep employees from making fair wages. Perhaps most importantly, too much government regulation keeps the power (and the money) in the hands of the wealthy and the well-connected, especially those already in politics. Excessive taxation by the government can also incentivise people to leave work, for instance, if the income tax is too high. Too little government regulation, however, can result in a lack of productivity and order. While many people (oftentimes conservatives) view a small, relatively uninvolved government as a good thing, they fail to realize that the government helps our economy in a lot of ways that we would not be able to help ourselves.
The amount of government regulation employed depends on the economic standing of a nation and vice versa, creating a cycle. For example, the use of DDT, an extremely harmful pesticide, has been banned by the US government – in the US. However, other countries’ governments cannot afford to do so because DDT helps control the spread of malaria, a disease passed from mosquitoes to people. The governments of third world countries can’t afford to worry about the environment if the polluting factories employ large percentages of the nation’s labor force. The problem with regulation in developing countries is that there is so much of it, but little of it actually works towards important, basic tasks. Economists have debated whether this regulation acts as a “helping hand” or more of a “grabbing hand,” allowing the people at the top to take advantage of the less fortunate. Wheelan uses the example of the time it takes to start a new business. Setting up a new business is much easier and faster to do and far less regulated in countries like Canada than it is in countries like Bolivia. However, this does not mean that consumers are safer in those undeveloped countries. In fact, “compliance with international quality standards is lower in countries with more regulation” (92).
5) Chapter five (two paragraphs).
a. What does information asymmetry have to do with the hiring process, in regards to gender? What does the author feel about this discrimination? Do you agree with him? Explain. What do you feel about his long term solution to the problem?
Information asymmetry is a situation in which an individual has an idea of what their future looks like, but a firm, organization, or corporation does not. A good example of this issue is in the hiring of women. If a firm is deciding to hire one of two equally qualified young people, and one is a man and one is a woman, they will likely choose the man because it is more likely that the woman will be taking more time off from work than the man if they both choose to start families. However, the man may have decided that he wants to be a stay at home dad and the woman may have decided that she does not want children. The firm does not know this and therefore, they make their decision based on statistical probability. Wheelan explains that he believes this is unfair but rational (while most forms of discrimination are irrational). As much as I hate to say it, I agree with him. I would rather hire someone that will likely (according to general data) spend more time with the company and therefore earn more money for the company. Although women have come a long, long way in the workplace, I find it unfortunate that these assumptions are still made. Wheelan’s long-term solution to the problem – to do background checks on job applicants – to try to get rid of any statistical assumptions the firm might be making. Although I think this would help some, background checks certainly cannot predict someone’s future. Background checks cannot predict things like unintentional pregnancies, or even if someone simply changes their mind.
b. Explain the problem of private health insurance? Why do the costs continue to rise? What is the problem with public health insurance? Discuss adverse selection, as it relates to this chapter.
The problem with private health insurance is that insurance companies can refuse to insure people that are sick or are likely to become sick in the future, and that private companies cannot possibly cover the diverse range of completely healthy to deathly ill people in the United States. The costs are continuing to rise as our medical technology becomes more advanced, or seems to become more advanced (in the cases of those new expensive technologies that don’t really work any better than their less expensive predecessors). As more and more people want to take advantage of the rapidly improving technology, insurance companies have to keep up with the rising costs. The problem with public health insurance is that it costs one sum that will be way too much coverage for one individual and not enough for another. It is impossible to guess what one person will need versus another. Adverse selection is “a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality” (Investopedia.com). In the case of insurance, those that lead high-risk lives are more likely to purchase life insurance. Similarly, those that know that are more vulnerable to illnesses and health complications are more likely to purchase health insurance. This is a problem for insurance companies, because these are the people that they will actually need money to cover. Insurance companies prefer to cover those that lead low-risk, healthy lifestyles and will likely not need insurance money to cover them.
6) Chapter six (one paragraph). The author discusses the symptom of being poor, and the illness of being poor. What does the author mean? Do you agree with him? Explain. How does the poverty line right now compare to 100 years ago? Why is America like a real life version of “Revenge of the Nerds?” What’s so important about Human Capital?
The author says that a symptom of being poor is not being able to find good jobs. On the other hand, he says that the illness of being poor is caused by “a lack of skills, or human capital” (129). He makes this distinction because many people blame poverty on a lack of job opportunities, while the problem is really the lack of skills necessary to fill those jobs. I completely agree with him; I think that instead of trying to create more jobs, we need to start with the foundation – education opportunities – so that more people can be qualified to get jobs. In the past century, standards for those in poverty have risen. In fact, “The poverty line is now at a level of real income that was attained only by those in the top 10 percent of the income distribution a century ago” (136). (However, I would like to know if this statistic was adjusted for inflation.) America is like a real life version of “Revenge of the Nerds” because the difference between the incomes of skilled and unskilled workers is increasing. Education, intelligence, and human capital is valued more now than ever before. Human capital is “the sum total of skills embodied within an individual: education, intelligence, charisma, creativity, work experience, entrepreneurial vigor, even the ability to throw a baseball fast” (127). Human capital is so important because it is what we have to offer society even if we lose our monetary or material wealth. Wheelan uses an example here: even if Bill Gates lost his job and all his money, he would still be ok, because of his human capital. He had what it takes to build a tech empire once; the loss of his money could not take that away.
7) Chapter seven (one paragraph). What does the efficient market theory have to do with financial markets? Discuss the positives and negatives of the theory. Why do Wall-Street types not like it? Explain the coin flipping experiment, as it relates to investment diversification.
This chapter discusses the efficient market theory which explains that since everyone (supposedly) can find the same information about certain stocks, no one can buy stocks that will continually “beat the market.” (Obviously, if someone has illegal inside information, this theory does not apply.) The positives of this theory are that no one person or few people can inflate the price of the stock, and thus, the price can remain relatively consistent. The major negative of the theory is that since everyone is on a pretty level playing field, everyone involved in the market experiences the same effects of fluctuations in stocks’ values, which can lead to recessions. Wall-Street types dislike this theory because it decreases the need for private investing, which many of them are involved in. The efficient market theory also gives rise to index funds. Index funds are “type of mutual fund with a portfolio constructed to match or track the components of a market index” (Investopedia.com). Index funds are relatively cheap to manage and deliver low portfolio turnover – the private investor makes less money. The coin flipping experiment describes a situation in which you flip a coin ten times. You have $100,000 invested in one stock. If you flip heads, your investment quadruples. If you flip tails, you lose everything. There is a 50% chance that you lose everything just on the first try. Failing to diversify your investments is an incredibly risky move. However, if you diversify your investments (you don’t put all your eggs in one basket) into ten separate accounts and flip for each one, you will likely still be making money even if some of your investments are worth nothing.
8) Chapter eight (one paragraph). Why have mohair farmers earned a subsidy from the federal government for decades? What can you derive that economics tells us about politics?
Mohair farmers have been earning a US government subsidy for decades because of what mohair used to be used for. In the 50s, mohair was widely used to make army uniforms as a substitute for Angora wool. This government did this so that there would enough yarn to make uniforms if another war began. The US government continued to supply these subsidies for four decades, even after the uniform manufacturers switched to synthetic materials. The populous didn’t really know or care about this continuation because of how small the population of mohair farmers was; the enormous subsidies that these farmers got came from pennies out of each taxpayer’s pocket. If the subsidies had stopped coming in, the mohair farmers would have gone after the government, and since no one else seemed to care, the government continued the act. Thus, economics tells us that small groups and populations benefit most from the government’s involvement in the economy. Small populations reap the benefits of a ignorant and uncaring population as a whole. Additionally, these smalls groups are more effective when going to the government for a change, as the costs of the change, spread over a much larger population, are more likely to be ignored and go unnoticed. The government then has to make a choice to choose the path that does more good than harm (in costs) for the public. Unfortunately, politicians do not always do the right thing in this situation; politicians will most likely choose the path that will get more people on their side.
9) Chapter nine: Explain how the average American is three times as rich as they would have been in 1950. Explain the most effective “knock” on GDP. What does the author think about the effectiveness of fiscal policy? Explain how a current account surplus/deficit can be good and bad.
The average American is three times as rich as they would have been in 1950 because workers today, coupled with modern technology, can produce a lot more than they could in 1950. Even though prices have risen since the middle of the twentieth century, wages have risen significant alongside them. The amount of time one had to work to be able to buy a certain product has decreased significantly in the past century. The most effective “knock” on GDP is that in reality, GDP is not an accurate reading on how a nation is doing as a whole. All the GDP is is a crude way of measuring a country’s economic growth. It does not take into account the overall well-being of the populus, which has a massive effect on the efficiency of industry. Wheelan does not think that fiscal policy is all that effective. A nation’s government should, in theory, have the power and the necessary ability to regulate various parts of the economy and the economic cycle as a whole. However, it takes too much coordination and speed between sectors of the government for this to realistically happen quickly and frequently. Wheelan explains that a current account surplus is good because it allows the holder (the government) to spend more on necessities. A deficit can be good or bad. Creating a large deficit by borrowing money from other nations to advance a country’s own standing shows growth. However, having a large deficit that has no positive return is a bad thing.
10) Chapter ten: What is the drastic consequence of poor monetary policy the author discusses at the start of the chapter? Do you agree with this argument? Explain. What is the relationship between governments who owe money, government policies to fight inflation, and monetary policy? Does this change your opinion of how monetary policy is used by the US Government? The drastic consequence of poor monetary policy that Wheelan discusses at the start of the chapter is rapid and chronic deflation such as that seen in the 1920s and 1930s. This specific time of deflation threw the United States and much of the world into a depression, which helped give rise to World War II. I agree with this argument. During this period, the US government could have regulated stock prices and the money supply more tightly. With so many people looking to “get rich quick” through the stock market and succeeding, it was a recipe for disaster – and the government should have seen it coming. Wheelan explains that the government can force inflation to occur by pushing certain policies, like ones that change the interest rates. This inflation would be positive for an indebted nation because the decreasing value of its own money allows it to pay back much of its debt to other nations. At first glance, this seemed a bit sketchy to me, as I don’t really see inflation as a positive – why would the government try to make it happen? However, as I read on, I realized that inflation can sometimes be a good thing, and that US monetary policy may enforce things that look negative and downright sketchy in the moment but can actually lead to something good in the future.
11) Chapter eleven: What is the relationship between specialization and productivity? Discuss, in two paragraphs or less, your opinions on globalization after reading this chapter. Cite data from the book to prove your point. Finally, discuss the problem of “good intentions” on globalization and “sweatshops.” What do you propose to solve this problem?
In this chapter, Wheelan discusses the relationship between specialization and productivity. Specialization leads to productivity. When each individual is assigned to a certain task, rather than doing everything to sustain himself, the populus as a whole is much more productive. It can industrialize and trade. Individuals have more time to spend on other things and more money with which to buy other things. Wheelan links specialization and productivity to globalization in an example that he uses. Engineers in Seattle use their time and resources to design and build airplanes. Meanwhile, people in Bangladesh use their time and resources to manufacture shirts. The engineers in Seattle could make those shirts, but they spend their time doing what they do best – building airplanes. This demonstrates specialization on a global scale, rather than on a national or even regional one. Because certain people and groups around the world spend their resources on making different things, global trade is necessary. However, this seemingly positive, simple, and necessary concept is actually highly controversial and complicated. I do believe that globalization and trade have made our world better as a whole. It is the driving force that encourages developing countries to industrialize. However, people in the United States reap the benefits of globalization in a much different way than say, those shirtmakers in Bangladesh. While outsourcing jobs from the United States and similar developed countries does create jobs for those in developing or undeveloped countries, the conditions under which those people must work are often atrocious. They are paid mere cents for the hour and often get sick or hurt on the job. The sad reality is that this is what causes those nations to become richer and raise their standing in the world. While globalization is a pretty positive thing in my opinion, there is a level of humanity that I believe must be upheld worldwide. The problem with “good intentions” and “sweatshops” in respect to globalization is that the developed nations imposing these policies and concepts onto developing nations want the world to believe that they have good intentions, that they want to create jobs for these people and help the country get richer and develop further. However, the jobs created in these nations are often “sweatshop” jobs for which workers are paid very little and work under awful conditions. However, this is often the only job opportunity that these workers have. Therefore, even though there are some disturbing consequences of globalization and trade, it does make the world better off as a whole.
12) Chapter twelve: After reading this chapter, explain and discuss what we can do to help developing nations. What do these nations need to do to help themselves?
There is much that can be done for developing nations if countries such as the United States take it upon themselves to intervene and bring about positive change. We can facilitate the growth of a strong and stable economy by providing capital to poor countries. This can be seen as an investment; these nations are likely to pay us back in the future when they have established industry and their own economy. We can also facilitate the improvement of human capital in these countries, chiefly by helping to establish education systems. Education is the foundation of a nation’s well-being and advancement. We can also give these nations a headstart with humanitarian aid. This can ensure that the population is happy and healthy, both of which contribute to human capital. These developing nations can also do a lot to help themselves. The creation of a government that is strong but not overbearing is necessary. Governments that involve themselves too much in the economy keep a country poor and do not allow for economic growth. Establishing a democratic government is a good path for nations looking to facilitate the growth of their economy. The establishment of property rights is also of utmost importance. They allow the poor population to go out and find a specialized occupation.