Governments produce goods {community goods} and services {community services} that are not profitable or proper for businesses. For example, national government provides defense, prints money, and has retirement and disability programs. Local government provides education, fire services, housing, police services, and roads.
national treasury {exchequer}|.
Government can provide public goods that make better citizens, better consumers, or better-trained workers {external effect, government}, such as public education and health-and-safety publications.
States typically have laws {fair trade law} to protect small retailers against chain stores belonging to large corporations.
Nations can spend for popular job-creating programs that are run by state or led by cronies {macroeconomic populism}, by borrowing from other nations or printing money. This can cause inflation, bank failure, and currency devaluation. This also usually has high tariffs to protect jobs.
National governments can run businesses {nationalization}|, perhaps as benevolent monopolies. Nationalized firms can be inefficient and fail to meet customer needs.
Patents {patent, business}| allow inventors to make, sell, and use inventions as sole owners. Others must pay {licensing, patent} to use invention.
Government can guarantee good base prices {price support}|.
National government can spend money in industry sectors to raise demand {pump priming, economics}|.
Countries typically have funds {social security}| in which workers pay income percentage into fund, from which they or their spouses can retrieve money when they retire or become disabled.
Unemployment payments, accident or disability payments, illness payments, and old age payments {transfer payment, government}| provide money directly to people unable to work.
Anti-poverty programs, retraining grants and programs, aid to dependents, and aid to handicapped {welfare, government}| provide money indirectly to people unable to work.
Programs {workmen's compensation}| can receive percentage of worker income for use in case of death or disability.
People pay money to government in many forms {tax, types}. Taxes include capital-gains, excise, export, import, sales, turnover, and withholding taxes. Income tax can be on personal or business revenue. Estate tax can be on wealth at death. Property tax can be on real estate holdings. National taxes are income and value-added taxes. State taxes are income taxes, excise taxes, and sales taxes. Local taxes are property taxes. Taxes can be regressive or progressive.
Taxes {capital gains tax}| can be on capital gains over more than one year {long-term capital gains tax} or less than one year {short-term capital gains tax}.
Taxes {excise tax}| can be on each item or service.
Taxes {export tax}| can be on goods sent to foreign countries.
Taxes {import tax}| can be on goods purchased from foreign countries.
Taxes {sales tax}| can be a percentage, typically 3% to 8%, of retail purchase price, usually excluding food.
Taxes {turnover tax}| can be on buying and selling goods or services.
People typically must send income percentage {withholding tax}| to government to pay future taxes. Employers typically send paycheck percentage to government.
Taxes {progressive tax}|, such as income taxes, can assess at higher rates for higher incomes or wealth. They take lower percentage of income or wealth from lower-income people.
Fixed percentage taxes {regressive tax}|, such as sales and property taxes, take more value from lower-income people than from higher-income people. These taxes reduce consumption more than savings.
Governments can reach target GNP and control economic cycles by changing money price and availability {monetary policy}| {monetary theory}.
money supply: printing money
Governments can increase or decrease money in circulation {money supply} by printing or not printing money.
money supply: bonds
Governments can sell and buy bonds at fixed interest rates for different periods, such as three-month bonds and thirty-year bonds.
money supply: bank loans
Governments can raise or lower their bank-loan interest rate, the discount rate. If discount rate is lower, banks can charge customers lower loan interest rate, so people borrow more and money in circulation increases.
money supply: reserves
Governments can require banks to keep lower or higher percentages of money to cover loans, by the reserve ratio. If reserve ratio is lower, banks can loan more, people can borrow more, and circulating money increases.
interest rate
Printing money, decreasing discount rate, decreasing reserve ratio, and offering bonds increases money supply. When money supply increases, interest rates decrease, because money is less valuable. When interest rates decrease, money supply increases, because people save less.
Not printing money, increasing discount rate, increasing reserve ratio, and buying bonds decreases money supply. When money supply decreases, interest rates increase, because money is more valuable. When interest rates increase, money supply decreases, because people save more.
government
People receive income from working, spend for personal expenses, and have expectations about economy. Income changes slowly, but spending and expectations can change quickly. Government can affect people's spending and expectations. Government can raise and lower money supply, independently of taxes and spending, because it is the largest and most powerful institution and can incur or pay down debt. See Figure 1.
To stop expansion and inflation, governments increase interest rates and decrease money supply, to encourage saving and discourage borrowing. See Figure 2.
To stop recession, governments decrease interest rates and increase money supply, to encourage spending and encourage borrowing. See Figure 3.
Money passes from person to person {circulation, money}| {money circulation}.
Governments can vary interest rate {discount rate}| at which central bank lends money to commercial banks.
Money-supply and disposable-income increases result in larger increases in spending {multiplier effect, money}|, because increased money passes from person to person, by repeated spending. The multiplier process causes larger GNP increase than original income increase.
money supply
Government controls money supply. Government can change planned national expenditures or savings and so disposable income.
marginal propensities
People save some income and spend rest. Money-supply and disposable-income increases add extra income. People who receive extra income must decide how much to save {marginal propensity to save, multiplier} and how much to spend {marginal propensity to consume, multiplier}. Fraction that people decide to spend is money that goes into circulation. Average marginal propensity to spend is never 100%.
marginal propensities: change
Multiplier effect causes marginal-propensity-to-spend changes to multiply throughout economy.
circulation
Some money-supply or disposable-income increase goes to merchants. Merchants decide how much extra income to save or spend. Some money-supply or disposable-income increase goes to middlemen. Middlemen have marginal propensities to spend. Some money-supply or disposable-income increase goes to producers. Producers have marginal propensities to spend. Some money-supply or disposable-income increase goes to workers and investors. Workers and investors are the people that started the cascade. Some money-supply or disposable-income increase keeps cascading.
If average marginal propensity to spend is high, more people receive significant extra income. If average marginal propensity to spend is low, fewer people receive significant extra income. Typically, extra money is miniscule after ten transaction levels.
transaction velocity
Average marginal propensity to spend determines average number of times currency units change hands {transaction velocity, currency}. Transaction velocity can be ten.
multiplier
For example, people can spend 75% of increased money supply or disposable income for personal consumption, government, or exports and 3% for saving, 20% for taxes including Social Security and Medicare, and 2% for imports. Assume transaction velocity is 10. Income increase x multiplies through economy. Multiplier is sum, over transaction-velocity number, of the cascade of marginal propensities to spend. In this example, multiplier is 0.75 * x + 0.75 * (0.75 * x) + 0.75 * (0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * x) = (0.75 + 0.54 + 0.41 + 0.30 + 0.23 + 0.17 + 0.13 + 0.09 + 0.06 + 0.04) * x = 2.8 * x. Number of terms is 10. Terms contribute successively lower values.
multiplier: example
Assume average marginal propensity to spend is 90% = 9/10. For every 10 extra dollars, average person spends 9 dollars and saves 1 dollar. See Figure 1. After 10 people receive remaining money, changes are insignificant, so transaction velocity is 10. Multiplier is approximately 9.
multiplier: USA
USA multiplier is 3 or 4.
multiplier: time
The multiplier process takes three to six months to complete. The multiplier effect makes economic planning difficult for more than two years.
Governments can change required minimum ratio {reserve ratio}| of bank reserves to demand deposits, because money available for loans is amount over minimum percentage of demand deposits {free reserves} {excess reserves}. If amount available for loans is more, interest rate is less, and people take out more loans for higher amounts.
Average number of times currency units change hands {money turnover} is money-supply use rate {transaction velocity, monetary policy}|. It measures economy expansion.
Of two moneys with same denomination, people hoard higher-valued one and circulate lower-valued one {Gresham's law} {Gresham law} (Thomas Gresham).
People spend a fraction of total disposable income {average propensity to consume} (APC) and save a fraction {average propensity to save} (APS). APC + APS equals one, because people must spend or save income.
People consume a fraction of disposable-income increases {marginal propensity to consume, income} (MPC) and save a fraction {marginal propensity to save, income} (MPS). For people, MPC + MPS equals one, because people must spend or save income.
Governments can adjust tax rates and government spending {fiscal policy}| {fiscal theory} to obtain target GNP and/or control economic cycles.
government revenue
People and businesses receive income from working, spend for personal expenses, and have expectations about economy. Income changes slowly, but spending and expectations can change quickly. Government can control spending using tax policies.
government spending
Government can spend more or less, independently of taxes, because it is the largest and most powerful institution and can increase or decrease debt. See Figure 1.
taxes
Tax decrease with no government-spending change increases demand, because people have more money. See Figure 2.
Tax increase with no government-spending change reduces demand, because people have less money. See Figure 3.
spending
Government-spending decrease with no taxation change decreases government demand. See Figure 4.
Government-spending increase with no taxation change increases government demand. See Figure 5.
spending and taxes
Government-spending decrease with equal tax decrease decreases overall demand somewhat, because government spends all, but tax decrease only fractionally increases private demand. See Figure 6.
Tax increase with government-spending decrease reduces overall demand greatly. See Figure 7.
Tax decrease with government-spending increase increases overall demand greatly. See Figure 8.
Government-spending increase with equal tax increase increases overall demand somewhat, because government spends all, but tax increase only fractionally decreases private demand. See Figure 9.
balanced budget
If government spending equals government revenue, GNP still tends to increase {balanced budget theorem}, because taxation only fractionally reduces private spending, but government spends all.
spending purposes
Government spending allocates resources to public functions, redistributes income, and stabilizes economic fluctuations.
tax effects
Taxation reduces private consumption and saving. Goods taxes keep price high but do not encourage production, because producers do not receive higher price. Fixed percentage taxes, such as sales, property, and other regressive taxes, take more value from lower-income people than from higher-income people. Regressive taxes reduce consumption more than savings. Taxes that assess at higher rates for higher incomes or wealth, such as income taxes and other progressive taxes, take lower percentage of income or wealth from lower-income people. Progressive taxes reduce savings more than consumption.
Outline of Knowledge Database Home Page
Description of Outline of Knowledge Database
Date Modified: 2022.0225