Eco part 3 Flashcards
When can taxes improve efficiency?
i) Correcting market failures (aligning MSC and MSB); ii) Spreading distortions across multiple sectors.
Direct vs. Indirect Taxes
Direct: Levied on income (e.g., income tax). Indirect: Levied on goods/services (e.g., sales tax, VAT).
Why is a sales tax regressive?
Poorer households spend a higher % of income on taxed goods, leading to a higher effective tax burden.
Laffer Curve
Inverted-U relationship between tax rates and revenue. At 100% tax rate, revenue is zero due to disincentives to work.
Balanced Budget Multiplier
When ∆G = ∆T, the multiplier is 1. Tax leakage reduces the overall impact but leaves a small positive effect.
Tax-adjusted Multiplier Formula
k*= 1 / 1−MPC(1−t). Higher t reduces the multiplier due to increased leakages.
Recurrent vs. Development Expenditures
Recurrent: Salaries, debt interest. Development: Infrastructure projects (e.g., schools, highways).
Effect of Currency Depreciation
Boosts exports (cheaper) but raises import prices, risking inflation. Short-term J-curve effect may worsen trade balance.
Sterilization in Monetary Policy
Central bank offsets forex interventions (e.g., selling bonds after buying foreign currency to prevent money supply growth).
New Classical vs. Keynesian Fiscal Policy
New Classical: Self-correcting markets. Keynesian: Persistent unemployment without government intervention.
Money Multiplier Formula
Multiplier = 1/Reserve Ratio. Higher reserve ratios reduce lending capacity.
M0, M1, M2 Definitions
M0: Currency + reserves. M1: M0 + demand deposits. M2: M1 + time deposits.
IS-LM Model Components
IS: Goods market equilibrium (I=S). LM: Money market equilibrium (L=M). Intersection determines output and interest rates.
Crowding Out Effect
Higher government borrowing raises interest rates, reducing private investment and net exports.
Ricardian Equivalence
Tax cuts financed by borrowing don’t boost demand—households save expecting future tax hikes.
Motives for Holding Money
Transactions (daily needs), Precautionary (emergencies), Speculative (investment opportunities).
Comparative Advantage Example
Country A produces wheat at 2 cloths/unit; Country B at 1 cloth/unit. Country B should specialize in cloth.
Criticism of Heckscher-Ohlin Model
Static, ignores tech differences, economies of scale, and dynamic comparative advantage.
Prebisch-Singer Hypothesis
LICs face declining terms of trade as primary product prices fall relative to manufactured goods.
ISI vs. Export-Oriented Growth
ISI: Protect domestic industries. Export-oriented: Global competitiveness via open trade and FDI.
IMF Stabilization Policies
Tight monetary/fiscal policies reduce inflation but may lower growth and increase unemployment.
Human Development Index (HDI)
Measures life expectancy, education, and income. Better reflects welfare than GDP alone.
Dollarization Pros/Cons
Pros: Stable currency. Cons: Loss of monetary control (e.g., Argentina adopting USD).
J-Curve Effect
Devaluation initially worsens trade balance (inelastic demand) before improving it (elastic demand).
Marshall-Lerner Condition
Devaluation improves trade balance if∣PED x +PED m ∣>1.
Monetary Policy Tools
Reserve ratio, discount rate, open market operations (OMOs), forex interventions.
Sterilization in BOP Context
Central bank sells bonds to neutralize money supply changes from BOP surpluses/deficits.
Liquidity Trap
Interest rates near zero; monetary policy ineffective as people hoard cash (Keynesian view).
Unholy Trinity
Impossible triad: Fixed exchange rates, free capital flow, independent monetary policy. Choose two.
