Chapter 12 Key Questions #2,3

2. Assume that a hypothetical economy with an MPC of .8 is experiencing severe recession. By how much would governmentspending have to increase to shift the aggregate demandcurve rightward by $25 billion? How large a tax cut would beneeded to achieve this same increase in aggregate demand?Why the difference? Determine one possible combination of government spending increases and tax decreases that would accomplishthis same goal.

Multiplier = 1/ MPS (1-MPC)
= 1/.8
= 5 (billion)
tax * 0.8 = 5 (billion)
tax cut = 6.25 (billion)
Government can either increase spending by 1 billion, or cut taxes by 5 billion

3. What are government’s fiscal policy options for endingsevere demand-pull inflation? Use the aggregate demand-aggregatesupply model to show the impact of these policies onthe price level. Which of these fiscal policy options do you thinka “conservative” economist might favor? A “liberal” economist?

The government can either increase the taxes, or decrease government spending. A Conservative economist would most likely increase taxes, while a Liberal economist would most likely decrease the government spending in this situation.

Last Word Europe Unemployment

Weigh the two arguments regarding unemployment in Europe. Is unemployment high because of high because of high natural rates of unemployment or because of deficient aggregate demand?

Argument #1 claims that high unemployment rates reflect the high natural rates of unemployment in Europe. Although most countries are working at full employment, frctional and structual unemployment occur naturally. The source of this natural rate of unemmployment is from governemnt policies and union contracts. Argument # 2 claims that high unemployment rates are due to defiecient aggregate demand. The cause of this is due to the government, who are fearful of their economy, so they dont implement fiscal or monetary policies, which would increase aggregate deman. The answer to the debate would most likely lie between the two arguements. Unemployment in Europe could be due to natural rates of unemployment as much as aggregate demand. Both arguments include the government as a cause and its policies play a large role in unemployment. Therefore the cause of this high unemployment would mostly be blamed upon the government.

US GDP/Consumption Low Due to High Prices

http://www.940news.com/nouvelles.php?cat=22&id=43070

Within the article, it states that the USA has had surges of price increases within the energy section of the economy especially in oils. The price of electricity, oil and other aspects of electricity have gotten more expensive over the last few months, reducing the amount of money left for consumers to consume, invest, etc. These higher prices have led to the lowest amount of consumption increase, in years at only 0.3% compared to last years 0.7%. The high prices not only lower consumption only, they lower GDP as a whole. GDP which is the measure of total consumption within a country is measure by 4 aspects, consumption, investments, government spendings and net exports. The high prices of energy, would leave less money for the citizens to spend on either consumption and investment, reducing two major portions of a countries GDP, lowering it as a whole. Consumption in the USA is measure to be about 2/3 of the total GDP as stated in the article. If consumption continues to decrease, as many analysts predict, the country may go into a recession, however, that is not likely as long as prices lower, and consumption/investment rises again.

Unemployment/Economy in Germany

http://www.businessweek.com/globalbiz/content/mar2007/gb20070313_172340.htm?chan=globalbiz_europe_economics+%2B+policy

This article explains Germany's economic situation, in which in 2007 the German economy is set to grow at the fastest pace in almost a decade. After numerous years of high unemployment, the unemployment is predicted to drop to about 8.8% this year or below 3.75 million people of the population. The high amount of unemployment before which ranged up to near the 13.6%(2003) and 10.8%(2006), was caused by the high amounts of tax given to citizens which is currently at 19% of the person's salary and the problems the country had to provide jobs for every person. However, because Germany is prospering from their exports, they have been able to turn the situation around, by decreasing unemployment by about 2% in one year. Also by changing their gloomy situation around, Germany has been able to increase the growth of their economy by a predicted 2.8% this year, due to the exports that Germany continues to make, which are predicted to increase by 11%. This article therefore describes Germany's turn around, in which unemployment used to be high, taxes high, but now has decreased their unemployment, increased exports and increased economic growth, causing them to still have the third largest economy in the world.

Negative Externalities in Cars

http://news.independent.co.uk/environment/article2334915.ece

According to this source, which was recently published, the high production and use of automobiles in England are actually producing more negative externalities than just pollution. The high demand by the population for cars is matched by a high supply of automobiles by numerous firms in the market. Cars are known for the amounts of pollution they produce, however, only recently was another negative externality discovered, that the cars increase chances of urban flooding. This urban flooding is caused by the high demand of land used for roads/parking lots and other car related structures due to the rising numbers of cars. This leads to the earth around these areas to be unable to soak up the majority of the rainfalls causing frequent flooding.

Negative externalities are defined as costs that result from an economic transaction that affect other groups or third parties negatively. This means that when producing certain goods, third parties could be negatively affected, in this case pollution and flooding. With negative externalities in society, the supply of the good is at equilibrium for the firms and the car industry, however, for society, the construction of the cars and roads exceeds the optimum amount wanted. This means that although the firms are producing at their own optimal level or efficiency, they are not producing at society's optimum level, making it a market failure and making it an inefficient system. A market failure occurs when resources are overallocated or underallocated, in this situation, cars and roads are being overallocated causing flooding, therefore resulting in market failure, as seen in the graph below.

As seen in the graph above the equilibrium point of the firms is not equal to the optimal equilibrium. The marginal private costs exceed the marginal social costs, showing that cars and roads are being overallocated, causing in the "external cost" to exist as seen by the arrow in between the two cost curves. Governments have several options to try and shift the marginal private closer closer to the optimal cost curve.

One of these options is to tax firms that are producing cars, or tax the construction of roads to prevent pollution and flooding from occuring. By taxing the firms that construct cars and roads, the production of these goods will be lowered, and the price of these good would increase. The amount of tax would depend on the good itself, and the amount of the tax would affect how far the marginal private cost curve shifts. The tax can be determined by matching the amount taxed to the external cost to equal the two curves. By taxing the car industry, less cars would be produced, reducing the amount of pollution in the air, and get all the car buyers/sellers to bear full costs of cars(which is more now since they cause urban floods as well). Also by building less roads, or making the road production more expensive, flooding can be prevented, because less natural land would be covered by roads.

As seen here in the second graph, when taxes are implemented for the production of cars or roads, the supply of the goods shifts down/towards the left. When compared to the first graph, it can be seen that the marginal private cost is closer to the optimal cost, decreasing the overall amount of external costs.

Another option the government has is to subsidize land owners, who may sell their lands to firms who want to place roads there. If the government subsidizes the land owners, the supply of land would shift closer to an optimal level for society and may get quite close to the optimal level. This would also reduce the amounts of roads built, thus decreasing the amount of cars since they are complementary goods. This would allow for less amounts of flooding, since the natural land is able to soak up the water created from rainfall instead of flooding if there were roads.

A final method could be to make the construction of roads in certain areas of England completely illegal, to prevent the entire flooding situation from further escalating. By making it illegal, and implementing fines to those firms who continue mass production, supply of the cars and roads will be reduced. However, depending on the amount fined, firms may decide to continue to supply the cars and roads, if profit is still available. So these are three methods the government in England can use, however, thus far, the government has not done anything to prevent the pollution and urban floods.