- There
is an economic role for government in a market economy whenever the
benefits of a government policy outweigh its costs. Governments often
provide for national defense, address environmental concerns, define
and protect property rights, and attempt to make markets more competitive.
Most government policies also redistribute income. Even Adam Smith
recognized that the market has some limitations and shortcomings and
that governmental policies have the role of attempting to compensate
for those failures. Governments pay for the goods and services they
use or provide by taxing or borrowing from the public.
- Most
federal government tax revenues comes from personal income and payroll
taxes. Payments to Social Security recipients, the costs of national
defense, medical expenditures, and interest payments on the national
debt constitute the bulk of federal government spending. Most state
and local government revenues come from sales taxes, grants from the
federal government, personal income taxes, and property taxes. The
bulk of state and local government revenue is spent on education,
public welfare, road construction and repair, and public safety.
- Markets
do not allocate resources effectively if: (1) property rights are
not clearly defined and enforced, (2) externalities (spillover effects)
affecting large numbers of people are associated with the production
or consumption of a product, (3) markets are not competitive, or (4)
the existence of public goods. A government policy to correct a market
imperfection is not justified economically if the cost of implementing
it exceeds its expected net benefits.
- An
important role for government in the economy is to define, establish,
and enforce property rights. A property right to a good or
service include the right to exclude others from using the good or
service and the right to transfer the use and ownership of the resource
to others. Property rights provide the incentives for the owners of
resources to weigh the value of present uses against the value of
conserving the resources for future uses.
- Externalities
exist when some of the costs and benefits associated with production
and consumption fall on someone other than the producers or consumers
of the product. When a price fails to reflect all the benefits of
a product, too little of the product is produced and consumed. Government
can use subsidies to help correct for insufficient output; it can
use taxes to help correct for excessive output; or it can regulate
output directly to correct for over or underproduction or consumption
of a product.
- Public
Goods and services provide benefits to more than one person at
a time, and their use cannot be restricted only to those people who
have paid to use them. If a good or a service cannot be withheld from
those who do not pay for it, providers expect to be unable to sell
it and, therefore, will not produce it. Governments provide an alternative
method to markets for supplying goods and services when it appears
that the benefits to society of doing so outweigh the costs to society
- In
the United States, the federal government enforces antitrust laws
and regulations to try to maintain effective levels of competition
in as many markets as possible; frequently, however, laws and regulations
also have unintended effects - for example, reducing competition.
There are cases, however, when one producer can supply total output
in a market at a cost that is lower then when two or more producers
divide production, thus competition may be impossible (natural
monopolies, for example, public utilities.) In this case, government
regulations may then be used to try to control price, output, and
quality.
- Governments
often redistribute income directly when individuals or interest groups
are not satisfied with the income distribution resulting from markets;
governments also redistribute income indirectly as side-effects of
other government actions that affect prices or output levels for various
goods and services.
- Important
question? Do government officials try to promote the general welfare
of the nation, or are they guided by their own self-interests? Businesses
that fail to satisfy consumer wants go bankrupt, but how do we know
when government programs fail, and how do we change or eliminate failed
government programs? Why do some farmers receive large subsidies from
the government, and why are many businesses protected from competition
by tariffs or quotas - even when only a small percentage of the labor
force is employed in those industries? Why don't taxpayers rise up
and put a stop to the favoritism accorded to certain industries and
special interests groups? And why do so few people participate in
the political process, and so many choose not to register or vote?
- Governments,
like markets, also have shortcomings and imperfections. Citizens,
government employees, and elected officials do not always directly
bear the costs of their political decisions. This often leads to policies
whose costs outweigh their benefits to society. Incentives exist for
political leaders to implement policies that disperse costs widely
over large groups of people and benefit small, and politically powerful
groups of people. Furthermore, incentives exist for political leaders
to favor programs that entail immediate benefits and deferred costs;
few incentives favor programs promising immediate costs and deferred
benefits, even though the latter programs are sometimes economically
more effective than the former programs.
- Although
barriers to international trade usually impose more costs than benefits,
they are often advocated by people and groups who expect to gain substantially
from them. Because the costs of these barriers are typically spread
over a large number of people who pay only a little and may not recognize
the cost, policies supporting trade barriers are often adopted through
the political process. Price controls *floors or ceilings) are often
advocated by special interest groups. Price controls reduce the quantity
of goods and services produced, thus, depriving consumers of some
goods and services whose value would exceed their cost.
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