Chapter 2 Outline
A. General Comments
1. Economists generally argue that government action is desirable only if thereis market failure and if there is some assurance that government action will correct this failure.
2. Market failure occurs when the private sector fails to achieve its economicgoals.
a. These economic goals include an economy that: 1) grows fairly rapidly, 2) generates full employment, and 3) is free from rapid inflation.
B. Smoothly Rising Real Output
1. Gross domestic product (GDP), the value of all the final goods and servicesproduced each year in the United States, is the standard measure of total output.
2. Economic growth implies continuous annual increases in this output.
3. Increases in GDP can occur because of either an increase in the price level or an increase in output. Economic growth occurs when output, or real GDP, grows.
a. Real GDP is GDP adjusted for inflation.
4. Normally, an increase in real GDP is accompanied by both an increase in productivity and an increase in employment.
5. If real GDP is rising smoothly, the economy is likely to come close to achieving economic growth, full employment, and low inflation.
6. Real GDP has not risen smoothly over time; it has fluctuated around the ideal path.
7. Some economists think the government should used monetary and fiscal policies to smooth out the fluctuations in real GDP.
a. Monetary policy involves changes in the nation's money supply and interest rates by the Federal Reserve.
b. Fiscal policy involves the use of government spending or taxes to directly change total spending in the economy.
c. Economists differ in their views of the effectiveness of monetary and fiscal policy.
C. Economic Efficiency
1. Economists are concerned about three types of efficiency: allocative efficiency,dynamic efficiency, and X-efficiency.
a. Allocative efficiency achieves the largest possible output of goods and services from the existing stock of resources and technology.
b. A dynamically efficient economy finds the lowest-cost organizational structure to achieve technological change and product improvements.
c. An X-efficient economy achieves the lowest-cost means of production and product development in existing organizations.
2. Allocative efficiency occurs when marginal social benefits are equal to marginal social costs.
a. Marginal social benefits (MSB) are the sum of marginal private and marginal external benefits.
1. Marginal private benefits (MPB) are the direct benefits of a unit of a good or service.
2. Marginal external benefits (MEB) are the indirect benefits of a unit of a good or service.
b. Marginal social costs (MSC) are the sum of marginal private and marginal external costs.
1. Marginal private costs (MPC) are the direct costs of a unit of a goodor service.
2. Marginal external costs (MEC) are the indirect costs of a unit of agood or service.
3. In general, the market does a good job of allocating efficiently; however, the market will fail if there is a monopoly, externalities, or public goods.
a. If there is a monopoly, production will occur at a point where MSB exceed MSC. An amount less than the allocatively efficient amount is produced.
b. If there are marginal external benefits, production will occur at a point where MSB exceed MSC. An amount less than the allocatively efficient amount is produced.
c. If there are marginal external costs, production will occur at a point where MSC exceed MSB. An amount greater than the allocatively efficient amount is produced.
d. Because it is not possible to exclude those who do not pay from benefiting from the provision of a public good, the "free rider" problem exists, and a quantity less than the allocatively efficient quantity will be produced.
D. Distributional Equity
1. The distribution of income in the United States is relatively unequal.
a. The poorest 20 percent of the families receive 4 - 5 percent of total income, while the richest 20 percent receive 40 - 45 percent of total income.
2. Some defend the market distribution of income on the basis that it rewards individuals according to their contribution to national output.
3. Some argue for a government policy of redistributing income.
a. Some argue that market incomes only imperfectly reflect the efforts of resource owners.
b. Some argue that too little income redistribution will occur in the absence of government programs.
c. Some argue for redistribution as an insurance against poverty.
d. Some argue the redistribution of income decreases social unrest and helps to prevent crime.
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