Microeconomics: Inequality and Poverty - Assignment Example

Final Exam Edmund Phelps plan to help the working poor: “apply tax credits for “qualified employers” or hire disadvantaged people for “eligible jobs” Phelps’ plan is to change the status of low, or no employment and wages for those he calls disadvantaged. Phelps believes that the source of the poor communities’ decline is lack of jobs and wages. The solution to this therefore, is through provision of employment and wages. The plan is to introduce employment subsidies, of which Phelps selects application of continuing tax credits to employers who offer employment to low-wage workers. The more a private company employs low wage workers, the more tax credit the company receives. This will encourage companies to employ the disadvantaged group of people. The main reason behind Phelps’s choice of poverty reduction strategy is that, with employment, these people will improve their social productivity (Phelps, 1997). Social productivity is the totting up of an individual’s productivity, and external productivity. Private productivity is what an individual has to offer an employer in terms of services; it is an individual’s worth in the workplace. External productivity is an individual’s value to the society. When one is employed, he or she has improved ability to be a responsible partner, parent, citizen, community member. This is an additional reward for being employed. An individual’s self- esteem is also increased. It is a better way to deal with the poverty situation, than social welfare programs. According to Phelps, the need for social welfare will reduce since only the disabled would need the services. He also argues that the provision of such subsidies eliminates cases of misuse of funds since it cannot be exploited by those who refuse to work (Phelps, 1997). Phelp’s plan is an improvement to the current government policies. The U.S government has formulated welfare programs to help reduce poverty, and uplift the social standards of homeless and poor people. The plan was good, but currently, the nation has experienced increased spending on such programs. Ziliak (2011) indicates that in some major programs, real spending has doubled or tripled. This is caused by a variety of factors; including deep recession and demographic shifts. What the country considers the safety net through which it shields its people, has lost its anti-poverty focus. It no longer alleviates hardship among the poor, for the trend of increased inequality and poverty is not changing. Denk, Hagemann, Lenain, and Somma (2013) also note that, if reforms should be made, they should be able to promote inclusive growth which helps reduce market misrepresentations. One of the ways of ensuring that is through gradual elimination of the corporate and individual tax expenditures that excessively benefits high earners. This is expected to reduce the gap between the high income and low income earners, and improve resource allocation. Phelps’s plan is an incentive that is similar to the solution offered above. It will reduce the tax paid by the private company employers, and encourage employment. Through this, it would still be working towards reducing the gap between income groups. Denk, Hagemann, Lenain and Somma’s proposition also includes a more effective poverty alleviating social program that truly identifies the needy, while lessening governmental complexity (2013). Through the provision of employment for the disabled, those who refuse to work will not benefit from the plan. It, therefore, acts as a means of identifying those who truly need social welfare. Phelps’ plan is expected to help the government reduce its expenditure on welfare programs through employment of the disadvantaged, and through elimination of those who do not deserve to be in the programs (Denk, Hagemann, Lenain & Somma, 2013). 2. Investment capital is the finance available for investment. Investment capital can be transformed into fixed capital goods, can be used to invest in new technology, and can be used to invest in methods of production with lower costs (Baumol & Blinder, 2007). Fixed capital goods are such as vehicles, machinery, and premises. Capital investment is done to expand the productive capacity of a business. Through increased productive capacity, may be the cost of production can be reduced. All these are interlinked in one way or the other. Investing in new technology may be for sustainability of the business, but may also be a decision to increase the business’ productivity, or to reduce the cost of production. Capital investment is also done to replace obsolete equipment. It is done to produce new products, and to reduce the cost of production per unit (Cumming 2010). New methods of production mean new equipment, machinery, and some fixed capital goods may be needed. Investment capital can be used for this purpose. New methods of production may also mean implementation of a new technology. It may also mean finding new strategies that will lead to reduced cost of production (Cumming 2010). How interest rates impact the availability of investment capital Investment capital can be in different forms, for example, in the form of debts, and the amount of money spent on various equipment and infrastructure for the purpose of producing goods and services. The market rate of interest on loans affects both the debts, and the investment capital in the form of infrastructure and equipment. Businesses take loans to finance various business projects. These loans attract specific interests some of which may be fixed. These interests are determined by the market interest rate. It means, therefore, that the higher the interest rate, the more interest is paid on the debt. There is an inverse proportionate relationship between interest rate and rate of saving. If interest rates are high, businesses will be encouraged to save, therefore availability of investment capital. If interest rates reduce, businesses have an advantage of taking debt, hence increased access to capital (Baumol & Blinder, 2007). Interest rates directly affect the opportunity cost, and opportunity determines whether the investment capital should be used for a specific purpose. An example is, if there is investment capital available for use, but there are higher interest rates in the market. The business managers will weigh on whether to save the money and get more money on the capital, instead of investing it on equipment that may not earn as much as the opportunity cost. Interest rates also affect decision making on whether to get capital from banks or not. High interest rates discourage borrowing, while low interest rates encourage borrowing (Baumol & Blinder, 2007). 3 Three main arguments in favor of trade restrictions are; That trade restrictions are for national defense. Foreign producers should not be allowed to produce defense goods in a country even if the cost of production is lower than if the country was producing the goods alone. That trade restrictions are there to encourage start up industries that may face unfair competition from foreign industries that are more developed. The small sized industries may not compete effectively because of their size, resources, and level of growth. Trade restrictions protect the country from dumping. It is argued that foreign companies dump their goods in the country. This is because such companies sell their products at a lower price below the production costs. This will affect the domestic company’s market price and performance, yet the foreign companies are only dumping the goods (Baron & Kemp, 2004). Trade restrictions are important because of the above reasons and more. However, economists argue for free trade. They are of the view that trade restrictions are too costly for the economy of a nation. Johnson (2012), indicates that economists found out that the overall trade restrictions’ cost is higher than the benefits achieved from it. Trade restrictions lead to high annual loss to the economy from various industries. In the Textile and apparel industry alone, for example, the loss is about $ 10.04 billion annually. The annual cost per job saved is also about $ 182,545 in the same industry (Johnson, 2012). From an economist’s perspective, it would be advisable to allow free trade, for a lot of funds will be saved, and economic growth can be achieved if the funds are channeled towards the correct investments. Very few industries are protected at the expense of a whole nation’s economy. This is an argument that counters the protection of infant industries. It is also argued that free trade will encourage innovation, leading to quality products for the people. It encourages competition, leads to better paying jobs, increased savings, and increased investment. This means that the fear of a foreign country dumping goods in a nation should not be an excuse. Arguing from an economist’s perspective, allowing such companies to produce such products is one way of getting better products, better paying jobs, more saving and more investments. If the country is afraid of the foreign country dumping its products, it can invest in the production of its own products with the money saved from the jobs in the country (Froning, 2000). Free trade allows entry of a variety of products and services in a country at lower prices. This is one way of improving the standard of living of the people. Free trade fosters economic development. Trade restrictions according to economists, diminish the economic efficiency, limit world trade, reduce employment and total production, encourage retaliation, and raise prices. It is only under specific circumstances where economists will argue against free trade. Such are the cases concerning the safety of the citizens, like those linked to terrorism. Restrictions based on the defense of a nation, may in the end destabilize the economy of the nation (Froning, 2000). 4. The financial crisis is something that results from long term poor economic choices that strain the economies. It is all about the investors, consumers, finance institutions, and the governments’ activities. Failure by the government to recognize the symptoms of a future financial crisis, and set up preventive measures is a contributing factor. The same applies to financial institutions such as banks. 2007-2009 global financial crisis was realized when the market unexpectedly stopped funding to several monetary entities. This prompted the Federal Reserve to reduce the discount rates so that the banks could afford to lend the firms cut off from the market, some funds. This was in August 2007, and through 2007 to 2008, the FED reduced its interest rates. In 2007 mid-September, the main policy interest rate was reduced. As of June 2006, the rate stood at 5.25%, but in 2007 mid-September, it was reduced in steps of fifty basis points, 25 points more than the normal change rate. This practice was continued as the economy worsened and financial strains grew. It went to 3% in January 2008, and further down to 2.25% in March 2008. The Federal Reserve also bailed out some financial institutions, for example, Bear Stearns when the market failed to fund it. More problems were to come with some financial institutions going bankrupt, for example, Lehman, and the fed lowering the funds rate further down to zero. Economic activity reduced sharply, and the credit strains became severe, but with time, the economy changed and credit began to flow again, and markets improved steadily (Poole, 2009). This financial crisis was caused by a variety of factors. Kenc and Dibooglu (2009) indicate that it is a combination of poor risk management, macroeconomic imbalances, and weak financial regulation and supervision. It is due to poor risk management because the financial institutions, and the government, failed to regulate the flow of capital into the US, and to manage the financial market. It is postulated that because the world economy was integrated, the macroeconomic imbalances led to the activities that eventually led the world to the crisis situation. Financial globalization revealed asymmetric distribution of investment opportunities, which drove different markets into an accumulation of official exchange reserves, just to be on the safe side. This, however, led to increased capital flows, reducing the interest rates, and increased consumer spending, causing the European and United States banks to intensify their search for increased leverage and higher yields. This meant that their risk taking also intensified, and they had to rely on opaque and complex financial instruments. These risks were accompanied by lack of proper supervision and regulation by the government leading to the crisis situation. The banks did this as long as it was self-sustaining, where surplus countries provided capital flows to finance the external deficits run by US and European financial institutions. The exchange rates were low and this was an advantage to the financial institutions which needed to sustain the surplus and deficit configurations. This led to large current account deficits in some European countries, Australia, and in the US. It created a shortage of sufficiently safe assets. All these led to a series of actions by financial institutions, the governments, and consumers, that led to the 2007-2009 financial crisis (Kenc & Dibooglu, 2009). References Baron, J. and Kemp, S. (2004). Support for trade restrictions, attitudes, and understanding of comparative advantage. Journal of Economic Psychology 25: 565–580. Baumol, W., and Blinder, A. (2007). Microeconomics: principles and policy, 2007 Update. 10th Ed. Mason, Ohio: Cengage Learning. Denk, O., Hagemann, R. P., Lenain, P. and Somma, V. (2013). Inequality and poverty in the united states public policies for inclusive growth. Retrieved from: http://www.oecd-ilibrary.org/economics/inequality-and-poverty-in-the-united-states_5k46957cwv8q-en Froning, D. H. (2000). The Benefits of Free Trade: A Guide For Policymakers. Retrieved from: http://www.heritage.org/research/reports/2000/08/the-benefits-of-free-trade-a-guide-for-policymakers Johnson, J. T. (2012). International Trade. Retieved from: http://www.harpercollege.edu/mhealy/eco212i/lectures/internat/internat.htm Kenc, T. and Dibooglu, S. (2009). The 2007-2009 Financial Crisis, Global Imbalances and Capital Flows: Implications for Reform. Retrieved from: http://www.umsl.edu/~dibooglus/personal/financial%20crisis_revised.pdf---F1 Phelps, E. S. (1997). Rewarding work: how to restore participation and self-support to free enterprise. New York: Harvard University Press. Poole, W. (2009). Causes and consequences of the financial crisis of 2007–2009. Harvard Journal of Law & Public Policy, 33 (2): 421-441. Ziliak, J. P. (2011). Recent Developments in Antipoverty Policies in the United States. Discussion Paper no. 1396-11. Retrieved from: http://www.irp.wisc.edu/publications/dps/pdfs/dp139611.pdf Read More