what is the role of government in the economy essay

The Government's Role in the Economy

Using Fiscal and Monetary Policies to Regulate Economic Activity

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• U.S. Economy
• Supply & Demand
• Archaeology
• Ph.D., Business Administration, Richard Ivey School of Business
• M.A., Economics, University of Rochester
• B.A., Economics and Political Science, University of Western Ontario

In the narrowest sense, the government's involvement in the economy is to help correct market failures or situations in which private markets cannot maximize the value that they could create for society. This includes providing public goods, internalizing externalities (consequences of economic activities on unrelated third parties), and enforcing competition. That being said, many societies have accepted a broader involvement of government in a capitalist economy .

While consumers and producers make most of the decisions that mold the economy, government activities have a powerful effect on the U.S. economy in several areas.

Promoting Stabilization and Growth

Perhaps most important, the federal government guides the overall pace of economic activity, attempting to maintain steady growth, high levels of employment, and price stability. By adjusting spending and tax rates (known as fiscal policy) or managing the money supply and controlling the use of credit (known as monetary policy ), it can slow down or speed up the economy's rate of growth and, in the process, affect the level of prices and employment.

For many years following the Great Depression of the 1930s, recessions —periods of slow economic growth and high unemployment often defined as two consecutive quarters of decline in the gross domestic product, or GDP—were viewed as the greatest of economic threats. When the danger of recession appeared most serious, the government sought to strengthen the economy by spending heavily itself or by cutting taxes so that consumers would spend more, and by fostering rapid growth in the money supply, which also encouraged more spending.

In the 1970s, major price increases, particularly for energy, created a strong fear of inflation , which is an increase in the overall level of prices. As a result, government leaders came to concentrate more on controlling inflation than on combating recession by limiting spending, resisting tax cuts, and reining in growth in the money supply.

A New Plan for Stabilizing the Economy

Ideas about the best tools for stabilizing the economy changed substantially between the 1960s and the 1990s. In the 1960s, the government had great faith in fiscal policy, or the manipulation of government revenues to influence the economy. Since spending and taxes are controlled by the president and the Congress, these elected officials played a leading role in directing the economy. A period of high inflation, high unemployment , and huge government deficits weakened confidence in fiscal policy as a tool for regulating the overall pace of economic activity. Instead, monetary policy—controlling the nation's money supply through such devices as interest rates—assumed a growing involvement.

Monetary policy is directed by the nation's central bank, known as the Federal Reserve Board, which has considerable independence from the president and the Congress. The "Fed" was created in 1913 in the belief that centralized, regulated control of the nation’s monetary system would help alleviate or prevent financial crises such as the  Panic of 1907 , which started with a failed attempt to corner the market on the stock of the United Copper Co. and triggered a run on bank withdrawals and the bankruptcy of financial institutions nationwide.

• Conte, Christopher and Albert Karr.  Outline of the U.S. Economy . Washington, D.C.: U.S. Dept. of State.
• Fiscal Policy in the 1960s and 1970s
• Comparing Monetary and Fiscal Policy
• The 1980s American Economy
• American Economy of the 1990s and Beyond
• What Is Fiscal Policy? Definition and Examples
• Economic Stagflation in a Historical Context
• Microeconomics Vs. Macroeconomics
• Learn the Definition What Is Okun's Law in Economics
• The Quantity Theory of Money
• Liquidity Trap Defined: A Keynesian Economics Concept
• Are Wars Good for the Economy?
• How Money Supply and Demand Determine Nominal Interest Rates
• Understanding How Budget Deficits Grow During Recessions
• A Mixed Economy: The Role of the Market
• The Importance of Monetary Policy

Functions of government in an economy Essay

Introduction, economic functions of the government, reference list.

Government is defined as a particular group of people controlling a nation at a particular time and in which their manner of administration is structured while economy constitutes how government organizes labor, capital and land to produce goods and services in a country (Bennett, 1998) Government role in an economy is how the organizes factors of production to create goods and services in a country (Dollery, 2006).

The government has several economic responsibilities to achieve to enhance prosperity of a country. First, the government provides legal and social frame in controlling business activities in the country. This is achieved through enactment of laws protects private ownership of property and enforcement of contracts regarding business transactions (Hill, 1982).

In addition, the government uses the police force to maintain law and order resulting to security of workers and firms within an area. They also inspect and maintain a system of standards for measuring and weighing products thus ensuring transparency in trade (Giersch, 1988). Secondly, the government maintains competition in the market by controlling monopoly and enacting antitrust laws that prevent businesses from merging into so as to control and set market prices (Bennett, 1998)

Similarly, the government plays a major role in redistribution of income in the country, since impersonal market that tends to favor given producers or traders, the government intervenes through progressive tax system thus reducing the disposable income on citizens who might have adopted high standards living due to high level of income (Giersch, 1988).

Secondly, the government redistributes income through market intervention by modifying the prices of goods and services that would have been higher when established through market forces of demand and supply (Hill, 1982). For example, the government could provide farmers with above market-prices of farm outputs to stabilize the market price and increase their income (Bennett, 1998)

In addition, the government puts mechanisms to cover spillover costs that entail the production or consumption of goods or services that are inflicted on individuals without the proper compensation such as environmental pollution that is likely to affect the lives of residents (Bennett, 1998)Moreover, the government ensures economic stability of a country by adjusting its spending and taxation or increasing spending on public goods thus maintaining strong economic value of the currency (Zeckhauser,1983).

Stabilization of the economy reduces inflation country thus controlling unemployment and price level as the government adjusts spending and tax rates to slow down or speed up economic growth rate (Giersch, 1988). The government then formulates a policy that emphasizes on supply of money and interest rates through the budget and provides goods and services which the private individuals are not willing to venture in or those threatening national security such as production of atomic bombs Dollery, 2006).

The government takes care of the needs beyond the reach of market forces of demand and supply through provision of services and enactment of rules and regulations that encourages investments in a country (Bennett, 1998).This leads to mass-production in the industrial sector leading to high economic growth and improved standard of living since many countries adopted liberal market economy (Dollery, 2006).

Bennett.D. (1998). Multicultural states: rethinking difference and identity ‎.Sidney :HarperCollins Publishers Australia

Dollery .B. (2006). Australian local government economics‎ Brian . Sidney: Macmillan Publishers

Fan. Q. (2009) “Innovation for development and the role of government ” New York: St. Martin’s Publishers.

Giersch .H. (1988) “ Reassessing the Role of Government in the Mixed Economy ” New York: Oxford University press.

Hill.L. (1982) “ Role of government in a market economy” New York: Oxford University press

Zeckhauser.A. (1983) “What Role for Government? Lessons from Policy Research” New Jersey: John Wiley and Sons.

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Bibliography

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• Is Facebook Making Us Sad: Emotions and Spillover Effects
• European Integration: Neo-Functionalism of the 1960s
• The Work of Art in the Age of Mechanical Reproduction by Walter Benjamin as a Claim for Originality
• “Questions for Free-Market Moralists” by Srinivasan
• Anubis Weighing Heart in Religion
• Income Distribution and Redistribution
• Poor Segments of Population: Tax Cuts Effects
• Addressing Failure When Enacting Change
• Compare and Contrast the Services Contract Act of 1965, the Davis Bacon Act and the Walsh Healey Act
• American Political Parties in the Late Nineteenth Century
• Executive and legislative structures
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• Problems of the Poorest People, Capital Flight, and Migration

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15.1 The Role of Government in a Market Economy

Learning objectives.

• Discuss and illustrate government responses to the market failures of public goods, external costs and benefits, and imperfect competition and how these responses have the potential to reduce deadweight loss.
• Define merit and demerit goods and explain why government may intervene to affect the quantities consumed.
• Discuss ways in which governments redistribute income.

What do we want from our government? One answer is that we want a great deal more than we did several decades ago. The role of government has expanded dramatically in the last 75+ years. In 1929 (the year the Commerce Department began keeping annual data on macroeconomic performance in the United States), government expenditures at all levels (state, local, and federal) were less than 10% of the nation’s total output, which is called gross domestic product (GDP). In the current century, that share has more than tripled. Total government spending per capita, adjusted for inflation, has increased more than six fold since 1929.

Figure 15.1 “Government Expenditures and Revenues as a Percentage of GDP” shows total government expenditures and revenues as a percentage of GDP from 1929 to 2007. All levels of government are included. Government expenditures include all spending by government agencies. Government revenues include all funds received by government agencies. The primary component of government revenues is taxes; revenue also includes miscellaneous receipts from fees, fines, and other sources. We will look at types of government revenues and expenditures later in this chapter.

Figure 15.1 Government Expenditures and Revenues as a Percentage of GDP

Government expenditures and revenues have risen dramatically as a percentage of GDP, the most widely used measure of economic activity.

Source: U.S. Department of Commerce, Bureau of Economic Analysis, NIPA Tables 1.15 and 3.1.

Figure 15.1 “Government Expenditures and Revenues as a Percentage of GDP” also shows government purchases as a percentage of GDP. Government purchases happen when a government agency purchases or produces a good or a service. We measure government purchases to suggest the opportunity cost of government. Whether a government agency purchases a good or service or produces it, factors of production are being used for public sector, rather than private sector, activities. A city police department’s purchase of new cars is an example of a government purchase. Spending for public education is another example.

Government expenditures and purchases are not equal because much government spending is not for the purchase of goods and services. The primary source of the gap is transfer payments , payments made by government agencies to individuals in the form of grants rather than in return for labor or other services. Transfer payments represent government expenditures but not government purchases. Governments engage in transfer payments in order to redistribute income from one group to another. The various welfare programs for low-income people are examples of transfer payments. Social Security is the largest transfer payment program in the United States. This program transfers income from people who are working (by taxing their pay) to people who have retired. Interest payments on government debt, which are also a form of expenditure, are another example of an expenditure that is not counted as a government purchase.

Several points about Figure 15.1 “Government Expenditures and Revenues as a Percentage of GDP” bear special attention. Note first the path of government purchases. Government purchases relative to GDP rose dramatically during World War II, then dropped back to about their prewar level almost immediately afterward. Government purchases rose again, though less sharply, during the Korean War. This time, however, they did not drop back very far after the war. It was during this period that military spending rose to meet the challenge posed by the former Soviet Union and other communist states—the “Cold War.” Government purchases have ranged between 15 and 20% of GDP ever since. The Vietnam War, the Persian Gulf War, and the wars in Afghanistan and Iraq did not have the impact on purchases that characterized World War II or even the Korean War. A second development, the widening gap between expenditures and purchases, has occurred since the 1960s. This reflects the growth of federal transfer programs, principally Social Security, programs to help people pay for health-care costs, and aid to low-income people. We will discuss these programs later in this chapter.

Finally, note the relationship between expenditures and receipts. When a government’s revenues equal its expenditures for a particular period, it has a balanced budget . A budget surplus occurs if a government’s revenues exceed its expenditures, while a budget deficit exists if government expenditures exceed revenues.

Prior to 1980, revenues roughly matched expenditures for the public sector as a whole, except during World War II. But expenditures remained consistently higher than revenues between 1980 and 1996. The federal government generated very large deficits during this period, deficits that exceeded surpluses that typically occur at the state and local levels of government. The largest increases in spending came from Social Security and increased health-care spending at the federal level. Efforts by the federal government to reduce and ultimately eliminate its deficit, together with surpluses among state and local governments, put the combined budget for the public sector in surplus beginning in 1997. As of 1999, the Congressional Budget Office was predicting that increased federal revenues produced by a growing economy would continue to produce budget surpluses well into the twenty-first century.

That rather rosy forecast was set aside after September 11, 2001. Terrorist attacks on the United States and later on several other countries led to sharp and sustained increases in federal spending for wars in Afghanistan and Iraq, as well as expenditures for Homeland Security. The administration of George W. Bush proposed, and Congress approved, a tax cut. The combination of increased spending on the abovementioned items and others, as well as tax cuts, produced substantial deficits.

The evidence presented in Figure 15.1 “Government Expenditures and Revenues as a Percentage of GDP” does not fully capture the rise in demand for public sector services. In addition to governments that spend more, people in the United States have clearly chosen governments that do more. The scope of regulatory activity conducted by governments at all levels, for example, has risen sharply in the last several decades. Regulations designed to prevent discrimination, to protect consumers, and to protect the environment are all part of the response to a rising demand for public services, as are federal programs in health care and education.

Figure 15.2 “Government Revenue Sources and Expenditures: 2007” summarizes the main revenue sources and types of expenditures for the U.S. federal government and for the European Union. In the United States, most revenues came from personal income taxes and from payroll taxes. Most expenditures were for transfer payments to individuals. Federal purchases were primarily for national defense; the “other purchases” category includes things such as spending for transportation projects and for the space program. Interest payments on the national debt and grants by the federal government to state and local governments were the other major expenditures. The situation in the European Union differs primarily by the fact that a greater share of revenue comes from taxes on production and imports and substantially less is spent on defense.

Figure 15.2 Government Revenue Sources and Expenditures: 2007

The four panels show the sources of government revenues and the shares of expenditures on various activities for all levels of government in the United States and the European Union in 2007.

Sources: Survey of Current Business , July 2008, Tables 3.2 and 3.10.5; Paternoster, Anne, Wozowczyk, Monika, and Lupi, Alessandro, Statistics in Focus—Economy and Finance , Eurostat 23/2008. For EU revenues, “Taxes on production and imports” refers mainly to value-added tax, import and excise duties, taxes on financial and capital transactions, on land and buildings, on payroll, and other taxes on production. In the category “Current taxes on income, wealth, etc.” are taxes on income and on holding gains of households and corporations, current taxes on capital, taxes on international transactions, and payments for licenses. Capital taxes refer to taxes levied at irregular and infrequent intervals on the value of assets, or net worth owned, or transferred in the form of legacies or gifts. Social contributions cover actual amounts receivable from employers and employees.

To understand the role of government, it will be useful to distinguish four broad types of government involvement in the economy. First, the government attempts to respond to market failures to allocate resources efficiently. In a particular market, efficiency means that the quantity produced is determined by the intersection of a demand curve that reflects all the benefits of consuming a particular good or service and a supply curve that reflects the opportunity costs of producing it. Second, government agencies act to encourage or discourage the consumption of certain goods and services. The prohibition of drugs such as heroin and cocaine is an example of government seeking to discourage consumption of these drugs. Third, the government redistributes income through programs such as welfare and Social Security. Fourth, the government can use its spending and tax policies to influence the level of economic activity and the price level.

We will examine the first three of these aspects of government involvement in the economy in this chapter. The fourth, efforts to influence the level of economic activity and the price level, fall within the province of macroeconomics.

Responding to Market Failure

In an earlier chapter on markets and efficiency, we learned that a market maximizes net benefit by achieving a level of output at which marginal benefit equals marginal cost. That is the efficient solution. In most cases, we expect that markets will come close to achieving this result—that is the important lesson of Adam Smith’s idea of the market as an invisible hand, guiding the economy’s scarce factors of production to their best uses. That is not always the case, however.

We have studied several situations in which markets are unlikely to achieve efficient solutions. In an earlier chapter, we saw that private markets are likely to produce less than the efficient quantities of public goods such as national defense. They may produce too much of goods that generate external costs and too little of goods that generate external benefits. In cases of imperfect competition, we have seen that the market’s output of goods and services is likely to fall short of the efficient level. In all these cases, it is possible that government intervention will move production levels closer to their efficient quantities. In the next three sections, we shall review how a government could improve efficiency in the cases of public goods, external costs and benefits, and imperfect competition.

Public Goods

A public good is a good or service for which exclusion is prohibitively costly and for which the marginal cost of adding another consumer is zero. National defense, law enforcement, and generally available knowledge are examples of public goods.

The difficulty posed by a public good is that, once it is produced, it is freely available to everyone. No consumer can be excluded from consumption of the good on grounds that he or she has not paid for it. Consequently, each consumer has an incentive to be a free rider in consuming the good, and the firms providing a public good do not get a signal from consumers that reflects their benefit of consuming the good.

Certainly we can expect some benefits of a public good to be revealed in the market. If the government did not provide national defense, for example, we would expect some defense to be produced, and some people would contribute to its production. But because free-riding behavior will be common, the market’s production of public goods will fall short of the efficient level.

The theory of public goods is an important argument for government involvement in the economy. Government agencies may either produce public goods themselves, as do local police departments, or pay private firms to produce them, as is the case with many government-sponsored research efforts. An important debate in the provision of public education revolves around the question of whether education should be produced by the government, as is the case with traditional public schools, or purchased by the government, as is done in charter schools.

External Costs and Benefits

External costs are imposed when an action by one person or firm harms another, outside of any market exchange. The social cost of producing a good or service equals the private cost plus the external cost of producing it. In the case of external costs, private costs are less than social costs.

Similarly, external benefits are created when an action by one person or firm benefits another, outside of any market exchange. The social benefit of an activity equals the private benefit revealed in the market plus external benefits. When an activity creates external benefits, its social benefit will be greater than its private benefit.

The lack of a market transaction means that the person or firm responsible for the external cost or benefit does not face the full cost or benefit of the choice involved. We expect markets to produce more than the efficient quantity of goods or services that generate external costs and less than the efficient quantity of goods or services that generate external benefits.

Consider the case of firms that produce memory chips for computers. The production of these chips generates water pollution. The cost of this pollution is an external cost; the firms that generate it do not face it. These firms thus face some, but not all, of the costs of their production choices. We can expect the market price of chips to be lower, and the quantity produced greater, than the efficient level.

Inoculations against infectious diseases create external benefits. A person getting a flu shot, for example, receives private benefits; he or she is less likely to get the flu. But there will be external benefits as well: Other people will also be less likely to get the flu because the person getting the shot is less likely to have the flu. Because this latter benefit is external, the social benefit of flu shots exceeds the private benefit, and the market is likely to produce less than the efficient quantity of flu shots. Public, private, and charter schools often require such inoculations in an effort to get around the problem of external benefits.

Imperfect Competition

In a perfectly competitive market, price equals marginal cost. If competition is imperfect, however, individual firms face downward-sloping demand curves and will charge prices greater than marginal cost. Consumers in such markets will be faced by prices that exceed marginal cost, and the allocation of resources will be inefficient.

An imperfectly competitive private market will produce less of a good than is efficient. As we saw in the chapter on monopoly, government agencies seek to prohibit monopoly in most markets and to regulate the prices charged by those monopolies that are permitted. Government policy toward monopoly is discussed more fully in a later chapter.

Assessing Government Responses to Market Failure

In each of the models of market failure we have reviewed here—public goods, external costs and benefits, and imperfect competition—the market may fail to achieve the efficient result. There is a potential for government intervention to move inefficient markets closer to the efficient solution.

Figure 15.3 “Correcting Market Failure” reviews the potential gain from government intervention in cases of market failure. In each case, the potential gain is the deadweight loss resulting from market failure; government intervention may prevent or limit this deadweight loss. In each panel, the deadweight loss resulting from market failure is shown as a shaded triangle.

Figure 15.3 Correcting Market Failure

In each panel, the potential gain from government intervention to correct market failure is shown by the deadweight loss avoided, as given by the shaded triangle. In Panel (a), we assume that a private market produces Q m units of a public good. The efficient level, Q e , is defined by the intersection of the demand curve D 1 for the public good and the supply curve S 1 . Panel (b) shows that if the production of a good generates an external cost, the supply curve S 1 reflects only the private cost of the good. The market will produce Q m units of the good at price P 1 . If the public sector finds a way to confront producers with the social cost of their production, then the supply curve shifts to S 2 , and production falls to the efficient level Q e . Notice that this intervention results in a higher price, P 2 , which confronts consumers with the real cost of producing the good. Panel (c) shows the case of a good that generates external benefits. Purchasers of the good base their choices on the private benefit, and the market demand curve is D 1 . The market quantity is Q m . This is less than the efficient quantity, Q e , which can be achieved if the activity that generates external benefits is subsidized. That would shift the market demand curve to D 2 , which intersects the market supply curve at the efficient quantity. Finally, Panel (d) shows the case of a monopoly firm that produces Q m units and charges a price P 1 . The efficient level of output, Q e , could be achieved by imposing a price ceiling at P 2 . As is the case in each of the other panels, the potential gain from such a policy is the elimination of the deadweight loss shown as the shaded area in the exhibit.

Panel (a) of Figure 15.3 “Correcting Market Failure” illustrates the case of a public good. The market will produce some of the public good; suppose it produces the quantity Q m . But the demand curve that reflects the social benefits of the public good, D 1 , intersects the supply curve at Q e ; that is the efficient quantity of the good. Public sector provision of a public good may move the quantity closer to the efficient level.

Panel (b) shows a good that generates external costs. Absent government intervention, these costs will not be reflected in the market solution. The supply curve, S 1 , will be based only on the private costs associated with the good. The market will produce Q m units of the good at a price P 1 . If the government were to confront producers with the external cost of the good, perhaps with a tax on the activity that creates the cost, the supply curve would shift to S 2 and reflect the social cost of the good. The quantity would fall to the efficient level, Q e , and the price would rise to P 2 .

Panel (c) gives the case of a good that generates external benefits. The demand curve revealed in the market, D 1 , reflects only the private benefits of the good. Incorporating the external benefits of the good gives us the demand curve D 2 that reflects the social benefit of the good. The market’s output of Q m units of the good falls short of the efficient level Q e . The government may seek to move the market solution toward the efficient level through subsidies or other measures to encourage the activity that creates the external benefit.

Finally, Panel (d) shows the case of imperfect competition. A firm facing a downward-sloping demand curve such as D 1 will select the output Q m at which the marginal cost curve MC 1 intersects the marginal revenue curve MR 1 . The government may seek to move the solution closer to the efficient level, defined by the intersection of the marginal cost and demand curves.

While it is important to recognize the potential gains from government intervention to correct market failure, we must recognize the difficulties inherent in such efforts. Government officials may lack the information they need to select the efficient solution. Even if they have the information, they may have goals other than the efficient allocation of resources. Each instance of government intervention involves an interaction with utility-maximizing consumers and profit-maximizing firms, none of whom can be assumed to be passive participants in the process. So, while the potential exists for improved resource allocation in cases of market failure, government intervention may not always achieve it.

The late George Stigler, winner of the Nobel Prize for economics in 1982, once remarked that people who advocate government intervention to correct every case of market failure reminded him of the judge at an amateur singing contest who, upon hearing the first contestant, awarded first prize to the second. Stigler’s point was that even though the market is often an inefficient allocator of resources, so is the government likely to be. Government may improve on what the market does; it can also make it worse. The choice between the market’s allocation and an allocation with government intervention is always a choice between imperfect alternatives. We will examine the nature of public sector choices later in this chapter and explore an economic explanation of why government intervention may fail to move market solutions closer to their efficient levels.

Merit and Demerit Goods

In some cases, the public sector makes a determination that people should consume more of some goods and services and less of others, even in the absence of market failure. This is a normative judgment, one that presumes that consumers are not always the best judges of what is good, or bad, for them.

Merit goods are goods whose consumption the public sector promotes, based on a presumption that many individuals do not adequately weigh the benefits of the good and should thus be induced to consume more than they otherwise would. Many local governments support symphony concerts, for example, on grounds that the private market would not provide an adequate level of these cultural activities.

Indeed, government provision of some merit goods is difficult to explain. Why, for example, do many local governments provide tennis courts but not bowling alleys, golf courses but not auto racetracks, or symphony halls but not movie theaters? One possible explanation is that some consumers—those with a fondness for tennis, golf, and classical music—have been more successful than others in persuading their fellow citizens to assist in funding their preferred activities.

Demerit goods are goods whose consumption the public sector discourages, based on a presumption that individuals do not adequately weigh all the costs of these goods and thus should be induced to consume less than they otherwise would. The consumption of such goods may be prohibited, as in the case of illegal drugs, or taxed heavily, as in the case of cigarettes and alcohol.

Income Redistribution

The proposition that a private market will allocate resources efficiently if the efficiency condition is met always comes with a qualification: the allocation of resources will be efficient given the initial distribution of income . If 5% of the people receive 95% of the income, it might be efficient to allocate roughly 95% of the goods and services produced to them. But many people (at least 95% of them!) might argue that such a distribution of income is undesirable and that the allocation of resources that emerges from it is undesirable as well.

There are several reasons to believe that the distribution of income generated by a private economy might not be satisfactory. For example, the incomes people earn are in part due to luck. Much income results from inherited wealth and thus depends on the family into which one happens to have been born. Likewise, talent is distributed in unequal measure. Many people suffer handicaps that limit their earning potential. Changes in demand and supply can produce huge changes in the values—and the incomes—the market assigns to particular skills. Given all this, many people argue that incomes should not be determined solely by the marketplace.

A more fundamental reason for concern about income distribution is that people care about the welfare of others. People with higher incomes often have a desire to help people with lower incomes. This preference is demonstrated in voluntary contributions to charity and in support of government programs to redistribute income.

A public goods argument can be made for government programs that redistribute income. Suppose that people of all income levels feel better off knowing that financial assistance is being provided to the poor and that they experience this sense of well-being whether or not they are the ones who provide the assistance. In this case, helping the poor is a public good. When the poor are better off, other people feel better off; this benefit is nonexclusive. One could thus argue that leaving private charity to the marketplace is inefficient and that the government should participate in income redistribution. Whatever the underlying basis for redistribution, it certainly occurs. The governments of every country in the world make some effort to redistribute income.

Programs to redistribute income can be divided into two categories. One transfers income to poor people; the other transfers income based on some other criterion. A means-tested transfer payment is one for which the recipient qualifies on the basis of income; means-tested programs transfer income from people who have more to people who have less. The largest means-tested program in the United States is Medicaid, which provides health care to the poor. Other means-tested programs include Temporary Assistance to Needy Families (TANF) and food stamps. A non-means-tested transfer payment is one for which income is not a qualifying factor. Social Security, a program that taxes workers and their employers and transfers this money to retired workers, is the largest non-means-tested transfer program. Indeed, it is the largest transfer program in the United States. It transfers income from working families to retired families. Given that retired families are, on average, wealthier than working families, Social Security is a somewhat regressive program. Other non-means tested transfer programs include Medicare, unemployment compensation, and programs that aid farmers.

Figure 15.4 “Federal Transfer Payment Spending” shows federal spending on means-tested and non-means-tested programs as a percentage of GDP, the total value of output, since 1962. As the chart suggests, the bulk of income redistribution efforts in the United States are non-means-tested programs.

Figure 15.4 Federal Transfer Payment Spending

The chart shows federal means-tested and non-means-tested transfer payment spending as a percentage of GDP from 1962–2007.

Source: Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2004–2013 (Jan., 2003), Table F-10p. 157; thereafter January, 2008, Table F-10 with means-tested as medicaid plus income security and non-means tested everything else.

The fact that most transfer payments in the United States are not means-tested leads to something of a paradox: some transfer payments involve taxing people whose incomes are relatively low to give to people whose incomes are relatively high. Social Security, for example, transfers income from people who are working to people who have retired. But many retired people enjoy higher incomes than working people in the United States. Aid to farmers, another form of non-means-tested payments, transfers income to farmers, who on average are wealthier than the rest of the population. These situations have come about because of policy decisions, which we discuss later in the chapter.

Key Takeaways

• One role of government is to correct problems of market failure associated with public goods, external costs and benefits, and imperfect competition.
• Government intervention to correct market failure always has the potential to move markets closer to efficient solutions, and thus reduce deadweight losses. There is, however, no guarantee that these gains will be achieved.
• Governments may seek to alter the provision of certain goods and services based on a normative judgment that consumers will consume too much or too little of the goods. Goods for which such judgments are made are called merit or demerit goods.
• Governments redistribute income through transfer payments. Such redistribution often goes from people with higher incomes to people with lower incomes, but other transfer payments go to people who are relatively better off.

Here is a list of actual and proposed government programs. Each is a response to one of the justifications for government activity described in the text: correction of market failure (due to public goods, external costs, external benefits, or imperfect competition), encouragement or discouragement of the consumption of merit or demerit goods, and redistribution of income. In each case, identify the source of demand for the activity described.

• The Justice Department sought to prevent Microsoft Corporation from releasing Windows ’98, arguing that the system’s built-in internet browser represented an attempt by Microsoft to monopolize the market for browsers.
• In 2004, Congress considered a measure that would extend taxation of cigarettes to vendors that sell cigarettes over the Internet.
• The federal government engages in research to locate asteroids that might hit the earth, and studies how impacts from asteroids could be prevented.
• The federal government increases spending for food stamps for people whose incomes fall below a certain level.
• The federal government increases benefits for recipients of Social Security.
• The Environmental Protection Agency sets new standards for limiting the emission of pollutants into the air.
• A state utilities commission regulates the prices charged by utilities that provide natural gas to homes and businesses.

Case in Point: “Fixing” the Gasoline Market

Figure 15.5

Emily – gas prices in san diego – CC BY-NC-ND 2.0.

Moderating the price of gasoline is not an obvious mission for the government in a market economy. But, in an economy in which angry voters wield considerable influence, trying to fix rising gasoline prices can turn into a task from which a wise politician does not shrink.

By the summer of 2008, crude oil was selling for more than $140 per barrel. Gasoline prices in the United States were flirting with the $4 mark. There were perfectly good market reasons for the run-up in prices. World oil demand has been rising each year, with China and India two of the primary sources of increased demand. The world’s ability to produce oil is limited and tensions in the Middle East were also adding doubts about getting those supplies to market. Ability to produce gasoline is limited as well. The United States has not built a new oil refinery in more than 30 years.

But, when oil prices rise, economic explanations seldom carry much political clout. Predictably, the public demands a response from its political leaders—and gets it.

Largely Democratic Congressional proposals in 2008 included such ideas as: a bill to classify the Organization of Petroleum Exporting Countries (OPEC) as an illegal monopoly in violation of U.S. antitrust laws, taxing “excessive” profits of oil companies, investigating possible price gouging, and banning speculative trading in oil futures. With an overwhelming majority on both sides of the aisle, Congress passed a bill to suspend adding oil to the Strategic Petroleum Reserve—a 727 million gallon underground reserve designed for use in national emergencies. President Bush in 2008 was against this move, though in 2006, when gas prices were approaching $3 a gallon, he supported a similar move. Whether or not to offer a “tax holiday” on the 18.4 cents per gallon federal gas tax stymied some politicians during the 2008 presidential campaign because Hillary Clinton, a Democrat, and John McCain, a Republican, supported it, while Barack Obama, a Democrat, was against it. Mostly Republican proposals to allow offshore drilling and exploration in the Arctic National Wildlife Refuge also received attention.

These measures were unlikely to have much affect on gas prices, especially in the short-term. For example, the federal government would normally in a two-month period deposit 10 million gallons of gasoline in the strategic reserve; consumption in the United States is about 20 million gallons of gasoline per day. World gasoline consumption is about 87 million gallons per day. Putting an additional 10 million gallons into a global market which will consume about 5 billion gallons in a 60-day period is not likely to have any measurable impact.

The higher oil prices were very good for oil companies. Exxon Mobil, the largest publicly traded oil company in the United States, reported profits of nearly $11 billion for the first quarter of 2008. Whenever oil prices rise sharply, there are always cries of “price gouging.” But, repeated federal investigations of the industry have failed to produce any evidence that such gouging has occurred.

Meanwhile, market forces responding to the higher gasoline prices are already at work. Gasoline producers are looking at cellulosic ethanol, which can be produced from materials such as wood chips, corn stalks, and rice straw. Automobile producers are examining “plug-in” hybrids—cars whose batteries could be charged not just by driving but by plugging the car in a garage. The goal is to have a car that could go some distance on its battery before starting to use any gasoline. Consumers are doing their part. Gasoline consumption in the United States fell more than 4% by the summer of 2008 from its level one year earlier.

These potential market responses are the sort of thing one would expect from rising fuel prices. Ultimately, it is difficult to see why gasoline prices should be a matter for public sector intervention. But, the public sector consists of people, and when those people become angry, the urge for intervention can become unstoppable.

Sources: Paul Davidson and Chris Woodyard, “Proposals To Cut Gas Prices Scrutinized,” USA Today , May 11, 2006, p. 5B; Joseph Curl, “Bush Orders Suspension Of Gas Rules; Federal Probe To Look At Price-Gouging Charges,” The Washington Times , April 26, 2007, p. A1; David M. Herszenhorn, “As Gasoline Prices Soar, Politicians Fall Back on Familiar Solutions,” The New York Times , May 3, 2008, p. A16; Richard Simon, “The Nation; Mixing Oil and Politics; Congress Votes To Stop Shipments to the Nation’s Reserve. The Move Could Save Motorists Some Money,” Los Angeles Times , May 14, 2008, p. A18.

Answers to Try It! Problems

• This is an attempt to deal with monopoly, so it is a response to imperfect competition.
• Cigarettes are treated as a demerit good.
• Protecting the earth from such a calamity is an example of a public good.
• Food Stamps are a means-tested program to redistribute income.
• Social Security is an example of a non-means-tested income redistribution program.
• This is a response to external costs.
• This is a response to monopoly, so it falls under the imperfect competition heading.

Principles of Economics Copyright © 2016 by University of Minnesota is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License , except where otherwise noted.

The Role of Government in the Economy

The 1930s were one of the most challenging times for America. The economic crisis and recession resulted in the emergence of 15 million unemployed workers (Patel 2016). The scope of the problem is proven by the fact that this period was called the Great Depression. For the first time in its history, the USA had such significant issues in the industry, economy, and banking sector. The need for governmental support became evident, while President Hoover was not able to promote the positive change (Patel 2016). The new President, Franklin Roosevelt, insisted on providing additional powers to the government to improve the lives of common Americans (Patel 2016). The creation of a New Deal indicated a reconsideration of the role of government in the economy and its becoming a leading actor supporting Americans in their attempts to recover after stress.

The New Deal was a campaign launched by President Roosevelt with the primary goal of affecting the most important aspects of the economy and promote positive change. It included a series of programs and projects that guaranteed the relief for people living in a state and provided them with an opportunity to earn money needed for their living. At the same time, the New Deal meant that the role of the government changed, as from the passive observer, it transformed into an active player which acquired multiple authorities and tools to control the economy and guarantee that the crisis would not strike again, and the living conditions will gradually improve (Rauchway 2008). The program focused on the most vulnerable groups, such as farmers, the unemployed, the youth, and the elderly, who suffered from the crisis most of all.

The most important federal programs launched by the government and agencies responsible for the improvement were the Civilian Conservation Corps (CCC), the Civil Works Administration (CWA), the Farm Security Administration (FSA), the Social Security Administration (SSA), and the National Industrial Recovery Act of 1933 (NIRA) (Rauchway 2008). During the First 100 Days, Congress ended the prohibition, and it had a positive impact on the economy (Patel 2016). Additionally, the Tennessee Valley Authority Act promoted by the President’s administration created the TVA and contributed to establishing multiple working places in areas with various difficulties (Patel 2016). At the same time, workers acquired an opportunity to unionize and bargain collectively to attain higher wages and enhanced working conditions, which was critical for the improved quality of their lives (Patel, 2016). The First 100 Days were characterized by the significant changes in the lives of common Americans and the economy of the USA, which created the basis for the success of other programs.

The CCC was a public word relief program initially headed by Robert Fechner, who was the first director. It was launched in 1933 with the major aim to offer jobs to young men and help families with difficulties during the Great Depression. It contributed to reducing the number of unemployed and higher income for many households (Patel 2016). CWA another job creation program in terms of the New Deal, which introduced new manual-labor and temporary jobs for millions of people in the USA. Harry Hopkins became the head of this agency, which acted to improve the economic situation in the state (Rauchway 2008). The FA was another program and agency formed in 1937 to manage the high rates of poverty in rural areas. The farmers were organized to work together on farms owned by the government with the use of modern equipment and with the guidance of experts (Rauchway 2008). It helped poor farmers to find jobs and survive. Finally, the NIRA was a critical labor and consumer law enacted in 1933 to provide the President with authority to monitor industry and ensure fair wages, prices, and promote the economic recovery (Patel 2016). Additionally, it presupposed a national program for public works Public Works Administration (PWA). It was a significant step towards the improvement of the economic situation in the USA (Rauchway 2008).

The given programs had a serious impact on the USA and created the basis for the gradual improvement of the situation. The economy of the state was revitalized because of the regulations from the government and wise taxation and wages policies (Rauchway 2008). Moreover, the establishment of federally-funded infrastructure and improvement projects in all regions preconditioned the creation of new jobs for workers and provided businessmen with an opportunity to earn (Patel 2016). Finally, multiple social projects resulted in social guarantees to people suffering from the Great Depression and helped them to survive and find ways to earn money.

Altogether, the positive impact of the New Deal and its projects cannot be overestimated. It indicated the changing role of the government and its growing importance for regulating the economy of the state. Millions of jobs were created, and people acquired an opportunity to earn money needed for their survival. Even today, the social incentives of the campaign can be felt, as there are unions protecting the rights of workers and social guarantees that help individuals to feel some relief and rely on the government in difficult times.

Reference List

Patel, Kiran. 2016. The New Deal: A Global History . Princeton University Press.

Rauchway, Eric. 2008. The Great Depression and the New Deal: A Very Short Introduction . Oxford University Press.

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Concept 12: Roles of Government in the US Economy

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Fundamentals

Overview: It's no secret that government is significantly involved in the U.S. Economy. But do you know all the things the various levels of government do in the economy? This lesson will help you understand the complex ways the government interacts with the U.S. Economy.

Although the United States economy leans toward a market economy , the government plays a significant role. The most obvious way the government is involved in the U.S. economy is providing public goods and services like education, military protection, national parks and federal highways. These goods and services are paid for with tax revenue, which introduces a second role of government – redistribution of income .

One significant way the government redistributes income is through entitlement programs and unemployment. Taxes are collected from individuals and businesses (with income taxes being the largest source of funds), and that money is paid to other people in the economy who may not be working (unemployment) or are retired (Social Security). People often have strong opinions about how much assistance the government should offer and to whom, so this role creates controversy.

The government also serves an important role in protecting private property – which is critical for markets to function properly. That means that other people don’t have a right to live in your house or use your invention, and you can seek legal help if they try. When markets fail to function properly, the government sometimes steps into a market to resolve a market failure by limiting the power of a monopoly or to address negative side effects for third parties, like pollution. The government may also affect markets through regulations that impact the way producers make goods and services.

Intermediate

At this point in the United States there is not really a question of whether the government should play a role in the economy, but to what degree . The government could provide more public goods and services or fewer. The government could raise taxes or lower them. Regulations on markets can be added or taken away. A very small percentage of people in the U.S. hold beliefs that there should be no government involvement in the economy or total government control of the economy.

There is broad public support for things like making sure food is produced safely (a regulation), educating children (a public service), or allowing artists to own their work (protecting property). Should restaurants be forced to use organic ingredients, though? Should local, state, or federal governments – or no one – say what school curriculum should be? Should a company be allowed to trademark or copyright a sequence of DNA? These kinds of questions show the issues with trying to figure out how much government should be involved.

Since its inception, the role of government in the U.S. economy has tended to increase instead of decrease. It is hard to remove public goods and services or programs like Social Security once they are created because people rely on them. As much as they may not like regulations, businesses dislike flip-flopping and uncertainty even more, so many regulations stick around even after they have served their original purpose.

The industrial revolution, New Deal, World War II, War on Poverty and responses to recessions in 2008 and 2020 all greatly expanded the role government plays in the U.S. economy. In addition, that role has grown increasingly complex. With new technologies like digital currencies, there are questions about how much a government can regulate and control digital transactions across the world and how much it can enforce things like property rights on computer codes that are not physically “owned.” As more people choose to work through the “gig” economy there are questions about how to enforce things like minimum wage and how much the government should interfere in these situations. As technology evolves, it stands to reason there will be additional issues related to the government’s role in the economy. Understanding the basic roles the government plays in the economy can help to clarify arguments for these pending debates.

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Describe the roles of government in the United States economy.

Explain why government provides public goods and services, redistributes income, protects property rights, and resolves market failures.

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Essays on the Economic Role of Government

Fundamentals

• Warren J. Samuels 0

Michigan State University, USA

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Table of contents (12 chapters)

Front matter, fundamental conceptions, the nature and scope of economic policy.

Warren J. Samuels

Welfare Economics, Power and Property

Interrelations between legal and economic processes, some fundamentals of the economic role of government, the legal-economic nexus, the theory of regulation, normative premises in regulatory theory, regulation and regulatory reform: some fundamental conceptions, deregulation: the principal inconclusive arguments, ecosystem policy and the problem of power, the compensation problem, an economic perspective on the compensation problem, the role and resolution of the compensation principle in society: part one — the role, the role and resolution of the compensation principle in society: part two — the resolution, back matter.

• economic policy

Book Title : Essays on the Economic Role of Government

Book Subtitle : Fundamentals

Authors : Warren J. Samuels

DOI : https://doi.org/10.1007/978-1-349-12374-2

Publisher : Palgrave Macmillan London

eBook Packages : Palgrave Political & Intern. Studies Collection , Political Science and International Studies (R0)

Copyright Information : Palgrave Macmillan, a division of Macmillan Publishers Limited 1992

eBook ISBN : 978-1-349-12374-2 Published: 18 June 1992

Edition Number : 1

Number of Pages : XIV, 340

Topics : International Political Economy , Political Science

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What are the economic functions of a government?

Readers question: What are the functions of government in a capitalist economy?

In summary, the economic functions of a government include:

• Protection of private property and maintaining law and order / national defence.
• Raising taxes.
• Providing public services not provided in a free market (e.g. health care, education, street lighting)
• Limit market failure through the regulation of markets, e.g. regulations on environment/labour markets/monopoly.
• Macroeconomic management, e.g. use of fiscal and monetary policy to control business cycle – recession and inflation.
• Reducing inequality/poverty.

What do we mean by a capitalist economy?

A capitalist / free market economy means that most business and consumption decisions are left to private firms and individuals. The government does not get involved in owning the means of production or deciding what and how to produce. However, there is no ‘pure capitalist’ system without any kind of government intervention. In practice, there are degrees of government intervention – a mixed economy. These are the reasons governments intervene in the economy.

Main functions of government

1. Protection of private property / national security. If a country has a problem with crime, then it will discourage investment and the quality of life. The role of the government is to ensure basic law and order, through ensuring the rule of law. This involves protecting the rights to private property. In a free market, there is an incentive to free ride on the provision of law and order, therefore it tends to be under-provided. A government can pay for policing through general taxation. A similar function of the government is to provide for national defence – paying for an army. It is military spending which often was the primary cause of the first taxes. Kings raising taxes to pay for his army.

Policing and courts are an example of a public good – which usually require government provision.

2. Raising taxes. To provide public goods and public services, the government needs to raise tax. They can do this in a variety of ways – taxes on goods (customs duties), taxes on income, taxes on people (poll tax) and tax on property and land. The government has to consider the best way of raising taxes. A good tax is efficient (doesn’t distort economic activity); easy to collect (hard to avoid); fair (may involve taking a higher proportion of high earners). If the government run a budget deficit , they will need to raise the shortfall through borrowing and selling government bonds.

3. Providing public services . Public goods tend to be not provided in a free market because of the free rider problem . Therefore, these goods and services need to be provided by the government. Examples of public goods include street lighting, roads and law and order. There are also public services which are provided piecemeal in a free market, like education and healthcare. However, the government may feel that these merit goods are important for equality and improving labour productivity. Therefore, most governments provide some form of state provided education and health care.

4. Regulation of markets . Adam Smith in ‘ Wealth of Nations ‘ noted that in a free market, firms were often able to create monopoly power . This enables them to charge excessive prices to consumers. The government may need to regulate monopoly power, e.g. prohibiting mergers or setting price limits in natural monopolies (industries like tap water and railways).

Also, firms may develop monopsony power , where they are able to pay low wages and provide poor working conditions for workers. In this case, the government may need certain regulations on labour markets, such as minimum wages, minimum age of working and provide basic levels of health and safety.

5. Macroeconomic management . Capitalist economies can be subject to economic cycles – economic booms and recession. Recessions can lead to lost output and higher unemployment. In this case, the government may use fiscal policy to influence aggregate demand. The government may also use monetary policy , though, in recent years, many governments have delegated monetary policy to an independent Central Bank. In addition to trying to solve recessions, the government will also try to avoid inflation. This can involve higher taxes and higher interest rates.

6. Reducing inequality/poverty. In a capitalist economy, we may see a growth in inequality and poverty. This can be due to inherited wealth and opportunity. It can also be due to monopoly power. The government may feel the need to ensure everyone has an equal opportunity, for example providing education so even those from poor family have the opportunity to get qualifications. It may also involve redistributing income from high earners to low-income earners, e.g. progressive taxes such as higher rate of income tax and providing means-tested benefits such as income support/housing benefit and state pensions.

Where does the government spend its money?

This shows the relative destination of government spending. The largest budget is for social protection pensions and welfare benefits.

• Should the government intervene in the economy?

7 thoughts on “What are the economic functions of a government?”

This is misleading. A government is not a household. It is a sovereign issuer of currency and can spend what is needs to to recover from recession and provide services. It does not tax and spend, it spends and taxes, mainly to control inflation and to redistribute wealth because it is not always wise to increase the money supply. At this moment in time it is necessary to create money as wel as tax those who receive too much in profits and subsidy.

l think the economic welfare functions of the government were clearly laid down. In as much as governments are not doing what they ought to do, there economic functions are those listed above.

The above core mandates or functions of government in the economy are quite significant. However, I think one of the key functions of government in the economy which is not included in the above is that of establishing and deepening or maintaining a cordial and diplomatic relationship with foreign countries. This plays an important role in the world of global business where sovereign governments or nations inter-depend on each other for a cohesive business environment. This is more revealing where there is a trade war between two countries as recently between China and the United States.

how much influence do you think the government should have on the market economy?

How does a Government controls Finance in South Africa? What the Government do to make sure that there is no inequality?

I think those functions mentioned above are all correct even in my own reasoning I think those are how the government can participate in economics

which of these function do you think it is controversial?

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Government's Role in the Economy

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Why Do Governments Intervene?

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The Federal Reserve System

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• Government & Policy

What Impact Does Economics Have on Government Policy?

Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. Her expertise is in personal finance and investing, and real estate.

Economic conditions often inform the policy changes that governments elect to enact. Specifically in the United States, government policy has always had a large amount of influence on economic growth, the creation of new business entities, and the success of financial markets.

In the broadest sense, a country's economic activity reflects what people, businesses, and governments want to buy and what they want to sell. Because the U.S. has a capitalist economy that relies on the principles of a free market, theoretically, it is primarily the decisions of consumers and producers that mold the economy.

Key Takeaways

• Economic conditions often inform the policy changes that governments elect to enact.
• In the U.S., government policy has always had a large amount of influence on economic growth and the creation of new business entities.
• For those in political power, having a track record of economic growth is often an important consideration (especially if they are in a position of seeking re-election).
• To ensure strong economic growth, there are two main ways that the federal government may respond to economic activity: fiscal policy and monetary policy.
• In the U.S., the Federal Reserve System directs the country's monetary policy.

The government may decide to regulate some aspects of economic activity in order to engineer economic growth or prevent negative economic conditions in the future. In general, a government's active role in responding to and influencing the economic circumstances of a country is for the purpose of preserving and furthering the economic interests of the general public.

For those in political power, having a track record of economic growth is often an important consideration (especially if they are in a position of seeking re-election). In the U.S., many studies have shown that the economy is a major factor that affects how people vote (specifically in the U.S. presidential election). Strong economic growth typically translates to high job creation, stronger wage growth, better financial market performance, and higher corporate profits.

How Do Governments Respond to Economic Activity?

To ensure strong economic growth, there are two main ways that the federal government may respond to economic activity: fiscal policy and monetary policy .

Monetary Policy

One of the most common ways that a government may attempt to influence a country's economic activities is by adjusting the cost of borrowing money. This is most often done by lowering or raising the federal funds rate , a target interest rate that impacts short-term rates on debt such as consumer loans and credit cards. The Federal Reserve increases the federal funds rate to constrict economic growth and decreases the federal funds rate to encourage economic growth.

Another form of monetary policy is the act of the Federal Reserve buying and selling government securities. When the Fed buys a security from a bank, it increases the money supply by injecting funds into that bank. Alternatively, it can sell securities to remove cash and decrease the money supply.

Monetary Policy Example

In response to the COVID-19 pandemic, the Federal Reserve quickly reduced the federal funds rate to 0%. By setting prevailing interest rates very low, the Federal Reserve attempted to support economic activity, maximize employment, and meet price stability goals.

Fiscal Policy

The government may also enact policies that adjust spending, change tax rates, or introduce tax incentives. In regard to government budgets, the government identifies whether or not it wants to spend more money than it anticipates collecting. This process of evaluating public spending aims to promote economic prosperity or cool an overheated economy.

Instead of focusing on how the government spends money, common fiscal policy revolves around how the government collects money. Offering tax incentives, additional tax credits, or lowering tax rates decreases the economic burden on citizens and promotes economic growth. Striking down favorable tax laws or increasing taxes slows economic activity.

Fiscal Policy Example

In response to the COVID-19 pandemic, the Federal government awarded economic impact payments (i.e. stimulus checks) to qualifying Americans. The government directly sent eligible individuals money to promote economic activity and encourage household spending.

Fiscal and monetary policies are both intended to either slow down or ramp up the speed of the economy's rate of growth. This, in turn, can impact the level of prices and the employment rate in the country. However, there are subtle differences between these two types of government action.

Differences Between Government Policies

Change in the money supply or how easy credit is to obtain

Adjustment in federal funds interest rates or money supply

Set by Central Bank

Heavily independent of the political process

Impacts debt industries like housing market

Change in how the existing monetary supply is utilized

Adjustments in government spending and tax rates

Set by Federal Government

Heavily integrated with political process

Impacts government budgets/net deficits

In the U.S., the Federal Reserve System directs the country's monetary policy. The Federal Reserve System—also called "the Fed"—is the central bank of the United States. Established in 1913 by Congress, the Fed controls the money supply and actively uses policy to respond to and influence economic conditions.

The Fed adjusts the interest rate that banks charge to borrow from one another. (This cost is then passed onto consumers.) The Fed may lower the interest rate to keep borrowing cheap, ensure that credit is widely available, and boost consumer (and business) confidence. Conversely, the Fed may decide to raise interest rates in a strong economy, or in response to inflation concerns—the increase in prices that occurs when people have more to spend than what's available to buy.

In the two ways governments can intervene in the economy, you'll note that monetary policy is set by the Federal Reserve, an independent entity technically not part of the Federal government. On the other hand, fiscal policy requires political intervention and majority approval (for items not issued by executive order by the President).

Achieving Financial Stability in the U.S. Economy

Prior to the creation of the Fed in 1913, the U.S. had experienced several severe economic disruptions as a result of massive bank failures and business bankruptcies. As an institution, the Fed was tasked with ensuring financial stability in the U.S. economy.

After the Great Depression , the greatest threat to the stability of the U.S. economy was recessionary periods: periods of slow economic growth and high unemployment rates. In combination, these two factors created a sustained period of decline in the gross domestic product (GDP). In response to this, the government increased its own spending, cut taxes (in order to encourage consumers to spend more), and increased the money supply (which also encouraged more spending).

Beginning in the 1970s, a different economic reality emerged. This expansionary economy with substantial money supply growth led to a sustained period of a high level of inflation. In response to these economic factors, the U.S. government started focusing less on combating recession and more on controlling inflation. Thus, the government enacted policies that limited government spending, reduced tax cuts, and limited growth in the money supply.

At this time, the government also shifted away from its reliance on fiscal policy—the manipulation of government revenues to influence the economy. The fiscal policy did not prove effective at addressing high levels of inflation, high levels of unemployment , and vast government deficits. Instead, the government turned to monetary policy—controlling the nation's money supply through such devices as interest rates—in order to regulate the overall pace of economic activity.

Since the 1970s, the two main goals of the Fed have been to achieve maximum employment in the U.S. and to maintain a stable inflation rate. This dual mandate is difficult to achieve; by combating one of the goals, it becomes more difficult to fight the other.

While outside events may influence economic activity, governments use economic means to enact changes as they see fit. This may include changes to tax policy, adjustments to the federal funds rate, fluctuations in the money supply, or alternations to government spending.

Should the Government Intervene in the Economy?

Whether or not the government should intervene in the economy is a deeply-rooted philosophical question. Some believe it is the government's responsibility to protect its citizens from economic hardship. Others believe the natural course of free markets and free trade will self-regulate as it is supposed to.

Why Might the Government Intervene in the Economy?

The government has an inherent interest in protecting the well-being of its citizens. Due to prevailing conditions in the world, the government might see fit to enact certain legislation to preserve the quality of life for its citizens. The government might also enact legislation to promote economic well-being and equity across different socioeconomic classes.

What Are Some Ways the Government Intervenes in the Economy?

The government has two primary ways of interacting with the economy. Through monetary policy, the government controls prevailing interest rates and makes obtaining debt easier or harder. Through fiscal policy, the government controls spending levels and how to allocate resources.

Keynesian economic theory holds that governments should hold their citizens out of a recession. Governments do this by enacting monetary and fiscal policies. By having a central bank (i.e. the Federal Reserve), the United States has the ability to manipulate economic policy in an attempt to intervene when appropriate.

U.S. Department of State. " U.S. 2022 Midterm Elections: Role of the Economy in Elections ."

Sage Publications. " Economic Perceptions and Voting Behavior in US Presidential Elections ."

Federal Reserve Board. " Monetary Policy Principles and Practice ."

Federal Reserve Board. " Federal Reserve issues FOMC statement, March 15, 2020 ."

Internal Revenue Service. " Economic Impact Payments: What You Need to Know ."

Federal Reserve Board. " What Is the Purpose of the Federal Reserve System? "

Federal Reserve History. " The Great Inflation ."

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Government Role in Economy Essay

• Author Kimberly Ball
• Category Popular Essay Topics

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Topic: Role of Government in Regulating the Economy.

The government is actively involved in economy regulation and stabilisation. Measures that the government has put in place to regulate the economy have rendered effective results (Maxwell, Lyon, & Hackett, (2000). The above measures that the government has put in place to regulate the economy are discussed as follows.

In consideration to private enterprises, the government controls and regulates their actions to ensure that the enterprises serve the expected interests of the people as a whole and the country concerned. Government regulation is usually considered necessary mostly in areas where a private enterprise has been granted a monopoly, as with the rail roads. Government has set up public policy which permits private companies to make reasonable profits; public policy also limits the ability of private companies to raise prices of their commodities and services beyond reasonable expectations. This is unfair because the public depends on their services. For example, in situations whereby food and drug organisations requires quality standards of food and drug substances, in other manufacturing industries, the government sets quality guidelines to ensure fair competition without using direct control (Qu, & Ennew, (2005).

The government uses taxation of various commodities and services to create social or economic benefits that presumably are not expected to occur naturally in a pure market economy. According to a research done by Institute for Research on the Economy of Taxation, benefits of taxation to the economy of a given country are real. Taxation is useful in the prevention of inflation in any given country. Inflation has negative impacts to the economy in that it will lead to the decline of an economy (Maxwell, Lyon, & Hackett, (2000).

Government regulation, for example, the regulation of drugs may prevent the introduction of substances with harmful side effects and may also lead to a delay in the release of lifesaving products in the market. This leads to both positive and negative Impacts of government regulation to a country’s economy. However, the prevention of introduction of harmful substances into the economy promotes the economy; it also inhibits the production of the lifesaving products which will promote the economy. Here the government should not support regulating the drugs to allow lifesaving products reach the market (Qu, & Ennew, (2005).

The government imposes tariffs on imports. This leads to a reduced number of imports hence promoting the locally produced products. Tariffs are useful for a stable economy; tariffs also increase government revenues which are in turn useful to the economy of a country. Tariffs boost the local good manufacturers of a country who now face reduced competition in their home market. The reduced competition in their home market leads to an increase in price of the concerned commodity and service, this leads to the rise in the sales of domestic producers. The increase in production and price causes domestic producers to hire more workers which in turn makes consumer spending to rise. Tariffs hence lead to a stable economy of a country and thus it’s suitable for the government to use them for a good economy (Vogel, (2009).

The government also uses low taxation on locally produced products to promote their local manufacturers. This is an act of regulation since through high taxation of imports; the local producers get the chance to sell more than their foreign counterparts (Rauch, & Schleicher, (2015). Similar to the use of tariffs, low taxation on locally produced products leads to a stable economy, it also leads to creation of job opportunities to the unemployed personnel. When job opportunities are high, the production of a country is high hence increasing the amount of income earned by the local producers. Here the government tends to play a big role in regulating foreign products and promoting their own products hence leading to a growth in the economy of the country concerned (Rauch, & Schleicher, (2015).

Government uses Deregulation to promote its economy. Deregulation is the relaxing of rules and regulations which have been imposed on an industry or a business. Deregulation mostly applies in financial institutions which are directly involved in the finances of a country (Haufler, (2013). This leads to a higher rate of production by the local producers and promotes the working rate of customers hence improving a countries economy. Through deregulation, the government is assumed to have regulated imports which at some extend lower the country’s economy. Imports slow down the rate of production and hiring and hence inhibiting the GDP growth. Through deregulation, the government’s aim of regulating the economy is achieved (Haufler, (2013).

The Government also uses Tax Cuts and Rebates which are designed to ensure that more of the money or income goes back into the pockets of the consumers. A larger portion of that money is spent by the consumers at various businesses which tend to increase the businesses’ revenues, cash flows and profits (Haufler, (2013). When consumers have more money, this means that their businesses have the resources to procure capital, grow, expand and improve technology. All this actions are aimed at increasing productivity which in turn grows the economy. Tax Cuts and Rebates allow customers to stimulate the economy themselves through imbuing the economy with more money. Through this the government achieves a stable economy (Haufler, (2013).

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Home — Essay Samples — Government & Politics — Government Surveillance — Discussion About the Role of Government in Economy 

Discussion About The Role of Government in Economy 

• Categories: Economic System Government Surveillance

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Published: Feb 8, 2022

Words: 724 | Pages: 2 | 4 min read

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Home / Essay Samples / Government / American Government / The Role of Government in Society: Why is It Important

The Role of Government in Society: Why is It Important

• Category: Government , Science
• Topic: American Government , Global Governance , Political Culture

Pages: 3 (1450 words)

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Role of Government 

Function of government .

• The main function of government is to protect basic human rights, including the right to life, liberty, and property rights. The idea of natural rights is due to the fact that everyone deserves these rights. These are the rights that a God gave humans beings when they were born. It is assumed that people are born with these rights and should not be stripped of them without their consent.
• Government has a duty to fight poverty and improve the quality of life of its citizens. To achieve this, the government must create an environment that is good for prosperity and economic growth.
• All modern governments accept the responsibility of protecting the political and social rights of their citizens.
• Government can participate directly in the economy for promoting various economic activities.
• The function of government is to form a more perfect Union.
• Government is form to establish justice in the society.
• Government can provide health services, education and welfare services to the peoples of the societies.
• Government can promote the common well-being in the state or the country.
• Government provides security to the peoples live within a country or a state.
• The government provides public services because the public is happier if they are taken care of and they also need support.
• It gives national security because the defense of a country must be structured to ensure the safety and health of its population
• Government can sets the laws, rules and regulations in the country because we need rules to determine how well a nation works so people know how to act. To enforce the 'rule of law', the government must operate a system of laws and courts.
• Managing foreign affairs is one of the most important functions that the government performs.
• One of the most important functions of government is to protect civil liberties.

Significance of Government 

Branches of government .

• Executive branch
• Legislative branch
• Judiciary branch

Executive Branch

Legislative branch, judiciary branch, levels of government .

• Federal government
• State and territory government
• Local government

Federal Government

State and territory government, local government, system of government.

• Unitary system
• Federal system
• Confederate system

Unitary System

Federal system, confederate system.

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