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Relationship of Economics and Public Fiscal

Francis Ian L. Ofendoreyes, RN.,LPT

PA 207 Public Fiscal Administration
Master in Public Adminstration
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Chapter Overview

 Chapter 7 – Specialization and the Gains

from Trade
 Chapter 8 - Money and Inflation

 Chapter 7 – Recessions and Depressions

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Chapter 7
Specialization & Gains from Trade

 You may not realize it, but every day everyone is

engaged in trade, and everybody benefits.

 The benefit of trade arises when you have a large

supply of something.

 …swap things that are in high supply (and have low

value to you) in exchange for things that are in short
supply (and have high value to you).
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Chapter 7
Benefits of Trade

 The Hidden Benefits of Comparative Advantages

 Any two countries can benefit from trade, regardless of

where absolute advantages may lie.

 That’s because it’s not only the country that can

produce at the cheapest cost, it can also be the
country that produces at the cheapest opportunity
cost.
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Chapter 7
Benefits of Trade

 International trade is the exchange of services,

goods, and capital among various countries and
regions, without much hindrance.

 The international trade accounts for a good part of a

country’s gross domestic product.

 It is also one of important sources of revenue for a

developing country.
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Chapter 7
Benefits of Trade

 The rise in the international trade is essential for the

growth of globalization.

 The restrictions to international trade would limit the

nations to the services and goods produced within
its territories, and they would lose out on the
valuable revenue from the global trade.
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Chapter 7
Benefits of Trade

 The benefits of international trade have been the

major drivers of growth for the last half of the 20th
century.

 Nations with strong international trade have become

prosperous and have the power to control the world
economy.

 The global trade can become one of the major

contributors to the reduction of poverty.
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Chapter 7
Specialization

 Specialization is a method of production whereby

an entity focuses on the production of a limited
scope of goods to gain a greater degree of
efficiency.

 Many countries, for example, specialize in

producing the goods and services that are native to
their part of the world, and they trade for other
goods and services.
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Chapter 7
Specialization

 Remember, wealth is not created from jobs; it’s

created from productivity.

 Let the most productive country specialize in what it

does comparatively best and trade with other
countries that are comparatively better in other
things. Everyone ends up with more goods and
services. Everyone is wealthier.
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Chapter 8
Money and Inflation

 Money - it can be anything generally accepted as

payment.
 Money serves three basic functions:

 It’s a medium of exchange

 It’s a unit of account

 It’s a store of value

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Chapter 8
Money as a Medium of Exchange
 The first reason for having a currency is that it allows for
more efficient exchanges of goods and services. In the
absence of money, people resort to barter;
 Currency acts like a sophisticated accounting tool. It keeps
tabs on the value of what each person has produced. If you
don’t produce anything, you don’t sell anything, and you
can’t buy anything.
 Currency allows for the most efficient distribution of goods
and services, and that’s why any modern society will
always have a currency. There has to be a way to account
for who is producing stuff and who is buying stuff.
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Chapter 8
Money as a Unit of Account

 The second benefit of a currency is that it provides a unit of

account, which just means that money allows people to
have a consistent way to measure value.
 When all goods and services are priced in a common
currency, it’s easy to see relative values. You just need to
know what everything is worth.
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Chapter 8
Money as a Store of Value

 The third function of money is that it allows you to defer

purchases.
 The ability to store value also helps to manage risk across
time.
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Chapter 8
Ravages of Inflation

 “Inflation is as violent as a mugger, as frightening as an

armed robber, and as deadly as a hitman.” – President
Reagan
 ”…inflation is taxation without representation” – Economist
Milton Friedman
 Inflation is the general rise in prices.
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Chapter 8
Ravages of Inflation

 Most modern currency is called fiat money, which means it

has no intrinsic value like coins made of gold or silver
do.
 It is just declared by the government to be legal for all
public and private debts.
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Chapter 8
Ravages of Inflation

 Problem #1 : Erosion of Purchasing Power

 Inflation eats away at your purchasing power.

 Inflation also harms investments.

 Problem #2: Future Planning Becomes Difficult

 It makes it difficult for people to plan for the future or make

future investments.

 The problem is compounded for bigger, long-term projects.

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Chapter 8
Ravages of Inflation

 Problem #3: Price Distortion

 People respond to incentives, and the price mechanism is the

nation’s way to determine who needs what.

 Prices work best when they’re allowed to rise and fall with
changing needs.

 However, if inflation is present, prices just generally rise, so it

distorts the benefits conveyed by prices.
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Chapter 8
Ravages of Inflation

 Problem #4: Inflation Creates Money Illusion

 Inflation causes people to spend time and other resources to

produce things that aren’t needed.

 If inflation gets out of control, it’s called hyperinflation.

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Chapter 8
Recession and Depressions

 GDP – Gross Domestic Product

 the total monetary or market value of all the finished goods and
services produced within a country's borders in a specific time
period.
 As a broad measure of overall domestic production, it functions
as a comprehensive scorecard of the country’s economic
health.
 ​GDP=C+I+G+(X−M)

where:
C=Consumer spending on goods and services
I=Investment spending on business capital goods
G=Government spending on public goods and services
X=Exports
M=Imports
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Chapter 8
Recession and Depressions

 Ideally, a 2% to 3% growth per year is ideal for GDP

growth.
 If GPD is growing slower, we cant produce the necessary
goods and services for the growing labor force – high
unemployment and sluggish economy = RECESSION
 If the economy grows faster than 3%, it’s growing too
quickly- employees and equipment are pushed to the limits.
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Chapter 9
Recession and Depressions

 DEMAND-PULL INFLATION: demand pulling prices higher.

 COST-PUSH INFLATION: increase in costs of goods and

services which in turn increases prices to cover costs.

 …higher inflation, consumer’s purchasing power is

decreased, which is simply means that they can buy fewer
goods and services with the same amount of money.
 As prices rises, interest rates will also rise.
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Chapter 9
Recession and Depressions

 With higher prices and interest rates, people then spend

less, and business produce less in response.
 As sales slow, employees get laid off and then even less.
As spending slows and unemployment rises, consumer
confidence falls.
 People begin savings more and spending less as fears of
layoffs increase. It becomes a vicious cycle, and the
economy slowly sinks.
 The economy entered recession.

 Recession = when GDP falls for two consecutive quarters.

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Chapter 9
Economic Depressions

 A state of the economy resulting from an extended period

of negative economic activity as measured by GDP.
 It is often described as a more severe form of a recession
that leads to extended unemployment, a spike in credit
defaults, broad declines in income and production,
currency devaluation and a deflationary economy.
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Chapter 9
Fed Tool
(US Federal Reserve)
 Federal Reserve, or the Fed Reserve is the US’s central
bank.
 Charged with three key goals for the nation:

 Maximize employment

 Create stable prices

 Moderate long-term interest rates

 Fed has three key tools in getting the economy back on its
feet; all three are indirect ways of influencing interest rates.
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Chapter 9
Fed Tool
(US Federal Reserve)
 Fed Tool #1: Open-Market Operations

 It can buy or sell bonds in the open market, and in doing so it

changes the amount of dollars circulating in the banks.

 As the supply of dollars changes, so does the price of money –

the interest rates.

 Open-market operations are by far the most common way

the Fed can alter the money supply to influence the
direction of interest rates.
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Chapter 9
Fed Tool
(US Federal Reserve)
 Fed Tool #2: Changing the Discount Rate

 If the Fed increases the discount rate, it sends a signal to

banks that they’re on the hunt to increase rates.

 Most banks, in response, will voluntarily increase rates.

 And if Fed reduces the discount rate, bank will follow suit and
reduce interest rates.
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Chapter 9
Fed Tool
(US Federal Reserve)
 Fed Tool #3: Changing the Reserve Requirement

 Withholding 10% of each deposits.

 Because banks have to withhold a fraction of the total money

deposited, it creates an expansionary process: the amount of
money circulating in the economy is far greater than that issue
by central bank.
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Chapter 8
Recession and Depressions

 While changing the reserve requirement definitely alters the

supply of money, the Fed is reluctant to change these
conditions because of the radical changes it can cause to
the money supply.
 Small changes in the reserve requirement can dramatically
increase or decrease the amount of money in circulation.