Politics and Economics I

Question 1

The Six Economic Functions of Government in the United States

Answer 1

Regulation, Competition, Correcting Externalities, Public Goods and Services, Income Redistribution, Economic Stability.

Question 2

The Six Economic Functions of Government in the United States - Regulation

Answer 2

The government regulates legal and social framework. It helps ensure that legal contracts for businesses are enforceable through a court system. This helps keep all people accountable when doing business together. This function also ensures that when you purchase a home or other asset that you have certain rights and protections. See also: Competition, Correcting Externalities, Public Goods and Services, Income Redistribution, and Economic Stability.

Question 3

The Six Economic Functions of Government in the United States - Competition

Answer 3

The government helps maintain competition. Part of the government’s role is to enforce anti-trust laws, which keep monopolies from happening. This ensures many businesses are able to compete and offer products and services to consumers. As a result, you experience better quality products and lower prices. See also: Regulation, Correcting Externalities, Public Goods and Services, Income Redistribution, and Economic Stability.

Question 4

The Six Economic Functions of Government in the United States - Correcting Externalities

Answer 4

The government is there for correcting externalities. Externalities are effects of business decisions that can affect people or parties that had no say in a matter or no control over decisions in the first place. An example is factory pollution. A factory may produce a great product that is needed in the economy, such as pet food, vehicles, or aspirin. In making that product, the factory may create a lot of pollution or waste that can cause health concerns for nearby areas. In this case, the government can step in and can tax or set regulations to help ensure pollution and waste is kept at acceptable levels. See also: Regulation, Competition, Public Goods and Services, Income Redistribution, and Economic Stability.

Question 5

The Six Economic Functions of Government in the United States - Public Goods and Services

Answer 5

The government provides public goods and services. One of the government’s duties is to ensure we all feel safe through an adequate national defense program. They also provide national parks, like Yellowstone and Yosemite, that we can enjoy. Things that many of us rely on, such as prisons, fire services, public schools, transportation, and delivering mail, are all examples of this. These are all things that the public and, by extension, the government have deemed too important to be left to the devices of private businesses and organizations or to the whims of making a profit. See also: Regulation, Competition, Correcting Externalities, Income Redistribution, and Economic Stability.

Question 6

The Six Economic Functions of Government in the United States - Income Redistribution

Answer 6

The government is responsible for the redistribution of income. In a capitalist and free market economy, there are often inequalities or gaps in how income is distributed among social classes. The government uses a progressive tax system to help distribute income in a more socially just manner so that all individuals have opportunities to improve their standard of living. The thought is that society is better off as a whole if all citizens can improve their financial situation, and not just the ultra wealthy. Besides the income tax system, the government provides services such as housing assistance, healthcare (Medicaid and social security services), unemployment programs, and food stamp programs to help those in need get the necessary assistance. See also: Regulation, Competition, Correcting Externalities, Public Goods and Services, and Economic Stability.

Question 7

The Six Economic Functions of Government in the United States - Economic Stability

Answer 7

The government is there to promote economic stability. Through the Federal Reserve Bank, tax policies, and spending programs, the government is able to help control and manipulate the unemployment and inflation in the economy to what it deems are appropriate levels. This is important because additional government projects and lower taxes on business owners can result in more jobs for the economy. This means it is easier for you to find a job! If interest rates or the national money supply were left unchecked, you might find that you could pay 20% annual interest on a car loan. See also: Regulation, Competition, Correcting Externalities, Public Goods and Services, and Income Redistribution.

Question 8

Resource Allocation

Answer 8

The process of dividing up and distributing available, limited resources to competing, alternative uses that satisfy unlimited wants and needs. Given that the world is rampant with scarcity (unlimited wants and needs, but limited resources), every want and need cannot be satisfied with available resources. Choices have to be made. Some wants and needs are satisfied, some are not. These choices are the resource allocation process. An efficient resource allocation exists if society has achieved the highest possible level of satisfaction of wants and needs from the available resources AND resources can not be allocated differently to achieve any greater satisfaction.

Question 9

Efficiency

Answer 9

Economic efficiency implies an economic state in which every resource is optimally allocated to serve each individual or entity in the best way while minimizing waste and inefficiency. When an economy is economically efficient, any changes made to assist one entity would harm another. In terms of production, goods are produced at their lowest possible cost, as are the variable inputs of production.

Question 10

Productive Efficiency Vs. Allocative Efficiency

Answer 10

Productive efficiency means that, given the available inputs and technology, it is impossible to produce more of one good without decreasing the quantity that is produced of another good. Thus, all choices along a given PPF, such as B, C, and D as displayed on its curve, display productive efficiency, but R, lying within the PPF curve, does not.

Question 11

Productive Efficiency Vs. Allocative Efficiency

Answer 11

Allocative efficiency means that the particular combination of goods and services on the production possibility curve that a society produces represents the combination that society most desires. How to determine what a society desires can be a controversial question, and is usually a discussion in political science, sociology, and philosophy classes as well as in economics. At its most basic, allocative efficiency means producers supply the quantity of each product that consumers demand. Only one of the productively efficient choices will be the allocatively efficient choice for society as a whole.

Question 12

Systems for Allocation - Contributive Standard

Answer 12

The contributive standard distributes income based on a person’s contribution to production. This standard answers the ‘For Whom?’ question of allocation primarily through the use of prices and markets. The resources used to produce goods that more highly valued society (meaning they better satisfy unlimited wants and needs) command higher prices and thus generate more income to their owners. An actor, for example, who can attract millions of adoring. $7-a-ticket fans to one performance of an action-packed, blockbuster movie produces a good that is more highly valued by society than a philosophy professor who spends all semester teaching a handful of reluctant, $100-a-credit-hour students the finer details of existentialism. See also, Needs Standard and Equality Standard.

Question 13

Systems for Allocation - Needs Standard

Answer 13

The needs standard distributes income based on how many goods and services people require. A manual laborer, for example, who exerts more physical effort, would receive more income to buy more food than an office worker who burns fewer calories during the day. The U.S. welfare system primarily employs this needs standard when determining the poverty line and subsequent welfare payments. See also, Contributive Standard and Equality Standard.

Question 14

Systems for Allocation - Equality Standard

Answer 14

The equality standard distributes income equally to every person in society. Everyone–every man, woman, and child–would, in other words, receive exactly the same, per capita income–no more, no less. If, for example, total income earned by 270 million people in the United States is $7 trillion, then every person would receive $25,925.90 each–no more, no less. See also, Needs Standard and Contributive Standard.

Question 15

Demand-Side Economics or Keynesian Economic Theory

Answer 15

A macroeconomic economic theory emphasizing short-run aggregate demand adjustments: Consumption of goods and services, investment by industry in capital goods, government spending on public goods and services, and net exports. It advocates the use of government spending and growth in the money supply (altering interest rates or selling or buying government-issued bonds), or inflation, to stimulate the demand for goods and services and therefore expand economic activity. High consumer spending leads to business expansion resulting in greater employment opportunities. Higher levels of employment create a multiplier effect that further stimulates aggregate demand, leading to greater economic growth. It seeks optimal performance of the economy through activist stabilization and economic intervention by the government to prevent boom-and-bust business cycles. It risks overlooking the long-term causes of economic growth or the natural rate of unemployment that exist even when the economy is producing at potential GDP. British economist John Maynard Keynes saw his theories successfully demonstrated in the 1930s when they helped end the Great Depression and into the 1950s and 60s when capitalism experienced its Golden Age. Compare with Supply-Side Economics.

Question 16

Supply-Side Economics or Neoclassical Economic Theory

Answer 16

A macroeconomic economic theory emphasizing aggregated supply adjustments. It focuses on the underlying determinants of output and employment in markets, and thus tends to put more emphasis on economic growth and how labor markets work. In general, it has three pillars: tax policy, regulatory policy, and monetary policy. It advocates the reduction of marginal tax rates encouraging more earnings, savings, and investment and thereby expanding economic activity and the total taxable national income. In regards to regulatory policy, supply-siders tend to ally with traditional political conservatives—those who would prefer a smaller government and less intervention in the free market. Pertaining to monetary policy, the Federal Reserve’s ability to increase or decrease the quantity of dollars in circulation, it tends to view inflation as a cost that offers no offsetting gains in terms of lower unemployment. Supply-side economics is not very helpful at explaining rapid boom-and-bust cycles in unemployment, nor is it helpful at reacting to deep and long-lasting recessions. An example of supply-side economics is ‘Reaganomics’, or the ‘trickle-down’ policy espoused by 40th U.S. President Ronald Reagan in the 1980s. Compare with Demand-Side Economics.

Question 17

The biggest difference between Demand-Side and Supply-Side Economics.

Answer 17

This is the single big distinction: A pure Keynesian believes that consumers and their demand for goods and services are key economic drivers, while a supply-sider believes that producers and their willingness to create goods and services set the pace of economic growth.

Question 18

Governments and Fiscal and Monetary Policy in Relation to the Economy.

Answer 18

The U.S. government uses both fiscal and monetary policy to protect our economy and promote long-term economic growth. The protections that fiscal policy provides are help in a recession, keeping inflation in check, and preventing boom and bust periods in the economy. Monetary policy also provides the protections of promoting maximum employment, stable prices, and moderate long-term interest rates.

Question 19

Fiscal Policy

Answer 19

Fiscal policy includes government budget decisions regarding federal spending and money raised by the government through taxes and budget deficits or surpluses. By adjusting overall demand for goods and services through changes in taxation and government spending, the government hopes to control unemployment levels and inflation, which adversely affect the economy’s health. Fiscal policy can be either expansionary or contractionary.

Question 20

Monetary Policy

Answer 20

Monetary policy consists of the actions of a central bank, currency board, or other regulatory committees that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep in the vault (bank reserves). The Federal Reserve is in charge of monetary policy in the United States. Broadly speaking, there are two types of monetary policy: expansionary and contractionary.

Question 21

Budget Deficit

Answer 21

A budget deficit occurs when expenses exceed revenue, and it is an indicator of financial health. The government generally uses this term in reference to its spending rather than business or individuals. Accrued government deficits form the national debt.

Question 22

Two Ways the Government Promotes Business

Answer 22

First, the government can provide any number of programs, such as loans and research grants, to help businesses prosper. Second, the government also gives incentives to businesses in the form of favorable tax laws, such as tax credits and tax deductions.

Question 23

Fiscal Policy - Expansionary

Answer 23

Expansionary fiscal policy is appropriate when the economy is operating below its normal output, as in recessions and troughs in the business cycle when unemployment is high, business profits are low and businesses are not operating at full capacity. Government spending will be increased and/or taxes for individuals (and perhaps small businesses) will be reduced to stimulate the economy.

Question 24

Fiscal Policy - Contractionary/Deflationary

Answer 24

Contractionary fiscal policy occurs when the business cycle is near its peak, businesses are at full capacity, unemployment is low, and business profits are high. The government decreases spending and may increase taxes for individuals and businesses. A government will often wipe out its deficit and create a surplus during a contractionary fiscal period.

Question 25

Tax Credit

Answer 25

A tax credit is an amount of money that taxpayers can subtract from taxes owed to their government. The value of a tax credit depends on the nature of the credit; certain types of tax credits are granted to individuals or businesses in specific locations, classifications, or industries. Unlike deductions and exemptions, which reduce the amount of taxable income, tax credits reduce the actual amount of tax owed.

Question 26

Tax Deduction

Answer 26

A tax deduction is a deduction that lowers a person’s tax liability by lowering his taxable income. Deductions are typically expenses that the taxpayer incurs during the year that can be applied against or subtracted from his gross income in order to figure out how much tax is owed. There are two kings of tax deductions: standard and itemized. Standard deductions are a set amount to be deducted, while itemized deductions are based on things such as mortgage interest, charitable gifts, and medical expenses. The difference between deductions, exemptions, and credit is that deductions and exemptions both reduce taxable income, while credits reduce tax.

Question 27

Tax Exemption

Answer 27

Tax exemption is a monetary exemption which reduces taxable income. Tax exempt status can provide complete relief from taxes, reduced rates, or tax on only a portion of items. Examples include exemption of charitable organizations from property taxes and income taxes, veterans, and certain cross-border or multi-jurisdictional scenarios. The difference between deductions, exemptions, and credit is that deductions and exemptions both reduce taxable income, while credits reduce tax.

Question 28

Monetary Policy - Federal Reserve

Answer 28

The Federal Reserve System is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of financial panics (particularly the panic of 1907) led to the desire for central control of the monetary system in order to alleviate financial crisis. While the U.S. government attempts to influence the Federal Reserve, they are an independent body.

Question 29

Monetary Policy - Federal Reserve - Three Tools to Control the Money Supply

Answer 29

The Fed has three tools it uses to control the money supply: - Changing the reserve requirement in banks. - Open market operations (OMO): Buying U.S. treasury bonds on the open market. - Changing the discount rate (the interest rate set by central banks).

Question 30

Monetary Policy - Federal Reserve - Reserve Requirement

Answer 30

Reserve requirements are the amount of cash that banks must have, in their vaults or at the closest Federal Reserve bank, in line with deposits made by their customers. Set by the Fed’s board of governors, reserve requirements are one of the three main tools of monetary policy — the other two tools are open market operations and the discount rate.

Question 31

Monetary Policy - Federal Reserve - Open Market Operations

Answer 31

Open market operations (OMO) refer to the buying and selling of government securities (bonds) in the open market in order to expand or contract the amount of money in the banking system. Security purchases inject money into the banking system and stimulate growth (expansionary). The deposits become part of the cash that commercial banks hold at the Fed, and therefore increase the amount of money that commercial banks have available to lend, thus decreasing interest rates indirectly. While sales of securities to individuals and institutions do the opposite and contract the economy, which decreases the amount of money left for commercial banks to lend, thus increasing interest rates (contractionary). Open market operations are one of the three main tools of monetary policy — the other two tools are reserve requirements and the discount rate.

Question 32

Monetary Policy - Federal Reserve - Open Market Operations - Bonds

Answer 32

A bond is a form of loan or IOU: The ‘holder’ of the bond is the lender (creditor). The ‘holder’ “buys” the bond from an ‘issuer’. The ‘issuer’ of the bond is the borrower (debtor). The ‘issuer’ “sells” the bond to the ‘holder’. The ‘coupon’ is the interest. Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure. Bonds are used by companies, municipalities, states, and sovereign governments to raise money and finance a variety of projects and activities.

Question 33

Monetary Policy - Federal Reserve - Discount Rate

Answer 33

The discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from the Federal Reserve’s discount window. Discount rates are one of the three main tools of monetary policy — the other two tools are reserve requirements and the open market operations.

Question 34

Monetary Policy - Federal Reserve - Discount Rate - Expansionary Monetary Policy

Answer 34

If the Fed implements an expansionary monetary policy, the supply of credit increases and its costs fall. This type of policy is often implemented as an attempt to encourage economic growth. The Fed wants to put businesses and banks in a position to want to take out loans and create healthy investments that will sustain the economy.

Question 35

Monetary Policy - Federal Reserve - Discount Rate - Contractionary Monetary Policy

Answer 35

If the Fed implements a contractionary monetary policy, the supply of credit decreases and its cost increases. This is most often done to control inflation.