Module 5 - Government Decision Making

Overview of Government Decision Making

  • Module 5: Risk & Reward focuses on government/society decision making within the context of economics.

  • Learning Objectives:

    • Understand challenges in modeling government/societal decisions.

    • Identify economic components: Households, Businesses, and Government.

    • Define governmental roles including legal frameworks, competition maintenance, economic stabilization, income redistribution, and resource reallocation.

    • Acknowledge limitations of economic-only measures for decision making.

Key Questions about Government’s Purpose

  • Considerations for government functions:

    • Security and legal structure.

    • Problem resolution and fair competition.

    • Promotion of stability, arts, sciences, education, health care, and safety nets.

Challenges in Government Decision Making

  • Understanding government decisions requires awareness of their societal roles.

  • Comparison with governments from different countries shows variance in roles and decisions.

Households as Economic Units

  • Representation of U.S. households:

    • Approximately 125 million households in the U.S.

    • Households both supply economic resources and serve as major spenders.

  • Income Categories:

    • Classified by earning methods and distribution among households.

Functional Income Distribution (2020)

  • Breakdown of U.S. Income:

    • Compensation of Employees: 69%

    • Proprietors Income: 10%

    • Rental Income: 4%

    • Corporate Profits: 13%

    • Net Interest: 4%

Income Distribution by Population Percentiles (2020)

  • Income Shares:

    • Lowest Fifth: 2.9%

    • Second Fifth: 8.0%

    • Third Fifth: 13.9%

    • Fourth Fifth: 22.6%

    • Highest Fifth: 52.7%

    • Top 5%: 23.5%

Changes in Income Distribution (1970 vs. 2021)

  • Comparative Shares of Household Income:

    • Lowest Fifth: 4.1% (1970), 2.9% (2021)

    • Second Fifth: 10.8% (1970), 8.0% (2021)

    • Third Fifth: 17.4% (1970), 13.9% (2021)

    • Fourth Fifth: 24.5% (1970), 22.6% (2021)

    • Highest Fifth: 43.3% (1970), 52.7% (2021)

Household Spending Behavior

  • Allocation of disposable income:

    • Personal Taxes saw 14.6% in 2021, up from 3% in 1941.

    • Personal Saving and Personal Consumption Expenditures are key components of income use.

Personal Savings

  • Definition and Trends:

    • Savings consist of income not spent or taxed and typically account for about 5% of income.

    • Motivated by security and speculation.

Composition of Personal Consumption Expenditures

  • Spending breakdown:

    • Durable Goods: 13%

    • Nondurable Goods: 22%

    • Services: 65%

    • Examples of durable and nondurable goods and services impact on the economy.

Business Sector Overview

  • Businesses, representing the second private sector component, exist in various forms including sole proprietorships, partnerships, and corporations.

  • Characteristics of different business types:

    • Sole Proprietorships: 72% of firms

    • Partnerships: 10% of firms

    • Corporations: 18% of firms (including S Corporations)

Corporate Structure and Functionality

  • Advantages of Corporations:

    • Corporations account for 5% of businesses but produce over 60% of revenue.

    • Attract capital easily, feature limited liability, and exist independently of owners.

Principal-Agent Problem

  • Problematic alignment related to principals (shareholders) vs. agents (managers):

    • Conflict exists as agents may prioritize personal gain over business profitability;

    • Emphasizes the need for checks in corporate governance.

Government's Multifaceted Role

  • Key Responsibilities of Government:

    • Legal & Social Structure provision

    • Competition maintenance

    • Economic stabilization

    • Income redistribution

    • Resource reallocation

Government's Role in Legal Structure

  • Legal frameworks ensure:

    • Rights of private ownership and contract enforcement;

    • Impacts on resource allocation are significant, necessitating balanced interventions.

Maintaining Competition

  • Importance of Competition:

    • High competition fosters efficient production; monopolies lead to higher prices.

    • Regulations may be necessary for monopolistic industries (e.g., utilities).

Achieving Economic Stability

  • Stabilization Strategies:

    • Addressing unemployment through increased government spending or tax cuts.

    • Managing inflation via tax raises or reducing government expenditures.

Government Income Redistribution

  • Mechanisms include:

    • Transfer payments to vulnerable populations (e.g., welfare, food stamps).

    • Modifying market prices and implementing progressive taxation to address income disparities.

Economic Outcomes Post-Taxation and Transfers (2019)

  • Overview of income disparities before and after interventions demonstrating effectiveness of redistributive policies on income equality.

Addressing Externalities

  • Definition and Impact:

    • Externalities influence third parties without compensation, requiring government intervention.

    • Legislative measures and selective taxation can mitigate negative externalities.

    • Positive externalities like education should be subsidized to encourage consumption.

Government Finance Basics

  • Government Purchasing vs. Transfer Payments:

    • Distinction in resource absorption and their effects on the economy.

Overview of Federal and State Finance

  • Federal Revenue Sources:

    • Personal income tax, payroll taxes, corporate taxes, and excise taxes make up significant shares.

  • State Revenue Sources:

    • Derived primarily from taxes, with specific allocations for educational and public welfare.

Local Government Financing

  • Breakdown of Local Revenue Sources:

    • Heavy reliance on property taxes, with significant spending directed towards public education and safety.

Measuring Government Performance

  • Metrics used by economists:

    • Income distribution, unemployment rates, GDP, healthcare outcomes, educational statistics, and crime rates to evaluate societal well-being.

Limitations of Economic Measures

  • Economic indicators alone may not encompass societal well-being; government aims should address happiness and freedom alongside economic efficiency.

Alternative Perspectives on Success Metrics

  • Discussion surrounding the importance of individual happiness (Bentham) versus practical freedoms and capabilities (Sen).

Striking a Balance in Policy Making

  • Need for equilibrium between various policy objectives, including economic efficiency, individual capabilities, and collective happiness.

Conclusion on Decision-Making Models

  • Current deficiencies in models of governmental decision making,

    • Highlighting the challenge of prioritizing political gain over social welfare considerations.