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UNIT 7
The Free Enterprise System
CHAPTER 23
Government and the Economy
The Role of the Government
• Providing Public Goods• Government provides goods and services that private
businesses do not provide Business produce
private goods (goods that when consumed by an individual cannot be consumed by another)
Subject to the exclusion principle (a person is excluded form using a good unless they pay for it)
Governments produce public goods (can be consumed by more than one
person) Subject to the nonexclusion principle (no person
is excluded from the benefits, whether they pay or not)
Difficult to charge for public goods so they are provided by the government
Government raises money to pay for them through taxes
The Role of Government
ExternalitiesUnintended side effect of an
action that affects some one not involved in the action
Government produces public goods to create positive externalities, where everybody benefits (some are direct, some indirect)
Some externalities can be negative (action harms third party)
One role of government is to prevent negative externalities
The Role of Government
Maintaining CompetitionSole provider of a good or service is a monopolyNo competition means they can charge higher
prices, take advantage of consumersGovernment tries to encourage competition through:
Anti-trust laws (laws to control monopoly power) Sherman Antitrust Act passed in the 1890 banned
monopolies and other forms of business that prevented competition
Merger is when two or more business combine to form a single business
If it threatens competition government can step in to prevent it
The Role of Government
Regulating market activitiesTo prevent negative
externalities the government regulates business in three important areas
A.Natural Monopolies Firms that produce all of a particular
good or service for the community called a natural monopoly
Market situation where costs of production are minimized by having a single firm produce the product
Many public services are provided by a single supplier (water, gas, electric)
The Role of Government
B. Advertising and Product Labels
Government involved with labeling, product information, and truth in advertising
Federal Trade Commission (FTC), Food and Drug Administration deal with the safety and purity of products
C. Product Safety Consumer Product Safety
Commission can recall or take products off of market if they are unsafe
Measuring the Economy
Measuring GrowthGross Domestic Product
(GDP) is measure of economic output
Dollar value of all goods and services produced in a year
Could go up because of price increases
Real GDP is production after price increases have been removed
Measuring the Economy
Business CycleEconomy does not grow at a constant rate, goes
through growth and declineEconomic expansion is when the GDP goes up, it
reaches a peak and then declinesA recession is when the GDP goes down for six
strait monthsExpansions are usually longer than recessions
Measuring the Economy
Unemployment Anther measure of economic health is
employment Civilian labor force includes all
civilians 16 or older actively looking for employment or are working
Unemployment rate is percentage of people that are not working but looking for jobs
Fiscal Policy Government policy to help control the
economy Involves government spending and tax
policies Political differences prevent the
effective use of fiscal policy to help the economy
Political parties have different ideas about taxes and spending
Measuring the Economy
Price StabilityInflation is the sustained increase of
prices over timeIndicator of economic performanceToo much inflation reduces the
purchasing power of moneyReduces the value of money saved Samples prices every month of 400
commonly used products, known as the consumer price index
Government can do very little to control the price of inflation because it results from monetary policy decisions that the government does not make
Measuring the Economy
Stocks and Stock MarketsTwo ways to make money from
stocks Dividends- share of corporations profits
that are distributed to stockholders Capital gains- when stock is sold for more
than it was originally bought for
Price of a stock can change Sales or profits of a company (raises or
lowers price) Rumor of a possible takeover or news of a
technological breakthrough can change demand for companies stock (raises in price)
Measuring the Economy
Stocks and Stock Markets Stock indexes measure stock prices over
time Dow Jones Industrial Average and Standard and
Poor’s are the two most popular indexes DJIA represents 30 popular stocks Sand P tracks the prices of 500 stocks
Give and idea of the market as a whole Stocks are publicly traded on the stock
exchange Makes buying and selling easy
Most stocks in the US are traded on the New York Stock Exchange (NYSE), located on Wall Street
These indexes reveal investors expectations about the future
If investors expect growth stocks go up (bull market)
If stock prices fall it is called a bear market
The Government, the Economy and You
Income InequalityAmerica is a wealthy country but
not all Americans are wealthyLevel of education has a major
impact on a person’s income More education=more income Government tries to encourage people
to improve education at all levels Free lunch programs to low interest
college loansHaving wealthy parents provides
access to more educational opportunities and business opportunities
The Government, the Economy and You
Discrimination Women and minority groups are
often not paid as well white men, often passed over for promotions
The government has passed Equal Pay Acts (1963, 2003) and the Fair Pay Act (2008) that require equal pay for equal skills and responsibilities
The 1964 Civil Rights Act bans discrimination on the basis of gender, race, religion and national origin
1990 The Americans with Disabilities Act extended this protection to people with physical and mental handicaps
The Government, the Economy and You
PovertyPeople living in poverty receive special attention from
the governmentThe most effective programs have incentives that
encourage people to go back to work or improve their employment situation
Most welfare programs are federal programs Food Stamps, WIC (nutrition and health care assistance to
children under 5)Some welfare programs pay cash to certain people
Supplemental Security Income (SSI) payments to disabled persons 65 and older
Temporary Assistance to Needy Families (TANF) payments to families because parent is deceased, disabled or absent
Number of months that a person can receive assistance is limited, goal is to make sure people look for jobs
The Government, the Economy and You
Workfare ProgramsUsed to describe welfare recipients to
exchange some of their labor in exchange for benefits Most programs are run at the state level Designed to teach skills needed to succeed in
workforce Many states require workfare if families receive TANF
benefitsTax policiesGovernment helps people with progressive
tax policies Taxed at a lower rate for lower incomes and higher
rates for higher incomes Earned Income tax credit gives tax credits and cash
payments to qualified workers
CHAPTER 24
Money and Banking
What is Money?
Three functions of money1. Serves as a medium of exchange- trade money for
goods and services2. Store of value- hold it until we a re ready to use it,
and it does not lose value3. Measure of value- used to assign value to a good or
service
What is Money?
Anything that people are willing to accept in exchange for goods is money
Three characteristics of moneyA. PortableB. DivisibleC. Durable
Currency is both coins and paper money
We accept money because we are sure that someone else will accept its value as well
What is Money?
The Financial System1. Used as a safe place to store money2. Money is out to work by lending it to people or businesses3. Financial institutions make a profit from the interest they
charge on loans4. Act to bring savers and borrowers together Types of Financial institutions Commercial banks
Provide full banking services to businesses and individuals Most important part of our financial system
Savings and Loans Traditionally loan money to people buying homes and real estate
Credit Unions Work on a not for profit basis Often sponsored by certain business groups Give workers a financial institution with low costs
What is Money?
Keeping our financial system safe Two factors for the safety of the U.S. banking system Regulation One of the most regulated industries in the country Required to follow rules to minimize risk Insurance When banks fail the federal government insures their deposits up
to $250,000 Federal Deposit Insurance Corporation (FDIC) federal
corporation that insures accounts Makes customers feel safe wherever they deposit their money
The Federal Reserve System
Federal Reserve is the central bank of the USWhen banks need money they borrow from the
FedUS divided into 12 Federal Reserve districtsFederally chartered commercial banks are
required to be members of the FedMember banks own stock in the Fed and earn
dividends from it
The Federal Reserve System
Fed was established in 1913To raise money they sold stock and
required largest banks to buy itThe president, with the approval of
the Senate, appoints the seven members of the Board of Governors
The president appoints one board member as the chairman who serves a four year term
Board is independent of politics because they do not rely on Congress for appropriations for operating expenses
The Federal Reserve System
Advisory Councils report on the condition of the economy in each district financial institutions issues related to consumer loans
Major policy making group is the Federal Open Market Committee (FOMC) Makes decisions by manipulating the money
supplyRegulatory functions of the Fed
Banking regulation Oversees large commercial banks and regulates
mergers Regulates American connections with foreign
banks and foreign banks in the US Consumer borrowing
Requires lenders to spell out terms of loans Specifies what information lenders must provide
The Federal Reserve System
Acting as the Government’s Bank1.Holds the governments money2.Sells US Bonds and Treasury Bills
These help fund government activity When they reach maturity after a period of time they can
be exchanged for cash with interest
3.Fed issues the nations currency and controls its circulation
The Federal Reserve System
Conducting Monetary Policy Controls the supply of money and the cost of borrowing
moneyWays the Fed manipulates the monetary supplyA.Can raise or lower the discount rate
The rate the Fed charges member bans for loans Stimulate economy= lower discount rate Slow down the economy= raises the discount rate
B.Can raise or lower the reserve requirement for banks Banks have to keep certain percentage of total deposits in Federal
Reserve Banks If they raise requirement banks have less money to lend
C.Can change money supply through open market operations The purchase and sale of government bonds and Treasury bills puts
money in the hands of investors and the government
The Federal Reserve System
Monetary policies are effective because they are made by relatively few people
Decisions can be made quickly if one policy does not work
They are free of the constraints of politicians
How Banks Operate
Banks are started by investors Pool money, property and certificates of
deposit to capitalize bank Banks need to attract depositors a) Offer checking accountsb) Savings accounts
pay interest based on how much money customer has deposited
c) Certificates of deposit customer gives money to bank for specific
time and bank pays interest at the end of the time period
CDs pay higher interest than savings accounts Making loans
This is how banks make a profit Loan money to businesses and consumers Can increase the supply of money
CHAPTER 25
Government Finances
The Federal Government
Each year the federal government creates a budget
Blueprint of how the government will spend its money
Created by the president and Congress Budget year is called a fiscal year (FY), lasts
from Oct. 1 –Sept. 30
The Federal Government
Budget Process President presents a proposed budget to
Congress Congress passes a budget resolution
Sets targets for revenues and spending and how much will be spent in each category
Categories of spending Mandatory spending does not need annual
approval Social security, interest payments on government debt
Discretionary spending government expenditures that need to be approved each year Military, highway construction, agriculture subsidies, etc.
Appropriations Bills Law that approves spending for a particular activity 13 separate appropriations bills Each must be approved by both houses of Congress and
the president
The Federal Government
Federal RevenuesIncome tax provides
nearly half of all government revenue Some paid by April 15th of each
year and some is withheld from paychecks
Corporations pay taxes on their profits
Payroll Taxes- second largest source of federal income Taxes deducted from workers
paychecks to fund Social Security and Medicare
The Federal Government
Excise taxes- paid when consumers purchase gasoline, tobacco, alcohol, telephone services
Estate Taxes- paid when wealthy people die and pass money on to their heirs
Other federal revenues –fees paid at national parks, fees paid by companies to extract natural resources from government property
The Federal Government
Forms of TaxationProportional tax- takes
same amount from everyone regardless of how much someone earns
Progressive tax- taxes increase as income increases
Regressive tax- percentage paid goes down as your income rises
The Federal Government
Federal Expenditures Social Security is the largest
expenditure by the federal government (22.4 cents on every dollar) Will grow in the future as the
population ages National defense is the second
largest category of federal spending (16.3 cents for every dollar)
Each year the government spends a portion of the budget to pay the interest on money the government has borrowed
Education, highways and foreign aid account for billions of dollars in spending, but less than most people think
State and Local Governments
State and local governments have their own budget approval process, revenues and expenditures
State Governments Most important state revenues are
intergovernmental revenues (money one level of government receives from another) Federal government gives money to states for highways,
education, healthcare, etc. Most states depend on sales tax as a source of
revenue Tax levied on consumer purchases of all products Collected by business owners and turned over to state on a
regular basis Not all states have sales taxes
Third largest source is comes from contributions state employees make to pension and retirement plans
State Income tax is the fourth largest source Not all states have state income tax
State and Local Governments
Local Governments Also depend on intergovernmental
revenues Most of the money is provided by the state
Second largest source of local revenue is property tax
Taxes paid on land, houses and property owned Real property- land and buildings Personal property- stocks, bonds, cars
Most local governments tax only on real property
Taxes property based on assessed (estimated) value
Revenue from utility companies, sales taxes, fees and fines are other sources of local revenue
State and Local Governments
ExpendituresEntitlement programs are an important
state expenditure States try to provide and maintain basic health
and living conditions Entitlement programs provide health, nutritional
or payment programs to people meeting eligibility requirements
States spend money on higher education States subsidize college education to keep costs
reasonableHighway construction
States have to maintain local highways and roadsEmployee retirement, hospitals, education,
corrections equal a relatively small amount of state expenditures
State and Local Governments
Local Government Expenditures Education
Local tax revenue goes to pay for public education
Accounts for one-third of local government spending
Police and Fire Protection Water Supply
Local governments usually in charge of maintaining local water supply (Lake Maumelle)
Sewage and Sanitation Responsible for sewage and solid
waste disposal Local governments maintain sewage
treatment plants and landfills
Managing the Economy
Surplus when the government collects more than they spend
Deficit when the government spends more than they collect Deficit for 2009 was 1.42 trillion
dollars When federal government needs
to borrow money they sell bonds
All money borrowed and not paid back is the government's debt
Huge budget deficits of 1980s, early 90’s and last few years have increased federal debt Each person in the US now owes
$46,000 per person
Managing the Economy
Balanced budget is when spending equals revenue
Federal government is not required by law to have a balanced budget
Many state and local governments are required by law to balance their budgets (Arkansas is required)
When revenues go down states are required to make cuts
Revenue often goes down during bad economic times, when states need to spend more on entitlements
Many states try to maintain an emergency fund to help budget shortfalls
Managing the Economy
In theory federal government can stimulate the economy by increasing spending and cutting taxes This increases deficits , drives up debt and
creates problems in the futureWhen economy grows government can
reduce spending, increase taxes to increase revenue and lower government debt
Politics make cutting spending, spending money and raising taxes difficult, if times are good or badA. Most people want lower taxes and no cuts in
government servicesB. It takes time to pass appropriations bills
Managing the Economy
Government action sometimes takes a long time to take effect or sometimes do not have the desired effect
The economy has automatic stabilizers to stimulate the economy1. Unemployment insurance2. Welfare programs3. Progressive income tax structure
These programs provide income during hard economic times
Automatic stabilizers go into effect faster than discretionary spending measures