1.The circular Flow
 The flow of payments in an economy is a circular flow. Individuals--people living in households--work for businesses, rent their property (or their capital) to businesses, and manage and own the businesses. All these activities generate incomes--flows of payments from businesses to households. But households then spend their incomes--on consumption goods, in taxes paid to governments (that then spend the money on goods and services), and on assets like stock certificates and bank CDs that flow through the financial sector and are then used to buy investment and other goods. All these are expenditures The two flows--of incomes and of expenditures--are equal: all expenditures on products are ultimately someone's income, and every piece of total income is also expended in some way. 2. The role of government in the market system. | |
| 2.a Public goods Public goods are goods or services that can be consumed by several individuals simultaneously without diminishing the value of consumption to any one of the individuals. This key characteristic of public goods, that multiple individuals can Consume the same good without diminishing its value, is termed non-rivalry. No rivalry is what most strongly distinguishes public goods from private goods. A pure public good also has the characteristic of non-excludability, that is, an individual cannot be prevented from consuming the good whether or not the individual pays for it. For example, fresh air, a public park, a beautiful view, national defense. Let us consider one other fairly clear example of a public good. The example is television and radio broadcasting without commercials. No-commercial broadcasting is a different service than broadcasting with commercials, and we are concerned here only with no-commercial broadcasting. Broadcasting with commercials is a substitute for broadcasting without commercials, but not a perfect substitute. 2 .b Externalities - | |
A positive externality is something that benefits society, but in such a way that the producer cannot fully profit from the gains made. A negative externality is something that costs the producer nothing, but is costly to society in general.
Examples of positive externalities are environmental clean-up and research. A cleaner environment certainly benefits society, but does not increase profits for the company responsible for it. Likewise, research and new technological developments create gains on which the company responsible for them cannot fully capitalize.
Negative externalities, unfortunately, are much more common. Pollution is a very common negative externality. A company that pollutes loses no money in doing so, but society must pay heavily to take care of the problem pollution caused.
The problem this creates is that companies do not fully measure the economic costs of their actions. They do not have to subtract these costs from their revenues, which means that profits inaccurately portray the company's actions as positive. This can lead to inefficiency in the allocation of resources.
Because neither the market nor private individuals can be counted on to prevent this inefficiency in the economy, the government must intervene.
The government's basic goal is to force companies to internalize externality costs. This means that if a company's pollution creates economic costs (for example, the medical bill of a patient who gets sick from pollution), then the government will force the company to pay that cost. In this way, the company can more accurately compare revenues and expenses and decide whether production is indeed profitable.
To achieve its goal, the government can use one of several types of regulation. It can create pollution limits, tax companies for polluting, or hand out tradable pollution permits.
2.c Monopoly
- Pure monopoly exists when a single firm is the sole producer of a product for which there are no close substitutes. They are very desirable from the point of view of a company and, usually, not very desirable for consumers. Three characteristics define pure monopoly:
1. There is a single seller.
2. There are no close substitutes for the firm’s product.
3. There are barriers to entry.
Whereas the perfectly competitive firm was a price taker, the monopolistic firm is a price maker. That is, it has control over the price.
Examples of monopoly are public utilities such as gas, electric, water, cable TV, and local telephone service companies, professional sports teams, DeBeers, and Alcoa. Also, monopolies may exist at the local level because of geographic location. Barriers to entry are the main line of defense for incumbent monopolies and may be of different types. Economies of scale constitute one major barrier. They occur where decreases in unit costs depend on output size. In this case, because a large firm with a large market share is most efficient, new firms cannot afford to enter the market and gain market shares. Public utilities are known as natural monopolies because they possess such economies of scale. Barriers to entry also exist in legal forms as patents or licenses. Patents grant the inventor the exclusive right to produce a product for 20 years (new worldwide patent period established with a 1995 GATT agreement). Licenses are granted by the government and allow only one or few firms to operate in a given market. Finally, barriers to entry may arise from the exclusive ownership or control of essential resources.
2.d Business cycles
Economic growth is not a steady phenomenon; rather, it tends to exhibit a pattern as follows:
1. an expansion of above-average growth
2. a peak
3. a contraction of below-average growth
4. a trough or low-point
The troughs then are followed by periods of expansion and the cycle generally repeats, though not in a regular manner. These fluctuations in economic growth are known as the business cycle and are depicted conceptually in the following diagram:
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Indicators of the Business Cycle
Because the business cycle is related to aggregate economic activity, a popular indicator of the business cycle in the U.S. is the Gross Domestic Product (GDP). The financial media generally considers two consecutive quarters of negative GDP growth to indicate a recession. Used as such, the GDP is a quick and simple indicator of economic contractions.However, the National Bureau of Economic Research (NBER) weighs GDP relatively low as a primary business cycle indicator because GDP is subject to frequent revision and it is reported only on a quarterly basis (the business cycle is tracked on a monthly basis). The NBER relies primarily on indicators such as the following:
- employment
- personal income
- industrial production
2.e The public choice theory of government
- Public choice theory examines the way different voting mechanisms to sum up individual preferences into social choices. This approach also analyzes government failures, which arise when state actions fail to improve economic efficiency or when the government redistributes income unfairly. Public choice theory points to issues such as short time horizons of elected representatives, the lack of a hard budget constraint, and the role of money in financing elections as sources of government failures. A careful study of government failures is crucial for understanding the limitations of government and ensuring that government programs are not excessively intrusive or wasteful.
3.Overview of the united states government.
Microeconomic and macroeconomic policies are tools government officials use to stimulate or control economic growth. For this reason, the policies are often pawns in political dialog and congressional debates where tradeoffs and compromises must be made among various polices to move the government decision-making and legislative process forward.
3.a Microeconomic Policies.
Microeconomics is the study of how consumers (demand) and producers (supply) make decisions toward allocating limited resources. Microeconomic policies apply when federal, state and local governments make decisions that will affect the behavior of consumers and producers.
3.b Macroeconomic Policies.
Macroeconomics is the study of the whole economy or national economic parameters such as Gross National Product (GDP), unemployment, inflation, national savings and investment and how these parameters individually and collectively affect economic growth. Macroeconomic policies are policies made by the federal government specifically designed to modify one or more of these parameters.
3.c Government spending
Economic theory does not automatically generate strong conclusions about the impact of government outlays on economic performance. Indeed, almost every economist would agree that there are circumstances in which lower levels of government spending would enhance economic growth and other circumstances in which higher levels of government spending would be desirable.
If government spending is zero, presumably there will be very little economic growth because enforcing contracts, protecting property, and developing an infrastructure would be very difficult if there were no government at all. In other words, some government spending is necessary for the successful operation of the rule of law. Figure 1 illustrates this point. Economic activity is very low or nonexistent in the absence of government, but it jumps dramatically as core functions of government are financed. This does not mean that government costs nothing, but that the benefits outweigh the costs.
4.Government in other economics.
4.a Overview of major market economic.
Getting Organized: Command, Market, and Mixed Economies
Not all economies are organized in the same way. The three major ways they can be organized are as a market economy, a command economy, or a mixed economy.
In a market economy, consumers and businesses decide what they want to produce and purchase in the marketplace. They make these decisions by “voting with their dollars.” Producers decide what to produce given the demand they see in the marketplace in terms of their sales and the prices they get for their goods and services. In a pure market economy, also known as a laissez-faire economy (from the French “allow to do”), the government plays a very limited role in what is produced. The government does not direct, and may even lack the power to direct, the private sector to produce certain goods and services.
In a command economy, also known as a planned economy, the government largely determines what is produced and in what amounts. It directs producers to make and deliver goods and services in specified amounts. In practice, command economies are associated with socialism and communism, two closely related forms of government. Socialism and communism are characterized by collective ownership of the means of production and central planning functions that try to produce what people want and need, in the quantities and at the time required. The underlying philosophy of socialism is “from each according to his abilities, to each according to his needs.”
In command economies, the people (in the form of the state) own the means of production. The state, which is seen to embody the will of the people, decides what will be produced according to a plan based upon what the state calculates to be people's need and desire for various goods and services. The state also plays an important role in determining how goods and services are distributed, that is, in deciding who gets how much of what.
In a mixed economy both market forces and government decisions determine which goods and services are produced and how they are distributed. In general, market forces prevail in mixed economies. The government does not direct the private sector to produce certain goods and services in certain quantities at certain times. However, the government's influence in the economy stems from the amount of money (raised in the form of taxes and borrowings from the private sector) that it spends and, through various forms of welfare, redistribute.
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