1. Chapter 12 Government Decisions and Economic Success

2. What role should the government play in our economy?

3. Role of Government Free market protection Free market protection –Anti-monopoly Public Goods/Services Public Goods/Services Economic Stability Economic Stability Protection/Sovereignty Protection/Sovereignty Preservation of Rights Preservation of Rights Regulation of Trade Regulation of Trade Foreign Affairs Foreign Affairs

4. Disagreements Objectives Objectives Priorities Priorities Poverty vs. Investment? Poverty vs. Investment? Inflation vs. Unemployment? Inflation vs. Unemployment? Free Trade vs. Protectionism? Free Trade vs. Protectionism?

5. Theories of Govt. Involvement Classical School Classical School –Adam Smith- Laissez-Faire –Jean Baptiste Say Free-Market emphasis Free-Market emphasis Less govt. intereference Less govt. intereference Keynesian School Keynesian School –Govt. spending can fix economies

6. The Classical Theory Free-markets correct themselves Free-markets correct themselves –Supply and Demand Wages Wages Prices Prices Interest Rates Interest Rates –Tend towards Full-employment in the long-run Little need for Govt. intervention Little need for Govt. intervention Great Depression challenged this notion Great Depression challenged this notion Micro-economics Micro-economics

7. Keynesian Economics John Maynard Keynes John Maynard Keynes –Father of Macro- economics

8. Spending drives the economy Spending drives the economy –People –Businesses –Govt. Recessions Recessions –Must rely on Govt. spending –Increase Demand AD= C + I + G + Trade Balance AD= C + I + G + Trade Balance

9. Keynes (cont.) Key tools (Fiscal policy) Key tools (Fiscal policy) –Taxes –Govt. Spending Recession Recession –Decrease taxes or increase spending Expansion Expansion –Increase taxes or decrease spending “Fine tune the economy” “Fine tune the economy”

10. Political Reality of Demand Side Policy NO MATTER HOW THE ECONOMY IS DOING Democrats rarely want tax cuts Democrats rarely want tax cuts Republicans rarely want tax increases Republicans rarely want tax increases Democrats push for more spending Democrats push for more spending Republicans (in theory) push for spending cuts. Republicans (in theory) push for spending cuts.

11. Fiscal Policy Taxing and Spending (Congress) Taxing and Spending (Congress) Discretionary Discretionary –Requires action by Congress, President, or agency Automatic Automatic –Doesn’t require new action –Ex. Welfare, Unemployment Benefits, Income taxes

12. Weaknesses in Keynesian Theory Predicting/Analyzing the economy is hard Predicting/Analyzing the economy is hard Debt/Deficits Debt/Deficits Time lags Time lags Inflation vs. Unemployment Dilemma Inflation vs. Unemployment Dilemma –Inflation: Cut spending or increase taxes –Unemployment: Opposite “Crowding-out Effect” “Crowding-out Effect” –Increased spending/borrowing Increases interest rates Increases interest rates Decreases private spending Decreases private spending Inflation without growth in Long Run Inflation without growth in Long Run

13. Demand-Pull Inflation

14. Supply-Side Economics Milton Freidman Focusing on shifting supply curve to the right Focusing on shifting supply curve to the right –increase employment –decrease inflation. Decrease Costs of Production Decrease Costs of Production “Trickle Down Theory” “Trickle Down Theory” –Encourages Investment Investment Job creation Job creation Reduced inflation Reduced inflation

15. Supply-Side Weaknesses Markets don’t always “clear” back to equilibrium Markets don’t always “clear” back to equilibrium –“downward sticky” wages Workers won’t accept lower wages Workers won’t accept lower wages Unions Unions Minimum wage laws Minimum wage laws –Unemployment doesn’t “fix” itself fast enough.