1. Copyright © 2005 Pearson Education Canada Inc.10-1 Chapter 10 The Public Sector

2. Copyright © 2005 Pearson Education Canada Inc.10-2 Learning Objectives 10.1Explain externalities and the four other economic functions of government. 10.2Describe the two main political functions of government and how decision making differs depending on whether the individual is in the public or private sector.

3. Copyright © 2005 Pearson Education Canada Inc.10-3 Learning Objectives 10.3Distinguish between average and marginal tax rates and explain the Canadian tax system.

4. Copyright © 2005 Pearson Education Canada Inc.10-4 Externalities and Other Economic Functions of Government Market Failure  A situation in which an unrestrained market economy leads to too few or too many resources going to a specific economic activity.  A strong argument in favour of government intervention.

5. Copyright © 2005 Pearson Education Canada Inc.10-5 Externalities and Other Economic Functions of Government Externalities  Occur when the consequence of an economic activity spills over to affect third parties. Third Parties  Parties who are not directly involved in a given activity or transaction.

6. Copyright © 2005 Pearson Education Canada Inc.10-6 S2S2 Externalities and Other Economic Functions of Government S1S1 D Price of Steel per Tonne P1P1 E Q1Q1 With external costs: 1) Residents incur cost of pollution 2) Supply = S 1 A Q2Q2 P2P2 E1E1 Without external costs: 1) Steel mill pays the the cost of pollution 2) Supply shifts to S 2 Quantity of Steel per Year

7. Copyright © 2005 Pearson Education Canada Inc.10-7 Externalities and Other Economic Functions of Government Price of Flu Shots Quantity of Flu Shots per Year P1P1 Q1Q1 E S D1D1 P2P2 Q2Q2 E1E1 D2D2 Without external benefits: 1) Too few influenza shots are given 2) Demand = D 1 With external benefits: 1) More shots are given at a higher price 2) Demand shifts to D 2

8. Copyright © 2005 Pearson Education Canada Inc.10-8 Externalities and Other Economic Functions of Government With external costs, price is too low and quantity too high and third parties bear part of the costs. Without external costs, consumers buying the product bear the total cost of production and reduce consumption.

9. Copyright © 2005 Pearson Education Canada Inc.10-9 Externalities and Other Economic Functions of Government Correcting for Negative Externalities Special taxes commensurate with the cost to the third parties Regulations to determine maximum allowable production

10. Copyright © 2005 Pearson Education Canada Inc.10-10 Externalities and Other Economic Functions of Government Correcting for Positive Externalities Special financing for the production of the product Subsidies to the consumer/business of the good or service Regulations to require greater production

11. Copyright © 2005 Pearson Education Canada Inc.10-11 Externalities and Other Economic Functions of Government The Other Economic Functions of Government Providing a Legal System  Defining and protecting property rights Promoting Competition  Market failure may occur if markets are not competitive  Monopoly power  Anticombines legislation

12. Copyright © 2005 Pearson Education Canada Inc.10-12 Externalities and Other Economic Functions of Government Providing Public Goods  Goods to which the principle of rival consumption does not apply. The use of a good is exclusive to the people who purchase or rent it.  Free Rider Problem Some individuals take advantage of the fact that others will shoulder the burden of paying for public goods.

13. Copyright © 2005 Pearson Education Canada Inc.10-13 Externalities and Other Economic Functions of Government Ensuring Economywide Stability  Three goals of the federal government: Full employment Price stability Economic growth

14. Copyright © 2005 Pearson Education Canada Inc.10-14 The Political Functions of Government Merit Goods  Goods deemed socially desirable through the political process museums ballet concerts  Provided through subsidization

15. Copyright © 2005 Pearson Education Canada Inc.10-15 The Political Functions of Government Demerit Goods  Goods deemed socially undesirable through the political process cigarettes gambling illegal drugs  Controlled by prohibition and taxation

16. Copyright © 2005 Pearson Education Canada Inc.10-16 The Political Functions of Government Income Redistribution  Transfer Payments Payments for which no goods or services are rendered oold age security owelfare oemployment insurance benefits

17. Copyright © 2005 Pearson Education Canada Inc.10-17 The Political Functions of Government Income Redistribution  Transfers in Kind Payments in actual goods and services for which no goods or services are concurrently rendered in return ohealth care opublic housing

18. Copyright © 2005 Pearson Education Canada Inc.10-18 The Political Functions of Government Collective Decision Making: The Theory of Public Choice Collective Decision Making  How voters, politicians, and other interested parties act and how these actions influence nonmarket transactions

19. Copyright © 2005 Pearson Education Canada Inc.10-19 The Political Functions of Government Similarities in Market and Public-Sector Decision Making 1) Individuals motivated by self-interest 2) Scarcity and opportunity cost 3) Competition

20. Copyright © 2005 Pearson Education Canada Inc.10-20 The Political Functions of Government Similarities in Market and Public-Sector Decision Making 4) Similarity of individuals and incentives Incentive Structure oThe system of rewards and punishments individuals face with respect to their actions

21. Copyright © 2005 Pearson Education Canada Inc.10-21 The Political Functions of Government Differences Between Market and Collective Decision Making 1) Government (political) goods at zero price Goods (and services) provided by the public sector 2) Use of force

22. Copyright © 2005 Pearson Education Canada Inc.10-22 The Political Functions of Government Differences Between Market and Collective Decision Making 3) Voting versus spending Political system oOne person gets one vote Market system oThe dollars one spends count as votes

23. Copyright © 2005 Pearson Education Canada Inc.10-23 The Political Functions of Government Differences Between Market and Collective Decision Making 3) Voting versus spending Political system oRun by majority rule Market system oRun by proportional rule

24. Copyright © 2005 Pearson Education Canada Inc.10-24 The Political Functions of Government Differences Between Market and Collective Decision Making 3) Voting versus spending Spending of dollars can indicate intensity of want Votes cannot

25. Copyright © 2005 Pearson Education Canada Inc.10-25 The Political Functions of Government Bureaucrats  Nonelected government officials who are responsible for the day-to-day operation of government and the observance of its regulations and laws.

26. Copyright © 2005 Pearson Education Canada Inc.10-26 The Political Functions of Government Rational Ignorance  Voters choose to ignore costs and benefits of many decisions. Benefits of obtaining information about a decision are far less than the cost of obtaining the information.

27. Copyright © 2005 Pearson Education Canada Inc.10-27 Tax Rates and the Canadian Tax System

28. Copyright © 2005 Pearson Education Canada Inc.10-28 Tax Rates and the Canadian Tax System Taxation Systems  Proportional Taxation (flat-rate tax) Marginal tax rate = Average tax rate Everyone pays the same percentage of their income in taxes

29. Copyright © 2005 Pearson Education Canada Inc.10-29 Tax Rates and the Canadian Tax System Taxation Systems  Progressive Taxation Marginal tax rate > Average tax rate As a person’s taxable income increases, the percentage of income paid in taxes increases

30. Copyright © 2005 Pearson Education Canada Inc.10-30 Tax Rates and the Canadian Tax System Taxation Systems  Regressive Taxation Marginal tax rate < Average tax rate As a person’s taxable income increases, the percentage of income paid in taxes decreases

31. Copyright © 2005 Pearson Education Canada Inc.10-31 Tax Rates and the Canadian Tax System Arguments for the Progressive Tax  Redistribution of Income  Ability to Pay  Benefits Received

32. Copyright © 2005 Pearson Education Canada Inc.10-32 Tax Rates and the Canadian Tax System Who Really Pays the Corporate Income Tax?  Tax Incidence (the distribution of tax burdens among various groups in society) Consumer Stockholder Employees

33. Copyright © 2005 Pearson Education Canada Inc.10-33 Tax Rates and the Canadian Tax System

34. Copyright © 2005 Pearson Education Canada Inc.10-34 Tax Rates and the Canadian Tax System

35. Copyright © 2005 Pearson Education Canada Inc.10-35 Tax Rates and the Canadian Tax System Federal Spending

36. Copyright © 2005 Pearson Education Canada Inc.10-36 Tax Rates and the Canadian Tax System Provincial and Municipal Spending