AP Microeconomics Efficiency, Equity, and the Role of Government PDF

AP Microeconomics Page 1 of 5 Unit Overview: Efficiency, Equity, and the Role of Government Focus Sheets Externalities and Public Goods A third-party benefit is a positive externality and a third-party cost is a negative externality. Governments s...

AP Microeconomics Page 1 of 5 Unit Overview: Efficiency, Equity, and the Role of Government Focus Sheets Externalities and Public Goods A third-party benefit is a positive externality and a third-party cost is a negative externality. Governments sometimes step in and pay some costs so its citizens can enjoy positive externalities. Positive externalities result from many of the goods and services the government provides. Governments intervene in many cases of negative externalities and impose policies and regulations to reduce them. A private good is a good that private suppliers produce and that consumers are willing and able to pay for. Private goods are exchanged voluntarily; if a person can't pay for a good, they can't buy it. A public good is a good that the government supplies. Some examples are national defense, lighthouses, air traffic controls, streetlights, flood control, and traffic signals. Public goods are non-exclusionary and non-rival in consumption. A good is non-exclusionary if the provider can't stop those who don't pay for a good from enjoying it. A good is non-rival in consumption if one person can use it without leaving less available for others. Since providers of public goods can't exclude users and the goods are non-rival in consumption, private businesses can't supply these goods and make a profit. That's why the government provides public goods. The government tries to weigh the benefits and costs of a good. Sometimes these costs and benefits are externalities. Sometimes markets don't perform as people want, so the government steps in to correct market failure. Externalities and public goods are examples of market failure. A market failure is a socially undesirable outcome resulting from the unrestrained operation of markets. This means the cost to society is greater than the benefit to society. Reasons for market failure: The government intervenes in some cases when a firm or firms act to restrict competition. Of course, most firms are trying to eliminate their competitors. Government usually intervenes only when the restrictions on competition make consumers much worse off. Public goods are another market failure. If we relied on private firms to supply all goods and services, the market would fail because companies wouldn't produce some goods, such as streetlights and flood control. When the government provides these goods and services, it's correcting the failure of the market to provide them. ___________________ Copyright © 2021 Apex Learning. See Terms of Use for further information. AP Microeconomics Page 2 of 5 Unit Overview: Efficiency, Equity, and the Role of Government Focus Sheets A third market failure is the presence of positive and negative externalities. In the case of positive externalities, the government may pay some of the cost of the transaction since the transaction benefits society more than it benefits the buyer. In other words, the government pays some of the cost so the buyer will buy more. In the case of negative externalities, the government will impose additional costs on the sellers since the transaction costs society more than it costs the seller. Imperfect information by buyers and sellers may also cause markets to fail. Information is costly. When a buyer or seller makes a decision to buy or sell, they base their decision on the information they have. Since the future is uncertain, and because information takes time and effort to gather, people make decisions with less than perfect information all the time. There are situations other than market failures in which the government takes an active role in the economy. The government creates and enforces laws and contracts. A system of well-defined rules and regulations, and well-defined property rights, is essential for economic health. When it's unclear who has the right to capture the value of something, all sorts of trade will disappear. When there are very high transaction costs, sometimes a trade won't occur even though the value of the trade to everyone is higher than the cost of the trade to everyone. Another economic function of government is trying to assure a strong economy by encouraging: Full employment Important because jobs are the main source of most people's income. Both the economy and society suffer when people are unemployed. Full employment doesn't mean 100% employment. In fact, the economy is considered to be at full employment when only 95% of the work force is employed and 5% is looking for work. Price stability Promoting this means trying to prevent rapid increases in prices. Inflation is the general increase in prices and wages. The government tries to prevent high levels of inflation, because it can cause economic instability. Economic growth This is an increase in the quantity and quality of goods an economy produces. The main causes of economic growth are population growth and technological change. There are costs of government intervention. The government uses resources when it intervenes. These resources may have been used in some other way. The government's choices about when and how much to intervene in a market reflects the values of the government's decision-makers. ___________________ Copyright © 2021 Apex Learning. See Terms of Use for further information. AP Microeconomics Page 3 of 5 Unit Overview: Efficiency, Equity, and the Role of Government Focus Sheets Income Distribution and Taxes Income distribution tells us how much of a nation's total income is received by different segments of the population. The U.S. federal government's census bureau compares the earnings of all income earners in the nation, then measures and ranks income to examine its distribution. There are several ways to look at income data. For example, you can study households in general—that is, anyone living together—or focus on specific types of households, such as family households, those with single individuals, those of a specific race or ethnic origin, or those in different geographical regions. A common way to analyze income distribution is to rank family household incomes, from lowest to highest, and divide the rankings into fifths or quintiles. Each quintile represents 20% of the family households. This table shows the aggregate, or total, income separated into quintiles. Quintile Lowest Second Middle Fourth Highest % of 3.7% 9.0% 15.1% 23.3% 49% Income (1996) % of 4.1% 10.8% 17.4% 24.5% 43.3% Income (1970) You can see from this table that in 1996, the poorest 20% of the population earned 3.7% of the total national income. The wealthiest 20% of the population earned 49% of the total national income. The richest 20% of the people in the country received almost half of all the income. An equitable (fair) income distribution might be one where each quintile earns 20% of aggregate income. A common way to measure income inequity is to use a Lorenz curve of income distribution. This graph shows the amount of income inequity that exists at any one point in time. 60 % of Total 50 Income 40 Income 30 Inequality 20 10 20 40 60 80 % of Total Family Households ___________________ Copyright © 2021 Apex Learning. See Terms of Use for further information. AP Microeconomics Page 4 of 5 Unit Overview: Efficiency, Equity, and the Role of Government Focus Sheets Household income is an imperfect measure of how well-off the household is. Some important indicators of well-being are left out of this data: It lists income but not wealth. It lists income before taxes and welfare payments. It doesn't account for the fact that many people will move in and out of different quintiles during their lifetime. Poverty means a household's income isn't enough to cover basic food and housing expenses. What's included in basic expenses will depend on the household. The federal government defines a new poverty level each year. These levels vary depending on the size of the household. Since poor families spend about a third of their income on food, the official poverty line is set at three times the U.S. Department of Agriculture's minimum food budget. Most often poverty is caused by unemployment. Unemployment increases when the economy goes into recession. There are other reasons why people may be unemployed, including poor job skills, low levels of education, or social inequities. As a nation we spend tax dollars on various programs to help the poor. These programs are generally called welfare. A few of the larger government welfare programs include Medicaid, which provides medical care to the poor, and AFDC, Aid to Families with Dependent Children, which provides monetary assistance for children. The government also provides food stamps to help buy food and housing subsidies to help pay for housing. People often criticize welfare programs for being ineffective. Many welfare programs were designed to be safety nets for those temporarily "down on their luck," but research shows that some welfare recipients never leave the programs. Some in the public want to get people "off welfare." There are public and private programs that try to get people off welfare and help them become productive individuals in the labor force. There are a number of education and retraining programs that have had some success. But these programs have some trouble because many welfare recipients are children. While children benefit from the programs, they have little control over whether their parents take the steps to maintain eligibility. Taking benefits away from long-time recipients might make these children much worse off than they already are. The government uses other means to increase the incomes of the poorest segment of the population. For example, the minimum wage law is meant to provide higher incomes to low income households. ___________________ Copyright © 2021 Apex Learning. See Terms of Use for further information. AP Microeconomics Page 5 of 5 Unit Overview: Efficiency, Equity, and the Role of Government Focus Sheets We need taxes in our economy because taxes pay for public goods and services. Taxes also make it possible for the government to redistribute income throughout society by collecting money from high-income households and transferring it to low income households. Each of us pays many different taxes: If you work, you pay a personal income tax and social insurance taxes, which include social security and Medicare. If you drive a car, you pay an excise tax on gasoline and a license tax for your car. Excise taxes are also put on the sale of alcohol and tobacco. In some states there's a sales tax on consumer items. Corporations and businesses also pay taxes. In different states and regions there are a number of local taxes that are levied on specific items. For example, some cities have a "bed tax" on hotel rooms, while other cities tax telephone or utility bills. If taxes are to be effective, people must believe that taxes are fair. In describing a "fair" income distribution, we said fair meant it should be the same for everyone. There are different tax distributions that are fair according to different criteria. Some people say those who benefit from the government expenditure should pay the tax. This is the benefit principle of taxation. The ability to pay principle of taxation holds that the people with the most money should pay most of the taxes. The federal government's personal income tax follows this idea. The more income a person earns the greater the share of income they pay in taxes. This is also called a graduated or progressive tax. While taxes may be levied along the lines of either the benefit principle or the ability to pay principle, there's still the question of who actually ends up bearing the burden of the tax. The incidence of a tax tells us who ultimately pays the tax burden. There are three ways to collect taxes on income. Proportional taxation This method takes the same percentage of income from all taxpayers. This is a flat tax levied on all taxpayers at the same percentage. Progressive taxation This method takes a larger percentage of income as income increases. A person with a higher income pays a higher percentage of their income than a person with a lower income. Regressive taxation This method takes a larger percentage of lower incomes and a smaller percentage of higher incomes. When expressed as a percentage of income, the burden of a regressive tax decreases as income increases. ___________________ Copyright © 2021 Apex Learning. See Terms of Use for further information.