ROLE OF GOVERNMENT IN A MARKET ECONOMY

Discussion

With a partner, brainstorm ideas about what the government should do or what functions the government should perform in our economy

(create a written list)

Role of Government in a Market Economy

• Gov’t has a LIMITED role

• In market economies, most decisions are made by individual consumers and producers/privately owned businesses

• LAISSEZ-FAIRE (hands off, leave it alone)

Role of Government in a Market Economy

1. Provide a legal system to make and enforce laws and to protect private property rights

2. Provide public goods that individuals or private businesses would not provide

Role of Government in a Market Economy

3. Correct market failures such as external costs and external benefits

4. Maintain competition by regulating competition

Role of Government in a Market Economy

5. Redistribute income by taxing those with larger incomes and helping those in need

6. Stabilize the economy by reducing unemployment and inflation, and promoting economic growth

Public Goods

• Most goods and services produced in market economies are private goods and services.

• The consumers who purchase these goods consume these goods; for example, a hamburger is a private good.

• National defense is an example of a public good.

Public GoodsPublic goods differ from private goods because they have these characteristics:

• Shared consumption:

When one person consumes a public good, it does not prevent others from also consuming the good.

• Nonexclusion:

Once a public good is produced, it is difficult or impossible to exclude others from consuming the good, even if they did not pay for it.

• Can you think of other examples???

• Police• Fire department• Street lights • Lighthouses

Public Goods

• Because people can consume public goods without paying for them (called the free-rider problem), private businesses do not have incentives to produce enough public goods.

• Therefore, the government often provides them, through tax dollars, if people want them.

Externalities

• Market prices usually reflect the costs producers pay to produce goods and the benefits consumers receive from the good.

• A kind of market failure occurs when market prices fail to reflect all the costs and all the benefits involved.

• This kind of market failure is called an externality problem.

Externalities

*Externalities exist when some of the costs or benefits associated with the production or consumption of a product spill over to third parties, who do not produce or pay to consume the product.

Externalities

• Positive externalities are benefits enjoyed by someone who does not produce or pay to consume a product.

• An example of a positive externality is elementary education, because society as a whole benefits when others can read and write. The government provides free public education to encourage everyone to be educated.

• Positive externalities often call for government subsidies or government provision.

Can you think of other POSITIVE externalities?• Immunizations• Landscaping/home maintenance• Research development• Education

Externalities

• Negative externalities are costs paid by someone who does not produce or pay to consume a product.

An example of a negative externality is air pollution caused by cigarette smoking:

Because others suffer from the smoke, the government may pass laws preventing smoking in certain places.

• Negative externalities often call for the government to clearly define property rights, or for corrective government measures such as taxation or fines.

Can you think of other NEGATIVE externalities?• Automobile exhaust• Factory pollution• Cigarette smoking• Barking dogs (loud pets)

PRICE CONTROLS

Government Imposed Control on PricePrice controls are usually enacted when policymakers believe the market price is unfair to either buyers or sellers. • Price Ceiling (prevents you from going up)• A legal maximum on the price at which a good can be sold

(designed to help buyers)

• Price Floor (prevents you from going down)• A legal minimum on the price at which a good can be sold

(designed to help sellers).

FloorA Price Floor is a minimum legal price ABOVE the equilibrium price

It provides perverse incentives (unintended consequence), causing a surplus.

Floor, above, surplus

Figure 4 A Market with a Price Floor

Copyright©2003 Southwestern/Thomson Learning

(b) A Price Floor That Is Binding

Quantity ofIce-Cream

Cones

0

Price ofIce-Cream

Cone

Demand

Supply

$4Pricefloor

80Quantity

demanded

120Quantitysupplied

Equilibriumprice

Surplus

3

Ceiling

A Price CEILING is a maximum legal price BELOW the equilibrium price.

It provides perverse incentives (unintended consequence), causing a shortage.

Ceiling, below, shortage

Figure 1 A Market with a Price Ceiling

Copyright©2003 Southwestern/Thomson Learning

(b) A Price Ceiling That Is Binding

Quantity ofIce-Cream

Cones

0

Price ofIce-Cream

Cone

Demand

Supply

2 PriceceilingShortage

75

Quantitysupplied

125

Quantitydemanded

Equilibriumprice

$3

Floors and Ceilings

•A price ceiling prevents the price from moving up to a natural equilibrium. A price ceiling will inevitably cause a shortage. Examples are rent control and legally imposed limit on price of gasoline.

•A price floor prevents the price from moving down to a natural equilibrium. A price floor will inevitably cause a surplus. Example are the minimum wage and agricultural price supports.

GOVERNMENT SPENDING AND BUDGETING

The Federal budget•A financial plan that summarizes where the governments funds will be coming from and how it intends to spend them

Types of spending

• Mandatory Spending- 2/3 of all federal expenditures• Includes entitlements (based on age, income, and other

factors) such as Social Security, veteran’s benefits, and food stamps• It also includes interest on the national debt that the

government pays to those individuals and institutions who hold federal bonds

• Discretionary Spending- 1/3 of all federal expenditures• What Congress and the President choose to spend• This includes things like roads, defense, space exploration, and

foreign aid

Why has the cost of government been increasing?

• Inflation- the value of the dollar in terms of what it could buy, or purchasing power, has been declining

•National Security- In the 20th century the US has engaged in multiple wars and provided aid to other countries ruined by hunger and war. • 16 cents out of every federal budget dollar was spent for national defense in 2001.

•Population Growth and Longevity- Our population has more than doubled in the 20th century and the longevity of people’s lives has increased due to a higher standard of living.• The elderly receive more services than any other age group in the population. More people are eligible for Social Security retirement benefits, Medicare, veteran’s pensions, etc

•Environmental and Social Problems•Our advanced standard of living has created environmental problems like pollution and garbage which must be dealt with•¾ of the US population lives in cities and suburbs increasing the problems of waste disposal, housing, education, transportation, and public health and safety

Types of budgetsTerms:

Receipts- Money coming inExpenditures- Money going out

1. Balanced Budgeta. Receipts = Expenditures

b. A budget is balanced by calculating how much it will take to pay for the expenditures in the year ahead and then setting taxes to whatever amount necessary to balance the budget

2. Deficit Budget1. Expenditures > Income

2. Deficits must be made up out of savings and with loans

3. The total value of the federal government borrowing is the national debt

3. Surplus Budget1. Receipts > Expenditures

2. The government can then decide what to do with the extra funds (ex. Reduce national debt, reduce taxes, increase spending without raising taxes or adding to the debt)

Who does the US owe?• US Banks and Citizens• Loans that are paid to the American and corporations are “all

in the family”. Repaying that debt has no effect on the total income in the US

• Foreign individuals, businesses, and governments• In order to pay them back, US dollars are sent abroad• This money in turn is used to buy US goods and services which

results in less of these goods and services for Americans and the price of what remains to increase

Dangers of a large National debt• 1. May cause businesses that borrow to pay higher interest rates this will reduce private business investment because of the increased cost of borrowing money• 2. May lead to rising prices and inflation The more governments borrow, the more they spend. If their spending increases faster than there are goods and services, prices will go up• 3. Today’s national debt will have to be paid off by

future generations of Americans…. YOU!!!