Economies of Public Policies
Micro Economics
Macro Economics
Decisions made by individuals & firms
Price, Opportunity Cost, Factors of production
Equilibrium
Aggregate Economy, Inflation, National Output, GDP, Unemployment rate
Policies : Fiscal & monetary
Economics : Resources management ➡️ Scarcity, Limited
- Economics 2. Public 3. Policies
Capitalism
Natural resources (Land, Labour, Capital, Enterprise) ➕ Man-made resources (Capital) ➕ Man (Labor) ➡️ Entrepreneur
Govt intervention in Micro-economics : taxes, price control, price ceiling, price floor, embargoes, regulation
Assumption 1 : Scarcity ➕ Assumption 2 : Wants ➡️ Choices ➡️ Opportunity Cost
Self-Interest ➡️ Market - "invisible hand" ➡️ Competition
Flow can be measured by GDP/GDI
Business Cycles
Money is a concept.
Money is Price.
Economics : Resource management, Public Policies : intervention by the state - Why, How, When
Market failures
Normative economics
Private goods - goods provided by the individual suppliers through market
Public goods
Common resources
Beyond the market
Externalities : a cost or benefit caused by a producer that is not financially incurred or received by the producer
Markets
Provide everything (all goods & services) ❌
Most efficient ❌
Markets do not provide public goods
Self Interest / Fair play ❌
Not quite - Monopolies / Oil companies
No Monopoly / No dominance / No competition
Incomes gaps / no equity
No outside incentives ❌
Incentives ✅
No waste ❌
A lot of waste ✅
Externalities ✅
Self clearing ❌
Business cycles
Principles of market
Opportunity cost
Competition
Exchange
Comparative advantage
Factors of production
Scarcity
Market, state and basic principles of economics
People face tradeoffs
The cost of something is what you give up to get it
Rational people think at the margin
People respond to incentives
Trade can make everyone better off
Markets are usually a good way to organise economic activity
Governments can sometimes improve market outcomes
A country's standard of living depends on its ability to produce goods & services
Prices rise when the government prints too much money
Society faces a short-run tradeoff between inflation & unemployment
Efficiency (when society gets the most from its scarce resources) vs. Equality (when prosperity is distributed uniformly among society's members)
Tradeoff : To achieve greater equality,
could redistribute income from wealthy to poor. But this reduces incentive to work and produce, shrinks the size of the economic “pie.”
Opportunity cost : whatever must be given up to obtain it
Making decisions requires comparing the costs and benefits of alternative choices.
Rational people : systematically and purposefully do the best they can to achieve their objectives.
Marginal changes : incremental adjustments to an existing plan
Incentive : something that induces a person to act, i.e. the prospect of a reward or punishment
Rational people respond to incentives
Benefits for countries : Get a better price abroad for goods they produce / Buy other goods more cheaply from abroad than could be produced at home
Market : a group of buyers and sellers
"Organize economic activity" - what goods to produce, how to produce them, how much of each to produce, who gets them
Market economy : allocates resources through the decentralized decisions of many households and firms as they interact in markets
"Invisible Hand" : works through price system (Adam Smith, The wealth of nations)
The interaction of buyers and sellers determines prices.
Each price reflects the good’s value to buyers and the cost of producing the good.
Prices guide self-interested households and firms to make decisions that, in many cases, maximize society’s economic well-being.
Important : enforce property rights
Market failure : when the market fails to allocate society’s resources efficiently
Externalities : when the production or consumption
of a good affects bystanders
Public policy may promote efficiency
Government may alter market outcome to promote equity
Productivity : the amount of goods and services produced per unit of labor
depends on the equipment, skills, and technology available to workers
Inflation : increases in the general level of prices
The faster the govt creates money, the greater the inflation rate.
In the short-run (1–2 years),
many economic policies push inflation and unemployment in opposite directions.
Market Power : a single buyer or seller has substantial influence on market price
Externalities : 3rd party effects
Market failures
Inefficient resource allocation
Lost societal benefits
Underproduction of public goods
Public goods : high societal value
Examples : smoking in non-smokers / pollution - regional / traffic congestion / COVID19
Society, Public, Environment, Bystanders
Corrective action ➡️ Govt. ➡️ Policies ➡️ "Stick"
Regulations
Market efficiency
Negative externalities : Cost on 3rd parties ➡️ Pollution
Positive externalities : Clean env. ➡️ Windmills / clean energy
Carrots ➡️ Incentives
Market without externalities
Market with externalities
MC (S) ⬅️➡️ MB (B)
⬇️ P
MC ⬅️➡️ MB
⬆️ EXTERNALITIES (Cost/ Benefits)
Economic Systems
Resources
Transformation
Resources ➡️ Wants of people
Firms & households
1. What to produce
2. How to produce
3. Is it targeted? to whom?
Basic questions : What, How, For whom
Factors of influencing
Rational
Economic
Political
Other
Ideological
Basic Preliminaries
Economic System : The method used by a society to produce and distribute goods and services
Influenced factors : Political systems / Social Arrangement
3 basic Economic questions
What to produce
How to produce
For whom to produce
Traditional Economic System : relies heavily on habit, custom or ritual to answer 3 basic economic questions
Command Economic System : found within communist political systems
Focus on one particular method of livelihood
Economic roles are passed from generation to generation
Market Economic Systems : individuals and businesses answer 3 basic economic questions through voluntary exchange
Capitalism & Free enterprise
Mixed Economic System : Combines elements from traditional, command and market systems - heavily depend on one of the basic forms
Pros : Resource planning / Zero unemployment / Control of externalities / No competitive waste / Public & merit goods
Cons : Allocative inefficiency / over-manning / Lack of incentives to innovate / Lack of international trade / Shortages / Rationing
Pros : Entrepreneurship / Innovation / Variety / Profits / Consumer sovereignty
Productive resources are owned and governed by govt.
Cons : Business failure / Monopoly practices / Unemployment / Competitive waste
Productive resources are owned and run by individuals
Government : Organisations formed to exercise authority over the actions of people who live together in a society and to provide and finance essential services
The biggest agent in any economy
Political Institutions : The extent to which individuals have the right to participate in decisions that determine what governments do varies from society to society.
Constitute the rules and generally accepted procedures that evolve in a community for determining what government does and how government outlays are financed
Positive Economics : Scientific approach to analysis that establishes cause-and-effect relationships among economic variables
Normative Economics : Designed to formulate recommendations as to what should be accomplished
Objective
Not objective
Useful to the positive approach in that it defines relevant issues
Useful to the normative approach in that it cannot make recommendations to achieve certain outcomes without an underlying theory of human behavior
The efficiency criterion / Pareto optimality : Normative criterion for evaluating effects of resource use on individual well-being
Government Finance
Govt. does not earn like a firm ➡️ Govt. needs to raise funds to finance their expenses ➡️ therefore the Govt. uses taxes
Govt. taxes individuals and firms according to the value of their property
Govt. taxes ➡️ income earning activities and consumption of goods and services
Taxation is the primary source of revenue for Govt.
Market & Govt.
Markets : Incomes & payments are rationed through price
Govt :There is no direct link between taxes and the goods and services provided by the Govt. ➡️ Taxes do no ration income or expenses.
Govt. activity requires reallocation of resources from private sector to Govt. ➡️ Individuals must let Govt.to take individual's right to command, so that the Govt. can provide goods and services
Govt. Policy to tax less ➡️ incentive = benefit
Method of finance ➡️ can distort the prices of goods and services in ways that prevent competitive markets from achieving efficiency
Distribution of Income : alternative financing methods can reduce income that people have to depend on private goods and services
Alternative financing schemes can influence prices and amounts of private goods exchanged in markets
Taxes : compulsory payments associated with certain activities
Tax revenue : ➡️ purchase of inputs necessary to produce Govt-supplied goods and services ➡️ Redistribution of purchasing power among citizens
Reallocation of resources : ➡️ Ability of individuals to command resources is reduced ➡️ Revenue is used to bid for resources necessary to provide Govt. goods & services ➕ Income support to recipients of Govt.
Tax finance : resources released and made available to Govt. do not always correspond to resources required to produce the politically chosen govt. provided goods and services
Govt. demands on resources with reduction in private demands due to taxes ➡️ Relative prices of certain inputs change
Alternative to taxation : Govt. acquisition of resources directly
Tax base : Item or economic activity on which the tax is levied
General tax : taxes all components of the economic bases
Selective tax : Taxes only certain portions of the tax base, allows exemptions and deductions from general tax base
Excise tax : tax on the manufacture or sale of a particular good or service ➡️ selective tax on a particular form of wealth
Tax on profits : selective income tax ➡️ taxes only a particular form of income
Tax rate structure : the relationship between tax collected during a given accounting period and the tax base
ATR = Total Taxes Paid / Value of Tax base
MTR = 🔼 Total Taxes Paid / 🔼 Value of the Tax Base
Externalities
Market failure ➡️ Insufficient resource allocation, Lost societal benefits, Under production of public goods (those that have a high societal value)
Examples : Smoking on non-smokers, Pollution, Traffic congestion, COVID19
Negative externalities : Cost on 3rd party (Ex : Pollution)
Externalities / 3rd party effect ➡️ Bystanders
Externalities ➡️ Corrective action is taken by Govt. through the market itself ➡️ via policies and regulations (stick) and carrot (incentives)
Positive externalities : benefits (Ex : Clean energy, Education - 3rd party effect ➡️ social benefits, COVID vaccine, Fire brigade, Technology Spillover - can spread to other areas)
3rd Party Cost + PMC = Social Cost
We under price and overproduce ➡️ Negative externality
How to put : Govt. put additional taxes (Lesser Qs, Higher Ps)
Qs < Qm ➡️ Not market Eq. qty / Social Opt. qty ➡️ Social - Welfare maximised
Individual, Market & Govt.
Role of Govt : Govt. has gotten big and getting bigger ➡️ Citizens are giving up substantial amounts of their income as taxes to finance Govt. expenditure
Rise in Govt. role in economy (Ex: economic crisis) ➡️ Increasing ageing population changes policy and expenditure
If there's no Govt. : Judicial system, National defence and homeland security, Social security, Unemployment insurance ➡️ won't be there or disorganized
Microeconomics & Govt. : the role of markets as means of establishing prices that influence individual choices to use resources
Most efficient form of resource allocation ➡️ Has the invisible hand to operate the market ➡️ Assumes that markets are always clear and stable
Macroeconomics & Govt. : Aggregate behaviour and market instability ➡️ assumes that markets fail
Needs to see economy in aggregate, different from markets
Business cycles operate Govt. play in allocate resources and how individual choices, influence what Govt. policies affect the incentives of workers, investors and firms to engage in production
Govt. services & market goods : Govt. resources are used to provide citizens with goods and services ➡️ Govt. goods and services shared by all
Govt. goods and services are distributed through non-market rationing ➡️ Govt. goods and services are not made available to people according to their willingness to pay and their use is not rationed by price. (Ex : National defence)
Pure Markets : Virtually all goods and services would be supplied by private firms for profits and all exchanges of goods and services would take place through markets with prices determined by free interplay of supply and demand.
Individuals would be able to purchase goods and services freely, according to their tastes and economic capacity, given that the market determines prices
All productive resources are privately owned by individuals who decide how to use these resources ➡️ These decisions are influenced by market prices for goods and services
Private business firms are organised to hire resources in input markets to produce goods and services desired by household members
Mixed Economies : Provision of a significant amount of goods and services takes place through political institutions
This involves interactions among all individuals of the community rather than just buyers and sellers ➡️ Market goods, buyers are not compelled to purchase something they do not want ➡️ Political decisions often compel citizens to finance Govt. services
The Govt. participates in market as buyers of goods and services ➡️ Govt. use purchased inputs from households and acquire ownership rights of such productive resources as land and capital
Govt. and Taxes : The Govt. requires businesses and households to pay taxes, charges and fees
Budget Balance & Govt. Debt
Fiscal Policy : the use of govt. budget to stabilise the economy
Short term ➡️ helps to move economy back to full employment during recessions
Long term ➡️ Impact of a deficit on national saving and future living standards
Stimulus Bill : created to increase employment during the recession ➡️ Causes federal deficit
GDP : a measure of the aggregate income generated from domestic production of goods & services
Deficit as a % of GDP ➡️ burden of the federal borrowing ➡️ a share of aggregate income of the nation
Size of the federal budget deficit/surplus : influenced by the fluctuations in economic activity normally associated with the business cycle
Federal govt. expenditure ⬆️, Unemployment ⬆️
Tax revenue ⬆️, Employment and GDP ⬆️
Corporate income tax collection ➡️ sensitive to fluctuations in economic activity
Personal income tax collection ➡️ based on a progressive rate structure also fluctuate with the level of economic activity
Budget balance
Unified budget balance : the difference between all federal government expenditures and revenues "on" or "off" budgets
NIPA budget balance : official measure of federal deficit in the national income and product accounts
Real budget balance : measure of change in federal debt after adjusting for effects of inflation and changing interest rates on the real market value of the outstanding net debt
Deficits : affects resource allocation and overall size of the govt. in the economy
Surplus : used to finance new govt. spending to tax rate reductions
Higher interest rates : encourage more saving, decrease private consumption
Ricardian equivalence : when an increase in govt. borrowing to finance deficit causes increase in private saving that keeps level of interest rates fixed
Balanced budget or surplus implies that market demand for credit is equal to private demand for credit
National saving is the sum of personal saving by households, business saving, and saving by the government sector
Net contribution of government to national saving is combined deficit/surplus of federal government and all state and local governments
Reduced supply of savings can contribute to higher real interest rates and lower economic growth
Net Federal Debt – that portion of the debt of the federal government held by the general public
Internal debt – portion of a government’s indebtedness owed to its citizens
External debt – portion of a government’s debt borrowed from abroad
Comparedwithtaxfinancing,debtfinancingallows current generation more private consumption opportunities over its lifetime