1. The Free Enterprise System
Unit 7

2. Government and the Economy
Chapter 23

3. 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

4. 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

5. 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

6. 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)

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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)

13. 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

14. 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

15. 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

16. 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

17. 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

18. Money and Banking
Chapter 24

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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

29. 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

30. 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

31. Government Finances
Chapter 25

32. 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

33. 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

34. 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

35. 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

36. 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

37. 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

38. 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

39. 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

40. 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

41. 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

42. 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

43. 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

44. 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

45. 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