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15.1: The Role of Government in a Market Economy

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  • Learning Objectives

    1. Discuss and illustrate government responses to the market failures of public goods, external costs and benefits, and imperfect competition and how these responses have the potential to reduce deadweight loss.
    2. Define merit and demerit goods and explain why government may intervene to affect the quantities consumed.
    3. Discuss ways in which governments redistribute income.

    What do we want from our government? One answer is that we want a great deal more than we did several decades ago. The role of government has expanded dramatically in the last 75+ years. In 1929 (the year the Commerce Department began keeping annual data on macroeconomic performance in the United States), government expenditures at all levels (state, local, and federal) were less than 10% of the nation’s total output, which is called gross domestic product (GDP). In the current century, that share has more than tripled. Total government spending per capita, adjusted for inflation, has increased more than six fold since 1929.

    Figure 15.1 “Government Expenditures and Revenues as a Percentage of GDP” shows total government expenditures and revenues as a percentage of GDP from 1929 to 2007. All levels of government are included. Government expenditures include all spending by government agencies. Government revenues include all funds received by government agencies. The primary component of government revenues is taxes; revenue also includes miscellaneous receipts from fees, fines, and other sources. We will look at types of government revenues and expenditures later in this chapter.

    Figure 15.1 Government Expenditures and Revenues as a Percentage of GDP


    Government expenditures and revenues have risen dramatically as a percentage of GDP, the most widely used measure of economic activity.

    Source: U.S. Department of Commerce, Bureau of Economic Analysis, NIPA Tables 1.15 and 3.1.