Ch 5 The Economy and Income Security Introduction control them Presidents typically win or lose over economic conditions but can do little to The Political Marketplace The Foundation of the Economy The problem of collective action o As group size increases it is more difficult to act collectively because there is a greater incentive to free ride Approaches to Managing the Economy Economic Goals Governments wish to promote economic growth low inflation full employment and a positive balance of trade o Economic growth Expanding opportunities for people and businesses which is more desirable than a stagnant or declining economy o Low inflation Inflation occurs when there are too few goods and Classical Economic Model services available making prices rise o Full employment 4 5 o Positive balance of trade Better to be a net exporter and import a smaller portion of what you consume Less dependent on other countries Though importing is sometimes better for consumers ex cheaper cars o Holds that supply and demand are natural regulatory tools thus the economy regulates itself Laissez faire High unemployment or high inflation result from changes in technology or government interference o Problems It is not possible to have a large market economy without the government to say government should be hands off is to call for a very small economy Under a variety of conditions information asymmetries poor institutions monopoly etc markets operate inefficiently o Austerity Policies that reduce a government s budget deficit Classical approach favors austerity in times of a recession Keynesianism John Maynard Keynes o The view that in the short run especially during recessions economic output is strongly influenced by aggregate demand total spending in the economy o Encourages deficit spending o Ex FDR New deal Though some argue the monetary policy of abandoning the gold standard helped the US recover more quickly Tools for Managing the Economy Fiscal Policy Taxing and spending decisions o Progressive taxation Wealthier members of society pay a higher portion of their incomes as taxes o Flat tax All earners pay the same rate People argue that a flat tax leads to a much higher incidence of taxes on low income people making it more of a regressive tax o Regressive taxation Poorer persons pay a larger share of their income Ex Sales taxes and Excise taxes on alcohol and tobacco o Tax incidence Refers to who pays the tax Ex People who work pay a portion of their income into Social Security o Tax deductions Reduces taxable income Ex Receiving tax deduction for paying tuition Monetary policy Managing the supply of money o The Federal Reserve Board consists of Chairperson Appointed by President and Senate for 4 year terms Current is Janet Yellen Six Board of Governors Appointed by President and Senate for 14 year terms o Sets discount rate for member banks Lower discount rate Lower interest rates for customers Money is inexpensive to borrow Companies will expand people will build houses buy cars etc Higher interest rate is desirable when inflation is too high o Fed often criticized for wielding too much power that cannot be checked market outcomes Regulation Government intervention in the decisions that firs make or in o Happens during market failure monopolies information asymmetries etc o Price setting Establishing a price ceiling or floor on an industry with limited competition Ex Medicaid Producers doing this is called price fixing and is illegal o Entry restrictions Franchises certificates of need and license fees Introduces a barrier to entry Doctors need certification o Service obligations Hospitals must provide care for people in need o Criticized as a hindrance to economic growth o Supply side approach or trickle down economics Favors tax cuts Taxes o Leads to regressive taxation Logic is that excess taxation reduces the incentive to invest in the economy as holders of capital and dividends choose leisure over investment as a way to use their time o Laffer Curve tax collections According to the Laffer Curve tax cuts can lead to an increase in Tax Rates and Government Transfers Tax deductions are sometimes referred to as tax expenditures for the government is essentially giving money back to individuals that meet the criteria Measured by the U S Bureau of Labor Statistics More whites employed than blacks and employment increases with level of Unemployment education Deficits and Debts Since 1995 the US government has had a budget deficit for all but four years o 1998 1999 2000 2001 The public debt is the accumulation of deficits over the years o Increased dramatically following the war in 2001 and bailout in 2009 o Is about 18 5 trillion o Only way to reduce deficit and debt is to Cut spending raise taxes or both Service taxes tradeoff The problem that results in the deficit and in rising debt Government sells treasury bonds to investors o State governments cannot do this must sell bonds on private markets How Do Societies Ensure That Their Members Have Economic Security Rawls Veil of Ignorance o Philosopher John Rawls asks readers to imagine they were born in an original position behind a veil of ignorance Rawls argued most desirable way to organize world would be to maximize the resources benefits rights etc available to the worst off o Described as a maximum plan In contrast according to the utilitarian principle John Harsanyi argued that the best way to organize society is so the highest average benefit should be accorded to citizens The Mixed Solution o Norman Frohlich and Joe Oppenheimer tested these competing solutions Concluded that most frequently preferred solution is one in which individual earnings may be maximized but a floor beneath no person will fall exists How to Provide Income Security Savings save 12 The Income Inequality problem o US Households save on average 4 5 where Swedish households o Income Inequality The extent of the difference in total earnings between the highest income people in an area and those with the lowest incomes o Why is there so much inequality Incomes of those with substantial amounts of capital will see their incomes and wealth rise at a greater rate than others Primary way this inequality has been broken in the past is with significant increases in top tax rates WWI WWII Reduction in tax progressivity Since the end of WWII the richest members of society have seen their tax rates decrease Beginning in the 1970 s incomes in English speaking countries began
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