The%20Role%20of%20Government%20in%20the%20Economy

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The Role of Government in the Economy
2
Historical Connections

• As Canada entered the 21st Century, government
  involvement continued to attract controversy.
• Both federal and provincial governments continued
  to scale back involvement in the economy and in
  turn began to dismantle the social welfare
  safety net that distinguished Canada among
  industrialized nations.
• Privatization and deregulation led to more
  economic freedom and responsibility for
  individuals and groups.

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Historical Connections

• The Great Depression
• Among industrialized countries, few human
  tragedies parallel he pain and suffering
  inflicted by the Great Depression in the 1930s.
• In Canada, unemployment soared to 20 and
  production levels dropped 37. Canada was
  arguably the nation that suffered the most.
• Why? (see article)

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• Up to this point most glitches in the economic
  system seemed to correct itself but now this
  economic tragedy persisted and no end was in
  sight.
• By 1933 it was clear that something radically had
  to be done in order to prevent this disaster from
  becoming worse.

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• To combat this, a British economist by the name
  of John Maynard Keynes, suggested that
  governments spend their way out of the Depression
  by hiring unemployed workers for major public
  works projects.
• His plan worked as the workers spent their wages
  which stimulated economic activities in the
  private sector.
• Keynes plan, along with the beginning of WWII
  led the way for the Canadian economy to return to
  full employment.

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• So why do governments become involved in the
  operation of the market?
• To answer this we have to further consider the
  writings and theories of Adam Smith.
• He believed that the free-market system would
  channel selfish, egoistic motives toward the
  betterment of society.
• The term invisible hand was introduced to
  describe the effect that a free-market economic
  system has on directing the self-interests of
  individuals toward a common goal.

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The Invisible Hand
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• He wrote about how the free-market will tend to
  allocate resources to their most efficient use.
• For example, if you start a business and you are
  not successful than that means that not enough
  consumers want your product.
• If enough people buy your product you will earn a
  living, your welfare increases and so does that
  of your customers.

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• If you are successful at your business this will
  attract competition.
• In order to continue to sell your product or
  service it will be necessary that you make your
  good or service more attractive.
• This can be done by lowering prices or improving
  the quality of the product or service.

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Possible Shortcomings of a Free-Market System

• Leading to the Great Depression some deficiencies
  lead to more governmental intervention.
• Market Imperfections
• Consumers and suppliers may not have satisfactory
  information with which to make decisions.
• Advertising often helps to fill this gap although
  more often than less it is meant to persuade
  rather than inform.

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Market Imperfections

• Health standards, government building codes,
  Industry Canada and Service Canada are designed
  to fill these gaps.

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Market Imperfections

• Market Imperfections
• The second imperfection in the marketplace is
  lack of effective competition.
• 2. The marketplace does not always create
  sufficient competition.
• If new firms are prevented from entering the
  industry then there would be higher prices and
  lower quantity of product.

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Market Imperfections

• Under the Competition Act it is illegal for firms
  to get together and fix prices, or sell a product
  at a loss to eliminate competitors, or for
  manufacturers to refuse to sell to retailers who
  do not charge a set price for the product.
• In situations where natural monopolies arise it
  is inefficient to have more than one firm supply
  a product or service. The government either
  provides the service or regulates the company
  that provides the service.
• ex) NB Power, ulilities such as gas, water,
  electricity, phone, and cable

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Shortcomings - Third Party Effects

• A market transactions may affect someone other
  than the buyer and seller, this third-party may
  be affected in a positive or negative manner.
• Government action, either in the form of a tax or
  the requirement to install new equipment, may be
  implemented when there is a negative third-party
  effect, such as polluting a river during
  production of paper.

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Third-Party Effects

• In a truly Free Market the people and environment
  in the surrounding area will suffer if the mill
  is allowed to operate without any environmental
  regulations. This is an additional cost or
  effect.
• Govt. will step in in these situations to impose
  taxes or restrictions that shifts the supply
  curve due to increased costs and therefore a
  higher equilibrium price.

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Third-Party Effects

• Govt. response to negative third-party effects.

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Third-Party Effects

• A product with a positive third-party effect is
  either subsidized by the government thus
  increasing supply or paid for on behalf of
  consumers thus increasing demand.

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Unmet Public Goods

• The market may not be able to provide a number of
  goods and services that are important to society
  such as national defense, policy protection or
  water supply.
• The benefits from these services are spread over
  such a large segment of the population that it is
  difficult to charge a fee for their use based on
  the benefits received.
• These unmet public goods are provided by the
  government or contracted out to private
  companies.

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Shortcomings

• Unmet Public Goods describes those goods and
  services not provided by the Free Market System
  due to the difficulty of charging a fee to the
  beneficiary of the good or service.

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Everyday Economics

• Read Privatization found on page 92 of the text
  book and answer questions 1-5. Be sure to chat
  with your classmates about the questions to get a
  variety of perspectives.

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Shortcomings

• Distribution of Income
• One of the main advantages of the free-market
  system is competition, competition among
  businesses and individuals.
• In the pursuit of earning an income, individuals
  compete with each other for jobs.
• If a person is unable to compete in a free-market
  system, he or she will not be able to earn an
  income. In these situations the government has
  intervened in order to achieve a more equitable
  distribution of income.

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Shortcomings

• Social welfare programs, such as assistance to
  the elderly and disabled, and employment
  insurance, are financed with a progressive income
  tax.
• Income differentials in Canada would not be a
  serious problem if every Canadian earned enough
  money to meet his or her basic needs.
• Poverty is defined in terms of a minimum income
  necessary for an individual or family.

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Shortcomings

• The presence of regional income differences has
  prompted the federal government to transfer tax
  dollars in the form of equalization payments to
  the lower-income provinces and to undertake
  economic development projects.
• In Canada social-welfare spending accounts for
  the largest portion of all federal government
  spending and approximately one-fifth of all
  provincial and local government spending.

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Economic Stabilization

• Classical economists believed that fluctuations
  in economic growth, employment, and prices were
  temporary and the free-market system would make
  adjustments to return to a period of more stable
  economic activity.
• The Great Depression changed this attitude of
  many policy makers. The adjustments of government
  spending and tax policy to economic conditions is
  know as fiscal policy.

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Impact of Govt. Intervention

• Price Ceilings
• A price ceiling is a government imposed maximum
  price.
• It is used when the government believes that the
  equilibrium price established in the market is
  too high and many people feel that they cannot
  afford to buy the product.

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• It is illegal to set a price above a price
  ceiling, as a result a shortage occurs.
• A subsidy may be offered to the seller or the
  product must be rationed to eliminate the
  shortage. The result of this subsidy would be a
  shift to the right in the supply curve.

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• Price Floors
• A price floor is a government imposed minimum
  price.
• It is illegal to set a price below a price floor.
  as a result a surplus occurs.
• A limit on the quantity produce is one method
  used to eliminate a surplus.
• Another method is to shift the demand to the
  right through advertising which may cause
  increased interest in the product or service.

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• Excise Taxes
• An excise tax is one levied by government on the
  suppliers of certain products.
• Excise tax on liquor and tobacco is a source of
  revenue for the government.
• Excise tax on air conditioners in automobiles is
  meant to reduce the sales of air conditioners for
  environmental reasons.

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• Price elasticity of demand and supply determine
  the incidence of tax, or who bears the larger
  burden of the tax.
• If the demand is more inelastic than supply than
  the consumer bears the larger burden of the tax,
  and vice versa.
• If the government wants to raise tax revenue it
  will tax a product which has an inelastic demand.
• If the government wants to reduce consumption
  than it will tax a product which has an elastic
  demand.

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• To clarify an confusion with excise taxes take a
  look at the Everyday Economics reading on page
  106-107. Answer questions 1,2,3

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Review Questions

• Pg. 109 1,2,5,7,8,17,22,23,25