Chapter 15: Economic Policy Flashcards
- Define and explain three key features of a capitalist/free-market economy. How did Adam Smith conceptualize the system as?
The three features of a free-market economy is free-markets, competition, and self-interest. Free markets means private ownership of resources and materials, no restrictions on prices, wages, supply, and demand. Competition means no restrictions on who can compete, since competition boosts innovation. Self-interests means that both the consumer and producer can do what is best for themselves.
Adam Smith conceptualized this system as an invisible hand, outside of the governments control in order to promote efficiency that both roles as producer and consumer play. This invisible hand will bring both the consumer and producer together, and lead to self-regulation. Giving the government no need to interfere.
- What are examples of free-market failures? What can be done to keep this from happening?
Three examples of free-market failures are: Monopolies, asymmetric info, and negative externalities. A monopoly is a single business that controls the supply of a product, effectively blocking out competition and stifling innovation since one corporation is in total control. Asymmetric information simply means that one person has more information on a product that they can use to gain an advantage in the trade. But typically the person who will know most about the product is the producer, taking away the ability for the consumer to gain a fair price. Negative externalities is the third, and occurs when a negative cost occurs due to the trade of a specific commodities that all of society must pay, instead of just the producer. And with just a little bit of government intervention this issues can prevented, or their impact lessened. Capitalism has natural flaws that can’t be overlooked, and must be solved as the consequences can cause a lot of inequality.
- Why is the concept of supply and demand important in a free market economy?
The business model closely follows the supply and demand model. In the supply model, prices go up when supply goes down, and prices go down when supply goes down. While in the business model the producer is the supplier while the consumer is the demand, both in labor and commodities. And in a free market economy, this would create equilibrium as long as the government stayed out, ideally…
- What are the key mechanisms at work in fiscal policy? Describe and discuss; do not list.
- What are the key mechanisms associated with monetary policy? Describe and discuss; do not
list.
- What steps might be taken by a government utilizing Keynesian economics to combat a
slowing economy? Conversely, what steps might be taken by a government utilizing Keynesian
economics to combat a growing economy? Why would a government intervene in each of these
cases?
When the economy is slowing down the government might lower taxes and raise government spending, lower taxes give people a larger supply of money as well as increase the demand for labor, and raised government spending means an increase in government programs and increase government-based funding. But when an economy is growing fast, the government might raise taxes and lower government spending. The raised taxes will put less money in people’s wallets, so the demand for labor goes down, while the lower government spending will lower the money going into government programs and government-based funding will go down.
They do this because when the economy is slow unemployment is lower, so this gets people back to work but causes prices to rise. While the economy is quick however, unemployment is high but prices are low, so fixing will lower those high prices. All of this too maintain a consistent and steady GDP/ overall economy.
- What is the overall goal that fiscal and monetary policy attempt to achieve (and how)? What is
the importance of inflation and unemployment on GDP?
The overall goal is to slow down the economy when growth is rampant, but also to stimulate the economy when it slows down. With fiscal, you lower or increase taxation as well as government spending, and with monetary you lower or increase the interest rate as well as the appeal to buying bonds. To have GDP grow efficiently you want producers to produce, and consumers to consume. But having high employment means more money in hands of the consumer so prices go up, but when prices go up people can’t afford commodities. And the same is true the other way around, if you have high inflation the demand for work goes down so employment climbs upwards.
- Why is excessive income inequality a possible threat to democratic values?
Income inequality is typically associated with authoritative governments. But generally speaking, the richer people have more money thus more influence in the government and a louder voice. So populations with huge income gaps could have the richest running the country in a way that disparages the lower-income classes.
- What is the difference between entitlement and discretionary spending? Identify two
examples of each.
Entitlement spending is mandatory spending or things the government has to pay for. Two examples of this would be social security and Medicaid. Discretionary spending is non-mandatory spending meaning everything else, that Congress can dictate, that money is spent on. Two examples of this could be transportation and or education.
- What is the difference between horizontal and vertical equity in taxation?
Horizontal equality is when two individuals are the same if not very similar, so are taxed similarly. While vertical equity is when two individuals are not similar at all so one gets taxed more than the other, usually the one who has more gets taxed more. Essentially equal people get treated equally, unequal people get treated unequally usually in the favor of the less fortunate person.
