Chapter 5 Unit 2 Study Guide Governments and the Economy role necessity etc A government wishes to promote the growth of the economy via a few ways This includes a low inflation rate full employment 4 5 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 Economic Growth Definition The increase in the market value of the goods and services produced by an economy Economic growth is crucial because a growing economy suggests expanding opportunities for people and businesses which is more desirable than a stagnant and declining economy Measurements The percent rate of increase in growth domestic product adjusted for inflation or real GDP The growth of the ratio of GDP to population GDP per capita which is also called per capita income Recession Negative growth rate Attributed to an increase in productivity New physical resources oil water minerals etc and Increased human resources education technology Sustainability 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 Employment Rate Ratio that measures the proportion of the country s working age population that is employed Heavily dependent on economic growth When in growth jobs open 0 is unattainable People are always changing jobs 4 5 seems to be When in recession jobs close almost full employment 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 Inflation is often caused by increases in the production of money or excess money in the economy Low inflation is desirable because inflation affects the price producers must pay to produce goods and services and also affects the price consumers pay for goods and services Inflation occurs when there are too few goods and services and labor supply available in the market makign prices rise Balance of Trade Exports Imports Positive balances are desirable because a country is less dependent on others for products service 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 Generally more exports job availability Government and Taxes Executive and Congress How much leverage do they have over the economy Approaches to Managing the Economy Keynesian Inspired largely by John Maynard Keynes Encourages deficit spending 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 Keynesian economics sees that government could act as an employer and contractor of last result as in the Depression Keyne s solution was to conceive of aggregate demand as the product of consumption government spending and investment and to argue that when demand lagged because of lags in those elements it is appropriate for government to use deficit spending and that is to spend more than is budgeted to pay for public works and to pay workers Example FDR and the New Deal program of economic recovery Classical The Classical or Laissez faire model states that we should rarely intervene Supply and demand are natural regulatory tools The economy regulates itself The classical model holds that supply and demand are natural regulatory tools thus the economy regulates itself AKA Laissez faire No interference by the government or anyone else in the regulation of an individual s affairs When in the face of recession Austerity 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 Monetary Policy Managing the supply of money Done by the Federal Reserve in the United States 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 Federal Reserve Discount Rate Fiscal Policy Taxing and Spending decisions Done by the President and Congress Taxes regressive proportional progressive Taxes solving a Collective Action Problem Society wants specific programs but individuals may not be willing to pay for them Solution give us your money or we put you in jail Tax rates in the US who pays who gets what Regulation Regulation involves government intervention in the decisions that firms make or in market outcomes Regulations are rules that affect the incentives for undertaking various activities Regulation may include legal regulation social and environmental regulations direct control of market outcomes by the use of tariffs price regulations and taxes by providing subsidies Price Setting A good can only cost X amount An outside source like the government to establish a price ceiling or floor Entry Restrictions Only specified firms may participate they meet some criteria Service Obligations Minimum standards of operations for firms Oversight Decisions that firms make are subject to government scrutiny Laffer Curve Tax cuts can lead to an increase in tax collections That is moving from a tax rate of zero to some value t leads to an increase in government revenue but beyond t government revenue decreases If taxes are far to the right in this figure there is an argument to be made that cutting them can increase government revenue Veil of Ignorance John Rawls asks readers to imagine a world in which they are born in an original position behind a veil of ignorance By this Rawls means that people would enter the world in some set way of being disregarding their intelligence and the veil of ignorance means they would not know the circumstances into which they would be born He argues that the most desirable way to organize the world would be to maximize the resources benefits rights and so on available to the least well off in society so as to ensure a floor for the poorest society Income Inequality How
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