Unit 6

Role of Government

in a Market Economy

Circular Flow of a Mixed Economy

Role of Government in a Market Economy

Explanation Example

Provide a legal system

Provide public goods

Correct market failures (externalities)

Maintain competition

Redistribute income

Stabilize the economy

Role of Government in a Market Economy

Explanation Example

Provide a legal system

Make laws

Enforce laws

Court system

Protect life, liberty, and property

Provide public goods

Goods & services available to everyone

Items cannot do for profit

Police, street lamps, civil defense sirens, roads,

school, national defense

Correct market failures

(externalities)

Unintended consequences of market transaction (good

or bad)

Pollution, barking dog smoking, loud music vaccines, education

Maintain competition

Promotes efficient use of resources, greater Q, lower

P, better qualityAnti-trust legislation

Redistribute income

Take money from one group of people and give to

another group.

“Robin Hood” Social Security, Medicare Welfare,

Food Stamps

Stabilize the economy

Low inflation

Low unemployment Slow, growing GDP

Fiscal policy to fight recession

ECONOMIC GOALS of Federal Government

• LOW inflation

• LOW unemployment/ HIGH employment

• SLOW, GROWING GDPC + I + G + (exports - imports) = GDP

Stabilize the economy

1. Low inflation

2. Low unemployment

3. Slow, growing GDP

Business cycle

Should the Federal Government attempt to even out the business cycle?

Fiscal Policy

Ability of federal government to stabilize the economy

Tools of Government

Recession Inflation

TAX

SPEND

Why has the government grown?

• Population growth• Rising expectations• Inflation• Increased military spending• Promoting economic stability

Year 1929 1994 2009 2010

Spending $9 billion $2,200 billion $3,983 billion $3,552 billion

% of GDP 10% 19 % 27% 24 %

“Taxes are what we pay for civilized society”

Why do people dislike paying taxes?

1. Government can coerce people.– Markets are based on voluntary actions.

2. Costs are obvious; benefits are not.– Reduce the link between payment &

consumption.

QUESTION: What is the “perfect” tax?ANSWER: The one you pay & I don’t

What is a “good tax”

1. The tax is “fair”.

2. The tax is clearly imposed.

3. The tax is certain.

4. The tax is simple.

5. The tax is efficient; doesn’t cost more to collect than money it raises.

Two principles of taxation

• Benefits-received principle

• People pay taxes based on government services received.

• Gas tax roads• Hunting license

DNR

• Ability-to-pay principle

• People should pay taxes according to how well that person can shoulder the burden.

• Income tax• Estate tax

Regressive taxes “poor pay more”

• Poor pay higher % of income in taxes• same $ amount paid = different % of income• $1000 $8,000 $80,000• $800 $800 $800

Progressive taxes

• Rich pay higher % of income in taxes• $1000 $8,000 $80,000• 1% 10% 80%• $ $ $

“the more you make, the more they take”

Proportional taxes

• All income pay same % of income in taxes• $1000 $8,000 $80,000• 10% 10% 10%• $ $ $

same % of income;

Different $ amts.

What is a fair tax?

CRIT ERIATax or Fee Ability to pay

Pr; Re; Prop

Efficiency

+ or -

Simplicity

+ or -

Benefits-Rec + or -

Driver’s license fee

Personal income tax

SS tax

(FICA)

Sales tax

Property tax

Taxes

• Government collects taxes as a form of revenue to pay for expenditures.

• Government uses taxes to encourage behavior (subsidies & tax credits) and discourage behavior (sin taxes).

• Excise tax ~ specific product tax (gas)• FICA tax ~ Federal Insurance Contributions Act;

payroll tax = 7.65%– 6.2% funds Social Security (capped at $106,800)– 1.45% funds Medicare

Public goods

“Fear the Boom and Bust”

• Watch rap1. How should the economy be “steered”

according to Keynes?2. Hayek wants to “set markets free” from

what?3. Explain the implications these opposing

economic viewpoints have for policymakers?

Video is posted at nreconomics.wikispaces.com under Unit 6

Credit Crisis Visualized

1. Define leverage.

2. Define CDO.(collaterized debt obligation)

3. Explain credit default swaps.

4. What role did the rating system play in the crisis?

5. Define subprime mortgage.

6. How did CDOs become riskier?

7. Define “underwater”.

Video is posted at nreconomics.wikispaces.com under Unit 7 parts 1 & 2