ECON chapters 8, 10, and 11
Is defined as an increase in the money supply which provides a short-term stimulus to the macroeconomy resulting in higher levels of output employment and incomes
Expansionary monetary policy
What is an Externality?
Externality, or external effect, is present if an activity significantly impacts the wellbeing of someone other than the persons directly engaging in the activity.
Reserve Requirements
Reserve Requirements refer to minimum restrictions on the amount of money that a bank must keep on hand at any point in time, in the form of either cash in its vault or deposits with the central bank.
Which of the following is a good example of a pure public good
National Defense
Rent Seeking Define and explain the phrase. Is it illegal the same way that corruption or kleptocracy is? Explain how peanut farmers getting the government to pass a tariff law (tax on imported peanuts) is beneficial to them but damaging to the rest of society.
• Rent seeking is the attempts by people to manipulate government action or influence government decisions in order to make themselves better off at the expense of others. Groups of individuals or firms with common interests usually try to lobby the federal government to act in their favor without regarding the overall interests of others. • Rent seeking is not illegal in the same way that corruption or kleptocracy is since rent seekers usually try to use methods based on legal merit in order to gain governmental favor. • Consider the following scenario: Georgian peanut farmers convince Congress to pass a tariff of $10 per pound of peanuts against Chinese peanuts. o Benefits to Georgian peanut farmers: a. This artificially benefits the Georgian peanut farmers because they can now sell more peanuts at higher prices (without having to improve the quality of their peanuts) since the Chinese now have an extra burden in the market. o Damages to the rest of the U.S. economy: Peanut connoisseurs in the United States now have to pay more for the same quality of peanuts.
Discuss the Consumer Price Index: Who collects and interprets the data? How? How often?
• The Consumer Price Index provides a "measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services". • The Department of Labor's Bureau of Statistics collects and interprets the prices of the certain list of items that are purchased at a regular basis by a metro family of four on a monthly basis. These prices are acquired by government-employed "secret shoppers" who scour many stores and restaurants for the prices of said listed items.
What is the root of the word "kleptocracy"? How is it related to "crony capitalists"?
• The word "klepto" (the root word) means "to steal or thief" while "cracy" means "rule by". Therefore, the literal meaning the word kleptocracy means "rule by thieves". As such, a kleptocracy is a government with corrupt leaders (kleptocrats) that use their power to exploit the people and natural resources of their own territory in order to extend their personal wealth and political powers. • Since government officials and businesses often have close interactions, it is not hard to conclude that kleptocrats and crony capitalists can behave similarly in order to benefit themselves personally (at the expense of the government and economy). o For example, crony capitalists can bribe kleptocrats so that they (the crony capitalists) can rig the economy in their favor.
Informational Problems What information does government lack when making a decision about what govt. provided goods to produce? How does a market system get this information? How does this relate to the "Economic Calculation Problem" outlined in our text?
• When making a decision about what government-provided goods to produce, the government lacks the knowledge of the true marginal cost or marginal benefit of the decision (i.e. market transactions). • A market system gets this information by observing the self-interested behavior of the participants and graphing their observations through supply and demand curves. • The "Economic Calculation Problem" points that a system of planning can never achieve efficient outcomes precisely because the planners do not have the information generated by market transactions available to them.
What are the 7 specific causes of Government Inefficiency or Failure?
1. Informational Problems 2. Cost of Compliance Problems 3. Corruption or Kleptocracy 4. Regulatory Capture 5. Rent Seeking 6. Logrolling and Rational Ignorance 7. 7.Deadweight loss of Taxation
What are the four major sources of market failure that we identified in class?
1. Problem of "Market Power" or Monopoly 2. Problem of Public Goods and Common Property 3. Problem of Market-generated Externalities 4. Problem of lack of information
What is a "medium of exchange"? How does it differ from barter?
A "medium of exchange" is an intermediary instrument used to facilitate the sale, purchase or trade of goods and services between parties. This action eliminates the "Dual Coincidence of Wants". A "medium of exchange" is different than bartering because a "medium of exchange" is used instead of a good/service as an instrument to facilitate trade between different members of the economy.
What is a Common Good or Common Resource? What are its characteristics? Give examples.
A common good or common resource is a hybrid good that that is simultaneously rival and non-excludable, sharing one characteristic each with both a private good and a public good. Some examples are wild fish in the ocean and air.
What is a negative externality? Give an example.
A negative externality, or external cost, refers to a burden borne by someone other than the buyer or seller of a good. They are negatively affected by others and not compensated. An example is any sort of pollution.
What is a positive externality? Give an example.
A positive externality, or external benefit, refers to the gain realized by someone other than the buyer or seller of a good. Positively affected by others and are free-rides. Some examples are vaccinations, installations of smoke detectors in attached apartments, basic scientific research, and the installation of Lojack in automobiles.
Which of the following is not one of the primary policy tools used by a Central Bank
A) loaning money to low-income homebuyers at below-market interest rates in order to make housing affordable for all b) setting the discount rate C) setting the reserve requirements
Place a solid horizontal line below the equilibrium price that you have identified, and label it a price ceiling. What will happen to Quantity demanded at the price ceiling? What will happen to Quantity Supplied at that same price? Do we have a surplus or shortage of cell phones?
After the price ceiling was put in place, the quantity demanded became greater than the quantity supplied. As a result, we have a shortage of cell phones.
What is Agenda Control?
Agenda control is the capacity to set the choices that are available to others.
What happens in the long-run to the price level if the money supply doubles? Is cut in half?
Assuming both V and Q are constant, the price level will double in the long-run if the money supply doubles. Assuming both V and Q are constant, the price level will cut in half in the long-run if the money supply is cut in half.
Explain Allocative Inefficiency. Why is a government that produces either too much or too little of a public good inefficient?
Allocative Inefficiency is occurring if the government is not allocating scarce resources to the production of goods that are most highly valued. (Is the government producing too many things or too little things?) A government that produces either too much or too little of a public good is inefficient because it either produces a scarcity of the public good or a surplus of a public good respectively (i.e. something that is different from the market equilibrium).
Suppose that the value of consumer price index of Canada increase from 178.3 up to 180 4.8 between 2017 and 2018.Based upon these values Canada's inflation rate for 2018 was
Approximately 3.65%
The FED can increase the money supply in the US by
Decreasing the discount rate
Can private firms protect a common resource? Why not?
Firms cannot protect a common resource because it due to its non-excludable nature.
Which of the following is not part of the coasian solution to the problem of externalities
Prevent parties from negotiating with one another regarding infringement of property rights caused by externalities
Draw a graph to illustrate what happens to interest rates when money supply is reduced. Explain the impact of the now higher interest rates.
Higher interest rates cause lower consumption by consumers and lower production by producers, decreased amounts of loan borrowing, and an increased incentive to save rather than spend. Additionally, higher interest rates on the short-term may indirectly prevent inflation for some time.
Economic problems caused by the hyperinflation
Hoarding and stockpiling create shortages of durable goods, such as automobiles and washing machines. Even perishable goods, like bread and milk, become scarce as the economy falls apart. People lose their life savings as cash becomes worthless. For that reason, the elderly is the most vulnerable to hyperinflation.
What would happen to that price level in the long-run if the government printed another $5,000?
If the government printed another $5000, the price level in the long-run would be increased to $7.50.
Money and Inflation: How is the inflation rate tied to the Money Supply?
If the money supply increases, then the inflation rate will also increase, and vice versa.
Explain the mechanism of enforcement that keeps a government from printing too much money under a gold standard.
In order to back money with gold, a country agrees to two requirements: the first is that no paper will be printed without gold in the government's vault as security and the second is that anyone holding paper money has the right to redeem it for a fixed quantity of fold form the issuing government. The first requirement is enforced by the second. If a government tried to issue an amount of currency well in excess of the amount of gold it had on hand, then it would open itself up to a "run" on its vaults, by which we mean a situation where many people choose to redeem their paper money for the gold at the same time but there is not enough gold for everyone to do so.
What was the result of hyperinflation in Germany in the 1920's?
In the 1920's, the hyperinflation in Germany caused the destruction of the savings of the middle class and political unrest (in terms of the rise of the Third Reich). The inflation got to 29,500 % in October 1923 that caused prices to double every 3.7 days. Ex: "it took a basket full of paper money to go shopping" "money was cheaper than wall paper" "shows that cost 12 million Marks in 1913 sold for 32 trillion Marks in 1923".
Draw a graph of the Loanable Funds market and show a right-ward shift in money supply. What does this do to market interest rates?
Increasing the money supply lowers the market interest rates (as shown in the graph).
One of the principal functions of money is that it serves as a store of value this role could be described by recognizing that money
Is an asset that can be used as a means to hold wealth
The Central Bank of the United Kingdom
Is the Bank of England which was founded in 1694
How can it be rational to be ignorant of what your government representatives are doing in Washington or in various state houses?
It can be rational to be ignorant of what your government representatives are doing in Washington or in various state houses because being informed often yields high costs and produce little benefits. (If the majority of other people don't want to know about something, why should you?)
Equation of exchange is
MV = PQ
Define Market Failure in terms of efficiency. What is the "market" failing to do?
Market failure refers to situations in which the free market outcome is inefficient, in that there is a positive Deadweight Loss at the free market level of trade (i.e., the level of trade that emerges from the interaction of self-interested buyers and sellers). The market is failing to come up with an effective solution to money issues (i.e. generate the perfect outcome).
Last weekend Brenda won $1,500 at a casino in Mississippi. She decided to use the money to purchase a new TV from Walmart she was able to use the money to acquire the new TV since money serves as a
Medium of Exchange
Are price controls successful at tamping down inflation when the government is continuing to increase the money supply? What will solve the inflation problem?
No, price controls are not successful at tamping down inflation when the government is continuing to increase the money supply because 1. price levels are not the root cause of the economic problems 2. it will only curb inflation temporarily but as soon as you let price control go, prices will fly back up again Decreasing the money supply over time and increasing the reserve requirements (the minimum restrictions on the amount of money that a bank must keep on hand at any point in time) will solve the inflation problem.
Government failure can be described as a situation in which
Milton Friedman
Can a government on a gold standard use expansionary monetary policy to stimulate the economy during a recession?
No, government cannot use expansionary monetary policy to stimulate the economy during a recession because the government would be forced to take a passive approach to the problem and the economy would be expected to recover in time (but only after a prolonged period of higher than normal unemployment and lower than normal economic growth).
Has any country ever had a hyperinflation when on a gold standard?
No, no country has ever had a hyperinflation when on a gold standard.
Do price controls help consumers on net?
No, price controls do not help consumers on net because price controls were invented to help solve inflation but inflation is caused by the money supply, so it forces consumers to buy the product they want at a non-equilibrium price (and creates deadweight loss through surpluses and shortages).
What can cause the business cycle to enter into a recession?
Over-optimistic behavior by investors and supply shocks can cause the business cycle to enter into a recession.
Why don't people vote out the politicians who participate in logrolling?
People do not vote out the politicians who participate in logrolling because either the voters choose to be rationally ignorant or believe that their respective representative is benefitting their own district/state.
Why does chronic inflation tempt politicians into imposing wage and price controls? Which U.S. President imposed price controls? When?
Politicians are tempted to implement price and wage controls NOT because it will help solve root problems of the rise on prices, BUT because it will make the people happy and they will get reelected. Richard Nixon imposed price controls in 1971 in order to curb inflation and improve his political appearance.
Why do politicians find themselves under political pressure to increase the money supply?
Politicians find themselves under political pressure to increase the money supply because there is a direct correlation to re-election and the state of the economy so they will often "inflate" the economy in the short-term (as lower interest rates help everyone out temporarily).
Which of the following is a common source of market failure
Pricing by firms with Market power. Market provision of private Goods Market provision of the good which generates an externality
Explain Productive Inefficiency
Productive Inefficiency is occurring if the government is not producing a certain item at the lowest possible cost with the least amount of waste. (Is the government producing things well?)
What's Fred Price controls are implemented in the u.s. in an unsuccessful attempt to reduce inflation during the time when _____ was president
Richard Nixon
Discuss the issues of "dual coincidence of wants" arising from barter exchange
The "Dual Coincidence of Wants" is technical way of saying that for a barter to take place, one side of the transaction has to want what the other side has, and vice versa. Due to the increased frequency of specialized tastes of advanced societies, one person may not have a good that another person needs (unlike a simple society).
Explain the Condorcet Paradox
The Condorcet Paradox refers to a situation in which a series of pair wise majority votes over more than two options leading to a cycling of winners.
Under what conditions can the government increase the money supply without triggering inflation?
The government can increase the money supply (for a short time) without triggering inflation if the economy is in a recession (that is if there is widespread unemployment, bankruptcies, and disruptions).
How does the Condorcet Paradox undermine the concept of the government achieving the "will of the people"?
The Condorcet Paradox undermines the concept of the government achieving the "will of the people" by revealing that the collective preferences of society are irrational. When group preferences are characterized by such internal contradictions, the concept of the "will of the people" is meaningless. As a result, any attempt to determine if a voting system reveals "the will of the people" is meaningless.
Describe Open Market Operations
The Fed buys the financial securities (bonds) on the open market. Then, the purchased securities are paid for with money that the Fed creates. Next, the seller of the security deposits in a bank the money received from the sale. Finally, banks loan out the new deposited money to consumers and investors
How can the Fed use its money creation powers to slow an economy that is "overheating"? What is this policy called?
The Fed can use its money creation powers to slow an economy that is "overheating" by decreasing the money supply (which dampens overall economic activity, resulting in lower levels of output, employment, and incomes in the short term (but greater stability in the long term)). This policy is called contractionary monetary policy.
How does the Fed control the Money Supply? Explain the methods the Fed uses listed below.
The Fed controls the money supply through Open Market Operations, Discount Loans, and Reserve Requirements
Describe Discount Loans
The Fed lowers the interest rate on the Discount Loans to make it to banks. Next, banks borrow money from the Fed that has just been created for the purpose. Finally, banks loan out the new money to consumers and investors
Discuss the Federal Reserve System. What kind of bank is it? Who controls the Fed?
The Federal Reserve System is the central bank that prints money and controls the money supply in the US. Controls the Fed. The U.S. government controls the Fed.
The Gold Standard: What is it?
The Gold Standard is an arrangement where a country fixes the value of its currency in terms of a specific amount of gold.
What is the Money Supply? Who controls the amount of it in circulation?
The Money Supply is the amount of money in circulation. The Federal Reserve controls the amount of it in circulation.
Which political party came into power in Germany because of the resulting debacle?
The Nazi party came into power in Germany because of the extreme hyperinflation.
What is the Tragedy of the Commons? What causes it? Why do we have to turn to government to solve this problem?
The Tragedy of the Commons is an economic problem in which every individual tries to reap the greatest benefit from a given resource. As the demand for the resource overwhelms the supply, every individual who consumes an additional unit directly harms others who can no longer enjoy the benefits. Market failure cause the Tragedy of the Commons because the free markets fail to provide the efficient amount of common goods. We have to turn to the government to solve this problem because the government will reduce the resulting deadweight loss caused by this economic problem.
How can the Fed use it money creation powers to stimulate the economy as it slides into recession? What is this policy called?
The fed can use its money creation powers to stimulate the economy as it slides into recession by increasing the money supply (which provides a short-term stimulus to the macro economy, resulting in higher levels of output, employment, and incomes). This policy is called expansionary monetary policy.
What is voter cycling?
The following outlines voter cycling: If you pair a candidate with one other candidate, then pair the winner with the third candidate, and then pair that winner with the initially defeated candidate, we end up with a cycle in which each of the three win one of the three elections. (i.e. A beats B, B beats C, and C beats A)
Market failure can be described as a situation in which
The free market overcome is not efficient
What are the market solutions to externalities? How is this related to the Coasian solution?
The market solutions to externalities is 1. Clearly and fully define property rights 2. Make Individuals pay compensation if they infringe upon the property rights of others 3. Allow parties to negotiate with one another regarding infringements upon property rights caused by externalities The Coasian solution is another name for the listed market solutions.
What do the new rates do to the amount of home buying and other interest rate sensitive purchases?
The new lowered rates increase the amount of home buying and other interest rate sensitive purchases.
inflation is defined as an increase in
The overall General level of prices for goods in the economy
Set up an equation of exchange assuming that the money supply is $10,000, V=4, Q=8,000. What will the price level stabilize at? Why not higher? Why not lower?
The price level will stabilize at five dollars. For the price level to be higher or lower, the money supply should be increased or decreased respectively (as the money supply is easier to control than the velocity of money).
Using the original numbers from your practice equation of exchange from #4 above, assume that the quantity of real goods and services increased from 8,000 items to 12,000 items when the money supply increased from $10,000 to $15,000. What would happen to inflation?
The price still stabilizes at around five dollars like in problem #4. As such, it can be concluded that no noticeable inflation has occurred since before the increase of items and money supply.
What are the public solutions?
The public solutions (or governmental solutions) are 1. Command and Control (e.g., direct regulation) 2. Govt. Sponsored Market Solutions: A. Taxes and Subsidies B. Cap and Trade
Draw a graph of the gasoline market and identify the market equilibrium, the market price and the market quantity. Draw in a Social Cost curve that shows the external cost of pollution caused by the gasoline. Where is the social optimum quantity of gasoline. Higher or lower than the market?
The social optimum quantity of gasoline is lower than the market equilibrium quantity of gasoline. Meanwhile, the social optimum price is higher than the market equilibrium quantity of gasoline.
What are the two main sources or classes of government failure?
The two main sources or classes of government failure are either (1) the government fails to perform a necessary task efficiently (i.e. fails to achieve productive efficiency) or (2) the government fails to do only those tasks that it should do (i.e. fails to achieve allocative efficiency).
Where does the term come from?
This term comes from French Philosopher Nicolas de Condorcet who noted that the collective preferences of people can be cyclic.
Explain using the equation of exchange.
Using the equation of exchange (M * V = P * Q), a direct correlation between money supply and the inflation rate can be proven. Assuming V (velocity of money) and Q (real level of aggregate output of finished goods and services during the present period) is constant, increasing M (money supply) will increase P (economy's overall price level).
A Fourth of July fireworks display in downtown Atlanta is
Very non rival in consumption
How do we measure inflation?
We measure inflation by the Consumer Price Index (CPI).
. What problems did the invention of money overcome?
With its meaning of "stone of value," money originated as the solution to problems of bartering which is the exchange of one good for another between two people (subject to the issues of the "dual coincidence of wants").
Which of the following countries experienced hyperinflation that peaked at an annual rate of 79,600,000,000% in mid November 2008 (at which time prices would approximately double every 24.7 hours)?
Zimbabwe
What is a price control?
legal restriction on the price at which trade can take place
As depicted in figure 8.1 the expansion phase of the business cycle can be further decomposed into periods of
recovery and prosperity
In what way is a good either excludable or non-excludable? Give examples
• A good is excludable if it is easy for a provider to prevent consumption by those who do not pay. o Ex. food, piece of clothing, TV/satellite broadcast • A good is non-excludable if it is difficult (or very costly) to prevent consumption by those who do not pay. o Ex. AM or FM radio broadcasts, outdoor fireworks display
In what way is a good either rival or non-rival in consumption? Give examples
• A good is rival in consumption if consumption by one person diminishes the quantity of the good available for other to consume. o Ex. An item of food, a piece of clothing • A good is non-rival in consumption if consumption by one person does NOT diminish the quantity of the good available for other to consume. o Ex. AM or FM radio broadcasts, TV/satellite broadcast, outdoor fireworks display
Why can't a private entrepreneur make a profit from selling a highly desired public good like flood control? Explain the impact of Free-riders. Can a business profitably produce tornado warnings or lighthouses?
• A private entrepreneur can't make a profit from selling a highly desired public good like flood control because you can't force people to pay for something that is called "public" even though it is helpful and lots of people are going to use it. However, there is no way that a private entrepreneur cannot effectively exclude others from using it and reduce its availability to said people. • The following outlines the general impact of free-riders: If a public good were provided in a free market, the amount traded would be less than the efficient quantity, since many people would attempt to enjoy the benefits of units purchased by others, while not purchasing any units themselves. • A business cannot profitably produce tornado warnings or lighthouses due to their nature as public goods (both non-rival in consumption and non-excludable). We are either leaving the light on for everyone or leaving it off for everyone. There is no way to make money and will eventually go bankrupt. Government uses involuntary payments to keep public areas like so running.
What is a Public Good in economics, and how does it differ from the ordinary meaning of the words? What is a Private Good?
• A public good is a good that is both non-excludable and non-rivalrous in that individuals cannot be effectively excluded from use and where use by one individual does not reduce availability to others. • It differs from the ordinary meaning of the word as it does not have to be seen as universally "good" (the subjective kind of good) to the public. • A private good is a good that is rival in consumption and excludable.
Using the equation of exchange explain why it is difficult to have inflation under a gold standard. Could you have inflation if a huge new gold deposit was discovered?
• Assuming M = $3 billion (monetary amount of gold), V = 8, P = $12 (overall price level), and Q = 2 billion items, M times V would equal P times Q. Increasing M would be difficult as gold is both expensive and difficult to mine. As such, P would still equal $12. In conclusion, inflation is difficult to have under the gold standard. • Inflation could however occur if a huge new gold deposit was discovered.
How are both consumers and producers hurt by the tax? What is Social Surplus and how does the tax reduce it?
• Consumers are hurt by the tax because there is a certain amount of money that they have to pay the government for buying a particular good. • Producers are hurt by the tax because there is a certain amount of money that they have to pay to the government for selling a particular good. Additionally, they may have potentially fewer sales since the quantity demanded is lowered due to the presence of the tax. • Social surplus is difference between the consumers' willingness to pay for a commodity and the actual price paid by the consumers. The tax reduces social surplus by reducing the difference between the consumer's willingness to pay for a commodity and the actual price paid by the consumers as the actual price paid is increased by the tax.
Corruption or Kleptocracy Why is corruption a problem for a country? How does it cause a government to make inefficient decisions when providing govt. goods?
• Corruption (a situation where regulations are not enforced and decisions are not made evenly and without bias) is a problem for a country because it results in significant government failure (which hampers economic development and growth). • Corruption causes a government to make inefficient decisions when providing government goods by allowing corrupt politicians to make selfish decisions that are not in the government's best interests but rather in accordance with their own interests.
Deadweight Loss from Taxes Defined and explain the term. How does a tax on an item reduce the size of the market for a good?
• Deadweight loss is a loss to one party without simultaneously being a gain to another party. A deadweight loss is imposed whenever taxes are imposed because they reduce the size of the market for the good taxed. • A tax on an item reduces the size of the market for a good because people will naturally by less of the good if the price of the item goes up. (The supply curve shifts upward due to a per unit tax - a requirement for a fixed dollar amount to be paid to the government for each unit of good traded - and subsequently causes the quantity demanded to be decreased).
Deflation
• Deflation is a situation where prices on average are falling in an economy over time.
Bureaucratic Provision Why do government bureaucracies fail to provide their goods efficiently? What is the "cost of compliance", and how is it related to bureaucracy?
• Government bureaucracies fail to provide their goods efficiently because the resources must be used to comply with government regulations. • The "cost of compliance" is the expenditure of time or money in conforming with government requirements such as legislation or regulation. Businesses can be hard to start if the cost of compliance imposed by a bureaucracy is too high (i.e. if the bureaucracy imposes plenty of regulations to said businesses).
What is Government Failure? Contrast with Market Failure?
• Government failure refers to situations in which total social surplus is decreased by government intervention in a market. • Market failure differs since it focuses on the failure caused by the insufficient level of trade that emerges from interaction between self-interested buyers and sellers.
Hyperinflation
• Hyperinflation is a very high rate of inflation, over 100% a year.
What is Inflation? Hyperinflation? Deflation? How do they differ? What do they have in common?
• Inflation concentrates on the overall increase of prices in the economy while hyperinflation usually focuses on a specific time period where the prices of goods are extremely high. Deflation occurs at a lower frequency than inflation and is the opposite of inflation. • Both inflation and hyperinflation relate to the overall increase of prices in the economy. All three focus on the rate of change of prices at a given period of time.
What is Inflation?
• Inflation is the overall increase in the level of prices in an economy over time.
Logrolling and Rational Ignorance Define and explain the terms. How is it possible for vote trading to lead to government in a democracy providing goods that people do not value more that they cost?
• Logrolling refers to a process of vote trading in which an individual agrees to vote in favor of one proposal in exchange for favorable votes from others on different proposals. Logrolling is especially common when the legislators are relatively free of control by their national party leaders and are trying to secure votes for bills that will concentrate sizable benefits on their own home districts while spreading most of the costs out over taxpayers in the rest of the country. • Rational ignorance is is ignorance among voters as to what their representatives are doing, and the voter is rational for being ignorant. In a representative democracy, becoming informed on matters of public policy has high costs and low benefits to individual voters. As a result, it is rational for them to remain ignorant or uninformed. • It is possible for vote trading to lead to a government in a democracy providing goods that people do not value more that they cost by oversupplying the economy with a good that results in a negative net Total Social Surplus. This oversupplying is caused by negotiations (through vote trading) between representatives who are self-interested on behalf of their respective districts.
Explain what monopoly and market power mean. Why can some firms raise their prices without fear, but other firms have to charge the market equilibrium price?
• Market Power refers to a firm's ability to charge more than the competitive market price for a good or service. • Monopoly refers to a market structure refers to a market structure in which there is a single seller of a unique good for which there are no close substitutes. • Some firms can raise their prices without because they don't have any competition (or very little competition) while other firms have to charge the market equilibrium price because they have to compete with plenty of other firms.
Does modern paper money have intrinsic value? If not, why do people accept it in exchange for real goods and services?
• No, modern paper money has no intrinsic value because its value can be destroyed or diminished easily. All of the U.S. dollars could evaporate in value if something disrupted with our belief that the U.S. economic AND political system was functional and strong. • People accept paper money in exchange for real goods and services since it is currently used as a universal method for the exchange of goods and services.
Discuss overconfidence among business investors and supply shocks. Give examples from recent history. (Housing bubble of 2007 and OPEC crisis of 1974) Explain.
• Overconfidence among business investors can cause the business cycle to enter into a recession since the investors can take unnecessary risks and cause businesses to over expand. o For example, during 2007, real-estate investors believed that housing prices will continue to rise due to a sharp increase in housing prices. Since the interest rates were low and the general populace had a relatively large amount of disposable income, investors began to invest like crazy in hopes that they will get a profit. After the housing bubble burst, the effects ranged from the following: massive amounts of foreclosure, lower chances to get loans, higher unemployment, failing neighborhoods, and rougher living conditions. • Supply shocks are significant and drastic changes in supply of a good that is essential for economic activity. Supply shocks can cause recessions by disrupting financial markets and ruining investment plans. o For example, in the OPEC crisis of 1974, oil supply was at an all-time low when OPEC declared an oil embargo on the U.S. during the Yom Kippur War. As a result, new factories were shut down and some workers were laid off. Since the newly laid-off workers will reduce their spending, demand fell for other products as well. Other businesses had to do the same until people adjusted their spending and said businesses adjusted what type of products that they will produce.
Describe the Business Cycle. Describe the individual parts of the cycle. Draw a picture of it and label the peaks, troughs, recessions and expansions.
• Peak: highest point between the end of an economic expansion and the start of a contraction in a business cycle • Trough: lowest point on the business cycle; the stage of the economy's business cycle that marks the end of a period of declining business activity and the transition to expansion • Recession: a situation which the economy as a whole is in decline; more specifically, a recession occurs after the business cycle peaks, but before it becomes a trough • Expansion: an increase in the level of economic activity, and of the goods and services available; an expansion occurs after the business cycle becomes a trough, but before the business cycle peaks
Price ceiling? Price floor?
• Price ceiling: legally established max price which trade can take place • Price floor: • legally established min price at which trade can take place
What is the difference between the recovery phase and the prosperity phase of the business cycle?
• Recovery phase: starts at the trough and lasts until the economy has surpassed its previous peak; in this phase, new firms are started and older firms that survived the downturn start to increase their sales and rehire workers • Prosperity phase: occurs once real GDP goes above its previous peak; in this phase, investors take risks that are not warranted and businesses over-expand, ultimately setting up the economy for a correction (the next recession)
Regulatory Capture Define and explain the phrase. Who is "captured"? Who does the "capturing"? Literal or metaphorical? What does the regulated industry do with the power achieved by capturing the government regulators?
• Regulatory capture refers to a situation in which firms in a regulated industry influence a regulatory agency to the point where the agency enacts policies that are in the best interest of the regulated firms, even if the policies are not in the best interest of the general public. • The regulatory agencies are "captured", and the firms do the "capturing". This action of capturing is metaphorical. • With the power achieved by capturing the government regulators, the regulated industry can act in their own best interests instead of the general public's best interests.