The role of Government in the U.S. economy and Market

Structures

Chapters 3 & 7

What role should the government play in the economy?

• Focus Lesson 2, activity 1

The American tradition of free enterprise

• Free Enterprise-The social and political commitment to giving the people the freedom and flexibility to try out their business ideas and compete in the marketplace.

Several key characteristics make up the basic principles of free enterprise.

1. Profit Motive

The drive for the improvement of material well-being.

2. Private property rights

The right to control your possessions as you wish.

3. Competition

The rivalry among sellers to attract consumers.

Helps keep prices low

The Basic Principles of the American Free Enterprise

Policymakers (the government) pursue three main outcomes as they seek to stabilize the economy.

Promoting Economic Strength

1. Employment• Provide jobs for everyone who is able to work.

• An unemployment rate of 4-6% is desirable 2. Growth• For each generation of Americans to do better than previous ones, the

economy must grow to provide additional goods and services.• How is your generation better off than your parents?

3. Stability• Stability gives consumers, producers, and investors confidence in the

economy and in our financial institutions, promoting economic freedom and growth.• Ex: prices of milk

• Focus lesson two, activity 2

Public Goods• A public good is a shared good or service for which it would

be impractical to make consumers pay individually and to exclude nonpayers.

– Funded by the public sector, the part of the economy that involves transactions of the government.

– Private Sector: the part of the economy that involves the transactions of individuals and business.

– A free rider is someone who would not choose to pay for a certain good or service, but who would get the benefits of it anyway if it is provided as a public good.

Market Failures• A market failure is a situation in which the market, on its

own, does not distribute resources efficiently.– Would the free market ensure that roads are built everywhere they

are needed?

Example of market failure

• Proposal: Farmers want a local river to be dammed

• Benefits: the dam will provide flood protection

• Cost: If an individual farmer were to build the dam, the cost to him would outweigh the benefits

• Decision: No. The farmers would collectively benefit from a dam, but no single farmer will build it.

Example of the creation of a public good

• Proposal: The government considers funding the dam

• Benefit: the dam will provide flood protection

• Cost: Higher taxes, changing ecosystem

• Decision: Yes. The government will fund the project

• Result: The benefits of the dam extend to so many people that their collective benefit exceeds the total cost of the dam.

•If farmers also wanted irrigation ditches built to carry the lake water to their fields, would the ditches be built as a public good?

Public or Private Good?

• Police• Flood Control• Rock Concerts• Public Elementary school• Court System• College Education• Parks• Libraries• Movie Tickets

Externalities

Positive Externalities

• A possible source of hydroelectric power

• Swimming• Boating• Fishing• Lakefront views

Negative Externalities• Loss of wildlife habitat due

to flooding• Disruption of fish

migration along the river• Overcrowding due to

tourism • Noise from racing boats

and other watercraft

•An externality is an economic side effect of a good or service that generates benefits or costs to someone other than the person deciding how much to produce or consume.

•The building of a new dam and creation of a lake generates:

Externalities: Positive or Negative?• 1. Dynamo Computers hires underprivileged teens and trains them to be computer programmers. Those

workers are then available to be hired by other companies, who benefit from the workers’ skills without having paid for them

• 2. The Enchanted Forest Paper Mill dumps chemical wastes into a nearby river, making it unsafe for swimming. The downstream city of Tidy Ville is forced to install special equipment at its water-treatment plant to clean up the mess. If the treatment costs is $20 per ton of paper produced, and the mill’s production cost is $100 (the cost of all the materials required to produce it) the full, or social cost of a ton of paper is $120. The community, not the polluter, winds up paying the $20

• 3. Your next-door neighbor takes up the accordion and holds Friday night polka parties in his backyard. Unfortunately, you hate polka music

• 4. Mrs. Garland buys an old house that is an eyesore in the neighborhood. She paints it, cuts the grass, and plants flowers. Her neighbors were not involved in the economic decision. But they receive benefits from it. Such as higher property values and a better view.

Focus lesson 2, activity 3

Providing a safety netWhile the free market has proven better at generating wealth than any other economic system, the wealth is spread unevenly throughout society. The government has created opportunities to assist the poor.

•Welfare•Temporary Assistance for Needy Families (TANF)•Social Security•Unemployment insurance•Workers’ compensation•Medicare and Medicaid

Government policies keep firms from controlling the prices and supply of important goods. Antitrust laws are laws that

encourage competition in the marketplace.

Government and Competition

1. Regulating Business PracticesThe government has the power to regulate business practices if these practices give too much power to a company that already has few competitors.

2. Breaking Up MonopoliesThe government has used anti-trust legislation to break up existing monopolies, such as the Standard Oil Trust and AT&T.

3. Blocking MergersA merger is a combination of two or more companies into a single firm. The government can block mergers that would decrease competition.

4. Preserving IncentivesIn 1997, new guidelines were introduced for proposed mergers, giving companies an opportunity to show that their merging benefits consumers.

Defining a Monopoly• A monopoly is a market dominated by a single seller.

– Monopolies form when barriers prevent firms from entering a market that has a single supplier.

– Monopolies can take advantage of their monopoly power and charge high prices.

Different market conditions can create different types of monopolies.

Forming a Monopoly

1. Economies of ScaleIf a firm's start-up costs are high, and its average costs fall for each additional unit it produces, then it enjoys what economists call economies of scale. An industry that enjoys economies of scale can easily become a natural monopoly.

2. Natural MonopoliesA natural monopoly is a market that runs most efficiently when one large firm provides all of the output.

3. Technology and ChangeSometimes the development of a new technology can destroy a natural monopoly.

A government monopoly is a monopoly created by the government.

Government Monopolies

• Technological Monopolies – The government grants patents, licenses that give the inventor of a new

product the exclusive right to sell it for a certain period of time. • Franchises and Licenses

– A franchise is a contract that gives a single firm the right to sell its goods within an exclusive market. A license is a government-issued right to operate a business.

• Industrial Organizations– In rare cases, such as sports leagues, the government allows companies in

an industry to restrict the number of firms in the market.

In addition to monopolies, other business activities may be considered illegal by the government.

Anti-Competitive Practices

Collusion• Collusion is an agreement among

members of an oligopoly to set prices and production levels. Price- fixing is an agreement among firms to sell at the same or similar prices.

Cartels• A cartel is an association by

producers established to coordinate prices and production.

Deregulation is the removal of some government controls over a market.

Deregulation

• Deregulation is used to promote competition. • Many new competitors enter a market that has been deregulated. This is

followed by an economically healthy weeding out of some firms from that market, which can be hard on workers in the short term.

Exploring Monopolies