| Chapter 2 Outline |
| III. WHAT SHOULD GOVERNMENT DO? |
| 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. |