Role Of The Govt. Macro Economics Chap02


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Role Of The Govt. Macro Economics Chap02

  1. 1. Markets and Government in a Modern Economy
  2. 2. <ul><li>Markets exist because none of us produces all the goods and services we require to satisfy our needs and wants. </li></ul>Why Do Markets Exist? A market is an arrangement that allows buyers and sellers to exchange goods and services.
  3. 3. How markets solve the three economic problems? <ul><li>What —determined by the dollar spend of consumers </li></ul><ul><li>How —determined by the competition among different producers </li></ul><ul><li>For whom —determined by the supply and demand in the markets for factors of production </li></ul>
  4. 4. The Market System Relies on Supply and Demand to Solve the Trio of Economic Problems
  5. 5. Trade, Money and Capital <ul><ul><ul><li>Specialization </li></ul></ul></ul><ul><ul><ul><li>2. Division of Labor </li></ul></ul></ul>Specialization is the concentration of the productive efforts of individuals and firms on a limited number of activities.
  6. 6. Key Concepts <ul><li>Gross Domestic Product (GDP) </li></ul><ul><ul><li>The monetary value of all goods and services produced within Pakistan in a given time period </li></ul></ul><ul><li>Real GDP </li></ul><ul><ul><li>The volume of goods and services produced within Pakistan (i.e. GDP adjusted for changes in the price level) </li></ul></ul><ul><li>Economic Growth </li></ul><ul><ul><li>The percentage rate of increase of real GDP </li></ul></ul><ul><li>Inflation </li></ul><ul><ul><li>The annual percentage rate of change of the general price level </li></ul></ul>
  7. 7. Objectives of economic policy <ul><li>What are the government’s main economic objectives? </li></ul>
  8. 8. The Economic Role of Government <ul><li>Three main economic functions </li></ul><ul><li>Increasing efficiency </li></ul><ul><li>Promote equity </li></ul><ul><li>Fostering macroeconomics stability and growth </li></ul>The Economic Role of Government
  9. 9. <ul><li>The key elements of the Government's objectives are: </li></ul><ul><li>Delivering macroeconomic stability (a very broad macroeconomic aim) </li></ul><ul><li>Meeting the productivity challenge (an important supply-side target) </li></ul><ul><li>Increasing employment opportunity for all (a labour market objective) </li></ul><ul><li>Ensuring fairness for families and communities (commitment to equity ) </li></ul><ul><li>Protecting the environment (green economics has a macroeconomic dimension) </li></ul>The Economic Role of Government
  10. 10. C. The Economic Role of Government
  11. 11. Answering the Three Economic Questions <ul><li>What key economic questions must every society answer? </li></ul><ul><li>What basic economic goals do societies have? </li></ul><ul><li>What types of economic systems exist today? </li></ul>
  12. 12. Economic Goals <ul><li>Societies answer the three economic questions based on their values. </li></ul>Economic Goals Making the most of resources Economic efficiency Freedom from government intervention in the production and distribution of goods and services Economic freedom Assurance that goods and services will be available, payments will be made on time, and a safety net will protect individuals in times of economic disaster Economic security and predictability Fair distribution of wealth Economic equity Innovation leads to economic growth, and economic growth leads to a higher standard of living. Economic growth and innovation Societies pursue additional goals, such as environmental protection. Other goals
  13. 13. Macro stability can be measured by the volatility of key indicators: <ul><li>1 . Consumer price inflation (annual % change in prices) </li></ul><ul><li>2 . Real GDP growth over one or more business cycles </li></ul><ul><li>3 . Changes in measured unemployment / employment </li></ul><ul><li>4 . Fluctuations in the current account of the balance of payments </li></ul><ul><li>5 . Changes in government finances (i.e. the size of the fiscal deficit or surplus) </li></ul><ul><li>6 . Volatility of short term policy interest rates and long term interest rates such as the yield on government bonds </li></ul><ul><li>7 . Stability of the exchange rate in currency markets </li></ul>
  14. 14. Four Economic Systems An economic system is the method used by a society to produce and distribute goods and services. Traditional economies rely on habit, custom, or ritual to decide what to produce, how to produce it, and to whom to distribute it. In a centrally planned economy the central government makes all decisions about the production and consumption of goods and services. In a market economy economic decisions are made by individuals and are based on exchange, or trade. Mixed economies are systems that combine tradition and the free market with limited government intervention.
  15. 15. Government’s Role in a Mixed Economy <ul><li>In a mixed economy, </li></ul><ul><li>The government purchases land, labor, and capital from households in the factor market, and </li></ul><ul><li>Purchases goods and services in the product market. </li></ul>Product market Factor market monetary flow physical flow monetary flow physical flow Circular Flow Diagram of a Mixed Economy Households Firms Government expenditures expenditures government-owned factors taxes taxes government purchases
  16. 16. Circular Flow Model of a Mixed Economy
  17. 17. The Free Market Economy <ul><li>In a free market economy, households and business firms use markets to exchange money and products. Households own the factors of production and consume goods and services. </li></ul>Product market Factor market monetary flow physical flow monetary flow physical flow Circular Flow Diagram of a Market Economy Households Firms Households pay firms for goods and services. Firms supply households with goods and services. Households supply firms with land, labor, and capital. Firms pay households for land, labor, and capital.
  18. 18. The Free Market Economy Product market Factor market Product Market – The market in which households purchase the goods and services that firms produce. Factor Market – The market in which firms purchase the factors of production from households. (Factors of production = land, labor, and capital!) monetary flow physical flow monetary flow physical flow Circular Flow Diagram of a Market Economy Households Firms Households pay firms for goods and services. Firms supply households with goods and services. Households supply firms with land, labor, and capital. Firms pay households for land, labor, and capital.
  19. 19. Economic Goals Achieved by a Free Market Economy <ul><li>Economic Efficiency </li></ul><ul><li>As a self-regulating system, a free market economy is efficient. </li></ul><ul><li>Economic Growth </li></ul><ul><li>Because competition encourages innovation, free markets encourage growth. </li></ul><ul><li>Economic Freedom </li></ul><ul><li>Free market economies have the highest degree of economic freedom of any economic system. </li></ul><ul><li>Additional Goals </li></ul><ul><li>Free markets offer a wider variety of goods and services than any other economic system. </li></ul>
  20. 20. The Market’s Self-Regulating Nature <ul><li>In every transaction, the buyer and seller consider only their self-interest , or their own personal gain. Self-interest is the motivating force in the free market. </li></ul><ul><li>Producers in a free market struggle for the dollars of consumers. This is known as competition , and is the regulating force of the free market. </li></ul><ul><li>The interaction of buyers and sellers, motivated by self-interest and regulated by competition, all happens without a central plan. This phenomenon is called “the invisible hand of the marketplace.” </li></ul>
  21. 21. <ul><li>In a centrally planned economy , the government owns both land and capital. The government decides what to produce, how much to produce, and how much to charge. </li></ul>Centrally Planned Economies Socialism is a social and political philosophy based on the belief that democratic means should be used to distribute wealth evenly throughout a society. Communism is a political system characterized by a centrally planned economy with all economic and political power resting in the hands of the government.
  22. 22. Problems of a Centrally Planned Economy <ul><li>Centrally planned economies face problems of poor-quality goods, shortages, and diminishing production. </li></ul>
  23. 23. Comparing Mixed Economies <ul><li>An economic system that permits the conduct of business with minimal government intervention is called free enterprise . The degree of government involvement in the economy varies among nations. </li></ul>Continuum of Mixed Economies Centrally planned Free market Source: 1999 Index of Economic Freedom , Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick Iran North Korea Cuba China Russia Greece Peru United States South Africa France United Kingdom Pakistan Canada Singapore Hong Kong