Government and the

Economy
Participation, Intervention, and Fiscal Policy
Continuum of government participation

Communism/Dictatorship Socialism Capitalism

What is the proper role of government in the
market economy?
• Market economy promotes exchange in a free market.
• Most theories of market economy promote competition as the best
regulator as opposed to government.
• No market economy is truly free of government influence.
Common roles of government:
1. Regulating Business/Externalities
2. Providing Public Goods
3. Promoting economic Well-Being
4. Stabilizing the Economy
5. Moderating the Business Cycle
Regulating Business
For a market economy to thrive participants willingness to enter voluntary
exchanges depends on their confidence that the exchange will be fair.
Government has to foster a stable legal environment
Correcting the short comings of the market system that create injustices that
create lack of trust in the economy:
• Enforce contracts
• Preventing Abuses of labor by employers
• Protecting consumers, savers, borrowers, investors
• Limiting negative externalities
• Promoting competition by correcting for monopolies
Providing Public Goods
Public goods are goods and services made available to and consumed
by all citizens by government regardless of paying any taxes or fees.
- Non exclusion: everyone eligible to receive regardless of paying taxes
- Shared consumption: Use of the public good is not preventative of
others using it.
Government needs to produce social necessary goods and services
because:
• Generally no profit so no incentive to be produced
• Free Rider Problem: If I can get away without paying I will
• Extreme high start up costs
Promoting Economic Well-Being
• Improving the standard of living focusing on areas such as diet,
product consumption, medical care, and education.

• Redistributing income to reduce the disparity of wealthy and poor.

• Transfer payments to provide household income, medical care, higher
education, housing, job training/retraining, business to service providers
Stabilizing the Economy/Moderating the
Business Cycle
• Using Fiscal policies to influence inflation, unemployment, low
demand
• Taxes: Raising or lowering to create incentives or disincentives
• Spending: Grants, loans, or direct purchases

• Using Monetary policies for the same purposes

• Discount rate
• Reserve rate
• Open market exchanges
Influence the Economy’s performance with
Fiscal Policy
Fiscal Policy: The overall government program that establishes levels of taxing,
borrowing, and spending that promote the desired economic goals for the
nation.

The economic stage of development creates different priorities among the economic goals.

The culture and history of the nation will influence the perception of the three basic
questions:
1. What to produce
2. How to produce
3. For whom to produce
Tools of Fiscal Policy to encourage or temper
aggregate demand.
• Tax rates: The government can change the % of taxes to be collected
• Tax incentives: The government can give businesses or consumers tax
credits connected to investing or buying certain goods/services.
• Government Spending: The government can increase or reduce their
spending on infrastructure or goods and services to be consumed by
the government.
• Public Transfer Payments: The government can redistribute tax dollars
to nonproductive individuals in the economy without any exchange.
• Setting Tax Brackets: The government can structure the tax brackets
among income levels
 Types of Taxes
• Income Taxes: Taxes on a person or business’ wages/salary, interest, dividends, and tips.
• Proportional/Flat tax: Applies the same percentage of tax to all income levels
• Regressive tax: Takes a larger percentage of tax from lower income levels
• Progressive tax: Takes a larger percentage of tax from higher income levels
• Sales/Consumption Taxes: Taxes collected as percentage of the price paid on purchased
goods and services.
• Property Taxes: Taxes collected based on the value of property owned by a person or entity.
• Excise taxes: Taxes placed on manufacturing, sale, or consumption of particular goods or
services.
• Estate taxes: Taxes placed on the transfer of wealth among individuals typically at death.
• Gift taxes: Taxes placed on large gifts of money or personal property.
• Customs duty/Tariffs: Taxes placed on imports/exports with foreign goods or services
• Licenses: Fee placed on the permission to perform certain services/activities or use
particular goods.