Macroeconomics Exam 4 Material

Fiscal policy: government decisions about taxes and government spending

• If gov. spending in 1 year is greater than tax revenue collected that year → budget deficit

• If gov. spending in 1 year is less than tax revenues collected that year → budget surplus

• If gov. spending = tax revenues collected → balanced budget

• Debt: all previously unpaid deficits.

Taxes- Basic terms:

• Tax base: the value of the good/service, income, wealth, etc. that is being taxed ($ amount)

• Tax rate: percent of tax base paid to the government in taxes (% amount)

• Tax revenue: amount of money actually collected in taxes ($ amount)

Most of the revenue for the U.S federal government comes from income tax

Income tax systems:

• Progressive: as your income increases so does your tax rate

• Regressive: as your income increases, your tax rate falls

• Proportional: everyone pays the same % of income

The U.S. has a progressive, marginal tax rate system

How do we decrease debt?

• Decrease government spending

• Increase tax revenues

• Both!

How to increase tax revenues?

• Question: What if we increased income tax on the rich? Fair share?

  • Increasing tax rates does not always increase tax revenues; it could increase tax revenue, decrease tax revenues, or it could be the same

How can we decrease debt? (pt 2)

• Increase tax revenues through economic growth

  • Laffer curve

• Decrease gov. spending → how does gov. pay for spending?

  • Tax revenues

  • Borrowing through the sale of government bonds

    • Wasteful spending?

• Combination of both increasing tax revenues and decreasing gov. spending

• Cutting wasteful spending

  • Barely does anything

• Most of government spending goes to social security (2022- 19%)

  • Medicare is 12% and defense is 12%

3 Categories of spending:

• 1. Mandatory spending

  • Must be spent unless Congress changes laws

• 2. Discretionary spending

  • Congress decides each year

• 3. Net interest on debt

Problems with Social Security (1937)

• People live longer, but the age you can collect is basically unchanged

• Baby boomers are all retiring (1945-1964)

  • Huge increase in number of kids

  • When they were in the workforce it was great but now they’re all retiring and are very expensive

• Incentives created

  • Decrease in savings rate and decrease in the number of people working → decrease in economic growth

• Benefits per person have increased over time

• Social Security trust fund

  • A bunch of gov. bonds (IOUs)

  • Used to be a surplus of tax revenues but now it is in a deficit

Medicare (1965) and Social Security (1937)

• Both are known as transfer programs

  • Also known as “pay-as-you-go” programs

• Current working population pays for current elderly population

Medicare (1965)

• Elderly (65+ qualify)

• Elderly gets to choose Medicare plan

• Think of it as subsidized healthcare for the elderly

• The price of the plan is a small % of the actual cost to cover them

• Elderly can also buy supplement health insurance

Issues with the Medicare program:

• 1. Increase in benefits per elderly person over time

• 2. People live longer, but qualification age is still 65

• 3. Increased demand for healthcare and Rx drugs

Pork barrel spending: Paid for by all but only benefits some

Inflation is a monetary phenomenon

Hyperinflation is a fiscal phenomenon

• If gov. is fiscally irresponsible who pays for spending with newly printed money → hyperinflation

Comparative advantage: If you have comparative advantage in the production of oranges you can produce the oranges at a lower opportunity cost than other producers

Absolute advantage: You can produce more outputs with the same amount of inputs compared to other producers

Autarky

• Self sufficiency

• You can produced everything you consume by yourself

Specialization and trade

• You specialize in producing the good/service in which you have comparative advantage in and then trade the value of that with others

Free international trade

• Imports and domestically produced goods/services are not treated differently

• Free trade between U.S. states because of the Commerce Clause

• Protectionism: Domestic gov. favors domestic producers over foreign producers

  • More costly to buy imports

2 Major direct trade restrictions:

• 1. Tariffs: Tax on imports paid by the foreign producer to the U.S. government (domestic gov)

• 2. Quotas: Limit on the amount of a good allowed to be imported in a given time period

The “chicken” tax

• Germany placed a 50% tariff on U.S. imported chicken which resulted in the United States placing a 25% tariff on ALL foreign trucks and cargo vans

Trade Restrictions

• Tariffs

• Quotas

  • Example: the Japanese Auto Quota (1981-1944) had effects on:

    • 1. Auto consumers: An increase in the prices of autos → makes consumers worse off and other industries who use autos as inputs

    • 2. U.S. Auto industry: Better off because they sell more autos at a higher price

    • 3. U.S. Economy as a whole: Worse off because the gain to the U.S. auto workers and firms is less than the loss to the U.S. auto consumers and other industries

    • 4. Japanese auto workers: Could be better off, could be worse off, or the same; it depends on how much prices rise by

      • If big increase in price → better off

      • If small increase in price → worse off

      • Offsetting increase in price → the same

• Trade deficit: Import more than you export

• Trade surplus: Export more than you import

• Balanced trade: Import as much as you export

  • All of these are natural features of trade. Neither is bad)

  • The U.S. has a trade deficit with China (we buy more from China than China buys from us)

    • Tring to reduce our trade deficit with China by restricting trade makes us worse off as a whole

Exchange rates

• These are just prices

• Can be expressed as either $/F (how much $ is needed to buy one unit of F), OR F/$ (how much F is needed to buy 1$)

Appreciation and Depreciation of Currencies

• Appreciation: For the dollar to appreciate against F, the ($/F) exchange rate must FALL

• Depreciation: For the dollar to depreciate against F, the ($/F) exchange rate must RISE

2 Major exchange rate regimes

• 1. Floating exchange rate: the exchange rate is market determined

• 2. Pegged or fixed rate: Trying to keep the exchange rate between your currency and:

  • Some commodity price (ex: the price of gold) OR

  • Some other country’s currency the same over time