03 27 2014 Section 2 The Seven Major Sources of Economic Progress 1 The Legal System the importance and incentives of private property rights 2 Competitive markets lead to economic growth 3 Importance of limiting government regulation 4 An efficient capital market 5 Monetary stability and inflation 6 Low tax rates 7 Free trade 1 The Legal System Private property rights o The right to exclusive use of property o Legal protection against invasion from other individuals o The right to sell transfer exchange or mortgage the property The four main incentives of private property rights 1 Owners have incentive to use resources in ways that are considered beneficial to others Ex empty lot 2 Owners have incentive to care for and manage what they own Ex how do you drive a rental car compared to your own 3 Owners have incentive to conserve for the future Ex popcorn at the movies 4 Owners have the incentive to make sure their property does not damage your property Ex keeping your dog on a leash An even handed enforcement of understandable and stable laws is important for economic growth non corrupt 2 Competitive Markets Promotes efficient use of resources and provides a continuous stimulus for innovative improvements of consumers methods of production Places pressure on the producers to operate efficiently and cater to preferences Gives firms a strong incentive to develop better products and discover low cost o Ex model T costs less by creating the assembly line Also discovers the business structure and size of the firm that can best keep the per unit cost of a product or service low 3 limits on government regulation many countries impose regulations that limit entry into various businesses and occupations and reduces competition o regulations and health codes for opening a business lessens competition o ex rose shop regulations encourage government lobbying instead of production regulations that substitute political authority for the rule of law and freedom of contract tend to undermine gains form trade imposition of price control will also stifle trade o what do price ceilings and price floors have in common 4 an efficient capital market a nation must have a mechanism that channels capital into wealth creating projects governments can and do intervene in capital markets by allocating investment fund and fixing interest rates o distorts market incentives o increases the importance of political action relative to economic action o makes unproductive investments more likely 5 Monetary Policy inflationary monetary policies distort price signals undermining the market economy Money serves 3 major functions in our economy 1 Medium of exchange 2 Unit of account 3 Store of value monetary policy when the supply of money is constant or increases at a slow and steady pace the purchasing power of money will be relatively constant Which is good for the economy o inflation when the supply of money expands rapidly compared to the supply of goods and services the value of money declines and the general level of prices rise Cause 3 major problems a Reduces investment b Distorts the information delivered by prices c Results in less productive use of resources Nominal values value expressed in current dollars Real Values values that have been adjusted for the effects of inflation The key to price stability is to control the growth of money supply The central bank should be help accountable for the inflation rate A country could tie its currency to another country s currency or just adopt it 6 Low Tax Rate 7 Free Trade people will produce more when they are permitted to keep more of what they earn a high taxes discourage work effort and reduce the productivity of labor b high tax rates will reduce both the level and efficiency of capital formation c high marginal tax rates encourage individuals to consume tax deductible goods in place of nondeductible goods even if nondectuctible goods are more desirable a nation progresses by selling goods and services that it can produce at a relatively low cost and buying those that would be costly to produce The Law of Comparative Advantage o people of each nation benefit if they can zcquire a product or service through trade more cheaply than if they produce it themselves o international trade allows domestic producers and consumers to benefit from the economies of scale typical of many large operations o international trade promotes competition in domestic markets and allows customers to purchase a wide variety of goods at lower prices government barriers to trade o tariffs o quotas o subsidies potential reasons for the government to restrict international trade o the politics of special interest groups and trade restrictions the national defense argument the infant industry argument the antidumping argument 03 27 2014 Lessons from the great depression Time period characterized by human suffering soup lines falling GDP high unemployment The length and severity of the depression were the result of four major factors 1 Contraction of the money supply The fed aggressively reduced money supply immediately before and This resulted in uncertainty and large fluctuation with regard to prices which following the 1929 crash stifled exchanged 2 Smoot Hawley Tariff of 1930 soared 3 Tax increases Increased tariffs by more than 50 on 3 200 products Countries responded with higher tariffs trade was reduced and unemployment The government passed a huge tax increase in 1931 taking the top marginal tax rate from 25 to 63 79 in 1936 Reduced demand and the incentive to work at a time when unemployment was high and jobs were already hard to find 4 Price controls regulations and constant policy changes Agricultural adjustment act AAA Government paid farmers to reduce output to keep prices high National Industrial Recovery Act NIRA Government forced firms to form a cartel and charge a certain price for products reduce competition and promoted monopoly pricing Government and business leaders set production quotas prices wages working hours and distribution methods for each industry non compliers were imprisoned 03 27 2014 Financial crisis of 2008 Characterized by The boom and bust by the housing crisis Rising default and foreclosure rates o Default couldn t pay back loan in the 90 day Sharp downturn in the stock market Soaring energy prices Caused by 1 Regulations that lowered mortgage lending standards 2 Prolonged low interest rate policy of the fed during 2002 2004 3 4 High and growing