Chapter 15:
The government sector
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
CHAPTER OUTLINE
LEARNING OUTCOMES
15.1 THE GOVERNMENT OR PUBLIC SECTOR
15.2 THE ROLE OF GOVERNMENT IN THE ECONOMY: AN OVERVIEW
15.3 MARKET FAILURE (AS JUSTIFICATION FOR GOVERNMENT INTERVENTION)
15.4 FURTHER REASONS FOR GOVERNMENT INTERVENTION IN THE ECONOMY
15.5 HOW DOES GOVERNMENT INTERVENE?
15.6 GOVERNMENT FAILURE
15.7 NATIONALISATION AND PRIVATISATION
15.8 FISCAL POLICY AND THE BUDGET
15.9 GOVERNMENT SPENDING
15.10 FINANCING OF GOVERNMENT EXPENDITURE
15.11 TAXATION
15.12 TAX INCIDENCE: WHO REALLY PAYS THE TAXES?
IMPORTANT CONCEPTS
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LEARNING OUTCOMES
Once you have studied this chapter you should be able to
• explain why government participates in economic affairs
• describe how government intervenes in the economy
• explain why governments, like markets, can fail
• distinguish between nationalisation and privatisation
• explain what fiscal policy means
• discuss government spending and the financing of such spending
• discuss the criteria for a good tax
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: explain why government participates in economic affairs
15.1 THE GOVERNMENT OR PUBLIC SECTOR
Figure 15-1 The composition
of the public sector
(Textbook page 276)
PUBLIC SECTOR
GENERAL
GOVERNMENT
Central government
(e.g. national
government
departments)
Provincial government
Local government
Public corporations
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
THE GOVERNMENT OR PUBLIC SECTOR
Figure 15-2 The interaction between
government and households and firms
(Textbook page 277)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: explain why government participates in economic
affairs
LO: explain why government participates in economic affairs
15.2 THE ROLE OF GOVERNMENT IN THE
ECONOMY: AN OVERVIEW
What is the appropriate division between government and the market?
• Private initiative and market forces are generally more efficient
• Free markets cannot function properly without government enforcement of
contracts
• Government intervention may be necessary to correct market failure
• Market systems often do not produce equitable outcomes
Equity
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
Efficiency
LO: explain why government participates in economic affairs
LO: describe how government intervenes in the economy
15.3 MARKET FAILURE (AS JUSTIFICATION
FOR GOVERNMENT INTERVENTION)
Market failure occurs when the market system is unable to achieve an
efficient allocation of resources.
Five cases of market failure:
• Monopoly and imperfect competition
• Public goods
• Externalities
• Asymmetric information
• Common property resources
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
MARKET FAILURE
(AS JUSTIFICATION FOR GOVERNMENT INTERVENTION)
LO: explain why government participates in economic affairs
LO: describe how government intervenes in the economy
Monopoly and imperfect competition
Possible responses to the existence of the market power of monopolists and
oligopolists
1) Do nothing
2) Impose price control
3) Tax the full excess profits
4) Through competition policy
And in a natural monopoly?
1) Government regulates private production
2) Government undertakes production
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
MARKET FAILURE
(AS JUSTIFICATION FOR GOVERNMENT INTERVENTION)
LO: explain why government participates in economic affairs
LO: describe how government intervenes in the economy
Public goods (or non-private goods)
Table 15-1 Four types of good (Textbook page 279)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
MARKET FAILURE
(AS JUSTIFICATION FOR GOVERNMENT INTERVENTION)
LO: explain why government participates in economic affairs
LO: describe how government intervenes in the economy
Externalities
The external costs and benefits of a transaction or activity that are carried
or enjoyed by parties not directly involved in the transaction or activity.
Figure 15-3 Negative
externalities in a perfectly
competitive market (Textbook
Externalities
page 281)
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External costs
=
Negative externalities
External benefits
=
Positive externalities
Marginal social cost > Marginal
private cost
Marginal social cost < Marginal
private cost
ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
MARKET FAILURE
(AS JUSTIFICATION FOR GOVERNMENT INTERVENTION)
Externalities
LO: explain why government participates in economic affairs
LO: describe how government intervenes in the economy
Figure 15-3 Negative externalities in a perfectly competitive market (Textbook page 281)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
MARKET FAILURE
(AS JUSTIFICATION FOR GOVERNMENT INTERVENTION)
LO: explain why government participates in economic affairs
LO: describe how government intervenes in the economy
Asymmetric information
Figure 15-4 Asymmetric
information in a goods market
(Textbook page 282)
See Box 15-1 MORAL HAZARD AND ADVERSE SELECTION (Textbook page 283)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
MARKET FAILURE
(AS JUSTIFICATION FOR GOVERNMENT INTERVENTION)
LO: explain why government participates in economic affairs
LO: describe how government intervenes in the economy
Common property resources
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Consumption
Exclusion
Rivalrous
Non-excludable
Fisheries (fish in the ocean
Other marine resources
Wildlife
Air
Rivers
The environment
Common grazing land
ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: explain why government participates in economic affairs
LO: describe how government intervenes in the economy
15.4 FURTHER REASONS FOR GOVERNMENT
INTERVENTION IN THE ECONOMY
• Income distribution
• Macroeconomic growth and stability
• Merit goods
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
FURTHER REASONS FOR GOVERNMENT INTERVENTION IN
THE ECONOMY
LO: explain why government participates in economic affairs
LO: describe how government intervenes in the economy
Summary
Three broad functions of government:
• Allocative
• Distributive
• Stabilisation
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: describe how government intervenes in the economy
15.5 HOW DOES GOVERNMENT INTERVENE?
What instruments can government use to intervene?
1. Public provision of goods and services
2. Through its role as a market participant
3. Through government spending
4. Through taxation
5. Through regulation
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: explain why governments, like markets, can fail
15.6 GOVERNMENT FAILURE
Two broad groups of public officials:
• Politicians
• Bureaucrats
Three primary sources of government failure:
1) The behavior of vote-maximizing politicians
2) The behavior of bureaucrats and the lack of competition
3) Rent seeking
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: distinguish between nationalisation and privatisation
15.7 NATIONALISATION AND PRIVATISATION
Nationalisation – The transfer of ownership from private enterprise to
government
Privatisation – The transfer of assets from the public sector to the private
sector
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: explain what fiscal policy means
15.8 FISCAL POLICY AND THE BUDGET
Fiscal policy – A policy in respect of the level and composition of:
• Government spending
• Taxation
• Government borrowing
The main instrument of fiscal policy is the budget.
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
FISCAL POLICY AND THE BUDGET
LO: explain what fiscal policy means
Demand management
Fiscal policy
Budget
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
Monetary policy
LO: discuss government spending and the financing of such spending
15.9 GOVERNMENT SPENDING
Government spending classifications
Government spending
Economically
Consumption
spending
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Functionally
Investment
spending
ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
GOVERNMENT SPENDING
LO: discuss government spending and the
financing of such spending
Table
Government
in South
Africa and
as a2012/13
15-315-2
Functional
compositionspending
ofin
budget
expenditure
Trends ofTable
government
spending
South
Africa1990/91
1.
1
2.
2
percentage of gross domestic
expenditure,
(Textbook
page 292) 1960–2013 (Textbook
page 290)
Growth in government spending
Possible explanations for
growth in government
spending:
• Changingspending
consumer
Changes in the functional composition of government
preferences
• Political and other
shocks
• Redistribution of
income
• Misconceptions and
entitlement
• Population growth and
urbanisation
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
GOVERNMENT SPENDING
LO: discuss government spending and the
financing of such spending
Table 15-4
Budget deficits,
public debt and
interest on
public debt in
South Africa,
1997–2013
(Textbook page
292)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: discuss government spending and the financing of such spending
15.10 FINANCING OF GOVERNMENT
EXPENDITURE
Government spending financed by:
• income from property
• taxes
• borrowing
Borrowing (to finance budget deficit):
• domestic capital markets (government bonds)
• international capital market (government bonds)
• central bank (SARB) (inflationary financing)
Borrowing increases public debt and interest on public debt
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LO: discuss the criteria for a good tax
15.11 TAXATION
Criteria for a good tax
What is good tax?
• Neutral
• Equitable
– Horizontal equity
– Vertical equity
• Administrative simplicity
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
TAXATION
LO: discuss the criteria for a good tax
Click on the type of tax to reveal more information.
Click again to hide.
Different types of taxes
DIRECT
OR
INDIRECT The ratio between tax
The ratio of tax
The ratio of tax paid
paid and taxable
paid to taxable
to taxable income is
income decreases as
Levied on
persons, more
Levied
on
transactions
and are
income
increases
PLUS
the same
at all
taxable income
specifically
the income or
usually paid by those who
as
taxable income
levels of income.
increases (or rises as
wealth
of
individuals
and
consume
the
goods and services
increases.
taxable income falls).
OR
GENERAL
SELECTIVE
organisations companies.Example:
in question.
Example:
• Company tax
Example:
•Examples:
Personal tax
Examples • VAT
Levied on most goods and services.
on specific goods only.
PLUS Levied
• personal income tax
• VAT
Example:
Example:
• company tax
• customs duties
OR
OR
PROGRESSIVE
PROPORTIONAL
• • VAT
• •Excise
duties
estate duties
excise
duties REGRESSIVE
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
TAXATION
LO: discuss the criteria for a good tax
Three main taxes in South Africa:
1
Personal income tax
2
Company tax
3
Value-added tax (VAT)
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Click again to hide.
• Personal income tax
– Taxable income (tax base)
– Marginal
• Company
tax tax rate and average
(or effective)
tax rate
– Company
profits
(tax base)
– Direct taxtax
• Value-added
–
Progressive
Proportional
tax
– Indirect
tax tax
–
Includesindex
capital gains tax
– General
– Regressive tax
ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
TAXATION
LO: discuss the criteria for a good tax
The rise in the overall tax burden
Table 15-5 Taxation in South Africa,
1960–2013 (Textbook page 296)
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
15.12 TAX INCIDENCE: WHO REALLY PAYS
THE TAXES?
All taxes are paid by individuals
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ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
IMPORTANT CONCEPTS
•
•
•
•
•
•
•
•
•
•
•
•
•
•
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General government
Public sector
Market failure
Public goods
Rivalry
Excludability
Mixed goods
User charge
Externalities
External costs
External benefits
Asymmetric information
Principal–agent problem
Moral hazard
•
•
•
•
•
•
•
•
•
•
•
•
•
•
ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
Adverse selection
Common property resources
Tragedy of the commons
Business cycle
Macroeconomic policy
Fiscal policy
Merit goods
Government spending
Transfer payments
Taxation
Regulation
Government failure
Rent-seeking
Nationalisation
IMPORTANT CONCEPTS
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
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Privatisation
Budget
Demand management
Expansionary policy
Contractionary policy
Lags
Budget deficit
Inflationary financing
Public debt
Interest on public debt
Tax neutrality
Horizontal equity
Vertical equity
Benefit principle
Tax avoidance
Tax evasion
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
ECONOMICS FOR SOUTH AFRICAN STUDENTS
CHAPTER 5: DEMAND AND SUPPLY IN ACTION
Direct taxes
Indirect taxes
General tax
Selective tax
Progressive tax
Proportional tax
Regressive tax
Taxable income
Marginal tax rate
Average tax rate
Bracket creep
Capital gains tax
Value-added tax
Tax incidence
Statutory incidence
Effective incidence