07 Domestic Policy

Define and explain three key features of a capitalist/free-market economy. How did Adam Smith conceptualize the system?

1. Private property: Individuals can own and control resources, enabling them to buy, sell, and profit from their possessions

   Market Competition: Businesses compete, which fosters innovation and optimizes pricing based on supply and demand

   Limited Government Intervention: The government steps back, allowing individuals to make their own production and consumption choices

2. Adam Smith described the system as guided by the “invisible hand” where individuals chasing their own interests naturally benefit society, leading to overall prosperity and economic growth.

What are examples of free-market failures? What can be done to keep this from happening?

1. Free-market failures can occur in various forms, such as monopolies, where one entity dominates and restricts competition; negative externalities, like pollution, which harm third parties; and information asymmetry, where buyers or sellers lack essential information, leading to suboptimal decisions.

2. To mitigate these failures, regulations can be implemented to promote competition, provide information transparency, and impose taxes or incentives to address external costs

What are the key mechanisms at work in fiscal policy? Describe and discuss; do not list.

Fiscal policy operates mainly through government spending and taxation decisions which influence economic activity. When the government decides to increase public spending, it injects money into the economy, which can stimulate demand and lead to job creation. Conversely, adjustments in taxes can either increase consumers’ disposable income, encouraging spending, or reduce it to cool down an overheating economy. The balance and timing of these fiscal measures are critical in managing economic cycles and achieving overall economic stability.

What steps might be taken by a government utilizing Keynesian economics to combat a slowing economy? Conversely, what steps might be taken by a government utilizing Keynesian economics to combat a growing economy? Why would a government intervene in each of these cases?

1. To combat a slowing economy, a government using Keynesian principles would typically increase public spending and/or reduce taxes. This is aimed at boosting aggregate demand by encouraging consumer spending and business investment, ultimately fostering job creation and economic growth.

2. In a growing economy, especially one facing inflation, a government following Keynesian economics might decrease public spending or increase taxes. These actions are intended to cool down economic activity, manage inflation, and ensure sustainable growth.

3. Governments intervene during a slowing economy to prevent deeper recessions and promote recovery, while in a growing economy, intervention is aimed at curbing inflation and maintaining economic stability to prevent unsustainable growth.

What is the overall goal that fiscal and monetary policy attempt to achieve (and how)? What is the importance (the impact) of inflation and unemployment on GDP?

1. In response to a sluggish economy, a government applying Keynesian principles is likely to increase public expenditure and/or reduce tax rates. This strategy is intended to enhance aggregate demand by promoting consumer spending and encouraging business investment, which in turn can lead to job creation and economic recovery.

2. When confronted with a booming economy that is experiencing inflation, a government adhering to Keynesian economics may consider reducing public spending or raising taxes. These measures aim to temper economic activity, control inflation, and promote sustainable growth.

3. Governments typically intervene during economic downturns to prevent deeper recessions and facilitate recovery, whereas intervention during economic expansions is aimed at curbing inflation and ensuring economic stability to avert unsustainable growth.

What is the difference between entitlement and discretionary spending? Identify two examples of each

1. Entitlement spending is mandatory and guaranteed by law, such as Social Security and Medicare, while discretionary spending is optional and determined by annual appropriations, like defense and education funding.

2. Entitlement Spending: Social Security, Medicare & Discretionary spending: Defense, Education

What is the difference between horizontal and vertical equity in taxation?*

Horizontal equity focuses on fairness among equals, while vertical equity focuses on fairness based on differing abilities to pay

Why is the Social Security program in the United States a cause for concern? What are the possible solutions (identify three) and why do politicians generally ignore this concern (and the solutions)?

1. Social Security is facing financial challenges due to demographic changes like an aging population and longer life expectancies, which may lead to insufficient funds for future beneficiaries

2. Raise the retirement age to reduce the number of beneficiaries, increase payroll taxes to raise more revenue, adjust benefits or use a less generous calculation for cost-of-living adjustments

3. Politicians may ignore the issue due to its political sensitivity and potential backlash from votes who rely on these benefits.

What were the key problems associated with the old welfare program (AFDC)? In what ways did the new welfare (TANF) attempt to fix the problems with AFDC?

1. The AFDC program had issues such as dependency on government assistance, insufficient incentives to work, and lack of provisions for job training or education.

2. TANF aimed to reduce dependency by setting time limits on benefits, requiring work or participation in job training programs, and providing support for families transitioning to self-sufficiency

Keynesian Economics advocates

The use of government spending and taxing to help stabilize the economy.

Laissez-faire economics assumes that (select all that apply)

1. Citizens are responsible for their own economic well-being

2. Government officials do not know enough about economic and would do more harm than good.

3. Economic down-turns are natural

AS noted in lecture, possible reason(s) for a “market failure”, or the failure of the Invisible Hand is/are (select all that apply)

1. The presence of a monopoly

2. Negative externalities

3. Information asymmetry

If the Federal Reserve wants to help boost a sagging economy which of the following is the most direct way it can do this?

Lower interests rates so that banks can provide more loans at cheaper rate to individuals and businesses

When the government directly intervenes in the economy by raising or lowering taxes, this is an example of:

Fiscal Policy

_____ refers to the increase of price levels of goods and services over a specific period of time

Inflation

When the government decreases interest rates, this tends to ____ economic activity and ____ inflation rates

increase; increase

When the government runs a budget deficit it must make up for the shortfall in revenues by

Borrowing

The presidential package that created Social Security was

the New Deal

The Welfare Reform Act of 1996, enacted by President Clinton, limited lifetimes benefits to

Five years

The program often labeled the “third rail” of American politics for its sacrosanct status is

Social Security