Economy Theories

7/25/2019 Economy Theories

1/17

The concepts of economic development and economic growth (in terms of

megaends). From this perspective, how important are natural resources?

Economic development as a process that generates economic and social, quantitative and,

particularly, qualitative changes, which causes the national economy to cumulatively and

durably increase its real national product. In contrast and compared to development,

economic growth is, in a limited sense, an increase of the national income per capita, and

it involves the analysis, especially in quantitative terms, of this process, with a focus on

the functional relations between the endogenous variables; in a wider sense, it involves

the increase of the GDP, GP and I, therefore of the national wealth, including the

production capacity, e!pressed in both absolute and relative si"e, per capita,

encompassing also the structural modifications of economy.

Economic growth is a comple!, long#run phenomenon, sub$ected to constraints li%e&

e!cessive rise of population, limited resources, inadequate infrastructure, inefficient

utili"ation of resources, e!cessive governmental intervention, institutional and cultural

models that ma%e the increase difficult, etc.

Economic growth is obtained by an efficient use of the available resources and by

increasing the capacity of production of a country. It facilitates the redistribution ofincomes between population and society. 'he cumulative effects, the small differences of

the increase rates, become big for periods of one decade or more. It is easier to

redistribute the income in a dynamic, growing society, than in static one.

Why GD per capita cannot accurately assess the living standard?

GDP is not a measure of the living standard, but sooner or later determines it& investment

(negative one as well) and consumption.

GDP e!cludes non#mar%et activities as household production& great disadvantage for the

less developed countries.

It does not include blac% mar%et activities

It ignores distribution of wealth and the previous production of wealth


2/17

!elative power e"uality# the fundamental determinant of economic performance

Perfect competition& producers cannot gather power over consumers* "ero producer

power. +ithout relative power there is no coercive ta%ing and peaceful production

(ta%ing from nature) is the only way to human purposeful action.

The $oren% curve and the G&'& coefficient

'he oren" curve is a graphical representation of the distribution of income or of wealth.

-n the graph, a straight diagonal line represents perfect equality of wealth distribution;

the oren" curve lies beneath it, showing the reality of wealth distribution. 'he difference

between the straight line and the curved line is the amount of inequality of wealth

distribution, a figure described by the Gini coefficient.

'he Gini coefficient is the ratio of the area between the line of perfect equality and the

observed oren" curve to the area between the line of perfect equality and the line of

perfect inequality. 'he higher the coefficient, the more unequal the distribution is.

The ex postand the ex antecoercion

E! ante& sing e!#ante analysis helps to give an idea of future movements in price or the

future impact of a newly implemented policy.

E! post& /nother term for actual returns. 'he use of historical returns has traditionally

been the most common way to predict the probability of incurring a loss on any given

day.

What is a coercive transaction? Descrie it graphically

-ur emotional responses produce ordinal ran%ings and ran% classes of situations; they

cover less particular cases (coercive and voluntary, $ust and un$ust); It is mechanisms of

emotional processes that are less local in comparison to mechanisms of abstract

reasoning.


3/17

Imagine I am loo%ing to find housing to live in. I am presented, in the status quo, with the

following choices&

0. Pay a landlord rent to live in some building.

1. 2e homeless.

If I pay the landlord rent, this will be described as a voluntary, non#coercive transaction.

ow for e!ample two. Imagine I am thin%ing of getting a $ob. I have the following

options in the status quo&

0. Get a $ob and pay income ta!es on the income from that $ob.

1. Do not get a $ob.

'hat third option is the one libertarians would choose, but the state3through violent,

physical coercion3has prevented them from having this option.

rivate and pulic goods. *ternalities and mar+et failure# the need for state action

ulic goods& Economists define a public good as being non rival and non e!cludable.

'he non#rival part of this definition means that my consumption does not affect your

consumption of a good. Public goods include fresh air, %nowledge and information,

national security, flood control systems, lighthouses, and street lighting.

rivate goods& / private good I4 rival and e!cludable. /n e!ample of the private good is

bread& bread eaten by a given person cannot be consumed by another (rivalry), and it is

easy for a ba%er to refuse to trade a loaf (e!clusive).

ar+et failure#/n economic term that encompasses a situation where, in any given

mar%et, the quantity of a product demanded by consumers does not equate to the quantity

supplied by suppliers. 'his is a direct result of a lac% of certain economically ideal

factors, which prevents equilibrium.

*ternalities# ollution emitted by a factory that spoils the surrounding environment

and affects the health of nearby residents is an e!ample of a negative e!ternality. /n

e!ample of a positive e!ternality is the effect of a well#educated labor force on the

productivity of a company.


4/17

The parado* of voting and the prolem of agendum

5a$ority of 67890, this means that not all voters are single pea%ed 3 according to

their preferences.

5ultiple pea%ed preferences

'here is no equilibrium alternative

The theorem of median voter

/ median voter is a voter with a preference between the e!treme.

'he median voter theorem ma%es two %ey assumptions&

:irst, the theorem assumes that voters can place all election alternatives along a one#

dimensional political spectrum

4econd, the theorem assumes that voters preferences are single#pea%ed, which means

that voters choose the alternative closest to their own view. 'his assumption predicts that

the further away the outcome is from the voters most preferred outcome, the less li%ely

the voter is to select that alternative.

The logrolling and its implications

# E!changing of votes,


5/17

Why the mar+et structure of perfect competition is the ideal one?.

# eo#classical economists argued that perfect competition would produce the best

possible outcomes for consumers, and society.

nder perfect competition, there are many buyers and sellers, and prices reflect supply

and demand. /lso, consumers have many substitutes if the good or service they wish to

buy becomes too e!pensive or its quality begins to fall short. ew firms can easily enter

the mar%et, generating additional competition. >ompanies earn $ust enough profit to stay

in business and no more, because if they were to earn e!cess profits, other companies

would enter the mar%et and drive profits bac% down to the bare minimum.

The prisoners/ dilemma game without communication

'wo members of a criminal gang are arrested and imprisoned. Each prisoner is in solitary

confinement with no means of communicating with the other. 'he prosecutors lac%

sufficient evidence to convict the pair on the principal charge. 'hey hope to get both

sentenced to a year in prison on a lesser charge. 4imultaneously, the prosecutors offer

each prisoner a bargain. Each prisoner is given the opportunity either to& betray the other

by testifying that the other committed the crime, or to cooperate with the other by

remaining silent. 'he offer is&

# If / and 2 each betray the other, each of them serves 1 years in prison
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# If / betrays 2 but 2 remains silent, / will be set free and 2 will serve ? years in

prison (and vice versa)

# If / and 2 both remain silent, both of them will only serve 0 year in prison (on the

lesser charge)

The prisoners/ dilemma game with communication

>ommunication enlarges the range of possible payoffs, even in the PD, where cheap tal%

should ma%e no difference theoretically. :ran% (0@@A) reports e!perimental results that

show that when sub$ects are allowed to interact for ?7 minutes before playing the PD,

they are able to predict quite accurately their opponentBs behavior. 5oreover, roughly

AC8 of the sub$ects who predict that their opponent will cooperate (defect) respond with

the same action. / longer period of communication also leads to a higher probability of

cooperation. 2oth the level of cooperation and the accuracy of the predictions drop when

players are allowed to interact only for 07 minutes.

The tools of money supply

Discount rate

equired reserve ratio

-pen mar%et operations

5oral suasion'he :ederal eserve basically uses three tools to affect the supply of money available for

the economy. -pen#mar%et operations are the most subtle of the three, and consist of the

buying and selling of .4. treasury securities to


7/17

'he .4. practices what is %nown as ons& (in the long run) >antillon effect, sin% rates not sufficient, the automatic increase of

ta! rates

0antillion effect#'his effect describes the fact that newly#created money is distributed

neither equally nor simultaneously among the population. 'his means that people

handling money partially benefit from inflation and partially suffer from it. 5onetary

dispersion is never neutral. 5ar%et participants who receive the new money early and

e!change it for goods benefit in comparison with those who get the newly#created money

later. +e can see a transfer of assets from late money users to early money users.

The "uantity theory of money

/n economic theory which proposes a positive relationship between changesin the

moneysupply and the long#term price of goods. It states that increasing the amount of

money in the economy will eventually lead to an equal percentage rise in the prices of

products and services. 'he calculation behind the quantity theory of money is based upon

:isher Equation&

>alculated as&
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8/17

+here&

5 represents the money supply.

F represents the velocity of money.

P represents theaverage pricelevel.

' represents the volume of transactions in the economy.

Why monetary policy can e a prolem

5onetary gap

*lapse of time between the moment a monetary measure is ta%en and the moment that

measure has an impact on economy

'he monetary gap is variable and long (longer than the time period in which good

predictions about economy are possible).

'he changes in the velocity of money

Felocity is important for measuring the rate at which money in circulation is used for

purchasing goods and services. 'his helps investors gauge how robust the economy is,

and is a %ey input in the determination of an

economys inflationcalculation. Economiesthat e!hibit a higher velocity of money

relative to others tend to be further along in thebusiness cycleand should have a higher

rate of inflation, all things held constant.

1hares and onds. The price of a ond and the interest rate

/ bond is adebt investmentin which an investor loans money to an entity (typically

corporate or governmental) which borrows the funds for a defined period of time at a

variable or fi!ed interest rate. 2onds are used by companies, municipalities, states and

sovereign governments to raise money and finance a variety of pro$ects and activities.

-wners of bonds are debtholders, or creditors, of the issuer.
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9/17

'he present value of a future value& if i*078, 077 euros will become 007 euros

after one year. 'he present value of 007 euros is 077 euros

'he value of a bond which has a coupon of 07 euros when interest rate is 078 is

07&7,0*077 euros

'he inverse relation between the price of a bond and interest rate

The determinants of international speciali%ation

# 4peciali"ation determined by climate and the different available factors of

production

# 4peciali"ation determined through tradition and investments (e!.& auto production

in omania)

# 4peciali"ation determined by behavioral traits of populations of the various

countries (e!.& German production of industrial equipment)

# E!ternal efficiency phenomenon

The false argument of depressive effect of imports

0 a * 0? clothes in Germany

0 a * 1 clothes in omania

/fter trade& 0 a * 0 clothes

In this situation, international trade benefits& 'he German auto firm, omanian

firm producing clothes and the consumer in the two countries

Possible changes in the long run

>osts entailed by changes

+ays to deal with frictions


10/17

The false argument of infant industries

Protection to infant industries until they are successful in&

aproducing with the same costs

bproducing with lower costs

:alsehood&

ain case of the same costs

bin case of lower costs

The false argument of cheap foreign laor

ogic& higher wages entail higher costs

Proof against&

07.7770.777 units, ma%es 07 per unit

0.77767 units, ma%es 17 per unit

The false argument of specific productivity

ogic&

aindustrial sectors have a higher productivities versus agriculture

bhigher productivities offset lower costs

Conclusion: Industrial sectors should be developed by each country irrespective of costs

In omania& 0 tractor*177 to corn

In Germany& 0 tractor*077 to corn

>onclusion& omania should produce corn and Germany should produce tractors

'heory of specific productivity& if + in tractor production is C times higher, one

omanian wor%er could produce C!177to* A77 to, which is the equivalent of C tractors

+hen buying German tractors& 177to&077to* 1 tractors

>onclusion& do not import tractors and produce your own tractors (even if they are more

e!pensive)


11/17

'he falsehood of the argument& productivity depends on the level of training and capital

per wor%er

'he same training and the same capital per wor%er entails the same productivity& the

equivalent of 177to corn

177to&177to*0or one tractor, if the tractor is produced by your own industry and the case

of import from Germany is dropped

Why the surplus of foreign trade and the surplus of capital account cannot y

themselves e favorale

The fi*ed e*change rates# advantages and disadvantages

2dvantages#

/ fi!ed e!change rate may minimi"e instabilities in real economic activity

>entral ban%s can acquire credibility by fi!ing their countrys currency to that of a

more disciplined nation

-n a microeconomic level, a country with poorly developed or illiquid money

mar%ets may fi! their e!change rates to provide its residents with a synthetic

money mar%et with the liquidity of the mar%ets of the country that provides the

vehicle currency

/ fi!ed e!change rate reduces volatility and fluctuations in relative prices

It eliminates e!change rate ris% by reducing the associated uncertainty

It imposes discipline on the monetary authority

International trade and investment Hows between countries are facilitated

4peculation in the currency mar%ets is li%ely to be less destabili"ing under a fi!ed

e!change rate system than it is in a fle!ible one, since it does not amplify

fluctuations resulting from business cycles

:i!ed e!change rates impose a price discipline on nations with higher inflation

rates than the rest of the world, as such a nation is li%ely to face persistent deficits

in its balance of payments and loss of reserves

Disadvantages#


12/17

'he main criticism of a fi!ed e!change rate is that fle!ible e!change rates serve to ad$ust

the balance of trade. +hen a trade deficit occurs under a floating e!change rate, there will

be increased demand for the foreign (rather than domestic) currency, which will push up

the price of the foreign currency in terms of the domestic currency. 'hat in turn ma%es the

price of foreign goods less attractive to the domestic mar%et and thus pushes down the

trade deficit. nder fi!ed e!change rates, this automatic rebalancing does not occur

The floating e*change rates# advantages and disadvantages

:loating e!change rates have these main advantages&

0. o need for international management of e!change rates

1. o need for frequent central ban% intervention

?. o need for elaborate capital flow restrictions

C. Greater insulation from other countriesB economic problems

:loating e!change rates also have disadvantages&

igher volatility&

se of scarce resources to predict e!change rates

'endency to worsen e!isting problems&

The une"ual inflation rates or the change in relative prices as a determinant of

changes in e*change rates

/s a general rule, a country with a consistently lower inflation rate e!hibits a rising

currency value, as its purchasing power increases relative to other currencies. During the

last half of the twentieth century, the countries with low inflation included Japan,

Germany and 4wit"erland, while the .4. and >anada achieved low inflation only later.

'hose countries with higher inflation typically see depreciation in their currency in

relation to the currencies of their trading partners. 'his is also usually accompanied by

higher interest rates.


13/17

The change in relative incomes as a determinant of changes in e*change rates

'he current account is the balance of trade between a country and its trading partners,

reflecting all payments between countries for goods, services, interest and dividends. /

deficit in the current account shows the country is spending more on foreign trade than it

is earning, and that it is borrowing capital from foreign sources to ma%e up the deficit. In

other words, the country requires more foreign currency than it receives through sales of

e!ports, and it supplies more of its own currency than foreigners demand for its products.

'he e!cess demand for foreign currency lowers the countrys e!change rate until

domestic goods and services are cheap enough for foreigners, and foreign assets are too

e!pensive to generate sales for domestic interests

/ ratio comparing e!port prices to import prices, the terms of trade is related to current

accounts and the balance of payments. If the price of a countrys e!ports rises by a greater

rate than that of its imports, its terms of trade have favorably improved. Increasing terms

of trade shows greater demand for the countrys e!ports. 'his, in turn, results in rising

revenues from e!ports, which provides increased demand for the countrys currency (and

an increase in the currencys value). If the price of e!ports rises by a smaller rate than that

of its imports, the currencys value will decrease in relation to its trading partners.

The change in relative interest rates as a determinant of changes in e*change rates

Interest rates, inflation and e!change rates are all highly correlated. 2y manipulating

interest rates, central ban%s e!ert influence over both inflation and e!change rates, and

changing interest rates impact inflation and currency values. igher interest rates offer

lenders in an economy a higher return relative to other countries. 'herefore, higher

interest rates attract foreign capital and cause the e!change rate to rise. 'he impact of

higher interest rates is mitigated, however, if inflation in the country is much higher than

in others, or if additional factors serve to drive the currency down. 'he opposite


14/17

relationship e!ists for decreasing interest rates # that is, lower interest rates tend to

decrease e!change rates.

The alance of international payments# components and properties

ecording of all payments between a country and all other countries

'he principle of double#entry accounting

/ll payments to the country by foreigners are receipts and are recorded with 9

/ll payments to foreigners are recorded with 3

'rade balance& surplus and deficit

'rade balance and economic performance

Increase and decrease in official reserves

4ince many international transactions included in the balance of payments do not involve

the payment of money, this figure may differ significantly from net payments made to

foreign entities over a period of time.

In theory, a current account deficit would have to be financed by a net inflow in the

capital and financial account, while a current account surplus should correspond to an

outflow in the capital and financial account for a net figure of "ero. In actual practice,

however, the fact that data are compiled from multiple sources gives rise to some degree

of measurement error.

2alance of payments and international investment position data are critical in formulating

national and international economic policy. >ertain aspects of the balance of payments

data, such as payment imbalances and foreign direct investment, are %ey issues that a

nationBs economic policies see% to address.

!easons for ta*ation

egative e!ternalities& compensation to receiver

Positive e!ternality& compensation to producer


15/17

'>*5onetary cost 9negative e!ternality

Public goods& (0) non#e!clusive& :ree rider effect

(1) on#e!haustive

Implementation of social $ustice

+hat is social $ustice and how can it be implementedK

awlsB ma!i#min principle

>oercive transfers versus public goods

'he nature of state

E! ante coercive activities

The ta* shifting and the ta* incidence

'he legal payer of ta!

'he real payer of ta!

E!ample& the increase of F/' in omania

'a! incidence reveals which group, the consumers or producers, will pay the price of a

new ta!. :or e!ample, the demand for cigarettes is fairly inelastic, which means that

despite changes in price, the demand for cigarettes will remain relatively constant. ets

imagine the government decided to impose an increased ta! on cigarettes. In this case, the

producers may increase the sale price by the full amount of the ta!. If consumers still

purchased cigarettes in the same amount after the increase in price, it would be said that

the ta! incidence fell entirely on the buyers.

The system of flat ta*# advantages and disadvantages

/ system that applies the same ta! rate to every ta!payer regardless of income brac%et. /

flat ta! applies the same ta! rate to all ta!payers, with no deductions or e!emptionsallowed. 4upporters of a flat ta! system propose that it would give ta!payers incentive to

earn more because they would not be penali"ed with a higher ta! brac%et. In addition,

supporters argue that a flat ta! system is fairer because it imposed the ta! on all ta!payers

regardless of income.


16/17

ros&

/ flat ta! spreads the ta! burden across all earners, which means that

more people pay for the benefits of government, direct or indirect, that

they receive.

/ flat ta! means that the marginal benefit of earning a dollar is always

the same; there are no diminishing returns to wor%ing harder to ma%e

more money.

/ revenue neutral flat ta! will lower ta!es on the wealthy, which will

give them more disposable income to spend.0ons&

4ince the basic necessities of life cost at least a certain amount, a flat

ta! will cut more deeply into the disposable income of lower#income

ta!payers.

:or ta!payers with very low income, the imposition of ta! could force

them into penury.

/ revenue#neutral flat ta! will increase the ta! burden on the poor and

middle#class, who are suffering disproportionately in this economy.

2y the same to%en, the marginal utility of a dollar decreases as income

increases; a flat ta! will, therefore, in utilitarian terms, impose a lower

ta! rate on high#income earners.

The system of progressive ta*ation# advantages and disadvantages

/ ta! that ta%es a larger percentage from the income of high#income earners than it does

from low#income individuals. 2asically, ta!payers are bro%en down into categories based

on ta!able income; the more one earns, the more ta!es they will have to pay once they

cross the benchmar% cut#off points between the different ta! brac%et levels.

ro&

0. It helps to provide a buffer against income inequality.

1. It encourages a system of social $ustice that allows everyone to have a chance at

success.

?. It provides higher overall levels of revenue.

C. It gives people a safety net in which they can operate.

0on&


17/17

0. It may be interpreted as discriminatory.

1. 'hose who barely brea% into a new ta! brac%et may lose their additional earnings.

?. It encourages the wealthy to not be transparent about their income.

C. It creates a complicated system of bureaucracy.

The causes of udgetary deficits

0auses&

0 Disappearance of the capital accumulation norm

1 Disappearance of the balanced budget norm

? Disappearance of the gold standard&

C Political myopia

6 'he generational hiatus

The effects of udgetary deficits

ffects#

0'he danger of inflationary monetary growth meant to pay bac% the government

debt

1'he decrease of loans supply to the private sector, increase in interest rates and

slow down of economic growth

?'he danger of destroying the democratic institutions through the growth of state

sector

ut forth two solutions to the prolem of permanent udgetary deficits

'he gold standard

'he constitutional rule of the balanced budgets

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Economy Theories