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Fundamental Economic Problem
The impact of unlimited human rights on the limited resources of nature.
- 1. Develope resonable assumptions about economic behavior
- 2. Identify categories and variables to measure those categories
- 3. State the hypothesis about the relation between variables
- 4. Empirically test the theory
- Empirical method not objective in the state sense.
- We can establish facts but there are values in facts.
- Empirical method is objective.
- First establish assumptions and make them into facts.
- Concerned with what is the facts.
- Value free
- Concerned with what ought to be.
- Value judgements
An economy is efficient if it takes all opportunities to make some people better off without making our people worse off
Insuring that everyone gets their fair share.
Production Possibilities Frontier
- 1. Society produces two goods
- 2. Society uses resources efficiently
- 3. Technology is constant
- 4. Resources are constant
Law of Demand
There is an inverse relationship between the price of a good and the quantity demanded of that good all else equal.
Determinants of Demand
- 1. Changes in peoples preferances.
- 2. Changes in peoples income.
- 3. Changes in prices of substitute and complementary goods.
- 4. Peoples expectations about the future.
Self adjusting market
- Demand goes up shortage
- Supply goes up surplus
Circular Flow Model
- Households--Factor Markets-- Firms-- Markets for Good and Services.
- Factors Factors G&S G&S
Supply creats its own demand
Leakage of savings vs injection of investment
- Injections-- Investment
4 categories of Government Spending
- National Defense- 15%
- Education- 17%
- Other Good and Services- 25%
- Transfers- 44%
- The transfer of tax revenues in general to specific programs.
- Social security, unemployment, medicare...
The Four Functions of Goverment
- 1. Provide public goods and services-- national defense, criminal justice system, education.
- 2. Redistribution of Income-- transfering tax revenues to the transfer programs.
- 3. Stablization- government has the responsibility to promote full employment with stable prices.
- 4. Economic regulation
- 1. Non-excludability- the supplier cannot prevent consumption of the good by people who do not pay.
- 2. Non-Rivalry- If others consume the goods this does not diminish the benefit to an individual.
- 1. They are excludable- suppliers can prevent people who do not pay from consuming the good.
- 2. They are rival in consumption- additional persons consuming the good would diminish the benefit to an individual.
Free Rider Program
Applies to non-excludable goods- self interestedpersons (who do not pay for the good) consume the good by taking a free ride from persons to pay.
- Marginal Tax Rate-- Changes in taxes paid/ changes in income.
- Average Tax Rate- Total tax/ Total income
Taxes on Wealth
- Property- Levied on land annd buildings to help pay for local public services.
- Estate- Levied at the time of death on estate and inheritance.
Taxes on Activites
- Sales- a flat tax on retail prices
- Excise- taxes on the manufacture liquor, tabacco and gasoline.
- Social Security- Payroll tax on wages and salary.
Theories of Taxation
- 1. Equity are tax burdens distributed in a just way.
- 2. Efficiency- does the tax improve productive allocatoins of resources in the economy.
- 3. Emforcability- cam the tax be enforced? If not should they not tax.
Two Principles of Tax Equity
- 1. Horizontal Equity- equals should be treated equal.
- 2. Vertical Equity- People who are economically unequal should bear equal tax burdens.
Two Additional Priciples
- 1. The Benefit Principle- People should be taxed according to the benefits they recieve.
- 2. The Ability to pay Principle- The fairest tax is based on the ability of the tax payer to pay.
Three tax Rates
- 1. The progressive Tax Rate- the tax rate increases as income increases. (10, 20, 30, 40)
- 2. The regressive tax rate- the tax rate decreases as income increases. (40, 30, 20, 10)
- 3. the proportional- the tax rate stays the same as income increases. (10, 10, 10, 10)
The Welfare State
- Non-Means- tested transfer. (social security, medicare, unemployment)
- Means- qualify if your income falls below poverty threshold. (TANF, EITC, Supplemental Security income, food stains)
Argument against the Welfare State
- 1. Gov't should not redistribute income- the proper role of gov't is to maintain rule of law.
- 2. Efficiency v. Equity- the welfare state leads to marginal tax rates that are too high. Reduces work efforts and the problem of the notch.
Gross Domestic Product (GDP)
The current market value of final goods and services produced within the bounderies at the US in a given year.
Gross National Product (GNP)
The current market value of final goods and services produced by US firms at home and abroad.
How to measure GDP
- 1. The national income and product accounts.
- 2. Value added approach
The national income and product accounts
- Expenditures- Consumption, Investment, Gov't Spending, Exports/Imports.
- Income- compensation to employees, Rents, Profits, Indirect business taxes.
The Value Added Approach
The difference between the proce of a good and the cost of intermidiate goods used to produce it.
Does GDP measure well being?
- It does measure well being but we need to be cautious of it.
- Does not measure distribution of income, quality of output or environmental damage.
Three Price Indexes
- 1. the consumer price index CPI- uses the goods and services consumed by the average urban house hold.
- 2. the producer price index PPI- uses goods purchased by wholesalers.
- 3. the GDP price Deflator- uses final good and services that are produce in the economy.
Calulating Rate of inflation
- P1- the price index in a current year
- P0- Price index in a earlier year
Real vs. Nominal
- Nominal- The value of something in terms of curent prices.
- Real- A nominal value after adjusting for inflation.
Three types of Inflation
- 1.Demand Pull inflation- occurs when aggregate demand exceed capacity in the economy.
- 2. Cost push inflation- Due to increased prices of factors of production.
- 3. Expectations inflation- occurs when the public comes to anticipate inflation.
The Economic Effects of inflation
- 1. The Equity Effects- inflation reduces real income.
- 2. The Efficiency Effects- inflation contributes to higher cost of production.
- # unemployed/ civilian labor force X 100.
- A person is unemployed if they are not working but have been actively seeking work during the previous four weeks.
Three types of unemployment
- 1. Frictional unemployment- people who are inbetween jobs.
- 2. Strctural unemployment- people who are unemployed due to structural changes in economy.
- 3. Cyclical unemployment- thsi is related to the level of aggregate demand in the economy.
The Natural Rate of unemployment
- Unemployment that exists when economy is at capacity.
- Fictonal + Structural Unemployment
Externalities (spillover effect)
Is an additional cost or benefit not reflected in the price of a good.