Economics

1. Economics The Role of the Government

2. Warm-Up • Think back to the Circular Flow Model. • Draw it and explain what is happening in the different markets.

4. You can add the government to the circular flow model. It is in the middle of everything. • It takes money from Households and Business (10 and 14) and provided goods and services to them (9 and 13). • The government also enters the product market and the factor market. • It takes finished products from the product market (16) and factors of production from the factor market (12). • In return it has to make payments to these markets. (11 and 15).

5. Government Functions • Legal and Social Framework: • Through the laws the government sets the rules of the game. • It will then go after people or businesses that do not follow the rules. 2) Maintains competition: • Without competition the rules of supply and demand would not work. • As you can see a monopoly will alter the economic game.

6. Government Functions 3) Redistribution of Income: • The government attempts to reallocate income so that the uneducated and unskilled have a chance in society. • transfer payments: relief to the destitute, aid to the dependent and handicapped and unemployment compensation to the unemployed. • Market Intervention: setting minimum prices for farmers, minimum wages... • Personal income taxes take a larger portion of income from the rich than from the poor.

7. Government Functions 4) Reallocation of Resources: • We assume that the market will allocate resources to the fullest. • The problem is that this fails to take into account spillovers (externalities)

8. Exclusion Principle: The exclusion of those who do not pay for a product from the benefits of the product. • Shared consumption: everyone can use it. • Ex: Exclusive: a hamburger • Nonexclusive: national defense • Non-shared: any private good • Shared: Education

9. Public Good: • a good or service to which the exclusion principle is not applicable • which is provided by government if it yields substantial benefits to society. • They must be non exclusive and shared consumption

10. Questions to Consider • What happens if someone refuses to pay for a public good? • Can they be excluded? • Are public goods shared?

11. 52 • READ P 223-236

12. Externality (also called spillovers): • some of the benefits or costs of production or consumption of a good spill over to a third party (other than the buyers and sellers) • Social Costs (also called external costs): • the costs that fall on someone else.

13. Negative externality (spillover cost): • When production or consumption of a commodity inflicts costs on the third party without compensation. • Ex: pollution by manufactures. • When this happens the costs of production (the same disposal of pollutants) is passed on to the third party. • This means that the company is not paying the full cost of production. • This means the supply curve will be further out (right) than if they had to cover the costs.

15. In order to correct negative externality the government should: • impose a tax equal to the negative externality. • The supply curve will shift up equal to the amount of the tax. • This is an attempt by the government to make the company pay for the externality. • use legislation to make the firm correct the externality. • This will cause the supply curve to shift up.

16. Positive externality: production or consumption of a good or service may provide a benefit to the third party. • Ex: immunizations, education... • Social Benefits (also called external benefits): are the benefits that fall on someone else. • When this happens the demand for the product is actually understated.

17. More people would actually demand the product. This is corrected by: • Providing incentives to partake in that good or service. (Laws requiring kids to go to school) 2) Provide incentives for the companies to increase supply. (Provide a tax subsidy to the firms.)

19. 1) Smoking creates an external cost. • The smoker gets the satisfaction and the tobacco company gets the money. • However we have to cope with the smell, the litter the health hazard from breathing the smoke and the higher insurance rates. • 2) DUI leads to wrecks that can hurt innocent people.

20. 3) Landscaping ones yard provides a positive external benefit to the neighborhood. • The resale on their homes increases. • 4) Education provides higher standards of living, better health and lower burden on police • Total Cost = Private Cost + Social Cost • Total Benefit = Private Benefit + Social Benefit

21. Coase Theorem: says that the government does not have to get involved in externality if: • 1) Property ownership is clearly defined • 2) Number of people is small • 3) Bargaining costs are negligible • The reason for this is that given the above stipulation, the externality can be worked out between the players involved.

22. Sometimes large numbers of people are involved: If this is the case often you will see: • 1) Direct controls: legislation • 2) Specific taxes: this tax is charged to those companies that cause negative externalities. • 3) A market for externality rights. (selling the rights to create negative externalities)

23. One thing you have to look at is that as you force externalities out of society you are increasing the cost of doing business. • Soon with diminishing marginal returns setting in the point will come where the MC of reducing externalities exceeds the MB. • At that point the company will go out of business and society loses.

24. 54 AND 55 • READ P 203-219

25. Warm-Up • Using diagrams, explain the difference between a positive externality and a negative externality.

26. It is difficult to determine demand for a public good. • Because the government cannot deny access to its services the demand curve for its goods and services will be nonexistent or understated. • People will not fess up to the demand for the good if they know they will get it for free anyway. • You have to get people to say what they would pay rather than do without. • If you do derive a demand and supply curve you can get the equilibrium point.

27. Benefit-Cost Analysis: • When taking on a project, businesses must look at the marginal benefits vs the marginal costs. • When the public sector utilizes a good or service it represents a decline in production in the private sector. • This means you have to look and see if the benefit to the public sector outweighs the loss to the private sector. • You can then look at degrees of benefit v. degrees of costs.

29. To determine the size of the project you have to look at marginal costs and marginal benefits. • You want to pursue the project as long as Marginal Benefit exceeds Marginal Costs. • Once they are close to equal you quit pursuing them. • You can see from the above table that Marginal Benefit is closest to Marginal Cost under plan C. • (Notice that at this point you have the largest net benefit.)

30. One major problem you will have is that you cannot truly measure the costs and benefits associated with a project. • The externalities are too great in number and width. • Ex. Building of the outer loop. They can estimate the actual cost of doing this. Buying the property, building the roads, maintaining the roads. Connecting the roads to other roads.... • However, it does not take into account the costs of the additional pollution, the increased need for police and ambulances to cover the area, etc.

31. Our society is based on a Democracy. Yet is it efficient? • People vote yes and no based on their own economic basis. • If I am not willing to spend the money for a project I will vote no. • However, this does not mean that others would not be willing to spend more than the minimum on that project. • Should the project then be passed? • Sometimes this vote will bring about the opposite. • I may vote yes and others may vote yes when in fact the net benefit is less than the net cost.

32. The bottom line is that the yes/no vote fails to include strength of preferences of the individual voter. • Majority voting may produce economically inefficient outcomes. • The ways to get around this are: • 1) Interest Groups: those that will benefit the most may try to persuade others through advertising. • 2) Political Logrolling: the trading of votes to secure favorable outcomes on decisions which otherwise would be adverse.

33. Paradox of Voting: a situation where society may not be able to rank its preferences consistently through majority voting. • Median-Voter model: under majority rule the median voter will in a sense determine the outcomes of elections.

34. Activities 56 and 57 • Read pages 241-260

35. Warm-Up • The government imposes a tax on a firm. Using a diagram, explain what happens.

36. Government Revenue and Spending • In 1997 all levels of the government collected around $2 trillion • $9,500 for every man women and child in the United States.

37. Economic Impact of Taxes • Resource Allocation: • When businesses are taxed it is an increased cost of doing business for them. • This shifts the supply curve to the LEFT. • This will increase prices. • This causes people to buy less (quantity demanded), which in turn cause business to hire less factors of production. • (Circular flow diagram)

38. Economic Impact of Taxes • Behavior Adjustment: • People's actions can be influenced by taxes. • The quantity demanded decreases when price increases. • Ex: Sin Tax-tobacco, alcohol and other socially undesirable products. • Lower taxes leads to more money in people’s pockets, which will translate to more savings

39. Economic Impact of Taxes • Productivity and Growth- • high taxes can reduce people's incentive to increase production. • Ex. Why should I work harder? The government will just take it anyway.

40. Property Tax cuts • Sometimes a local government will cut property tax for large companies to encourage them to expand. • This leads to more jobs, etc....

41. Criteria for Taxes to be effective • Equity- fairness. • What is fair? Should only wealthy pay? Should only those that can afford to pay get it? • In 1998 the top 1% of wage earners paid 33% of all taxes • The top 8% of wage earners paid 62% of all taxes • The lower 92% of wage earners paid 38% of taxes • The lowest 33% paid virtually nothing • Tax Loopholes: exceptions or oversights in the tax laws that allow some people and business to avoid paying certain taxes. • Many feel these are unfair because it allows some people to not pay part of their taxes.

42. Criteria for Taxes to be effective • Simplicity- • average people should be able to interpret and apply each tax. • People are more willing to pay it if they understand it. • Accountants and tax lawyers make billions each year because people cannot understand the tax code and therefore pay professionals to figure it out. • It is estimated that complying with the IRS tax codes increases the cost of goods and services in the US by 20%.

43. Criteria for Taxes to be effective • Efficiency- • should be easy to administer and should make revenue for government. • Income taxes: • employer withholds a portion of person’s paycheck and sends it to the government. • At the end of the year they notify the person as to how much was withheld.

44. Tax Burden • 1) Benefits- Received Principle: • households and businesses should purchase the goods and services of government basically in the same manner in which other commodities are bought. • This means that those that benefit should pay the tax burden. • Problems: • 1) How do you determine who benefits? Things like highways and parks are easy to handle but what about things like education? • 2) How do you handle redistribution income? You cannot ask a person on welfare to foot their own bill.

45. Tax Burden • 2) Ability to Pay Principle: • tax burden should be tied directly to ones ability to pay, based on wealth. • The reasoning behind this is that each dollar received by an individual actually provides less and less satisfaction so that person is not hurt as much by the larger tax burden. • The problem with this is how do you determine how much more satisfaction one gets. • Another problem is that it leads to the desire to not work as hard to earn the extra income because the government will just take it anyway.

46. Tax types • 1) Progressive: • average rate increases as income increases. (The marginal rate will also increase as income rises.) • Such a tax claims not only a larger absolute amount, but also a larger fraction or percentage of income as income increases.

47. Tax types • 2) Regressive Tax: • average rate declines as income increases. • This takes a smaller proportion of income as income increases. • Ex: 15% if income is less than 10,000 and 10% if it is more than 10,000 • Ex. Property Taxes. Rich people do not spend as large % of income on property taxes than the poor.

48. Tax types • 3) Proportional Tax: • Average rate remains the same regardless of the size of income. • Ex: Income tax set at 25%. Everyone pays 25% of their income no matter how much you make. • Federal Personal Income Tax is progressive: The rates range form 15% to 31%. • EX. Corporate Income Tax. They spend all they make.

49. Sales Tax • Sales Taxes: (4%) in Gwinnett. What kind is it? • The rich people do not spend all of their income. They save it and therefore do not spend sales taxes. The poor will spend almost all of their income on things with sales taxes.

50. Not all taxes work the way they are supposed to work. • Sometimes the ones that are supposed to pay the tax do not. • Tax incidence: income lost as a result of the taxes after tax shifting. • Tax shifting: transfer of taxes to another group.