Economics (8%) Flashcards
perfectly competitive market:
definition
In economic theory, perfect competition occurs when all companies sell identical products, market share does not influence price, companies are able to enter or exit without barriers, buyers have perfect or full information, and companies cannot determine prices.
it must take the market price of its output as given, so it faces a perfectly elastic, horizontal demand curve.
perfectly competitive market:
marginal revenue
the firm’s marginal revenue (MR) and the price of its product are identical.
negatively sloped demand curve: implications
A firm that faces a negatively sloped demand curve, however, must lower its price to sell an additional unit, so its MR is less than price (P).
imperfectly competitive market:
definition
Imperfect competition refers to a market structure where there are multiple sellers and buyers, but they have some degree of control over the price and quantity of goods or services. This means that firms can differentiate their products or manipulate prices to gain an advantage.
Breakeven Point
Occurs when total revenue (TR) equals total cost (TC), meaning price equals average total cost (ATC). The firm covers all its economic costs and earns normal profit.
Shutdown Point
Occurs when price is below average variable cost (AVC). The firm cannot cover its variable costs and should shut down in the short run. In the long run, the firm exits the market if it cannot cover total costs.
Economies of Scale
Cost per unit decreases as output increases, resulting in a downward-sloping long-run average cost (LRAC) curve. Achieved through factors like increased returns to scale, specialization, efficient technology, and bulk purchasing.
Diseconomies of Scale
Cost per unit increases as output increases, resulting in an upward-sloping LRAC curve. Caused by factors like management inefficiencies, duplication, and higher resource prices due to supply constraints.
Short-Run Total Cost (STC) Curves
reflect the cost for different plant sizes. Each STC curve has a corresponding short-run average total cost (SATC) curve.
Long-Run Total Cost (LRTC) Curve
An envelope curve derived from the lowest STC for each output level. The LRAC curve is the envelope of all SATC curves, representing economies and diseconomies of scale.
Minimum Efficient Scale
The lowest point on the LRAC curve where the firm operates at least cost per unit.
If an agricultural firm operating in a perfectly competitive market expands its production and unit sales by 10%, what is the most likely result?
Answer: a 10% increase in total revenue.
The marginal revenue per unit sold for a firm under perfect competition will most likely be:
Answer: equal to average revenue.
Market Structure:
Perfect Competition:
Characteristics
Many sellers and buyers.
Homogeneous products.
No single producer can influence the market price.
Firms are price takers.
Very low barriers to entry and exit.
No non-price competition.
Market Structure:
Perfect Competition:
Example
Example: Agricultural products like wheat or corn.
Market Structure:
Perfect Competition:
Impact on Profit
Firms earn normal profit in the long run as profits are driven down by competition.
Market Structure:
Monopolistic Competition:
Characteristics
Characteristics:
Many sellers.
Differentiated products.
Some degree of pricing power.
Low barriers to entry and exit.
Significant non-price competition (e.g., advertising).
Market Structure:
Monopolistic Competition:
Example
Bottled Drinks
Market Structure:
Monopolistic Competition:
Impact on Profit
Firms can earn some economic profit in the short run, but in the long run, profits are competed away.
Market Structure:
Oligopoly:
Characteristics
Characteristics:
Few large sellers.
Products can be homogeneous or differentiated.
Significant barriers to entry.
Some or considerable pricing power.
Non-price competition (e.g., advertising, product differentiation).
Market Structure:
Oligopoly:
Examples
Commercial airlines, automobile manufacturers.
Market Structure:
Monopolistic Competition:
Impact on Pricing
Firms’ pricing and output decisions are interdependent, leading to strategic behavior and potential for collusion.
Market Structure:
Monopoly:
Characteristics
Characteristics:
Single seller.
Unique product with no close substitutes.
Very high barriers to entry.
Considerable pricing power.
Some non-price competition (e.g., advertising).
Market Structure:
Monopoly:
Example
Local utility companies.
Market Structure:
Monopoly:
Impact on Profits
Monopolists can earn long-term economic profits, but they are often regulated by the government.
Factors Determining Market Structure
Number and size of firms.
Degree of product differentiation.
Power over pricing decisions.
Barriers to entry and exit.
Degree of non-price competition.
Porter’s Five Forces:
Threat of Entry
Potential for new competitors to enter the market.
Porter’s Five Forces:
Power of Suppliers
Suppliers’ ability to influence the price of inputs.
Porter’s Five Forces:
Power of Buyers
Buyers’ ability to influence the price and terms of purchase.
Porter’s Five Forces:
Threat of Substitutes
Availability of alternative products.
Porter’s Five Forces:
Rivalry among Existing Competitors
Intensity of competition among current firms.
True or False:
Firms in more competitive markets (perfect competition and monopolistic competition) have less control over prices and face constant pressure to innovate and reduce costs.
True
True or False:
Firms in less competitive markets (oligopoly and monopoly) can exert more control over prices and potentially earn higher profits, but they also face strategic considerations and regulatory scrutiny.
True
A market structure characterized by many sellers with each having some pricing power and product differentiation is best described as:
Monopolistic competition.
A market structure with relatively few sellers of a homogeneous or standardized product is best described as:
Oligopoly.
Monopolistic Competition:
Number of Buyers and Sellers
Large Number of Buyers and Sellers:
Numerous firms in the market, each with a small market share.
Buyers and sellers are well-informed about products and prices.
Monopolistic Competition:
Product Differentiation:
Each firm offers products that are close substitutes but not identical.
Differentiation can be based on quality, features, branding, or services.
Monopolistic Competition:
Barriers to Entry and Exit
Low Barriers to Entry and Exit:
Firms can enter or leave the market with relative ease.
Entry and exit costs are relatively low compared to monopoly or oligopoly.
Monopolistic Competition:
Non-Price Competition:
Firms rely heavily on advertising and marketing to differentiate their products.
Brand loyalty and customer service are crucial for maintaining market share.
Monopolistic Competition:
Pricing Power
Firms have some control over their pricing due to product differentiation.
They can raise prices without losing all customers, unlike in perfect competition.
Monopolistic Competition:
Demand Curve
Downward-Sloping Demand Curve
Firms face a downward-sloping demand curve, indicating that lower prices increase quantity demanded.
There are ranges where demand is elastic and ranges where it is inelastic.
Monopolistic Competition:
Long-Run Equilibrium:
In the long run, economic profit tends to zero due to new entrants in the market.
Monopolistic Competition:
Benefits
Variety and Innovation:
Product differentiation leads to greater variety and can meet diverse consumer preferences.
Provides incentives for innovation and improvement.
Oligopoly Market Structure:
Number of sellers
Small Number of Sellers:
Few firms dominate the market.
Each firm’s actions affect the others.
Oligopoly Market Structure:
Product Differentiation
Products can be homogeneous (e.g., cement) or differentiated by brand (e.g., breakfast cereals).
Oligopoly Market Structure:
Barriers to Entry
High entry costs and significant barriers, such as technology, brand loyalty, or regulatory requirements, limit new competitors.
Oligopoly Market Structure:
Pricing Power
Firms have substantial pricing power and can influence market prices.
Oligopoly Market Structure:
Non-Price Competition
Firms often engage in advertising and other strategies to differentiate their products.
Oligopoly Market Structure:
Kinked Demand Curve
Assumes competitors will match price decreases
but not price increases.
Results in a kinked demand curve and a discontinuous marginal revenue curve.
Explains price rigidity in oligopoly markets.
Oligopoly Market Structure:
Cournot Assumption
Firms decide on output assuming rivals will not change their output.
Each firm maximizes profit where marginal revenue equals marginal cost.
Leads to Cournot equilibrium, with prices higher and output lower than perfect competition but less extreme than monopoly.
Oligopoly Market Structure:
Nash Equilibrium
Firms choose strategies considering rivals’ reactions.
No firm can increase profit by unilaterally changing its strategy.
Reflects interdependent decision-making in oligopoly.
Oligopoly Market Structure:
Dominant Firm Model
A dominant firm sets prices, and other firms follow.
The dominant firm acts similarly to a monopoly within its market segment.
Price followers avoid undercutting the dominant firm due to higher costs or fear of price wars.
Oligopoly Market Structure:
Long-Run Equilibrium
Long-run economic profits attract new entrants, reducing market share and profits for existing firms.
Firms may innovate or engage in non-price competition to maintain market position.
Oligopolistic pricing strategy most likely results in a demand curve that is:
Kinked
Collusion is less likely in a market when
Companies have similar market shares.
In an industry composed of three companies, which are small-scale manufacturers of an easily replicable product unprotected by brand recognition or patents, the most representative model of company behavior is
Perfect competition
Measuring Market Power:
Via Elasticity of Demand and Supply:
Perfect Competition
very elastic
An elastic demand is one in which the change in quantity demanded due to a change in price is large.
Measuring Market Power:
Via Elasticity of Demand and Supply:
Oligopoly + Monopoly
demand is inelastic, companies may have market power.
Measuring Market Power:
Via Econometric Approaches:
Time-Series Regression
Uses historical sales data over time but may not reflect current market conditions.
Measuring Market Power:
Via Econometric Approaches:
Cross-Sectional Regression
Uses sales data from different companies or transactions in the same period, but requires extensive data and can be complex.
Measuring Market Power:
Simple Calculations:
Concentration Ratio
Concentration Ratio:
Measures the sum of market shares of the largest N firms.
Simple to compute but doesn’t directly quantify market power.
May not reflect potential competition or the impact of mergers accurately.
Measuring Market Power:
Simple Calculations:
Herfindahl-Hirschman Index (HHI)
Herfindahl-Hirschman Index (HHI):
Squares the market shares of the top N companies and adds them.
Ranges from 1 (monopoly) to 1/M (perfect competition, where M is the number of firms).
Reflects the impact of mergers better than the concentration ratio.
Does not account for potential market entry or demand elasticity.
Business cycles
Business cycles are recurrent expansions and contractions in economic activity affecting broad segments of the economy.
Classical cycle
Classical cycle refers to fluctuations in the level of economic activity (e.g., measured by GDP in volume terms).
Growth cycle
Growth cycle refers to fluctuations in economic activity around the long-term potential or trend growth level.
Growth rate cycle
Growth rate cycle refers to fluctuations in the growth rate of economic activity (e.g., GDP growth rate).
Business cycles:
four phases
recovery
expansion
slowdown
contraction.
Business cycles:
recovery phase
(“Trough”)
In the recovery phase of the business cycle, the economy is going through the “trough” of the cycle, where actual output is at its lowest level relative to potential output.
Economy is at a trough, starting to increase activity.
Output rises, closing the negative output gap.
Business cycles:
expansion phase
In the expansion phase of the business cycle, output increases, and the rate of growth is above average. Actual output rises above potential output, and the economy enters the so-called boom phase.
Output increases above potential.
Increased consumer spending, production, employment, and investment.
Possible shortages in production factors and rising prices.
Business cycles:
slowdown phase
(“Peak”)
In the slowdown phase of the business cycle, output reaches its highest level relative to potential output (i.e., the largest positive output gap). The growth rate begins to slow relative to potential output growth, and the positive output gap begins to narrow.
Growth rate begins to slow.
Positive output gap narrows.
Optimism persists, but hiring slows, and inflation decelerates.
Business cycles:
contraction phase
(“Downturn”)
In the contraction phase of the business cycle, actual economic output falls below potential economic output.
Output falls below potential.
Declining consumer and business confidence.
Increased layoffs, rising unemployment, and possible recession.
Credit cycles
Credit cycles describe the changing availability—and pricing—of credit.
Credit cycles:
strong peaks
Strong peaks in credit cycles are closely associated with subsequent systemic banking crises.
Leading economic indicators
have turning points that usually precede those of the overall economy.
Coincident economic indicators
have turning points that usually are close to those of the overall economy.
Lagging economic indicators
have turning points that take place later than those of the overall economy.
diffusion index
A diffusion index reflects the proportion of a composite index of leading, lagging and coincident indicators that are moving in a pattern consistent with the overall index. Analysts often rely on these diffusion indexes to provide a measure of the breadth of the change in a composite index.
Market Conditions and Investor Behavior:
Recovery
Risky assets repriced upward; equities rise before economy bottoms.
Market Conditions and Investor Behavior:
Expansion
Boom phase with strong growth; increased asset prices.
Market Conditions and Investor Behavior:
Slowdown
Risky assets peak; safe assets gain value.
Market Conditions and Investor Behavior:
Contraction
Preference for safe assets; government securities valued higher
Which rule is most likely used to determine whether the economy is in a recession?
Real GDP has two consecutive quarters of negative growth.
Variables to consider for identifying business cycle peaks and troughs in the absence of an official committee:
Unemployment
GDP growth
industrial production
inflation.
The characteristic business cycle patterns of trough, expansion, peak, and contraction are:
A.periodic.
B.recurrent.
C.of similar duration.
B is correct. The stages of the business cycle occur repeatedly over time.
During the contraction phase of a business cycle, it is most likely that:
A.inflation indicators are stable.
B.aggregate economic activity relative to potential output is decreasing.
C.investor preference for government securities declines.
B is correct. The net trend during contraction is negative.
An economic peak is most closely associated with:
A. accelerating inflation.
B. stable unemployment.
C. declining capital spending.
A. accelerating inflation.
Credit Cycles:
definition
Credit cycles describe the changing availability and pricing of credit, reflecting growth in private sector credit essential for business investments and household purchases of real estate.
They are connected to real economic activity, captured by business cycles that describe fluctuations in real GDP.
Credit Cycles:
Characteristics:
Economic Strength
Economic Strength: When the economy is strong, lenders are more willing to extend credit on favorable terms.
Credit Cycles:
Characteristics:
Economic Weakness
Economic Weakness: When the economy is weak, lenders tighten credit, making it less available and more expensive, often leading to declines in asset values like real estate.
Credit Cycles:
Interactions with Business Cycles:
Recessions
Business cycles can be amplified by credit cycles, leading to deeper recessions and more extensive expansions.
Credit Cycles:
Interactions with Business Cycles:
Recoveries
Recessions with financial disruptions (e.g., house and equity price busts) tend to be longer and deeper.
Credit Cycles:
Interactions with Business Cycles:
Comparing Length
Credit cycles often last longer than business cycles, with distinct peaks and troughs.
With which sector of the economy would analysts most commonly associate credit cycles?
A.Exports
B.Construction and purchases of property
C.Food retail
B is correct. Credit cycles are associated with availability of credit, which is important in the financing of construction and the purchase of property.
The reason analysts follow developments in the availability of credit is that:
A.loose private sector credit may contribute to the extent of asset price and real estate bubbles and subsequent crises.
B.loose credit helps reduce the extent of asset price and real estate bubbles.
C.credit cycles are of same length and depth as business cycles.
A is correct. Studies have shown that loose credit conditions contribute to the extent of asset price and real estate bubbles that tend to be followed by crises.
Employment:
Recovery Phase
Layoffs slow. Businesses rely on overtime before moving to hiring. Unemployment remains higher than average.
Employment:
Expansion Phase
Businesses move from using overtime and temporary employees to hiring. Unemployment rate stabilizes and starts falling.
Employment:
Slowdown Phase
Businesses continue hiring but at a slower pace. Unemployment rate continues to fall but at slowly decreasing rates.
Employment:
Contraction Phase
Businesses first cut hours, eliminate overtime, and freeze hiring, followed by outright layoffs. Unemployment rate starts to rise.
Employment:
Recovery Phase
Low but increasing as companies start to enjoy better conditions. Capex focus on efficiency rather than capacity.
Upturn most pronounced in orders for light producer equipment.
Typically, the orders initially reinstated are for equipment with a high rate of obsolescence, such as software, systems, and technological hardware.
Employment:
Expansion Phase
Customer orders and capacity utilization increase. Companies start to focus on capacity expansion.
The composition of the economy’s capacity may not be optimal for the current structure of demand, necessitating spending on new types of equipment.
Orders precede actual shipments, so orders for capital equipment are a widely watched indicator of the future direction of capital spending.
Employment:
Slowdown Phase
New orders intended to increase capacity may be an early indicator of the late stage of the expansion phase.
Companies continue to place new orders as they operate at or near capacity.
Employment:
Contraction Phase
New orders halted, and some existing orders canceled (no need to expand).
Initial cutbacks may be sharp and exaggerate the economy’s downturn. As the general cyclical bust matures, cutbacks in spending on heavy equipment further intensify the contraction. Maintenance scaled back.
Sales & Production:
Recovery Phase
Decline in sales slows. Sales subsequently recover. Production upturn follows but lags behind sales growth.
Over time, production approaches normal levels as excess inventories from the downturn are cleared.
Sales & Production:
Expansion Phase
Sales increase. Production rises fast to keep up with sales growth and to replenish inventories of finished products.
This increases the demand for intermediate products. “Inventory rebuilding or restocking stage.”
Sales & Production:
Slowdown Phase
Sales slow faster than production; inventories increase.
Economic slowdown leads to production cutbacks and order cancellations.
Sales & Production:
Contraction Phase
Businesses produce at rates below the sales volumes necessary to dispose of unwanted inventories.
Inventory:
Recovery Phase
Begins to fall as sales recovery outpaces production.
Inventory:
Expansion Phase
Ratio stable.
Inventory:
Slowdown Phase
Ratio increases. Signals weakening economy.
Inventory:
Contraction
Ratio begins to fall back to normal.
Although a small part of the overall economy, changes in inventories can influence economic growth measures significantly because they:
A.reflect general business sentiment.
B.tend to move forcefully up or down.
C.determine the availability of goods for sale.
B is correct. Inventory levels can fluctuate dramatically over the business cycle.
Inventories tend to rise when:
A.inventory–sales ratios are low.
B.inventory–sales ratios are high.
C.economic activity begins to rebound.
A is correct. When the economy starts to recover, sales of inventories can outpace production, which results in low inventory–sales ratios. Companies then need to accumulate more inventories to restore the ratio to normal level.
Inventories will often fall early in a recovery because:
A.businesses need profit.
B.sales outstrip production.
C.businesses ramp up production because of increased economic activity.
B is correct. The companies are slow to increase production in the early recovery phase because they first want to confirm the recession is over. Increasing output also takes time after the downsizing during the recession.
In a recession, companies are most likely to adjust their stock of physical capital by:
A.selling it at fire sale prices.
B.not maintaining equipment.
C.quickly canceling orders for new construction equipment.
B is correct. Physical capital adjustments to downturns come through aging of equipment plus lack of maintenance.
The inventory–sales ratio is most likely to be rising:
A.as a contraction unfolds.
B.partially into a recovery.
C.near the top of an economic cycle.
C is correct. Near the top of a cycle, sales begin to slow before production is cut, leading to an increase in inventories relative to sales.
Economic indicators
Economic statistics provided by government and established private organizations that contain information on an economy’s recent past activity or its current or future position in the business cycle.
Leading Indicators
Turning points that usually precede those of the overall economy; they are believed to have value for predicting the economy’s future state, usually near-term.
Coincident economic indicators
Turning points that are usually close to those of the overall economy; they are believed to have value for identifying the economy’s present state.
Lagging economic indicators
Turning points that take place later than those of the overall economy; they are believed to have value in identifying the economy’s past condition.
Leading/Lagging/Coincident:
Inventory-to-Sales
Lagging
Leading/Lagging/Coincident:
Loans Outstanding
Lagging
Leading/Lagging/Coincident:
Industrial Production Index
Coincident
Leading/Lagging/Coincident:
Real Personal Incomes
Coincident
Leading/Lagging/Coincident:
Manufacturing and Trade Sales
Coincident
Leading/Lagging/Coincident:
Stock Market
Leading
Leading/Lagging/Coincident:
Housing Prices
Leading
Leading/Lagging/Coincident:
Retail Sales
Leading
Leading/Lagging/Coincident:
Building Permits
Leading
Leading/Lagging/Coincident:
Average Weekly Hours
(Manufacturing)
Leading
Leading/Lagging/Coincident:
Consumer Expectations
Leading
Composite Indicators
Traditionally, most composite indicators to measure the cyclical state of the economy consist of up to a dozen handpicked variables published by organizations like the OECD or national research institutes. The exact variables combined into these composites vary from one economy to the other. In each case, however, they bring together various economic and financial measures that have displayed a consistently leading, coincident, or lagging relationship to that economy’s general cycle.
Diffusion Index
Reflects the proportion of the index’s components that are moving in a pattern consistent with the overall index.
Nowcasting
making forecasts about the current economic conditions
Fiscal Policy
Refers to the government’s decision about taxation and spending.
Monetary Policy
Actions taken by a nation’s central bank to affect aggregate output and prices through changes in bank reserves, reserve requirements, or its target interest rate.
True/False:
Economic decisions made by households and corporations influence the economy, but government decisions have a far greater impact.
True.
This is because governments often employ a significant portion of the population and are major spenders and borrowers.
Key Objective of Monetary and Fiscal Policy
The primary goal of these policies is to create a stable economic environment with positive growth and low, stable inflation.
Monetary Policy:
What does it aim to regulate?
Aims to regulate the quantity of money and credit to stabilize economic growth and inflation.
Fiscal Policy:
What does it aim to regulate?
Aimed at regulating economic activity.
Aggregate Demand:
Definition
Total amount companies and households plan to spend.
Fiscal Policy:
Influencing Aggregate Demand:
Expansionary Policy
Aimed at increasing AD
Fiscal Policy:
Influencing Aggregate Demand:
Contractionary Policy
Used to reduce AD during economic booms.
Fiscal Policy:
Economic Stabilization:
Role During Recessions
Increase spending to raise employment and output.
Fiscal Policy:
Economic Stabilization:
Role During Booms
Reduce spending and increase taxes to prevent overheating.
Fiscal Policy:
Automatic Stabilizers:
Definition
Mechanisms that automatically adjust government spending and taxes in response to economic conditions without the need for explicit policy changes.
Fiscal Policy:
Automatic Stabilizers:
Example
unemployment benefits and progressive tax systems.
Fiscal Policy:
Discretionary Fiscal Policy:
Definition
Deliberate changes in government spending or tax rates to influence aggregate demand.
Budget Surplus:
Definition
Budget Surplus: Government revenues exceed expenditures.
A rising surplus indicates contractionary policy.
Budget Deficit:
Definition
Budget Deficit: Government expenditures exceed revenues.
A rising deficit indicates expansionary policy.
National Debt Size Relative to GDP:
Arguments why it matters
High debt-to-GDP ratios can lead to higher interest rates, crowding out private investment, and potential solvency issues.
National Debt Size Relative to GDP:
Arguments why it doesn’t matter
Some argue that as long as debt is managed and the economy grows, high debt levels can be sustainable, especially if borrowing finances productive investments.
Keynesians
Economists who believe that fiscal policy can have powerful effects on aggregate demand, output, and employment when there is substantial spare capacity in an economy.
Monetarists
Economists who believe that the rate of growth of the money supply is the primary determinant of the rate of inflation.
The least likely goal of a government’s fiscal policy is to:
A.redistribute income and wealth.
B.influence aggregate national output.
C.ensure the stability of the purchasing power of its currency.
C is correct. Ensuring stable purchasing power is a goal of monetary rather than fiscal policy. Fiscal policy involves the use of government spending and tax revenue to affect the overall level of aggregate demand in an economy and hence the level of economic activity.
Which of the following best represents a contractionary fiscal policy?
A.Temporary suspension of payroll taxes
B.Public spending on a high-speed railway
C.Freeze in discretionary government spending
C is correct. A freeze in discretionary government spending is an example of a contractionary fiscal policy.
A “pay-as-you-go” rule, which requires that any tax cut or increase in entitlement spending be offset by an increase in other taxes or reduction in other entitlement spending, is an example of which fiscal policy stance?
A. Neutral
B. Expansionary
C. Contractionary
A is correct. A “pay-as-you-go” rule is a neutral policy because any increases in spending or reductions in revenues would be offset. Accordingly, there would be no net impact on the budget deficit/surplus.
Which of the following is not associated with an expansionary fiscal policy?
A. Rise in capital gains taxes
B. Cuts in personal income taxes
C.New capital spending by the government on road building
A is correct. A rise in capital gains taxes reduces income available for spending and hence reduces aggregate demand, other things being equal. Cutting income tax raises disposable income, while new road building raises employment and incomes; in both cases, aggregate demand rises and hence policy is expansionary.
Fiscal expansions will most likely have the greatest impact on aggregate output when the economy is in which of the following states?
A. Full employment
B. Near full employment
C. Considerable unemployment
C is correct. When an economy is close to full employment, a fiscal expansion raising aggregate demand can have little impact on output because there are few spare unused resources (e.g., labor or idle factories); instead, there will be upward pressure on prices (i.e., inflation). The greatest impact on aggregate output will occur when there is considerable unemployment.
Which one of the following is most likely a reason to not use fiscal deficits as an expansionary tool?
A.They may crowd out private investment.
B.They may facilitate tax changes to reduce distortions in an economy.
C.They may stimulate employment when there is substantial unemployment in an economy.
A is correct. A frequent argument against raises in fiscal deficits is that the additional borrowing to fund the deficit in financial markets will displace private sector borrowing for investment (i.e., crowding out).
The most likely argument against high national debt levels is that:
A. the debt is owed internally to fellow citizens.
B.they create disincentives for economic activity.
C.they may finance investment in physical and human capital.
B is correct. The belief is that high levels of debt to GDP may lead to higher future tax rates, which may lead to disincentives to economic activity.
Fiscal Policy Tools:
Government Spending:
Transfer Payments
Transfer Payments:
Welfare payments via social security systems (e.g., state pensions, unemployment benefits).
Provide basic income for low-income households and adjust income distribution.
Not part of GDP as they do not reflect production activity.
Fiscal Policy Tools:
Government Spending:
Current Government Spending
Regular spending on goods and services, such as health, education, and defense.
Significant impact on skill levels and labor productivity.
Fiscal Policy Tools:
Government Spending:
Capital Expenditure
Infrastructure investments (e.g., roads, schools, hospitals).
Increases a nation’s capital stock, affecting long-term productive potential.
Fiscal Policy Tools:
Government Spending:
Justifications for Spending:
Public Services
Provide universally beneficial services like defense.
Fiscal Policy Tools:
Government Spending:
Justifications for Spending:
Economic Growth
Infrastructure spending supports economic development.
Fiscal Policy Tools:
Government Spending:
Justifications for Spending:
Income Redistribution
Ensures minimum income levels and reduces income inequality.
Fiscal Policy Tools:
Government Spending:
Justifications for Spending:
Economic Objectives
Manage aggregate demand to control inflation, employment, and growth.
Fiscal Policy Tools:
Government Spending:
Justifications for Spending:
Subsidies for Innovation
Support high-risk investments in new technologies or markets.
