Chapter 1

Individuals and Government

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Public Finance
 Public finance is the field of economics
that studies government activities and the
alternative means of financing government
expenditures.

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Government
 Governments are organizations formed to
exercise authority over the actions of
persons who live together in a society and
to provide and finance essential services.

3
Political Institutions
 Political Institutions are rules and generally
accepted procedures that evolve for
determining what government does and
how government outlays are financed.

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 Examples of Political Institutions
 Majority rule
 Representative government

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The Allocation between Private
and Government Resources
 Private
 Food
 Housing
 Cars
 Clothing
 Government
 National Defense
 Public Schools
 Police

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Figure 1.1 A Production-Possibility Frontier
C
Government Goods and
B
Services per Year G2

G1 A

0 X2 X1 M
Private Goods and Services per Year
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Distribution of Government
Goods and Services

 Nonmarket rationing:
 Prices and willingness to pay those prices are
not applicable to goods like national defense.

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The Mixed Economy: Markets
and Politics

 Pure Market Economy

 Virtually all goods and services are supplied by for-
profit private firms.
 Supply and demand determine price.
 Mixed Economy
 A mixed economy is one in which government
supplies a considerable amount of goods and services
and regulates private economic activity.

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Figure 1.2 Circular Flow in the Mixed Economy
Goods & Services Goods & Services
Output
Market
Dollars Dollars

Income Support
& Subsidies Subsidies
Taxes, fees, charges Taxes, fees, charges
Households Government Services
Government Government Services
Firms

Dollars Input Dollars

Market
Resources Resources
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Government Expenditures in the
United States
 Government purchases of
 labor
 land
 capital

 Government Transfer Payments

 Welfare
 Social Security

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Growth in Government Expenditures

Table 1.1 (abbreviated)

Year GDP Federal State Total Percentage
Government and Local Government of GDP
Government Total

1930 91.3 2.5 7.5 10.0 10.95

1945 223.0 84.7 8.5 93.2 41.79

1960 527.4 85.8 34.1 119.9 22.73

1975 1635.2 345.4 152.1 497.5 30.42

2002 10442.1 2073.9 1050.9 3124.8 29.93

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 International Comparisons
Country Government Current Expenditures
as a Percentage of GDP 2001

Denmark 49.1
France 48.8
Germany 45.1
United Kingdom 39.4
Japan 38.1
Canada 36.7
United States 31.9
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Figure 1.3 Total Government Expenditure as a
Percentage of GDP 1929-2002

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Structure of Federal Government
Expenditures

 Purchases of Goods and Services

 Transfer Payments
 Grants in Aid to State and Local
Governments
 Net Interest Paid

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 Federal Expenditure by Category,
2002
Table 1.2

Category Percentage of Total Federal

Expenditures
Transfer Payments 44.9

Purchases 28.2

Interest 14.7

Grants to State and Local 10.0

Other 2.2
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Figure 1.4 The Distribution of Federal Expenditure,
1966-2002

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Federal Government Expenditures by Function

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The Structure of State and Local Government
Expenditures in the United States

 Education
 Civilian Safety
 Transportation
 Executive, Legislative, and Judicial
 Income Security
 Health and Hospitals
 Recreational and Cultural Activities
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State and Local Government Expenditures

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Financing Government
Expenditures in the US
 Taxes:
 Income (Corporate and Personal)
 Payroll
 Excise
 Customs

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Federal Revenues

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State and Local Government Revenues

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State Budget Crunch of 2002
 37 states were forced to reduce their budgets.
 Revenues were typically 10% less than anticipated.
 States with the most severe deficits:
 AK, AZ, CA, NY, NC, OK, OR, VA, and WA
 Causes
 Cuts in taxes on business and individuals in the 1990s
 No sales tax collections on services
 Growth in costs of Medicaid

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Implications of a
Graying America
 Social Security
 In 2008 baby-boomers start to retire and collect
 The ratio of workers to retiree falls
 Medicare
 Health care inflation is substantially higher than
overall inflation
 Medicaid
 Increased use of long-term care for baby-boomers

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How Much Government is
Enough?
 The question of how much government is
enough is an important one in any society. It
is the tradeoff between public and private
goods. When government gets bigger, its
increased involvement comes at the expense
of less private consumption.

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