CHAPTER 5



CHAPTER 5

The Public Sector

Summary

1. How does the government interact with the other sectors of the economy?

• The circular flow diagram illustrates the interaction among all sectors of the economy—households, businesses, the international sector, and the public sector. §1

2. What is the economic role of government?

• The market system promotes economic efficiency. Economic efficiency means that in an economy one person cannot be made better off without harming someone else. §2.a

• The market system does not result in economic efficiency when there are market imperfections, externalities, or public goods. Market imperfections occur when information is imperfect. §2.b–2.g

3. Why is the public sector such a large part of a market economy?

• Two general reasons are given for the government’s participation in the economy: The government may resolve the inefficiencies that occur in a market system, or the government may be the result of rent seeking. §2.b–2.g

• Economic efficiency means that some people cannot be made better off without others being made worse off. Some people do not like the result of the market outcome and want to alter it. In such cases, resources are devoted to creating a transfer of income. This is called rent seeking. §2.g

4. What does the government do?

• The government carries out microeconomic and macroeconomic activities. The microeconomic activities include resolving market imperfections, externalities, and public goods problems. The macroeconomic activities are directed toward monetary and fiscal policies and minimizing disruptions due to business cycles. §3

• Governments often provide public goods and services such as fire protection, police protection, and national defense. Governments place limits on what firms and consumers can do in certain types of situations. Governments tax externalities or otherwise attempt to make price reflect the full cost of production and consumption. §3.a

Governments carry out monetary and fiscal policies to attempt to control business cycles. In the United States, monetary policy is the province of the Federal Reserve, and fiscal policy is up to the Congress and the president. §3.b

5. How do the sizes of public sectors in various countries compare?

• Market systems rely on the decisions of individuals. Centrally planned systems rely on the government to answer economic questions for all individuals. §4

• The size and influence of the public sector ranges from the market economies of the United States and Canada to the centrally planned economy of Cuba. §4.a

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