Chapter 2: Problems
4. Although the economy fails to achieve stable unemployment and inflation rates, government action is not necessary as a corrective measure. Do you agree or disagree? Explain.
The answer to this question will depend on which economists student's believe. If the student agrees with economists who view the economy as self-equilibrating, then they would agree with this statement. According to this view, the economy has a strong tendency to move towards full employment. Any unemployment or inflation will be temporary. In this case, there is no need for government action. On the other hand, the student may argue that the forces moving the economy towards full employment are weak and slow to take effect. In this case, there will be room for the use of fiscal and monetary policies.
7. Distinguish between allocate efficiency, dynamic efficiency, and X-efficiency. Provide a practical example of each.
Allocative efficiency achieves the largest possible output of goods and senrices from the existing stock of resources and technologies. Dynamic efficiency occurs when the economy finds the lowest-cost organizational structure to achieve technological change and product improvements. X-efficiency means that the lowest-cost means of production and product development within an organizational structure are achieved.
Suppose that given its resources and technology, an economy can produce a maximum of 500 six-packs of Bud Light and 400 bags of pretzels. If the economy is producing this combination of goods, it is allocatively efficient. On the other hand, if the economy is producing 400 six-packs of Bud Light and 400 bags of pretzeis, it is allocatively inefficient.
Suppose that the economy can achieve technological change and product improvements in the beer industry with either a competitive or a monopoly market structure. Suppose the competitive market structure allows these changes to occur at a lower cost. If the beer industry is competitive, it is dynamically efficient.
Suppose ABC Corporation produces at a higher cost than the otherwise identical DEF Corporation. DEF Corporation would be X-efficient.
8. What is capture theory, and how does it help in assessing the case for government action?
According to capture theory, it is special interests, not public interests, that capture the benefits of government intervention. Capture theory poses a challenge to the premise of antitrust policy. The proponents of this theory argue that antitrust policy has simply been a means of transferring wealth. There is little interest in achieving efficiency when using these policies. If correct, capture theory mitigates the case for govermnent intervention in the case of market power.
9. Should the government intervene in the economy to change the distribution of income.'/ Why or why not?
The answer will depend on the student's point of view. The student may believe that the market-determined distribution of income is fair in the sense that it reflects rewards according to how much individuals contribute to national output. In other words, rewards are in line with productive effort. This is important in creating work incentives, stimulating savings, and encouraging an efficient allocation of resources. In addition, it is likely that some redistribution would occur even in the absence of government intervention. Thus, some students may believe that government policies designed to redistribute income are unnecessary.
Other students may believe such programs are justified. First, the link between rewards and productive effort may be weak. Some also argue that a much smaller differential than the one that currently exists could be used to stimulate work effort, savings, and an efficient allocation of resources. There is also the argument that "too little" redistribution would occur in the absence of government policies. This is due to the public good nature of redistribution. Finally, some argue for redistribution on the bases of insurance against poverty and mitigating social unrest. Thus, some students may believe that government policies designed to redistribute income are needed.
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