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Individuals and Government
Chapter 1
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Public Finance Public finance is the field of economics
that studies government activities and the alternative means of financing government expenditures.
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Government Governments are organizations formed to
exercise authority over the actions of persons who live together in a society and to provide and finance essential services.
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Political Institutions Political Institutions are rules and generally
accepted procedures that evolve for determining what government does and how government outlays are financed.
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Examples of Political Institutions
Majority rule Representative government
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The Allocation between Private and Government Resources
Private Food Housing Cars Clothing
Government National Defense Public Schools Police
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Figure 1.1 A Production-Possibility Frontier
G2 B
X2
G1 A
X1
C
M 0
Go
vern
men
t G
oo
ds
and
Ser
vice
s p
er Y
ear
Private Goods and Services per Year
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Distribution of Government Goods and Services
Nonmarket rationing: Prices and willingness to pay those prices are
not applicable to goods like national defense.
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The Mixed Economy: Markets and Politics
Pure Market Economy Virtually all goods and services are supplied by for-
profit private firms. Supply and demand determine price.
Mixed Economy A mixed economy is one in which government
supplies a considerable amount of goods and services and regulates private economic activity.
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Figure 1.2 Circular Flow in the Mixed Economy
Input
Market
Output Market
Government Households Firms
Subsidies
Taxes, fees, charges Government Services
Taxes, fees, charges Government Services
Income Support & Subsidies
Dollars
Resources
Dollars
Goods & Services
Dollars
Goods & Services
Dollars
Resources
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Government Expenditures in the United States
Government purchases of labor land capital
Government Transfer Payments Welfare Social Security
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Growth in Government Expenditures
Table 1.1 (abbreviated)
Year GDP Federal Government
State and Local
Government
Total Government
Percentage of GDPTotal
1930 91.3 2.5 7.5 10.0 10.95
1945 223.0 84.7 8.5 93.2 41.79
1960 527.4 85.8 34.1 119.9 22.73
1975 1635.2 345.4 152.1 497.5 30.42
2002 10442.1 2073.9 1050.9 3124.8 29.93
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International ComparisonsCountry Government Current Expenditures
as a Percentage of GDP 2001
Denmark 49.1
France 48.8
Germany 45.1
United Kingdom 39.4
Japan 38.1
Canada 36.7
United States 31.9
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Figure 1.3 Total Government Expenditure as a Percentage of GDP 1929-2002
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Structure of Federal Government Expenditures
Purchases of Goods and Services Transfer Payments Grants in Aid to State and Local
Governments Net Interest Paid
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Table 1.2
Category Percentage of Total Federal Expenditures
Transfer Payments 44.9
Purchases 28.2
Interest 14.7
Grants to State and Local 10.0
Federal Expenditure by Category, 2002
Other 2.2
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Figure 1.4 The Distribution of Federal Expenditure, 1966-2002
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Federal Government Expenditures by Function
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The Structure of State and Local Government Expenditures in the United States
Education Civilian Safety Transportation Executive, Legislative, and Judicial Income Security Health and Hospitals Recreational and Cultural Activities
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State and Local Government Expenditures
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Financing Government Expenditures in the US Taxes:
Income (Corporate and Personal) Payroll Excise Customs
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Federal Revenues
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State and Local Government Revenues
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State Budget Crunch of 2002 37 states were forced to reduce their budgets. Revenues were typically 10% less than
anticipated. States with the most severe deficits:
AK, AZ, CA, NY, NC, OK, OR, VA, and WA Causes
Cuts in taxes on business and individuals in the 1990s
No sales tax collections on services Growth in costs of Medicaid
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Implications of a Graying America Social Security
In 2008 baby-boomers start to retire and collect The ratio of workers to retiree falls
Medicare Health care inflation is substantially higher than
overall inflation Medicaid
Increased use of long-term care for baby-boomers
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How Much Government is Enough? The question of how much government is
enough is an important one in any society. It is the tradeoff between public and private goods. When government gets bigger, its increased involvement comes at the expense of less private consumption.
