Chapter 4

Government in the mixed economy

David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,

6th Edition, McGraw-Hill, 2000
Power Point presentation by Peter Smith
What do governments do?

create laws, rules and regulations

buy and sell goods and services
make transfer payments
impose taxes
try to stabilize the economy
affect the allocation of resources

4.2
Government spending
The scale of government activity has grown steadily in
industrial countries since 1880

60
% of national income

50 Japan
40 USA
30 Germany
20 UK
France
10
Sweden
0
1880 1929 1960 2000

4.3
What should governments do?

Governments may be justified in

intervening in the economy in the
presence of market failure

Six ways in which intervention may

improve the allocation of resources:

4.4
What should governments do?
(1) The business cycle
decisions on taxation and spending may affect the
business cycle
not always favourably
(2) Public goods
goods that, even if consumed by one person, are
still available for consumption by others e.g.
clean air
the free-rider problem prevents the market from
achieving production of the right amount of such
goods.

4.5
What should governments do?

(3) Externalities
costs and benefits of production are not
always reflected in market prices
e.g. pollution, congestion.
(4) Information-related problems
private markets may not produce the
right kinds and amounts of information
e.g.
food labelling, health and safety
regulations.

4.6
What should governments do?
(5) Monopoly and market power
resource allocation may be improved by
limiting or regulating the market power of
monopoly firms
(6) Income redistribution and merit goods
concern with equity issues
e.g. protecting vulnerable groups
merit goods are goods that society thinks people
should consume regardless of income
e.g. health, education

4.7
 Who pays a commodity tax?
With no tax, market
S'
equilibrium is at P0, Q0
Price

S With the tax, supply is S'S'

and equilibrium is P1Q1
P1

P0 but who pays the tax?

S'

S
D

Q1Q0 Quantity
4.8
 Who pays a commodity tax?
S' Area A is borne
by consumers
A S Area B is borne
by producers
P1
Area C is a
P0 welfare loss.
C
S' The incidence of the
B
tax depends upon the
S D elasticities of demand
and supply.
Q1Q0
4.9