The Economic

Role of Government

Slides to Accompany Economics: Public and Private Choice 9th ed.

James Gwartney, Richard Stroup, and Russell Sobel
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What is
Government?

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What is Government?

The entity that has a monopoly over

the legitimate use of force to modify
the actions of adults.
An institutional process through which
individuals collectively make choices
and carry out activities.

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Differences and Similarities

in Public and Private
Decision-Making
Competitive behavior is present in both
the market and public sectors.

Private sector action is based on voluntary

choice; public sector is based on majority
rule.

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Six Economic Functions

of Government (Stobb)
1.

2.
3.
4.
5.
6.

Maintain the legal and social

framework
Maintain competition
Provide public goods and services
Correct for externalities
Stabilize the economy
Redistribute income
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GOVERNMENT FUNCTION IN
ECONOMY (MUSGRAVE)
According to Musgrave, there are 3
functions of goverment in economy

Allocation Function
Distribution Function
Stabilization Function

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Allocation Function
of Government:

The process by which total resource

use is divided between private and
social goods and by which the mix of
social goods is chosen

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Allocation Function

Basically the resources of a country are limited

The government must determine how much of its

resources will be used to produce public goods, and
how much will be used to produce individual items

The government must determine how much the public

goods is required by citizens, how much should be
provided by the government, and how much that can be
provided by the company

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Distribution Function:

Adjustment of the distribution of

income and wealth to ensure
conformance with what society
consider a fair or just state
distribution

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Distribution Function

distribution function government policies

aimed at changing the final distribution of
goods/services across consumers, usually with
the intention of realizing a fairer
apportionment of consumption/income/wealth.
redistribution government policies designed to
alter the distribution of
income/wealth/consumption across members of
society.

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Distribution Function

income support monetary payments (such as

unemployment benefits and social security
payments) made to certain individuals, which
directly alter the distribution of income within a
society.
redistribution in-kind public provision of
goods/services (such as healthcare, education,
housing, food) for certain individuals, which
alter the consumption of goods/services within
society.
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Fiscal Policy Tools :

Tax-trasfers scheme-combining taxation of highincome with a subsidy to low-income

households
Progressive taxes used to finance public services
A combination of taxes on goods purchased
largely by high-income consumers with
subsidies to other goods which are used chiefly
by low-income consumers

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Stabilization Function:

The use of budget policy as a means of

maintaining high employment, a
reasonable degree of price level
stability, and an appropriate rate of
economic growth, with allowances for
effect on trade and on balance of
payments

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Modern Expectational Phillips Curve

Actual minus expected
rate of inflation

PC
10 %
Persons under-estimate inflation

5%

Persons correctly forecast inflation

0%
Persons over-estimate inflation

-5%
Unemployment
rate

-10 %
Natural rate

The modern view stresses that it is the actual rate of

inflation relative to the expected rate that matters.
When the actual rate is greater than (less than) the expected
rate, unemployment will be less than (greater than) its
natural rate.
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Buffer Stocks

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Government Intervention in
Markets

Buffer Stocks:

Influencing market supply through

holding or releasing stocks to stabilise
prices or incomes
Short term measure
Used in agriculture where supply
can be volatile
Assumption: supply is perfectly inelastic
in short run
Only useful where goods can be stored!

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Government Intervention in
Markets Buffer Stock
to stabilise price

S (Bad harvest)

S (Good Harvest)

Price

Government
sets a target
price (TP)

After a good
harvest the
government buys
up 60 units and
TP puts them into
store

Target Price

D
50

100

160
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After a bad
harvest,
government
releases 50 into
market

Quantity Bought and Sol

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