Chapter 1

Individuals and Government

Dr Doaa Akl Ahmed

MSc. and PhD. In Economics,
University of Leicester, England
Associate Professor of Economics, Benha University
 Learning outcomes
1. Explain the difference between governments and political institutions
2. Use a production-possibility curve to explain the tradeoff between
private goods and services and government goods and services.
3. Describe how the provision of government goods and services through
political institutions differs from market provision of goods and
services
4. Explain how government affects the circular flow of income and
expenditure in a mixed economy.
5. Explain the difference between government purchases and transfer
payments
 Government
• Governments are organizations formed to exercise authority
over the actions of persons who live together in a society and to
provide and finance essential services.
Individuals interact with governments by many ways:
1. Individuals pay taxes
2. in many cases, individuals are the receivers of income
financed by those taxes such as Social Security pensions,
unemployment insurance compensation, and subsidies to the
poor.
The extent to which individuals have the right to participate in
decisions that determine what governments do varies from society
to society. What governments do, how much they spend, and how
they obtain the means to finance their functions reflect political
interaction of citizens.
 Political institutions
• Political Institutions are the organizations that create,
impose, and apply laws and determine what government does
and how government expenditures are financed.
• democratic institutions offer citizens an opportunity to
express their desires through voting and through attempts to
influence the voting of others.
• Majority rule is an example of democratic institutions in
which one alternative (such as a political candidate or a
referendum to increase spending for education) is chosen over
others if it receives more than half the votes.
 The Allocation between Private and
Government Resources

Government goods and Private goods and services:

services: • Food
• Education (public schools) • Housing
• National defence • Cars
• Infrastructure (e.g., roads) • Clothing
• Health services • Private schools and hospitals

requires labour, equipment, buildings,

and land (limited resources).

The real cost of government goods and services is the value of private goods
and services that must be sacrificed when resources are transferred to
government use (include a tradeoff)
 The Allocation between Private and
Government Resources
Private are those items, such as food and clothing,
Goods that are usually made available for sale in
markets.

some goods and services are shared by all;

they cannot be used by any one citizen such
as roads, Police, national defence, and fire
Government protection, usually are not sold in markets.
Goods and
services some goods and services are limited in
availability to certain groups, such as the
aged or children, as with Social Security
pensions and public primary and secondary
schooling. .
 The Allocation between Private and
Government Resources

The Production Possibility

Frontier (PP) shows the alternative
combinations of government goods
and services and private goods and
services that can be produced in an
economy, given its productive
resources and technology and
assuming that resources are fully
employed
 The Allocation between Private and
Government Resources
• There is a tradeoff between
producing private and public goods
• To increase the production of
public good, the production of
private goods should be decreased

• If all resources are used to

provide private goods, we
produce at point M.

• If all resources are used to

provide Public goods, we produce • If all resources are
at point C. divided between them,
we produce at points
such as A or B.
Distribution of Government Goods and Services

Government goods and services are distributed to groups of

individuals through the use of nonmarket rationing which
means that Prices and willingness to pay those prices are not
applicable to goods such as national defence.

Freely available to all and not criteria such as income, age,

rationed by prices with no
direct charge and no eligibility
requirements (such as the
provision of national defence)
family status, residence, or
the payment of certain taxes,
fees, or charges are used to
determine eligibility to
receive benefits (such as
subsidized foods and road
fees)
 LECTURE 1 CHECKPOINT

1. What are political institutions?

2. Give four examples of government goods or services
and discuss how they are distributed to citizens.
3. Use a production-possibility curve to show the cost of
increasing government provision of medical service.
 Lecture 2
Learning outcomes
1. Distinguish between mixed economy, command economy and free
economy.
2. Explain how government affects the circular flow of income and
expenditure in a mixed economy.
3. Describe the difference between government purchases and transfer
payments
4. Clarify the main functions o the government
Mixed Economy vs pure market economy
Pure Market Economy
– Almost all goods and services are supplied by private firms for
profit.
– all exchanges of goods and services would take place through
markets
– Supply and demand determine price.
– Individuals can purchase goods and services freely, according
to their tastes and their income and wealth, given the market-
determined prices
Mixed Economy vs pure market economy

Mixed economy
– government supplies a large amount of goods and services.
– government regulates (control) private economic activity use
taxes and subsidies to affect incentives to use resources.
– government expenditures is around %25 to %50 of GDP.
– Taxes absorb at least %25 of national income
– provision of goods and services takes place through political
institutions (e.g., parliament).
– Political decisions often force citizens to finance government
services and programs, regardless of their personal
preferences.
 Circular Flow in the Free Economy
Two sectors (Households and Firms), Two markets (inputs and
outputs)

In Inputs market:

1. Households sell and firms buy

the services of labor, capital,
and land

2. Firms pay income to

households

• wages for labor services

• interest for the use of capital

• Rent for the use of natural

resources
 Circular Flow in the Free Economy
Two sectors (Households and Firms), Two markets (inputs and
outputs)

In output market:

1. Firms sell and households buy

final goods and services
according to market prices

2. Households pay the price of

final products with the dollars
earned from the sale of their
productive resources

All goods and services would be

produced by businesses and there
is no role for government.
Circular Flow in the Mixed Economy
Goods & Services Goods & Services
Output
Market
Dollars Dollars

Income Support
& Subsidies Subsidies
Taxes, fees, charges Taxes, fees, charges
Households Government Services
Government Government Services
Firms

Dollars Input Dollars

Market
Resources Resources
 Circular Flow in the Mixed Economy
Three sectors (Households, firms and government), Two markets
(inputs and outputs)
In Inputs market:

• The role of households firms is the

same in free market.

• Governments purchase inputs

from households and use them to
provide commodities that are not
sold to households and business
firms but are made available
through nonmarket rationing.

• governments do sometimes own

and operate enterprises such as
the postal service, and railroads.
 Circular Flow in the Mixed Economy
In output market:

• Government buy outputs of

business firms such as paper, cars,
and guns (Government
expenditure).

• To pay for them, government

requires firms and households to
make various payments such as
taxes, charges, and fees

• Government might acquire

resources at rates of compensation
below actual market prices (as is
the case with compulsory military
service).
Government purchases and government
transfers
Government Purchases: are those that require factors of
production (land, labour, capital and entrepreneurship) to be
diverted from private use by individuals and firms to be used by
the government (i.e., it is related to government innervation in the
inputs market)

For example, to supply national defence services, the government

must acquire steel, labour, and other inputs necessary to support
the armed forces and maintain aircraft, tanks, ships, and other
capital equipment.

A municipal (local) government must acquire vans and hire labour

to collect garbage.
Government purchases and government
transfers
Government transfers: are those expenditures that redistribute
purchasing power among citizens thus represent a source of
income support to recipients who are not required to provide
any service in return for the income received.

• No payments are required

Examples:

Unemployment compensation.

Retirement pension.

Disability benefits

Work injury transfers

 How Much Government?
• The size of the government is determined by the percentage o
public expenditure to GDP.

• It differs largely between nations depending on the political

regime.

• In democratic nations, it is determined by political institutions

such as parliament

• In nondemocratic nations, it is determined by dictators or

committees that yield political power (such as the former Soviet
Union)- usually prices are determined by planners. Additionally,
they prefer to produce military goods and services and heavy
industry whereas consumers goods and services are given low
propriety.
 How Much Government?
• Modern mixed economies have large government sectors that
supply services such as national defence, police and fire
protection, roads, education, and also provide income support
and medical insurance for the elderly, and the poor.

• For most modern industrial nations, government expenditures

account for between %25 and %50 of GDP
60

50

40

30

20

10

0
 The Functions of Government
• In many cases, the government can provide us with items that
we cannot easily make available for ourselves or purchase from
others in markets.

• For example, governments provide a justice system of law

enforcement and courts. Government power used to establish
rules that regulate the social interaction among individuals and
to settle disputes among citizens.

• a society cannot function well without these rules and without a

government.
 The Functions of Government
• Governments use their power to redistribute income and
economic opportunity among citizens.

• For example, they use tax revenues to provide income support

for elderly, unemployed, and poor citizens.

• Governments apply different policies to stabilize economic

fluctuations (reducing unemployment and inflation and inducing
economic growth).

• Governments regulate production and consumption to improve

health and eliminate monopolistic powers in the market.