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Economy, Government and the Economy

political elections, Federal Reserve System, central banking system, contagious diseases, flammable material

Although the market system in the United States relies on private ownership and decentralized decision-making by households and privately owned businesses, the government does perform important economic functions. The government passes and enforces laws that protect the property rights of individuals and businesses. It restricts economic activities that are considered unfair or socially unacceptable.

In addition, government programs regulate safety in products and in the workplace, provide national defense, and provide public assistance to some members of society coping with economic hardship. There are some products that must be provided to households and firms by the government because they cannot be produced profitably by private firms. For example, the government funds the construction of interstate highways, and operates vaccination programs to maintain public health. Local governments operate public elementary and secondary schools to ensure that as many children as possible will receive an education, even when their parents are unable to afford private schools.

Other kinds of goods and services (such as health care and higher education) are produced and consumed in private markets, but the government attempts to increase the amount of these products available in the economy. For yet other goods and services, the government acts to decrease the amount produced and consumed; these include alcohol, tobacco, and products that create high levels of pollution. These special cases where markets fail to produce the right amount of certain goods and services mean that the government has a large and important role to play in adjusting some production patterns in the U.S. economy. But economists and other analysts have also found special reasons why government policies and programs often fail, too.

At the most basic level, the government makes it possible for markets to function more efficiently by clearly defining and enforcing people’s property or ownership rights to resources and by providing a stable currency and a central banking system (the Federal Reserve System in the U.S. economy). Even these basic functions require a wide range of government programs and employees. For example, the government maintains offices for recording deeds to property, courts to interpret contracts and resolve disputes over property rights, and police and other law enforcement agencies to prevent or punish theft and fraud. The Treasury Department issues currency and coins and handles the government’s revenues and expenditures. And as we have seen, the Federal Reserve System controls the nation’s supply of money and availability of credit. To perform these basic functions, the government must be able to shift resources from private to public uses. It does this mainly through taxes, but also with user fees for some services (such as admission fees to national parks), and by borrowing money when it issues government bonds.

In the U.S. economy, private markets are generally used to allocate basic products such as food, housing, and clothing. Most economists—and most Americans—widely accept that competitive markets perform these functions most efficiently. One role of government is to maintain competition in these markets so that they will continue to operate efficiently. In other areas, however, markets are not allowed to operate because other considerations have been deemed more important than economic efficiency. In these cases, the government has declared certain practices illegal. For example, in the United States people are not free to buy and sell votes in political elections. Instead, the political system is based on the democratic rule of “one person, one vote.” It is also illegal to buy and sell many kinds of drugs. After the Civil War (1861-1865) the Constitution was amended to make slavery illegal, resulting in a major change in the structure of U.S. society and the economy.

In other cases, the government allows private markets to operate, but regulates them. For example, the government makes laws and regulations concerning product safety. Some of these laws and regulations prohibit the use of highly flammable material in the manufacture of children’s clothing. Other regulations call for government inspection of food products, and still others require extensive government review and approval of potential prescription drugs.

In still other situations, the government determines that private markets result in too much production and consumption of some goods, such as alcohol, tobacco, and products that contribute to environmental pollution. The government is also concerned when markets provide too little of other products, such as vaccinations that prevent contagious diseases. The government can use its spending and taxing authority to change the level of production and consumption of these products, for example, by subsidizing vaccinations.

Even the staunchest supporters of private markets have recognized a role for the government to provide a safety net of support for U.S. citizens. This support includes providing income, housing, food, and medicine for those who cannot provide a basic standard of living for themselves or their families.

Because the federal government has become such a large part of the U.S. economy over the past century, it sometimes tries to reduce levels of unemployment or inflation by changing its overall level of spending and taxes. This is done with an eye to the monetary policies carried out by the Federal Reserve System, which also have an effect on the national rates of inflation, unemployment, and economic growth. The Federal Reserve System itself is chartered by federal legislation, and the president of the United States appoints board members of the Federal Reserve, with the approval of the U.S. Senate. However, the private banks that belong to the system own the Federal Reserve, and its policy and operational decisions are made independently of Congress and the president.

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