Chapter 6 Know how the government has grown over the years and have a general idea of where the government is spending taxpayer dollars Size of government is indicated by government expenditures as a percentage of U S GDP 1930 9 4 2010 39 7 Government spends most taxes in Medicare Social Security and Defense Know the definition of transfer payments Transfer payments transfers of income from some individuals to others social security unemployment benefits welfare etc Understand the theories related to the economics of voting 1 Rational Ignorance Effect a rational individual has little or no incentive to acquire information needed to cast an informed vote 2 Median voter theory The idea that a vote maximizing politician in a two party system will be close to the middle so that there is little difference between candidates and the preferences of the median voter will be represented Know when the political process works well and the idea of user charges When voters pay in proportion to the benefits they receive then productive projects will be passed and unproductive projects will not User charges requires people who use a service more to pay a larger share of the cost Understand the ways in which the political process does not work well 1 Special interest effect An issue that generates substantial benefits for a small group by generating minimal costs to a large group Done through A Logrolling The practice of trading votes by a politician to get the necessary support to pass desired legislation Ex Florida will vote for Maryland s bill if Maryland will vote for Florida s bill and so on B Pork barrel Legislation a package of spending projects benefiting local areas financed through the federal government Ex When a bill is sent to the president to be approved or denied all the congressman have a paragraph in their for what they want even if it has nothing to do with the actual bill 2 Shortsightedness Effect politicians will favor programs that generate current visible benefits even if long term costs of the project outweighs the benefits Ex Politicians like short term over long term 3 Rent seeking Actions taken by individuals and groups in order to use the political process to take the wealth of others Ex People try to obtain wealth through the political process 4 Lack of profit motive Unlike private firms the public sector lacks the incentive to produce efficiently Ex Politicians spend tax payers money not their own Chapter 11 Know the basic differences between Classical and Keynesian Economics Classical Economics believes that market and resource prices are flexible and allow the economy to self correct fairly quickly Keynesian Economics believe that market and resource prices are inflexible and therefore the market will not be able to quickly correct itself Know how to calculate the marginal propensity to consume and the expenditure multiplier Also know how the broken window fallacy is related to the expenditure multiplier MPC additional consumption additional income Expenditure Multiplier M 1 1 MPC Broken window fallacy Breaking a window will create work for the window maker and he will spend the money he earns and so forth For the expenditure multiplier to work it must come from resources that otherwise would have been unemployed Money spent on recovery from destruction does not actually benefit society Know what it means for the government to run a budget deficit a budget surplus and a balanced budget Budget deficit government spending is greater than government revenues T G T G Budget surplus government revenue is greater than government spending Balanced budget government revenues taxes is equal to government expenditures T G Know what fiscal policy is and the Keynesian idea of using counter cyclical fiscal policy to stabilize the economy 1 During recessions use expansionary fiscal policy increase government 2 During expansions use restrictive fiscal policy decrease government spending reduce taxes spending increase taxes Understand the timing problems associated with fiscal policy 1 Recognition lag Our ability to forecast is extremely limited 2 Administrative lag Change in fiscal policy requires legislative action which 3 Impact lag A change in fiscal policy will not have an immediate impact on takes a long time the economy Know the automatic stabilizers and how they can promote economic stability without any discretionary change in policy 1 Unemployment compensation Recession More people will be unemployed and receive unemployment benefits so it will increase the budget deficit Expansion Less people will be on unemployment benefits so there will be a budget surplus 2 The corporate profit tax Recession Companies will make less money during a recession so the government will make less money from taxes Expansion The government receives more money from taxes during an expansion so there will be a budget surplus 3 The progressive income tax Recession People will be laid off and paid less during a recession so the government will receive less money and be in a budget deficit Expansion People will be paid more and more people will be employed during an expansion so the government will receive more money from taxes and be in a budget surplus Chapter 12 Know the classical view of why fiscal policy is not as effective as Keynesians originally thought called crowding out which is a reduction in private spending due to higher interest rates generated by budget deficits financed through government borrowing Crowding Out a reduction in private spending due to higher interest rates generated by budget deficits financed through government borrowing Know the new classical view of why fiscal policy is not as effective as Keynesians originally thought called the Ricardian equivalence which is the belief that a tax reduction financed with government debt will exert no effect on aggregate demand because people will know that higher future taxes are coming Ricardian equivalence belief that a tax reduction financed with government debt will exert no effect on aggregate demand because people will know that higher future taxes are coming Understand the Keynesian view of the paradox of thrift and how it affects the economy Paradox of Thrift When many people drastically increase their savings and reduce consumption total savings may decrease Economy will be worse off Understand the political incentives behind discretionary fiscal policy and why it can lead to amassing huge amounts of debt Politicians
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