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Chapter 12

Chapter 12. Government Decisions and Economic Success. What role should the government play in our economy?. Role of Government. Free market protection Anti-monopoly Public Goods/Services Economic Stability Protection/Sovereignty Preservation of Rights Regulation of Trade

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Chapter 12

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  1. Chapter 12 Government Decisions and Economic Success

  2. What role should the government play in our economy?

  3. Role of Government • Free market protection • Anti-monopoly • Public Goods/Services • Economic Stability • Protection/Sovereignty • Preservation of Rights • Regulation of Trade • Foreign Affairs

  4. Disagreements • Objectives • Priorities • Poverty vs. Investment? • Inflation vs. Unemployment? • Free Trade vs. Protectionism?

  5. Theories of Govt. Involvement • Classical School • Adam Smith- Laissez-Faire • Jean Baptiste Say • Free-Market emphasis • Less govt. intereference • Keynesian School • Govt. spending can fix economies

  6. The Classical Theory • Free-markets correct themselves • Supply and Demand • Wages • Prices • Interest Rates • Tend towards Full-employment in the long-run • Little need for Govt. intervention • Great Depression challenged this notion • Micro-economics

  7. John Maynard Keynes Father of Macro-economics Keynesian Economics

  8. Spending drives the economy • People • Businesses • Govt. • Recessions • Must rely on Govt. spending • Increase Demand • AD= C + I + G + Trade Balance

  9. Keynes (cont.) • Key tools (Fiscal policy) • Taxes • Govt. Spending • Recession • Decrease taxes or increase spending • Expansion • Increase taxes or decrease spending • “Fine tune the economy”

  10. Political Reality of Demand Side Policy NO MATTER HOW THE ECONOMY IS DOING • Democrats rarely want tax cuts • Republicans rarely want tax increases • Democrats push for more spending • Republicans (in theory) push for spending cuts.

  11. Fiscal Policy • Taxing and Spending (Congress) • Discretionary • Requires action by Congress, President, or agency • Automatic • Doesn’t require new action • Ex. Welfare, Unemployment Benefits, Income taxes

  12. Weaknesses in Keynesian Theory • Predicting/Analyzing the economy is hard • Debt/Deficits • Time lags • Inflation vs. Unemployment Dilemma • Inflation: Cut spending or increase taxes • Unemployment: Opposite • “Crowding-out Effect” • Increased spending/borrowing • Increases interest rates • Decreases private spending • Inflation without growth in Long Run

  13. Demand-Pull Inflation

  14. Focusing on shifting supply curve to the right increase employment decrease inflation. Decrease Costs of Production “Trickle Down Theory” Encourages Investment Job creation Reduced inflation Supply-Side EconomicsMilton Freidman

  15. Supply-Side Weaknesses • Markets don’t always “clear” back to equilibrium • “downward sticky” wages • Workers won’t accept lower wages • Unions • Minimum wage laws • Unemployment doesn’t “fix” itself fast enough.

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