Transcript Chapter 4 Government in the mixed economy

Chapter 4
Government in the mixed economy
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
6th Edition, McGraw-Hill, 2000
Power Point presentation by Peter Smith
What do governments do?
create laws, rules and regulations
 buy and sell goods and services
 make transfer payments
 impose taxes
 try to stabilize the economy
 affect the allocation of resources

4.1
Government spending
The scale of government activity has grown steadily in
industrial countries since 1880
% of national income
60
50
Japan
USA
Germany
UK
France
Sweden
40
30
20
10
0
1880
1929
1960
2000
4.2
What should governments do?

Governments may be justified in
intervening in the economy in the
presence of market failure

Six ways in which intervention may
improve the allocation of resources:
4.3
What should governments do?


(1) The business cycle
– decisions on taxation and spending may affect
the business cycle
– not always favourably
(2) Public goods
– goods that, even if consumed by one person,
are still available for consumption by others –
e.g. clean air
– the free-rider problem prevents the market
from achieving production of the “right”
amount of such goods.
4.4
What should governments do?

(3) Externalities
–
costs and benefits of production are not
always reflected in market prices
 e.g.

pollution, congestion.
(4) Information-related problems
–
private markets may not produce the
“right” kinds and amounts of
information
 e.g.
food labelling, health and safety
regulations.
4.5
What should governments do?

(5) Monopoly and market power
–

resource allocation may be improved by
limiting or regulating the market power
of monopoly firms
(6) Income redistribution and merit goods
–
concern with equity issues
 e.g.
–
protecting vulnerable groups
merit goods are goods that society thinks
people should consume regardless of income
 e.g.
health, education
4.6
Who pays a commodity tax?
Price
S'
S
P1
P0
With no tax, market
equilibrium is at P0, Q0
With the tax, supply is S'S'
and equilibrium is P1Q1
…but who pays the tax?
S'
S
D
Q1Q0
Quantity
4.7
Who pays a commodity tax?
A
P1
P0
S'
C
B
S
D
Q1Q0
S'
Area A is borne
by consumers
S
Area B is borne
by producers
Area C is a
welfare loss.
The incidence of the
tax depends upon the
elasticities of demand
and supply.
4.8