UNIT 7 The Free Enterprise System. CHAPTER 23 Government and the Economy

UNIT 7

The Free Enterprise System

CHAPTER 23

Government and the Economy

The Role of the Government

• 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

ExternalitiesUnintended 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


Maintaining CompetitionSole provider of a good or service is a monopolyNo competition means they can charge higher

prices, take advantage of consumersGovernment tries to encourage competition through:

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


Regulating market activitiesTo prevent negative

externalities the government regulates business in three important areas

A.Natural Monopolies 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)


B. Advertising and Product Labels

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 GrowthGross 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


Business CycleEconomy does not grow at a constant rate, goes

through growth and declineEconomic expansion is when the GDP goes up, it

reaches a peak and then declinesA recession is when the GDP goes down for six

strait monthsExpansions are usually longer than recessions


Unemployment Anther measure of economic health is

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


Price StabilityInflation is the sustained increase of

prices over timeIndicator of economic performanceToo much inflation reduces the

purchasing power of moneyReduces 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


Stocks and Stock MarketsTwo ways to make money from

stocks 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 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)


Stocks and Stock Markets Stock indexes measure stock prices over

time 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 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 InequalityAmerica is a wealthy country but

not all Americans are wealthyLevel of education has a major

impact on a person’s income More education=more income Government tries to encourage people

to improve education at all levels Free lunch programs to low interest

college loansHaving wealthy parents provides

access to more educational opportunities and business opportunities


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


PovertyPeople living in poverty receive special attention from

the governmentThe most effective programs have incentives that

encourage people to go back to work or improve their employment situation

Most welfare programs are federal programs 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


Workfare ProgramsUsed to describe welfare recipients to

exchange some of their labor in exchange for benefits 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

benefitsTax policiesGovernment helps people with progressive

tax policies 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

CHAPTER 24

Money and Banking

What is Money?

Three functions of money1. Serves as a medium of exchange- trade money for

goods and services2. Store of value- hold it until we a re ready to use it,

and it does not lose value3. 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 moneyA. PortableB. DivisibleC. 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 System1. Used as a safe place to store money2. Money is out to work by lending it to people or businesses3. Financial institutions make a profit from the interest they

charge on loans4. Act to bring savers and borrowers together Types of Financial institutions Commercial banks

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

The Federal Reserve System

Federal Reserve is the central bank of the USWhen banks need money they borrow from the

FedUS divided into 12 Federal Reserve districtsFederally chartered commercial banks are

required to be members of the FedMember banks own stock in the Fed and earn

dividends from it


Fed was established in 1913To raise money they sold stock and

required largest banks to buy itThe 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


Advisory Councils report on 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) Makes decisions by manipulating the money

supplyRegulatory functions of the Fed

Banking regulation Oversees large commercial banks and regulates

mergers Regulates American connections with foreign

banks and foreign banks in the US Consumer borrowing

Requires lenders to spell out terms of loans Specifies what information lenders must provide


Acting as the Government’s Bank1.Holds the governments money2.Sells US Bonds and Treasury Bills

These help fund government activity When they reach maturity after a period of time they can

be exchanged for cash with interest

3.Fed issues the nations currency and controls its circulation


Conducting Monetary Policy Controls the supply of money and the cost of borrowing

moneyWays the Fed manipulates the monetary supplyA.Can raise or lower the discount rate

The rate the Fed charges member bans for loans Stimulate economy= lower discount rate Slow down the economy= raises the discount rate

B.Can raise or lower the reserve requirement for banks Banks have to keep certain percentage of total deposits in Federal

Reserve Banks If they raise requirement banks have less money to lend

C.Can change money supply through open market operations The purchase and sale of government bonds and Treasury bills puts

money in the hands of investors and the government


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 Pool money, property and certificates of

deposit to capitalize bank Banks need to attract depositors a) Offer checking accountsb) Savings accounts

pay interest based on how much money customer has deposited

c) Certificates of deposit 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

This is how banks make a profit Loan money to businesses and consumers Can increase the supply of money

CHAPTER 25

Government Finances

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


Budget Process President presents a proposed budget to

Congress Congress passes a budget resolution

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 Social security, interest payments on government debt

Discretionary spending government expenditures that need to be approved each year 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


Federal RevenuesIncome tax provides

nearly half of all government revenue 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 Taxes deducted from workers

paychecks to fund Social Security and Medicare


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


Forms of TaxationProportional 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


Federal Expenditures Social Security is the largest

expenditure by the federal government (22.4 cents on every dollar) 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) Federal government gives money to states for highways,

education, healthcare, etc. Most states depend on sales tax as a source of

revenue 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 Not all states have state income tax


Local Governments Also depend on intergovernmental

revenues 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 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


ExpendituresEntitlement programs are an important

state expenditure 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

reasonableHighway construction

States have to maintain local highways and roadsEmployee retirement, hospitals, education,

corrections equal a relatively small amount of state expenditures


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 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 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 Each person in the US now owes

$46,000 per person


Balanced budget is when spending 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


In theory federal government can stimulate the economy by increasing spending and cutting taxes This increases deficits , drives up debt and

creates problems in the futureWhen 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 badA. Most people want lower taxes and no cuts in

government servicesB. It takes time to pass appropriations bills


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 economy1. Unemployment insurance2. Welfare programs3. Progressive income tax structure

These programs provide income during hard economic times

Automatic stabilizers go into effect faster than discretionary spending measures

Documents

UNIT 7 The Free Enterprise System. CHAPTER 23 Government and the Economy