EEconomic Freedom EEconomic Growth EEconomic Stability EEconomic Equity EEconomic Efficiency.

Role of GovernmentUnit 4

Economic Freedom

Economic Growth

Economic Stability

Economic Equity

Economic Efficiency

Broad Social Goals

Provide a legal system

Provide public goods

Correct market failures

Maintain competition

Redistribute income

Stabilize the economy

Role of Government

Define property rights – Legislation

Transfer property – Contract Law

Protection of property- Criminal and Tort Law

Strategies in court proceeding – Game Theory

Legal System

The right to private property is one of the most basic characteristics of the market system.

Must bewell-definedenforceable marketable

Private Property

Laws that grant property rights to the creator of new ideas and new inventions.Patents Copyrights Trademarks

Intellectual Property Rights

Lacks a strong legal system poor property rights lack of investment poor

economic growth

Why Capitalism fails other places?

In order for capitalism to function a country must have, enforceable, marketable, and well defined property rights

One solution: Grameen Bank Micro Loans

http://www.grameen-info.org/

Who wrote, “In this world nothing is certain but death and taxes”?Benjamin Franklin

Who was the author of The Wealth of Nations?Adam Smith

Who wrote The General Theory of Employment, Interest and Money?John Maynard Keynes

What does TNSTAAFL stand for?There’s no such thing as a free lunch

Economic Quiz

A good that, once produced, is available for all to consume, but the producer cannot easily exclude nonpayers.

Public Goods

Shared consumption - one person consumes a public good, it does not prevent others from also consuming the good

Nonexclusion - once produced it is difficult if not impossible to exclude others from consuming the good, even if they did not pay for it.

Free Rider - people who consume a public good without paying for it.

Public Goods

Exclusionary – can exclude those who have not paid for the good or service

Non shared consumption (Rival) – prevent simultaneous consumption by other consumers.

Private Goods

Public? Private? Or Private with Shared? College education Electric Power National Defense Groceries Water Professional sports events Postal Service Interstate highway

facilities Elementary schooling Police protection

Theatres Flood control Spraying for Mosquitoes Toll roads Parks Cable TV Congested roads Ice cream Haircuts

When some of the costs or benefits associated with the production or consumption of a product spill over to third parties, who do not produce or pay to consume the product.PositiveNegative

Externalities

Negative Externalitiesare costs incurred by

someone who does not produce or pay consume a productExamples: pollution,

smoke, barking dogOverproduction/

overallocation Government taxes

or fines

Visual 5.2

Illustrating a Negative Externality

Positive Externalitiesare benefits enjoyed

by someone who does not produce or pay consume a productExample: public

education, flu shot, fire protection

Underproduction/ underallocation

Government subsidy

Visual 5.3

Illustrating a Positive Externality

Correcting a Positive Externality

A lack of well defined property rights enforceable, and marketable.

The Tragedy of Commons- Objects that are held “in common” by society that has no incentive to maintain them.

Examples: Environment, endangers species and public property.

Problem

Policy #1 Create property rights that are: well defined, well enforced, and marketable. The fish are not over fished

Policy #2 Create a change in Benefit (X) or

Cost (X) through subsidy or tax.

Policy #3 Government Regulation

Step 3 Consider Policy Alternatives

Kenya, Tanzania, Uganda- made it illegal to kill elephants and sell ivory-laws are hard to enforce and the population continues to decline.

Real Problems

Botswana, Malawi, Namibia, Zimbabwe have made elephants a private good by allowing people to kill elephants but only those on their property. Landowners now have an incentive to preserve species on their own land.

Elephant population increasing (profit motive on its side)

Real Solutions

Private PropertyFree EnterpriseSelf-InterestCompetitionMarkets and Prices Limited Government

Basic Characteristics of a Market System

Benefits of CompetitionForces produces to

operate efficientlyLowers prices Improves the quality

of goods and services

Forces producers to be innovative

Perfect Competition Monopolistic Competition OligopolyMonopoly

Market Structure

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

Adam Smith, 1776Wealth of Nations

Monopoly Pure monopoly –

(rare) industry is the firm!

Near monopoly– single firm has the bulk of sales in a specific market

Natural Monopoly – high fixed costs – gas, electricity, water, telecommunications, rail

65%

90%

Intel -80%Western Union- 80%Brannock – 80%

May be appropriate if natural monopoly

Encourages R&D

Encourages innovation

Development of some products not likely without some guarantee of monopoly in production

Economies of scale can be gained – consumer may benefit

Advantages of a Monopoly

Consumer pays higher prices

Potential for supply to be limited - less choice

Potential for inefficiency –

X-inefficiency – complacency over controls on costs

Disadvantages of a Monopoly

What can policymakers do?

Make a monopolized industry more competitive- Break it up.

Regulate the behavior of the monopolies

Turning some private monopolies into public

Doing nothing at all

Monopoly Regulation

A few competitors in the market SupermarketsBanking industryChemicals

Covert Collusion: Cartels are illegal in the US

In 1993- Borden, Pet, Dean food companies plead guilty to rigging bids on prices of milk products sold to schools and military bases.

Overt Collusion: Cartel- a group of producers that typically creates a

formal agreement to how much they will charge or produce.

Example: Organization of Petroleum Exporting Countries: OPEC

Oligopoly

Outcomes depends jointly on the actions of each participant.

Strategic behavior-self-interested behavior that takes into account the reaction to others

Mutual interdependence- a situation in which each firm’s profits depends not entirely on its own price and sales strategies but also on those of the other firms.

Game Theory

Prisoner’s Dilemma

Confess Silent

Confess 3 yrs 3 yrs 0 20 yrs

Silent 20 yrs 0 1yr 1yr

Each player is individually better off confessing if the other player confesses or remains silent, but the best outcome for the group is to cooperate and both go free.

Dominant strategy is to confess, a Nash Equilibrium exists.

Bonnie –Prisoner 1

Clyde - Prisoner 2

Adam Smith needs

revision

Dilbert announces

that his knowledge of the prisoner’s dilemma will save him.

Common knowledge is generally a dizzying concept. But, a single stage of reasoning, or even two, often misses strategic complexity, as in this episode

The importance of knowing the game's rules, if the rules

of the game change, then the game can be rigged to one player's advantage.

Using Game theory to predict

behavior.

Transfer of income from some individuals to othersthat money should be distributed to benefit the poorer

members of society

that the rich have an obligation to assist the poor

Questions Society must answerWho needs help?

How much?

How should it be allocated?

Private or public responsibility?

Redistribution of Income

Progressive –average tax rate increases as the taxpayer’s income increases and decreases as the taxpayer’s income decreases.

Flat- average tax rate remains constant as the taxpayer’s income increases or decreases

Regressive- average tax rate decrease as the taxpayer’s income increases and increases as the taxpayer’s income decreases

Taxes

Taxes

An economics professor at Texas Tech said he had never failed a single student before but had, once, failed an entire class. That class had insisted that socialism worked and that no one would be poor and no one would be rich, a great equalizer. The professor then said ok, we will

have an experiment in this class on socialism.

All grades would be averaged and everyone would receive the same grade so no one would fail and no one would receive an A. After the first test the grades were averaged and everyone got a B. The students who studied hard were upset and the students who studied little were happy. But, as the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too; so they studied little. The second test average was a D! No one was happy. When the 3rd test rolled around the average was an F.

The scores never increased as bickering, blame, name calling all resulted in hard feelings and no one would study for the benefit of anyone else. All failed, to their great surprise, and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great; but when government takes all the reward away; no one will try or want to succeed.

Could not be any simpler than that....

A Simple Story

Deficit/Surplus/Debt Tax Revenue – Government Spending=

Deficit – negative balance government must borrow.

Or

Surplus – positive balance

Debt- The total accumulation of the deficits the Federal government has incurred through time. Total amount owed. US securities: Treasury bills, Treasury Notes, Treasury Bonds and US Saving Bonds 2008

2012$15,574,428,564,198.34

$10,852,628,401,130.22

A Trillion Dollar

1 Million Dollars

$10,000

100 Million Dollars1 Billion Dollars

1 Trillion Dollars

National debt is the sum of all securities issued by the US Treasury

US Debt

US Deficit / Surplus

Special Interest Pork Barrel Spending the

politicians win political favor with a small group of highly valued local constituents by spending on projects that cannot others wise be economically justified.

Logrolling trading votes to secure favorable outcomes can either diminish or increase in economic efficiency.

The total market value of all final goods and services produced in a country in a year.

Gross Domestic Product (GDP)

Final good: A hamburger Intermediate good: meat, bun, lettuce, tomato

Spending by households on goods and services such as food, rent, medical expenses and so on but does not include new housing. 2/3 of GDP

Consumer Spending (C)

Spending by business on machinery, factories, equipment, tools and construction of new buildings.

Investment (I)

Spending by people abroad on US goods and services (exports) minus spending by people in the US on foreign goods and services (imports)

Net Exports (Nx or X-M)

Government Spending (G)Spending by all levels of government on

goods and services. Includes spending on the military, schools, and highways.

Not included in GDP

Secondhand SalesIllegal activities Transfer payment Financial transactionsIntermediate Goods

Intermediate good: meat, bun, lettuce, tomato

Business Cycle

Changes in federal-government spending or taxes.Expansionary Fiscal PolicyContractionary Fiscal Policy

Fiscal Policy

designed to stimulate the economy in a recession

↑government spending and/or

↓ taxes

Expansionary Fiscal Policy

designed to slow down the economy to control inflation

↓ government spending and/or

↑ taxes

Contractionary Fiscal Policy

Frictional - workers “in between” jobs

Structural- workers whose skills are not demanded by employers

Cyclical- workers unemployed because of a slow down in the economy (recession).

Unemployment Map

Types of Unemployment

A rise in the general level of prices

Measurement of inflation CPI Consumer

price index

Inflation

Germany Aug. 1922-Nov. 1923Inflation Rate 1,020,000,000,000%

Before 1920, one mark would buy a full meal for 2 By Nov. 1923, a foot high stack of 50M mark notes to

feed one couple. German prices rose at the rate of 41 percent per day

Hungary Aug. 1945- 1946381,000,000,000,000,000,000,000,000,000%

Octillions

Worst Inflation on Record

x-mas price index

Money serves these functions:It is a medium of exchange It is a store on valueIt is a measure of value

What makes money important ?

The central bank’s attempt to control the supply of money to influence the national economy.

Monetary Policy

Contractionary Monetary Policy Fed’s actions that contract the growth of the nation’s money supply for the purpose of reducing inflation

Expansionary Monetary Policy Fed’s actions to increase the money supply to lower interest rates and expand real GDP.

Exchange equation M: the supply of money in the economy V: the velocity of money, number of times a

year the averageP: the overall price level in the economy,

reflecting the average price at which all output is sold

Q: the quantity of all goods and services produced; also know as real output

MV=PQ

Will Rogers

“There have been three great inventions since the beginning of time: fire, the wheel, and central banking”

The central bank for the US

Created in 1913

Chairmen of the Fed Janet Yellen

Federal Reserve Bank (FED)

Conduct monetary policyAct as the nation’s bankServe as bankers bankRegulate some transactions at banks and

other financial institutions

Functions of the FED

Federal Reserve Regions

The Fed

In which only a fraction of the total money supply is held in reserve as currency.

Banks create money with loans.

Repayment of loans destroys money.

Fractional Reserve Banking System

a certain percentage of the deposits people make in the bank that the bank must keep in its’ vault.

Excess ReservePart of the deposit that is not required in

reserves that the bank may loan out.

Required Reserve Ratio

Money Multiplier- 1 Reserve requirement ratio

Deposit X Multiplier = ↑ Money supply

Money Multiplier

Discount Rate

Buying /Selling Government Bonds

Reserve Ratio

Fed’s Tool Box

Interest Rate that the Fed charges bank for a loan

↓ IR- ↑ Money Supply

↑ IR- ↓ Money Supply

Discount Rate

Selling of US Bonds-↓ money supply

Buying of US Bonds-↑ money supply

Most frequently used by the Fed

Buying /Selling Government Bonds

Changing the amount of reserves that a bank must hold.

↑ RR - ↓ Money Supply because bank will lend less money out.

↓ RR- ↑ Money Supply, lend more money out.Rarely used by the Fed

Reserve Ratio