The Role of Government in a Market Economy Lesson taken from Bosshardt, W., Miller, S., Schug, M., and VanFossen, P., (Eds.). (2009) Understanding Economics in Civics and Government. New York, NY: National Council on Economic Education. Objectives Identify and analyze the economic functions of government in a market economy. Classify government economic activities according to the six economic functions of government. Analyze governmental economic actions within the liberal/conservative framework. Brainstorm What are some economic activities of local, state and national governments? The government could provide all of its citizens with an iPad. What problems might arise if government expanded its role along these lines? The government regulates some things but not others. Why not regulate in every problem area? What would happen if the government decided that all cars in the US must be yellow since yellow cars are easier for other drivers to see? Brainstorm Most Americans agree that the government should regulate some areas and not others. How does the government decide what to regulate? What criteria should there be in limiting the government’s role in our market economy? Most economists argue that there are six legitimate roles of government in a market economy. Role of Government in Market Economy Maintain the legal and social framework – Define and enforce property rights. – Establish a monetary system. Role of Government in Market Economy Maintain Competition. – Create and enforce antitrust laws, and regulate natural monopolies Provide Public Goods and Services – Public goods and services are those that markets will not provide in sufficient quantities. Private Goods Most goods and services produced in market economies are private goods and services. The consumers who purchase these goods consume these goods. Private goods are goods for which exclusion is possible and for which the marginal cost of another user is positive Examples: Public Goods Public goods differ from private goods because they have the following characteristics: – Shared consumption: When one person consumes a public good, it does not prevent others from also consuming the good – Nonexclusion: Once a public good is produced it is difficult or impossible to exclude others from consuming the good even if they didn’t pay for it. Public Goods Because people can consume public goods without paying for them (the free rider problem), private businesses do not have incentives to produce enough public goods. Therefore, the government provides them, through tax dollars, if people want them. More on Public Goods Few examples of pure public goods, but many goods have some public good characteristics and are therefore provided by the government How do the following illustrate shared consumption and/or non-exclusion? – Fire protection, police protection, lighthouses, weather forecasts etc. Public goods are examples of positive externalities Role of Government in Market Economy Stabilize the economy by reducing unemployment and inflation and promoting economic growth – Fiscal policy – Monetary policy Redistribute Income – Redistribute income from people who have higher incomes to those with lower incomes. Role of Government in Market Economy Correct for Externalities – Reduce negative externalities. – Encourage increased production of goods and services that have positive externalities. Externalities Market prices usually reflect the costs producers pay to produce goods and the benefits consumers receive from the good. A kind of market failure occurs when market prices fail to reflect all the costs and all the benefits involved. This kind of market failure is called an externality problem. Externalities Externalities exist when some of the costs or benefits associated with the production or consumption of a product spill over to third parties, who do not produce or pay to consume the product. Negative Externalities Negative externalities: costs paid by someone who does not produce or pay to consume a product Example: Because of these costs the government provides incentives (laws/fines) to reduce production of these goods or services Positive Externalities Positive: benefits enjoyed by someone who does not produce or pay to consume a product – Examples: – Government usually subsidizes the production of externalities or provides them Activity Read and complete Activity 4.2. Activity Read Activity 4.3. – Suppose a US senator proposes legislation that increases taxes for higher-income taxpayers, in order to provide more funds for public education. – A congressional leader argues that there should be a constitutional amendment that limits the size of the federal government. How would a liberal respond to headline # 9? How would a conservative respond? Closure What are the six economic functions of government? – Maintain legal and social framework – Maintain competition – Provide public goods and services – Correct for externalities – Stabilize the economy – Redistribute income Closure Why, since there is broad agreement that government should perform these functions, is there disagreement sometimes about whether government should engage in particular activities?