Government in a Market Economy

The production possibilities model provides a menu of choices among alternative combinations of goods and services. Given those choices, which combinations will be produced?

In a market economy, this question is answered in large part through the interaction of individual buyers and sellers. As we have already seen, government plays a role as well. It may seek to encourage greater consumption of some goods and discourage consumption of others. In the United States, for example, taxes imposed on cigarettes discourage smoking, while special treatment of property taxes and mortgage interest in the federal income tax encourages home ownership. Government may try to stop the production and consumption of some goods altogether, as many governments do with drugs such as heroin and cocaine. Government may supplement the private consumption of some goods by producing more of them itself, as many U.S. cities do with golf courses and tennis courts. In other cases, there may be no private market for a good or service at all. In the choice between security and defense versus all other goods and services outlined at the beginning of this chapter, government agencies are virtually the sole providers of security and national defense.

All nations also rely on government to provide defense, enforce laws, and redistribute income. Even market economies rely on government to regulate the activities of private firms, to protect the environment, to provide education, and to produce a wide range of other goods and services. Government’s role may be limited in a market economy, but it remains fundamentally important.

KEY TAKEAWAYS

· The ideas of comparative advantage and specialization suggest that restrictions on international trade are likely to reduce production of goods and services.

· Economic growth is the result of increasing the quantity or quality of an economy’s factors of production and of advances in technology.

· Policies to encourage growth generally involve postponing consumption to increase capital and human capital.

· Market capitalist economies have generally proved more productive than mixed or command socialist economies.

· Government plays a crucial role in any market economy.

TRY IT!

Draw a production possibilities curve for an economy that can produce two goods, CD players and jackets. You do not have numbers for this one—just draw a curve with the usual bowed-out shape. Put the quantity of CD players per period on the vertical axis and the quantity of jackets per period on the horizontal axis. Now mark a point A on the curve you have drawn; extend dotted lines from this point to the horizontal and vertical axes. Mark the initial quantities of the two goods as CD_A and J_A, respectively. Explain why, in the absence of economic growth, an increase in jacket production requires a reduction in the production of CD players. Now show how economic growth could lead to an increase in the production of both goods.

Date: 2014-12-21; view: 1214