OUTLINE -- Chapter 4

The Role of the Government in Market Economies

Brief Outline

  • Introduction
  • Review : Supply, Demand, and Economic Efficiency
  • The Role of Government in a Market Economy
    • Review how market economies achieve allocative efficiency [from the chapter 3 online lecture (supply and demand)]
    • Government Set Prices:
      Sometimes governments interfere and CAUSE allocative INefficiency (from the end of chapter 3)
      • price ceilings
      • price floors
    • Achieving the 5Es: Economic Functions of Government in a Market (Capitalist) Economy
      • Providing the legal structure
      • Maintaining competition
      • Redistributing income
      • Reallocating resources
        • negative externalities
        • positive externalities
        • public goods and services
      • Promoting stability
      • Government's Role: A Qualification
  • Government Finance
    • Federal Expenditures and Tax Revenues
    • State and Local Expenditures and Tax Revenue
    • Income Taxes
    • The Growth of Government

The Economic Role of Government and the 5 Es

I. Introduction

A. Structural Adjustment Policies
1. Privatization
2. Promotion of Competition
3. Limited and Reoriented Role for Government
4. Price Reform: Removing Controls
5. Joining the World Economy
6. Macroeconomic Stability

B. Review: Capitalism, Markets, and Efficiency

1. Capitalism and Limited Government
  • private property and economic growth
  • markets and prices
  • role of self interest
  • freedom of enterprise and choice
  • competition = capitalism
  • limited role for government

2. Why limited government?

II. REVIEW: Supply, Demand, and Economic Efficiency

A. The Market System and Efficiency
See: The supply and demand model and allocative efficiency
1. WHAT WE GET:
a. Goal of businesses: Maximize Profits
b. Therefore,they will produce where:
  • the Market Equilibrium quantity
  • the quantity where Qs=Qd
  • the is "what we get"

 

  • Graphically:

c. Assumptions: pure capitalism

2. WHAT WE WANT: ALLOCATIVE EFFICIENCY

a.. Review :
(1) Allocative Efficiency
definition - using our limited resources to produce:
  • The quantity of goods and services that maximizes society's satisfaction
  • using resources to produce more CDs that people want and fewer cassette tapes that they don't want
  • no shortages and no surpluses

(2) Benefit-Cost Analysis

definition -
the selection of ALL possible alternatives where the marginal benefits are greater than the marginal cost

select all where: MB > MC
up to where: MB = MC
but never where: MB < MC

B. Allocative Efficiency is achieved where:

1. MSB=MSC
a. define Marginal Social Benefits (MSB)

b. define Marginal Social Costs (MSC)

c. therfore if society gets

all quantities where: MSB > MSC
up to where: MSB = MSC
but never where: MSB < MSC

this will be the quantity where society's Satisfaction will be maximized or the allocatively efficient quantity

2. Graphically:

 

C. THEREFORE:

1. Businesses will produce the profit maximizing or market equilibrium quantity - the quantity where Qd=Qs

2. Society wants the allocatively efficient quantity - the quantity where MSB=MSC

3. WHAT WE GET = WHAT WE WANT if:

b. Market Demand = Marginal Social Benefits (D=MSB)
1. law of diminishing marginal utility
2. assuming no spillover benefits D=MSB

c. Market Supply = Marginal Social Costs (S=MSC)

1. law of increasing costs
2. assuming no spillover costs S=MSC

D. Competitive Markets and Allocative Efficiency (MSB=MSC)

1. if there are no spillover costs, then S = MSC,

2. if there are no spillover benefits, then D = MSB,

3. Graphically:

4. Then: WHAT WE GET = WHAT WE WANT and market economies achieve allocative efficiency

 

In a market economy with no externalities:

  • no positive externalities or spillover benefits
  • no negative externalities or spillover costs
    the profit maximizing or market equilibrium quantity
    (what we get)

    WILL BE THE SAME AS

    the allocative efficient quantity
    (what we want)
D. Preview of this chapter - 2 Parts:
1. Markets ACHIEVING efficiency and Governments Causing Allocative Inefficiency
2. Markets NOT achieving the 5 Es and the Role of Government

III. Governments Causing Allocative Inefficiency (pp. 57-61 )

A. Price Ceilings and Allocative Inefficiency
1. definition
2. graphically
3. effects
4. examples
a. World War II price controls
b. rent controls
c. credit card interest rates
d. anti-price gouging laws (plywood after a hurricane)
e. food price controls in LDCs

B. Price Floors (Supports) and Allocative Inefficiency

1. definition
2. graphically
3. effects
4. examples
a. farm price supports
b. minimum wage

 

IV. Economic Functions of Government: Markets not achieving the 5 Es and the Role of Government

A. Five Reasons for Government Involvement
1. legal and social framework
2. maintaining competition
3. redistribution of income
(correcting market failure to achieve equity)
4. reallocation of resources
(correcting market failure to achieve efficiency)
5. stabilizing unemployment and inflation and promoting economic growth

B. Legal and Social Framework

providing the legal foundation and a social environment conducive to the effective operation of the market system

C. Maintaining Competition

1. review competition
a. large numbers
b. free entry and exit

2. the problem with monopolies

a. higher prices
b. smaller quantities
C. allocative and productive inefficiency

3. role of government

a. preventing monopolies -- antitrust laws
b. regulating monopolies -- natural monopolies

D. Correcting Market Failure to Achieve Equity

1. define equity
2. how does equity affect society's satisfaction?
3. US income distribution 

4. role of government

a. transfer payments
b. market intervention
c. progressive income taxes

E. Correcting Market Failure to Achieve Allocative Efficiency

1. Externalities (or spillovers)
a. negative externalities (spillover costs)
1) definition
2) examples
3) markets and inefficiency
4) correcting for negative externalities (spillover costs)
a) legislation
b) specific taxes

5) failure to provide for the future

a) explanation
b) role of government

b. positive externalities (spillover benefits)

1) definition
2) examples
3) markets and inefficiency
4) correcting for positive externalities (spillover benefits)
a) increase demand
b) increase supply
c) government provision

c. public goods and services

1) definition
2) examples
3) markets and inefficiency
4) allocating resources to public goods

F. Stabilization

1. unemployment
2. inflation
3. role of government
a. fiscal policy
b. monetary policy

V. Government Finance

A. Federal Expenditures
1. pensions and income security [35%]
2. national defense [20%]
3. health [21%]
4. interest on the public debt [7%]
5. all other [17%]

B. Federal Tax Revenues

1. personal income tax [43%]
2. payroll taxes[37%]
3. corporate income tax[13%]
4. excise taxes [3%]
5. all other [4%]

C. State Finance

1. state expenditures
  • education - 35%
  • public welfare - 28%
  • health and hospitals - 7%
  • highways - 7%
  • public safety - 4%
  • all other - 19%

2. state receipts

  • sales and excise taxes - 48 %
  • state income taxes - 34%
  • corporate income taxes
  • licenses and fees
  • grants from the federal government
  • lotteries - 39 states

D. Local Finance

1. local expenditures
  • education - 44%
  • welfare, health, hospitals - 12%
  • public safety - 11%
  • housing, parks, sewerage - 8%
  • streets amd highweays - 5%

2. local receipts

  • property taxes - 73%
  • sales and excise taxes - 17%

E. Regressive, Proportional, and Progressive Taxes

WASHINGTON

House Dems hit on sales tax proposal

House Democrats plan to attack GOP candidates nationwide on their support of a national sales tax proposal, hoping the issue will help their attempt to take over the House.

Democrats think a national sales tax would mean that lower-income families will pay more of the country's tax burden and have been running advertisements attacking GOP candidates for supporting the idea. "We think that Republican candidates and Republican incumbents who are supporting this legislation must respond to their constituents about how they're going to deal with moving the tax burden," said Rep. Robert Matsui, D-Calif.

From wire reports

Northwest Herald
Wed., Oct 27, 2004, page 3A

Letters to the Editor

Logan Scott
Breckenridge
June 27, 2006

Several friends have asked: "Why should we pay sales tax on lift tickets? I don't want to pay a $14 sales tax on my season pass. Don't we pay enough already?" Perhaps a better question would be: "How might we use the revenue?"

Summit County has a highly regressive tax structure in the form of its sales tax on food for home consumption, i.e. the tax we pay on groceries at the supermarket. In most states, such a tax is in fact illegal. According to the USDA, a budget minded family of four averages $153/week on groceries or $7,966/year. Our 5 percent groceries sales tax adds about $400 to that cost. For someone earning $10/hour, that is about one week's wages. Clearly, the sales tax on food places a disproportionate burden on the working poor who are the foundation of our tourist industry.

Imposing a 4 percent sales tax on lift tickets would provide a revenue stream that could be used to reduce or eliminate groceries tax while maintaining a neutral position on overall sales tax collections. A 4 percent sales tax on lift tickets would help shift the burden from those who can least afford it to those who can and help make Summit County a more family friendly place to live.

Other possible uses? How about funding affordable housing initiatives specifically earmarked for police, school teachers, firemen, and other persons vital to our community. Affordable daycare continues to be a major concern, especially with the impending loss of Kinderhut triggered by VRI actions. Do we really want to continue providing VRI with a free ride on sales taxes and 6.7 million dollar subsidies to build gondolas? I think not. It is time for a lift ticket tax.

http://www.summitdaily.com/article/20060627/LETTER/106270043&SearchID=73249722340253

E. Personal Income Tax

1. taxable income
2. progressive tax
a. marginal tax rates
b. average tax rates

3. Fed. Income Tax Rates

TAX SCHEDULE:

http://www.irs.gov/

E. International Comparisons

F. Government Growth

1. ways to measure government size
2. purchases vs. transfer payments
(exhaustive and nonexhaustive expenditures)
3. growth of government expenditures [govspendgr.gif] [stgvspgr.gif]
a. correcting for inflation
b. compared to other sectors
c. growth of transfer payments