Unit 1 - Economic Policy

Question 1

Positive economics - Economic Policy

Answer 1

Economic policy as exogenous, observing impacts (its like you are watching a movie without giving your opinion on what you’re watching)

Question 2

Normative economics - Economic Policy

Answer 2

Benevolent social planner, best choice in from of information asymmetries (You’re not just observing you are deciding what should happen for the best outcome)

Question 3

Policial Economics - Economic Policy

Answer 3

Economic policy as endogenous, but we are still an exogenous observer (You notice how the characters in a movie influence the story, but you’re not part of the story yourself)

Question 4

What to Policy Makers do?

Answer 4

1. Set and enforce the rules of the economic game
2. Tax and Spend
3. Issue and manage the currency
4. Produce goods and services
5. Fix problems or pretend to
6. Negotiate with other countries

Question 5

Set an enforce the rule of the economic game - What do Policy makers do?

Answer 5

Set and enforce the rule of the economic game.
- Market outcomes depend on power relations between certain groups. It is important to watch out for corruption and fraud because powerful groups might try to bend the rules in their favour.
- Economic Legislation: Framework for the decisions of private agents
- Enforcement = protection of property rights, competition policy, labour law and supervision of regulated markets

Question 6

Tax and Spend - What do policy makers do?

Answer 6

2. Tax and Spend
   - Taxes and social insurance affect households’ and firms’ income and behaviour
   - Infrastructure, research and education spending lead to productivity and growth
   - Spending or overall taxation leads to aggregate demand

Question 7

Issue and Manage Currency - What do policy makers do?

Answer 7

• Funcion of the central bank, usually independ of state governmnet, but it still counts as economic policy
• Interest rates, stabilising currency etc

Question 8

Produce goods and services - What do policy makers do?

Answer 8

Produce goods and services such as education. healthcare, transport and energy

Question 9

Fix problems or pretend to - What do policy makers do?

Answer 9

Ministers - deal with financial market turmoil, wage negotiations, mergers

Question 10

Negotiate with other countries - What do policymakers do?

Answer 10

Trade liberalisation, defining global rules and objectives

Question 11

Objectives of economic policy

Answer 11

• Improving standards of living
• Sustainable growth
• Full employment
• Price stability
• Fair distribution of income
• Reducing poverty

Question 12

Instruments for economic policy

Answer 12

• Monetary policy (Interest rates, but also non-conventional monetary policy)
• Fiscal policy (public expenditures and taxes)
• Others (structure of taxation, subsidies etc)

Question 13

A simple representation of economic policy

Answer 13

Policy maker -> Instruments -> Objectives

Question 14

Changing the instituions: Structural reform

Answer 14

1. IMF - measures that change the institutional framework and constraints governing market behaviour and outcomes
2. OECD - Improves long-term material living standards through higher productivity and labour utilization

Question 15

Macroeconomic reasons to intervene by implementing allocation policies?

Answer 15

1. Allocation - Aim to make the economy more efficient and hence to raise the pace of the economy in the long-run. State intervention is justified when it is able to remedy market failures
2. Stabilisation - To limit short-term deviations from long-term equilibrium, and to avoid efficiency loss from not being in it
3. Redistribution - Can even improve efficiency e.g education/healthcare which leads to productivity

Question 16

Imperfect competition _ Microeconomics reasons to intervene/ reasons for allocation policies

Answer 16

1. Imperfect Competition: Perfect competition leads to profit maximisation. Monopolies have some market power so it is considered that the elasticity of demand is no longer infinite. Monopolies however, are not always undesirable, when production involves high fixed costs and increasing returns to scale, larger firms or even monopolies are more efficient than smaller firms.
   - Solutions: Anti-trust policies (Blocking mergers, preventing power abuse)

Question 17

External effects - Microeconomic reasons to intervene/reasons for allocation policies

Answer 17

External effects: External effects (externalities) are effects of a product or activity that impact people not directly involved in making or buying the product. They can be negative like pollution, or positive like the benefits of Research and Development (R&D).
- To combat this there is the ‘polluter-payer principle’ which means to fix negative externalities by taxing them (e.g. pollution) and by subsidising or giving tax exemptions to the positive ones e.g. (R&D).

Question 18

imperfect information - Microeconomic reasons to intervene/reasons for allocation policies

Answer 18

If information has a strategic character (which is special information that some companies know that others do not) and if agents use it to their profit, the market outcome is no longer necessarily Pareto-optimum.
- Pareto-optimum refers to a situation where no one can be made better off without making someone else worse off.
- Adverse selection happens when someone hides important information
- Solutions: Disseminating information which ensures everyone knows the relevant information. Other solutions are accounting and financial reporting standards and public solution.

Question 19

Market incompleteness - Microeconomic reasons to intervene/reasons for allocation policies

Answer 19

For competitive market equilibrium to be Pareto-optimum, there should exist markets for all necessary transactions at all relevant horizons. This is not always true, so the government could intervene with: Grants, scholarships and student loan guarantees.

Question 19

Collateral effects of economic policy

Answer 19

Can be positive (e.g. gains in efficiency from trade openness or technological progress) or negative (e.g. the fact that those two can create unskilled labour)