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USC ECON 205 - Budgets and the Laffer Curve

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ECON 205 2nd Edition Lecture 20Outline of Last Lecture I. Savings-Investment Relation and Net Exports in an Open EconomyII. The European Monetary UnionIII. InflationOutline of Current LectureI. The Laffer Curve and Government SpendingII. The Three Types of BudgetsIII. Aggregate Measures (Supply and Demand) and the GDPIV. Social Overhead and the Life Cycle ModelCurrent LectureI. The Laffer Curve and Government SpendingA 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 BudgetsThere 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 GDPThe 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 consumptionpart 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 ModelSocial overhead means hospitals, schools, streets, parks, etc. We have plenty of opportunities tospend 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


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