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INDIVIDUALS AND GOVERNMENT
C h a p t e r 1
Allocation of Resources
Resources are allocated between government and private use:
For government use:
Roads
Schooling
Fire Protection
For private use:
Food
Clothing
Units of private goods and services are forgone by individuals so that government can provide goods and services.
Production Possibility Curve
The Mixed Economy
Characteristics of a mixed economy:
Government supplies many goods and services
Government regulates private economic activity
Government expenditures equal to of GDP
Government participates in markets as a buyer of goods and services
Circular Flow
Government Expenditures in the U.S.
Government purchases divert productive resources from private use:
National defense
Steel, labor
Government transfer payments redistribute purchasing power among citizens:
Social benefits
Social Security, Medicare
Government Expenditures, 1929–1950
Government Expenditures, 1951–1972
Government Expenditures, 1973–1989
Government Expenditures, 1990–2008
Government Expenditures in the U.S.
Structure of Federal Government Expenditure
Distribution of Federal Expenditures
Structure of Federal Government Expenditure
Structure of Federal Government Expenditure
State and Local Government Expenditures
State and Local Government Expenditures
Financing Government Expenditures
Federal Government—Taxes
Financing Government Expenditures
Financing Government Expenditures
State and local governments—Taxes, Federal Grants
Financing Government Expenditures
Functions of Government
Provide items we cannot easily make available for ourselves or purchase from others in markets
Law enforcement and courts
Redistribute income and economic opportunity
Income support for elderly, unemployed, poor
Stabilize economic fluctuations
Inflation
Regulate production and consumption
For improved health, elimination of excessive monopolistic control over prices
How much government is enough
How much should governments do, and how much should be left to private enterprise and initiative through market sale of goods and services
Aging Populations & Public Finance
Percentage of U.S. residents age 65 or older: 1950 – 8.3%; 2000 – 12.3%; 2050 – 21.1%
Significant effects on Social Security and government-funded health care expenditures
Tax rates to finance programs must increase or benefits to recipients must decline to avoid causing large federal budget deficit
Population Aging
Old-Age Dependency Ratios
Appendix I – Tools of Microeconomic Analysis
Indifference Curve Analysis
Tool for understanding choices people make regarding purchase and use of goods and services
Understanding choices to give up leisure time to obtain income through work
Understanding choices to give up consumption today for more consumption in the future
Uses concept of the market basket – a combination of various goods and services available for consumption over a certain period
Assumptions Underlying Indifference Curve Analysis
People can rank market baskets from most to least desired.
If basket A is preferred to basket B and basket B is preferred to basket C, then basket A must be preferred to basket C.
People always prefer more of a good to less of it, all other things being equal.
The amount of money people will give up to obtain additional units of a given good will decrease as more of the good is acquired.
Indifference Curve Analysis
Indifference Curve – a graph of all combinations of market baskets among which a person is indifferent
Indifference Map – a way of describing a person’s preferences; shows a group of indifference curves
Indifference Curves
Budget Constraint Line
Consumer Equilibrium
Changes in Income
Changes in Price of Good X
Income and Substitution Effects
The Law of Demand
The inverse relationship between price and the quantity of a good purchased per time period
Demand curves slope downward, other things being equal
Changes in quantity demanded are movements along the curve in response to price changes.
Change in demand is a shifting in or out of the curve, caused by changes in income, tastes, or the prices of substitutes or complements for the good.
The Law of Demand
Price Elasticity of Demand
Measures the percentage change in quantity demanded due to a given percentage change in price:
Consumer Surplus
Indifference Curves and the Allocation of Time
Production and Cost
Production function – the maximum output obtainable from any given combination of inputs (land, labor, materials, capital), given technology
Two periods to production:
Short run (inputs cannot be varied)
Long run (all inputs are variable)
Isoquant Analysis
Isoquants - curves that show alternative combinations of variable inputs that can be used to produce a given amount of output
Costs
Total cost (TC) – the value of all inputs used to produce a given output
Variable cost (VC) – the cost of variable inputs such labor, machines, and materials
Fixed cost (FC) – cost of inputs that do not vary with output
Average cost (AC) – equal to total cost of production divided by the number of units produced
Average variable cost (AVC) – variable cost divided by the number of units produced
Average fixed cost (AFC) – difference between average cost and average variable cost
Short-Run Cost Curves
Competition
Perfect competition exists when a firm is one of many producing a small market share of a standardized product with no difference in quality.
A competitive firm sells its output in a perfectly competitive market and is a price taker, because it takes the price of its product as given.
Profits are maximized by producing that output for which price is equal to marginal cost:
P = MC
Supply
Short-run supply curve – price exceeds minimum possible average variable costs of production
Long-run competitive equilibrium – economic profits are zero so that no incentive exists for firms to either enter or leave
Long-run industry supply curve – a relationship between price and quantity supplied for points at which the industry is in equilibrium:
P = LRMC = LRACmin
Long-Run Competitive Equilibrium
Long-Run Supply
Price Elasticity of Supply
The percentage change in quantity supplied in response to any given change in price:
Long-Run Supply

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