Week Three First Discussion: Monopolies Second Discussions: 1.Is a budget deficit harmful to the economy? 2.Should marijuana be decriminalized? 1

Monopolistic Competition Characteristics – Small Market Shares – No Collusion – Independent Action Differentiated Products – Product Attributes – Service – Location – Brand Names and Packaging – Some Control Over Price 2

Competition Competition forces firms to be as efficient as possible. They can charge the lowest possible prices to get people to buy their goods and services. o This process answers the question, “How to produce?” To have competition, you need many firms in a particular industry. o You need enough so that no one firm is large enough to have any influence over price. When sectors of American industry are not very competitive the price system doesn’t work well. o The invisible hand becomes less active and more ineffective. o The forces of supply and demand are distorted. 3

Trust Capitalism is based on trust. o Lenders expect borrowers to pay back loans. o Buyers and sellers expect contracts to be honored. o Workers expect to be paid by employers. If we do not trust that these agreements will be honored, the economy will not function. Self-interest can lead economic actors to behave in a trustworthy manner, so they can continue to do business. The legal system reinforces trust by providing consequences for dishonest behavior. 4

Three Options for Fiscal Policy Balanced Budget: G = T – Government expenditures equal tax revenue for the fiscal year. Budget Deficit: G > T – Government spending is greater than tax revenue for the fiscal year. – Government borrows difference by issuing Treasury bonds. Budget Surplus: G < T – Government spending is less than tax revenue for the fiscal year. 5

Government Purchases versus Transfer Payments The federal, state, and local governments spend over $5.0 trillion a year.  Approximately half is government purchases. The largest government purchase is defense. These end up in the “G” part of GDP. GDP = C + I + G + Xn  The other half is transfer payments. The largest transfer payment is social security. These payments end up in the “C” part GDP. 6

Recessionary Gaps and Inflationary Gaps Recessionary Gap occurs when equilibrium GDP is less than full- employment GDP. – Inadequate Aggregate Demand (C + I + G + X n ) – Fiscal Policy solution is to run a budget deficit (raise G or lower T). Inflationary Gap occurs when equilibrium GDP is greater than full-employment GDP. – Excess Aggregate Demand sparking inflation – “Too many dollars chasing too few goods.” – Fiscal Policy solution is to create a budget surplus (decrease G or raise T). Budget deficits are only appropriate during recessions. 7

Putting Fiscal Policy into Perspective Problem in Depression was inadequate Aggregate Demand for output (real GDP). Equilibrium stuck below full-employment level: – C stays low because consumers are unemployed or cutting back. – I stays low because businesses have low profit expectations and no incentive to expand inventories or production. – The only component of AD that the government can control is G. Increase G to increase AD. – Or, by cutting taxes (T), government can hope consumers and businesses will spend additional income. Running a budget deficit could jump-start the economy. 8