1

Individuals and Government

Chapter 1

2

Public Finance

Public finance is the field of economics

that studies government activities and the

alternative means of financing government

expenditures.

3

Government

Governments are organizations formed to

exercise authority over the actions of

persons who live together in a society and

to provide and finance essential services.

4

Political Institutions

Political Institutions are rules and generally

accepted procedures that evolve for

determining what government does and

how government outlays are financed.

5

Examples of Political Institutions

Majority rule

Representative government

6

The Allocation between Private

and Government Resources

Private

Food

Housing

Cars

Clothing

Government

National Defense

Public Schools

Police

7

Figure 1.1 A Production-Possibility Frontier

G2B

X2

G1A

X1

C

M 0

Go

vern

men

t G

oo

ds a

nd

Serv

ices p

er

Year

Private Goods and Services per Year

8

Distribution of Government

Goods and Services

Nonmarket rationing:

Prices and willingness to pay those prices are

not applicable to goods like national defense.

9

The Mixed Economy: Markets

and Politics

Pure Market Economy

Virtually all goods and services are supplied by for-

profit private firms.

Supply and demand determine price.

Mixed Economy

A mixed economy is one in which government

supplies a considerable amount of goods and services

and regulates private economic activity.

10

Figure 1.2 Circular Flow in the Mixed Economy

Input

Market

Output

Market

Government Households Firms

Subsidies

Taxes, fees, charges

Government Services

Taxes, fees, charges

Government Services

Income Support & Subsidies

Dollars

Resources

Dollars

Goods & Services

Dollars

Goods & Services

Dollars

Resources

11

Government Expenditures in the

United States Government purchases of

labor

land

capital

Government Transfer Payments

Welfare

Social Security

12

Growth in Government Expenditures

Table 1.1 (abbreviated)

Year GDP Federal

Government

State

and Local

Government

Total

Government

Percentage

of GDP

Total

1930 91.3 2.5 7.5 10.0 10.95

1945 223.0 84.7 8.5 93.2 41.79

1960 527.4 85.8 34.1 119.9 22.73

1975 1635.2 345.4 152.1 497.5 30.42

2002 10442.1 2073.9 1050.9 3124.8 29.93

13

International ComparisonsCountry Government Current Expenditures

as a Percentage of GDP 2001

Denmark 49.1

France 48.8

Germany 45.1

United Kingdom 39.4

Japan 38.1

Canada 36.7

United States 31.9

14

Figure 1.3 Total Government Expenditure as a

Percentage of GDP 1929-2002

15

Structure of Federal Government

Expenditures

Purchases of Goods and Services

Transfer Payments

Grants in Aid to State and Local

Governments

Net Interest Paid

16

Table 1.2

Category Percentage of Total Federal

Expenditures

Transfer Payments 44.9

Purchases 28.2

Interest 14.7

Grants to State and Local 10.0

Federal Expenditure by Category,

2002

Other 2.2

17

Figure 1.4 The Distribution of Federal Expenditure,

1966-2002

18

Federal Government Expenditures by Function

19

The Structure of State and Local Government

Expenditures in the United States

Education

Civilian Safety

Transportation

Executive, Legislative, and Judicial

Income Security

Health and Hospitals

Recreational and Cultural Activities

20

State and Local Government Expenditures

21

Financing Government

Expenditures in the US

Taxes:

Income (Corporate and Personal)

Payroll

Excise

Customs

22

Federal Revenues

23

State and Local Government Revenues

24

State Budget Crunch of 2002 37 states were forced to reduce their budgets.

Revenues were typically 10% less than anticipated.

States with the most severe deficits: AK, AZ, CA, NY, NC, OK, OR, VA, and WA

Causes Cuts in taxes on business and individuals in the

1990s

No sales tax collections on services

Growth in costs of Medicaid

25

Implications of a

Graying America

Social Security

In 2008 baby-boomers start to retire and collect

The ratio of workers to retiree falls

Medicare

Health care inflation is substantially higher than overall inflation

Medicaid

Increased use of long-term care for baby-boomers

26

How Much Government is

Enough?

The question of how much government is

enough is an important one in any society.

It is the tradeoff between public and private

goods. When government gets bigger, its

increased involvement comes at the

expense of less private consumption.