8/10/2019 Chap_5_2009 Econ

1/23

Chapter 5: The Institutions of a Modern Market Economy

Objectives of Government Policy Tax System Legal System Financial System

Organization of Business Labor Market Trade Policy Industrial Policy Developing Human Resources

8/10/2019 Chap_5_2009 Econ

2/23

The Objectives of Government Policy

The government performs three functions: Allocation making the economy work efficiently, correcting

market failure Distribution looking after equity, providing safety net. Stabilization -- growth, inflation.

8/10/2019 Chap_5_2009 Econ

3/23

Comparative Expenditure on Allocation Function

8/10/2019 Chap_5_2009 Econ

4/23

Distribution Function

Income support Affects incentive in the labor market via

Reservation wages Search time Voluntary unemployment

Can both increase and decrease efficiency Redistribution in-kind

Merit goods Voucher systems

8/10/2019 Chap_5_2009 Econ

5/23

Comparative Expenditure on Allocation Function

8/10/2019 Chap_5_2009 Econ

6/23

Allocation Function

1. Production of Public and Quasi Public Goods 2. Provision of Information 3. Product Regulation

4. Environmental Regulation5. Financial market Regulation

8/10/2019 Chap_5_2009 Econ

7/23

Stabilization Function

Accepted really after 1930s Could do it only after a framework to do it in Gathering statistics is very important Improved performance since WWII

Avoided depression Almost avoided recession

8/10/2019 Chap_5_2009 Econ

8/23

US Real Growth postwar

8/10/2019 Chap_5_2009 Econ

9/23

The Tax System

Direct taxation Personal income tax Social security taxes Corporate taxes Expenditure taxes Wealth and estate taxation

Indirect taxation Taxes on commodities, sales, exchanges Tariffs: imports, exports, Real estate

Types:

Progressive Average rate increases with income Regressive

Average rate falls with income Proportional

Rate remains constant with income

8/10/2019 Chap_5_2009 Econ

10/23

The Tax System

8/10/2019 Chap_5_2009 Econ

11/23

The Legal System

Ownership and property Rights Freedom to engage in economic activity The enforcement of contracts and compensation Bankruptcy law

When the business goes wrong, who gets to gnaw on the bones ofthe business first? Accounting and financial disclosure

What companies have to tell you is very important. Clear definition of governmental responsibility

System of civil compensation (torts)

8/10/2019 Chap_5_2009 Econ

12/23

The Financial System

Central Bank Used to control and insure the value of the currency Oversee the banking system Lender of Last Resort Clearing Bank

Depository institutions Banks

Checking and Savings

Non-depository institutions Market for financial assets Are markets self-regulating?

8/10/2019 Chap_5_2009 Econ

13/23

Central Banks Functions

Functions To act as a clearing bank for the banks To act as the promulgator and enforcer of financial regulation, designed to

enhance the stability and efficiency of the financial system Recently neglected or given to other agencies To act as a lender of last resort To monitor the foreign exchange value of the currency To control the overall stock of money in the economy, and hence the

interest rate through use of the following tools: Open-market operations , by which the central bank buys or sells government

bonds to and from the public Reserve requirements , which constitute controls on the minimum amount of

liquid reserves which banks must hold against the liabilities that it owes its

depositors The discount rate , which is the interest rate at which the central bank lends

money to banks to provide the reserve base against which banks can lend toborrowers

8/10/2019 Chap_5_2009 Econ

14/23

Central Bank Independence The pros and cons of a central banks independence

Pros: Independence means not beholden to any party or group. Has the legitimacy of expertise can be given to a real banker who has no

electoral record Above politics not swayed by interests or obligations of any party. Takes long view not worried about the next election.

Can make tough decisions that would lose an elected politician his office. Con:

Undemocratic power not balanced by electoral control. Isolated can afford to be aloof and uninvolved in important issues. Politically remote Responsible to wrong community -- by picking a real banker or academic

he/she might have specific sectoral interests

8/10/2019 Chap_5_2009 Econ

15/23

Depository Institutions

Commercial banks Savings and Loan Banks Credit Unions Postal Savings Banks

8/10/2019 Chap_5_2009 Econ

16/23

Non-depository Institutions

Mutual Funds Venture Capital Funds Insurance Companies

8/10/2019 Chap_5_2009 Econ

17/23

The Market for Financial Assets The Ownership of Stock

Who owns the firms varies from country to country and therefore ability tocontrol varies too (Table 5.3)

Financial Markets Provide Corporate Governance

The Market for Corporate Control

8/10/2019 Chap_5_2009 Econ

18/23

The Organization of Business

The Corporate Form is the predominant form in most marketeconomies (vital innovation for the development of moderncapitalism) Favors risk Pools capital Limits liability

The South sea bubble was an early example of perhaps harmfulaspects of corporate form.

The issue of Corporate Responsibility is Corporateresponsibility Is a corporation a social institution? What is the Stakeholder society?

8/10/2019 Chap_5_2009 Econ

19/23

The Labor Market

Union form can differ, with impact on performance Craft

Descendants of guild system Industry

Covers many occupation in a single industrial grouping (e.g. UAW)

Company Common in Japan

General The Teamsters for instance, covers not just wagon drivers and truckers,

but policemen and secretaries as well

Rates of unionization vary widely across nations (see next slidefor table)

8/10/2019 Chap_5_2009 Econ

20/23

Rates of Unionization

8/10/2019 Chap_5_2009 Econ

21/23

Trade Policy

Open versus closed Trade/GDP ratios

Multilateral GATT WTO

Unilateral Reciprocity

Free Trade areas Customs Unions

Common Markets Economic Unions

8/10/2019 Chap_5_2009 Econ

22/23

Industrial Policy

Micro Picking the winners

Macro Creating broad structure

Promoting new vs. burying old Japanese/European models

8/10/2019 Chap_5_2009 Econ

23/23

Developing Human Resources

The Educational System The Health-Care System

End of Presentation