Welcome to ECON 372: Comparative Economic Systems By: Dr. Jacqueline Khorassani

1. Marietta College, Spring 2011 Welcome to ECON 372: Comparative Economic SystemsBy: Dr. Jacqueline Khorassani Week Five Lecture Slides Source: Chapter 2 & Jackie (pp 39-52)

2. Notes • Exam 1: Wednesday, February 9 • Team 1 paper is on Japan, Sweden and France and is due on Monday, February 28 • Team 2 paper is on Germany, Russia & another country of their choice and is due on Monday, March 14

3. Another reason why pure market capitalism may result in inefficiencies • Imperfect Information (P 39) • How does imperfect information result in inefficiencies? • Asymmetric Information • You know something others don’t • Examples? • You know the car you are selling has lots of problems but the buyers don’t not know • They buy it from you at a price that is higher than the price they would have paid if they had full information. • So you have an incentive to produce more than socially optimal amount of those cars (inefficient) • Do the graph for this one yourself • Market demand is higher than full information demand

4. Is the problem of asymmetric information limited to pure market capitalistic system? • No • The same problem exists in other systems too

5. How does imperfect information result in inefficiencies? 2. Moral Hazard Problem • Keith has his car fully insured but Steve has no insurance. • Who is more likely to be a careless driver? • Insurance companies’ customers are more likely to become careless. • Does this cause inefficiencies? • If insurance company knew this, Keith’s premium would have been higher & Keith would have not insured his car fully • Insurance companies are providing more than optimal level of insurance • Is this problem limited to market capitalistic system?

6. Another source of inefficiency in market capitalism • Labor unions • Why? • They are monopolies in resource (input) market • Firms are buying all of their inputs (labor) from one supplier (union) • Union controls the wage rate (price of labor)

7. If monopoly in output market creates inefficiencies, so does monopoly in input market • Less than optimal amount of labor is supplied in the market • Less than optimal amount of output is produced. • How can you use this in your paper? • The higher the percentage of labor force belonging to unions  the lower the efficiency in production

8. Macroeconomic Instabilities of Market Capitalism (pp 43-48) • Market economy may result in a higher unemployment rate than a planned economy • Why? • Private firms need to make profit to continue producing • Need to minimize cost when possible • If no demand for output, then no demand for labor  unemployment • Substitute a cheaper input for labor when possible  unemployment

9. Why unemployment is less of a problem in planned economy? • An state owned enterprise can afford to operate at loss for longer time than a privately owned business. • They are less likely to lay off workers

10. Up until the Great Depression • The general belief was that • The invisible hand would work • What is the role of the invisible hand? • Markets (including the labor market clear quickly) • Recession (and the resulting unemployment) is temporary • As soon as the unemployed workers lower their wage expectations, they will find employment • This is the Classical view

11. LRAS1 Price level LRAS2 Wage SRAS1 • Classical View 1 S 10 2 SRAS2 8 3 4 D1 D2 AD1 AD2 Labor 15 100 RGDP 12 95 • 15 workers are hired and RGDP = 100 (full employment) • If for some reason AD drops to AD2 • Demand for labor drops to D2 • At a wage = 10 , surplus of labor wage drops no unemployment • SRAS increases (due to lower wage) • LRAS decreases (due to smaller work force (12 instead of 15) which lowers the capacity to produce)

12. But the invisible hand did not work very quickly in 1930s • Labor market did not clear. Why? • Labor unions would not let wage rate drop (Classical View) • Firms did not invest (despite low interest rates) because of their pessimistic views about future sales (Keynesian View) • No investment = no hiring

13. Keynesian view on recession • The invisible hand needs a push sometimes • In times of recession government should conduct expansionary fiscal and monetary policy

14. Fiscal Policy • What is it? • Using taxation or government spending to • Decrease unemployment • Decrease inflation • What are the fiscal policy tools? • Government spending (G) • Taxes (T)

15. Types of fiscal policy • Contractionary • When is it implemented? • When there are inflationary pressures in economy • Graph • Reduce G or increase T • What if G goes down? • What if T goes up? • Expansionary • When is it implemented? • When there are recessionary pressures in economy • Graph • Increase G (especially investment spending) or decrease T • What if G goes up? • What if T goes down?

16. Monetary Policy • What is it? • Decrease (expansionary) or increase (contractionary) in interest rates • Tools? • Open market operation, discount rate, reserve requirement

17. Expansionary monetary policy? • When? • When the economy is in recession • How? • Decrease interest rates • Firms and households borrow more • Buy more • Invest more • AD goes up Production and employment goes up • Contractionary monetary policy? • When? • In case of inflationary pressures • How? • Increase interest rates • Firms and households borrow less • Buy less • Invest less • AD goes down price goes down

18. Note • Both fiscal and monetary policies are demand side policies. • Their immediate effect is on AD • There also supply side policies • To shift the SRAS