{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

clareg_01_220_103_01_spencer_chap4

clareg_01_220_103_01_spencer_chap4 - This material may be...

Info icon This preview shows pages 1–17. Sign up to view the full content.

View Full Document Right Arrow Icon
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 2
Image of page 3

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 4
Image of page 5

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 6
Image of page 7

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 8
Image of page 9

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 10
Image of page 11

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 12
Image of page 13

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 14
Image of page 15

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 16
Image of page 17
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: This material may be protected by Copyright Law (,Tttie 17 . . Learning Guide Watch for answers to these important questions What Is the role of government in our economy? How do we distinguish toe- tween the diflerent types of goods that government provides? Can government provide goods effi- ciently? What concepts can help us analyze and evaluate the provision of goods by the publlo sector? How does the government raise money? How does it spend money? What methods can be used to achieve greater eifiolency in budgeting? What is the nature of our tax system? What principles are used to evaluate particular taxes and their attests? Who was John Stuart Mill? What views did he have of the role of gov- ernment In the economy? The Public Sector— Governmenl: Public Choice and Taxation Economic Scope and Functions at Government Spillovers. Market Failure, and Public Choice Public-Sector Budgeting Our Tax System Theories oi Taxation Completing the Circular-Flow Model Origins: Government in the Economy One of the most remarkable trends in contempomrv history has been the growth in the importance of gov. ' ; emmem in economic life. As measured by govern. ment purchases of goods and services, the public sec. tor bought 10 percent of the nation's toral Output in 1930. Today the public sector purchases approxi. mately twice that percentage of the nation's total our- put. These facts raise many questions concerning the economic functions of government in our mixed economy. This chapter examines a few of the more im- portant ones and provides some basic tools for under- standing them. Any serious discussion of government is bound to raise questions about taxes. Taxes, you may recall from your study of history, have sometimes been a major cause of wars and revolutions. Moreover. in our society today, taxes affect economic activity in many different ways. When we speak of government. we ordinarily mean the federal government. But this chapter will also say some things about government at the state level and the local level. The local level includes coun— ties, cities, villages. townships. school districts, and so OI]. A “1...”... n The Public Sector—Government: Public Choice and Taxation C ha pier 4 8 9 Economic Scope and Functions of Government For centuries. political scholars have theorized about the purposes and functions of government. In The wealth ofN'atiom, Adam Smith said that government’s role should be limited to national defense, the admin. istration of justice, the facilitation of commerce, and me provision of certain public works. Many people today would agree with Smith, although some might add a few items to his list. For present purposes, the' economic role of government can be considered to consist of two broad functions: (1) the promotion and regulation of the private sector, and (2) the provision of social goodS- Promotion and Regulation of the Private Sector Government promotes and regulates the private sec: tor in many ways. Sometimes it does this to the net ad: vantage, and sometimes to the net disadvantage, of so- cietv as a whole. A complete analysis of the public sector's economic functions is impossible here. How- ever, five major activities can be identified. Providing a Stable Economic Environment Government fa- cilitates the production, distribution, and consump- tion of goods and services. It does this by defining property rights, upholding contracts, adjudicating dis- putes, setting standards for weights and measures, en- forcing law and order, and maintaining a monetary system. These activities are so fundamental to organ»- nized society that they existed even in ancient civiliza- tions. The Code of Hammurabi (circa 2100 B.C.) and Lhelater laws of ancient Egypt and Rome, for example, went into considerable detail in defining property rights and related matters pertaining to commerce. Panning the Public Welfare Government establishes health and safety standards in industry and regulates minimum wages for certain classes of workers. It also Provides old-age, disability, sickness. and unemploy- ment benefits for those who qualify. Of course, these sOdal welfare measures are enacted primarily for hu- manitarian reasons. Nevertheless, some of the mea- ‘um "13‘! be tacit admissions that the private sector has failed to fulfill human wants in a manner that soci- ety regards as equitable. Granting Economic Privileges Through selective subsi- dies, tariffs. taxes, and other legal provisions. govern- ment favors particular consumers, industries, unions, and other segments of the economy. This elaborate network of privileges and controls results as much from political pressures as from economic logic. To a large extent, therefore, government privileges cause reduced efficiencies, higher prices, and misallocations of society's resources. Maintaining Competition Specific laws forbid unreguc laced monopolies and unfair trade and labor practices. If government enforces these laws vigorously, it helps ensure the perpetuation of a strong private sec to r. Encouraging Elliciency, Equity, Stability, and Growth Through appropriate tax, expendittxe, and regulatory policies, government seeks to'attain certain objectives. These include high employment, an equitable distribution of income. stable prices, and a steady rate of eco- nomic growth. The government’s efforts are not al. ways successful, however, for political reasons as well as for economic ones. Much of the study of econom- ics is concerned with learning to understand these reasons. This brief sketch of the economic activities of gov" ernment leads to an important observation: The promotional and regulatory activities of gov- ernment are complex and widespread. Some of these activities are undertaken to correct for market fail- ures. That is, they address the inability of the private sector, if left to itself, to achieve the goals of effi- ciency, equity, stability, and growth to the degree that society seeks. However, as you will see. the extent to which government activities contribute to the realiza— tion of these goals is often debatable. Provision of Social Goods All economic systems are concerned with the three fundamental questions: What will be produced? How will it be produced? and Who will receive the final one put? ln mixed capitalistic economies such as ours, these questions are answered primatin by the market 90 Pa rt 1 Overview: The EconomicSystem system. But if certain types of goods and services are not, in the public's opinion, adequately provided by a free market, supplying them usually becomes a func- tion of government. In this book we’ll refer to such products as social goods. For present purposes, they may be classified into two groups—apublic goods and merit goods. Public Goods Public goods are sometimes called “collective” goods. Examplesinclude national defense, street lighting, dis— ease control, the administration of justice through the courts, airtraffic control, and public safety. An essen- tial characteristic of public goods is that you cannoc be excluded from reaching their benefits whether you pay for them or not. Public goods can thus be distinguished from non- public goods. Nonpublic goods are private goods (such as food, automobiles, appliances, clothing, and ser- vices) thatpeople buy in the market and certain social goods, known as merit goods, which are described below. Someone who docsn ’I pay for nonpublic goods can conceivably be excluded from using them. There- fore: The distinction between public and nonpublic goods rests on what is called the mlwion principle. Ac- cording to this principle, a good is nonpublic if some- one who doesn’t pay can be excluded from its use. Otherwise, it’s a public good. Merit (Quasi-Public) Goods In addition to public goods, government provides men"! goods. These are goods that_government deems meritorious, or intrinsically worthy of production. Merit goods share. to different degrees, some of the properties of both public and private goods. There fore, merit oods are also sometimes called “ uasi— .. q public goods." Some examples of merit goods pro— vided by the federal and state gOVernrnents are parks,_ public housing, and public hospitals. Some examples‘ of merit goods pron'clcd by local governments are mu- 4 nicipal libraries. tennis courts, golf courses, and muse- ours. in contrast to public goods, merit goods are sub ject lo the exclusion principle, even though thepn'nciple may rial always be invoked. Therefore, merit goods are not pure public goods. People could be charged for the use- of merit goods instead of being given them “free” or at reduced prices. As you will see. this raises interesting questions about efficiency and equity. problems that are among the fundamental Concerns of economics. Conclusion: Achieving Efficiency Through the Market Throughout the nation’s history, government has served as a rescuer, subsidizer, owner, and regulator of special interests. It has saved failing companies, ii- nanced roads and canals, subsidized industries, shel- tered workers, protected consumers and businesses, stabilized credit, refereed competition, and regulated markets. Government has also become the chief producer) of social goods, both public and merit goods. Every- one receives the benefits of the former. The benefits of the latter are widely available and, in most cases, are provided at reduced prices. How does this affect the allocation of such goods? In a free market, prices perform the allocative function. A resource is always allocated to its highest- valued use, as determined by the prices that buyers offer. But the situation is different with most social goods. Because many are made available “free” or at reduced prices, it is impossible to know the value peo- ple place on the goods. How, then, should governmenl decide what and how much to produce? A reasonable answer to this question is that gov- ernment should seek ways of making more effective use of market mechanisms. This can be done through the use of special taxes, grants. and pricing strategies designed to test the demand for certain social goods. In this way, as you’ll see below, officials can be guided in learning how to improve efficiency in the provision of these goods. Equally important, legislators can con- sider whether certain social goods might better be pro- vided through the private sector. Something to Think About 1. Radio and network television broadcasting are public goods. Why? What about cable television broad- casting? 2. In the United States (but not in most other coun- tries). the great majority of radio and television broad- casts are profided by the private sector. Why do comv l r l l l a i l l t l a 3 The Public Sector—Government: Public Choice and Taxation C h a p l er 4 91 panics incur the costs of producing such goods if peo— ple can consume them without paying? Can you think of any other public goods that are provided by the pri- vate sector? 3. Aretha government’s postal services a public good? Why? Spillovers, Market Failure, and Public Choice Many social goods (as well as private goods) create “fallout” effects, or These are external bene- fits or Costs for which no compensation is made. Spillovers are also called The two terms are used interchangeably. so you should be familiar with both. For example, in the public sector, air—traffic con— trol at busy airports reduces noise for some nearby res- idents while increasing it for others. This is an unpaid- for benefit to the former and an uncompensated “cost” to the latter. In the private sector. similarly. a factory may provide income and employment to a com- munity while polluting its environment. Thus. spill— over benefits and costs exist with some private goods as Well as with some social goods. Spillovers are an indication of market failure. That is, their occurrence in a competitive free market is a Sign that the market hasn‘t allocated its resources effi- ciently. As you will recall from your study of demand and supply. resource misallocation occurs if a good‘s costs and/or benefits are not fully reflected by its equi- librium price. When that happens, it is because the EOOd's demand and supply curves do not incorporate the full value of society's sacrifices and preferences. The values that are not incorporated are externalities 01' spillovers. Their existence accounts for the failure of Competitive free markets to provide outputs that are soCially ideal. Redresstng Splllovers what can be done to correct for the effects of sPillovers? Because they are associated with private-sec- ‘01' market {allure. corrective action to eliminate or Offsel them can come only from government. Two major approaches may be considered—market mea- sures and nonmarket'measures. Market Measures: lnternalizing the Exiernalities One way of correcting for the effects of spillovers is to look for ways to incorporate them into a good’s mar— ket demand and market supply curves. This is illus- trated in Exhibit 1. Thus: In Figure (2) , any point on the normal market de- mand curve D expresses the demand price. This is the highest price that buyers are willing to pay for a given quantity of the good. The demand curve thus reflects only private benefits to buyers, not spillover benefits to nonbuyers or to society. Similarly, any point on the normal market supply curve S expresses the supply price. This is the least price necessary to bring forth a given output. That is, it is the lowest price that sellers are willing to accept in order to supply a given quantity of the good. The sup— ply curve thus reflects only private costs to producers, not spillover costs to anyone else. The diagram assumes that all benefits and costs are incorporated in the demand and supply curves—- there are no spillovers. Accordingly. the equilibrium quantity at Q is socially ideal because it represents an optimum allocation of society‘s resources. However, if i all benefits and costs are not included inthe demand and supply curves, then spillovers exist. The equilib— rium quantity is not socially ideal. In that case, govern- ment can undertake either of two sets of policy mea- sures to correct the situation: internalize Spillover Costs by Incorporating Them into the Mar- kel Supply Curve The effect of this approach is shown in Figure (b). It illustrates the case of an industry that pollutes its environment. thereby externalizing some costs of production to others. As a result. the supply curve S is “too low” because it does not include all of the costs of producing the product. Because of this, the equilibrium quantity is at Q rather than at Q'. One measure that government can adopt to cor. rect the situation is to require sellers to pay a specific tax. This is a per-unit payment on a good. That is, sell- ers would pay the tax Ton each unit of the good pro- duced. This would increase its costs of production by the amount of the tax, causing the supply corve to shift from 510 S'. if the tax is large enough. it can com- pensate for any spillover costs that were not included in the original supply curve. The tax will thus reduce output from the level at Q to the socially optimum level at (2', (Question: Can you show how the ideal out- put may also be achieved by imposing a specific tax on buyers?) 92 Part 1 Overview:lheEconomicSystern Spillover Effects in a Competitive Market FIGURE-(a) No S'ijillo’v‘ers When the demand and supply curves include all costs and benefits. there are no spillover effects. The equilibrium quantity at Ole optimum, or ideaL FIGURE (b) Spillover Costs Because some costs are exter- nallzed.'resources are overallocated. and 'too much" of the good (equal to 0'0) is produced. To achieve the ideal output at 0'. government can impose a specific tax of T per unit on sellers. This will raise the supply curve from S to S’. FtGURE (c) Spillover Benefits Because some benefits are externalized. resources are underallocated and 'too little" of the good (equal to 00') is produced. Government can achieve the ideal output at O’ by giving buyers at specific subsidy of U per unit, This will shift the demand curve upward from Dto D'. internalize Spillover Benefits by incorporating Them into the Market Demanil Curve The effect of this approach is shown in Figure (c). It illustrates the case of an indus- try, such as private higher education that externalizes some benefits by providing society with a more in— formed and concerned citizenry. As a result, the demand curve D is “too tow" because it doesn't in- clude all of the benefits obtained from the product. Bertrand and supply curves. I assuming no spillovers Spillover Because of this, the equilibrium quantityis at Qrather than at Q’. To correct this, government can bring about an increased OUIpUl of the product by giving buyers a spe- cific subsidy. This is a per unit grant on a commodity. As shown in the graph. buyers would receive the subsidy U on each unit of the good purchased. This would inv crease the consumption of the good, causing the de— The Public Sector—Government: Public Choice and Taxation Ch a plot 4 93 Inand curve to shift from D to D’. If the subsidy is large enough, it can compensate for any spillover benefits “(weren't included in the original demand curve. Thus, the subsidy will increase output from the level at Q to the socially optimum level at (2'. (Question: Can you demonstrate that government can also achieve the ideal output by granting a specific subsidy to sellers?) Nonmarkel Measures: Government Regulation and Provision in addition to the foregoing market devices, govern- ment can employ various nonmarket measures to in. fluence output and resource allocation. This is ac- complished by enacting appropriate legislation. For instance: Through government regulation, the outputs of some products (and by-products) for which spillovers are deemed to be undesirable can be reduced. Examples are industrial-waste disposal, smoke emission, and water pollution. In terms of Figure (b), in Exhibit 1, the purpose of such regu- lation is to shift the supply curve upward to achieve results similar to those attained by market measures {such as taxing sellers). Through government provision the output of some goods for which spillovers are deemed to be desirable can be enlarged. You will recall that when government makes available such products, they are called “merit goods.” Examples include public recreation, public housing, and public higher education. In terms of Figure (c), the pur— pose of such provision is to shift the supply curve downward, to achieve the same ideal output at- tained by market measures (such as subsidizing buyers) . Thus, government regulation and provision, by their very nature, focus on influencing the supply of goods. not the demand for them. Dealing with International Spillovers National governments can addre55 the domestic sPillmers created by production within their own Countries. But in many cases international spillovers OCCur. These result in external costs for some coun- mfis and external benefits for others. Examplesof international spillover costs are easy [0 find. Global warming, caused by heat-trapping gases b(fiched out of power plants and cars. can melt polar ice caps. flood coastal cities, and turn farmland into deserts. Stratospheric erosion, caused by chemicals and gases that eat away Earth's protective ozone layer, may subject people to excessive ultraviolet radiation. Pollution of the oceans and destruction of rainforests can alter food chains and organic systems. Examples of international spillover benefits are also apparent. National defense helps provide protec- tion to neighboring friendly countries. Thus, Canada and Mexico are more secure when the United States is wellwprotected. Improvements in education make for a more enlightened world citizenry. And advances in disease control, technology, and information systems create benefits that accrue to all nations. The ability to redress interna...
View Full Document

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern