The Free Enterprise System Unit 7

Government and the Economy Chapter 23

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 Externalities Unintended 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

The Role of Government Maintaining Competition Sole provider of a good or service is a monopoly No competition means they can charge higher prices, take advantage of consumers Government 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

The Role of Government Regulating market activities To prevent negative externalities the government regulates business in three important areas 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)

The Role of Government Advertising and Product Labels Product Safety 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 Product Safety Consumer Product Safety Commission can recall or take products off of market if they are unsafe

Measuring the Economy Measuring Growth Gross 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

Measuring the Economy Business Cycle Economy does not grow at a constant rate, goes through growth and decline Economic expansion is when the GDP goes up, it reaches a peak and then declines A recession is when the GDP goes down for six strait months Expansions are usually longer than recessions

Measuring the Economy 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

Measuring the Economy Price Stability Inflation is the sustained increase of prices over time Indicator of economic performance Too much inflation reduces the purchasing power of money Reduces 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

Measuring the Economy Stocks and Stock Markets Two 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)

Measuring the Economy 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 Inequality America is a wealthy country but not all Americans are wealthy Level 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 loans Having wealthy parents provides access to more educational opportunities and business opportunities

The Government, the Economy and You 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

The Government, the Economy and You Poverty People living in poverty receive special attention from the government The 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

The Government, the Economy and You Workfare Programs Used 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 benefits Tax policies Government 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

Money and Banking Chapter 24

What is Money? Three functions of money Serves as a medium of exchange- trade money for goods and services Store of value- hold it until we a re ready to use it, and it does not lose value 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 money Portable Divisible 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 System Used as a safe place to store money Money is out to work by lending it to people or businesses Financial institutions make a profit from the interest they charge on loans 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 US When banks need money they borrow from the Fed US divided into 12 Federal Reserve districts Federally chartered commercial banks are required to be members of the Fed Member banks own stock in the Fed and earn dividends from it

The Federal Reserve System Fed was established in 1913 To raise money they sold stock and required largest banks to buy it The 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

The Federal Reserve System 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 supply Regulatory 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

The Federal Reserve System Acting as the Government’s Bank Holds the governments money 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 Fed issues the nations currency and controls its circulation

The Federal Reserve System Conducting Monetary Policy Controls the supply of money and the cost of borrowing money Ways the Fed manipulates the monetary supply 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 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 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

The Federal Reserve System 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 Offer checking accounts Savings accounts pay interest based on how much money customer has deposited 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

Government Finances Chapter 25

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

The Federal Government 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

The Federal Government Federal Revenues Income 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

The Federal Government 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

The Federal Government Forms of Taxation Proportional 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

The Federal Government 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

State and 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

State and Local Governments Expenditures Entitlement 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 reasonable Highway construction States have to maintain local highways and roads Employee retirement, hospitals, education, corrections equal a relatively small amount of state expenditures

State and Local Governments 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

Managing the Economy 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

Managing the Economy 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 future When 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 bad Most people want lower taxes and no cuts in government services It takes time to pass appropriations bills

Managing the Economy 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 economy Unemployment insurance Welfare programs Progressive income tax structure These programs provide income during hard economic times Automatic stabilizers go into effect faster than discretionary spending measures