Government Interactions with the Economy

Government Interactions with the Economy

1) Negative Externalities- external costs lead to an over allocation of resources to the specific economic activity. There are 2 possible ways of correcting these overspills:

Ð'* Taxation- the government can demand an effluent fee, which is a charge to a polluter that gives the right to discharge into the air or water a certain amount of pollution.

Ð'* Regulation- the government could specify a maximum allowable rate of pollution. This would require the installation of pollution abatement equipment in its rate of output, or some combination of the 2. Finally, the government would need to determine the appropriate level of pollution as well as measuring the pollutants emitted to enforce such a regulation.

2) Positive Externalities- external benefits result in an under allocation of resources to the specific activity. There are 3 possible government corrections:

Ð'* Government Financing & Production- the government may choose to finance the desired additional production facilities so the right amount of the good will is produced.

Ð'* Subsidies- a negative tax made payable to a business or to a consumer when the business produces or the consumer buys a good or service. Reduction of the net price to a consumer causes larger quantities to be demanded.

Ð'* Regulation- the government can require by law that the individuals in the society undertake a certain action.

3) Providing a Legal System- all relationships among consumers and businesses are governed by the legal rules of the game. The government is in charge of settling disputes within the economy, and often imposes penalties for violations of legal rules.

Ð'* Property Rights- the rights of an owner to use and to exchange property. Much of our legal system is involved with defining and protecting these rights.

4) Promoting Competition- one of the roles of government is to serve as the protector of a competitive economic system.

Ð'* Antitrust Legislation- laws that restrict the formation of monopolies and regulate certain anticompetitive business practices. The Antitrust Diversion of the Department of Justice and the Federal Trade Commission attempt to enforce these antitrust laws.

Ð'* Monopoly- firms that have great control over the price of the goods they sell. In the extreme case, a monopoly is the only seller of a good or service. Reduction in the power of monopolies is the direct aim of antitrust legislation.

5) Providing Public Goods- goods for which the principal of rival consumption does not apply; they can be jointly consumed by many individuals simultaneously at no additional cost and with no reduction in quantity. Also no one who fails to help pay for the good can be denied the benefit of the good

Ð'* Private goods- goods that can be consumed by only one individual at a time. Private goods are subject to the principal of rival consumption.

Ð'* Principal of rival consumption- the recognition that individuals are rivals in consuming private goods because one person's consumption reduces the amount available for others to consume.

Ð'* Exclusion principal- the principal that no one can be excluded from the benefits of a public good, even if that person has not paid for it.

Ð'* True public goods must necessarily be provided by the government. However, this in no way implies you can categorize something as a public good simply because the government provides it.

Ð'* Free-rider problem- arises when individuals presume that others will pay for public goods so that individually they can escape paying for their portion without causing a reduction.

6) Ensuring economy wide stability- facing the problems of unemployment and rising prices, the government tries