Externalities and the Environment

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Meyer describes the “Tragedy of the Commons.” The IMF article explains how this type of problem is an example of an “externality.” What is an externality? What might be a good government policy to solve the problem of the environmental externality that leads to high greenhouse gas emissions?
Moral Hazard and Adverse Selection

“Moral hazard” is a term often used in the context of peoples’ behavior once they have insurance. Szuchman and Anderson explore the idea of moral hazard in personal relationships. How would you define moral hazard? Provide an example of a moral hazard that you have observed in your own community or workplace.

How does moral hazard differ from adverse selection? Provide an example to illustrate this concept.
Part 2 Dis of 5

 

Monetary policy is the action taken by the Federal Reserve to expand or contract the money supply and influence interest rates.

What are the current unemployment and inflation rates? How has the Fed redefined its targets for inflation and unemployment, and how do current conditions compare to those targets?

As the top advisor to the chair of the Federal Reserve, define contractionary and expansionary monetary policies and explain which you advise the Fed to pursue today—given the inflation and unemployment targets versus the current rates.
Inflation – Winners and Losers

We often hear of inflation characterized as a bad thing, but Meyer describes both winners and losers from inflation. Give an example of one way in which you would win from unexpected inflation and an example of one way in which you would lose from unexpected inflation.
Before answering these questions, review this Summary of New Fed Monetary Policies. You may consult other sources as well and include them in your bibliography.

Classical v. Keynesian Approaches to Smoothing Business Cycles

Fiscal policies are the actions of Congress on spending and taxing. (Note this is different from monetary policy, which is the action taken by the Federal Reserve to change the money supply and interest rates.)

Explain and compare the Keynesian and classical points of view on whether or not to intervene during the business cycle (an expansion = positive real GDP growth; and a recession = negative real GDP growth).
Are we in recession today? Use today’s real GDP growth rates to explain your answer.
As the President’s chief economist, describe the Keynesian fiscal policy you think the administration should follow, given today’s economic conditions. Support your point of view using principles of Keynesian economics, as described by Mayer in Chapter 16 of Everything Economics.
The attached summary (How our Government Supports its Citizens) outlines a number of government functions that contribute to a well-functioning society and economy.
List and explain two ways that in your everyday life there is a need for an effective government role in the economy.

What are two examples of government functions that help correct a market failure?

How our Government Supports its Citizens .docx(this document is attach, go through it before answering)

Sample Solution

Externality: An externality is a consequence of an economic activity that affects a third party who is not involved in the activity. It can be positive or negative. In the case of greenhouse gas emissions, the negative externality is the impact on the environment and future generations.

Government Policy: A carbon tax is a potential government policy to address the environmental externality of high greenhouse gas emissions. By imposing a tax on carbon emissions, the government can incentivize individuals and businesses to reduce their emissions and transition to cleaner energy sources.

Moral Hazard: Moral hazard occurs when individuals change their behavior after obtaining insurance, leading to increased risk. For example, a person with car insurance may drive more recklessly, knowing that their insurance will cover any damages.

Adverse Selection: Adverse selection occurs when individuals with a higher risk of experiencing a loss are more likely to purchase insurance. This can lead to higher premiums for everyone.  

1. www.numerade.com
www.numerade.com

Current Economic Conditions:

As of early 2024, the unemployment rate in the United States is relatively low, while inflation has been running higher than the Federal Reserve’s target.

Fed’s Redefined Targets:

The Fed has traditionally aimed for an unemployment rate of around 4-4.5% and an inflation rate of around 2%. However, in recent years, the Fed has indicated a willingness to tolerate slightly higher inflation rates in order to achieve a lower unemployment rate.

Contractionary vs. Expansionary Monetary Policy:

  • Contractionary monetary policy: Involves actions taken by the Fed to reduce the money supply and raise interest rates. This is typically used to combat inflation.
  • Expansionary monetary policy: Involves actions taken by the Fed to increase the money supply and lower interest rates. This is typically used to stimulate economic growth and reduce unemployment.

Recommendation:

Given the current economic conditions with relatively low unemployment and higher inflation, I would advise the Fed to pursue a contractionary monetary policy. Raising interest rates can help to cool down the economy, reduce demand-pull inflation, and prevent the economy from overheating.

Inflation Winners and Losers:

  • Winner: Individuals who hold assets that appreciate in value during inflation, such as real estate or stocks.
  • Loser: Individuals with fixed incomes, such as retirees on pensions, can lose purchasing power due to unexpected inflation.

Part 2: Classical vs. Keynesian Approaches and Government Functions

Classical vs. Keynesian Approaches:

  • Classical economists believe that the economy is self-correcting and that government intervention is not necessary to stabilize business cycles. They argue that market forces will eventually bring the economy back to equilibrium.
  • Keynesian economists believe that government intervention can be effective in smoothing business cycles. They argue that during recessions, government spending can help stimulate demand and create jobs, while tax cuts can put more money into the hands of consumers.

Current Economic Situation:

As of early 2024, the United States is not currently in a recession. Real GDP growth has been positive, indicating economic expansion.

Keynesian Fiscal Policy Recommendation:

Given the current economic conditions, a Keynesian fiscal policy would likely advocate for increased government spending to stimulate economic growth and job creation. This could involve investments in infrastructure, education, or social programs.

Government Functions and Market Failures:

Two examples of government functions that help correct market failures are:

  1. Providing public goods: Public goods, such as national defense, public infrastructure, and basic research, are essential for a well-functioning society but are often underprovided by the private sector due to the free-rider problem. Governments can address this market failure by providing these goods and services.
  2. Regulating markets: Governments can regulate markets to prevent monopolies and ensure fair competition. This helps to protect consumers from exploitation and promotes economic efficiency.

Additional examples of government functions that support citizens:

  • Social safety nets: Programs like Social Security, Medicare, and Medicaid provide financial support to individuals and families in need.
  • Education and training: Government-funded education and training programs help to develop a skilled workforce and promote economic growth.
  • Environmental protection: Government regulations and policies help to protect the environment and ensure sustainable resource management.
  • National security: Governments provide national defense and protect citizens from external threats.

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