Chapter 29 GOVERNMENT SPENDING Gottheil — Principles of Economics, 7e © 2013 Cengage Learning 1

Economic Principles © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 2 Public goods Merit goods Transfer payments

Government Spending and Public Goods © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 3 Public good A good whose benefits are not diminished even when additional people consume it and whose benefits cannot be withheld from anyone.

Government Spending and Public Goods © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 4 1.Which of the following offers the best example of a public good: a.Lift tickets sold at ski resorts b.A network of street lights c.Restaurant meals

Government Spending and Public Goods © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 5 1.Which of the following offers the best example of a public good: a.Lift tickets sold at ski resorts b.A network of street lights c.Restaurant meals

Government Spending and Public Goods © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 6 A private good, such as a lift ticket or a restaurant meal, is exclusively the property of the person who bought it. That person can prevent others from using the good. 2.What does the nonexclusiveness property of public goods mean?

Government Spending and Public Goods © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 7 2.What does the nonexclusiveness property of public goods mean? Public goods such as street lights are not exclusive, and nobody can be denied the benefits of the lighting.

Government Spending and Public Goods © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 8 3.What does the nonrival property of public goods mean? It means that use by one person does not subtract from what is available for others. Examples include street lights and public radio.

Government Spending and Merit Goods © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 9 Merit good A good that market demand and supply do not produce enough of.

Government Spending and Merit Goods © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 10 What are some examples of merit goods? Public-supported colleges and universities Public-supported arts and health care Libraries and museums

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e 11 EXHIBIT 1FEDERAL, STATE, AND LOCAL SPENDING: 2010 ($ BILLIONS) Source: Source: U.S. Department of Commerce, Bureau of Economic Analysis, National Income and Product Accounts, Tables 3.1–3.3, Washington, D.C., September 2011.

Exhibit 1: Federal, State, and Local Spending: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 12 1.Which level of government (federal or state/local) is the largest purchaser of goods and services? State and local

Exhibit 1: Federal, State, and Local Spending: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 13 2.In which category of government spending are Social Security contributions and benefits recorded? Transfer payments

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e 14 EXHIBIT 2CONSUMPTION EXPENDITURES IN 2010, BY FUNCTION ($ BILLIONS) Source: U.S. Department of Commerce, Bureau of Economic Analysis, National Income and Product Table , Washington, D.C., September 2011

Exhibit 2: Consumption Expenditures In 2010, by Function © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 15 1.What is the largest single functional category of expenditure by the federal government? National defense

Exhibit 2: Consumption Expenditures In 2010, by Function © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 16 2.What is the largest single functional category of expenditure by state and local government? Education

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e 17 EXHIBIT 3GOVERNMENT SPENDING ($ billions) ON SECURITY: 2010 Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, September 2008).

Exhibit 3: Government Spending on Security: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 18 Complete the sentence: The two largest security expenditure categories by state and local government were _____ and _____.

Exhibit 3: Government Spending on Security: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 19 Complete the sentence: The two largest security expenditure categories by state and local government were police and prisons.

Exhibit 3: Government Spending on Security: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 20 The burden of national defense spending falls exclusively upon the federal government.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 21 The budget for veterans’ benefits and services is dominated by disability and survivor compensation.

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e 22 EXHIBIT 4FEDERAL, STATE, AND LOCAL GOVERNMENT SPENDING ON EDUCATION: 2010 ($ billions) Source: U.S. Department of Commerce, Bureau of Economic Analysis, National Income and Product Accounts Table , Washington, D.C., September, 2011.

Exhibit 4: Federal, State, and Local Government Spending on Education: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 23 1.True or false: Total education spending is dominated by expenditures on elementary and secondary education. True. Elementary and secondary education consumes nearly three-quarters of the total education budget.

Exhibit 4: Federal, State, and Local Government Spending on Education: 2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 24 2.True or false: The federal government provides financial support for higher education, but not for primary or secondary education. False. The federal government provides some financial assistance at all levels.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 25 1.The highway system along accounted for what percentage of transportation spending: a.26.2 percent b.75.6 percent c.Over 90 percent

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 26 1.The highway system along accounted for what percentage of transportation spending: a.26.2 percent b.75.6 percent c.Over 90 percent

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 27 2.Which of the following has the smaller percentage of total government spending: a.Transportation b.Conservation and natural resources

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 28 2.Which of the following has the smaller percentage of total government spending: a.Transportation b.Conservation and natural resources

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 29 Other than telecommunications, there has been relatively little commercial motive for space travel. Federal spending on space exploration was $15.3 billion in 2004.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 30 3.What common denominator is there for government spending on security, education, transportation, natural resources, energy, and space? For each of these, the target population of beneficiaries is everyone.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 31 In contrast, agricultural subsidies are targeted at benefiting farmers, and public assistance programs are targeted at benefiting the poor and needy.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 32 Welfare Government-provided assistance—cash payments and goods and services—to the poor, the elderly, and the disabled. Eligibility is based principally on income and size of family.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 33 Until recently, eligibility for welfare was linked to single-parent families (Aid to Families with Dependent Children, AFDC) and to the sick or disabled (Supplemental Security Income Program, SSI).

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 34 Eligibility for AFDC and SSI meant entitlement, with no time limit specified.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 35 4.What new welfare program was created in 1996 and abolished AFDC? Temporary Assistance for Needy Families (TANF).

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 36 The new TANF program is not an entitlement. Welfare recipients must participate in work activities within two years of receiving welfare or risk losing it.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 37 In addition, a family is only eligible for a lifetime total of five years of welfare benefits.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 38 Food stamp program An aid program that provides low-income people with stamps that can be redeemed for food and related items.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 39 Medicaid A health care program administered through Social Security that is applicable to low- income and disabled people.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 40 Social Security A social insurance program that provides benefits, subject to eligibility, to the elderly, disabled, and their dependents.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 41 5.Which of the following are true about Social Security: a.It is compulsory. b.Everyone receives the same level of benefits. c.Your contributions are saved in an individual account that you can invest in stocks or bonds.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 42 5.Which of the following are true about Social Security: a.It is compulsory. TRUE b.Everyone receives the same level of benefits. FALSE c.Your contributions are saved in an individual account that you can invest in stocks or bonds. FALSE

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 43 6.What is the purpose of Medicare? Its purpose is to reduce the financial burden of illness on the elderly.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 44 7.How are Social Security and Medicaid funded? Social Security and Medicaid are pay-as-you- go programs that are financed through payroll taxes. The revenues go in to a trust fund from which benefits are paid out.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 45 8.With the proportion of elderly in the U.S. population growing, what are the future prospects for Social Security and Medicaid? As pay-as-you-go programs financed through payroll taxes, they are at risk because benefit demands are growing relative to the pool of working-age people paying the taxes to support the programs.

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e 46 EXHIBIT 5SOCIAL SECURITY EXPENDITURES AS A PERCENTAGE OF GDP FOR SELECTED ECONOMIES: 2006 Source: International Monetary Fund, Government Financial Statistics Yearbook, 2007.

Exhibit 5: Social Security Benefits as a Percentage of GDP for Selected Economies: 2006 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e Among the other rich industrialized countries listed in Exhibit 6, how does the U.S. rank in terms of Social Security benefits as a percentage of GDP? Social Security as a percentage of GDP is 2nd lowest (among those listed) in the United States.

Exhibit 5: Social Security Benefits as a Percentage of GDP for Selected Economies: 2006 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 48 2.What conclusions might one draw from Exhibit 6? Social Security is much less of a burden on the U.S. economy relative to many comparable industrialized countries.

How Much Does Government Spend? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 49 As of 2007 the U.S. paid $411.1 billion in interest on a debt that reached $9 trillion. 9.Since the 1980s, the public debt has grown considerably. How much did the U.S. spend in 2007? How large was the debt?

Is the Level of Government Spending Too High? © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 50 After learning about the different elements of government budgets, it becomes evident that wholesale cuts in government spending are difficult to advocate.

Discretionary Versus Mandatory Expenditures © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 51 A mandatory expenditure is an obligation undertaken by government that is fixed by law and cannot be summarily altered. Discretionary expenditures carry no such obligation and can be changed at the government’s will.

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e 52 EXHIBIT 6 Percent of Federal Budget Reflecting Discretionary and Mandatory Expenditures: 1970–2010 Source: The Budget for Fiscal Year 2011, Historical Tables, U.S. Printing Office, February, 2010

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e 53 EXHIBIT 7GOVERNMENT SPENDING: 1970–2010 ($ BILLIONS 2005) Source: Economic Report of the President, (Washington, D.C.: U.S. Department of Commerce, 2011).

Exhibit 6: Government Spending: 1970–2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 54 What has been the trend in the ratio of total government spending to GDP since 1970? It has more than tripled.

Exhibit 6: Government Spending: 1970–2010 © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 55 What has been the trend in the ratio of total government spending to GDP since 1970? The ratio of total government spending to GDP was 33.8 in 2001.

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e 56 EXHIBIT 8GOVERNMENT SPENDING AS A PERCENTAGE OF GDP: 1981–2010 Source: Organisation for Economic Co-operation and Development, calendar year data.

Exhibit 8: Government Spending as a Percentage of GDP © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 57 1.Of the countries shown in Exhibit 8, what has happened to the percentage of government spending to GDP since 1993? All have gone down slightly.

Government Spending and Resource Allocation © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 58 A key distinction between government spending and transfer payments is that government spending takes resources away from production of private goods.

Government Spending and Resource Allocation © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 59 In contrast, transfer payments shift spending from one group of people to another, and do not take resources away from production of private goods.

Government Spending and Resource Allocation © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 60 The purchase of private goods and services funded by transfer payments substitutes for the taxpayers’ purchase of private goods and services.

Government Spending and Resource Allocation © 2013 Cengage Learning Gottheil — Principles of Economics, 7e 61 Aside from transfer payments, government spending represents approximately 15 percent of GDP.