THE MARKET SYSTEM
Public Sector and Government Functions
AP ECONOMICS
CHAPTER 4
McConnell Brue
MARKET SYSTEM CHARACTERISTICS

PUBLIC SECTOR – includes all levels of
government (national, state & local)
 Performs
functions not possible by private
sector
 Provide public goods and services
 Receive tax revenue to pay for government
spending (or borrow!)
Economic Functions of Government
1. LEGAL & SOCIAL FRAMEWORK –

Laws promote order which inspires
confidence in the market system
 Ensures property rights (deeds, titles, etc)
 Protects ownership through “rule of law”
 Courts exist to mediate disputes and provide
fair and efficient solutions
Economic Functions of Government
2. PROVIDE PUBLIC GOODS AND
SERVICES

Would not be provided by the private sector
due to “free rider” problem & low incentives
 Can be offered to many at low additional
cost
 Difficult to “exclude” others from using
 Examples: military, ,police, fire protection,
streets & highways, public schools, libraries,
parks, monetary system, etc.
Economic Functions of Government
3. MAINTAIN COMPETITION – rules for fair
competition to protect businesses &
consumers
 Monopolies
are illegal (Sherman Antitrust Act)
 “Natural or Legal” Monopolies are allowed, but
regulated
 Examples of legal monopoly: cable service,
utility price regulation, mass transit, AMTRAK
Economic Functions of Government
4. REDISTRIBUTION OF INCOME – Market
system allows unequal distribution of
income. Society chooses to collectively
provide help for some social problems.
 Progressive
taxes - larger proportion of wealth
of the rich is taxed
 Transfer payments – provide for the poor,
disabled, unemployed, elderly, etc.
 Examples: Social Security, Medicare,
Medicaid, Food Stamps, other welfare
programs
Economic Functions of Government
4. REDISTRIBUTION OF INCOME (con’t)
Market Interventions – government
regulates prices for fairness
 Examples:
farm subsidies - payments to
farmers so low price will not hurt them
Minimum wage laws – require employers to
pay a fair wage so less skilled workers can
support themselves
Economic Functions of Government
5.CORRECTING FOR MARKET FAILURES
(Externalities; Spillover Costs & Benefits) –
when mkt produces wrong amount of a good or
service or fails to produce at all
or benefits goes to neutral 3rd party
 Producer does not pay full costs of production
Example: secondhand smoke, pollution, drunk
drivers, property improvements in neighborhood,
good schools improve community,
immunizations
 Cost
Economic Functions of Government

CORRECTING FOR MARKET FAILURES
Negative Externality can be corrected by:
Laws & regulations – costs must be paid upfront or
actions are outlawed; fines, etc.
 Taxes – cover the cost of government cleanup or later
treatment, solutions etc.

Positive Externality can be encouraged by:
Subsidies to producers to increase supply
Tax incentives (tax breaks, etc)
Government provides goods or services
Economic Functions of
Government
6. STABILIZING THE ECONOMY – to
correct economic problems (mainly
recession/unemployment or inflation)
Output depends on spending to
encourage production
 Too
little spending = recession &
unemployment
 Too much spending = inflation & instability
Economic Functions of
Government
 STABILIZING

THE ECONOMY (con’t)
Gov can correct through taxing and
spending
Too little spending – can reduce taxes
&/or increase gov spending
Too much spending - can increase
taxes &/or decrease gov spending
Circular Flow Chart
RESOURCES
RESOURCE
MARKET
COST OF
PRODUCTION
L,L,C,E,T
WRIP
BUSINESSES
HOUSEHOLDS
CONSUMER
SPENDING
REVENUE
GOODS &
SERVICES
PRODUCT
MARKET
GOODS &
SERVICES
Circular Flow Chart
RESOURCES
BUSINESSES
GOODS &
SERVICES
RESOURCE
MARKET
GOVERNMENT
PRODUCT
MARKET
L,L,C,E,T
HOUSEHOLDS
GOODS &
SERVICES