CHAPTER 1
Individuals and Government
Instructional Objectives
Chapter 1 is a general introduction to the field of public finance, emphasizing the
relationship between individuals and government. The functions of government are
outlined, and the importance of taxes in household budgets is highlighted. The chapter
seeks to develop an understanding of the economic role of government as a supplier of
useful goods and services. Students are also expected to digest data on the actual extent of
government activity in the United States and other nations. They should know the current
structure of government expenditures and revenues in the United States, how government
has grown since 1920, and how the structure of federal government spending has changed
since 1960.
In addition, the chapter seeks to demonstrate that the problem of scarcity implies
that an increase in resources devoted to government goods and services decreases
availability of resources for nongovernment uses. It is also made clear to students how
government provision of goods and services differs from market provision of goods and
services.
Changes in This Edition
All graphs and tables have been revised using the latest available data and information. The
International View on government spending throughout the world has been updated using
new OECD data. The categories for federal expenditure have been revised to conform to
current use of government consumption in the National Income and Product Accounts. The
discussion of state and local government expenditure and finances has been expanded.
There is a new section discussing state government fiscal difficulties in 2002 and 2003. The
new section details structural problems in state government finance and has information
about states that have been particularly impacted by financial problems. A new problem on
state and local government finance has been added to the chapter. New Internet Resources
have been added.
,Chapter Outline
Individuals, Society, and Government
The Allocation of Resource between Government and Private Use
How Government Goods and Services Are Distributed
The Mixed Economy, Markets, and Politics
Circular Flow in the Mixed Economy
International View: How Much Government?
Government Expenditures in the United States
Growth of Government Expenditures
The Structure of Federal Government Expenditure in the United States
State and Local Government Spending
The State Government Budget Crunch of 2002
Financing Government Expenditure in the United States
Market Failure and the Functions of Government: How Much Government is Enough?
Public Policy Perspective: The Graying of America: Implication for the Federal Government’s
Budget
Major Points and Lecture Suggestions
1. My objective in the first lecture is to make it clear to students how economic
analysis of the functions and activities of governments fits in with their other
courses. Since most students have already had at least one course in
microeconomics, I point out how governments can be thought of as agents for
supplying goods and services whose quantities have been determined through
political, as opposed to market, interaction. The role of government in the mixed
economy is schematically illustrated with a modified circular flow diagram.
Figure 1.2 represents a useful starting point for illustrating how the economic
analysis of government fits in with previous analyses of markets to which most
students will have already been exposed. I usually draw the diagram on the board
and show how both households and business firms have economic relations with
governments.
2. The tradeoff between government goods and services, and private goods and
services is illustrated with the production possibility curve. Figure 1.1 is familiar
to most students, and its application to analysis of government goods and
services usually captures their attention. It helps to use the graph in class to
, discuss reallocation of resources from military to nonmilitary uses. Another
interesting use of the graph is to show how increased environmental quality
improvement services supplied by government will require the sacrifice of
material goods and services, as the prices of such products as fuel, electricity, and
automobiles rise.
3. Emphasize that government goods and services are usually made available
through nonprice rationing:
a. Government goods are often available for collective use at no direct charge, as
is the case for roads, national defense, police services, fire protection, and
environmental protection.
b. Eligibility for obtaining the benefits of government services is determined by
criteria other than ability and willingness to pay. Politically determined
criteria, such as age, income, family status, and location of residence, often
determine a person’s eligibility to receive government transfers, such as food
stamps, and services, such as public schooling.
4. A general listing of the functions of government, as discussed in the text, is useful
to students. These functions are as follows:
a. Provision of useful goods and services, including the establishment of
property rights and the underlying legal system
b. Redistribution of income and economic opportunity among citizens
c. Stabilization (Note that this is not covered in the text.)
d. Regulation of private action
5. Note that the discussion of government finance in the chapter briefly outlines the
fact that the consequences of alternative means of finance differ in terms of the
impact on incentives to produce and on the distribution of well-being.
6. I usually photocopy the tables in Chapter 1 and bring them to class for the second
lecture. I believe that it is important for students to have some appreciation of the
current extent of government and the growth of expenditures and revenues in
recent years.
7. In addition to illustrating the growth of government, I seek to show how the
structure of federal government expenditure has changed significantly since
1960. First, point out to students the spectacular growth in the relative
importance of transfers from 1960 to 1980. You can also point out that transfers
stabilized at close to 40 percent of federal spending in the 1970s. After declining
slightly as a share of federal spending in the 1980s, they rose again in the 1990s,
and now account for about 43 percent of federal spending. Federal government
purchases of goods and services for consumption and investment has declined
over 60 percent of federal spending in 1960 to 27 percent in 1999. Since the end
, of the Cold War, purchases have declined as defense spending has been cut back.
However, the terrorist attacks of September 11, 2001, have resulted in both
increased government spending and a shift away from transfers toward
government consumption.
8. In discussing actual expenditures, use Table 1.3 and the accompanying pie chart
to show the importance of Social Security, income security, Medicare, and health
for the federal government, and point out that these programs account for about
two-thirds of federal government expenditures. Also point out that 37 percent of
state and local government expenditure is accounted for by education. Health
care spending by state and local governments, mainly for Medicaid, has been
growing rapidly and now accounts for 20 percent of state and local government
spending.
9. Use the data and accompanying pie charts in the chapter to show students how
income taxes, including payroll taxes and corporate profits taxes, account for
about 90 percent of federal government revenue. Also point out that sales and
property taxes account for nearly half of state and local government revenues and
that one in five dollars of receipts received by state and local governments comes
from federal grants-in-aid.
10. Many instructors are now spending more time in class discussing state and local
government fiscal problems. A new section in Chapter 1 discusses the structural
problems that are underlying state government budgets and discusses the
situation and impact on budgets for selected states that have been particularly
hard hit be revenue shortfalls.
A Note on the Appendix to Chapter 1
The appendix to Chapter 1 is a concise review of basic microeconomic principles used
throughout the text. The material is designed to aid students with weak backgrounds in
basic economic theory. It also provides a convenient reference for students who wish to
review basic concepts as they are needed. I advise my students to read the appendix, but I
do not cover any of the material in class.
Outline of the Appendix to Chapter 1
Indifference Curve Analysis
Assumptions about Preferences
Indifference Curves and Indifference Maps
The Budget Constraint
Consumer Equilibrium
Individuals and Government
Instructional Objectives
Chapter 1 is a general introduction to the field of public finance, emphasizing the
relationship between individuals and government. The functions of government are
outlined, and the importance of taxes in household budgets is highlighted. The chapter
seeks to develop an understanding of the economic role of government as a supplier of
useful goods and services. Students are also expected to digest data on the actual extent of
government activity in the United States and other nations. They should know the current
structure of government expenditures and revenues in the United States, how government
has grown since 1920, and how the structure of federal government spending has changed
since 1960.
In addition, the chapter seeks to demonstrate that the problem of scarcity implies
that an increase in resources devoted to government goods and services decreases
availability of resources for nongovernment uses. It is also made clear to students how
government provision of goods and services differs from market provision of goods and
services.
Changes in This Edition
All graphs and tables have been revised using the latest available data and information. The
International View on government spending throughout the world has been updated using
new OECD data. The categories for federal expenditure have been revised to conform to
current use of government consumption in the National Income and Product Accounts. The
discussion of state and local government expenditure and finances has been expanded.
There is a new section discussing state government fiscal difficulties in 2002 and 2003. The
new section details structural problems in state government finance and has information
about states that have been particularly impacted by financial problems. A new problem on
state and local government finance has been added to the chapter. New Internet Resources
have been added.
,Chapter Outline
Individuals, Society, and Government
The Allocation of Resource between Government and Private Use
How Government Goods and Services Are Distributed
The Mixed Economy, Markets, and Politics
Circular Flow in the Mixed Economy
International View: How Much Government?
Government Expenditures in the United States
Growth of Government Expenditures
The Structure of Federal Government Expenditure in the United States
State and Local Government Spending
The State Government Budget Crunch of 2002
Financing Government Expenditure in the United States
Market Failure and the Functions of Government: How Much Government is Enough?
Public Policy Perspective: The Graying of America: Implication for the Federal Government’s
Budget
Major Points and Lecture Suggestions
1. My objective in the first lecture is to make it clear to students how economic
analysis of the functions and activities of governments fits in with their other
courses. Since most students have already had at least one course in
microeconomics, I point out how governments can be thought of as agents for
supplying goods and services whose quantities have been determined through
political, as opposed to market, interaction. The role of government in the mixed
economy is schematically illustrated with a modified circular flow diagram.
Figure 1.2 represents a useful starting point for illustrating how the economic
analysis of government fits in with previous analyses of markets to which most
students will have already been exposed. I usually draw the diagram on the board
and show how both households and business firms have economic relations with
governments.
2. The tradeoff between government goods and services, and private goods and
services is illustrated with the production possibility curve. Figure 1.1 is familiar
to most students, and its application to analysis of government goods and
services usually captures their attention. It helps to use the graph in class to
, discuss reallocation of resources from military to nonmilitary uses. Another
interesting use of the graph is to show how increased environmental quality
improvement services supplied by government will require the sacrifice of
material goods and services, as the prices of such products as fuel, electricity, and
automobiles rise.
3. Emphasize that government goods and services are usually made available
through nonprice rationing:
a. Government goods are often available for collective use at no direct charge, as
is the case for roads, national defense, police services, fire protection, and
environmental protection.
b. Eligibility for obtaining the benefits of government services is determined by
criteria other than ability and willingness to pay. Politically determined
criteria, such as age, income, family status, and location of residence, often
determine a person’s eligibility to receive government transfers, such as food
stamps, and services, such as public schooling.
4. A general listing of the functions of government, as discussed in the text, is useful
to students. These functions are as follows:
a. Provision of useful goods and services, including the establishment of
property rights and the underlying legal system
b. Redistribution of income and economic opportunity among citizens
c. Stabilization (Note that this is not covered in the text.)
d. Regulation of private action
5. Note that the discussion of government finance in the chapter briefly outlines the
fact that the consequences of alternative means of finance differ in terms of the
impact on incentives to produce and on the distribution of well-being.
6. I usually photocopy the tables in Chapter 1 and bring them to class for the second
lecture. I believe that it is important for students to have some appreciation of the
current extent of government and the growth of expenditures and revenues in
recent years.
7. In addition to illustrating the growth of government, I seek to show how the
structure of federal government expenditure has changed significantly since
1960. First, point out to students the spectacular growth in the relative
importance of transfers from 1960 to 1980. You can also point out that transfers
stabilized at close to 40 percent of federal spending in the 1970s. After declining
slightly as a share of federal spending in the 1980s, they rose again in the 1990s,
and now account for about 43 percent of federal spending. Federal government
purchases of goods and services for consumption and investment has declined
over 60 percent of federal spending in 1960 to 27 percent in 1999. Since the end
, of the Cold War, purchases have declined as defense spending has been cut back.
However, the terrorist attacks of September 11, 2001, have resulted in both
increased government spending and a shift away from transfers toward
government consumption.
8. In discussing actual expenditures, use Table 1.3 and the accompanying pie chart
to show the importance of Social Security, income security, Medicare, and health
for the federal government, and point out that these programs account for about
two-thirds of federal government expenditures. Also point out that 37 percent of
state and local government expenditure is accounted for by education. Health
care spending by state and local governments, mainly for Medicaid, has been
growing rapidly and now accounts for 20 percent of state and local government
spending.
9. Use the data and accompanying pie charts in the chapter to show students how
income taxes, including payroll taxes and corporate profits taxes, account for
about 90 percent of federal government revenue. Also point out that sales and
property taxes account for nearly half of state and local government revenues and
that one in five dollars of receipts received by state and local governments comes
from federal grants-in-aid.
10. Many instructors are now spending more time in class discussing state and local
government fiscal problems. A new section in Chapter 1 discusses the structural
problems that are underlying state government budgets and discusses the
situation and impact on budgets for selected states that have been particularly
hard hit be revenue shortfalls.
A Note on the Appendix to Chapter 1
The appendix to Chapter 1 is a concise review of basic microeconomic principles used
throughout the text. The material is designed to aid students with weak backgrounds in
basic economic theory. It also provides a convenient reference for students who wish to
review basic concepts as they are needed. I advise my students to read the appendix, but I
do not cover any of the material in class.
Outline of the Appendix to Chapter 1
Indifference Curve Analysis
Assumptions about Preferences
Indifference Curves and Indifference Maps
The Budget Constraint
Consumer Equilibrium
