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

  1. 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