Download Government and the Economy

The Free Enterprise System
UNIT 7
Government and the Economy
CHAPTER 23
The Role of the Government
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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
 Externalities
 Unintended 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 Competition
 Sole provider of a good or service is a monopoly
 No competition means they can charge higher prices,
take advantage of consumers
 Government tries to encourage competition through:
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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 activities
 To prevent negative externalities
the government regulates
business in three important areas
A. Natural Monopolies
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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
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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 Growth
 Gross 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 Cycle
 Economy does not grow at a constant rate, goes through
growth and decline
 Economic expansion is when the GDP goes up, it
reaches a peak and then declines
 A recession is when the GDP goes down for six strait
months
 Expansions are usually longer than recessions
Measuring the Economy
 Unemployment
 Anther measure of economic health is
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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 Stability
 Inflation is the sustained increase of prices
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over time
Indicator of economic performance
Too much inflation reduces the purchasing
power of money
Reduces 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 Markets
 Two ways to make money from stocks
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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
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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
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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
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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 Inequality
 America is a wealthy country but not all
Americans are wealthy
 Level of education has a major impact
on a person’s income
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More education=more income
Government tries to encourage people to
improve education at all levels
Free lunch programs to low interest college
loans
 Having 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
 Poverty
 People living in poverty receive special attention from the
government
 The most effective programs have incentives that encourage
people to go back to work or improve their employment
situation
 Most welfare programs are federal programs
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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 Programs
 Used to describe welfare recipients to exchange
some of their labor in exchange for benefits
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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
benefits
 Tax policies
 Government helps people with progressive tax
policies
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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
Money and Banking
CHAPTER 24
What is Money?
 Three functions of money
1.
Serves as a medium of exchange- trade money for goods
and services
2. Store of value- hold it until we a re ready to use it, and it
does not lose value
3. 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 money
A.
B.
C.
Portable
Divisible
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 System
1.
Used as a safe place to store money
2. Money is out to work by lending it to people or businesses
3. Financial institutions make a profit from the interest they charge
on loans
4. Act to bring savers and borrowers together
 Types of Financial institutions
 Commercial banks
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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
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The Federal Reserve System
Federal Reserve is the central bank of the US
When banks need money they borrow from the Fed
US divided into 12 Federal Reserve districts
Federally chartered commercial banks are required to be
members of the Fed
 Member banks own stock in the Fed and earn dividends
from it
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The Federal Reserve System
 Fed was established in 1913
 To raise money they sold stock and
required largest banks to buy it
 The 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
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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)
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Makes decisions by manipulating the money supply
Regulatory functions of the Fed
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Banking regulation
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Oversees large commercial banks and regulates
mergers
Regulates American connections with foreign banks
and foreign banks in the US
Consumer borrowing
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Requires lenders to spell out terms of loans
Specifies what information lenders must provide
The Federal Reserve System
Acting as the Government’s Bank
1. Holds the governments money
2. Sells US Bonds and Treasury Bills
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3.
These help fund government activity
When they reach maturity after a period of time they can be
exchanged for cash with interest
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 money
Ways the Fed manipulates the monetary supply
A. Can raise or lower the discount rate
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The rate the Fed charges member bans for loans
Stimulate economy= lower discount rate
Slow down the economy= raises the discount rate
Can raise or lower the reserve requirement for banks
B.
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Banks have to keep certain percentage of total deposits in Federal Reserve Banks
If they raise requirement banks have less money to lend
Can change money supply through open market operations
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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
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Pool money, property and certificates of deposit to
capitalize bank
 Banks need to attract depositors
a)
Offer checking accounts
b)
Savings accounts
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pay interest based on how much money customer has
deposited
Certificates of deposit
c)
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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
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This is how banks make a profit
Loan money to businesses and consumers
Can increase the supply of money
Government Finances
CHAPTER 25
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
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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
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Social security, interest payments on government debt
 Discretionary spending government
expenditures that need to be approved each year
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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 Revenues
 Income tax provides nearly
half of all government revenue
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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
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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 Taxation
 Proportional 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)
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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)
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Federal government gives money to states for highways, education,
healthcare, etc.
 Most states depend on sales tax as a source of revenue
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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
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Not all states have state income tax
State and Local Governments
 Local Governments
 Also depend on intergovernmental
revenues
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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
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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
 Expenditures
 Entitlement programs are an important
state expenditure
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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
reasonable
 Highway construction
 States have to maintain local highways and roads
 Employee 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
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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
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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
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Each person in the US now owes
$46,000 per person
Managing the Economy
 Balanced budget is when spending
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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
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This increases deficits , drives up debt and creates
problems in the future
 When 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 bad
A.
B.
Most people want lower taxes and no cuts in
government services
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 economy
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Unemployment insurance
Welfare programs
Progressive income tax structure
These programs provide income during hard economic
times
 Automatic stabilizers go into effect faster than
discretionary spending measures
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