PUP 3002 01 Exam 2 Study Guide Chapter 5 The Economy and Income Security Why is it difficult to arrange collective action institutions to support the widely agreed upon idea that citizens should not fall below a basic income floor o As group size increases it is harder to act collectively because there is a greater incentive to free ride Microeconomics analyzes individual markets Macroeconomics analyzes the economy as a whole Economic Goals o Although difficult governments wish to promote economic growth low inflation full employment and a positive balance of trade Economic growth is crucial because a growing economy suggests expanding opportunities for people and businesses which is more desirable than a stagnant or declining economy The increase in the market value of the goods and services produced by an economy Recession negative growth rate Growth is attributed to an increase in productivity New physical resources oil water minerals etc Increased human resources education technology Growth is measured by The percent rate of increase in growth domestic product adjusted for inflation or real GDP also called per capita income o The growth of the ratio of GDP to population GDP per capita which is The world economy has experienced relatively low growth since the recession of 2008 although the rate of growth has increased recently While growth is good too much too quickly can at times be suboptimal This is often the case when growth is due to new resources or new access to resources Low inflation is desirable because inflation affects the price consumer s pay for goods and services Inflation The purchasing power of money When inflation is high the things you want cost more When inflation is low the things you want cost less Often caused by increases in the production of money or excess money in the economy Inflation occurs when there are to few goods and services including labor supply available in the market making prices rise Too little production or services pursuing money True full employment is not really achievable but 4 5 unemployment is considered full employment The drive to keep inflation low creates an unemployment floor below which unemployment will not be allowed to move o Classical economic model holds that supply and demand are natural regulatory tools thus the economy regulates itself A k a laissez faire invokes a policy that there should be no interference by government or anyone else in the regulation of an individual s affairs High unemployment and high inflation are a result from changes in tech and or government interference in the economy Two problems with letting the government correct itself It is not possible to have a large market economy without the government Markets operate inefficiently because of info asymmetries poor institutions liquidity deficits monopolies etc o Austerity policies that reduce a government s budget deficit They involve reducing gov t spending raising taxes or both Those favoring the classical approach favor austerity in times of recession The classical model says that in the face of recession we should use austerity because As economy worsens tax revenue decreases With lower revenue decrease government spending Don t go farther into debt when you have no income When the economy recovers spending can increase o Gross Domestic Product the total monetary value of all goods and services produced within a county in a given time period o A positive balance of trade is often politically desired because the average citizen believes it is better to be a net exporter and import a smaller portion of what they consume Net importer nations are less independent than nations that import less Positive balances are desirable because a country is less dependent on others for products Generally more exports job availability o Keynesian Economic Model governments can act as an employer and contractor of last resort Deficit spending to spend more than is budgeted to pay for public works and to pay services workers FDR was a huge supporter The new deal Government spending as a means by which to curb recessions especially in the creation of public sector jobs Argues that austerity increases the burden on citizens and prolongs recessions The President the Economy o National leaders particularly the President live and die by the economy o In times of low inflation growth low unemployment and positive trade balances approval rates are high as are re election rates o As these decrease turnover is high o The average voter model President Economic Conditions o Is this correct Probably not entirely President Other Leaders Bureaucracy World Conditions Domestic Conditions Tools for managing the economy External Events Economic Conditions o Fiscal policy has to do with taxing and spending Governments the President and Congress determine what to tax and how much to tax in order to pay for gov t services and to spur economic growth o Monetary policy involves managing the supply of money The Federal Reserve Board acts semi independently from the exec and leg branches When interest rates are low and money is inexpensive to borrow it is more likely that people will spend more The Federal Reserve Chairperson Selected by President approved by Senate 6 other members selected by President approved by Senate The Feds main job is setting the discount rate The rate member banks have to pay the Fed for money Lower discount rates to banks translate into lower interest rates for consumers When interest rates are low money is inexpensive to borrow it is more likely that companies will expand facilities people will build houses etc More expensive interest rates constrain economic activity o Regulation involves government intervention in the decisions that firms make or in market outcomes Regulatory interventions happen because of market failures Market failures include Natural monopolies oligopolies incomplete or missing markets info failures Regulation includes legal regulation social and environ regulation taxes and subsidies Price Setting may involve an outside source like a gov t to establish a price ceiling or floor on an industry with limited competition A good can only cost X amount A producer setting the price is considered price fixing and is illegal Entry restrictions Only specified firms may participate they meet some criteria May also serve as a form of economic protection for a trade by introducing a o Barrier to entry Service obligations Minimum standards of
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