ECON 205 2nd Edition Lecture 20 Outline of Last Lecture I Savings Investment Relation and Net Exports in an Open Economy II The European Monetary Union III Inflation Outline of Current Lecture I The Laffer Curve and Government Spending II The Three Types of Budgets III Aggregate Measures Supply and Demand and the GDP IV Social Overhead and the Life Cycle Model Current Lecture I The Laffer Curve and Government Spending A professor at USC named Laffer created the Laffer curve relating tax rate and revenues If the tax rate is zero the revenue of the government will be zero Furthermore if the tax rate is one hundred percent the revenue will be zero also When you get to the point of inflection you reach the maximum amount of revenue and optimal rate of taxation Where does tax money go It is spent in many places including national security and social benefits In the United States we spend more on national defense than the rest of the world combined The government is currently trying to cut the budget to balance our revenue and spending Deficit is an excess of spending versus revenue for only one fiscal year while debt is the entire excess over spending for all time In optimal macroeconomic theory the government should lower taxes and spend to drive the economy in a recession II The Three Types of Budgets There is the actual budget which is budget on paper the structural budget that is what the budget would be in an economy of optimal performance and the cyclical budget which is the difference between the two III Aggregate Measures Supply and Demand and the GDP The lack of aggregate demand is when the government has to interfere Keynes believed the government has to be the manager of the economy Aggregate demand is equal to consumption part of the GDP Aggregate supply is an abstract concept relating to the total consumption by the economy GDP is composed of consumption investment government expenditures and net exports For the United States for instance net exports are negative making the real GDP lower than it would be IV Social Overhead and the Life Cycle Model Social overhead means hospitals schools streets parks etc We have plenty of opportunities to spend money but if we don t we can create capital to stimulate employment Life cycle model of consumption consumption decisions are influenced by concern for future generation welfare
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