© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/eOSullivan/Sheffrin...

© 2003 Prentice Hall Business Publishing Economics: Principles and Tools, 3/e O’Sullivan/Sheffrin

Prepared by:

Fernando Quijano and Yvonn Quijano

C H A P T E R

3

Markets and GovernmentMarkets and Governmentin the Global Economyin the Global Economy


Why Do Markets Exist?

• Markets exist because we aren’t self-Markets exist because we aren’t self-sufficient but instead consume many sufficient but instead consume many products produced by other people.products produced by other people.

• The typical person is not self-sufficient The typical person is not self-sufficient but instead specializes by working at a but instead specializes by working at a particular job and uses his or her income particular job and uses his or her income to purchase goods and services.to purchase goods and services.


Specialization and theGains From Trade

• We can use the principle of opportunity We can use the principle of opportunity cost to explain the benefits from cost to explain the benefits from specialization and trade.specialization and trade.

PRINCIPLE of Opportunity CostThe opportunity cost of something is what you sacrifice to get it.


Production per Hourand Opportunity Cost

BrendaBrenda SamSam

Bread produced per hourBread produced per hour 66 11

Shirts produced per hourShirts produced per hour 22 11

Opportunity cost of one loaf of Opportunity cost of one loaf of breadbread

1/3 shirt1/3 shirt 1 shirt1 shirt

Opportunity cost of one shirtOpportunity cost of one shirt 3 loaves of 3 loaves of breadbread

1 loaf of 1 loaf of breadbread


Opportunity Cost andComparative Advantage

• Comparative advantage: The ability of one person or nation to produce a good at an opportunity cost that is lower than the opportunity cost of another person or nation.

• Absolute advantage: The ability of one person or nation to produce a particular good at a lower absolute cost than that of another person or nation.


How Do Markets Operate?

• Exchanges occur in two markets:Exchanges occur in two markets:

• Factor or input market: Factor or input market: The owners of The owners of the factors of production–natural the factors of production–natural resources, labor, physical capital and resources, labor, physical capital and human capital–sell these inputs to human capital–sell these inputs to organizations that use the inputs to organizations that use the inputs to produce goods and services.produce goods and services.

• Product or output market:Product or output market: The The organizations that produce goods and organizations that produce goods and services sell their products to consumers.services sell their products to consumers.


The Circular Flow Diagram

• The The circular flow circular flow diagramdiagram is a is a diagram showing diagram showing the flow of money the flow of money and goods and goods between markets.between markets.


Households as Sellers and Buyers

• In In labor marketslabor markets, , households sell their households sell their labor to firms for labor to firms for wages. About 75% wages. About 75% of income is earned of income is earned by households.by households.



• In In capital marketscapital markets, , households provide households provide savings that firms savings that firms use to purchase use to purchase physical capital. physical capital. Households receive Households receive interest or a share of interest or a share of the firm’s profits in the firm’s profits in return.return.



• In In natural resource natural resource marketsmarkets, , households sell households sell natural resources to natural resources to firms to use as firms to use as inputs in the inputs in the production process.production process.



• Inputs flow from Inputs flow from households into households into factor markets factor markets where they are where they are purchased by firms purchased by firms and then and then transformed into transformed into products. products.



• Products flow from Products flow from firms to product firms to product markets where they markets where they are purchased by are purchased by households.households.


The Global Economyand Interdependence

• Export:Export: A good produced in the A good produced in the “home” country (for example, the “home” country (for example, the United States) and sold in another United States) and sold in another country.country.

• Import:Import: A good produced in a foreign A good produced in a foreign country and purchased by residents of country and purchased by residents of the “home” country (for example, the the “home” country (for example, the United States). United States).


Major Imports and Exportsof the United States, 1999


Major Trading Partnersof the United States, 1999


Protectionist Policies

• Protectionist Policies:Protectionist Policies: Rules that Rules that restrict the free flow of goods between restrict the free flow of goods between nations, including tariffs (taxes on nations, including tariffs (taxes on imports), quotas (limits on total imports), imports), quotas (limits on total imports), voluntary export restraints (agreements voluntary export restraints (agreements between governments to limit imports), between governments to limit imports), and nontariff trade barriers (subtle and nontariff trade barriers (subtle practices that hinder trade).practices that hinder trade).


History of Tariff and Trade Agreements

• General Agreement on Tariffs and Trade General Agreement on Tariffs and Trade (GATT):(GATT): An international agreement that has An international agreement that has lowered trade barriers between the United lowered trade barriers between the United States and other nations.States and other nations.

• World Trade Organization (WTO):World Trade Organization (WTO): An An organization that oversees GATT and other organization that oversees GATT and other international trade agreements.international trade agreements.



• North American Free Trade Agreement North American Free Trade Agreement (NAFTA):(NAFTA): An international agreement that An international agreement that lowers barriers to trade between the United lowers barriers to trade between the United States, Mexico, and Canada (signed in 1994).States, Mexico, and Canada (signed in 1994).

• European Union (EU):European Union (EU): An organization of An organization of European nations that has reduced trade European nations that has reduced trade barriers within Europe.barriers within Europe.



• Asian Pacific Economic Cooperation Asian Pacific Economic Cooperation (APEC):(APEC): An organization of 18 Asian nations An organization of 18 Asian nations that attempts to reduce trade barriers between that attempts to reduce trade barriers between their nations.their nations.


Currency Markets and Exchange Rates

• Foreign exchange market:Foreign exchange market: A market A market in which people exchange one currency in which people exchange one currency for another.for another.

• Exchange rate:Exchange rate: The price at which The price at which currencies trade for one another.currencies trade for one another.


Exchange Rates in July 2001

NationNation CurrencyCurrencyValue in DollarsValue in Dollars

(U.S. $ equivalent)(U.S. $ equivalent)Units per DollarUnits per Dollar

(Currency per U.S. $)(Currency per U.S. $)AustraliaAustralia DollarDollar 2.512.51 1.961.96BrazilBrazil RealReal 0.410.41 2.412.41BritainBritain Pound sterlingPound sterling 1.411.41 0.710.71CanadaCanada DollarDollar 0.660.66 1.511.51FranceFrance FrancFranc 0.12910.1291 7.747.74GermanyGermany MarkMark 0.43320.4332 2.30772.3077Hong KongHong Kong DollarDollar 0.12820.1282 1.7991.799IrelandIreland PuntPunt 1.071.07 0.920.92IsraelIsrael ShekelShekel 0.240.24 4.194.19JapanJapan YenYen 0.00790.0079 125.75125.75MexicoMexico PesoPeso 0.10950.1095 9.129.12Saudi ArabiaSaudi Arabia RialRial 0.270.27 3.753.75


Global Interdependence

• Multinational corporation:Multinational corporation: An An organization that produces and sells organization that produces and sells goods and services throughout the goods and services throughout the world.world.

• Worldwide sourcing:Worldwide sourcing: The practice of The practice of buying components for a product from buying components for a product from nations throughout the world.nations throughout the world.


Global Interdependence

• Financial liberalization:Financial liberalization: The opening The opening of financial markets to participants from of financial markets to participants from foreign countries.foreign countries.

• International Monetary Fund:International Monetary Fund: An An organization that works closely with organization that works closely with national governments to promote national governments to promote financial policies that facilitate world financial policies that facilitate world trade.trade.


Government in a Market Economy

• The government has five general The government has five general responsibilities in a market-based economy:responsibilities in a market-based economy:

• Providing goods and services.Providing goods and services.

• Redistributing income.Redistributing income.

• Taxation.Taxation.

• Regulation of business practices.Regulation of business practices.

• Trade policy.Trade policy.


Percentage of Government Spending on Various Programs

Local Expenditures (1996)

Administration and other 32%

Education 42%

Health and hospitals 9%

Police protection 5%

Public welfare 5%Highways 5%

State Expenditures (1998)

Administration and other 20%

Education 35%

Public welfare 25%

Health and hospitals 8%

Highways 8%Police and

corrections 4%

Federal Expenditures (1999) Net interest 13%

Other 14%

National defense 16%

International affairs 1% Health 8%

Medicare 11%

Social security 23%

Income security 14%


Criteria for a Tax System

• The The benefit-tax approachbenefit-tax approach suggests that a suggests that a person’s tax liability should depend on his or person’s tax liability should depend on his or her benefits from government programs.her benefits from government programs.

• Vertical equity:Vertical equity: the idea that people with the idea that people with more income or wealth should pay higher more income or wealth should pay higher taxes.taxes.

• Horizontally equitable:Horizontally equitable: the idea that people the idea that people in similar economic circumstances should pay in similar economic circumstances should pay similar amounts in taxes.similar amounts in taxes.


Percentages of Government Revenue from Different Sources

Local Revenue (1996)

Property 45%

Individual income taxes 3%

Other 4% Sales 10%

Charges and miscellaneous

38%

General State Revenue (1998)

Corporate income taxes 4%

Charges, fees, other21% Sales 26%

Intergovernmental revenue 28%


Federal Revenue (1999)

Social insurance and retirement receipts 33%

Other 8%


Corporate income taxes 10%


Tax Rates in Different Nations

52

46.2 45.9 45.2 44.4 43.6 42.7 41.5 4138.7 38.3 37.9 37.4 37.2 37

35.2 35.1 34.2 34.2 33.6 33.229.9 28.9 28.7 28.4

21.1

16

49.8

0

10

20

30

40

50

60

Sweden

Denmar

k

Finla

nd

Belgiu

m

France

Austria

Norway

Italy

Luxem

burg

Netherla

nds

Hungary

Czech

Republic

Poland

Canad

a

United K

ingdom

Germ

any

New Zeal

and

Switzerla

nd

Spain

Portugal

Icela

nd

Irela

nd

Austria USA

Turkey

Japan

Korea

Mexi

co


Government Regulation of Markets

• Mixed economy:Mixed economy: A market-based A market-based economic system in which government economic system in which government plays an important role, including the plays an important role, including the regulation of markets, where most regulation of markets, where most economic decisions are made.economic decisions are made.


Alternative Economic Systems

• Centrally planned economy:Centrally planned economy: An economy in An economy in which a government bureaucracy decides how which a government bureaucracy decides how much of each good to produce, how to much of each good to produce, how to produce the goods, and how to allocate the produce the goods, and how to allocate the products among consumers.products among consumers.


Alternative Economic Systems

• Transition:Transition: The process of shifting from a The process of shifting from a centrally planned economy toward a mixed centrally planned economy toward a mixed economic system, with markets playing a economic system, with markets playing a greater role in the economy.greater role in the economy.

• Privatizing:Privatizing: The process of selling state firms The process of selling state firms to individuals. to individuals.

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