Unit 5 – Role of Government
Unit Overview
In this unit the students develop criteria to determine which activities government
should undertake and to evaluate how well government performs these activities.
The students first learn that governments must provide public goods. Pure public
goods are rare and must meet the criteria of shared consumption and non-exclusion.
Governments also correct market failures. A market failure occurs when the private
market produces too much or too little of a good because of negative and positive
externalities. Market failures also occur when people in markets do not have sufficient
information, and this is also used to justify government intervention.
Of course, governments also have less-than-perfect information. Although
government intervention may correct market failures, government policies can also
fail. Public-choice theorists believe politicians and government officials are as selfinterested as businesspeople. However, instead of trying to maximize profits,
"political entrepreneurs" seek to maximize power, salaries, prestige and votes. This
behavior results in government waste and inefficiency. Public-choice theory provides
balance to a discussion of the role of government.
Finally, some people believe that governments should make the distribution of income
more equal. Governments do this through taxation policies, although these policies do
not always have the desired effects.
Essential Unit and TSWs
Unit Statement: In this unit, the student will develop criteria to determine which
activities government should undertake and to evaluate how well government
performs these activities. Governments must provide public good and work to correct
market failures. However, government officials may operate with mixed motives
resulting in waste and inefficiency.
Essential Outcomes:
1. The Student Will explain the conditions for economic efficiency, using the
marginal social benefit and marginal social cost principle.
2. TSW articulate the ways in which externalities (both positive and negative),
public goods and the market distribution of income create market failures even
in competitive free-market economies.
3. TSW discuss and graph the effectiveness of government policies such as
subsidies, taxes, quantity controls (quotas) and public provision of goods and
services, which are designed to correct market failures and achieve economic
efficiency.
4. TSW examine how governments balance market failures caused by
monopolies with the government’s attempt to solve such problems by using
antitrust policy and regulations.
5. TSW consider whether a particular good or service should be provided by the
private sector or by government.
6. TSW identify key measures of income distribution such as the Lorenz curve
and Gini coefficient and examine the impact of government tax policies and
transfer programs, both on the distribution of income and on economic
efficiency.
The Lesson Planner




Lesson 1 explains the conditions under which a good or service should be
provided by the private sector or by government. The activities describe the
characteristics of public goods and private goods. The lesson uses Activities
52 and 53 and Visual 5.1.
Lesson 2 is all about externalities. A market externality refers to a situation in
which some of the costs or benefits from an activity fall on someone other
than the one pursuing the activity. Governments intervene to make the
allocation of these goods more efficient. The lesson also discusses
information-cost problems. It uses Activities 54, 55, 56 and 57 as well as
Visuals 5.2 and 5.3.
Lesson 3 focuses on public-choice economics. Although governments have
important economic functions, they sometimes perform these functions poorly.
In addition to market failures, there are government failures. The lesson uses
Activity 58 and Visual 5.4.
Lesson 4 discusses the economics of taxation. Governments use taxes to alter
the distribution of income in a society. This lesson discusses who actually
pays income taxes and how this affects the distribution of income. Activities
59 and 60 comprise this lesson. There are no activities on shifting tax
incidence in this unit. You may want to use Activity 21 in Unit 2 here.
Lesson 1 – Public vs. Private Goods
Introduction and Description
In the United States, most economic decisions are made in the marketplace through
the interaction of buyers and sellers. Some goods and services, however, can only be
provided by the government. The students should know the criteria that should be
used to judge whether a good or service should be provided by the private sector or by
government. They must know the characteristics of public goods and private goods.
Objectives
1. Define public good.
2. Describe the characteristics of a public good.
3. Develop a rationale for determining which goods should be produced by the
private sector and which goods should be produced by the public sector.
Time Required
One and one-half class periods or 68 minutes
Materials
1. Activities 52 and 53
2. Visual 5.1
Your Tasks
1. Ask the students to brainstorm jobs that government does. Have them list as
many functions of local, state and federal governments as they can.
2. Give a lecture on the economic role of government, using Visual 5.1.
3. Introduce the concept of a public good. Explain that a public good has both
shared consumption and non-exclusion. You might ask the students to classify
some goods using
a. exclusion
b. non-exclusion
c. non-shared consumption (rival good)
d. shared consumption (non-rival good) Some possibilities are
i. hamburger: exclusion and rival
ii. TV show: exclusion but non-rival
iii. park: exclusion but non-rival
iv. education: exclusion but non-rival
v. national defense: non-exclusion and shared consumption (nonrival)
4. Discuss the problem of free riders when people cannot be excluded from using
goods.
a. Ask what happens if a person does not contribute to public television.
b. Offer to sell a grade for the highest price. But once the first grade is
sold, everyone in the class gets this same grade. Who will buy the
grade? Will all the students join together to buy it? What if one student
refuses to pay? Compare the results with selling a private good.
5. Have the students read Activity 52 and answer the questions.
6. Discuss the answers to Activity 52. There might be some discussion on shared
consumption. For example, a private amusement park is shared consumption
until it is full. Health care is shared consumption in some areas (public health)
and not in others. This is a good opportunity to show these decisions are
difficult.
7. Have the students complete Activity 53 and discuss the answers. These are
opinions, but goods produced by government should meet the criteria of nonexclusion and shared consumption.
Lesson 2 – When Markets Fail
Introduction and Description
Some government intervention in the economy is designed to remedy problems
arising from third party costs and benefits of private activities or transactions.
Students who understand third-party effects, often called externalities, can analyze the
need for and effect of such government interventions.
Activity 54 provides an overview of the externality problem. When a government
tries to correct a negative externality, it can choose to intervene in a number of ways,
or the problem may be corrected by private negotiations, which is the basis for the
Coase Theorem (Activity 55).
When government does intervene, its objective is to use marginal analysis so the
marginal social benefit of the last unit produced equals the unit's marginal social cost.
Activity 56 provides practice in doing this type of analysis. Finally, competitive
markets can fail because of information cost, which is the basis of Activity 57.
Objectives
1.
2.
3.
4.
5.
6.
7.
8.
Explain how private market activities can cause externalities.
Define and give examples of third-party costs or negative externalities.
Define and give examples of third-party benefits or positive externalities.
Analyze ways positive and negative externalities can cause overproduction or
underproduction of goods and services.
Analyze the effectiveness of government policies designed to remedy
problems caused by positive or negative externalities.
Describe the Coase Theorem and use it to analyze how negotiations among
private-property owners can resolve market-allocation problems.
Analyze how marginal analysis can determine the optimum amount of
pollution cleanup.
Describe the information-cost problem, and analyze the effectiveness of
government policies to correct it.
Time Required
Three and one-half class periods or 158 minutes
Materials
1. Activities 54, 55, 56 and 57
2. Visuals 5.2 and 5.3
Your Tasks
1. Begin with a discussion on the external effects of production and some
common-sense examples of positive and negative externalities.
a. Smoking creates external costs. The smoker is satisfied, and the
tobacco company gains; but third parties often have to cope with smell
and litter, as well as the hazard to health from breathing secondary
smoke.
b. People who drive under the influence of alcohol are much more likely
to cause accidents than other drivers. These accidents cause third
parties to suffer personal injury and / or property damage.
c. The productive work of maintaining one's house is an example of an
external benefit provided by a consumer who also acts as a producer. If
people landscape their yards, paint and otherwise maintain their houses,
the whole neighborhood looks better. The houses are then usually
worth more than houses in comparable neighborhoods where the
owners do not maintain their houses to an equal extent.
d. Education provides third-party benefits. On the whole, people's
productivity increases with their level of education. A higher level of
education also tends to be correlated with better health and a lower
2.
3.
4.
5.
6.
7.
crime rate. Third parties benefit from this greater productivity through
fewer demands on health-care services and the lower burden on the
police and judiciary.
e. If you teach in a public school, ask the students why taxpayers should
pay for their education. One reason is the third-party benefits that
education creates.
Now use graphical analysis to illustrate negative and positive externalities and
how these externalities can be corrected.
a. Use Visual 5.2 to illustrate the effects of a negative externality.
b. Use Visual 5.3 to illustrate the effects of a positive externality.
Have the students complete Activity 54 and discuss the answers.
Discuss the Coase Theorem. Ronald Coase is a Nobel Laureate in economics.
His theory has many practical applications. The key is that resources can be
allocated efficiently if private ownership rights are assigned and when there
are no transaction costs. Most importantly, Coase maintained that no matter
who receives the legal rights to ownership, the assignment will have no effect
on the way economic resources are used. Your students may wonder why this
is a big deal, particularly because all transactions do have costs. The
excitement is that the Coase Theorem changes the way people look at
economic problems. There is less need for government intervention. In any
economic transaction, solutions that can benefit most parties can be achieved
by negotiations. For example, environmental problems can be resolved if
property rights are assigned rather than relying on government command and
control.
Have the students complete Activity 55 and go over the answers.
Now that we have established that markets fail because of externalities, how
should government treat the problem? The environment is an important issue.
Is it always a good idea to clean up the environment as much as possible? This
would ignore the opportunity cost of the cleanup. Therefore, the environment
should be cleaned up to the point where the marginal social benefit equals the
marginal social cost of the cleanup.
Have the students complete Activity 56 and discuss the answers. Keep these
points in mind as you discuss the answers:
a. Question 1(A). Correctly interpreted, it costs Firm 1 $160 to reduce
pollution emissions by the first unit. The marginal benefit from this
emission reduction is $350. Thus, it clearly pays to reduce emissions
by this first unit.
b. Question 1(B). Similarly, it costs Firm 1 $360 to reduce pollution
emissions by the fifth unit, while the marginal benefit from this
damage reduction is $150. Thus, it clearly does not pay to reduce
emissions by this fifth unit of pollution.
c. Question 2(A). With MSC of $160 less than MSB of $200, it pays for
Firm 2 to reduce pollution emissions by the fourth unit.
d. Question 2(B). The MSC of $160 is greater than the MSB of $150, so
it does not pay Firm 2 to eliminate the fifth unit of foul sludge
emissions. The explanations for Questions 3 and 4 are shown on the
answer key. Since the basic logic of "keep reducing so long as MSB >
MSC, and stop reducing when MSB < MSC" lends itself to graphical
exposition — and since a graph helps illustrate the social optimum of
MSB = MSC — two graphs of the numerical data in this problem are
in the answer key for Activity 56.
8. Another reason a market can fail is because of information costs. If either the
buyer or seller has better information, market efficiency may suffer. Although
an answer may be government regulation, this should be tempered by the fact
that governments also have less-than-perfect information.
9. Have the students complete Activity 57 and go over the answers.
10. Conduct a general discussion about why markets fail and how government can
correct these failures.
Lesson 3 – When Government Fails
Introduction and Description
Lessons 1 and 2 stress the economic functions of government, with particular
emphasis on market failures. This lesson deals with government failure and provides
balance in evaluating the role of government.
Throughout their education, the students have been told that democratic governments
try to improve society. They learn that some political leaders may be stupid,
incompetent or corrupt; but a responsible electorate can vote them out of office.
Furthermore, poor leadership is often blamed on political apathy. Most civics and
government classes stress the reasons why citizens should vote and actively
participate in the political process.
Public-choice economists believe that all this good-government stuff is bunk and that
when political activity is studied with the tools of economics, government will be seen
to fail more often than markets will. Their analysis shows why there is not much
difference between the political parties, why special interests prevail over the public
good, why it is rational not to vote and why bureaucrats are inefficient. It is not a
matter of getting the right people in government. Rather, government fails because
politicians and bureaucrats are trying to maximize their ability to gain votes and
power. Their behavior is as self-interested as anyone else's.
This lesson should increase the students' skepticism toward government. They may
agree with Winston Churchill, who said that democracy is the worst form of
government except for the alternatives.
Objectives
1. Describe the basic tenets of the public-choice model of government behavior.
2. Analyze the reasons why self-interest leads to the public good in a private
market but does not lead to the public good in the government sector.
3. Analyze political behavior using the theory of public choice.
Time Required
One and one-half class periods or 68 minutes
Materials
1. Activity 58
2. Visual 5.4
Your Tasks
1. Begin the lesson with an idea suggested by Ralph Byrns and Gerald Stone in
Great Ideas for Teaching Economics, 5th ed. (New York: Harper- Collins,
1992): A quick poll of the students in virtually any college classroom will
reveal a widespread call for "lower taxes and less government. "After
ascertaining that this is true through a show of hands in your class, either list a
large number (20 or so) of present or proposed government activities (e.g.,
national health care, national defense) on a chalkboard or pass out detailed
lists of such activities (perhaps to have the students take home to record their
responses). One activity at a time, have the students indicate by a show of
hands whether they favor: (a) eliminating the specific activity by government;
(b) substantially decreasing the funding for the activity; (c) keeping the
activity at present levels; or (d) increasing the government's participation in
this area. They will be surprised (and you may be as well) when virtually all
classes vote for substantial net expansions of many, or even most, government
programs. When asked to account for this seeming paradox, some students
may argue that most people want greater efficiency — more and better quality
government services at lower tax costs. You can question whether a greater
efficiency in government is likely, regardless of who marketplace resource
allocations with those resulting from public sector decision making. We have
found that this exercise invariably generates enthusiastic class participation.
2. Give a lecture on the basic ideas of the public-choice school of economics
using Visual 5.4. Here are some points to make. Question 1: Is it rational for
government leaders to favor special interests over the general public interest?
This is an important point in the public-choice doctrine. The idea is that
special interests have a big stake in government. Therefore, they take a big
interest in government. When they give politicians contributions and support,
the politicians know it. Each member of the public may lose just a little when
a special interest gets its way, so the public doesn't pay attention. Furthermore,
the public is ignorant. Therefore, the politician goes with the special interest.
The more concentrated the benefit for the special interest and the more
diffused the cost to the public, the more likely the special interest will get its
way. Question 2:Why are politicians mainly in the middle of the road? The
median-voter hypothesis predicts that politicians, regardless of party, will
appeal to the median voter in the constituency they represent. It also predicts
that politicians will take a more extreme position in the party primary election
(when they are appealing to the median voter in the party) than in the general
election. Question 3: Are people rational or irrational when they spend little
time evaluating candidates before they vote and when they don't vote? This is
known as rational ignorance. Why be informed about the candidates when
your vote counts so little? Why even vote? If this is true, why do so many
people vote? The public-choice answer is that voting is a consumption activity.
Voting gives people a feeling that they did their civic duty. By voting, they
can complain without guilt when they don't like a government policy.
Question 4:What is the effect of bureaucratic entrepreneurs on government? A
business is successful if it can maximize profits. A bureaucrat is successful if
he or she can maximize power. Bureaucrats are rewarded when they expand
the duties and clientele of their departments. A bureaucrat will have a smaller
department if it becomes more efficient. Bureaucrats have an incentive to
expand their departments, not to reduce them. With larger departments come
more power, a bigger office, a higher salary and a larger pension.
3. Have the students read the beginning of Activity 58 (up to the mystery
activity), and answer any questions they have.
4. Divide the class into groups, and have each group try to solve the mysteries.
5. Have the groups report their solutions and discuss them.
Lesson 4 – Efficiency, Equity, and the Effects of Government
Policies
Introduction and Description
Previous lessons have examined the role or size of government. This unit looks at the
distribution of income and the effects of government policies to change it. The
controversy weighs efficiency against equity. Markets work. In a world of scarce
resources, higher productivity is better than lower productivity. Markets create
incentives that increase productivity and the size of the pie.
It also may be true that the poor are needier than the rich. Markets create inequalities,
and governments use taxes and transfer payments to redistribute income. These very
policies, however, may create serious disincentives that damage efficiency and shrink
the size of the pie.
What should be the trade-off between efficiency and equity? Are there policies that
can improve both? Can government create hardheaded and softhearted policies?
Objectives
1. Define and differentiate between the ability-to-pay and the benefits-received
theories of taxation.
2. Define and differentiate among progressive, proportional and regressive taxes.
3. Describe the distribution of income in the United States.
4. Describe who pays income taxes and which income earners bear the greatest
burden of income taxes.
5. Analyze the effects of government redistribution policies.
Time Required
113 minutes
Materials
1. Activities 59 and 60
Your Tasks
2. Have the students read Activity 59 until they reach the questions.
3. Give a lecture-discussion on tax equity that covers these points:
a. The difference between the ability-to-pay and the benefits-received
theories of taxation
b. The difference between a nominal and an effective tax rate
c. The definitions of progressive, proportional and regressive taxes. Be
sure to make clear that the rate must be an effective rate applied
against income. Students confuse an income tax base with other tax
4.
5.
6.
7.
8.
bases, such as consumption or wealth. For example, they might
incorrectly conclude that the sales tax is a proportional tax since the
rate is the same for everyone. They will not distinguish between a
consumption base and an income base.
Have the students answer the questions on Activity 59 and discuss them.
Now bring up the question of whether the federal income tax is progressive,
proportional or regressive.
Have the students complete Activity 60 and discuss the answers.
Be sure to make the big point that the federal income tax is progressive. In
1997, the top 1 percent of taxpayers paid 33.2 percent of the taxes. Their tax
rate was 27.7 percent. The bottom 50 percent of taxpayers paid 4.3 percent of
taxes. Their tax rate was 4.5 percent.
Discuss the following philosophical issues:
a. Why is efficiency important?
b. Why is equity important?
c. Do policies that redistribute income hurt efficiency, or are there
policies that can improve both equity and efficiency?