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 Goods Public 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 Price Price 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).

Floor A 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 (b) A Price Floor That Is Binding Price of Ice-Cream Supply Cone Demand Surplus $4 Price floor 80 120 3 Equilibrium price Quantity of Ice-Cream Quantity demanded Quantity supplied Cones Copyright©2003 Southwestern/Thomson Learning

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 (b) A Price Ceiling That Is Binding Price of Ice-Cream Cone Supply Demand Equilibrium price $3 2 Price ceiling 75 125 Shortage Quantity of Ice-Cream Quantity supplied Quantity demanded Cones Copyright©2003 Southwestern/Thomson Learning

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.

Environmental and Social Problems 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 budgets Receipts- Money coming in Terms: Receipts- Money coming in Expenditures- Money going out Balanced Budget Receipts = Expenditures 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 Deficit Budget Expenditures > Income Deficits must be made up out of savings and with loans The total value of the federal government borrowing is the national debt Surplus Budget Receipts > Expenditures 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!!!